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 consultant’s proposals were “ irrational & misleading’ as option- contracts have a” time –period” and “premium factor” thus could not be “capped’ indefinitely. Also the proposal doesn’t 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. OPEC‘s 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 it’s 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 world’s 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 world’s 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 CPC’s 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 CPC’s 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 it’s 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 Bank’s 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 country’s 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 company’s requirements and specific

market views using its global expertise, which has structured a product that utilises CPC’s 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 doesn’t 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 People’s 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.

http://srilankareports.wordpress.com/2008/12/15/standard-chartered-bank-all-about-its-frauds/

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Standard Chartered Bank :: All about it’s 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 Act—which 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 People’s 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, Ameresekere’s 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 institutions—Standard Chartered Bank, Citibank, Deutsche Bank, Commercial Bank and People’s Bank—of 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 Ariyarathne—head of corporate and institutional banking at People’s Bank—had also been a member of the ‘Oil Hedging Report Study Group’. People’s 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 handled—if at all—by 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 Mel’s 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 Mel’s 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 Bank’s 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 bank’s 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 losses

Nov 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 can’t 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. It’s 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 country’s 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 for comment.

Hedging analysts said the island nation would have to pay at least $300 million during the next seven months if global oil prices remained at current levels around $50 per barrel.

They have fallen from a record above $147 in July.

An analyst said the court decision might damage Sri Lanka's credibility in international financial markets.

'Future agreements with any party are at risk and will have serious financial repercussions with possible increase of risk premium,' said the analyst, who did not want to be named.

'This might make it very difficult for Sri Lanka to borrow commercial loans in future as investors will be concerned over termination of contracts on those borrowings as well.'

Hedging analysts said the deal, designed to protect oil importer Sri Lanka against large movements in prices, had been done in such a way that CPC had to pay to the banks when the oil price fell below $100 per barrel.

Financial analysts said the deal could impose a major burden on the $32 billion economy when Sri Lanka's foreign exchange reserves have declined more than a quarter since mid-September because of the need to protect the rupee.

(Reporting by Ranga Sirilal and Shihar Aneez, additional reporting by Steve Slater in London, editing by Anthony Barker) Keywords: SRILANKA OIL/HEDGING

http://www.atimes.com/atimes/South_Asia/JK26Df01.htmlAsia TimesNov 26, 2008Sri Lankan oil bet burns $300m holeBy Feizal Samath

COLOMBO - The Sri Lankan government is grappling with a US$300 million payout to Citibank and Standard Chartered Bank (SCB), following disastrous oil futures contracts between the banks and the state-owned Ceylon Petroleum Corporation (CPC).

Sri Lanka's foreign reserves - worth around $2.7 billion or the equivalent of more than two months worth of imports - are already under pressure from the global economic crisis.

SCB and Citibank have been accused of not properly informing the state petroleum supplier of the risks involved in the futures contracts, but deny any wrongdoing. Overseas officials from the

two banks have been in Colombo over the past two weeks on "damage control" visits.

Central Bank governor Nivard Cabraal said its guidelines in derivatives trading had not been followed. Negotiations are underway between the CPC and the banks to restructure the contracts and reduce the burden on the fuel supplier.

Analysts recall that 15 years ago these two banks were implicated in a huge stock market scam following flagrant violation of the Reserve Bank of India guidelines on portfolio management services and ended up paying fines totaling $21 million.

The Sri Lankan crisis came to the fore this month after newspaper reports hinted that the CPC may default on its October (monthly) payment to the banks due to a cash problem, and that the banks had not properly advised the CPC on the risks involved in the hedging contract.

CPC chairman Asantha de Mel then called a press conference where, flanked by the CEOs of the two banks, denied claims that the CPC planned to default while also saying the corporation was made fully aware of the risks by the banks.

After the SCB and Citibank got involved in the futures contracts, three others banks also followed suit - on a smaller scale however - to get into oil futures contracts with the CPC.

The deals were made through a "zero cost collar" instrument where no premium is paid by the customer and the risks are shared with the banks. The CPC decision to hedge on oil as a protection against volatile oil prices came in January 2007 when there was speculation in the market that oil prices would rise to as much as $200 a barrel in the coming months.

Under the zero cost collar option, whenever the price rises between $100 and $135 per barrel, the banks pay an agreed amount (up to a maximum of $1.5 million a month) to the CPC. Any fall in prices below $100 (without any restriction unlike on the topside) means the CPC pays the banks.

Since January, the CPC gained $24 million (payment from the two banks) but lost $38.5 million - paid out just in two months - and is set to pay another $300 million (if the oil prices remain in the $50-$60 per barrel range) or more if it falls further. De Mel admitted that payment at current prices would be over $300 million.

On Friday, the benchmark Brent world crude price fell to $46.47 per barrel, a drop of almost $100 dollars per barrel from $143.33 on July 11 this year.

According to international news agency reports, crude oil prices are poised to fall by another 15% in the next week while recording their lowest price since May 2005. Even though Organization of Petroleum Exporting Countries is cutting down production to stem the sharp price fall, demand growth has fallen to its lowest in 23 years due to the world economic crisis, international market analysts say.

Dayasiri Jayasekera, Opposition legislator and member of the Parliamentary Committee on Public Enterprises (COPE), described the issue as serious. "Someone must be accountable for this huge loss to the country. We will be fully questioning Asantha de Mel on Thursday to get to the bottom of this," he told Inter Press Service.

Newspapers and analysts have clearly indicated that the CPC went for the wrong hedging (futures) option where the payment on the downside (borne by the CPC) was unlimited while on the topside (liability for banks) was restricted, and they accuse the banks of selling the wrong option and not advising the CPC of the risks.

Upul Arunajith, a derivatives specialist based in Canada, told IPS by e-mail that if the wrong instrument is used, the hedge will sooner or later go in the wrong direction and will lead into a crisis. "This is what happened in this case."

Arunajith, a Sri Lankan who initially made a proposal to the Sri Lankan government at the end of 2002 to introduce hedging, said that there were warning signals that the zero cost dollar instrument was the wrong strategy. "I had personally informed them of the impending disaster,'' he said. ''Neither SCB nor Citibank are specialized energy traders nor do they have the wherewithal to provide a hedge to the CPC for a huge exposure of $2 billion''.

At de Mel's press conference, Citibank Sri Lanka chief executive Dennis Hussey said the Sri Lankan government started the hedging process following a special cabinet approval, which has been carefully documented.

SCB's Sri Lanka chief Clive Haswell said the bank had received a written undertaking from the CPC that the latter was aware of the risks.

But CPC's board of directors said no such undertaking was given and are blaming de Mel, a political appointee and associate of President Mahinda Rajapaksa and Petroleum Resources Minister Mohamed Fowzie, for taking decisions without full board authority. Issues of impropriety are also surfacing with claims that some CPC officials got favors from the banks. Attorney General Priyadas Dep told The Sunday Times newspaper that his department - which normally scrutinizes state contracts to check its legality - was not consulted.

As pressure mounted on the government, Rajapakse summoned de Mel for a meeting. A parliamentary committee had also summoned de Mel for a hearing but the latter did not turn up, requesting time for proper preparation.

Political observers say while de Mel and the finance minister must take the rap for undertaking to use a hedging option where the downside risks were greater, the powerful CPC chairman's political connections will probably come to his rescue.

This was clearly seen when central bank officials, who had initially threatened to rap the banks for not following guidelines, seemed to relent later under pressure and are now guiding a re-negotiation of the payments.

As demands are being heard from some sections of the government to default payment on the basis that the banks misled the CPC, pressure has been mounting to pay up or face international repercussions.

Market analysts said that the two main foreign banks have hedged these instruments with the New York Mercantile Exchange (NYMEX). "Any default to the NYMEX by the banks will be perceived as default of a sovereign debt which will be disastrous to the country's international rating and jeopardize Sri Lanka's standing internationally to seek foreign commercial loans," one analyst said.

The government has resorted to large-scale borrowings in the international market over the

past two years to fund state spending, including for costly war against separatist Tamil rebels in the island nation's north.

(Inter Press Service.)

http://www.reuters.com/article/marketsNews/idUSCOL4879920081128

S.Lanka court suspends oil hedge, minister-lawyersFri Nov 28, 2008 11:32am EST 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 (C.N), Standard Chartered Bank (STAN.L), Deutsche Bank (DBKGn.DE) 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 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 for comment.

Hedging analysts said the island nation would have to pay at least $300 million during the next seven months if global oil prices remained at current levels around $50 per barrel.

They have fallen from a record above $147 in July.

An analyst said the court decision might damage Sri Lanka's credibility in international financial markets.

"Future agreements with any party are at risk and will have serious financial repercussions with possible increase of risk premium," said the analyst, who did not want to be named.

"This might make it very difficult for Sri Lanka to borrow commercial loans in future as investors will be concerned over termination of contracts on those borrowings as well."

Hedging analysts said the deal, designed to protect oil importer Sri Lanka against large movements in prices, had been done in such a way that CPC had to pay to the banks when the oil price fell below $100 per barrel.

Financial analysts said the deal could impose a major burden on the $32 billion economy when Sri Lanka's foreign exchange reserves have declined more than a quarter since mid-September because of the need to protect the rupee. (Reporting by Ranga Sirilal and Shihar Aneez, additional reporting by Steve Slater in London, editing by Anthony Barker)

http://www.srilankanewsfirst.com/General/7931.html

S.Lanka's ComBank says oil hedge case risk is $8.9 mlneditor on 12 December, 2008 02:56:34

Commercial Bank of Ceylon COMB.CM said on Friday its total risk would be $8.93 million if Sri Lanka's top court permanently suspends an oil hedging contract, news that helped drive its shares down more than 6 percent.

The island-nation's top listed private lender is one of five banks in an oil hedging deal with state-owned Ceylon Petroleum Corp (CPC), among them CitiBank (C.N: Quote, Profile, Research), Standard Chartered (STAN.L: Quote, Profile, Research), Deutsche Bank (DBKGn.DE: Quote, Profile, Research) and state-owned People's Bank.

"If the suspension of payments continues, our liability under our contract to make payments to our back-to-back market risk counterparty would total $8.93 million," the bank said in a statement to the stock exchange.

By 0738 GMT, shares in Commercial Bank plunged nearly 7 percent to 69.25 rupees a share, their lowest in more than three years. The stock later pared some losses to 6.4 percent. The hedging deal had been planned in expectations that oil prices would hit $200 per barrel, CPC officials have said.

Now in the range of nearly $44 per barrel, oil prices CLc1 are hovering around their lowest levels in nearly 4 years, and about $100 off a record of more than $147 struck in July.

On Nov. 28, the country'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 under a 'zero cost collar' contract.

The bank has an outstanding West Texas Intermediate (WTI) crude oil hedging contract with CPC, due to expire on June 30. The bank based its estimate on an exchange rate of 110 rupees per dollar and a WTI price of $48 a barrel.

Other banks in the contract refrained from commenting.

CPC said on Nov 10 it had hedged 30 percent of its 2.5 million barrel crude oil imports until end June 2009 with the five banks on 'zero-cost collar' deal.

Last month, the bank reported a nearly 7 percent rise in group net profit to 937.5 million rupees ($8.5 million) in the quarter to September from a year earlier.

http://landlikenoother.blogspot.com/2008/12/why-worry-about-cpc-sri-lanka-oil-hedge.html

W E D N E S D A Y , D E C E M B E R 0 3 , 2 0 0 8

Why worry about the CPC Sri Lanka oil hedge Scam?

[Re-posting an anonymous chain email circulating around]

Firstly, all patriotic Sri Lankan are shocked by the biggest foreign exchange scam in the history of

the country with a lead foreign bank making use of the poor risk management skills of the

chairman of CPC.

Nationalistic Sri Lankans are shocked and traumatized due to the following reasons.

What is the impact?

1.My country's foreign reserves will shrink by a massive USD 400 million.

With USD 400 million the government can provide the entire country 100% FREE fuel for 45

days.

2.With USD 400 million, I can fund the war for more than 3 months.

3.With USD 400 million, I can provide the population of 19 million a subsidy of Rs 2,300 each

month.

This includes for you and me.

4.My country has never been in need of foreign exchange more than now.

Recently, our foreign exchange position has depleted from USD 3.5Bn to USD 2.5bn due to the

intervention by Central Bank to maintain rupee stability.

5.The biggest financial challenge for any Country amidst the on-going global financial crisis is

to save the own foreign exchange.

