http://www.britannica.com/EBchecked/topic/259286/hedging

hedgingeconomics Main

method of reducing the risk of loss caused by price fluctuation. It consists of the purchase or sale of equal quantities of the same or very similar commodities, approximately simultaneously, in two different markets with the expectation that a future change in price in one market will be offset by an opposite change in the other market.

http://sundaytimes.lk/081130/FinancialTimes/ft314.html

The Sunday Times Sunday November 30, 2008

Oil hedging crisis? Any investment not backed by collaterals is sheer gambling

On June25, 2006, The Sunday Times FT ran an article headlined Lankan offers to stabilize oil prices, wherein a consultant stated that oil could have been capped around $40.00 /barrel compared to $ 70-72 /barrel , reigning at the time of the article, by using a combination of derivatives such as hedging, swaps and futures options. However through sheer curiosity I wrote a letter , which was published on 9th July 2006 , explaining inter alia -that the consultants proposals were irrational & misleading as option- contracts have a time period and premium factor thus could not be capped indefinitely. Also the proposal doesnt convey the associated risk factors the government would have been exposed to , had the oil prices dwindled or remained around the $ 40 mark

On Nov 9, 2008 The Sunday Times exposed the current status of CPC oil-hedging contracts with foreign banks in Sri Lanka. The banks claim that CPC was made aware fully of the risk factors which imply that the CPC had knowledge that it would lose millions of dollars (at least $300 million in this case) if oil touched around $70 per barrel, which was prevailing 18 months ago. Hence, did the CPC concept paper disclose this risk-exposure of the government, in the event oil prices reverted to $70/barrel or so, that prevailed few months ago, which was a high probability?

We are living in an information age and if you link to Google-Web Browser, you would encounter numerous authoritative articles, confirming that nearly 60% of oil traded was speculator driven. Anybody could speculate on 1000 barrels valued at $67000 by merely depositing $ 3375, (20%) either on a call option or put option and thereafter, if the price fluctuates on the opposite direction, up to a maximum of 20% , the position would get

automatically triggered, limiting the loss to $ 3375, with no collaterals to fall back. In this gambling plan, the balance 80% is leveraged-funds, furnished by Hugh-Speculator Funds & Investment Banks which commands trillions of dollars, and who are the ultimate beneficiaries. As the bookmakers never go bankrupt, even the combined -colossal sovereign wealth funds of OPEC would not be able to intervene, once the volatility is set in motion. OPECs only option is to curtail production, anticipating that the price would prop-up through fundamentals of Supply/Demand, although it is a forlorn hope in the foreseeable future.

With nations taken as hostage by these speculators the regulatory authorities have lobbied to increase the down- payment on oil futures contract , to 50 % or so instead of 20%, as this would mitigate the wild volatility, by restricting players to genuine buyers, which would be immensely beneficial to global trade and domestic monetary equilibrium of countries.

It should be emphasized that there is no fool proof technique of profiting from hedging or option trading, no matter what exotic jargon consultants/brokers may use such as zero cost collar hedging strategy, etc. Above all, to claim to be an expert in hedging is blissful ignorance particularly in a field even the mighty pension-funds and hedge funds had gone bust. In hindsight, we have a case where the captain of the Titanic blames the iceberg .

A good example is how Bank of Ceylon deals with its customers when negotiating a L/C particularly denominated in yen. With constant volatility of the yen, the bank would instantly cover its position and pass the best spot-rate to the client ensuring transparency and customer satisfaction. This is because the rules and regulations, (tested over a long period of time) are well defined and clearly in place, so that the dealers know their responsibilities towards the client as well as the bank, preventing any exposure to losses, consequent to volatility.

As a case study, the Port Authority has nearly $1 billion development loans from the Japanese government where the principle and interest are payable annually upto year 2035. It is common knowledge that the Yen had moved from $/y 250 to $/y 97 over the ears 1990-2008. During my tenure of service upto mid 2004, there had been many instances where the so called experts have suggested to hedge the yen against port authority Dollar Revenues. However in-depth studies of these proposals revealed that the huge up front premium factor for hedging the currency, would negate any financial benefit to the institute.

There is nothing novel in what I have stated and in my experience, officials in authoritative places , whether Treasury, Central Bank, Ministries, Board Members or even Corporate Executives, are extremely conversant with the risk factors of speculation. Hence these institutes are well insulated from consultants/experts, even though dismayed by the CPC episode. No wonder between 2002-2006 , the Sri Lankan expert from Canada had a frustrating experience in selling the instruments having met influential ministers as

quoted in The Sunday Times of 25th June 2006. Further the articles that appeared in your paper had critically analyzed this fiasco in-detail hence there is nothing more to amplify. The $ 300 million that is earmarked for vaporization is awesome to comprehend, as the new breakwater of the port could be built, without donor funds. Finally, as an avid reader of your column may I extend a word of appreciation to The Sunday Times FT editor for enlightening the readers with his incisive journalistic skills.

Anil Wirasinghe, (Rtd. Director Finance SLPA) Email anil_wirasinghe@yahoo.co.uk

http://www.lankabusinessonline.com/fullstory.php?nid=1933997040

Mon, 09 March 2009 14:03:04 National Hedge 12 Jul, 2007 13:52:50

Sri Lanka petro chief calls for national hedging policyJuly 12, 2007 (LBO) The head of Sri Lanka's state petroleum utility has called for a national policy on oil hedging for the longer term as international bankers were due to present a fresh proposal on short-term hedging.Earlier this year Ceylon Petroleum Corporation (CPC) dipped its fingers into gas-oil (diesel) options engaging in an options strategy called 'zero-cost collar' which gave a limited two-dollar upside protection for 300,000 barrels.

Derivative Games

In a zero cost collar, CPC sold a put option to fund a call option, avoiding the need to pay a premium giving protection from 70 to 72 dollars.

The cost of plain vanilla call options was high but it gave unlimited upside protection.

"At the time the premium of a call option was five dollars," CPC Chairman Ashantha de Mel said.

"To hedge 15 million barrels I would have had to spend 75 million dollars. This is not a decision the chairman of CPC or the minister of petroleum could take on his own."

He says if CPC had bought a call option for 5 dollars at the time diesel was 70 dollars a barrel he would have saved 13 dollars.

De Mel says he is calling the central bank and the treasury for a meeting to discuss the possibility of hedging greater volumes of petroleum products and using other derivatives such as futures and ask a committee of experts to device a policy.

"I think in hedging there should be a policy by the government. I do not think its fair for one person to given the entire burden of decisions," he said.

He says the country should decide the maximum level of it can afford to pay for oil and give the petroleum corporation the responsibility of ensuring that the costs are fixed.

Skinned Alive

If a hedge goes against the CPC, de Mel fears he would be "skinned" in parliament, as knowledge about hedging was minimal.

"If we get 7 out of 10 hedges right we should be happy," he says.

Nobody, de Mel claimed had said it was good that the CPC earned 1.5 million dollars from the zero cost collar earlier in the year. They had asked why a greater amount had not been hedged.

This week a team from Citibank was flying down from Singapore to make a presentation to the CPC for short-term hedging, perhaps for about a month. If the strategy is acceptable bids would be called from all banks.

"We feel oil would go up for the next month and then it should come down," de Mel says.

De Mel says the corporation would like to hedge for one year starting from around December or January, when oil prices usually bottom out.

"The country will have to say; are we going to hedge 60 percent, are we going to hedge 30 percent or are we going to hedge all 100 percent," de Mel says.

Analysts say a rule-of-thumb hedging strategy would be to fix about a third of the supplies through futures or forwards, hedge another third with options which allows a firm to benefit from a substantial swing in prices and leave the rest exposed to the spot market.

Several firms, including the national carrier Srilankan had been using fuel hedging, at one time hedging up to 80 percent of its fuel requirement, which is roughly about a third of its total expenses.

Forex Equation

De Mel also believes that hedging may allow the country to 'save' foreign exchange.

But economists point out that 'saving' foreign exchange cannot be done by hedging, as the outflow of foreign exchange is determined by changes in aggregate demand in the economy which drives imports.

Even if the CPC does not use hedging, the country would 'save' foreign exchange as long the CPC does not sell at a loss.

By funding losses with rupee debt, the CPC would in effect build up a speculative position against the national currency, which it has been doing in the past couple of months.

Balance of payments problems are not really caused by 'shortages' of foreign exchange but by excess domestic money in the economy which is usually created by increases in central bank's domestic assets, which is also known as money printing.

This in turn drives imports, causing pressure on the exchange rate to increase.

If the central bank continues to intervene and pump domestic liquidity into the system to maintain a particular reserve money target, a process known as 'sterilized intervention' demand pressure as well as pressure on the rupee would continue to rise.

Hedging, analysts point out; will only give a country some certainty about future prices, and not save any foreign exchange. Foreign exchange can only be saved by having an automatic price adjustment formula to eliminate losses.

