Political bickering on hedging: Ironic, isn’t it?

David Darmanin
The price of crude oil has never been so high, not even when adjusted according to inflation. The only record coming closest takes us back to 1864, when, during the Pennsylvania oil boom, barrels of crude were sold at $8.06 each, equivalent to just above $100 in the money of the day.
If not since then, the writing has been on the wall for the current situation has been there for a long time. Although their causes may have not all necessarily led directly to the current situation, many remember the impact of three consecutive energy crises this century: in 1973, in 1979 and 1990. Most decision makers of today have already experienced the effects of an energy crisis at first hand, even on a local level.
But in Malta, oil and its exploding prices have not been treated more seriously than the way any other political football would have been treated.
The saga starts in 1996, when the then Labour government introduced a hedging system for the purchase of crude oil.
Just like the gambling term “to hedge your bets”, hedging is an investment that serves to reduce or cancel risk by purchasing fuel in advance at a fixed price for future delivery, to protect against the shock of anticipated rises in price.
The 1998 snap election that returned PN to power, was soon followed by the then Minister for Economic Services Josef Bonnici’s decision to dismantle the hedging system for oil acquisitions.
Meanwhile, in 1999, the CEO of energy services multinational Halliburton publicly admitted “Peak Oil” during a speech to the London petroleum club.
Peak Oil is the point in time when the maximum rate of global petroleum extraction is reached, after which the rate of production enters terminal decline.
In that speech, Halliburton’s Richard Cheney had said that “by 2010 we will need on the order of an additional 50 million barrels a day.”
Soon after, Labour Party MP Louis Buhagiar had fiercely criticised the government for its decision to revert to the purchase of oil price at spot prices, outlining a calculation that this move would set the country coffers back by a staggering Lm25 million.
But in an equally aggressive tone, a spokesperson for Josef Bonnici quickly released a press statement in reply to Buhagiar’s claims, wherein he bizarrely denied that government had ever cancelled such agreements for oil hedging.
Moreover, the same statement read: “It was under the leadership of the chairman appointed by the previous government that Minister Bonnici, in November 1998, was given the unwise recommendation to renew hedging until the end of the year 2000. This was a dangerous speculation with the Maltese people’s money, in a product whose price is very volatile.”
Volatile indeed. As political attention focused on futile bickering, international prices of oil kept exploding since May 1999.
In September 2000, then leader of the opposition Alfred Sant laid blame on the Maltese government for the sudden increase in oil prices, qualifying his statement by pointing out that had government stuck to hedging agreements, the issue would have never existed.
Reacting to this claim, Bonnici retaliated with a press statement accusing Sant of “trying to make political gain from world events that are unpredictable and that cannot in any way be permanently neutralised.
“Indeed, even had an irresponsible hedging arrangement been entered into two years in advance, this would eventually run out and reality would still have to be faced,” he had said.
“Dr Sant would do well to explain why he allowed Enemalta to enter into such arrangements, who represented the foreign financial institution in Malta, and whether any senior official of the Labour party now works with the local company involved in the hedging arrangements. The illogical manner of the hedging agreements under Labour leaves grave doubts as to the real intention of these hedging arrangements. It should be noted that the foreign financial institution itself had warned that such long term hedging was extremely risky.”
The international backdrop that time was already showing signs of how grave the matter was becoming. Higher than normal demand for heating oil and winter gasoline had depleted already low inventories and prevented the traditional build-up of petrol stocks. As fears that there would be product shortages grew, speculators drove up wholesale gasoline prices across North America.
The September 11 events in 2001 saw the first slight drop in oil price, as many feared travelling, thus slowing the demand for petrol and jet fuel.
While the situation stabilised and oil price was on the rise again, the weeks leading to the invasion of Iraq in 2003 provoked concern about the possibility of a surge in the price of oil. It was in fact this preoccupation that led to an explosion, albeit short and temporary, in the price of oil.
But not the same can be said on when the US economy started recovering, and in May 2004 demand for oil products increased in inverse proportion to inventory supplies. As market speculators noticed this trend, they bid up prices.
Then the Chinese industry kept growing and demand for oil began increasing dramatically, thus causing a consistent increase in oil prices.
Not only Hurricane Katrina in 2005 was classified among the five deadliest, but it has also been the costliest hurricane of all.
The damage it caused extended to the destruction of oilrigs, refineries, pipelines and ports in the Gulf of Mexico. Katrina was held responsible for the immediate loss of more than 25% of US refining capacity, and this reflected badly on prices.
A mere three months after this disaster, the Maltese government introduced a 55% surcharge on electricity usage to compensate for the spike.
This measure was received with severe disparagement as it impinged heavily on cost of living. Its ripple effects were also felt in the lowering profit margins of small business operators.
In January 2006, surcharge rates fell to 47% but only two months later, they shot up to 67.5%.
During that time, the price of oil had hit the $70 per barrel mark. Reacting to this, a local independent board advising Enemalta on fuel procurement had recommended the acquisition of 75 per cent of its requirements by forward buying. On its part, Enemalta endorsed this recommendation and proceeded to readopt the hedging system.
In a press statement, MLP deputy leader Charles Mangion had said the committee’s recommendations were recognition that hedging is a useful technical tool for containing the negative effect of price volatility in the procurement of fuel.
That same month, tight petrol supplies in Canada and in the US contributed to higher, more volatile prices thereof.
The following June saw Air Malta announcing that within a year, its fuel bill shot up from Lm16.5 million to Lm21.6 million. Air Malta chairman Lawrence Zammit had also said that had it not been for hedging, fuel costs would have been even higher, in a considerable way.
In time, the squabbling on the issue calmed down and in September last year, Prime Minister Lawrence Gonzi admitted to sister paper Illum that if he had to go back in time, he “would have ordered enough oil to supply us for five years. We would have avoided the surcharge. We would have been rich. But we’re not prophets.”
When asked about his views on the fact that the PN government had dismantled hedging, in a later interview on Illum this year, Junior Minister Clyde Puli said: “I don’t agree with hedging… or rather, if we have to go for hedging it should be for a shorter period.”
Last July, climbing oil prices forced Finance Minister Tonio Fenech to announce an electricity surcharge increase to 95%, a rate worked out on the cost of fuel oils influenced by the rate Enemalta hedged on at $121.95 between April to June this year.
In recent months, as western economy faced tough challenges which stifled economic growth, demand for oil slowed down. Irrespective of this, the Organisation of Petroleum Exporting Countries decided to keep oil production going at the same rate, thus creating a realistic enough supply to demand ratio for prices to go down closer to the $100 per barrel mark.
Because of hedging, Enemalta is no longer in a position to set electricity surcharge to reflect spot prices of the day, so we’re lumped with the standing 95 per cent. Ironic, isn’t it?

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