Not to pay for a scam.

6.If we lose USD 400 million, then the US Dollar against rupee will move from 110 to 125.

The country will go into an economic crisis and this will be the starting point.

7.Why not spend the USD 400 million, we can fund the new port or the coal power plant

projects.

We do not even get USD 300 million of foreign grants every year.

How Did CPC get exposed?

This was started by Standard Chartered Bank.

SCB operates in more than 65 countries and was awarded with the Global Energy Risk

Innovation Award for beginning this transaction in 2007 in Sri Lanka.

This indicates no other country was stupid to buy such hedge products except Sri Lanka.

SCB started selling unfair deals using unethical means (explained later).

Later Citibank and Deutsche and Commercial also followed the party influenced by the greed for

profits – "why not we also make money." was the desire also for these banks.

The smart Bank of Ceylon and HSBC refused to enter into such agreements as they understood

the unfair structure.

Here are the reasons why it is unfair deal and why we should feel sorry for the Government.

You decide whether you would enter into such a structure or even gamble against such odds.

This is only a financial instrument and not a contract to buy oil.

It is a huge wrong gamble that oil price will only go up up up and never down.

The hedge was one sided in favour of the bank – meaning there was NO floor for CPC to protect

the down sided risk but, with a nice cap to protect the banks risks.

Unfair, unfair and this is not even a gamble but a cheat.

2.Any benefits the banks pay only for 2 months but, CPC has to pay banks for 12 months.

Sounds stupid but, it truly happened.

Again, not a gamble but, a cheat structure.

So, if oil prices went up even double, CPC gets peanuts USD 3 Million per contract.

Amazing isn't it?

So, how can CPC say if price went up I would get the blame for not hedging???

3.CPC pays for double the quantity hedged, if price goes down.

Whereas the bank pays only for half the quantity hedged, if price goes up.

Have you heard of such deals before?

4.Banks maximum exposure is USD 3 (THREE) million per transaction and CPC's unlimited, as

much as USD 400 million.

You decide if this is a good deal!

5.Finally, the deal is CPC paying for double the quantity, for 12 months with no floor to cover

the down risks.

For the bank, its half the quantity, for two months with a cap on the upside payment.

This is not gambling but cheating.

Because, CPC is betting on a card pack where all the cards in there favour are removed from the

pack.

6.This structure was called zero cost.

Actually the banks should have paid an up-front premium to CPC for entering into such

transactions.

Alternatively, the banks have reported more than US dollar 35 million (3.6 billion rupees) in

profits from such transaction and the head offices of these branches have earned more than

USD 52 million. (5.4 billion rupees.)

Central Bank and published financial records will indicate that these banks have already

repatriated more than 27 million dollars during the past 9 months from the country to their

head offices.

And the big payments have not started yet....SLR 40 billion.

How Did CPC get scammed?

Good question and we all wonder why?

You decide, if these are ethical practice and good governance.

1.The Chairman of CPC and a top decision maker travelled to Singapore, Dubai & USA several

times on first class.

The tickets were purchased by the foreign bank.

The CEO of the foreign bank also joined them during these visits for entertainment and the

travel never related to do with hedge.

Although Mr. Asantha De Mel told recently at a press conference that he travelled globally to

learn about hedging.

Dubai and Singapore are the most entertaining places in the world and you can imagine the fun.

It's a shopper's paradise with lots of other activities.

2.The expenses during the travel were millions of rupees for entertainment plus – plus –plus.

These were paid locally and also via the foreign branch offices.

A scrutiny of the local bank records will reveal this.

One of the marketing head responsible for selling this product in a foreign bank is the local pimp

to the foreign CEO.

He was given a handsome bonus including a vehicle for Rs 25 million, which he even travels

today.

Additionally, he was promoted as Head of the Corporate structure despite his own records for

fraud in the bank.

3.Accounts were opened to the local decision makers in Singapore (Orchard Branch) and

Dubai (Al Mankhool) which is the usual practice to say thank you for very large deals by

international banks..

As a matter of fact government officials were employed by the bank.

4.The bank not only employed government officials but also their family members.

Miss Stephanie De Mel the daughter of the Chairman of CPC was provided employment at the

Standard Chartered Bank dealing and Forex room a highly restricted area.

The Petrol hedge product was developed in this room.

Central Bank can verify this.

5.The losses started to build up in July 2008 and we all know that the derivative contracts are

mark to mark on a daily basis by the banks and it is also a regulatory requirement.

However, the banks did not inform and advise CPC to exit timely given the greed to grapple

extensive profits and bonuses for CEO.

6.It is industry knowledge that a few officers who had patriotic feelings towards the country

raised the unethical practice within the bank.

But, these employees were treated un-fairly and terminated without any reasons and

justification.

A few of these employees have filed litigation.

More Violations!

1.There are violations to Central Bank directions and guidelines on derivatives.

2.The Sri Lankan cabinet never approved this transaction.

It was also mis sold to the cabinet and the Cabinet never knew about the unfair structure and

the exposure to CPC.

3.The Attorney General Approvals were not obtained for signing the any documentation

including the ISDA Derivatives Contract..

4.The Board of CPC did not know the facts or approve the transactions.

5.The Central Bank did not know the facts or approve the transactions.

The situation now!

1.The CPC is exposed to payment of USD 400 million.

CPC is defending the banks, see why above.

2.The CEO's of the bank are putting pressure on the government, Central Bank and CPC to pay.

If CPC fails to pay, they will loose their jobs.

No one has interest about the country.

3.The CEO's of the banks are pushing to re-structure the debt claiming this is sovereign risk and

willing to provide discounts and hair-cuts.

This is not sovereign risk as the Central Bank & Treasury did not approve the transaction.

It is not like a loan or bond.

It is a speculative instrument that has gone wrong like in the USA.

4.If restructured, it will only serve to regularize the scam and still hundreds of millions of $ will

have to be paid.

Central Bank should declare transaction NULL & VOID.

The foreign banks are attempting to tarnish the image of the country by putting fear that this is

sovereign default.

It is not.

5.Some patriotic citizens are expected to file a fundamental rights case.

The legal fact!

1.CPC need not pay a single penny since this was miss selling.

2.There is ample evidence for miss selling.

3.There are ample court cases where court never favored mis selling and have pronounced that

these transactions are null and void.

There are legislative laws in the UK, USA, Canada, Singapore and various other countries against

such acts to protect governments and its citizens.

Can the foreign Banks help the country for future foreign Debt?

The CEO's of foreign banks are putting undue pressure and fear on the government and the

Central bank saying that this is a sovereign default and the government will not be able to raise

any debts in the future.

1.The current global financial crisis is expected to continue for atleast for the next two years.

In this situation several foreign banks are getting bankrupt and in fact, the governments are

helping them with bail out plans.

2.Citibank and Standard Chartered Bank shares have crashed by over 60% and they are looking

for help for themselves to survive from governments.

They have no liquidity and risk appetite.

3.The three foreign banks involved in this transaction have no commitment to the soils of Sri

Lanka. The proof is that all of them do not have a single branch outside Colombo although they

have been milking the country for over 100 years.

4.The recent debts raised by the foreign banks are in fact, international syndicate loans and

these banks only acted as brokers and there participation is less than 5%.

The Government can do the same structure with other local banks as well as other foreign

banks.

5.In the present global financial crisis and Sri Lanka's low credit rating, it is anyway not possible

to borrow more overseas at acceptable rates.

So, better save the reserves you already have.

6.Why should the government pay USD 400 million which had no benefit to the country to repay

a new USD 200 or 300 million of debt.

First, save what you have in your hands.

What should the Government Do!

1.Appoint an independent committee to investigate into the mal practices.

2.Central Bank has started investigation but, there is severe external pressure on them to close

their eyes.

3.The Bribery and Corruption Department and the CID to investigate.

4.Legally punish for the offense and save the country's foreign exchange.

5.Do not allow the opposition parties with vested interest to take advantage and include the

government also a party to this scam.

Government didnt know.

6. Do not allow the foreign banks to take shelter under sovereign risk.

This is not sovereign risk but mis selling and scam.

Standard Chartered was involved in a similar case (Harshad Mehta) in India in March 1992.

The Government of India took a serious stand against unethical practice and Sri Lanka should do

the same.

We should communicate to the international world that we cannot be taken for foolish financial

rides.

7.Take serious action against any institute, person that try to tarnish the sovereign image of this

country to shelter from mis selling. We are a trustworthy honourable country.

8.The Government should not under any circumstance agree to any re-structure or hair-cut

thinking this is sovereign default.

The Government has no obligation as per proven case laws to oblige for mis selling and corrupt

deals as per international laws and practices.

If you love your country pass this on to put pressure to government not to pay out our precious

dollars on this treason scam

THIS IS WRITTEN BY AN INDUSTRY EXPERT WITH EXTENSIVE KNOWLEDGE ON HEDGE PRODUCTS

AND EXPERIENCE IN FINANCIAL SERVICES BOTH, LOCALLY AND INTERNATIONALLY WITH THE

INTENTION OF SAVING THIS COUNTRY'S FOREIGN RESERVES AND THERE BY BUILD A BETTER

FUTURE FOR ALL THE CITIZENS OF THIS COUNTRY AND THE FUTURE GENERATIONS.

http://www.riunit.com/news_det.asp?newsid=122

RIU: Research Intelligence Unit

Sri Lanka: Over The Hedge?

Sri Lanka went through a historical milestone in the financial markets when they first used a

tailor-made oil hedge for purchasing crude oil. However, the instrument that was supposed to

save Sri Lanka millions of dollars on the import bill became a burden when the markets took a

downward turn. Since then hedging has become the worst nightmare of Ceylon Petroleum

Corporation (CPC) and associated ministries fuelling the nation. Lahiru Mudunkotuwa outlines

the ins and outs of the deal.

Risk mitigation

In order to find out how this blunder materialized we need to first understand what hedging is

all about and how hedging can be used effectively for financial gain from a transaction. Whilst

this type of financial instrument has been around in our local markets for a long time, the actual

use of hedging for oil imports by the CPC took place in 2007.

Commodities have always been subjected to price fluctuations due to whatever prevailing

market conditions determine supply and demand. Oil is a product which is highly volatile and

this is mainly due to various additional political-economy and security factors which affect the

market price. To reduce the amount of exposure to volatile market conditions hedging is used

widely amongst the oil importing nations of the world.

Corporations are exposed or subject to various types of fluctuations of prices due to the interest

rate changes, exchange rate variations and / or commodity price fluctuations. There are a

variety of risks involved in future transactions of any commodity such as micro-economic

exposure, macro-economic exposure, political stability exposure and transaction exposure.

Hedging is the mechanism for covering risk and derivatives are the instruments that are used to

do this. Unless these factors are managed efficiently and effectively companies are exposed to

the risk of huge losses and / or solvency. Therefore most firms have a treasury department with

highly qualified personnel to manage this risk which is a much specialised area of corporate

management. In layman’s terms, hedging is a way of covering your self from market

fluctuations. Governments and multinational companies use different types of tools or

derivatives to hedge themselves or to minimise their risk in their future positions and

transactions. The question that arises is whether this has been practiced adequately at the

national level in Sri Lanka.

In order to have any chance of getting to the bottom of what happened in the Sri Lankan oil

hedge bungle, we need to refresh ourselves on some of the key financial instruments that are

central to the practice of risk minimization;

Risky jargon

Swaps: A swap is a transaction whereby one party buys at a shorter date and sells at a forward

date in the same transaction or vice versa. These can be as interest rate swaps or currency

swaps. Swaps are used almost all over the world for minimising exchange or interest rate related

risks.

Forwards: When a party agrees to buy or sell at a future price and enters into a contract with

another party the transaction is referred to as a forward. Standard market dealings are usually

valued as spot deals (there and then) or valued for two working days from the time of

transaction. So any transaction beyond this is considered as a forward transaction. A forward

can be dealt on any odd dates as well as on any standard dates of trading.

Futures: These defer from forwards in two ways. Futures are only traded in financial exchanges

and are also a forward contract for a future date. They are traded only on standard durations -

one month, three months, six months and one year.