An accumulation of profits in any import firm would reduce demand in the aggregate economy, resulting in a 'saving' of foreign exchange.

http://sundaytimes.lk/081123/FinancialTimes/ft329.html

The Sunday Times: Sunday November 23, 2008

CPC energy hedge: Anatomy of a crisisBy Upul Arunajith

As the architect of this trailblazer project, I consider it my responsibility to provide an explanation as to what this CPC Hedge is all about given due regards to media reports during this entire saga in the recent past. Provided below is a succinct account of what really transpired and how a solution to a problem has led into a much more serious problem and placed the CPC in a vulnerable and yet another unprecedented crisis.

This unprecedented crisis obviously contests the validity of the concept of hedging. Notwithstanding its wide use with varying degrees of success internationally, Minister A.H.M. Fowzie has gone on record saying that in the future he will opt to keep out of hedging. He was not in favour of hedging at all from the very start. In this connection my task is to prove the validity of hedging and protect the project initiative for the greater benefit of the national economy. It will not be prudent for them to discard the entire concept of hedging given one bad experience.

I have read multiple interpretations to this word Hedging. A former chairman of the CPC interpreted hedging as a process to control the world market spot price! Recently I heard that hedging facilitates earning foreign exchange. If that be the case, I am sure CPC is in the wrong path for its losing foreign exchange due to a wrong hedge. I also hear that Hedging is Speculating a widely held belief. So we have seen all the definitions to this mystic word Hedging and not well understood.

What is hedging?

Hedging is a mechanism that protects buyers and sellers of commodities from adverse spot market price volatility by taking an opposite position in the Derivatives Market. Hedging is not speculating. On the contrary speculators add liquidity to the markets and facilitate the hedging process. Without speculators there will be no liquidity. Hence, hedging is not speculation. Hedgers and speculators play a mutual exclusive role.

Hedging is akin to an auto insurance programme. From a laymen interpretation, the same way the insurance policy protects the owner in the even of a contingency, so does the hedging programme insulates the buyers and sellers of commodities from adverse price movements. Derivatives facilitate the hedging process. Derivatives are traded in an organised Exchange or Over The Counter (OTC). Exchange traded instruments are futures and option while OTC are SWAPS and Options.

In the case of exchange traded derivatives, all trades are transparent and the performance is guaranteed. In the case of OTC derivatives, these are for the most part tailor-made to suit counter-party requirements and governed by International Swaps and Derivatives Association (ISDA). One of the cardinal rules associated with Derivatives trades is that these trades should be kept simple. The moment it gets too complicated and deals are structured, the risk associated with the instrument becomes hard to monitor.

The current sub prime mortgage is mostly driven by the excessive use of Credit Derivatives that traded in the OTC market and controlled by ISDA. This Credit Derivative instrument is a Credit Default Swap.The success of any hedging programme is entirely dependant upon the use of the: correct instrument Option, Futures correct strategy. Call, Strips, Southwest Airlines Jet Fuel Hedging Programe: Success Story.

2005 Hedged at US $ 26.00 bbl2006 Hedged at US $ 32.00 bbl2007 Hedged at US $ 31.00 bbl2008 /09 Hedged at US $ 35.00 bbl

Southwest Airlines was able to make profits in the billions as it took a proactive role way back in 2001 when oil was trading under US$20. For the record, I first made the proposal to the Sri Lankan government at the end of 2002 to introduce hedging.

If the wrong instrument is used, the hedge will sooner or later go in the wrong direction and will lead into a crisis. A case in point is the Orange County issue. Mettalgesellschaft Refining Hedge Programme Stack Hedge

The Mettalgesellschaft Refining Hedge provides a good example of a hedge that went bad and the refiner losses totalling a billion. The refiner used a Stack Hedge strategy using futures contracts.

The refiner had an agreement to sell a certain quantity of petroleum products at a fixed price on a long term supply contract. This exposure was hedged with short term futures contracts and when the market spot market price dropped, the refiner got margin calls and faced a funding gaps. This forced the refiner to close the position taking a massive loss of over US$ 1 billion.

This is a classic example of not being able to use the right instrument and failure to watch for warning signal of the market price movement. Tool and Strategy selection is critical to the success of any hedging programme. Failure to understand the tools and the strategies will sure lead to disaster.

CPC Hedging Programme Zero Cost Collar

In the case of the CPC hedge failure can be directly mapped out to the strategy implemented by the CPC. The tool selection was driven by cash flow constrain to some extent but this is not the only reason why CPC got into this crisis. There were warning signals that the Zero Cost Collar was the wrong strategy. I had personally informed them of the impending disaster to no avail. Nonchalance to the warning signals and failure to heed to advice was the key to the CPC. Thus the hedge went in the wrong direction.

The cabinet would have approved what the CPC concept paper recommended. Both parties lack the skills for a critical review. Hence pointing fingers at the cabinet is of no use for it was the CPC-prepared cabinet paper that promoted the Zero Cost Collar. Had they pursued the simple plain vanilla instuments, the risk is limited and can be monitored. In structured deals as stated earlier, the instrument risk cannot be monitored.

Basket Hedge Model Final product development

We developed the worlds first Basket Hedge model for the CPC in February 2007 locking in the price of Crude oil + Freight at US $ 61.50pb for 24 months, using a cash settled Call Option to Cap the price of crude oil + freight for a period of 24 months structured through the worlds fourth largest energy trading firm based in Geneva facilitated through a broker based in Singapore, as per discussion held at the Treasury in Colombo.

Hedge Structure Analysis:

During the term of the hedge, CPC pays only a maximum of US$61.50 for the commodity + freight, if the oil + freight cost remains above US$61.50pb, while having the flexibility of participating (in the open market) if the world market price drops below US$61.50pb.

If the market price drops to $50 the CPC purchases the commodity at the lower market price. If the market price is US$135 the CPC purchases the commodity at US$ 61.50 (the pre-agreed Call Option Cap Price). For having

this benefit, to Cap the price and also to participate the event of a price drop, CPC has to pay an Option Premium akin to an auto insurance premium.

Hedging the commodity and freight

We provided unlimited upside protection above US$61.50pb. If the price moved above 61.50pb, to US $ 100pb the hedge provider paid the variance between $100 and $61.50 = US $ 38.50 per barrel to the CPC. If the price dropped to $55 the CPC had flexibility to participate in the price drop.

Basket Hedge Model rejected by the CPC

Regrettably though, this hedge model was rejected by the CPC. In violation of the agreement we had at the Treasury meeting, the CPC went to two commercial banks in Colombo, Citibank and Standard Chartered Bank (SCB) and asked them to develop hedge models. In this context it has to be stated that neither of the two banks are specialized energy traders nor did they have the wherewithal to provide a hedge to the CPC for a huge exposure of US$2 billion.

Taking my idea and asking for counter proposals is an act of plagiarism by CPC. This is a departure from the agreement we had at the Treasury discussions to work with dedicated commodity hedge providers based overseas.

Local banks

Local banks did not have the financial stamina to provide the required coverage due to high volatility of oil and taking into account the CPCs exposure. This later proved to be the case when the Citibank made a strategic exit after making a US$4 million knock-out payment to the CPC when the hedge went in favour of CPC citing that there was a single client limitation. Following this development, CPC went back to the SCB to seek hedging. Given that SCB first sold a wrong hedge model to the CPC and also lost US$2 million going back to SCB is leading to financial suicide and definitely will not be in the interest of the CPC. Citibank did a good job of misleading the CPC but did a poor job in calculating the risk and ended up with a huge unexpected payment to the CPC.

This situation where the local banks are unable to provide coverage to the CPC given its exposure was discussed at the preliminary Treasury meeting and that was the reason why we all decided to work with foreign based hedge providers who were specialized in commodity trading and hedging.

SCB Zero Cost Collar Hedge Strategy:

Responding to the CPCs call to develop Hedge models, SCB developed a Hedge model using a strategy referred to as a Zero Cost Collar which is a wrong strategy. SCB developed this model in such a way that the CPC will

end up paying the SCB as opposed to the SCB making a payment to the CPC. Unfortunately, the calculations of the SCB backfired and the Bank eventually ended up paying the CPC.

Added to this there was an instance when the SCB sold a Crack Spread to the CPC and the CPC lost US$2 million. These financial losses are passed on to the average gullible consumers.

Citibank Leverage SWAP:

Having advised the CPC that the Zero Cost Collar as developed by the SCB was the wrong strategy, and the CPC Chairman having agreed that it was the wrong strategy in view of the vulnerability of the CPC to this strategy, CPC went to Citibank and signed an agreement to get an oil hedge at US$73 pb on a trial basis for a period of three months. Again this too was wrong and costly strategy.

Due respect given where its due, it was the current CPC chief Asantha De Mel who took the bold step to get into unchartered waters by implementing the concept of hedging. However it has to be stated where he went wrong was implementing the wrong strategy from the very inception. This could have been averted for he was given signals that it was wrong.

As a parting remark, this failure is only a teething problem associated with hedging and it is imperative that we continue with the hedging programme for that is the only salvation CPC will have against high spot market price volatility.

