Fuel Hedging – Don’t get caught out!
The COVID pandemic has clearly demonstrated to us the folly of hoping for the best and assuming everything will be alright. Many things that two years ago we took for granted have been swept away by health concerns, government restrictions and the knock-on effects to our societies. We take out a wide variety of insurance policies as individuals. We insure our property and possessions, our health, our holidays, our jobs, our old age, even our pets. So why do businesses not insure more of the risks associated with what they do?
Crude oil is one of the single most important driving forces of the global economy, and price fluctuations have significant effects on economic growth and welfare around the world. Though there are moves away from liquid fossil fuels and towards renewable fuels, the world economy is still largely dependent on diesel and petrol. Oil price shocks, due to exogenous events, began in earnest in the 1970’s and 80’s and are, if anything, becoming more frequent, they send shockwaves through the world markets and threaten businesses across the globe.
Global demand for oil tends to be steady and slow-moving, driven mainly by economic growth and, to an increasing extent, climate legislation. The prospects for future oil supply are more uncertain – not least considering the continuing political instability in exporting countries and uncertainty around the discovery and exploitation of new reserves (e.g. the Rovuma gas field in northern Mozambique). As a result of such uncertainties and black swan events, such as the global COVID pandemic, oil prices will likely undergo further (increasingly) drastic fluctuations in the future. Investors and business managers like stability and visibility. Volatility and wild price fluctuations can be hugely damaging to economies and businesses. These risks can be and need to be addressed!
The crude oil price and oil derivatives such as diesel and HFO are defined by dollar-denominated global benchmarks (e.g. Brent and WTI). In countries with weak and volatile local currencies the issues surrounding volatile fuel prices are often compounded and amplified by exchange rate volatility. South Africa is a good example of this, it’s refineries are old, inefficient and unreliable and are unlikely to be up-graded, this will eventually make the country dependent on imports of refined products which must be paid for in ‘hard’ currency. The ZAR has the unfortunate reputation of being the World’s most volatile currency, and this is not something that looks like changing anytime soon.The ZAR is not alone in being volatile, the majority of African currencies are intrinsically weak. The COVID pandemic has further weakened African economies and caused a very serious USD liquidity crisis. Though Dangote is building a huge refinery in Nigeria, to serve the whole region, the majority of African countries are and will remain dependent on imports of refined fuel products for many years to come. The combination of fuel price volatility and currency weakness creates a challenging environment for African businesses. These issues can be addressed, there are adequate hedging products to protect your business against the uncertainty.
The three most commonly used hedging tools are swaps, futures and options and they all require the establishment of credit lines with the entity executing the trades for them. There are reasons why many companies do not hedge their exposure to fuel price volatility. Fuel hedging has traditionally been the preserve of major trading companies and banks since hedging products entail costs, credit or balance sheet guarantees and posting margin. This has meant that most SMEs and even some larger companies simply cannot participate because they lack the free cash to do this.
But the situation is changing! ICAP Africa’s new business division Africa Direct is putting together a credit and financing package to allow a much wider range of companies to hedge their fuel price exposure and benefit from this risk mitigation. For more information contact info@icapafrica.org