One for the books

Jamaica hedges against higher oil price

Wall Street is urging developing world governments and large oil importing nations to use financial derivatives to lock in the benefits of last year’s crude price rout.

Jamaica has bought call options contracts from Citigroup that protect the Caribbean island against any unexpected rise in the cost of crude, according to a memo circulated by the bank.
The purchases are the first time Kingston has entered into an oil hedging arrangement and reflect a desire by the government to better manage its exposure to oil prices, which have rallied sharply since hitting $45 a barrel in January.
Jamaica buys around 9m barrels of crude a year, and faced an annual import bill of around $1bn between 2010-2014 when prices averaged above $100 a barrel. International benchmark Brent crude oil was trading around $64 on Tuesday.
Call options, common in commodity markets, give their owners the right to buy something at a given price by a future date. In this case, Jamaica has purchased call options that cover two-thirds of its annual crude imports — or 6m barrels of oil.
The options pay out if the crude price rises above $66 a barrel and cover the next 15 months. The total premium paid by Kingston for the contracts was $20m.
It is rare for oil-consuming nations like Jamaica to hedge their oil exposure. Typically derivatives are used by companies like airlines and some producer countries to manage their price risk.
Mexico’s state-backed oil company Pemex makes headlines once a year when its sovereign hedging programme kicks off. It is the biggest and most opaque annual oil trade which can move markets, as the producer country attempts to protect the oil revenues it relies on for a large share of its national budget.
Oil revenues amounted to 16 per cent of Mexico’s federal government income in the first quarter, down from 30 per cent a year before, and the oil market was buzzing with intrigue last week over two derivatives deals that bore the signature of a large producer guarding against a price collapse.
Citi — which has grown aggressively in commodity markets in recent years as many Wall Street and European rivals have pulled back — has been circulating a pitch book to other countries, including major consumers, after last year’s oil price collapse.
The bank has approached major buyers such as India, which is on course to become the world’s third-largest oil importer, as well as smaller consumers like Senegal and Ethiopia, according to people familiar with the situation.
It has also talked with Opec-member Nigeria — Africa’s largest oil producer — which pumps almost 2m barrels a day.
“The hedge structure is suitable for a sovereign who wishes to increase oil price certainty and avoid inflationary pressure due to a rise in oil prices, while still retaining full participation to a drop in prices,” Citi said in its email.
The bank said Jamaica’s hedging programme was administered through a steering group made up of the Ministry of Finance, the Central Bank, the country’s oil refiner and the Development Bank.