Zero-cost Collars?
Q
http://www.adaderana.lk/opinion.php?nid=2228
Beyond Crude Oil Hedging
October 18, 2011
For most Sri Lankans the 3 part article on âCPC Crude Oil Hedgingâ on this column became interesting and important when a British Supreme Court ordered Sri Lankan Government owned Ceylon Petroleum Corporation (CPC) to pay US $ 168 Million plus interest to Standard Chartered Bank to cover the outstanding balances on Crude Oil Hedging contracts. The readers of Ada Derana webpage were well informed of this issue through very detailed articles written by me, and it was raed by many all over the world. This was evident with remarks made by Dr. Harsha De Silva of UNP quoting me, at a Political Debate on âJanahandaâ political program on TNL Television on CPC. Citi Bank and Douche Bank will also seek a Supreme Court judgment in order to recover their respective outstanding amounts in the future. The Hedging was done wrong and this mistake has made a huge loss for CPC and Sri Lanka. Now it is time to see, the possibilities of avoiding payment to these foreign Banks within a legal framework.
The CPC was promoted with the idea of hedging much earlier than Mr. Asantha De Mel assumed duties as Chairman. However Mr. De Melâs little knowledge of Spot Foreign Exchange Margin Trading made it easier for him to make decisions on this new project. It was common knowledge that if anything goes wrong by trying to something new at CPC that it would cost the Chairman his seat and when the hedging went bad as expected, it cost Mr. De Mel his position. However most of the decision making on the method of hedging was done by the Central Bank of Sri Lanka (CBSL) and with all due respects our policymakers had no idea how to Hedge Crude Oil. They were text book economists and by the time we executed our Hedge the Crude Oil market had changed substantially. It is important to scrutinize the Cabinet paper which the CBSL forwarded for cabinet approval to execute the Hedge with these banks on behalf of CPC. Further we have to look if this cabinet paper instructed the Banks to hedge at precise price levels and use hedging method of âZero Cost Collarâ. Both CPC and CBSL wanted us to Hedge using the above method but they never instructed us to execute at any specific price. Never the less we refused to execute such a Hedge seeing the danger of the losses this could make in the event of market falling. We represented âRosenthal Collins Group,â which was at that time ranked No 21 among the largest Brokerage companies in the World, through âCytrade Financial LLC, Chicagoâ which was an Introducing Broker (IB).
It is one of the most important responsibilities of the Commodity Trading Advisor (CTA) to advice the Client of impending dangers of such a Hedging Method, and the team of CTA s from Cytrade Financial which included me, strongly advised CPC to avoid âZero Cost Collarâ style Hedging and further we refused to do so. Even if we wanted to execute such a deal our Brokerage Firm would not accept it due to the unlimited risk involved in the deal. But these Banks who are in a legal battle to get paid by CPC, carelessly, fraudulently accepted this request by the CBSL and the CPC and executed it outside the jurisdiction of the National Futures Association (NFA) of USA and Financial Services Authority (FSA) of UK. NFA and FSA have very clear guidelines to protect the Client. If we could prove, even with great shame, that when the CBSL gave instructions to execute the Hedge, the CBSL had no idea of the risks involved in such a Hedge, these Banks will have to completely forget about all the claims that they have leveled against Sri Lanka.
I hope that Sri Lankan legal team who handles this case would look not only at the defects in the contracts but also at the unethical execution of this Hedge which involves public funds of a small country. The American team of CTA s who were down in Colombo in December 2006 are ready to testify in UK or any other place that, CBSL had no prior experience nor local experts on the industry and one of the main reasons why they entrusted the Banks to execute the Hedge was due to the utmost trust CBSL had on these Banks. I am sure it is only the CPC in the whole world who would have executed such a dangerous and foolish Hedging Contract at that time. It is extremely difficult to believe that these three Banks which has a huge international presence and vast exposure to volatile Commodity markets executed this contract even if it was requested by the CPC, CBSL or by anyone else. There is clear foul play written all over this entire issue. For me being in the industry for a long time, it looks like âThe Banks Knew That the Price of Crude Oil would Fall.â They did not really buy or sell any real contracts but waited until such time Crude Oil prices crash, which was inevitable and let CPC make huge losses. Our loss will be the profit of the Bank. Many people often talk about Bucket Shop operations and they really donât have any idea and this is a classic example for Bucketing. I never knew the exact price levels of the execution and when I was informed by Derana, it was very clear that this Hedge was executed to Loose but not to Profit. Therefore we have to be united as Sri Lankans leaving all partisan rivalries and be supportive to the authorities to fight against these multinational organizations who exploit underdeveloped nations. The mistakes and frauds if any, by Sri Lankans who were involved in CPC Hedging Deal should be investigated. It is impossible for a few Multinational Banks to draw a Country in to a fraudulent contract without help within. Therefore the government should immediately look in to possibilities of some responsible Sri Lankan officials misleading the entire cabinet, influenced by large kick - backs by these Banks.
For Sri Lankans the word âHedgingâ is an unpleasant and fearful one. Hedging is not at all a bad instrument especially it is a must for an Agricultural Economy such as Sri Lanka. Unfortunately largest Hedge we ever executed was an expensive disappointing one. We as a nation will have to change our perception of Hedging without further delay. Wild fluctuations in Global Crude Oil prices are here to stay. The Government had taken the blows by subsidizing petroleum products but might not be able to continue forever. Policymakers can neither banish big Oil Price swings nor reasonably hope Sri Lanka would not depend on imported Oil in the foreseeable future.
Hedging is something if executed right, could help stabilize the energy market resulting in countryâs economic resilience and minimize the geo-political complications of this new and challenging time.
UQ