Options: Options are contractual arrangements giving the owner the right to buy or sell an asset

or a commodity at a fixed pre-agreed price on or before the given date. It is a right of the owner

to buy or sell and they are not obliged to exercise the transaction if they feel the market is

against them. For being able to do this the owner of the option pays a premium to the party

underwriting the option similar to an insurance policy. There is a huge risk involved for the

company undertaking to provide the facility because they may be subject to any type of market

volatility. Still if they are willing to take a calculated risk they will charge the risk premium from

the party taking the option. From the very basic definition of options, it is accepted that the

buyer pays the premium and keeps the right to buy or not to buy with themselves.

Miss-calculation

So what went wrong with the Sri Lankan deal? We went for a zero cost option which was tailor

made for our very own transaction of purchasing oil for Ceylon Petroleum Corporation. But

considering the huge premium involved, we have not opted for the simpler version of the option

and by using this tailor made complex package of zero option we have exposed or gambled

heavily on oil prices remaining at their highest levels ever and a continuous rise in the prises.

This would have been ok had Sri Lanka inked the deal some five years before when the oil price

hike was gathering momentum especially following the US invasion of Iraq. However, the geo-

political factors were either not considered or totally miss-calculated. Moreover, for oil prices to

continue on its record spike several other geo-political factors would have had to come into play

such as some type of US led conflict with Iran or Venezuela, the world’s second and third largest

oil producers coupled with perhaps further trouble in the Nigeria’s oil producing Delta region.

Fortunately, or unfortunately for the CPC, the nightmare global scenarios did not take place.

Moreover, with the election of Barak Obama as US President, the world has a chance of entering

into a more stable phase which will serve to calm the markets. Moreover, these markets are

already depressed by the global down turn that has witnessed all commodities across the board

falling due to stifled demand.

If anyone has been following commodity prices for even a short period of time, it is clear that all

prices fluctuate. There is no steady trend of rise or decline in any of the available exchanges

around the world. So how it was assumed by our decision makers that oil prices will only be

faced with a scenario of continuous rise is yet unknown.

As consumers of fuel in Sri Lanka, we are all in the same boat as all across the board are affected

by these decisions. When the oil prices were high we have received a payment of over $20

million from the facilitator of the oil hedge. But when these prices declined we are to pay a huge

sum and we have to purchase double our requirement as part of the agreement. We will not

only have to buy high priced oil, but due to this error it will also influence our foreign exchange

reserves which are already declining as a result of controlled intervention of the (pegged) rupee.

What happened will be a bitter lesson for all Sri Lankan’s using crude oil products. But it was

part of a learning curve for Sri Lanka and we need to rectify our costly mistakes and need to

introduce a more efficient and reliable system. The solution is not to blame the hedge but to use

correct instruments for the hedge so that costly mistakes like this would not be repeated in

future. We also have a right as citizens of Sri Lanka to ask those truly responsible for this miss-

calculation to be held to account.

© 2004 RIU. ALL RIGHTS RESERVED.

http://www.nowpublic.com/world/mexico-hedges-almost-all-its-oil-exportsMexico hedges almost all of its oil exportsShare: by rahul | November 10, 2008 at 07:07 pm

Non OPEC member and world’s sixth biggest oil producer, Mexico, takes measures to guard off the impact of declining world prices and recession.

By Javier Blas in London and Adam Thomson in Mexico City. Published: November 10 2008 23:38 | Last updated: November 10 2008 23:38. Mexico is taking steps to protect itself from the oil price remaining below $70 a barrel in the clearest sign yet of the concerns of producer countries at the impact of the global economic slowdown on their revenues. The world’s sixth biggest oil producer hedged almost all of next’s year oil exports at prices ranging from $70 to $100 at a cost of about $1.5bn (£961m) through derivatives contracts, according to bankers familiar with the deal. The cover is far higher than the country – which relies on oil for up to 40 per cent of government revenue – usually seeks. Last year, Mexico hedged 20-30 per cent of its exports. Mexico’s finance ministry declined to comment on Monday but said in its latest quarterly report that its oil income stabilisation fund spent about $1.5bn on “financial investments, as part of the measures taken for risk management”. Oil prices hit an all-time high of $147.27 a barrel in July but have since fallen to less than $65 as the global economy cools. In late afternoon trading in London on Monday, oil fell 18 cents to $60.86 a barrel. Tomas Lajous, a strategist at UBS in Mexico City, said the trades appeared to have occurred in late August and early September. “The hedge is very good news . . . a presumed cost of some $1.5bn is immaterial relative to risks,” he said. Signs that a big producer was hedging emerged over the summer as traders in New York noted a significant surge in options for December 2009. Mexico’s programme could have added some downward pressure to spot oil prices as banks involved in the deal – Barclays Capital and Goldman Sachs – offloaded some of their risk, selling futures, traders said. Neither bank would comment. Without the hedge, the recent price falls would have been a serious concern for Mexico. The government has already revised its budget, lowering its oil price target from $80 to $70. Last month, Agustín Carstens, Mexico’s finance minister, told the Financial Times in an interview that he had been stunned by the fall in oil prices. “What we have seen is amazing,” he said.

However, he pointed out that the government’s stabilisation fund had a $10bn cushion. “We should be in good shape.” Fitch, the ratings agency, cut the outlook on Monday on Mexico’s sovereign debt from stable to negative. Among the reasons, it cited were lower oil prices.

Source: ft.com

http://www.lbo.lk/fullstory.php?nid=473938104

Mon, 09 March 2009 09:03:47 Trading Friday 05 Dec, 2008 16:32:31

Sri Lanka shares fall, Com Bank down after oil hedge exposure revelationDec 05, 2008 (LBO) - Sri Lankan shares headed down Friday on low trading volumes with Commercial Bank falling sharply after it revealed a sizeable exposure in an crude oil hedge deal whose payments have been suspended on a court order.

The All Share Price Index fell 2.28 percent (36.64 points) to end at 1,567.17 while the more liquid Milanka dropped 3.39 percent (61.12 points) to end at 1,740.54.

Brokers said turnover was only 56 million rupees and that the outlook remained gloomy given difficult economic conditions and high interest rates that made equities less attractive.

Commercial Bank, the most actively traded stock, fell over six percent (4.75 rupees) to close at 69.50 rupees.

The said in a stock exchange filing that its exposure on the Ceylon Petroleum Corporation oil hedge deal is 982 million rupees with oil at 48 dollars a barrel, after payments were suspended by court.

The bank said the calculation on the contract, which expires in June 2009, was based on an exchange rate of 110 rupees per US dollar.

Bartleet Mallory Stockbrokers said they would trim the profit forecast for Commercial Bank based on the disclosure about the hedge exposure.

It said in a research note that the bank's actual liability could be around 540 million rupees after deducting for taxes.

"If the entire amount is to be made as a provision in the FY08 income statement then BMS Research would trim the forecast profit of 4.12 billion rupees in its recent research report to 3.58 billion rupees."

It said the extent of the bank's liability would vary based on global oil price movements.

"A further drop in oil price, below 48 dollars a barrel, will raise bank’s liability and vice versa."

In other trading on the Colombo bourse, Lanka Tiles suffered the sharpest fall, dropping 19 percent (6.50 rupees) to end at 27.50 after hitting a low of 20.50 during the day.

http://sundaytimes.lk/070819/FinancialTimes/ft328.html

The Sunday Times Online: ISSN: 1391 - 0531 Sunday, Augest 19, 2007Vol. 42 - No 12 Financial Times

CPC to hedge oil prices with Citibank help

The Ceylon Petroleum Corporation (CPC) is continuing to resort to hedging to reduce its exposure to price fluctuations in the world oil market.

“The corporation has adapted a structured risk mitigating strategy which includes fuel hedging as it is a technique not by which you will make money but by which you can reduce potential loss,” CPC Chairman Asantha de Mel told a media conference this week.

The CPC has entered into a new 6-month hedging arrangement for 200,000 barrels of fuel with Citibank which has structured a solution for CPC to manage its price volatility and to provide relief in prevailing market conditions for part of its oil imports. CPC has hedged 100,000 barrels of diesel for six months at a fixed price of 81.50 dollars a barrel and a maximum of 90 dollars a barrel with Citibank.

The Corporation bought diesel at a price of 87 dollars per barrel recently after Citibank came in and the bank has reimbursed the balance $5.50. “If the fuel price skyrockets above that price specified by the futures contract, the hedge will have paid off because CPC will save money by paying the lower price. However, if the price goes down, CPC is still obligated to pay the price in the contract and actually would have been better off not hedging,” De Mel said.

At the news briefing, CEO Citibank Sri Lanka Dennis Hussey handed over a cheque of $772,500 to the CPC Chairman who said this would be credited to a separate hedge fund.

Sri Lanka spends $2 billion on fuel imports and this sum would go up to three billion oil prices rise up to $100 per barrel which would be unbearable as the country’s foreign exchange reserves are very low at present, De Mel said.

http://uk.biz.yahoo.com/27012009/323/s-lanka-court-drops-oil-hedge-case-minister-suspension.html

FINANCIAL NEWS

Tuesday January 27, 09:52 AM S.Lanka court drops oil hedge case, minister suspension

COLOMBO, Jan 27 (Reuters) - Sri Lanka's Supreme Court on Tuesday terminated a court battle over oil hedging payments to banks that could cost the state oil company hundreds of millions of dollars, officials and lawyers said.

The Supreme Court in November suspended the oil hedging payments to banks and ordered the government to reduce retail petrol prices in line with falling global oil prices.

It 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).

But the court terminated the case on Tuesday, effectively ending the suspensions.

'They have dismissed the case, I'm also awaiting details,' said oil minister Fowzie, referring to the court case.

Lawyers said the group that launched the case, comprising a businessman and some opposition politicians, had earlier offered to withdraw it.

'The chef justice has terminated the proceedings of the court case,' said Uditha Egalahewa, the lawyer representing the petitioners, who had sought to cancel the hedging payments. 'As a result of that, all interim orders will be vacated.'

Opposition politicians have questioned the hedging pact by the CPC, with Citibank, Standard Chartered Bank, Deutsche Bank (Xetra: DBK.DE - news) and two local banks, made at a time of expectations that oil prices would reach $200 per barrel.

Crude prices have dropped instead, to stand around $47 a barrel on Tuesday, or about 70 percent below their July record high above $147, and the hedges mean the country will not benefit while the banks do.

Local and international hedging analysts have estimated the island nation would have to pay at least $300 million during the next five months if global oil prices stay around $50 per barrel.

Financial analysts said the deal could impose a major burden on the $32 billion economy at a time when Sri Lanka's foreign exchange reserves have declined more than a quarter since mid-September because of the need to protect its rupee currency.

(Reporting by Ranga Sirilal; Editing by Clarence Fernandez) Keywords: SRILANKA OIL/HEDGING

http://www.xe.com/news/Fri%20Nov%2028%2011:47:00%20EST%202008/100629.htm?categoryId=1&currentPage=1

S.Lanka court suspends oil hedge, minister-lawyers

2008-11-28 16:47 (UTC)

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 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 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 for comment.

Hedging analysts said the island nation would have to pay at least $300 million during the next seven months if global oil prices remained at current levels around $50 per barrel.

They have fallen from a record above $147 in July.

An analyst said the court decision might damage Sri Lanka's credibility in international financial markets.

'Future agreements with any party are at risk and will have serious financial repercussions with possible increase of risk premium,' said the analyst, who did not want to be named.

'This might make it very difficult for Sri Lanka to borrow commercial loans in future as investors will be concerned over termination of contracts on those borrowings as well.'

Hedging analysts said the deal, designed to protect oil importer Sri Lanka against large movements in prices, had been done in such a way that CPC had to pay to the banks when the oil price fell below $100 per barrel.

Financial analysts said the deal could impose a major burden on the $32 billion economy when Sri Lanka's foreign exchange reserves have declined more than a quarter since mid-September because of the need to protect the rupee.

(Reporting by Ranga Sirilal and Shihar Aneez, additional reporting by Steve Slater in London, editing by Anthony Barker) Keywords: SRILANKA OIL/HEDGING

(shihar.aneez@reuters.com; +94-112-375-903; Reuters Messaging; shihar.aneez.reuters.com@reuters.net)

COPYRIGHT

Copyright Thomson Reuters 2008. All rights reserved.

http://www.lankabusinessonline.lk/fullstory.php?nid=1383536281

Mon, 09 March 2009 09:03:18

Hedge Saga 5 Comment(s)29 Nov, 2008 13:38:04

Sri Lanka Standard Chartered says not directly affected, welcomes hedge probe

Nov 29, 2008 (LBO) - Sri Lanka's Standard Chartered Bank unit says it was not directly affected by a court order which halted payments due under a hedge it arranged for a state-run oil distributor and said it welcomed a probe into the deal.Sri Lanka's Supreme Court Friday ordered the country's central bank to probe the deal which it said was 'iniquitous' and propose remedies.

