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Pakistan should hedge half of its future oil purchases

December 19, 2014

By: ASAD RIZVI   Published on December 18, 2014

Until now oil prices after hitting USD 107 per barrel in June 2013 have plunged by 45 percent to USD 58 per barrel. It has given enough space and a sigh of relief to Pakistan’s ailing economy, which is solely dependent on foreign borrowed money. The size of oil bill is huge, that easily surpasses USD 14 billion annually or nearly 30 percent of country’s imports. Pakistan, therefore, needs to come up with a firm strategy to insulate itself against future risks by obtaining oil hedge.

Unlike the past, in FY2008-09 in order to save foreign exchange our economic managers took a decision in haste that went unnoticed, as they decided to slash the country’s strategic oil reserves by reducing its oil purchase by almost half. Then oil prices was comfortably averaging below USD 45 per barrel and soon after in next couple of months, oil prices surged sharply, costing the country nearly USD one billion.

Apart from Opec’s last month’s decision to resist a supply cut, banks trading volume has also fallen sharply. Liquidity is definitely a big factor after withdrawal of quantitative easing by the Fed may have kept speculators on sidelines for the moment. A weak global economic condition and shale production are surely a major factor responsible for decline in oil prices. Traders always play a key role in setting the trend. Hence, there is certainly a big threat of bounce back because of physical and speculators demand for oil, which is offered at cheap price. From a historical perspective oil price averaged around USD 20 from 1986 to 2002. In 2003, it surged beyond USD 30 to hit USD 60s by mid-2005 reaching an all-time historic high of USD 147 in July 2008. It has a history of quick bounce back.

Before the current fall occurred, oil has been comfortably hovering above USD 82 for past three years. During this period there has been a dramatic rise in shale oil exploration activity. Since oil prices have plunged sharply, drilling activity is likely to slow down, but production would remain intact, as an immediate cut for the producers may not be feasible. However, from Pakistan’s perspective, this could be another opportunity that should not go waste. We have to learn from Malaysia, Thailand and Indonesia. They were quick to announce end of subsidy. We too have to acquire such skills and act quickly, though Pakistan’s economy is differently placed.

For Pakistan it would be more prudent to obtain maximum oil hedge from international market instead of frequently asking for aid, grants and loans from donor agencies. Without wasting time, the government should make all-out efforts and quickly use its good offices by sending its representatives for asking/taking 3-5 years oil hedge, as it will require extra effort/permission at the highest level to get such a breakthrough. The safest strategy would be to book at least half of our oil requirement. They can buy the remaining part if oil makes a further slide to meet their requirements or buy from spot market.

If Pakistan succeeds in obtaining a hedge at around current price levels, it can comfortably do the budgeting accordingly and will get the protection from future volatility. The downside risk is too little against the upside risk. Even with half the hedge the country will save nearly USD 8-10 billion in next 3-5 years. It will also help in improving the domestic market liquidity condition, as one billion dollar is nearly Rs 100 billion.

Technically, in medium term oil has a strong baseline support around USD 52-58 levels and only break would see a drop extending towards USD 35-40 zones, but there is a risk of correction, upside break of USD 65-70 would see a surge towards USD 80-85 and hence this ideal opportunity should not be missed.

Copyright Business Recorder, 2014

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