(The writer, involved earlier in the hospitality trade in Sri Lanka, has been residing in Canada since the early 1990s. He has been involved in banking, risk management, commodity futures and derivaties trading. He could be reached at uarunajith@can.rogers.com).

http://www.lankaeverything.com/vinews/business/20081229123738.php

Impact on People\'s Bank & Commercial Bank of Ceylon of CPC Hedging Deals29-12-2008

Fitch Ratings Lanka has today said that People\'s Bank (Sri Lanka) (PB, \'A-(lka)\' (A minus (lka))/Positive) and Commercial Bank of Ceylon PLC (CB, \'AA+(lka)\'/Stable) are exposed to counterparty default risk following the Supreme Court of Sri Lanka\'s ruling on 28 November 2008, suspending payments due from Ceylon Petroleum Corporation (CPC) on hedging agreements entered into with the aforementioned local banks and three other foreign banks operating in Sri Lanka, namely, Citibank N.A.-Colombo

Branch (CITISL, \'AAA(lka)\'), Standard Chartered Bank, Sri Lanka Branch (SCBSL, \'AAA(lka)\') and Deutsche Bank A.G.

Acting as intermediaries, the banks structured these transactions with corresponding positions with offshore counterparties, earning a fee/commission; thus carrying only counterparty default risk. CB\'s exposure comprises payments due on a 70,000 barrel contract. PB\'s exposure comprises payments due on a 100,000 barrel contract, including payments due to CB on a 50,000 barrel contract. The payments due from state-owned PB to its counterparties have been halted, as the bank has sought legal advice on its obligations.

PB\'s \'A-(lka)\' (A minus (lka)) rating was last affirmed with a Positive Outlook on 6 October 2008, contingent on a capital infusion from the Ministry of Finance, and on the implementation of other measures to meet the regulatory minimum capital adequacy ratios on a solo basis by end-2008. PB\'s potential loss, based on current global oil prices, could, in Fitch\'s opinion, result in compounding the delay in achieving the minimum capital adequacy ratios as initially expected.

Fitch believes that CB\'s ratings are not likely to be affected, as the bank\'s capital position is sufficient to absorb the potential losses (including payments due from PB) that may arise based on current global oil prices as estimated by management.

The crystallisation of the potential liability on CPC hedging agreements and any potential ensuing rating actions are contingent upon the final Supreme Court determination expected by early 2009.

The impact of CPC\'s hedging deals on CITISL and SCBSL\'s ratings are addressed in a separate release, \"No Impact to National Ratings of Sri Lanka Branches of Citibank & SCB from CPC Hedging Deals\", published on 29 December 2008.

http://www.dailynews.lk/2007/08/14/bus01.asp

Daily News: Tuesday, 14th August 2007

Risk management solution for CPCHiran H. SENEWIRATNE

Citi, one of the first foreign banks to enter Sri Lanka since liberalisation, has structured a solution for Ceylon Petroleum Corporation (CPC) to manage its price volatility and to provide relief in prevailing market conditions for a part of its oil imports.

Concerned with the inflationary impact that high oil prices were having on the economy, the Central Bank of Sri Lanka (CBSL) encouraged CPC to explore ways of mitigating this risk.

In pursuance of the instructions of the CB the Ceylon Petroleum Corporation (CPC) has entered into six months oil hedging arrangement with Citi Bank, CPC Chairman Asantha de Mel said.

In the month of July the CPC hedged 200,000 crude oil and diesel which gained US $ 772,500 by way of hedging with Citi Bank.

The funds will go to the hedging fund to provide subsidy for the general public, De Mel said at a media briefing to announce the City Banks tie up with the CPC for hedging arrangements.

The CPC has entered into hedging arrangements with Standard Chartered Bank apart from Citi Bank. As a result, CPC was able to gain more than US $ 1.5 million from the transaction from February to May from both banks, he said.

Few years ago our oil price bill was around US$ 800 million and has gone up to US $ 2 billion for a year, causing crisis for the countrys economy, De Mel said. In the meantime the world oil prices are expected to decline during the months of December and January.

The CPC commands a market share of 80 per cent of the downstream petroleum market (refi-ned products including petrol, gasoline, and jet kerosene).

At the request of the CPC, Citi Bank closely examined the companys requirements and specific market views using its global expertise, which has structured a product that utilises CPCs view on oil prices to be stabilised, De Mel said.

According to de Mel, the months of December and January it is believed that the world oil prices would come down and this fact prompted the CPC to take this step.

Sri Lanka is the net importer of both crude oil and refined petroleum products with an annual demand of approximately 3.8 million metric tonn- es.

The CPC Chairman said that they are planning to enter into the bunkering and lubricant business in the country as previously.

Most of the profits are utilised to keep the sales on a subsidised rate in order to ease the burden of the public, de Mel said.

De Mel also said that they are selling fuel to the Ceylon Electricity Board Rs. 20 less than the fixed price to avert electricity price hike.

Citi Bank Country Head/Chief Executive Officer, Dennis Hussey said that the CPC plays a pivotal role for the development of the country. This type of a hedging arrangement would definitely be able to control the inflation in the country, he said.

http://www.lankabusinessonline.com/fullstory.php?nid=1424691571Lanka Business Online Tue Jan 2009Hedge Deal:Sri Lanka oil hedge case interim orders cease to be operative: courtJan 27, 2009 (LBO) - Sri Lanka's Supreme Court Tuesday terminated proceedings in a case against oil hedges by the state-owned refiner, Ceylon Petroleum Corporation, with all interim orders that suspended payments to banks ceasing to be operative.

The Supreme Court said it was terminating proceedings as the government did not comply with its orders to bring down fuel retail prices according to a pricing formula. Lawyers representing the government argued in court that the government should be given more time to consider the order and submit a fresh pricing formula

But the court rejected the argument, saying the government should first comply with order and then say if it has problems with it.

http://www.dailymirror.lk/DM_BLOG/Sections/frmNewsDetailView.aspx?ARTID=39184

Front PageFriday, January 30, 2009

By Sumaiya Rizvi

Hedging deals: JVP to go to courts

The JVP yesterday vowed to take legal action against high ranking government officials who had allegedly benefited underhand from the controversial oil hedging deals.

JVP Parliamentary group leader Anura Kumara Dissanayake claimed powerful people in the government had received commissions in the hedging deal and that led to the rejection of the Supreme Court ruling.

This is the first time in history where a government in the Southeast region has incurred a loss of Rs. 80, 000 million.The government cited a loss of Rs. 5720 million if it reduced petrol prices but now the hedging deal has caused a loss of Rs. 80000 million. The government said the reduction of petrol prices would weaken the governments military effort but it has nothing to say about the loss caused by the Hedging deal, Mr. Dissanayake alleg

The Central Bank governor cannot say that the government doesnt have to payback Rs. 80000 million to the Citi Bank and Deutch Bank, Mr. Dissanayake said referring to the order given by the Central Bank. The Central Bank cannot issue an order binding on all parties to the Hedging deal. Only the Supreme Court can do so, he said.

The President is the King of the jungle law since he chose to disregard the Supreme Court ruling to reduce the fuel prices, he said. The Government decided to interpret the Supreme Court ruling to their advantage when they reduced Rs. 20 per litre of fuel for three wheelers while reducing only Rs.2 per litre for other vehicles. Are there any three wheelers that pump petrol at the new prices, he asked.The JVP alleged the project E-Government was another corrupt multi million dollar government venture and vowed to expose all parties and their underhand dealings soon.

Govt. trying to exploit war victories: JVP

The government is trying to cash in on war victories at the upcoming Provincial council elections in the wake of the deteriorating economic situation, JVP Parliamentary group leader Anura Kumara Dissanayake alleged yesterday.

They know that the economy is crashing and without managing the crisis they are using the war to sell their election campaign, Dissanayake said.

The Western provincial council has eight months to go before it expires but the Government chooses to follow its agenda and hold elections as and when they plan, Dissanayake said.

The government is mindful that when the heat of the war victories goes down they will have no cover their economic mismanagement, he said.

How can the government ask the people to be vigilant of terrorist infiltration to an area, when there are thugs terrorizing people under the patronage of the government, he asked. And he said that the government is holding elections even in provinces under their control and that goes to show their fear psychosis to their chances of being re elected, he added.

http://www.colombopage.com/archive_09/January26144442RA.html

Petitioner of oil hedging deal threatenedMonday, January 26, 2009, 14:44 GMT, ColomboPage News Desk, Sri Lanka.

Jan 26, Colombo: Counsel Ravi Jayawardhana of 'Corruption Watch' who submitted a petition to the courts against the controversial oil hedging deal was reportedly threatened over the telephone to stop the legal action against the deal.

According to the police Jayawardhana has lodged a complaint at the Welikada police yesterday.

The caller had threatened him to stop the legal actions immediately, Counsel Ravi Jayawardhana said. He said the caller warned that he could be bombed or killed if he did not stop the judiciary action immediately.

Counsel Ravi Jayawardhana has filed a petition against the oil deal along with Chief Incumbent of the Nalandarama Vihara, Nugegoda Ven. Theeniyawala Palitha Thera, UNP MP Ravi Karunanayaka.

http://www.lankanewspapers.com/news/2008/11/34814_space.htmlCrisis over oil hedging dealsMonday, 10 November 2008 - 1:37 AM SL Time

CPC delays payments to Standard Chartered Bank, CitiBank

Two separate oil hedging deals between the Ceylon Petroleum Corporation (CPC) and Standard Chartered Bank (SCB) and CitiBank have gone wrong and about US$ 30 million was not paid by the CPC when the deadline (for the October payment) ended on Friday, informed sources said.