"Standard Chartered Bank welcomes further investigation and is confident of a favorable outcome as more details are revealed," the bank said in a prepared statement to press queries.

"As an international bank, recognized globally for our high levels of governance, we always seek to comply with relevant local and international laws and regulations."

The court order came after a cooking gas supplier and petroleum users including an opposition politician filed public interest petitions.

Sri Lanka's state-run Ceylon Petroleum Corporation found that oil hedges made under a complex options structure went against it when oil prices suddenly collapsed and it was faced with payments of around 30 million dollars a month.

Citibank, Deutsche, state-run People's Bank and Commercial Bank of Ceylon, a private bank had also sold options structures to CPC.

"Standard Chartered Bank is not a party to the application made to Supreme Court and is not directly affected," Standard Chartered said.

Analysts say banks may not themselves carry a position and it is customary to match counterparties in hedge contracts.

The counterparty could be a hedging speculator or a supplier of oil. Earlier this month Mexico engaged Goldman Sachs to hedge most of its oil output.

Bank had earlier been looking to stretch the payments to ease the cash flow of CPC.

Court said the halt on payments would stay in place until a probe by central bank is completed.

Court also ordered the chairman of CPC removed and the ministry of petroleum to be taken over by the President of Sri Lanka.

READER COMMENT(S)5. Amal Fernando Dec 04 I just have one question? While Standard Charted and Citi bank have no affiliation to Sri Lanka been foreign banks why do the most accepted and year on year award winning bank, Commercial Bank do such an irresponsible deal just for profits.4. Prem Elapatha Dec 03

I fail to understand one point, no one spoke a word when the CPC made profits in hedging - stiking deals at $100-$120 level when oil was at $140. Now one hedging went wrong and all hell broke loose.

It could be the case that CPC did not have the expertise, but the court, by ordering a stay order may be risking a sovereign default (not to mention cross-default in other foreign loans). SCB & Citi could, in fact, take the sovereign to international courts!

3. Upul Arunajith Dec 01 This is white-collar corporate crime.True the SC is a recognized international bank operating in Sri Lanka. That being the case, why did it take advantage of the CPC ignorance and sell them a wrong product. Why did they misuse soft dollars to gain undue advantage by giving CPC management overseas trips. Why did they open up bank accounts in Singapore?

Why did they organize a media conference to justify CPC/SC deal when they knew they were at the fault?

2. Francis Peiris Nov 29 I think this is the first instance where a court has ordered a halt to these kind of speculative trading transactions in the world. Standard Chartered Bank although a widely accepted international bank, is quite obvious at not having fully disclosed the parameters of the downside in speculative trading.

It is such similar trading activities in the international world that had wreaked havoc with Banks & financial houses such as Barings in the distant past & Bearsterns, Merril Lynch & several other leading institutions in the lead up to the present financial bailout in the US & Europe. The crippling effect on the state of such trades would have been evident if CPC had to cough out millions monthly.

Its a simple case of leading banks manipulating the financial system to their utmost benefit, with the connivance of a public official.

1. Bertram Nov 29 Standard Chartered is recognized globally for high levels of governance..but in Sri Lanka they have sold CPC officials a rotten deal..one rotten apple can spoil the whole barrel

http://www.gadling.com/2008/10/18/hows-that-oil-hedge-working-out/

How's that oil hedge working out?

by Grant Martin Oct 18th 2008 @ 10:00AM

With airlines in their worst state since 9/11 and bankruptices posting left and right, one lone airline, Southwest, has prevailed in staying profitable for the last few years.

How have they done this? Sure, they've got a pretty interesting business model, friendly customer service and a comprehensive network across America, but is that what's really keeping them on top?

Partially. It's more got to do with the oil hedge that the airline locked in well before it spiked up to $140 a barrel. Purchasing their fuel at rock bottom prices while the competition had to pay through the nose helped give Southwest the competitive edge. They could set their fares at lower prices (thus forcing the competition to match), not instill any crazy baggage or superfluous fees and still make a profit while the others were getting crushed.

Now that oil has come down from the stratosphere though, the oil hedge can actually work against them -- instead of paying the now $70/barrel of light sweet crude, they're still pinned to their commitment. And this last quarter, Southwest finally broke and actually posted a loss. Yesterday's Marketplace has an interesting piece to this effect.

So does this mean that the glory days of Southwest are now over? I doubt it. The airline had several consecutive quarters where they could stockpile cash above the competition, build their aviary and prepare themselves for the future. And lets face it -- they've got a business plan that's built around paying for jet fuel at that hedged price, so all they have to do is keep cooking.

Once oil rebounds and demand increases again, Southwest will be right back up on top.

http://dailytimes.com.pk/default.asp?page=2008%5C12%5C06%5Cstory_6-12-2008_pg5_37

Daily Times: Saturday, December 06, 2008

Sri Lankan bank says oil hedge case risk is $8.9 million

* Bank’s share plunges nearly seven percent to 69.25 rupees

COLOMBO: Commercial Bank of Ceylon said on Friday its total risk would be $8.93 million if Sri Lanka’s top court permanently suspends an oil hedging contract, news that helped drive its shares down more than six percent. The island-nation’s top listed private lender is one of five banks in an oil hedging deal with state-owned Ceylon Petroleum Corp (CPC), among them CitiBank, Standard Chartered, Deutsche Bank and state-owned People’s Bank. “If the suspension of payments continues, our liability under our contract to make payments to our back-to-back market risk counterparty would total $8.93 million,” the bank said in a statement to the stock exchange. By 0738 GMT, shares in Commercial Bank plunged nearly seven percent to 69.25 rupees a share, their lowest in more than three years. The stock later pared some losses to 6.4 percent. The hedging deal had been planned in expectations that oil prices would hit $200 per barrel, CPC officials have said. Now in the range of nearly $44 per barrel, oil prices are hovering

around their lowest levels in nearly 4 years, and about $100 off a record of more than $147 struck in July. On Nov. 28, the country’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 under a ‘zero cost collar’ contract. The bank has an outstanding West Texas Intermediate (WTI) crude oil hedging contract with CPC, due to expire on June 30. The bank based its estimate on an exchange rate of 110 rupees per dollar and a WTI price of $48 a barrel. Other banks in the contract refrained from commenting. CPC said on Nov 10 it had hedged 30 percent of its 2.5 million barrel crude oil imports until end June 2009 with the five banks on ‘zero-cost collar’ deal. Last month, the bank reported a nearly seven percent rise in group net profit to 937.5 million rupees ($8.5 million) in the quarter to September from a year earlier. Reuters

http://www.island.lk/2008/12/07/news18.html

The Island Online

Sri Lanka IOC unit says oil derivative exposure ‘manageable

Dec 06, 2008 (LBO) - The Sri Lanka unit of the Indian Oil Corporation has unwound some oil derivatives it bought earlier in 2008, but is left with 70,000 barrels worth deals that will expire next year, a top official said.

Lanka IOC says it has also bought downside protection for the deals at different levels for remaining contracts. It has 10,000 barrels outstanding with Commercial Bank and the balance with Citibank.

"We wound up some contracts. We bought protection at different levels," managing director R Ramakrishnan said.

"The majority of contracts expire in June and July and some in August."

Lanka IOC imports about 300,000 barrels of refined products a month.

Ramakrishnan says the remaining contracts include ones based on WTI oil at around 90 US dollars. There was also protection at 70 dollars.

"We did a lot of balancing," he said. "It is manageable."

Sri Lanka’s petroleum and banking sector is in turmoil after the island’s Supreme Court halted payments to banks from state-run Ceylon Petroleum Corporation (CPC), on oil derivatives to Citibank, Standard Chartered, Commercial Bank and state-run People’s Bank.

Lanka IOC says it is honouring all contracts.

Exotic Derivatives

Lanka IOC had bought protection in consultation with banks by paying a premium, though oil prices have now fallen further.

CPC however had no permission to pay premiums, because it was limited by the cabinet to ‘zero-cost’ instruments.

In Sri Lanka, banks have been blamed for selling a complex product with no downside protection or a ‘knockout’. But the derivative is based on a structure used in securities markets known as a target accrual redemption note (TARN).

They are also known as leveraged target redemption forwards or swaps. The attraction for an oil distributor was that it was ‘zero-cost’, or no payment was involved. But it got ‘knocked out’ after accumulating about five dollars a month a barrel for three months.

Under a ‘zero-cost’ structure, the oil distributor wrote an option, earned a premium and used it to buy an option giving upside protection.

The upside risk was capped for taking on a downside risk. By doubling the downside risk (leveraging) the upside benefit could be increased.

The contracts were also ‘in-the-money’ or profitable from the start. Analysts say such benefits cannot be given without taking substantial downside risks.

Leveraged target redemption forwards have resulted in spectacular losses in recent turmoil, including at CITIC Pacific, a Hong Kong-listed Chinese firm. CITIC Pacific lost on a forex deal, rather than commodities, when the Australian dollar plummeted.

CITIC Pacific said in a stock exchange disclosure that, under Hong Kong accounting rules, leveraged forward contracts did not qualify for hedge accounting and had to be marked-to-market resulting in hundreds of million of dollars in losses.

International accounting rules says ‘hedges’ could be adjusted against the balance sheet to reduce the impact on the profit and loss account. Non-hedges have to be marked-to-market and taken to the profit and loss account.

Under ‘hedge accounting’ a derivative can be adjusted against the balance sheet and only the un-hedged portion brought to the profit and loss account.

Lanka IOC’s Ramakrishnan said he was not able to comment on the accounting treatment of the derivative exposure without checking with the finance department.

In an interim ruling court also said oil imports will have to be done by the government of Sri Lanka. Lanka IOC is a public listed ‘private’ firm ultimately controlled by the Indian government.

Hedge What?

In Sri Lanka, petroleum prices are set by politicians and not a price formula. As a result, oil distributors did not have a certain future retail price to ‘hedge’ against. However a price formula is expected to be presented to court on December 15.

On Friday the government said the retail petrol price has been brought down by 20 rupees a litre to 122 rupees. The Singapore wholesale price of refined petrol is only 25.50 rupees a litre according to Central Bank data.

Analysts say even if oil distributors did not use exotic products and only used straight forwards, they would have been hit by a clamour for price reductions.

In that scenario analysts say the only reasonable hedging instrument Sri Lankan distributors could use were plain options.

But options require up front money, which Sri Lanka’s cabinet did not allow CPC to do under its mandate.

State-run CPC was originally advised to use oil derivatives by Sri Lanka’s central bank from a foreign exchange perspective.

The central bank said in a statement Friday it advised the government to hedge because it believed a rising oil bill would "exert severe pressure on Sri Lanka’s balance of payments and the exchange rate."

Balance of Payments

But economists have pointed out that balance of payments crises develop from central bank ‘accommodation’ (or money printing) of forex outflows, to defend a dollar peg, in a process known as ‘sterilized intervention.’

Sri Lanka had no foreign exchange ‘shortages’ until a central bank was created in 1950, abolishing a currency board that had kept the currency stable under colonial rule.

Sri Lanka is now in the middle of a severe balance of payments crisis despite oil prices plummeting, due to central bank peg defence, and sterilization of reserve losses.

The International Monetary Fund has already advised Sri Lanka to abandon its peg.

CPC went in for exotic derivatives structures because it was not allowed to pay premiums to buy plain vanilla options or forwards by paying a premium and was confined to ‘zero cost’ instruments which compelled it take on a downside risk to get upside protection.

To get more upside protection and an ‘in-the-money-position’ where it got protection around the spot price it had to take more downside risks.

http://www.thecolombotimes.com/index.php?option=com_content&view=article&id=1529%3Apeoples-bank-combank-affected-not-scb-or-citibank-over-oil-hedge-fitch-&Itemid=3

People’s Bank, ComBank affected, not SCB or Citibank over oil hedge-FitchMonday, 29 December 2008 15:43

Fitch Ratings Lanka said today People’s Bank and Commercial Bank will be affected by the suspension of payments in the controversial oil hedging agreement with the Ceylon Petroleum Corporation (CPC) unlike Standard Chartered Bank (SCB) and Citibank who could receive support from their overseas headquarters over the payment issue.

