Thursday, 7 September 2000

Passive gambling

The Times of Malta

Passive gambling

Minister Josef Bonnici article `Slipper gambling` (The Times 7th September 2000) is a piece of commercial non-sense and political dishonesty.

Let`s start with the commercial non-sense first. Minister Bonnici asks if the net gain of US$ 1.7 from the two hedging agreements made by a Labour administration to cover the period ended in December 1999 was worth the risk involved and does it make sense to put so much at risk whilst attempting to beat the oil market this way`

The fact the` Minister is making this question` demonstrates that he commands` a very cloudy understanding of risk management in general and hedging agreements in particular.

Such tools are not meant for speculation to earn or lose money through guessing or missing the future price of oil.` Their efficacy cannot be measured purely by the amount of money gained` or lost versus a no-hedge position. These are risk management techniques where a perceived a risk is addressed` either by a conscious decision to run it or by applying risk management tools , in the particular case in question by entering into hedging agreements.

So contrary to what the Minister asserts, purposely or through misinformation, in the face of an uncertain future (and it is uncertain to all of us even to experts who are often better in explaining why their` predictions went wrong rather than in making correct predictions ) a decision to hedge is taking less risk than a decision not to hedge. The former is crystallising one`s costs and buying peace of mind at the expense of losing potential gains if prices fall below the hedge price. The latter is throwing yourself completely at the mercy of the markets and you just take it as it comes without limits to your exposure.` This is passive gambling. But it is gambling, and how!` Gambling which is avoided by all serious international companies to whom the price of energy is an important component of their costs e.g. airlines.

Let` consider` the case of Enemalta now.` For its domestic operations` i.e. excluding bunkering and aviation fuel,` Enemalta sells its products ( electricity, fuel and gas) in Maltese Liri at fixed prices controlled by government. In so doing it runs` inherent risks related both to the price of oil as well to the value of the US$ in which such oil is priced.` These input costs tend to vary substantially and from time to time, and` whoever is responsible for running Enemalta has to take a decision as to whether to hedge or to run the market risk.`

There exists no magic formula applicable to all circumstances and it very much becomes a question of managing risks. This` has become a specialisation of its own and of which apparently the responsible Minister has very poor opinion.` Normally one would be wise to hedge the input costs if the hedged priced allows reasonable profit margin from the fixed price of sale. However when the price of oil is high and one takes a view that the price is likely to fall then such hedging is avoided or only entered into for short term periods. This is the situation at the moment with the price of oil hovering between thirty and thirty five dollars. Per contra when the price is at a low level and the prospect is for an increase in price, one is more inclined to hedge for long term period to take maximum benefit of the then current low prices on the market.

The Minister describes as` mad game a request made to him in November 1998 to hedge oil prices for the year 2000 purely because Enemalta was losing its pants on the then outstanding hedging agreements. No Minister,` this is neither a mad game nor was Enemalta losing its pants.` It is a very sensible risk management tool. The lower the price of oil goes the more reason to hedge long-term to eliminate the risk of a price recovery. And Enemalta was not losing its pants. Enemalta was enjoying the peace of mind bought through the hedging agreement which permitted your government to reduce electricity rates after the election without causing havoc to Enemalta`s finances.

Which brings me to the political dishonesty. It is dishonest to say that Dr Sant consciously misled the Maltese public prior to last election when he stated that a re-elected Labour government would reduce electricity and water if the price of oil declined.` Labour promised to reduced the price of water and electricity because by August 1998 the price of oil had declined substantially below what it was when the increased tariffs when calculated a year before. And to ensure that the reduction in tariffs was made on a sustainable reduced cost base` a sensible risk management tool was applied through the` _ hedging agreement.` This is not gambling Minister. This is serious planning and sensible risk management.

Through his passive gambling the Minister in refusing Enemalta`s sensible suggestion to extend the hedge to cover the year 2000 to lock in on the falling oil price decided to play the passive gambling game.` The fact that for the first six months of this year the difference in cost of domestic consumption is just Lm2.3 million is little consolation.` What matters is what the difference is going to be in the last six months of this year when in the same period last year we were covered by the hedge protecting us from rising prices and this year we have noting to protect us from super high prices.

On present estimates I would guess that Enemalta is probably losing about Lm2 ` Lm3 million per month so the whole bill for the year thanks to` Minister Bonnici`s passive gambling could amount to between Lm 14 million and Lm20 million.` An impressive second prize to the first prize gained by the Minister of Finance last year in throwing away some Lm50 million liri from the sale of Mid-Med Bank.

There seem to be no end to the passive gambling mentality.` In promoting the US$ bonds being launched by Bank of Valletta a prominent local stockbroker has sent me promotional literature wherein he states `we feel the US Dollar is likely to maintain its value versus the Maltese Lira over a ten year horizon`. A further classic case of misguided passive gambling which the Authorities must not allow. Or perhaps amongst us we have an `expert` who could see ten years ahead.

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