The Sunday Times reliably understands that the two banks were scheduled to

meet their ambassadors (Britain and the United States) to put pressure on the CPC to pay, citing it as a sovereign bond, in the two hedging deals where the CPC was either misled or not properly advised, according to Central Bank rules, on the risks involved in this kind of instrument.

Banking sources said the Colombo branches of these banks were putting pressure on the CPC to make the payments since any accumulation of these losses could reach millions of dollars in the coming months, given that fuel prices were unlikely to rise sharply above the US$ 58-80 levels. If that happens, the local branches of these foreign banks may be under pressure to close, one banker said.

The CPC also has, somewhat smaller, oil hedging contracts with Deutsche Bank and the Commercial Bank. Another local bank which was requested by a foreign investment bank to get involved in a similar type of instrument (with the CPC) mid this year turned down the offer on the basis that the risk (to the CPC) was too high.

The biggest problem in the current hedging deals is that liability on the upside (SCB/CitiBank pays CPC) is limited while liability on the downside (when fuel prices fall and the CPC pays banks) is unlimited. (See details on the deals in The Sunday Times FT section). This risk has not been clearly understood by CPC officials and also Petroleum Minister A.H.M. Fowzie who was also approached by SCB before the deal was finalized.

Every month a payment is made, a few days after the last day of the month, and October`s due date was Friday but the payments to the two banks were not made. The sources said that during a meeting between CPC Chairman Asantha de Mel and SCB Country Head Clive Haswell on Friday, the SCB had offered a new, alternative (hedging) instrument saying under this instrument, last month`s liability ($16 million) could be reduced by half. The CPC, it is learnt, did not respond positively to this offer. The CitiBank Colombo CEO was also believed to have met the CPC chairman Asantha de Mel.

Mr. de Mel told The Sunday Times there was a delay in the payments to CitiBank, but on Monday the CPC planned to pay US $ 7 million to CitiBank. He also claimed that there were no problems with the Standard Chartered Bank.

When asked, SCB`s Haswell told The Sunday Times that it was the bank`s policy to refrain from discussing dealings with its clients. However, he said the Bank had a `very good and long-standing relationship with the CPC.` He said that the bank was supportive of the CPC`s activities and is working closely with them.

Under the hedging mechanism, either party has to pay the other when the oil prices fluctuate but in practice, the CPC has been doing all the paying as the downside risk was not properly calculated or the state petroleum distributor was not properly advised. Central Bank rules clearly state that authorized dealers must get an undertaking from customers that they clearly understand

the nature of the product and `inherent risks.`

While the CPC has made a serious mistake in not assessing the downside risk, I blame Standard Chartered Bank. They being the professionals, they have norms and they are not supposed to sell a product to a customer or country if they are not sophisticated enough to understand. The Bank has misled the country to make money,` one market trader said.

However The Sunday Times learns that the CPC had during late last year expressed concern to this bank that any hedging mechanism should sufficiently protect the CPC and provide an exit clause in case prices fall sharply, as they subsequently did. While the SCB is learnt to have acknowledged this concern, no attempt was made to alter the contracts to make sure the risk to the CPC was minimal. Some bankers also raised the issue of whether the CPC making risk-related foreign payments was a violation of exchange control regulations. This has never happened before as this is a negative payment unlike the normal foreign exchange that goes out for imports, etc. I wonder whether there is any violation here, a city banker noted. The deal was announced in January 2007 and prices were low at the time. However oil rose sharply to a high of $134 per barrel in July 2008 and subsequently crashed to a low of $58 throughout last week.

The Central Bank in recent times is particular about the risks involved in these instruments. In its latest directions on Financial Derivative Products issued in July 2008, it is stated that, All dealers should ensure that Board of Directors of corporations clearly understand the risks of the instruments and draw up/lay down adequate plans to mitigate the risks.

Under the 2007 deal, the oil price was capped at US$ 130 a barrel and the floor price was at US$ 100 a barrel. If the price rose above US$ 130 for three months, the hedge agreement terminates. This means that during these three months, Sri Lanka can only buy 100,000 barrels per month. If the price of petroleum was below US$ 100, the agreement terminates only after 12 months during which Sri Lanka is committed to buy 200,000 barrels per month.

Source(s)http://www.sundaytimes.lk/081109/News/sundaytimesnews_20.html

http://www.lbo.lk/fullstory.php?nid=711745482Lanka Business Online Fri Dec 2008Sri Lanka Commercial Bank exposure on hedge deal US$8.93mn

Dec 05, 2008 (LBO) Sri Lanka's Commercial Bank says its liability to a counterparty under an exotic derivative deal arranged for state-run Ceylon Petroleum Corporation (CPC) is 982 million rupees, after payments were suspended by court.

Commercial Bank of Ceylon said the contract, based on WTI crude would expire on June 30, 2009 and if the payments continued to be suspended with oil at 48 dollars, the liability was 8.93 million US dollars.

Brent crude fell below 46 dollars yesterday. Court suspended payments under hedge deals last week.

Commercial Bank said the calculation was based on an exchange rate of 110 rupees per US dollar.

Sri Lanka's central bank has been intervening in forex markets since September and injecting more than a 100 million rupees to the inter bank market in a 'sterilized intervention' campaign, bringing a peg with the US dollar under severe pressure.

Sri Lanka units of Citibank, Standard Chartered and Deutsche have also sold derivatives to CPC, but Standard Chartered said last week that the local unit was not affected.

According to a document released to the media last week, Commercial Bank has a sold a target redemption forward on a notional 10,000 barrels of WTI Light Sweet Crude which doubled when oil prices collapsed.

http://www.lankaenews.com/English/news.php?id=6741Sri Lanka will lose Rs. 40 billion if hedging agreement is not annulled; dollar to go high up to Rs. 125, Ravi JayawardhanaEvery citizen can be given fuel for 45 days free of charge

(Lanka-e-News, November 26, 2008, 9.15 AM) Corruption Watch activist Ravi Jayawardhana says that Sri Lanka will lose US $ 400 million (over Rs. 40 billion) unless the hedging agreement is annulled.

He says that this los amounts to 15% of the national wealth and every citizen can be given fuel for 45 days free of charge with that money. Further, the foreign reserves of the country will further collapse and the dollar will go high up to Rs. 125, he said. Addressing the Corruption Watch media conference held yesterday morning (25) in Colombo, counsel Ravi Jayawardhana stressed that the government should annul this treacherous agreement immediately.

He questioned if the Standard Chartered Bank had acted in line with the Central Bank instructions pertaining to the subject. He raised the following issues as well so that the Standard Chartered Bank to answer.

Did the bank make aware the Ceylon Petroleum Corporation (CPC) regarding the risky nature of the hedging deals?

Did the Standard Chartered Bank bear the costs of business class air tickets to Singapore and Dubai and other expenses for some senior officials of CPC?

For what purpose?

Did the CEO of the bank join this tour? Why?

Was a job offered to the daughter of a top rank official of the CPC? (Lanka-e-News learns that this job has been given to the daughter of the CPC Chairman)

Jayawardhana points out that this woman (the daughter of the CPC Chairman) was granted the employment while the discussion regarding the hedging deal was underway.

Meanwhile, Lanka-e-News learns that the son of a top official of the Central Bank international credit agreement division in Chartered Bank's foreign debt section while the discussion for the hedging deal was underway. However, that person is no more in Chartered Bank, Lanka-e-News learns.

The Corruption Watch raises the following issues as well. Was the cabinet approval obtained for the hedging deal? Did the director board of the CPC approve the agreement? Did the Secretary of the Ministry of Petroleum and Petroleum Resources approve it? Was the agreement studied by the Attorney General?

Ravi Jayawardhana pointed out that the economy of Sri Lanka is near collapse because of the treacherous hedging agreements with several foreign banks like Deusch Bank, City bank and Standard Chartered.

Chartered Bank alone has earned a profit of Rs. 700 million during the past six months from hedging deals with CPC. Jayawardhana said that the Chartered Bank CEO?s upkeep expenses are Rs. 2.5 billion and he had withdrawn a Rs. 600 million bonus last year. The bonus of the bank operator of the hedging deal, Rukshan Dias, is Rs. 20 million. He was offered a Rs. 22 million worth Range Rover by the bank.

170,000 metric tons of fuel has been stored in Muthurajawela storage by November 18. This is sufficient for seven months. Meanwhile, another 50,000 metric tons of petroleum is due to arrive in Sri Lanka next week. This stock has been purchased $ 76 per barrel whilst a barrel of petroleum is $ 57 on the open market. The loss to the country per each barrel of petroleum is $ 19 due to this deal alone. Sri Lanka has incurred a loss of US $ 7.6 million that equals to Rs. 850 million. (The actual price of a barrel of petroleum is $ 42 now. Hence the loss goes up as high as US $ 13.6 million that equals to 1468.8 million rupees.

