HEDGING PROGRAMMES
Strategy Market Risk
Table 2: Key Risk Indicators For Alternative Strategies No Action ◊
Swaps ◊
Impact on Credit Rating Market Impact Regret
Up-front Costs Funding Liquidity Risk
◊ ◊ ◊ ◊ ◊
Source: NquantX, LLC. * Risk after hedging: ◊ = High
governments should communicate the results in the context of the stated objectives of the hedging programme. A few communication tips for countries engage in hedging programmes are the following:
– Define the benchmark that will be used to measure the effectiveness of the programme
up-front. The benchmark should include the evaluation of the combined physical and hedging position.
– Isolate the hedging decision from the market view and other speculative elements of the
programme. Hedging should not turn into a bet that prices are likely to be higher or lower in the future.
– Do not attribute good hedge results to the ‘skills’ of the decision makers. Those claims will come
to haunt you in periods where the hedges lose money.
– Consider the use of out-of-the-money options as part of any hedging strategy to limit contingent
liabilities and potential regret.
– Set up a crisis communication plan in the event of a hedging loss. Put the loss in the context of
the overall strategy (e.g. stability of production revenues) and the defined benchmark, and then talk about the results of the hedge.
Conclusion In the last decades, energy and commodity
producing countries have not been active price hedgers. However, the status quo is changing as more countries implement sovereign hedging programmes to protect revenues against large price shocks. Given the high volatility of energy and commodity
prices, countries that fail to hedge will be forced to make difficult short-term trade-offs as they face budget shortfalls when prices decline. Countries with a well thought out and executed hedging
90 December 2012
◊ ◊ ◊ ◊ ◊
◊ = Medium
Puts ◊
◊ ◊ ◊ ◊ ◊
◊ = Low
strategy will avoid making decisions in crisis mode such as after an adverse market move. When evaluating hedging strategies, the economic
and political implications need to be carefully balanced. The Achilles’ heel of many hedging programmes is the failure to properly address and
Countries with a well thought out and executed hedging strategy will avoid making decisions in crisis mode ...
manage regret risk. Effective communication and active management of stakeholders expectations should be proactively managed to ensure the long term stability and success of a sovereign revenue hedging programme. •
Carlos Blanco is co-founder and Managing
Director of NQuantX LLC, a financial engineering firm that develops decision-support software
for hedging programs and trading strategies, as well as valuation and risk measurement of energy derivatives, long term contracts and physical assets. He is a faculty member of the
Oxford Princeton Programme, where he heads the Energy Derivatives Pricing, Hedging and
Risk Management Certificate courses (DPH), as well as other courses on energy trading and risk management.
E:
carlos@nquantx.com www.nquantx.com
Footnotes: 1. In addition, there are also structured products and exotic instruments that are often created by combining several basic hedging instruments.
2. See Alaska Department of Revenue (2002), Page 15.
References “Collateral, Cash Flow & Earnings at Risk: Time to update your risk metrics and policies?”. Blanco, C. 2010; WorldPower. “Hedging Oil Revenues.” Alaska Department of Revenue. October 21, 2002. “Mexico’s big gamble on oil pays off” Financial Times. September 7, 2009.
Put Spreads ◊
◊ ◊ ◊ ◊ ◊
Collars ◊
◊ ◊ ◊ ◊ ◊
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