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India should take this opportunity to hedge it's oil supply

The current oil price war is a once in a generation event. In terms of the COVID caused demand shock and the Saudi-Russian supply shock, it's a once in a lifetime event.

The time to hedge is now. To guarantee low oil prices for India for the coming year (s) and heal our current account deficit.

What is hedging?
A 'hedge' is a financial contract whereby you agree to purchase oil at a pre-determined price. Hedges are used to reduce price risk and they are a popular strategy used by some large oil users (particularly airlines) to ensure that fuel price volatility doesn't affect their plans.
Typically, under the contract, a user will offer to purchase oil at a fixed price at a later date. (say for eg. Jan 2021). The supplier will purchase oil today and will store it for delivery at that later date.

If oil prices are so low, why should we hedge?
Neither Saudi or Russia can afford to engage in this oil price war for too long. Their economies and forex reserves are too intertwined to be able to afford to fight this war for too long. They are going to cave sooner or later.
Furthermore, the main target of the oil price war is the US Shale oil Industry. This industry is a 400 pound gorilla in the oil world which has transformed energy markets and made US a net oil exporter, a feat unimaginable a few years ago. Essentially, clever American entrepreneurs learnt to extract oil from shale rock using advanced technology and caused the largest net increase in production in the shortest span of time. Between 2005 and 2020, the US has MORE THAN TRIPLED it's oil production. However, shale oil requires prices of over 40-50$ a barrel to be economical.
https://in.reuters.com/article/us-global-oil-shale-costs-analysis/few-u-s-shale-firms-can-withstand-prolonged-oil-price-war-idINKBN2130HL
Once the shale producers are destroyed we will once again be at the mercy of OPEC and the Arabs.
Have we seen such an oil price war before?
Yes. In the late 1980s, late 90s and between 2014-2016. Each time Saudi blinked and reduced oil production to shore up prices.
https://www.spglobal.com/en/research-insights/articles/why-saudi-arabia-s-oil-price-war-is-doomed-to-fail-fuel-for-thought
Do countries use hedges to hedge their oil supply?
Sort of. While typical consumers who hedge are usually airlines. Suppliers often hedge as well. Mexico (which is a large oil exporter) annually hedges almost all of it's production in what is called a 'Hacienda Hedge'. This year's hedge has saved the Mexican Economy
https://oilprice.com/Energy/Crude-Oil/Mexicos-Oil-Hedge-Just-Saved-Its-Economy.html

When is it a right time to hedge?
This one is tricky. The ideal time to hedge is when oil prices are near their bottom.
Just like there is talk of 'flattening the curve' with Covid, for traded commodities the best time to hedge is the 'bottom of the curve'
This chart shows the price of 1 barrel of Brent Crude oil up to 80 months into the future. That's almost 5 years!
https://www.erce.energy/graph/brent-futures-curve
The price of oil 5 years from now is shown to be currently at 54 dollars a barrel. That is much lower than what we were paying just last year in September when Saudi oil facilities were attacked.
What are the risks?
The risks are mainly three fold.

  1. Hedges work essentially by storing cheap oil today and having it delivered at a later date. As India is a large oil importer, any attempt to hedge oil consumption will immediately cause oil prices to rise. Therefore, while it may not be possible to hedge all of India's oil consumption, it is certainly possible to hedge a significant part of it.
  2. India will not be able to take advantage of lower oil prices if prices CONTINUE to stay low. However, past history shows this is unlikely.
  3. Indian Oil PSUs also export large amounts of their products overseas due to surplus refining capacity. However, if oil prices continue to be low, the relative cost of their products increases and export become uneconomical.
submitted by redindian_92 to india [link] [comments]

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