Corruption Watch has taken steps to sue CPC Chairman and the other responsible persons pertaining to the hedging agreement

http://www.tmcnet.com/usubmit/2008/12/08/3841848.htm

[December 08, 2008]SRI LANKA: OIL HEDGING DEAL BECOMING BILLION-DOLLAR PROBLEM(English IPS News Via Acquire Media NewsEdge) COLOMBO, Sri Lanka, Dec. 8, 2008 (IPS/GIN) -- As global oil prices dive, the Sri Lankan government finds itself saddled with a complicated oil hedging deal that could cost the country close to $1 billion.

State officials have been accused of high corruption over the deal with two foreign banks.

All that was brewing as a Sri Lankan group that advocates transparency prepared to mark Anti-Corruption Day on Tuesday.

Banking sources said the foreign banks involved, CitiBank and Standard Chartered Bank, are trying to restructure the hedging transactions with the government to minimize losses to the state. However one proposal being prepared by SCB could worsen the state petroleum agency's plight.

Putting further pressure on the controversial oil deal is a no-confidence motion being brought up against the government by the main opposition United National Party citing several corruption issues, including the oil hedging deal and one over a bankrupt budget airline.

The government is under "severe pressure" over this issue, said UNP parliamentarian Dayasiri Jayasekera, who has been raising many issues of state corruption in the legislature.

Transparency International-Sri Lanka's executive director J.C. Weliamuna said the deals have exposed poor governance and corruption in the state mechanism. Neither the regulatory mechanism nor the Cabinet have grappled with them nor were they alert on questionable deals in the country. "

The state-owned Ceylon Petroleum Corp. entered into contracts with five banks led by SCB, since January 2007, to protect itself against rising prices. When prices were over $135 per barrel in mid-2008, the CPC benefited as it had sought protection on the upside.

But with prices crashing after that and now sitting at $41 per barrel, the CPC ended up owing the banks, and the latest liability could be as high as $1 billion by May 2009, at current crude prices. If it falls to $25 dollars, as

reported in the British Financial Times on Friday, based on a report by investment bank Merrill Lynch, the liability would be higher.

The Supreme Court, on Nov. 28, temporarily stopped CPC payments to the banks until two petitions, alleging fraud and corruption in the hedging deals, were dealt with. The next hearing will be Dec. 15.

Under fire, the government on Thursday reduced gasoline prices and said it was preparing a new fuel pricing formula, in response to criticism that the benefits of falling oil prices were not being passed on to consumers.

The court suspended the CPC chairman and asked President Mahinda Rajapaksa to consider replacing Mohamed Fowzie as petroleum minister. Fowzie has been accused of not properly supervising theCPC on the hedging deals.

After the crisis blew, the Cabinet, on Nov. 17, appointed a risk management committee to review all hedging contracts and minimize the losses.

But petroleum industry officials said this was like closing the stable after the horse has bolted and point to the fact that two CPC officials, implicated in the deal, are also on the committee.

"Should not such a committee have been appointed at the beginning, when hedging took place after January 2007? Isn't there a serious conflict of interest in appointing officials implicated in the deal?" one analyst asked.

After the court's intervention the committee stopped

functioning.

"All these [hedging and Mihin Air] are gambles at a huge cost to the country. This corruption won't stop until the government shows political will to stem the rot. No one is accountable," Weliamuna said.

TI is marking Anti-Corruption Day this week with a seminar in Colombo on Tuesday on governance issues relating to the global financial crisis and its impact in Sri Lanka. Peter Eigen, founder and former chairman of the Berlin-based anti-corruption watchdog, was to participate.

Mihin Air is a government budget airline set up two years ago that has been swirling in debt of more than $50 million and was forced to suspend operations earlier this year. It is to be re-started this month with a fresh

injection of millions of rupees from the Treasury Department.

Allegations of widespread corruption has dogged President Mahinda Rajapakse's government, centering around his three brothers, Chamal, Gotabaya and Basil. Chamal is aviation and ports minister, Gotabaya is defense secretary and Basil is presidential adviser.

Local bankers, unconnected to the deal, say foreign trips paid for by foreign banks for CPC officials to learn about hedging were unethical.

A senior banking industry official, who declined to be named, expressed the view that impropriety accusations in the hedging agreements entered into with SCB and CitiBank are valid. "If it is a proper commercial transaction, you don't need to take the CPC chairman on foreign trips," one official said.

The official added that head offices of these international banks should think twice before pursuing any legal action for non-payments because these are highly questionable deals and raise ethical issues.

If the CPC fails to make the payments, the local branches of SCB and CitiBank may lose millions of dollars, bankers say.

Commercial Bank, a local bank that has a smaller exposure in the hedging contracts, said in a statement Friday that if the suspension of CPC payments continues, "our liability under our contract to make payments to our back-to-back market risk counterparty would total $8.93 million."

On the question of whether the suspended payments could result in Sri Lanka being perceived as a country that defaults payments, Chandra Jayaratne, a former chairman of the Ceylon Chamber of Commerce, said the court has stopped payments only temporarily.

"If the court holds that the hedging agreements are tainted with grand corruption, fraud or misrepresentation, then a contract is invalid," Jayaratne said. "If the contract is determined to be void after the Supreme Court judgment, I don't think anything is wrong."

Copyright ? 2008 Global Information Network

http://www.thecolombotimes.com/index.php?option=com_content&view=article&id=1397:ceylon-petroleum-corporation-hedging-deal-to-bribery-commission-&catid=1:political-news&Itemid=3

Ceylon Petroleum Corporation hedging deal to Bribery CommissionTuesday, 23 December 2008 00:50

Following the Supreme Court order the Central Bank of Sri Lanka is planning to send its initial report on the Ceylon Petroleum Corporation (CPC) hedging deal to the Bribery Commission.

Sources of the Central Bank confirmed that its initial report on the deal between CPC and two private banks is almost finished.

Earlier the Supreme Court directed the monetary board of the Central bank to probe this deal and to submit an interim report and this initial report follows it.

Reportedly the Bribery Commission is to conduct further investigations into the controversial deal that was signed last year between the CPC and the Citibank Sri Lanka and Standard Chartered Bank when the fuel prices were higher in the global market.

Under the deal CPC locked in fuel prices at around US$ 125 per a barrel until June 2009. But the sudden drop in global fuel prices to about US$ 40 per a barrel now would cause the government to lose nearly US$ 300 million.

As a result of a Fundamental Rights petition filed by Laugfs Gas Chairman K.H. Wegapitiya against the deal, the Supreme Court sacked the former Chairman of the CPC Asantha De Mel and asked the government to consider appointing a new petroleum minister.

http://www.lankanewspapers.com/news/2008/11/35170_space.html

Petrol hedge deals probedSunday, 16 November 2008 - 11:48 AM SL Time

The Central Bank (CB) has begun an extensive probe on the oil hedging deals by the Ceylon Petroleum Corporation (CPC), criticized over mounting losses, even as a government minister said there will not be any more hedging next year.

Even as CPC Chairman Asantha de Mel came out blazing at a news conference on Monday and stoutly defended the decision to resort to the `zero cost collar` option in hedging on oil prices, five-man teams from the CB visited five commercial banks on Thursday and Friday and obtained all documents pertaining to the transactions.

We believe there is a problem in the due process in these transactions and want to get to the bottom of it. We will be looking at all the documents over the weekend, a senior CB official said, adding our report will be based on whether the due process in line with CB guidelines was followed .

Standard Chartered Bank (SCB) CEO Clive Haswell told The Sunday Times that CB officers `visited` the SCB on Thursday. As criticism grew over huge

monthly payouts by the CPC to the banks due to falling oil prices, Petroleum Minister A.H.M. Fowzie told this newspaper that his Ministry planned to discontinue oil hedging once the current contracts end due to criticism from the opposition and `interested parties`.

While the SCB is said to have the widest exposure with the CPC on the oil hedges, the other banks involved are Citibank, Commercial Bank, Deutsche Bank and People`s Bank. SCB, Citi and Commercial flanked Mr. De Mel at Monday`s fiery media conference and separately issued a joint statement saying they had adequately explained the risks (of hedging) to the CPC.

Mr. de Mel also rejected The Sunday Times reports that the CPC may have been misled, saying the corporation was adequately informed of the risks and later, in an interview with this newspaper, said he and CPC Deputy General Manager-Finance Lalith Karunaratne had travelled across the world learning about hedging and were now experts in that field.

Mr. Fowzie says the CPC has gained $24 million over the period in which these contracts were done (since January 2007) when prices were high but lost that in one month alone when prices fell.

So far the CPC has paid out $38.5 million to the banks, mainly SCB and Citi. If current prices persist ($52-$60 per barrel), the CPC will be paying $300 million to the banks over the next six months, according to Mr De Mel. (A detailed report on the interview with the CPC chairman is in the FT section.) But Mr Fowzie commended the CPC chairman`s commitment to hedging saying the $24 million received by the Corporation earlier clearly indicated the benefit to the country from hedging.

Mr. de Mel said the `zero cost collar` hedging instrument was not the best option and that he was directed by the Cabinet to use this option. He however insisted that the country would have lost a lot of money if this option was not resorted to last year at a time when oil prices were high.

Mr. Fowzie pointed out that if the CPC chairman decided not to get involved in hedging (as stated by Mr de Mel in the interview) the ministry would appoint a special committee of experts to carry out his task and he (Minister) would also invite opposition members or their nominees to serve on this committee so that all transactions could be carried out in a transparent manner.

