Sunday, 25 January 2015

Time lags and hedges

Unable to find anything to criticise about Malta's economic performance the PN has launched its flavour of the month criticism based on fuel pump prices which have not yet reflected the sharp drop in the price of crude oil that has been registered internationally over the last 6 months.

This criticism is unfair and unprofessional, for these reasons:

  1. Fuel prices at the pump only follow the crude oil price movements with a time lag even in the absence of any hedging.  Crude oil needs refining and the cost of refining does not go down simply because the price of crude oil has gone down.  On the contrary the cost of refining oil could well go up if the price drop of crude leads to higher consumption and refining bottlenecks. 
  2. The cost of crude oil and the cost of refining are two important but not exclusive ingredients regarding the prices of fuel at the pump.   Energy and energy services are priced in USD and the rate of exchange between the EUR and the USD has dropped 16.5% from the 1.34 as at 1st August 2014 and last Friday's 1.12
  3. Hedging is generally undertaken in order to give stability to prices at the pump.   Stability permits better planning and is more conducive to consumption and investment.    Government has committed since last budget to keep fuel prices stable until March 2015.  Obviously to give such a commitment government has hedged the price at which it procures its supplies. Hedging is not meant to speculate for making a profit/loss but is meant to provide stability.  This stability comes at a cost that when prices fall hedged prices would be higher than spot prices.
Should we stop hedging because for once price movements worked against us?   No absolutely not.   Hedging is important for stability.   And we should be happy that energy prices have dropped as this price drop will be reflected in the prices we hedge for the future.

So criticism that government is cheating anybody by keeping fuel prices steady is unfair and unprofessional.   Nobody has 20/20 advance vision and being wise after the event is a sport any donkey can practice.

Government is not in the business of speculating price movements in energy or foreign exchange.  It is in the business of getting the best deals in the context of stability.  And for this hedging remains an important tool even if for some short period of time it may prove uneconomic.

Crude oil price and EUR USD rate of Exchange since Aug 2014

Look at the price chart of crude oil and USD/EUR exchange rate since 1st August 2014 to date by clicking the above link..

Anybody who can prove that they anticipated that crude oil will drop 53% in 6 months and that the EUR will fall 16% against the dollar has a right to criticise the government hedging policy.  All the rest would be making donkey's wisdom of being wise after the event.

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