Sovereign Hedging: Time For India?

Given the debt burden of the government and persistent volatility in oil prices, and a shift in the oil price target can shift the fiscal balance to unhealthy levels, it is in the interests of India to give due attention to oil price hedging in our policy discourse, opines.

- Mrugank Paranjape

Like individuals and corporate entities hedging their commodity price risk, instances of sovereigns governments too using public funds to shield their commodity price volatility, are not uncommon. Indeed, if public funds can be managed by nations, why not public risks? It becomes all the more important for sovereigns whose balance sheets are either directly dependent on commodity trade or are managed by large public sector entities. After all, the adverse effects of not managing the risks fall squarely on the public, sooner or later.

This thought seems to have led policymakers in countries such as Mexico to make commodity price hedging an integral part of their public policy. The Central American country, which is an important exporter of crude oil, undertakes a hedging programme every year to lock in the price it receives for its oil exports. As per media reports, in 2016, Mexico had hedged its oil exports of 2017, guaranteeing an average price of $42 per barrel during the year. In fact, the Government of Mexico had reportedly increased the amount of crude oil exports it will hedge in 2017 by about 18 per cent compared to 2016. In 2015, the government said it had paid over $1 billion to hedge 212 million barrels of oil exports at an average price of $49 per barrel to support the 2016 budget.

It is easy to see why Mexicans choose to hedge their oil price realisation when oil exports contribute to around 40 percent of the country’s total government revenues, estimated at around $400 billion. This policy of sovereign risk management idea was even appreciated by the Futures and Options World (FOW), which way back in 2009 hailed this policy as being ‘the best use of derivatives’.