OPINION: Canada Should Find Refuge in Hedges Before the Next Bust

While hedging isn’t free, it’s prudent, writes Tim Pickering of Auspice Capital

November 23, 2016

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Recently, oil revenues have sharply declined, affecting jobs, lives, and the future. Yet, this should not come as a surprise—volatile markets like crude oil have always been cyclical in nature. However, Alberta does not have to keep getting caught with its pants down. Instead of praying for prices to rebound, we could actually come up with a solution—something that would materially protect us as a province and as a nation from the downside risk of crude oil.

The solution is hedging. Given that non-renewable resource revenues account for roughly a third of Alberta’s economy—and affect federal transfer payments—you would think hedging would be obvious. Yet, we continue to be ambivalent.

Non-Renewable Resource Revenue

12-hedging-oil-price-busts-story
Source: Alberta Energy

As a result, Alberta’s non-renewable resource revenues are forecasted to drop from $9 billion in 2014-15 to $1.4 billion in 2016-17, a level not seen in 40 years. Since 2014, Alberta has lost about $13 billion in revenues. Had Alberta covered even one-third of its oil revenues using a conservative hedging strategy, the government could have easily generated billions over the past two years.

So why don’t we hedge? Just like when taking out an insurance policy on a home or your car, there is a risk/reward trade-off implicit within hedging. While it reduces or repays the potential risk of a bad consequence, it may have an associated cost and can chip away at potential gains. This has caused a general nervousness in the past as some have feared the province would miss out on higher revenues in the event of strong oil prices, leading to political risk.

While hedging isn’t free, it’s prudent. Most Albertans and Canadians would agree to give some upside in exchange for better job security and economic stability over the long term—especially when the probability of a downturn in the future is not only likely, but imminent.

Since the Gulf War, Mexico, Brazil, and Chile have used hedging to protect themselves from the risk of lost oil revenues. In fact, Mexico recently won Bloomberg’s “Oil Deal of the Year” for its stellar hedging program, which is expected to generate a cumulative hedge gain of $6.8 billion for 2015-2016.
For energy-dependent countries—or even provinces—social programs are paramount, and steep declines in oil revenues can cripple these initiatives. Moreover, these governments realize that an economic downturn is a great time to build infrastructure while labor is cheaper and inputs like energy are less expensive.

By implementing prudent hedging policies, our nation could be a force of stability and opportunity, even in commodity down-cycles. An effective hedging program can reduce the margin of error in budget projections, generate revenues when the economy needs the most support, take advantage of low price environments and offset cash flows to create jobs during difficult times.

Canada is well-positioned to be able to capitalize on the global oil marketplace. We lead the top 10 oil reserve nations in terms of human rights, democracy, social progress, freedom of speech, freedom of the press, equality, climate change regulations, environmental innovation and environmental leadership. Moreover, we have the resources and the ability to fill a growing global need. If Alberta makes a dedicated effort to protect against downside risk, and maximize the financial upside of our domestic oil industry, the positive effects will be felt nationwide.

Tim Pickering is the founder and president of Auspice Capital

Follow @AlbertaOilMag

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