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MANAGING GOVERNMENT MANAGING GOVERNMENT BUDGETS IN AN BUDGETS IN AN

ENVIRONMENT OF ENVIRONMENT OF UNPREDICTABLE OIL PRICESUNPREDICTABLE OIL PRICES

By Rachid AmuiBy Rachid Amui

Energy Analyst, UNCTADEnergy Analyst, UNCTAD

NOT AN OFFICIAL UNCTAD RECORD

22

OVERVIEWOVERVIEW

OIL PRICES AND GOVERNMENT OIL PRICES AND GOVERNMENT BUDGETSBUDGETS

PREDICTABILITY OF OIL PRICESPREDICTABILITY OF OIL PRICES

IMPACTS OF VOLATILE OIL PRICESIMPACTS OF VOLATILE OIL PRICES

LIVING WITH VOLATILITY – RISK LIVING WITH VOLATILITY – RISK MITIGATING STRATEGIESMITIGATING STRATEGIES

THE WAY FORWARDTHE WAY FORWARD

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OIL REVENUE AS % OF OIL REVENUE AS % OF GOVERNMENT REVENUEGOVERNMENT REVENUE

COUNTRYCOUNTRY 1998 – 1999 1998 – 1999 AVE.AVE.

2002 2002 ESTIMATEESTIMATE

NIGERIANIGERIA 75.7%75.7% 83%83%

ANGOLAANGOLA 78.8%78.8% 90%90%

EQUATORIAL EQUATORIAL GUINEAGUINEA

XXXX 61%61%

GABONGABON 49.9%49.9% 60%60%

CAMEROONCAMEROON 23.3%23.3% 20%20%

Source: Catholic Relief Services

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IMPORTERS AND IMPORTERS AND EXPENDITUREEXPENDITURE

GHANA – (USD 333.8m IN 1999 @ $18– USD GHANA – (USD 333.8m IN 1999 @ $18– USD 520.1m IN 2000 @ $30.8)520.1m IN 2000 @ $30.8)COMMON MARKET FOR EASTERN AND COMMON MARKET FOR EASTERN AND SOUTHERN AFRICA – ( USD 9 bn in 2003 – SOUTHERN AFRICA – ( USD 9 bn in 2003 – USD 15 bn IN 2004)USD 15 bn IN 2004)SOUTH AFRICA IMPORTS APPROX SOUTH AFRICA IMPORTS APPROX 270,000/DAY – AT$30 = $3.5bn; AT $50 = $5.0 270,000/DAY – AT$30 = $3.5bn; AT $50 = $5.0 bnbnZAMBIA OIL IMPORTS ABOUT ONE-FIFTH OF ZAMBIA OIL IMPORTS ABOUT ONE-FIFTH OF THE TOTAL IMPORT BILLTHE TOTAL IMPORT BILL

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PREDICTABILITY OF OIL PRICESPREDICTABILITY OF OIL PRICES

He who lives by the crystal ball soon learns to eat ground glass. Edgar R. Fiedler

OIL PRICES ARE UNPREDICTABLE AND RELYING ON FORECASTS IS VERY RISKY.

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Relying on forecasts is not a way to manage risk

The herd instinct among forecasters makes sheep look like independent thinkers.

Edgar R. Fiedler

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RELYING ON FORECASTED « AVERAGE » RETURNS IS HIGH-RISK. YOU NEED TO BE ABLE

TO MANAGE DOWNSWINGS.

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MOVEMENT OF OIL PRICESMOVEMENT OF OIL PRICES

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WHAT DRIVES VOLATILITYWHAT DRIVES VOLATILITY

LACK OF ACCURATE INFORMATION ON LACK OF ACCURATE INFORMATION ON SUPPLY/DEMAND BALANCESUPPLY/DEMAND BALANCELOW SPARE OIL PRODUCTION CAPACITY LOW SPARE OIL PRODUCTION CAPACITY TO MEET STRONG DEMANDTO MEET STRONG DEMANDLOW STOCKS AS AN EFFICIENCY DRIVELOW STOCKS AS AN EFFICIENCY DRIVEGEOPOLITICAL TENSIONSGEOPOLITICAL TENSIONSINSUFFICIENT US REFINING CAPACITYINSUFFICIENT US REFINING CAPACITYFREAK WEATHER FREAK WEATHER TRANSPORTATION PROBLEMSTRANSPORTATION PROBLEMSSPECULATORSSPECULATORSDEMONSTRATIONSDEMONSTRATIONS

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IMPACTSIMPACTS OF HIGHER OIL PRICES OF HIGHER OIL PRICES

HIGHER INFLATION & INTEREST RATESHIGHER INFLATION & INTEREST RATES

BALANCE OF PAYMENTS PROBLEMSBALANCE OF PAYMENTS PROBLEMS

BUDGET PROBLEMSBUDGET PROBLEMS

DECLINE IN ECONOMIC GROWTHDECLINE IN ECONOMIC GROWTH

EXCHANGE RATE APPRECIATIONEXCHANGE RATE APPRECIATION

HIGHER TRANSPORT COSTSHIGHER TRANSPORT COSTS

ECONOMIC INSTABILITY (E.G. DUE TO ECONOMIC INSTABILITY (E.G. DUE TO POWER CUTS)POWER CUTS)

SOCIAL UNRESTSOCIAL UNREST

MACRO

MICRO

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Widespread protests against fuel increases in Zimbabwe

By our correspondent23 June 2001

May 25, 2004   California truckers protest high fuel prices

INDONESIA: Fuel price rises spark protests - Jakarta, 3 October 2000

Protests by tens of thousands of workers and students have rocked Indonesia since the government of President Abdurrahman Wahid and Megawati Sukarnoputri, under pressure from international creditors, decreed an average 12% increase in the price of domestic fuel on October 1.

