To Hedge Or Not To Hedge

To Hedge Or Not To Hedge

The arbitration proceedings held in the High Court, London  recommended that the Ceylon Petroleum Corporation will indeed have to pay Standard Chartered Bank according to the hedging agreement entered into between them.

The Ceylon Petroleum Corporation earlier  was ordered by the Supreme Court with former Chief Justice Sarath Nanda de Silva passing judgement that the amounts due to the five banks be withheld as the agreements violated the Constitution.   The amount due to Standard Chartered Bank, the lead bank in the hedging consortium, runs to US$ 162 Million, plus interest as ruled by  Hamblen J, of the High Court in London. The Ceylon Petroleum Corporation however has indicated that they would be appealing against this decision in London.

The recent arbitration proceedings and the findings will be just a forerunner to the other four banks invoking similar proceedings to call for their dues which now seem a formality. Whether People’s Bank would proceed with the same vigour is yet to be seen. The other three arbitrations are being held in Singapore as per the individual agreements entered  into between these Banks and the Ceylon Petroleum Corporation. The total amounts due to the Banks could very well be much more than anticipated and the dent it would inflict on the foreign reserves of the country could be closer to 30 percent .

The seeds were sown
The Central Bank Governor Ajith Nivard Cabraal and the former Chairman of Ceylon Petroleum Corporation, Asantha de Mel had as early as January 2007 obtained cabinet approval to use Hedging as a tool to downsize risks of a volatile petroleum market. Though the cabinet approval was obtained, proper financial and accountability procedures were not followed by the Asantha de Mel. So much so that even the Central Bank Governor after an inquiry into the procedures of the banks that extended hedging services distanced himself from the former Chairman of CPC. The irony is that de Mel did not visualise the difference between the Corporation as a separate legal entity to that of Chairman, Petroleum Corporation. He seemingly acted on his own even bypassing his own Board of Directors.

The CPC had agreements with The National Iranian Oil Company, for the procurement of about 2.0 million metric tons of Iranian Light Crude per annum which is renewed annually. Another agreement was in force with The Saudi Arabian Oil Company for the procurement of about 135,000 metric tons of Arabian Light Crude Oil per annum, which is also renewed annually. The Iranian Company extended credit upto 120 days and later further extended  it upto 210 days. It is strange that the CPC as recently as a month ago ventured to purchase refined petrol from another company in the Emirates under questionable tender procedure which resulted in as many as 450 petrol pumps going defective and over a 1000 vehicles being damaged. That the CPC has not learnt from past mistakes is more than evident. Perhaps, the colossal blunder in the form of the hedging deal  where no one was held accountable is taken as carte blanche for other questionable practices within this organisation.

Presentation to President and Cabinet
It was way back on the 6th of September 2006 that a presentation was made to the President and the Cabinet of Ministers by the Governor of the Central Bank Ajith Nivard Cabraal assisted by two of his officers on the merits of hedging to offset the rising prices of oil. The Cabinet meeting of this day was privy to a power point presentation by the Governor under the caption, “Maintaining Stability in a Volatile Oil Global Market”. The Cabinet wished a study group consisting of officers from the Central Bank, Ministry of Finance and Planning, Ministry of Petroleum, Ministry of Power and Energy and thereafter present a report for a decision.

On the 19th of October 2006, P.B. Jayasundera, Secretary to the Treasury appointed the following to study and present a report:  Y.M.W.B. Weerasekara – Assistant Govenor of the Central Bank, Dr H. N. Thenuwara – Assistant Governor Central Bank, Saliya Rajakaruna – Chief Financial Officer Bank of Ceylon, Kapila Ariyaratne – Head of Corporate and Institutional Banking People’s Bank, Mrs Kanthi Wijeytunge – Additional Secretary, Ministry of Petroleum and Petroleum Resources, Lalith Karunaratne – Deputy General Manager  Finance Ceylon Petroleum Corporation and V.Kanagasabapathy – Financial Management Advisor Ministry of Finance and Planning.

The group submitted their report to Dr P. B. Jayasundera on the 16th of November 2006. The report was comprehensive and the recommendations were as follows,

CPC to hedge purchase of petroleum products, both crude oil and refined products in the international market.
Use zero cost collar as the hedging instrument with the upper band based on market developments.

Commence hedging with smaller quantities for a shorter period and gradually increase the quantity and the duration.
Grant  authority to the CPC to call for quotations for oil hedging, decide on future prices and purchase hedging instruments from reputed banks.