But this committee would be appointed only if the government decided to go ahead with oil hedging, he said. The criticism stems from the fact that the zero cost collar option provides for a price cap where payments on the upside (by the banks to the CPC) are restricted while on the downside payments (by the CPC) are unlimited. Both the CPC and the banks say no one anticipated that oil prices would fall to as low as $52 and at the time (January 2007) most experts predicted it could rise to as high as $200 or fall to around $80 on the low side.

Source(s)http://www.sundaytimes.lk/081116/News/sundaytimesnews_01.html

http://www.colombopage.com/archive_09/January27150857RA.htmlSri Lanka Supreme Court terminates the oil hedging deal Tuesday, January 27, 2009, 15:08 GMT, ColomboPage News Desk, Sri Lanka.

Jan 27, Colombo: Sri Lanka Supreme Court today terminated all the interim orders earlier issued on controversial oil hedging deal entered into agreement by the Ceylon Petroleum Corporation with some local and international banks.

Terminating the interim orders Chief Justice Sarath N. Silva said, if the Executive did not comply with the Judiciary, no purpose in proceeding with the case.

When the case was heard this morning counsel for the government asked for more time to study the implications involved in reducing petrol prices to Rs. 100 per liter, but the Court refused the request.

The Supreme Court earlier called an interim order on this controversial oil hedging deal suspending the Ceylon Petroleum Corporation (CPC) Chairman Asantha de Mel and CPC Deputy General Manager (Finance) Lalith Karunaratna.

Additionally the Supreme Court has suspended the CPC foreign exchange payments due to five commercial banks, Standard Chartered, Citi Bank, Commercial Bank, Deutsche Bank and Peoples Bank.

Under the interim order the Supreme Court ordered the government to reduce the petrol price to Rs. 100 per liter, but the government has refused to do so.

http://www.colombopage.com/archive_08/December3142307RA.htmlOil hedging deal was not my concept, says Sri Lankan oil minister Wednesday, December 3, 2008, 14:23 GMT, ColomboPage News Desk, Sri Lanka.

Dec 03, Colombo: Widening the problems at Ceylon Petroleum Corporation (CPC) further the Minister of Petroleum and Petroleum Development A.H.M. Fowzie today told the Parliament that the oil hedging deal was a cabinet approved project.

Making a special announcement at the Parliament this morning the Minister stressed that the oil hedging deal was not his concept but it was a concept of the Central Bank Governor, Ajith Nirvard Cabraal.

He pointed out that the Central Bank Governor has urged that hedging be commenced several times even before Cabinet approval was obtained for the deal.

Meanwhile main opposition United National Party MP Lakshman Kiriella said if the Cabinet had approved this oil hedging deal all the Cabinet should resign as they are responsible for the losses now.

Oil hedging deal at Ceylon Petroleum Corporation is one of the burning issues in the country currently and former Chairman of the CPC Asantha de Mel had to resign on the orders of the Supreme Court.

http://www.nidahasa.com/news/news.php?go=fullnews&newsid=679

Sri Lanka Supreme Court Terminates CPS's Hedging DealWed, 28 January 2009 02:50

50 views (NIDAHASA News) Sri Lanka Supreme Court yesterday (27) revoked the interim order issued earlier suspending the hedging contract.

Terminating the interim orders Chief Justice Sarath N. Silva said, if the Executive did not comply with the Judiciary, no purpose in proceeding with the case.

The orders to suspend the payments to the foreign banks, to subject the Ministry of Petroleum to the jurisdiction of the President and to remove Ceylon Petroleum Corporation (CPC) Chairman Asantha de Mel from the post would also be repealed, he added.

Supreme Court also suspended A.H.M. Fowzie, the minister of petroleum and petroleum resources development, and Ashantha de Mell, chairman of the state oil firm, Ceylon Petroleum Corporation (CPC).

The government will have to pay 500 million US dollars to the foreign banks due to the revoke of injunction.

According to CPC sources, it will have to pay around $ 18 million extra per month to banks for fuel due to hedging agreement.

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Standard Chartered Bank :: All about its Frauds HEDGING - well-conceived, intentional fraud

Commercial banks led by Standard Chartered Bank duped the Ceylon Petroleum Corporation, its former chairman Ashantha de Mel and others into unsuspectingly buying dubious deals in a well-conceived, intentional fraud on a government-owned statutory corporation, a public interest activist told the Supreme Court last week.Filing an intervening petition in the oil hedge case which is currently before that Court, Nihal Sri Ameresekere also said the CPC was not authorized to hedge through derivative instruments and could only carry out activities referred to in the CPC Actwhich is essentially and solely to deal with petroleum products. Therefore, the Central Bank or cabinet could not have suggested that the CPC embarks upon or engages in such separate, speculative business activity.

The Supreme Court will take up the hedging deal again tomorrow, when the Central Bank is expected to present a report on the controversial contracts.

Not petroleum hedging

Ameresekere describes the nature of the agreement entered into between the CPC and the five commercial institutions as hedging through derivative instruments. He says it is misleading to call it petroleum oil hedging when it is, in effect, speculating and/or gambling and/or betting on the movement of petroleum oil prices on notional quantities through a scheme of hedging through derivative instruments. He contends that this has nothing to do with the actual purchasing of petroleum oil by the CPC.

Reiterating that hedging through derivative instruments is a separate speculative gamble distinctly different from the purchasing of petroleum oil in a volatile market or otherwise Ameresekere says it is completely unrelated and alien to the actual purchasing of petroleum oil. He says linking the two was a misleading deception that had resulted in a catastrophe.

Ameresekere urges the Supreme Court to declare the hedging derivative instruments entered into between the banks and CPC null and void and of no force or avail in law. He calls the instruments unfair, inequitable, one-sided and unjust. He also seeks to make Central Bank Governor Ajith Nivard Cabraal; former Secretary to the Ministry of Finance and Treasury Secretary P B Jayasundera; Standard Chartered Bank; Citibank; Deutsche Bank;

Commercial Bank; and Peoples Bank parties in the fundamental rights application filed by Laugfs Gas Chairman W K H Wegapitiya.

Banks

A simple Internet search would have disclosed large-scale scams and frauds associated with hedging as well as derivative instruments, Ameresekeres petition states. For example, the European Parmalat bankruptcy was caused by derivatives of the reputed US banks J.P. Morgan Chase Bank, Bank of America and Citigroup. Hence, espousing hedging through derivative instruments ought to have been done with utmost caution and with requisite specialized expertise obtained through due process.

Ameresekere accuses the five financial institutionsStandard Chartered Bank, Citibank, Deutsche Bank, Commercial Bank and Peoples Bankof conduct unbecoming and unworthy of banks. He points out that a bank carries a fiduciary responsibility not to cheat and/or dupe and/or to get the better of a customer, but on the other and to advise a customer to protect the very interest of the customer.

A banker is a professional in whom reliance is totally placed by a customer, and no professional ought to take undue advantage of such trust reposed in a professional, he states. On the other hand, it appears that Standard Chartered Bank has unprofessionally induced, enticed and compromised public officials to sell dubious deals.

Attached to the intervening petition are true copies of invoices from Hemas Travel (Pvt) Ltd charged to Standard Chartered Bank in respect of air travel of the relevant public officers. The bills are dated 13 February 2008 and 29 September 2008.

Meanwhile, commercial banks operate under a Central Bank licence and are, therefore, subject to regulation and supervision. A bank is required to have ascertained whether the CPC was authorized and empowered to have dabbled in speculative business of hedging through derivative instruments.

The government

The petition states that a study group appointed by P B Jayasundera (as secretary to the ministry of finance and planning) had presented a report in November 2006 titled Oil Hedging Report of the Study Group. However, the specialized expertise, competence or exposure of the members of this study group to hedging through derivative instruments is not known.

Notably, Kapila Ariyarathnehead of corporate and institutional banking at Peoples Bankhad also been a member of the Oil Hedging Report Study Group. Peoples Bank subsequently entered into a hedging derivative instrument with the CPC.

The cabinet of ministers had considered a memorandum based on this study group report which was submitted by Minister of Petroleum and Petroleum Resources Development A H M Fowzie. Approval had been granted for the proposals to be implemented without delay, as suggested by the Central Bank of Sri Lanka.

Flawed

Ameresekere says that hedging through derivative instruments (involving high levels of public funds) ought to have been negotiated and entered into only with strict adherence to public finance circulars and guidelines. Cabinet appointed negotiating committees and technical evaluation committee should have been set up. There should have been specific cabinet approval in the context of the monetary value of instruments entered into.

In any case, as the speculative business activity of hedging through derivative instruments could not have been undertaken by the CPC, it should have been handledif at allby a specialized financial agency with the input of specialist expertise and experience with due process. Ameresekere says that it should also have received individual approvals from the controller of exchange under and in terms of the Exchange Control Act.

De Mels version:

This newspaper also contacted Asantha De Mel a former chairman of the CPC who was removed from his post by the Supreme Court for his role in the hedging affair.

