Sri Lanka petro chief calls for national hedging policy

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

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