In this context, Fitch said the national long-term ratings of Colombo branches of SCB and Citibank have are not affected. While the final court decision will not be known until early 2009, Fitch's view is that timely support would be made available to the two foreign banks from their respective head offices in order to meet their depositor and creditor liabilities in the event such support is needed; given that they are both branches and part of the same legal entities as Citibank N.A. and SCB, respectively. This support is, however, dependent on any regulatory restrictions or delays in remitting money into Sri Lanka, none of which is envisaged at the moment. In the case of People's Bank (PB) and Commercial Bank (CB), the two local banks are exposed to counterparty default risk. Acting as intermediaries, these 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.

Fitch said 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. It said 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.

http://www.dailynews.lk/2007/02/22/fin01.asp

Dai ly News Online: Thursday, 22 February 2007

Lanka’s first oil hedge against price instability

STANDARD CHARTERED I N GROU ND -BREAK I NG ROLE :

Hiran H. Senewiratne

HEDGING: World crude oil prices

are likely to increase next month

with the conclusion of the Chinese

New Year. Therefore it would have

a direct impact on local petroleum

prices, Ceylon Petroleum

Corporation (CPC) Chairman and

Managing Director Ashantha de

Mel said.

China is the largest consumer of

petroleum products and are

celebrating their New Year this

month. Therefore, most industries

are not operative in full swing,

which influenced a slash in the oil

prices at around US$ 60 per barrel.

According to de Mel there is a high probability of local oil prices increasing during March and the

Government is taking many precautions such as hedging to cushion the impact.

The CPC Chairman addressing the media conference noted that in efforts to maintain the price

of petroleum products and minimise the impact of escalating prices on the economy CPC made

hedging arrangements with the Standard Chartered Bank.

It noted that flexibility and quick manner in which Standard Bank has responded and was

working in addition to being persistent qualified the bank to be selected for oil hedging, he said.

Initially they will make hedging arrangements for 150,000 crude oil barrels per month besides

looking at its workability. They intend making hedging arrangements with a few more banks to

purchase another 300,000 barrels in the future.

At present Sri Lanka imports 900,000 crude oil barrels from Oman at US$ 55 per barrel which is a

little less than normal international prices. This is the first oil hedge to ensure stability in a sector

that is prone to price fluctuations.

LAUNCH: CEO Standard Chartered Bank Clive Haswell with Chairman CPC Ashantha de Mel at the launch of the hedge. Picture by Sumanachandra Ariyawansa

The cap strike at the upper limit is US$ 72 while the lowest is US$ 67.50, with Standard

Chartered Bank picked to transact the country’s first oil hedge.

This is carried out with the CPC, which hedges their exposure to diesel for a quantity of 150,000

barrels per month for a period of three months, starting March 1, de Mel said. CEO- Standard

Chartered Bank, Clive Haswell said that the Bank is delighted to structure the first commodity

option in Sri Lanka.

In December the Bank structured Sri Lanka’s first USD option clearly indicating its capability and

leadership in introducing innovative new products in the local market.

“As a leading international bank with a long heritage and presence in Sri Lanka we are firmly

committed to working with regulators and industry leaders to make Sri Lanka on par with other

big regional financial markets and in playing a pivotal role in contributing to the development of

the country, Haswell said.

http://www.lse.co.uk/PoliticsNews.asp?ArticleCode=hzwldj0sfxh9615&ArticleHeadline=slankas_combank_says_oil_hedge_case_risk_is_$89_mln

LSE: London South EastPolitics NewsMonday, 9th March 2009

S.Lanka's ComBank says oil hedge case risk is $8.9 mln

5-DEC-2008 10:03

COLOMBO, Dec 5 (Reuters) - Commercial Bank of Ceylon said on Friday its total risk would be $8.93 million if Sri Lanka's top court permanently suspends an oil hedging contract, news that helped drive its shares down more than 6 percent.

The island-nation's top listed private lender is one of five banks in an oil hedging deal with state-owned Ceylon Petroleum Corp (CPC), among them CitiBank, Standard Chartered , Deutsche Bank and state-owned People's Bank.

'If the suspension of payments continues, our liability under our contract to make payments to our back-to-back market risk counterparty would total $8.93 million,' the bank said in a statement to the stock exchange.

By 0738 GMT, shares in Commercial Bank plunged nearly 7 percent to 69.25 rupees a share, their lowest in more than three years. The stock later pared some losses to 6.4 percent.

The hedging deal had been planned in expectations that oil prices would hit $200 per barrel, CPC officials have said.

Now in the range of nearly $44 per barrel, oil prices are hovering around their lowest levels in nearly 4 years, and about $100 off a record of more than $147 struck in July.

On Nov. 28, the country'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 under a 'zero cost collar' contract.

The bank has an outstanding West Texas Intermediate (WTI) crude oil hedging contract with CPC, due to expire on June 30. The bank based its estimate on an exchange rate of 110 rupees per dollar and a WTI price of $48 a barrel.

Other banks in the contract refrained from commenting.

CPC said on Nov 10 it had hedged 30 percent of its 2.5 million barrel crude oil imports until end June 2009 with the five banks on 'zero-cost collar' deal.

Last month, the bank reported a nearly 7 percent rise in group net profit to 937.5 million rupees ($8.5 million) in the quarter to September from a year earlier.

($1= 110.10 Sri Lankan rupees)

(Reporting by Shihar Aneez; Editing by Clarence Fernandez) Keywords: SRILANKA COMBANK/HEDGING

(shihar.aneez@thomsonreuters.com; +94-11-237-5903; Reuters Messaging; shihar.aneez.thomsonreuters.com@reuters.net)

COPYRIGHTCopyright Thomson Reuters 2008. All rights reserved.

http://www.tradingmarkets.com/.site/news/Stock%20News/2070169/

INDIAN OIL CORP'S SRI LANKA UNIT SAYS OIL DERIVATIVE EXPOSURE MANAGEABLEMon. December 08, 2008; Posted: 01:41 AM

COLOMBO, Dec 08, 2008 (AsiaPulse via COMTEX) -- IOCOF | Quote | Chart | News | PowerRating -- The Sri Lanka unit of the Indian Oil Corporation (IOC) (BSE: 530965) has unwound some oil derivatives it bought earlier in 2008, but is left with 70,000 barrels worth of deals that will expire next year, a top official said.

Lanka IOC says it has also bought downside protection for the deals at different levels for remaining contracts. It has 10,000 barrels outstanding with Commercial Bank and the balance with Citibank.

"We wound up some contracts. We bought protection at different levels," managing director R Ramakrishnan said.

"The majority of contracts expire in June and July and some in August."

Lanka IOC imports about 300,000 barrels of refined products a month.

Ramakrishnan says the remaining contracts include ones based on WTI oil at around 90 US dollars. There was also protection at 70 dollars.

"We did a lot of balancing," he said. "It is manageable."

Sri Lanka's petroleum and banking sector is in turmoil after the island's Supreme Court halted payments to banks from state-run Ceylon Petroleum Corporation (CPC), on oil derivatives to Citibank, Standard Chartered, Commercial Bank and state-run People's Bank.

Lanka IOC says it is honoring all contracts.

Lanka IOC had bought protection in consultation with banks by paying a premium, though oil prices have now fallen further.

CPC however had no permission to pay premiums, because it was limited by the cabinet to 'zero-cost' instruments.

In Sri Lanka, banks have been blamed for selling a complex product with no downside protection or a 'knockout'. But the derivative is based on a structure used in securities markets known as a target accrual redemption note (TARN).

They are also known as leveraged target redemption forwards or swaps. The attraction for an oil distributor was that it was 'zero-cost', or no payment was involved. But it got 'knocked out' after accumulating about five dollars a month a barrel for three months.

Under a 'zero-cost' structure, the oil distributor wrote an option, earned a premium and used it to buy an option giving upside protection.

The upside risk was capped for taking on a downside risk. By doubling the downside risk (leveraging) the upside benefit could be increased.

The contracts were also 'in-the-money' or profitable from the start. Analysts say such benefits cannot be given without taking substantial downside risks.

Leveraged target redemption forwards have resulted in spectacular losses in recent turmoil, including at CITIC Pacific, a Hong Kong-listed Chinese firm. CITIC Pacific lost on a forex deal, rather than commodities, when the Australian dollar plummeted.

CITIC Pacific said in a stock exchange disclosure that, under Hong Kong accounting rules, leveraged forward contracts did not qualify for hedge accounting and had to be marked-to-market resulting in hundreds of million of dollars in losses.

International accounting rules says 'hedges' could be adjusted against the balance sheet to reduce the impact on the profit and loss account. Non-hedges have to be marked-to-market and taken to the profit and loss account.

Under 'hedge accounting' a derivative can be adjusted against the balance sheet and only the un-hedged portion brought to the profit and loss account.

Lanka IOC's Ramakrishnan said he was not able to comment on the accounting treatment of the derivative exposure without checking with the finance department.

In an interim ruling court also said oil imports will have to be done by the government of Sri Lanka. Lanka IOC is a public listed 'private' firm ultimately controlled by the Indian government.

In Sri Lanka, petroleum prices are set by politicians and not a price formula. As a result, oil distributors did not have a certain future retail price to 'hedge' against. However a price formula is expected to be presented to court on December 15.

On Friday the government said the retail petrol price has been brought down by 20 rupees a litre to 122 rupees. The Singapore wholesale price of refined petrol is only 25.50 rupees a litre according to Central Bank data.

Analysts say even if oil distributors did not use exotic products and only used straight forwards, they would have been hit by a clamour for price reductions.

In that scenario analysts say the only reasonable hedging instrument Sri Lankan distributors could use were plain options.

But options require up front money, which Sri Lanka's cabinet did not allow CPC to do under its mandate.

State-run CPC was originally advised to use oil derivatives by Sri Lanka's central bank from a foreign exchange perspective.

The central bank said in a statement Friday it advised the government to hedge because it believed a rising oil bill would "exert severe pressure on Sri Lanka's balance of payments and the exchange rate."

But economists have pointed out that balance of payments crises develop from central bank 'accommodation' (or money printing) of forex outflows, to defend a dollar peg, in a process known as 'sterilized intervention.'

Sri Lanka had no foreign exchange 'shortages' until a central bank was created in 1950, abolishing a currency board that had kept the currency stable under colonial rule.

Sri Lanka is now in the middle of a severe balance of payments crisis despite oil prices plummeting, due to central bank peg defence, and sterilization of reserve losses.

The International Monetary Fund has already advised Sri Lanka to abandon its peg.

CPC went in for exotic derivatives structures because it was not allowed to pay premiums to buy plain vanilla options or forwards by paying a premium and was confined to 'zero cost' instruments which compelled it take on a downside risk to get upside protection.

To get more upside protection and an 'in-the-money-position' where it got protection around the spot price it had to take more downside risks.

Court said total payments under the derivatives could be over 600 million US dollars for CPC, under current prices quoting documents submitted to court.

(LBO)

http://www.zibb.com/article/4787636/SRI+LANKA+OIL+HEDGE+CASE+INTERIM+ORDERS+CEASE+TO+BE+OPERATIVE+COURT

SRI LANKA OIL HEDGE CASE INTERIM ORDERS CEASE TO BE OPERATIVE: COURT

COLOMBO, Jan 28, 2009 (AsiaPulse via COMTEX) --

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.

