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I would like to thank Steven Barnett, Juan Pablo Cordoba, Jeffrey Davis, Alan Gelb, Rolando Ossowski, Alvaro Vivanco, and Peter Wickham for comments on earlier versions of this paper. Alavaro Vivanco also provided excellent research assistance. All remaining errors are mine.
The emphasis in the paper is on governments heavily dependent on oil revenue rather than governments that smooth domestic oil-product prices. However, most of the arguments apply equally to both.
See IMF Occasional paper 205, “Stabilization and Savings Funds for Nonrenewable Resources: Experience and Fiscal Policy Implications.”
It is the “effective” price in that the price received is actually a combination of two operations: the sale of oil on the spot market and the gain/loss on the futures contract. These two operations net out to give a price equal to the futures price.
Data on futures is available back to 1984, but continuous data on 12-month futures only goes back to 1990.
Corresponding in the sense that the average spot price for the month of June 2001 is compared to the average price of the 12-month futures contract that has the same delivery month (June 2001).
The options strategy simulated assumes that the options are European, that is, can only be exercised at maturity. In fact, NYMEX options are American, that is, can be exercised at any time up to maturity, and hence the gains from the options strategy are probably underestimated in this simulation.
Mexico produces three grades of crude oil: heavy Maya-22, which accounts for more than half of total production; light, low-sulfur Isthmus-34, accounting for less than one-third of total production; and extra-light Olmeca-39, which is about one-fifth of total production. Nevertheless, the coefficient of correlation between the Mexican export price and WTI for the period January 1983 and March 2001 is a relatively high 0.95.
Basis risk refers to the risk that the spot price of the object being hedged may move differently from the price of the instrument used to hedge it.
See World Bank, “Dealing with Commodity Price Volatility in Developing Countries: A Proposal for a Market-Based Approach,” September 1999 (page 4).
Texas Senator Teel Bivens said on May 1991 about the hedging program that “As long as Texas relies so much on oil revenue, there will always be the chance the state will lose its bet. The state clearly needs a way to hedge its bets.”
See Piatt’s Oilgram News: May 4, 1993. Vol. 71, No. 86, Pg. 6; and May 20, 1993. Vol. 71, No. 98, Pg. 4.
Open interest is the number of outstanding contracts, both futures positions which have not been offset and option contracts that have not expired or been exercised.
NYMEX open interest in futures contracts beyond six months is known. Total NYMEX options open interest is known, but is not broken down by maturities. We assume the same maturity profile as for futures. IPE open interest for futures contracts beyond six months is known. However, not even total option open interest is known. We assume the same ratio for the IPE of option open interest to futures open interest as for NYMEX.
These margins do earn interest, however.
For example, if a country wanted to keep a buffer in FX reserves equal to the reduction in one year of oil exports if the oil price fell from $25 to $15 a barrel and the country exported 40 million barrels a year, this would imply FX reserves of $400 million. If, however, the country were to sell the oil forward at $25, then it would not lose any revenue if the oil price went to $15 and the amount of capital tied up in margin requirements would be about $100 million. In other words, futures allow the same amount of protection but at a quarter of the commited FX resources.
See R. Weiner, “Petroleum Fiscal Dependence – Revenue Forecasting and Oil Price Volatility,” George Washington University School of Business and Public Management Working Paper No. 96-44, December 1996.
The United Nations, under the auspices of the United Nations Conference on Trade and Development (UNCTAD) has developed and implemented an energy price risk management training program for developing countries. Exchanges such as NYMEX and private sector firms can also provide substantial technical assistance.