State-run Indian Oil Corporation (IOC) has asked the Forward Markets Commission (FMC) to allow the company to hedge its refinery margins and end products such as petrol and diesel.
The country's largest refiner is also holding talks with the Multi-Commodity Exchange (MCX) to provide it with a platform to hedge refinery margins and end products.
At present, MCX provides a platform to oil exploration and marketing companies to hedge volumes for crude oil only.
"The purpose of hedging refinery margins is that you are assured of a particular level. As a refining company, we are more concerned about the refinery margins and our interest is to protect the same," said an IOC official. While exploration and production (E&P) companies are constantly exposed to the risk of fluctuations in oil prices, refiners and oil marketing companies (OMCs) are concerned about protecting their spread between crude oil and refined products (gasoline, diesel, naphtha, etc).
According to IOC, it has so far hedged anywhere between 5 and 10 million barrels of crude oil in 2007-08. It imports about 260 million barrels and it hedges less than 5 per cent of the same.
S V Narasimhan, director (finance), IOC, said, "The market has been very unstable in the past few months and thus we are not very aggressive on hedging. We are waiting for oil prices to stabilise and then we may take a position."
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IOC earned $6.36 on refining every barrel of oil in the second quarter of this financial year as against $8.44 gross refinery margin in the same period last year.
In a trading activity, when an organisation hedges its portfolio, it is primarily taking positions in the future market and operating within a pre-defined band of possible loss or gain. On the one hand, this feature could help the player achieve certainty of future cash flows, while on the other it could also eliminate the possibility of gaining from any favourable market movements.
For instance, if an E&P company enters into a long-term supply contract with a buyer to sell crude at $80 a barrel, it would not be able to benefit if the crude prices increase beyond $80.
An E&P company is exposed to the price risk for the entire duration of its business cycle (usually a year), thus exposing it to higher oil price risk with potential to impact the bottom line as well the top line. On the other hand, the oil refining and marketing companies are exposed to these risks only for the length of the input purchase to the product sale period, which ranges from few days to a couple of months.
In view of the volatility in global oil prices, the RBI in November 2007 had allowed domestic oil refining and marketing companies to hedge their price risk to the extent of 50 per cent of their inventory using OTC/ exchange-traded derivatives overseas.
But the companies have been playing safe so far. BPCL, which hedges crude oil to bring stability to its refining margins, says it is a fairly new territory for the company and it is still on the learning curve. BPCL trades around 20-25 per cent of its hedgeable products on OTC exchange.
BPCL's Mumbai refinery reported a gross refinery margin at $1.82 a barrel in Q2 FY09 as against $9.29 a barrel in Q1. In the first year of its hedging, it earned Rs 50 crore and says it will increase the amount this year.