5.  Grant authority to CPC to change the instrument based on the developments in the market.

The group recommended a two tier approach to hedging. The CPC imports around 26 million barrels of crude oil per annum; and the group showed in a table the cost benefits to the CPC if 13 million barrels were hedged with an upper cap and a further 13 million barrels at zero collar cap. But the zero collar cap was with a lower price included.  In this instance the study group had taken the upper cap at US $ 70/= and the Zero collar cap at US $ 60/=. See table.

Fowzie writes to cabinet
Thereafter the Minister for Petroleum and Petroleum Resources A. H. M. Fowzie forwarded a cabinet memorandum  04/2007 dated 18.01. 2007 making recommendations to hedge both crude and refined oil purchases with safeguards included by the group. However in his recommendations  (please see below) the cap in relation to zero collar was not included.

The recommendations were as follows:
1. CPC to hedge petroleum products, both crude and refined in the international market.
2. Use zero cost collar as hedging instrument with the upper bound based on market developments.
3. Commence hedging with smaller quantities for a shorter period and gradually increase the quantity and duration.
4. Grant authority to the CPC to call for quotations for oil hedging, decide on future prices and purchase hedging instruments from reputed banks.
5. Grant authority to the CPC to change instruments based on the developments in the market

Risk Committee appointed
The cabinet accordingly approved the cabinet paper on 24th January 2007. The cabinet also appointed another committee to manage the risks of hedging and the following were tasked.
1. W.B Ganegala, Secretary Ministry of Petroleum (Chairman/ Convenor)
2. Dr R.H.S Samaratunge, Deputy Secretary Treasury,
3. D Widanagam-achchi, Deputy Secretary Treasury,
4. Ashantha de Mel, Chairman CPC
5. Dr P. M. Weerasinghe, Chief Economist, CBSL
6. R. A. A Jayalath, Additional  Director, Int Ops CBSL
7. Lalith Karunaratne, Deputy General Manager Finance, CPC

Whether this committee functioned regularly or not is in question. It was left to two opposition MP’s to write to the Chairman of the Committee on Public Accounts of Parliament to take action to preserve documents pertaining to the hedging deals. Interestingly parliamentarians Vajira Abeywardene and Ravi Karunanayake drew attention to the early history and the seeds from where the hedging idea germinated. In their letter they mentioned letters written by an expert on hedging Upul Arunajith of Concept Development, Canada, to Ajith Nivard Cabraal dated as early as 30th December 2005, letter dated 1st January 2006 by Upul Arunajith again to Ajith Nivard Cabraal, letter dated 5th October 2006 again to the same person mentioned above and letter dated 10 October 2006 by Dr H. N Thenuwara to Upul Arunajith be preserved together with all other documenrtation connected to the hedging lest they be destroyed.

Blame game starts
By now with the prices of oil tumbling the CPC was in trouble. The newspapers and electronic media was awash with the story. The banks were being blamed by the government for not advising the CPC on the risks despite a Risks Committee of the government being in place. The head of Standard Chartered Bank Clive Haswell said that the Bank had received a written undertaking from the CPC that they were fully aware of the risks. The whole blame game had started due to the massive amounts now owed to the banks. Mind you the banks too had hedged against their risks with counterparts overseas (New York Mercantile Exchange NYMEX) which obligations were now being called.  The CPC Board distanced themselves blaming Chairman Ashantha de Mel, an appointee of President Rajapaksa for not informing the Board of Directors of all material facts. In other words the excreta had soiled the fan and no one was responsible.
Into this imbroglio came in news that the Chairman of CPC had benefitted from the Standard Chartered Bank extending free overseas travel to him and his family. This has been dealt with earlier but is taken into account at this stage purely to draw attention to the fact that there existed a close relationship between the former Chairman of the CPC and the Head of the Standard Chartered Bank Clive Haswell.

The country’s foreign reserves are going to take a beating in meeting these payments. The appeal process may delay the call for payment but when the other banks too fall in line, the government will be hard up to come up with a near US $ 500 million or thereabouts to meet the hedging losses. Whether the government will resort to passing the burden to the public by way of taxes or through the increase in prices will be watched keenly. The downside for the public is not only the taxes or increased prices but to watch a government let the perpetrators of this massive charade go scot free like all other acts of corruption highlighted through the media in the public interest. Whether this was an act undertaken in total ignorance or if there was a hidden agenda to enrich one or many would be known only if an impartial inquiry is initiated in a transparent manner. But none of us are holding our breath.

/ News

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