De Mels primary contention is that he was only an official carrying out instructions handed to him by the Central Bank, after cabinet had approved the Central Banks hedging scheme. He says he did not have to go back to cabinet each time he carried out a hedging deal because the hedging scheme had been approved by cabinet and there were specific instructions to carry out these instructions as expeditiously as possible. He also says that oil trading is a volatile market, which meant that there was no question of retaining other experts to look into deals. His choice he said was to obey instructions and go by the Central Bank advice.

He also says that if the banks made money that could be found out by obtaining a court order to examine the banks books. His brief explanation for the entire hedging failure is that there was global financial meltdown which caused the oil prices to dip in a way that absolutely nobody expected.He said that the zero collar option was agreed to because if there was to be a cap at the lower end, a premium had to be paid to the banks.

http://www.lankabusinessonline.com/fullstory.php?nid=1465301196

Mon, 09 March 2009 09:03:47 Zero Sum11 Nov, 2008 07:18:52 Sri Lanka CPC looks at capping hedge lossesNov 11, 2008 (LBO) Sri Lanka's state-run Ceylon Petroleum Corporation is looking at ways to cap losses from hedges that went against it by entering into opposite positions, Chairman Ashantha de Mel said."I can take a producers hedge where it is upside down compared to the normal one going up and I can collect on the downside," says de Mel.

"But the downside is I cant defend that risk as the prices, if they start rising, I'll have to pay the balance."

But CPC has also exhausted most of the lines with banks it deals with.

Zero Cost

CPC has hedged about 30 percent of its imports through a zero-cost structure using options. Zero cost structures operate with the CPC writing an option and using the premium to buy one.

By writing more than one option, and getting multiple premiums, CPC had 'leveraged' its zero cost structure. But when the position went against the utility, it had to buy twice the volume at a price higher than the market for a longer period.

De Mel said CPC had originally hedged "550,000 to 600,000" barrels but leveraging in the swap contracts the utility has entered into had bloated volumes to 900,000 suddenly when oil prices collapsed.

The structure would have given CPC only three months of imports at a fixed price. But when the position went against it, CPC had to buy twice the volume till the middle of next year.

De Mel says he bought in-the-money structures, when the spot price was already high. Analysts say such structures can seem irresistible.

But the banks insist that there was no mis-selling. De Mel says he went into the contracts with eyes open.

The hedged volume was about 33 percent of CPC's imports of 2.5 million barrels of crude and refined products a month, De Mel said.

Oil Bulls

"People were saying oil would go up to 200 dollars a barrel at the time," he said.

De Mel says he had the chance to cut the position by paying a fee when oil prices started to come down but "everyone" including Goldman Sachs and Citibank was saying it would go up.

Goldman Sachs almost collapsed due to bad bets made in debt markets and was saved by being converted into a commercial bank, by its former chief executive who happened to be the US finance secretary.

Though "everyone" appear to say on the surface that prices are going only up, derivative markets - unlike the underlying commodity markets - are zero-sum games, meaning one man's profit is another man's loss.

This means half the market needs to have the opposite 'view' to make the system work.

Classical monetary economists and the International Monetary Fund in particular (link), had been warning from the beginning of 2008 that the commodity bubble had to collapse after the underlying banking bubble collapsed (link)last year.

The outstanding contracts with Citibank were 400,000 barrels, Standard Chartered 300,000, Deutsche Bank 100,000, People's Bank 100,000, and Commercial Bank 20,000 barrels, de Mel said.

In the first nine months of 2008 the hedge contracts went in CPCs favour as it made profits of over 20 million dollars but from October CPC had lost 27 million dollars, de Mel said.

Exit Option

He said Citibank had been paid with a "small delay" with 6.5 million dollars being settled on Friday and 7.5 million dollars being paid Monday, denying reports that CPC was planning to or was pressured to default on the contracts.

Commercial Bank was also paid 500,000 dollars Monday and a payment with Standard Chartered was falling due on November 14, De Mel said.

The delay, CPC says was because "accounts had closed" or because "money had to be transferred".

The hedge contracts committed the utility to an average price of "about 100 dollars" a barrel, De Mel said. Now oil was trading around 60 to 70 dollars a barrel.

If the utility had bought plain vanilla options he would have been able to exit hedges but CPC had not been authorized to pay up front premiums by the cabinet.

"At the time we told them and said we would like to go in and pay an upfront premium and do the hedging so we won't have the downside risk," de Mel said.

"But the cabinet only gave us permission to do a zero cost hedging operation; not to pay any premium upfront."

A plain vanilla option allows the utility to exit the contract if the position goes against it. De Mel says options now trade around 11 dollars a barrel amid high volatility in prices.

Analysts say CPC got into trouble with the hedge because it was not allowed to market price products by politicians who wanted to buy votes by keeping fuel prices low.

There is also a peculiar belief in Sri Lanka that 'inflation' is a petroleum phenomenon and not a monetary one.

The utility was also forced to abandon a pricing formula by politicians.

When prices rise a price formula eliminates losses, eliminates the build-up of credit, macro-economic imbalances and inflationary pressures, eliminates pressure on the exchange rate and forces conservation.

When prices fall a price-formula also makes sure that Sri Lanka is cost competitive.

Corrected - Citi/Standard Chartered volumes

READER COMMENT(S)13. lasantha Dec 15 Now this country has unnecessary fear of hedging or use of derivatives that created by groups with different interest. The real benefit of heading with regard to petroleum is actually realised only now since the price has reversed to level where it stood three years before. Its an ideal time for Sri Lanka to look for sticking into long term proper hedging contacts.

We should look at developing a hedging strategy for the country in a time when there is a widespread interest of the concept called hedging. Of course with due approval process as required by the countrys legal system (may be by Attorney General or Supreme Court).

It is duty of media to convey the right message that the concept of hedging is not wrong only the instruments used by CPC went wrong.

The selection of derivatives is not a trivial process and should be done by experts. CPC should get advice of risk management experts with regards to OTC derivatives after identifying the right hedging strategy for the country. There are lots of gray areas with regard to inputs used for pricing of these

OTC options, different type of instruments ( even synthetic) to suite different movements in the markets most of which cannot be understood by ordinary people. Also, there are lots of areas where we can use derivatives, such as many petroleum products (including aviation & marine fuel), electricity, cross currency - EURO/USD, GBR/USD, and industrial raw material - rubber, textile yarns etc to name a few

12. lakshman Dalpadado Dec 05 As I mentioned before we should not come down too hard on the people who were involved in CPC hedging contracts. It was done with good intentions although the results are a financial disaster for the CPC and the country. Intentions are as important as results unless one thinks that there is some fraud involved. Without knowing full details I do not think it's appropriate to start any 'blood letting'

As I said in my posting, before many in the oil trade including OPEC, Investment Banks, the traders and almost everybody else were expecting oil to go up. Some analyst were saying that it would go up to USD 200- probably backed up by speculators.

There is also the accusation that hedge funds backed up by oil producers were responsible for the hike in oil prices to compensate for the losses most financiers( big timers) racked up by investing in the property markets and equities. When property goes down equities go up - when equities go down, commodities go up- when commodities go down OIl go up and the cycle repeats. Today the markets are manipulated by big fund managers. They have the clout to move markets. For example , if the Chinese Sovereign Wealth Funds sell all their US bonds, USA will collapse. Thats why the Americans are so nice to the Chinese. This is the New realty!

11. Dilshan Punchihewa Dec 01 I think, the main issue is not with the hedging itself, but with the way it was done. Unfortunately, the government entities are good in checking small issues like the late arrival of employees and forget the big issues.

There must be levels of responsibility and accountability. It is laughing thing to say that Mr. De Mel or any other person is responsible, if he can not pay for the damage done by mostly as a result of a poor system.

Had the oil prices turned the other way to $200, Mr.De Mel would have been regarded as a national hero. Intellectuals in the government hierarchies must serious think about this as their turn will come sooner or later. Finally, any individual should not be over powered by the system, for him to gamble with the economy.

10. lakshman Dalpadado Nov 29 It's not only Mr De Mel who got it wrong. Whole of UAE, Kuwait, Qatar, hedge funds and most investments banks also got it wrong.

Kuwait stock exchange was closed for several days and the government resigned a few days ago. UAE is going bankruptand the property market is going to collapse - do not listen to their hype. All were betting oil to go up to 200 USD a barrel!.

9. Subhas Nov 29 Did the banks explain to CPC the potential losses that CPC might have to carry under the hedge if the petroleum rates were to come down? What is the position of the Central Bank re this hedge?8. Upul Nov 17 We all have clearly defined roles to play in the society. While, De Mel has to be given due credit for implementing the concept of hedging, he also has to be held accountable for getting involved with the local banks and buying into the wrong strategy "Zero Cost Collar" hedge. He is more of a cricketer and less of a Energy hedger and his able assistant Lalith Karunarathna with a rudimentary knowledge on the mechanisms of Hedging recommended the Zero Cost Collar.

Introduction of the concept of Hedging is my initiative. I was the one who made the proposal to the government. However, it was plagiarized by Cabral, the governor and tried to present it has if it was coming from him and he got caught in the act when he made a blunder at a presentation making a mockery of the concept.