(LBO)

Copyright (C) 2009 Asia Pulse. All rights reserved

News Provided by COMTEX

http://www.abcmoney.co.uk/news/07200719137.htm

Sri Lanka to hedge oil purchasesPublished : Wed, 07 Feb 2007 06:55 By : Agencies

COLOMBO (XFN-ASIA) - The government said it plans to stabilise its oil bill by hedging payments through several foreign banks. The country has forecast this year's oil bill to hit 1.8 bln usd. Three foreign banks with local branches -- Citibank, Deutsche Bank and Standard Chartered Bank -- have been hired to hedge up to 25 pct of Sri Lanka's total oil purchases for a six month period. 'If oil prices go up from 72 dollars to 77 dollars per barrel, the banks will pay us 5 dollars. If it goes down to 68 dollars a barrel, we will pay the banks,' Petroleum Minister A.H.M. Fowzie said. 'We will first start by shortly hedging diesel imports because we use around 4,000 tonnes a day,' he said. 'We are currently buying diesel at 70 dollars a barrel, with six month prices fixed at around 72 dollars a barrel,' Fowzie said, referring to prices for futures contracts. Sri Lanka imports around 2.2 mln tonnes of crude oil each year, mainly via long-term contracts with Iran, Saudi Arabia and Malaysia, based on monthly price averages. 'Long-term contracts are good for us, it gives us security. Sometimes we even buy through concessionary credit lines,' Fowzie adds. 'We are looking to save around 300-400 million dollars on our oil import bill this year,' Central Bank governor Nivard Cabraal said.

afp

http://sundaytimes.lk/081214/FinancialTimes/ft310.html

The Sunday Times: Sunday December 14, 2008

Hedge now – in a proper way

By D. Kulasiri RanaweeraHats off to The Sunday Times for blowing the lid off the disastrous CPC hedging fiasco. Your paper exposed the amateurish, unethical and sleazy nature of this deal and the subterfuge used to dupe the Nation and the dreadful drain it would be on our meagre foreign reserves. However, while the post-mortem is still going on, let me be the devils advocate and extol the virtues of hedging and disclose a window of great opportunity. It will not be prudent to discard the entire concept of hedging on one bad experience. Even the critics of the ‘dodgy-deal’ and the Central Bank, with their newly acquired wisdom - after closely witnessing the ‘phenomenon of hedging`- accept that hedging can be beneficially utilised to secure assurance against future price increases on oil, the most volatile of commodities. Most of the major airlines abroad have used hedging wisely for quite some time to successfully arrest the fluctuating volatility of oil prices.

The benefit of hedging is most heightened when a volatile commodity is ‘pegged’ at its lower-end. You reap the benefits when the price begins to climb. With oil at around 45 to 55 dollars a barrel at current rates, now is the time to hedge rather than wait until it rises again. We should be able to hedge oil at 60 to 65 dollars a barrel for two years with a renowned International Energy Trading firm (since local banks do not posses the potency or the financial ‘clout`) in Geneva or Amsterdam via a reliable broker probably from Singapore.

The hedging method used could be the now favoured ‘Option- Premium Model` or even the wrongly derided and vilified ‘Zero-cost-collar method` with proper ‘downside’ escape clauses in place. It is unfair to blame Zero-cost-collar method - which is cheaper to initiate - for the` debacle’ the CPC brought on itself by entering into an agreement heavily ‘loaded’ in favour of the banks and to the detriment of the nation. The agreement was so one-sided that even the two banks agreed unusually to renegotiate the `hedge’ halfway into the contract and opted to accept reduced payment. Even J.P.Morgen, the renowned international investment bank, intervened accepting the flaws in the agreement. It even violated our own Central Bank code of practice and kept CPC`s own board of directors in the dark. Given these mysterious circumstances some even profess that the Bribery Commissioner should have a say.

Although the recent surge in oil prices were halted abruptly by the world monetary crisis and the ensuing ‘meltdown`, the natural tendency for oil prices is up than down. Oil price behaviour for the last two years - bar the last three months - confirms this. In January 2007 the barrel price was just below $60 and climbed rapidly to around $95 by December and then to that unprecedented $147 by the end of July 2008 and remained around these levels until September. Within a few months, when financial rescue packages worldwide take effect and help to turn the tide, the oil price will begin its customary climb. Saudi Arabia recently demanded its ‘pound of flesh` by stating that it wants the oil price at $75 a barrel and opted to reduce production forthwith.

Although the temporary lack of demand is halting the surge, its only a matter of time that it will creep up again. Hence, I firmly believe that the new CPC leadership under the guidance of the Central Bank and consultation with competent advisors use this narrow window to its advantage and hedge now. The Southwest Airlines fuel hedging programme which it conducted when the oil price was down at 20 dollar a barrel in 2001 was a great example of this strategy. The ‘hedge’ helped them to peg the price of a barrel at $26 a barrel in 2005; $32 in 2006; $31 in 2007, and $35 in 2008/09. So hedge now or repent .

(The writer is a London-resident financial adviser who returned to Sri Lanka recently and witnessed the saga of hedging unfold).

http://www.sundayobserver.lk/2007/08/19/fin05.asp

Sunday Observer: Sunday, 19 August 2007

Petroleum Corp, Citi in hedging contract

The Ceylon Petroleum Corporation (CPC) has entered into a hedging contract with Citi to

manage the price volatility and provide relief for a part of its oil imports.

It is difficult to predict when oil prices will increase or decrease as geo politics play a major role.

Therefore hedging will keep the prices down within the next six months.

Under the agreement Citi will hedge 100,000 barrels of crude oil and diesel imported by CPC.

This will help CPC to save valuable foreign exchange and also give subsidies to the people and

organisations such as CEB.

Country Head and CEO Citi Sri Lanka Dennis Hussey said that the CPC plays a vital role in Sri

Lanka's economy as one-fifth of the country's imports bill consist of oil.

Therefore we are very happy to be involved in this trailblazing hedge as this will help reduce the

oil price. Presenting the cheque for US$ 772,500 to CPC Chairman, Asantha De Mel, Hussey said

this money goes to the people of Sri Lanka and it is very rare that a Sri Lankan corporation

adopts these innovative methods. It is a way forward if inflation is to be curtailed.

Product Specialist Citi Singapore, Anath Doraswamy described the hedge as trailblazing adding

that prices will drop because of the hedge.

He said the future goal of Citi is to move into commodities in a big way in the markets we

operate. Economies are driven by commodities and therefore if commodities are hedged it

reduces inflation.

De Mel said that the CPC has the option of adjusting the hedged price as well, which is a big

advantage for us. He said that the Central Bank is concerned with the impact of the high oil

prices on inflation and called upon the CPC to look at ways to reduce the risk. One option was

fuel hedging.

This tie-up was a result of it, he said. He said that prior to this they did a crack margin hedge

with the Standard Chartered Bank for six months as well.

He said that the CPC only hedged diesel and crude oil because they did not see the need for

hedging petrol.

Citibank N.A. Sri Lanka branch commenced operations in December 1979 as a full service branch

of Citibank N.A. New York and has been a part of Sri Lanka's active financial market since its

inception.

CPC, the national oil corporation (Refiner and Retailer) is fully owned by the government.

Sri Lanka is a net importer of crude oil and refined petroleum products with an annual demand

of approximately 3.8 mln metric tonnes. CPC commands a 80% market share of the downstream

petroleum market (refined products including petrol, diesel and jet kerosene). CPC 's refinery

provides 50% of its own sales volume and caters to about 40% of the annual demand in the

country.

S.G

http://www.island.lk/2008/11/16/editorial.html

Oil hedges

Ceylon Petroleum Corporation Chairman Asantha de Mel last week told a press conference, hurriedly summoned to explain the losses CPC had taken over oil hedging contracts, that had the corporation not hedged and prices had gone up and not down, his neck would surely have been on the chopping block. Nobody would dispute this argument. When hedges worked in favour of CPC, the corporation was not shy about publicizing its achievement and the public was treated to a picture of a fat cheque for something like five million dollars being collected. It is very much a part of human nature to crow about successes and maintain a stony silence on failures. By last Sunday the news was out that CPC’s losses on hedging when oil prices plummeted was in the range of USD 27 million in October. But if profits made on previous hedges are taken to account, the net loss up to end October at USD 9 million was a third of that. Given that the oil market is yet on a downward roll, it looks like these losses will mount further this month.

De Mel socked home the point that whatever CPC’s hedging losses were, the country was benefiting hugely from the falling oil market. That too is something that nobody can or will dispute though the public, of course, has a quarrel with the government that the full benefit of the fall in prices has not been passed to the consumer. The government has countered that oil prices, particularly of kerosene and diesel, have long been subsidized and CPC has to recoup at least some of its losses now that the falling market has offered it a window of opportunity. There were reports that the corporation had defaulted on the payment of its hedging losses to the banks. This was strenuously denied both by the CPC Chairman as well as the CEOs of both Standard Chartered and Citi Banks, the main providers of hedging instruments, who were associated with de Mel at the news conference. The CPC chief made the point that given the profits he was making in the current market, he had no need to default. Also, default by a state-owned enterprise like the Petroleum Corporation will have serious implications for Sri Lanka’s national debt rating and this is something that all concerned will be too well aware of.

Simplistically, hedging can be likened to an insurance policy a motorist will take on his car. He will be paying the premium to the insurer and if no claim arises for several years, he may well consider such payment to have been wasteful expenditure. But should his car be wrecked in an accident and is a total write-off, having carried comprehensive insurance would be a Godsend rather than just a saving grace. So hedging, like insurance, is a measure of prudence where profits and losses depend on imponderables – will you meet with a serious accident as in the case of your motor car or the oil market move against you or in your favour as in the case under discussion. Merely because oil market movements have hit lows that even the best experts did not predict and caused hedging losses, CPC should not be faulted for its decision to hedge a relatively small 30% of its purchases. But big questions remain on whether the best possible hedge had been obtained and, most importantly, whether Sri Lanka has the necessary expertise to get what it needs through negotiations with more knowledgeable and sophisticated bankers whose eyes are fixed firmly on their own bottom line? There are many doubts on this score.

No clear answer was forthcoming at last week’s news conference on the kind of profits the banks had made on hedging. A reporter raised a pointed question on this subject pointing to published profit growth of one bank but de Mel, saying that the banks were really ``matchmakers’’ in this business, implied that there were no big bucks to be made by the banks on this score. Be that as it may, what is clear is that the kind of sophisticated expertise necessary for operations such as this does not seem to be available at CPC. Banks like other businesses are not into philanthropy and can be counted on to be hard-nosed in their quest for profit. As we have reported in this issue, the Central Bank had given the banks some directions into the parameters on which oil hedging could be done and are now checking on whether there had been strict compliance on this score by the banks that offered the instruments.

Everything that was said at the news conference, where de Mel did most of the talking, was indicative that relations between CPC and the banks are good if not cozy. He confirmed that his corporation was not contractually locked into a situation which would cost it hugely in the currently falling market and exit options are being looked at. Also, it is unlikely that the present oil prices favouring the buyer is for all time. The global financial meltdown played its own part in pushing down prices with paper traders in the various oil exchanges taking a heavy blow. Nevertheless, we must not forget that the Lanka Indian Oil Corporation (LIOC) which is the second player in Sri Lanka’s petroleum distribution market appears to have done better than

CPC in its oil hedges. It is well worth knowing whether this was just a matter of luck or greater sophistication and expertise. We would tend to tilt to the latter point of view. We lack expertise in many areas and it is necessary that we maximize our resources to meet the many challenges that confront us every day.

http://economictimes.indiatimes.com/News/Economy/Finance/RBI_grants_refiners_to_hedge_oil_inventories/articleshow/2564914.cms

RBI grants refiners to hedge oil inventories

The Economic Times23 Nov 2007, 1519 hrs IST, REUTERS

NEW DELHI: RBI has granted state refiners license to hedge half of their oil inventories for the first time, helping stabilise earnings amid high and volatile prices, company officials said on Friday.

By buying and selling crude oil and fuel swaps or futures, refiners such as Indian Oil Corp can mitigate the chances of a fall in global prices reducing the value of their stockpiles, which would cause profits to appear lower.

In its mid-term appraisal of credit policy last month, the Reserve Bank of India (RBI) granted a long-standing request of refiners to hedge 50 per cent of their inventory in international markets to limit earnings volatility.

It later clarified that the 50 per cent limit applied to volumes for the preceding quarter, not value of the holdings. "We will seek board approval by the end of this month or early next month. We hope to begin OTC sale of our inventory by January," IOC's director of finance S V Narasimhan told media.

He added that IOC would likely use over-the-counter (OTC) swaps rather than trading directly on international exchanges such as the New York Mercantile Exchange (NYMEX), host to the world's most active oil futures contract for US light, sweet crude. "It requires lots of procedural activity to trade on these exchanges, you have to trade daily... OTC is a fixed period, so right now we have no plans to trade on these exchanges," he said.

IOC normally keeps inventory of 7-8 million tonnes (nearly 60 million barrels), enough to meet about 15 days of demand and worth an estimated $6 billion at current prices.

CUSHION

With oil prices swinging widely - crude is up more than 40 per cent since mid-August - refiners are exposed to sharp rises or falls in the value of their stockpiles over the quarter. "This will enhance their operational efficiencies. It will be a cushion to the companies facing revenue

losses because government fixed prices," said Rohit Nagraj, research analyst with Angel broking. Bharat Petroleum Corp says besides managing its inventory risk, the new guideline will also help its Indian clients lock in a fixed price for future oil product deliveries.

