WHAT MATTERS MOST: Tell public more about call options
Last Friday, the Barbados National Oil Company Limited (BNOCL) cleared the air with fog.
This view is confirmed in the Editorial of the SUNDAY SUN which stated: “Yet amidst customer concern, a clearer explanation of the arrangements made by BNOC for the purchase of fuels may need to be given, if only to clarify matters for the public, especially since that pricing is a crucial part of the cost of supplying electricity, and given that the BL&P is a utility company regulated by the Fair Trading Commission.”
The fog is created at Clause 7 of the notice which is the basis of this article.
There is no relationship between BNOCL having to raise $30 million for its drilling programme and its call options with financial institutions.
It was stated at Clause 6: “From inception the company financed its capital programme, initially by loans and grants from international lending agencies, and in recent years through joint venture arrangements or internally generated funds.”
There is a terminal charge in BNOCL’s price of energy products which is used to generate the internal funding needed to assist with its capital programme.
It got foggier when it was stated that BNOCL has “the right to purchase an agreed quantity of product at a prearranged price or at the market price, whichever is lower”.
This statement implies that BNOCL is privileged to negotiate a prearranged price and, in the event that the market price is lower, BNOC is able to buy at the lower price. So if BNOCL has the best of both worlds, why is the supplier involved in this agreement?
According to the principle or workings, call options give BNOCL the right to buy an agreed quantity of product at a specific price for a specific time period. However, if the current market price is more than the agreed (strike) price, the call option is said to be in-the-money, that is, the buyer (BNOCL) wins. If the current market price is less than the agreed (strike) price, the call option is out-of-the-money, that is, the buyer (BNOCL) loses.
It is impossible for BNOCL to get financial institutions to negotiate call options and make the comment: “At no time during this hedging process did the company purchase or commit itself to purchase product at a price above the market price.”
The whole purpose of a call option is to take risk around the current market price going above or falling below the agreed (strike) price. BNOCL followed Cabinet’s advice and lost heavily, thus forcing consumers in Barbados to pay higher prices for energy products and electricity, at a time when fuel oil prices are declining.
There is no way that the board of BNOCL would have taken such a major policy decision without consulting with the minister and, by extension, the Cabinet of Barbados. Just over three months ago, Senator Jepter Ince identified hedging as a possible solution to coping with rising oil prices.
Between March and April of this year, oil prices were on the rise and this prompted the public comment from the senator. However, since then, oil prices have fallen. The BNOCL notice indicated that “the retail [pump] price of gasoline and diesel is set by Government based on the purchase invoices of the previous month”.
By mid-May and certainly mid-June, world oil and diesel prices fell and yet local retail prices continued to rise. The international prices stabilized in July and the downward trend resumed in August, yet again local retail prices for gasoline, diesel and electricity were on the rise.
Since the company negotiated call options with financial institutions and not with oil suppliers, it suggests that the financial institutions are the ones that understand risk and have to be paid a premium for undertaking the risk.
In trading risk one side wins and the other side loses.
Now that Government has confirmed that it hedged on oil prices and lost, it needs to fully reveal the nature of the call options which BNOCL has entered into. It is the duty of both the ministers of energy and finance to expose the options’ role in the rising prices of gasoline, diesel and electricity.
The public is hurting from the options!