De Mel now claiming that he and his Lalih Karunarathna are the two hedgindg experts in Sri Lanka got exposed further when they had to pay out big money to the Standard Chartered Bank and the Citi Banks and not stopping at that went on to protect the Banks.

The question remains, whose interest is De Mel Protecting. Bank or CPC.

7. Dimantha Nov 13 A Typical old school manager trying to be smarter on Hedging.... to get credit if the dollar value went to 200 Dollars. Bur Mr Ashantha De Mel did not know that there was a financial crisis in the making because he was more into cricket than BBC business News...

Well Mr De Mel, the plan has now gone totally not in favour. I think you should resign for your wrong Decision.

I personally know how much corruption is going on in at Ceylon Petroleum. Please note that all your private contractors are getting together and quoting on prices for maintenance and construction projects so that CPC pays a huge premium which goes to certain people.

Help the society. Act wisely.

6. sam Nov 11

Some body may have to see if the banks made a excessive profit out of this (high fees) also what the qulifications of the people in SL who looked at this. 12M vs 3 M sounds fishy.

best is to take a producers hedge and source and set off the payments. now seems a time not to be too careful.

5. Jonny Nov 11 Country has to pay for the irrational moves of CPC?4. A.R. Mohamed Nov 11 CPC has brought heavy burden on the public by not reducing fuel prices when world oil prices have come down drastically. If Singapore can sell petrol at about Sri Lankan Rs 62 per Litre, why can't Sri Lanka sell for atleast Rs 80/Litre? Public should not be asked to bear the burden for the mismanagement by the officials and polititions. As regards mismanagement in the CPC it pertinent to ask the following questions:

1. Is Mr. Ashantha de Mel a competent person to hold the post of Chairman of a vital corporation like the CPC?

2. What is his highest academic qualification?

3. What experience he has in the oil trade?

4. Did he have any experience in the business of hedging in the oil trade and able to understand the agreements connected with it to engage in the business of hedging?

5. Was relationship/political connection considered the main criteria to give the above post to him?

6. If he has messed-up the management and brought about massive losses to the company and also hardship to the general public with high fuel prices, will he reimburse the losses ?

7. If the answers to the above questions are not satisfactory, it is high time the CPC is replaced with a qualified, competent and with a person who is knowledgeable in the oil trade.

3. Bandula Nov 11 The cat is finally out of the bag. The CPC has bought oil till middle of next year. So that is the reason the price cannot come down before May 2009 according to chairman.

Mr. De Mel without trying to convince the public of his knowledge about zero cost structures or producers hedge could do a great service to the nation by resigning from this post and go back to SLC or somewhere so that we do not have to suffer.

2. Nov 11 Very well said, Banda1. Banda Nov 11 I think Mr. De Mel should get a "check up from the neck Up' done before anything else.

A 5th grader is smart enough to understand how stupid the original hedge arrangement was.

http://www.lankabusinessonline.com/fullstory.php?nid=342511919

Mon, 09 March 2009 09:03:54 Oil Bets 4 Comment(s)28 Nov, 2008 14:21:35 Sri Lanka court suspends petroleum retailer's hedge paymentsNov 28, 2008 (LBO) - Sri Lanka's supreme court has ordered the state-owned oil refiner, Ceylon Petroleum Corporation (CPC), to suspend controversial hedge payments to banks until a central bank probe into the matter is over.

It also ruled Friday that President Mahinda Rajapaksa should take over the petroleum ministry from minister A H M Fowzie..

The court also ruled that the chairman of the CPC, Ashantha de Mel, be replaced.

The ruling came in the wake of a controversy over the CPC oil hedges, which are now the subject of a probe by both the central bank and a team of Cabinet ministers.

The probes were launched after revelations that the oil hedges had turned sour and that the CPC stands to lose hundreds of millions of dollars as it was locked into buying oil at prices far higher than current market prices.

The CPC is also alleged to have not informed the cabinet clearly about the risks of derivatives trading.

Under the CPC's hedging deal with banks, it is locked into buying about a third of its monthly imports of 2.5 million barrels of oil at around 100 dollars when the market price is half that.

CPC chairman Ashantha de Mel has maintained that the deals were done on cabinet instructions which had not allowed the petroleum firm to make up front payments to buy less risky hedges.

Estimates of losses in the contracts with Citibank, Standard Chartered, Deutsche Bank and smaller contracts with two local banks could have ranged between 300 to 400 million dollars.

READER COMMENT(S)4. Viraj Hewage Dec 04 Hedging/financial derivatives are a gamble and they are inherently flawed, if you dont know it , dont do it. I doubt if CPC staff had the necssary knowhow to strike a hedge deal on their own ( assuming they did it on their own).

Banks are expert operators. Banks strike deals to make money , if there is no money , no deal.

On the otherhand oli plummeted from being 147 $ per barrel 6 weeks back to about 50$ per barrel ( the current rate). So if CPC struck an oil futures deal two months back (when price was around $ 135 a barrel) to buy buy oil at $100 per barrel in January 2009 , it would have been seen as a great deal because oil price was on the up - some pundits predicted it would reach $200. Now that the oil price is around $50, obviousely CPC deal is severly scrutinized / critisized.

The moral of the story is future is unpredictable and so are " futures " markets and therefore " futures" deals.

It is an open secret that price of oil is artificially manipulted by vested interests (including banks). Its hard to find an economic theory that could explain a $ 100 per barrel drop in oil prices in such short span leaving out the possibility of price manipulation.

If you do hedging , cover all your risks (bottom risks too - it depends on how one negotiates with the bank).

It takes a real hedge player to strike a balanced deal, still it may or may not work in your favour.

In general - capitalist market mechanisms are inherently flawed and designed to make the rich even richer.

In the middel east , hedging is permitted but gambling is not. Paradox. Banks sell well - we must not get caught. For example - we get at least 3 calls a week from banks in UAE offering personal loans - so I ask them , will the caller ( the saleperson) if default - they hang up.

If banks repeatedly call me for personal loans i might eventually get tempted to go for a loan I cant pay back and end up in trouble. So there should be laws to prevent banks from engaing in unethical practices like bombarding people with all kinds of rosy offers uninvited.

The point is powerful institutions like banks must serve society , not exploit. Having said that responsible organizations like the CPC must exercise due diligence at all times and never act unilaterially.

3rd world countries must strive to be self sufficient , better public infrastructue , less oil dependency - healthy living ( no smoking and drinking so people can meaningfully contribute to theirs and countries well being). We can learn from the ongoing chinese capitalism and russian capitalist socialism.

At the end of it all Sri Lanka must and will learn from its mistakes.

In Mahinda Rajapaksha we have a leader with a vision who feels the nations pulse and I am confident that under his command Sri Lanka can and will get better.

I know nothing about hedging, but I have what those who created this debacle lacked - common sense.

3. Nihal Wijethunge Nov 29 We as common people are lucky to have a chief justice like this who is not corrupt and bold enough to take strong decisions for the people. The only thing that appears to be not corrupt is the judiciary which is fast becoming the the only resort of the people.

Its high time that our corrupt politicians realise that they cannot get away easily in the future.

2. Nuwan Nov 28 People should not suffer due to the unacceptable agreement entered by few of officials.

Also the relevant counter parties should have ethical value rather than maximizing their profit.

This decision will enforced to government officials to re think prior to use their power and also private sector should not always think about the profit. They should earn profit but it should not unreasonable.

1. eagle Nov 28 Thanks Mr. President for taking over the petroleum ministry from minister A H M Fowzie and bye Mr. Ashantha, Marry x-mas

http://uk.biz.yahoo.com/28112008/323/s-lanka-court-suspends-oil-hedge-minister-lawyers.html

Friday November 28, 04:47 PM S.Lanka court suspends oil hedge, minister-lawyers

COLOMBO, Nov 28 (Reuters) - Sri Lanka's Supreme Court suspended the oil minister and halted payments to banks stemming from a hedging deal that could cost the state oil company hundreds of millions of dollars, lawyers said on Friday.

Opposition politicians have questioned the hedging arrangements by the state-owned Ceylon Petroleum Corporation (CPC), with Citi Bank, Standard Chartered Bank, Deutsche Bank (Xetra: 514000 - news) and two local banks, which were made in expectation that the oil prices would hit $200 per barrel.

Prices have dropped instead and the hedges mean the country will not benefit while the banks do.

'The Supreme Court granted interim relief suspending all the hedging payments to the banks until the final hearing,' said lawyer Uditha Egalahewa, who appeared on behalf of the petitioners seeking to cancel all hedging payments.

Lawyers said the court had suspended A.H.M Fowzie, the minister of petroleum and petroleum resources development, and Ashantha de Mell, chairman of the Ceylon Petroleum Corporation.

The court has yet to issue formal notifications of its ruling.

Asked to comment, Fowzie said he had heard of the court's decision.

'I do not know what the final outcome will be, until the final judgement,' he told Reuters.

A spokesman for Standard Chartered (LSE: STAN.L - news) in London said: 'As the matter is now sub-judice it would not be appropriate for us to comment on the interim ruling.'

He said in a statement the bank was not directly affected.

Deutsche Bank declined to comment.

Representatives of the CPC and the other banks involved could not immediately be reached