Nigeria's fuel protests gather support

By our correspondent23 March 2001

For local consumers, fuel prices are often of criticalimportance

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LIVING WITH VOLATILITY: OPTIONS LIVING WITH VOLATILITY: OPTIONS AVAILABLE AVAILABLE

DO NOTHING AND HOPE FOR THE BESTDO NOTHING AND HOPE FOR THE BEST

STABILISATION FUNDS STABILISATION FUNDS

HEDGING USING MARKET BASED HEDGING USING MARKET BASED

INSTRUMENTS – DERIVATIVES INSTRUMENTS – DERIVATIVES

COMMODITY LINKED BONDSCOMMODITY LINKED BONDS

Risks can be managed with foresight. Damage can be controlled with hindsight. Your choice.

Coopers and Lybrand, L.P.Advertisement in The Wall Street Journal,

December 7, 1995

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STABILISATION FUNDSTABILISATION FUND

FUND BUDGET

OIL REVENUES >TARGET LEVEL

TRANSFER TO BUDGET

EXPENDITURE

NON OIL REVENUES+

OIL REVENUES

BALANCED

14

HEDGING CONTRACTSHEDGING CONTRACTS

HEDGING PRINCIPLE IS GOVERNED HEDGING PRINCIPLE IS GOVERNED BY SIMPLE FORMULA: BY SIMPLE FORMULA:

GAINS/LOSSES IN PHYSICAL MARKET GAINS/LOSSES IN PHYSICAL MARKET + GAINS/LOSSES IN FINANCIAL + GAINS/LOSSES IN FINANCIAL MARKET = PRICE OBJECTIVEMARKET = PRICE OBJECTIVE

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CONTRACT TYPES:CONTRACT TYPES:OPTIONSOPTIONS

OPTIONS: AGREEMENT GIVES OPTIONS: AGREEMENT GIVES HOLDER THE RIGHT TO BUY OR SELL HOLDER THE RIGHT TO BUY OR SELL AN UNDERLYING ASSET – CALL/PUTAN UNDERLYING ASSET – CALL/PUT

SIMILAR TO INSURANCESIMILAR TO INSURANCE

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CONTRACT TYPES (cont’d)CONTRACT TYPES (cont’d)

FUTURES: STANDARDIZED CONTRACT FUTURES: STANDARDIZED CONTRACT ALLOWING HOLDER, BUYER OR SELLER, TO ALLOWING HOLDER, BUYER OR SELLER, TO ACCEPT OR DELIVER A GIVEN QUANTITY OF ACCEPT OR DELIVER A GIVEN QUANTITY OF ASSET AT A SPECIFIED PLACE, PRICE AND ASSET AT A SPECIFIED PLACE, PRICE AND TIME IN THE FUTURETIME IN THE FUTURE

DEPOSIT OF GOOD FAITH REQUIRED (5-DEPOSIT OF GOOD FAITH REQUIRED (5-10%)10%)

MARGIN CALLSMARGIN CALLS

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SWAPSSWAPSEXCHANGE OF CASH FLOW AT REGULAR EXCHANGE OF CASH FLOW AT REGULAR INTERVALS TO ANOTHER PARTY OVER INTERVALS TO ANOTHER PARTY OVER PREDERTIMINED TIME PERIODPREDERTIMINED TIME PERIOD

PRODUCING COUNTRY

IMPORTINGCOUNTRY

SPOT MARKET

PAYS <$40

PAYS >$40

SPOT PRICE SPOT PRICE

COUNTRY A END USERSFINANCIAL

INSTITUTION

RECEIVES DIFFERENCE RECEIVES MKT. PRICE

SELLS CRUDE AT MKT. PRICEPAYS DIFFERENCE TO A

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COMMODITY BONDSCOMMODITY BONDS

USEFUL AS DEBT SERVICING USEFUL AS DEBT SERVICING INSTRUMENT – ATTRACTIVE TO INSTRUMENT – ATTRACTIVE TO BUDGET PLANNERSBUDGET PLANNERS

FORWARD TYPE BONDSFORWARD TYPE BONDS

OPTION TYPE BONDSOPTION TYPE BONDS

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RISKS IN USING FINANCIAL RISKS IN USING FINANCIAL INSTRUMENTSINSTRUMENTS