"It will be possible for us to offer Indian customers structured products for naphtha, fuel oil, and aviation turbine fuel for managing their cost better," its director of finance S K Joshi said. "We will enter into simultaneous back-to-back contract with OTC, or ICE or NYMEX," he said.

Indian state-owned refiners, who operate two-thirds of the country's 2.8 million barrels per day capacity, have also been cleared since last year to hedge a small portion of their overall refining margins, allowing them to lock in profits years ahead.

"This year we target to hedge 5 percent of our total production, around 2.25 million tonnes, next year we hope it will be around 10 percent," Narasimhan said.

Indian officials declined to say which banks they would choose to help hedge their fuels, although the growing demand for risk management tools is a boon for giants such as Morgan Stanley, Barclays Capital and Citibank. Air India was allowed to hedge its jet fuel prices for the first time last year, while Sri Lanka was the first Asian country to attempt to protect itself from rising costs with derivatives.

http://www.srilankanewsfirst.com/General/8215.html

People’s Bank, ComBank affected, not SCB or Citibank over oil hedge-FitchEditor on 29 December, 2008 07:56:32 | 374 times read

Fitch Ratings Lanka said today People’s Bank and Commercial Bank will be affected by the suspension of payments in the controversial oil hedging agreement with the Ceylon Petroleum Corporation (CPC) unlike Standard Chartered Bank (SCB) and Citibank who could receive support from their overseas headquarters over the payment issue.

In this context, Fitch said the national long-term ratings of Colombo branches of SCB and Citibank have are not affected. While the final court decision will not be known until early 2009, Fitch's view is that timely support would be made available to the two foreign banks from their respective head offices in order to meet their depositor and creditor liabilities in the event such support is needed; given that they are both branches and part of the same legal entities as Citibank N.A. and SCB, respectively. This support is, however, dependent on any regulatory restrictions or delays in remitting money into Sri Lanka, none of which is envisaged at the moment. In the case of People's Bank (PB) and Commercial Bank (CB), the two local banks are exposed to counterparty default risk. Acting as intermediaries, these 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.

Fitch said 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. It said 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.

http://www.lankatimes.com/fullstory.php?id=13112

CPC hedges on its hedges?

At a swiftly-organized press conference on Monday that was organized in the wake of mounting public interest, Ceylon Petroleum Corporation (CPC) Chairman Asantha De Mel took great pains to explain the situation regarding the oil price hedging issue that has involved several institutions since the Financial Times comprehensively broke the story last week in our ‘Special Report’. Also present were the Chief Executive officers (CEOs) of Standard Chartered Bank; Clive Haswell, Citibank; Dennis Hussly and the Managing Director (MD) of Commercial Bank Amitha Gooneratne – the three banks that had offered CPC hedging solutions, and DGM Finance of CPC Lalith Karunaratne.

De Mel categorically denied that the CPC was in debt to any bank due to any inability to honour hedge fund agreement products running into millions of dollars. These products had been floated by several banks including the Standard Chartered Bank (SCB), Citibank, Commercial Bank, Deutsche Bank and the Peoples’ Bank, though the brunt of the deals concerned only the foreign entities (one local bank had turned it down as it felt the risk too high). (In our analysis of November 5th, we understood that Standard Chartered was the lead bank and information on others - as indeed the full extent of CPC’s hedging - was both patchy and conflicting). The CPC Chairman stated (and in a joint press release several present banks corroborated) that the payment deadlines had not been breached although market and media sources earlier had spoken of missed deadlines; De Mel himself mentioned a “small delay” with regard to a Citibank payment which he dismissed as “just a day’s”.

Cabinet Framed the CPC’s Hedging Mandate

The CPC Chairman outlined that it had been actively involved in hedging operations since February 2007 but insisted that it was “not out to make profits” or squander national foreign exchange on such efforts. De Mel pointed to his remit from Cabinet where the latter had specifically ordered the CPC to “undertake a zero-cost option” and not, as we had queried in our report, any other available (safer and more transparent) tool such as futures options via international exchanges. His main point was that it was, in his view, not possible to hedge on the

upside of oil price increases as well as the possible downside: “You can’t have your cake and eat it” the CPC Chairman asserted. The Cabinet was concerned about rising prices and so the CPC’s hedging arrangements were geared to limiting risk here, while at the then state of market information, CPC only anticipated a downside of a $90 floor at most - not the $60 levels seen recently. Moreover, why the Cabinet might have forced a zero cost option was not known, although it seems that the Government might have baulked if it had been asked to pay what CPC terms as expensive premiums if a non-zero cost option - perhaps a futures option - had been promoted instead.

The political unviability of this was something De Mel pointed out, meaning the common man would have been aghast at the thought of spending precautionary millions in advance. The FT is not entitled to view the relevant Cabinet paper; we note that the CPC press release talks of “Amongst other things, CPC is permitted to go for zero cost structures…”.

It is clear as we have outlined last week that the CPC could not have reliably predicted oil price increases or drastic decreases like a clairvoyant.

It is also clear in the FT article that no expectation of CPC being accused of “profit-making” was made; we believe CPC and its Chairman tried to act in good public interest though not necessarily transparently. The issue at stake was the cost of the 30% of oil imports hedged by CPC and whether adequate care – either by the Cabinet or CPC – had been taken as prudently informed entities on limiting the downside of sliding oil prices. De Mel’s counterstatement that the rest of our 70% oil imports benefitting from low current prices is well taken, as this may average out our total bill; however the issue of the cost of the 30% still remains.

But Banks Slow to Change Terms?

All contracts must also account for an exit strategy upside or downside: we were told that CPC did voice this concern to SC in late 2007 but it was unclear why SC had not gone out of its way to offer an exit option earlier, nor why CPC had not got one done. The only possible explanation is - as de Mel reiterated several times- he did not want to become a scapegoat if he exited his hedge and then found that prices increased dramatically. In other words, the upside risks was greater than potential exiting when things were going badly with falling prices.

In the FT analysis, we pointed out that it was an ethical duty of banks to ensure that institutions such as CPC or Cabinet that went in for hedge products from private banks clearly understood what they got themselves into as national resources were involved. In the joint bank statement issued on Monday, it says: “We wish to clarify that no mis-selling (a curious word and not mis-spelling- FT) was made on the part of any of these banks. As with all products sold by us, customers are provided the fullest awareness on the product as well as downside risks.” While the intentions of banks are often honourable (and we note that the CPC Chairman himself took special effort to support the actions and sentiments of the banks offering him these hedge solutions), it is not possible to judge here how fulsome their explanations have been, to whom and when. A cautionary Central Bank document (Financial Derivative Products) of July 2008 (after some deals were done) does raise a rather timely warning: “All dealers should ensure that Board of Directors of corporates clearly understand the risks of the instruments and draw up/lay down adequate plans…to mitigate the risks.” The recommendations formed by the special

government Sub-Committee which advised on this subject is also said to have been made in 2006, rather a long time ago in view of very fast changing financial circumstances globally. “The structures that have been offered to our clients are in line with what has been allowed by the Government.” Oh, alright then.

Tightlipped Bank Profits on Oil Deals

At the press conference, the foreign banks, Standard Chartered Bank and Citibank (which it was revealed had hedged 300,000 and 400,000 barrels of oil respectively) remained tight-lipped when the Financial Times pointed out that the Standard Chartered Bank published a 145% profit increase from “Non-interest foreign exchange commission” (Rs 702 million) for the six month results ending June 2007 versus June 2008. We were not able to obtain what percentage of this extraordinary profit might have come from hedging with CPC - or indeed if any other non-CPC institutions were involved. Allegations on Sri Lankan airlines are floated and the Bank on Thursday intimated multiple hedges taken place and some were “under discussion”. The CPC Chairman, when asked about large profits made by the foreign banks on hedging, stated broadly that “maybe it [profits - FT] came from some other avenue” and that the banks did not want to undertake “unnecessary risk”. While we do not expect banks to divulge exact numbers, it is doubtful if banks would enter into deals that are unprofitable or marginally profitable or indeed at a social cost, especially foreign banks that only recently advertised as priding themselves on aggressive exchange profiting activities. Commercial Bank, the only local bank present and one with a large local business footprint, had undertaken a very small hedge (20,000 barrels) and thus is not engaged in making significant profits from hedging.

At the end of this press conference, Standard Chartered Bank CEO Clive Haswell re-emphasised that the CPC had not defaulted on any obligation to any banks and spoke of rigorous internal ethical vetting of their sales products (hedging packages). He went onto highlight that Sri Lanka had never yet defaulted on any “sovereign” payment and seemed to remind us of the gravity of it breaching international norms.

Quite what this means is uncertain although it is clear to the banks present as well as those players involved that hedging issues and packages will not be taken lightly by the government or the general public. While banks are respected institutions in this country, the current behaviour of irresponsible entities abroad do not endear any foreign or local institutions here overreaching their pockets when scarce foreign reserves are at stake.

A Lack of Transparency

The issues we have highlighted in the FT Special Report have, with other subsequent newspaper media, made public institutions aware of possible lacunae in decision making. It further remains that a far greater transparency be offered especially by our public institutions, the CPC included, when resources are at stake and we urge CPC - and the Government - to be open and honest. As a public corporation perhaps CPC’s and the banks’ official assertions of rigorous scrutiny of hedging options can be shown in some more transparent and accessible ways. Mistakes, we feel have been made, but it may be time for the players to move on. The CPC Chairman himself ended the press conference on a brighter note that it was possible “now” to look at some new options to the existing hedging agreements to save money (hedging plus paying premiums).

Industry sources also suggest that some banks were talking of newer cost saving hedging products, a possibly convenient face saver. Remember Orange County

In all fairness, this episode has put the CPC and its Chairman between a rock and a hard place in a national issue. In its press release, the CPC states that the “CPC is committed to make the payments as and when they fall due. There is no question of defaulting on these payments. A default by CPC will be as good as a sovereign default, which could have serious consequences…” While we agree, we can also remind CPC of the bankruptcy of Orange County in Southern California in 1994 to the tune of $1.6 billion due to a hedging of that county’s investment portfolio that went unexpectedly wrong (-a wrong-way bet on interest rates). This constituted the largest financial failure of a local government in US history. The County successfully sued Merrill Lynch, KPMG, Morgan Stanley Dean Witter and nearly 30 other securities houses, accountancy and law firms for misdirected advice give to officials who were not sufficiently knowledgeable about the instruments they were sold and not adequately regulated or overseen. Merrill Lynch was held most responsible for steering the County’s (financially unsophisticated) Treasurer (who claimed he had been misled about the riskiness of the instruments) towards what the County deemed were risky and unsuitable securities. Merrill Lynch finally agreed to a $400 million settlement to avoid further litigation, with many other institutions also paying up. With these payments (over $864 million), the County was eventually able to resettle much of its creditors and although it still had to repay debts for years to come.

Source :dailymirror.lk

http://newshopper.sulekha.com/newsitem/apnews/2008/12/sri-lanka-dispute-over-gas-price-creates-shortage.htm

Sri Lanka: Dispute over gas price creates shortage

COLOMBO, Sri Lanka (AP) — The Sri Lankan government ignored a Supreme Court order to reduce state-set gas prices, declaring Friday that soaring fuel prices would remain unchanged.

The standoff between the court and the government has created an artificial fuel shortage and long lines at the pump.

Many filling stations, unsure what price to charge, did not fill tanks Thursday, fearing they would end up buying gas at the higher price and be forced to sell it at the court-ordered discount. Stations across Colombo ran out of fuel, and lines stretched into the streets for those that had some left.

The government, expecting oil prices to continue climbing, agreed earlier this year to buy all of its fuel at the price of $134 a barrel until next summer. In recent months, however, the price of oil has plummeted to under $50 a barrel.

A recent document submitted in court estimated the deal could cost as much as $775 million, economist Harsha de Silva said.

With oil prices plunging, the Supreme Court ordered the government Wednesday to immediately reduce the state-set price of gas from 122 rupees to 100 rupees (about $1).

But instead, the court's efforts have created a black market that sent the price in some places skyrocketing to 145 rupees a liter.

The government ignored the order, with Trade and Consumer Affairs Minister Bandula Gunawardena saying the Cabinet can't act because it never received an official copy of the court order. The court has said it delivered the ruling to the appropriate government officials.

Chandana Alutge, a university teacher, said he stopped driving his car because of the shortage.

"This is not good for the country," he said.

