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CPC hedging fiasco: The need for new thinking
Three times in a row, the impending disaster in connection with the “quasi” crude oil hedge developed by the commercial banks under review and the subsequent arbitration proceedings initiated by the banks against the CPC were predicted accurately. It is said that in youth and beauty, wisdom is seldom. But a more accurate maxim would be in youth, beauty and arrogance wisdom is seldom. It was the official apathy and arrogance that made this hedging mechanism an outright mess.
Validity of these rulings – the latest being the one in favour of the Deutsche Bank — against the CPC remains a matter of conjecture given what was developed under the pretext of “hedging” by financial institutions operating in the “commercial space” and sold to the CPC a non-financial entity, was an outright flop. The banks lacked the skills to develop hedge strategies, models and the wherewithal to provide a hedge to a major client as the CPC whose activities impact the economic activities and whose monetary exposure is in excess of US$ 2 billion.
CPC officials did not understand the intricacies of what they got into though the banks claim the CPC management understood the inherent risk. How can one expect a non-financial client to understand the risk associated with derivatives and hedging when the officials of these very financial institutions failed to understand the risk associated with the strategies and the models they developed. If they understood the implicit risk associated with these instruments they used, what action was taken to counter these risks. Recent developments in the realm of financial engineering have seen new tools introduced as Credit Default Swaps (CDS) to counter credit risk.
In the dirty business of global energy trade, wars are fought to gain control of oil. Unfortunately though, this seems to be the case even in Sri Lanka when it comes to the energy hedging programme. The commercial banks have had a field day with the CPC and a select few officials. Given concealed agendas, reasonably one cannot expect transparency in the process. The CPC hedging, the arbitration and the subsequent arbitration appeal process at best are one massive can of worms that is engineered to benefit a select few as in the case of the global energy industry.
We got the resources, to counter the ruling of the arbitration judge, provided there is sufficient interest among the policymakers. But what is thus far being demonstrated is pathetic and runs against the national interest as what we hear in the political cocktail circles is there are no losses caused by hedging. The senior minister who uttered these words should limit his comments to a subject he knows best and that happens to be in “culinary arts” and most certainly not “commodity hedging” and hedging! We both belong to the same school in the salubrious climes and had the same training.
The only difference being, I use that training in the national interest and with regrets the senior minister seems to be using the training to mislead the average consumer to gain political mileage even in a national crisis! For the record and his education, the CPC hedging debacle from a global standpoint, is one of the major financial failures running in to over US$ 5 billion when taken the economic and non-economic losses over the years. The missed opportunities are staggering.
The CPC need not pay any money to the bank. I am steadfast and hold my conviction as strong as ever. The CPC can be successful in the arbitration appeal provided there is interest and amenable to new thinking.
The level of thing that got the CPC in to this mess will not help it to get out of the mess. There has to be new thinking and new approach. Above all there has to be a genuine interest at a policymaking level to address this national crisis forthwith.
When the going gets tough, the tough has to get you going!
(The writer is Sri Lankan-born derivative specialist)
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