ARISE WHEN THERE IS NO CONTROLARISE WHEN THERE IS NO CONTROLDIRECTION OF PRICES ARE GROSSLY DIRECTION OF PRICES ARE GROSSLY MISJUDGED AND CASH CALLS – FUTURESMISJUDGED AND CASH CALLS – FUTURESFORGO EXTRA INCOME FORGO EXTRA INCOME EXCHANGE TRADED PRODUCTS DO NOT EXCHANGE TRADED PRODUCTS DO NOT NECESSARILY CORRESPOND TO HEDGER’S NECESSARILY CORRESPOND TO HEDGER’S ASSETASSETBASIS RISK – GOOD PRICE CORRELATION BASIS RISK – GOOD PRICE CORRELATION IMPORTANT TO MINIMISE BASIS RISKIMPORTANT TO MINIMISE BASIS RISKPOOR UNDERSTANDING OF INSTRUMENTSPOOR UNDERSTANDING OF INSTRUMENTS

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ADVANTAGES OF RISK ADVANTAGES OF RISK MANAGEMENTMANAGEMENT

ABLE TO EXCEUTE BUDGET PLABLE TO EXCEUTE BUDGET PLAANS NS WITHOUT RECOURSE TO ADDITIONAL WITHOUT RECOURSE TO ADDITIONAL FUNDINGFUNDINGEXPORTERS HAVE AN OPPORTUNITY EXPORTERS HAVE AN OPPORTUNITY OF OF A STEADY INCOME A STEADY INCOME BUT FORGO BUT FORGO EXTRA INCOME WHEN PRICES ARE EXTRA INCOME WHEN PRICES ARE HIGHHIGHMACROECONOMY IS GENERALLY MACROECONOMY IS GENERALLY UNAFFCETEDUNAFFCETED

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IMPLEMENTING THE USE OF IMPLEMENTING THE USE OF FINANCIAL INSTRUMENTSFINANCIAL INSTRUMENTS

MUST BE DONE WHEN UNIVERSALLY MUST BE DONE WHEN UNIVERSALLY ACCEPTEACCEPTEDDTIMING IMPORTANT – HIGH TIMING IMPORTANT – HIGH VOLATILITY GOOD FOR PRODUCERVOLATILITY GOOD FOR PRODUCERADAPT TO THE SKILLS AND LEVEL OF ADAPT TO THE SKILLS AND LEVEL OF UNDERSTANDING PRESENT IN UNDERSTANDING PRESENT IN COUNTRYCOUNTRYPLAN FOR POSSSIBLE SCENARIOSPLAN FOR POSSSIBLE SCENARIOSBE TRANSPARENTBE TRANSPARENT

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THE WAY FORWARD THE WAY FORWARD MAKE DEBT SERVICING BE MAKE DEBT SERVICING BE DEPENDENT ON COMMODITY PRICESDEPENDENT ON COMMODITY PRICES

USE FINANCIAL INSTRUMENTS TO USE FINANCIAL INSTRUMENTS TO SHIFT RISKSHIFT RISK

STABILISATION FUNDSSTABILISATION FUNDS ARE DIFFICULT TO ARE DIFFICULT TO MANAGE BUT CAN MANAGE BUT CAN WORK.WORK.

2323

It’s never easy… To quote from a presenter at one of our African Oil&Gas Trade and Finance Conferences “It was the morning after we started bombing I., world oil prices had dropped $10 per barrel overnight, the B. Administration announced that it would start a sale of oil…..The Secretary of Energy had convened a meeting with all his assistant secretaries…. He observed with the group that he had been cornered by John S., the President’s chief of staff… Why, he asked, didn’t the Energy Department sell in the futures markets when prices were high so we could have gotten much more….

The Secretary’s question: “What was he talking about?” A 10 minute discussion ensured in which every assistant secretary had his or her chance to explain to the Secretary, and it became quickly clear that not a single one of them understood the question either.

I suggested my Director that we answered the Secretary’s question. He whispered back “Bob, I don’t believe we can provide anything these people can use.” Later, I suggested we send a short paper to the Secretary. My boss responded “Don’t worry about it: no one will be thinking about this by tomorrow.” Unfortunately, he was exactly right.”

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LAST WORDLAST WORD

« THE BIGGEST POLITICAL CHALLENGE « THE BIGGEST POLITICAL CHALLENGE IS THE WIDESPREAD LACK OF IS THE WIDESPREAD LACK OF

UNDERSTANDING OF THE COSTS OF UNDERSTANDING OF THE COSTS OF DOING NOTHING, AND THE LACK OF DOING NOTHING, AND THE LACK OF

KNOWLEDGE AMONGST POLICY KNOWLEDGE AMONGST POLICY MAKERS ABOUT THE MERITS OF MAKERS ABOUT THE MERITS OF

APPROPRIATE POLICY REMEDIES »APPROPRIATE POLICY REMEDIES »

RANDALL DODD (DIRECTOR – FINANCIAL POLICY RANDALL DODD (DIRECTOR – FINANCIAL POLICY FORUM 21 SEPT 2004)FORUM 21 SEPT 2004)