The opposition United National Party claimed the government won't reduce the gas prices so it can use the extra profits to cover the losses from the oil hedge.

The court has made no comment on the dispute.

Posted: 3 months ago (2008 / 12)Copyright 2008 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed

http://topics.myjoyonline.com/business/200711/10347.asp.

Gov’t to hedge crude oil pricesLast Updated: Monday, 12 November 2007, 12:80 GMT

Government is exploring the possibilities of hedging crude oil prices, as part of measures to minimize the impact of the risk of exposure to world crude oil prices on the economy.

With the spate of rising international crude oil prices amidst speculations that the price would cross the all time US$100 per barrel mark before the close of the year, government thinks it is time to explore the grey area which is extensively harnessed by countries in Europe and Asia, and the US.

At a roundtable discussion in Accra supported by Standard Chartered Bank (Stanchart) on the topic, "Why Derivatives are the Next Step in the development of the Financial Markets in Ghana," stakeholders drawn from government, opposition, private financial and business sectors agreed to put in all necessary structures and systems to support the development of the derivatives market in Ghana.

Hedging is a financial instrument that can be used by government or the private sector to minimize the risk of exposure to commodity prices, equity prices, interest rates, and exchange rates.

In his address, the Minister of Finance and Economic Planning, Kwadwo Baah-Wiredu noted that the outlook for the economy remains positive, considering its resilience to the recent energy shocks, buoyant commodity sector and GDP growth set to hit the budget target of 6.5 percent, except for the exposure to the soaring crude oil prices.

The surge in the crude oil prices is expected to continue, as OPEC has projected decline in production, to be caused by falling output in Mexico and Brazil, the geo-political tension between Turkey and the Kurds and, US sanctions against Iran.

It has also projected demand for crude oil to increase by 100,000 barrels per day in the fourth quarter, due to stock piling for the winter season.

At its last review last week, the Monetary Policy Committee (MPC) of the Bank of Ghana (BoG) increased the prime rate to 13.5 percent after maintaining it at 12.5 for three consecutive times, the reason being the threat the crude oil prices pose to domestic price levels.

"With the gloomy overhang, the time cannot be riper for Ghana to begin exploring hedging crude oil prices, which I believe when well managed, would accrue tremendous gains to consolidate micro and macroeconomic stability," Mr. Baah-Wiredu said.

The CEO of Tema Oil Refinery (TOR), Dr. K. K. Sarpong, outlined the areas where hedging is needed at TOR as interest rates, foreign exchange transactions and crude oil prices.

"TOR spends at least US$100 million monthly on crude oil purchase, where are we going to get that kind of money from," Dr. Sarpong asked, indicating the need for hedging.

He said the company has not hedged because of its Board's knowledge of distasteful experiences at the Ghana National Petroleum Corporation (GNPC) and Anglogold Ashanti (formerly Ashanti Gold Fields).

In 1998, Anglogold Ashanti hedged 600 ounces of its 1.5 million annual production for 20 years, betting that the price of gold will continue to fall over this period. It turned sour as gold prices rather picked up. Presently, Anglogold gets US$615 for each ounce of gold, being the average of hedge and unhedged price while the market price stands atUS$850.

Amit Juneja, a Senior Manager on the Commodity Marketjng Desk of Stanchart, Singapore explained that hedging is a risk but depending on the way it is managed, it can be very useful against volatility.

He cited a case of Sri Lanka, in June last year when the government initially resisted but upon understanding of the market operations through competent advice, decided to hedge gas oil prices through its National Oil Company, when it was by then quoted at US$60 per barrel. For him, the Ashanti Gold instrument was not managed well enough.

"Once you ascertain that you have an exposure which is linked to international prices, hedging is worth considering. However, it requires harnessing of the appropriate knowledge, competence and expertise to manage properly against the downside risk," he said.

Source: B&FT

http://www.linkingpeopletogether.com/?p=2907

Sri Lanka - Oil Deals, Banks and Self interest – But Whose

Bad decision making by the Government and potentially unethical profit taking by a foreign bank offering select price hedging solutions for Sri Lanka’s oil imports are now costing an already impoverished consumer an extraordinary Rs 16 billion or much more upto June 2009.

This comes at a time when firstly, the global financial crisis has already unseated at least 10 heads of giant American financial corporations, yet to be brought to account for unethical and supposedly ignorant banking practices which initially raised billions in profits but have now cost tax paying consumers and the US economy dearly. The international ramifications are still unknown and smoldering.

Secondly, the price of crude oil has dropped from a peak US$ 147.27 a barrel (early July 2008) to today’s US$ 60-63 levels. Yet the prices paid by Sri Lankans at the petrol station have been unchanged since May 24th 2008 at Rs 170 for premium Octane 95 petrol, Rs 157 for Octane 90, Rs 125 for Super Diesel and Rs 110 for ordinary diesel as at today. So who benefits and for how long?

Thirdly, national foreign exchange reserves are dwindling and today stand at about US$ 2.6 billion. The country can ill afford to gamble on its thinning vaults; taking protective measures through minor import exchange restrictions on October 31st may be overlooking the larger issues at stake.

To understand where Sri Lanka stands with our oil imports (imports are said to be about 30 million barrels per year in 2008: 15 million crude, the balance refined petrol and diesel), we need to be aware of the forces at work in the global oil industry (see box). Sri Lanka currently buys oil from a private company, Trafigura Pte Ltd. (Singapore) which has allegedly been linked to oil-for-food scams in Iraq, and the deals are hedged through a local branch of an established foreign bank. Though market sources say only about 30% of all oil imported is hedged, it is the cost of the hedge to the country that is an issue.

As our chart depicts, oil prices were only recently spiralling upwards, not downwards. The price of crude unrefined oil in June was about US$ 130. This triggered concern in the Cabinet and a special committee was hurriedly appointed to find solutions to the vexing question of how we finance our oil imports. The Committee duly discussed what would have been a strategic response to an issue where millions of dollars of increasingly scarce Sri Lankan foreign exchange was involved. Their decision, unavailable to the public, recommended the Cabinet to enter into an oil price hedging agreement, hedging being one of several available instruments, with a foreign bank. It is not yet clear on what basis such a bank was selected but we presume that in

the absence of a reputed local risk management unit at any government institution (despite several hedges being done todate), the chosen bank was deemed more technically aware and better able to field risk limiting hedging products. For an explanation of some commonly used risk instruments, please see our box.

Accordingly, in June, the Cabinet endorsed the hedging instrument to try insure the country against upward spiralling oil prices. The Ceylon Petroleum Corporation (CPC) signed an agreement with a foreign bank to limit the country’s exposure to volatile oil prices - but mainly upward volatility and it seems not downward! The committee, we believe, would have carefully evaluated all oil price limiting options - such as hedging, futures and exchange opportunities - available to the country under all potential circumstances for the oil market (rising prices and falling prices), been aware of tools used by other countries in similar predicaments, and fully understood the nature and consumer implications of the specific risk package that was offered by the foreign banker. Moreover, we believe that the onus would have been on any foreign bank that submitted such a price hedging financial package (or “banking product”) to fully educate the recipients on what their package cost to the country both for the upside and downside of oil price movements, as any ethical banker might be obliged to do. Sri Lanka being a small country with currently dwindling foreign exchange resources (US$ 2.26 billion), we expect that a risk solution commensurate with our means would have been selected. However, the Daily Mirror learns that this may not quite be the case.

According to market sources on the specific agreement offered by the foreign bank (details are publicly unavailable and not disclosed on the outdated CPC website), the CPC undertook a hedge solution from the assortment of international

options available. It was contractually obliged to buy crude oil at between US$125 and $145 a barrel; our purchase quantity was 100,000 barrels per month. If the price of oil went above a $145 ceiling (“cap”) set by the bank package, the CPC was entitled to buy a specified quantity only for two months at $145, thereby soon relieving the oil producer from obligations for future supply at this rate. If the price was between $145 and $125, Sri Lanka could buy at the prevailing international market (“spot”) price but in fixed quantity. Should the price drop below US$125, the “floor” price, then the CPC was obliged to buy not just 100,000 barrels per month but 200,000 barrels per month at the difference between US$ 125 and the spot price for

the balance period on contract i.e presumably June 2009, irrespective of world market prices. Any layman might question whether such contracts constitute a hedge for the country or the producer, as indeed whether it is a hedge or a gamble.

These obligations allegedly translate into Sri Lanka needing to pay US $12 million for October 2008 (being $125 floor price minus $65 spot price in October x 200,000 barrels). If prices remain for example at $65, we have to pay $12 million (Rs. 1.3 billion) x 12 months, or $144 million (Rs 15.9 billion) until June 2009. Thus on a downside in oil prices, we are potentially tied into an unfavourable deal for almost a year, deemed by hedging industry as a long time. Moreover, this is only one contract out of several presently; according to market information the total receivables for this foreign bank was $24 million dollars for October 2008.

A Very Profitable Deal

A look in a local newspaper of August 29th 2008 at the 6 months’ published P&L accounts of a foreign bank (Interest Income: Rs. 4791 million) indicates that the bank made a very commendable gain of 145% in “Non-interest Income/ Foreign Exchange Income” from Rs 484 million at June 30th 2007 to Rs 1186 million by June 30th 2008. While the bank’s entire Operating Profit for that first half of 2008 was Rs 1393 million, a full Rs 702 million (say US $6.2 million) was attributable to this one foreign exchange area. By way of parallel indication on the same newspaper, a much larger leading local bank (Income : Rs. 21,284.9 million, Interest Income Rs 17,970.4 million) with a Operating Profit of Rs 2259 million made a net gain of only 30.75% in the same accounting period, a modest Rs 253.2 million mainly from “forward foreign exchange deals done in 2008” (its footnote). While the business of a bank is to make profit in as much as the business of government is to offer its citizens a better cost of living, such foreign exchange commitments seem to be of questionable benefit to our citizens.

Bottom Line

We believe the country will need to consider very substantial foreign exchange payments over the next year as a result of these hedging deals, with possible effects on our deficit; the exact amount can not be determined due to confidentiality, lack of transparency on the nature and number of deals undertaken and the performance of oil prices in the next few months. Certainly billions of Rupees will need to be committed unless such deals are terminated or a lucky credit line becomes available as the government has enough other cash problems to boot.

• In this scenario, with local fuel prices fixed from May 24th 2008, will the Sri Lankan consumer be afforded any relief from the price he or she pays at the pump till late next year?

• There are indications that the Government may be considering some relief; the pressing question is will any price relaxations be real i.e not political, cross-subsidization or temporary relief ploys for cosmetic reasons but based on prudent good decision making?

• Indeed can the Government now afford to give relief?

• Was the Cabinet aware that it may have effectively recommended hedging the producer ?

• Will the Government be able extricate itself from binding contracts that seem to benefit the bank who promoted and negotiated the appropriate or inappropriate hedge risk product for this country?

• It is ethical for responsible banks to profitably milk the country of scarce reserves on a large scale when on October 31st 2008 the Central Bank hurriedly imposed import curbs on 44 “non-essential” items (from chocolates to electrical items) to thwart dwindling reserves ( Sunday Times headlines)? It is the small businesses that will suffer too.

• While current low oil prices (if obtained through contract) and high Lankan pump prices may help CPC cushion itself from its huge past debts incurred (Daily News, June 25 2007: Chairman CPC declares a Rs 1 billion loss), when will the ordinary consumer benefit?

http://www.lankanewspapers.com/news/2008/11/35610.html

SRI LANKA: Oil Futures Gamble Burns 300 Million Dollar Hole Monday, 24 November 2008 - 8:37 PM SL Time

The Sri Lankan government is grappling with a costly 300 million dollar payout to Citibank and Standard Chartered Bank (SCB), following a disastrous oil futures contract between the banks and the state-owned Ceylon Petroleum Corporation (CPC).

Sri Lanka`s foreign reserves -- worth around 2.7 billion dollars or the equivalent of more than two months worth of imports -- is already under pressure from the global economic crisis.

SCB and Citibank have been accused of not properly informing the state petroleum supplier of the risks involved but vehemently deny any wrongdoing. Overseas officials from the two banks have been in Colombo over the past two weeks on `damage control` visits.

Central Bank (CB) governor Nivard Cabraal said its guidelines in derivates trading had not been followed. Negotiations are now underway between the CPC and the banks to re-structure the contracts and reduce the burden on the fuel supplier.

Analysts recall that 15 years ago these two banks were implicated in a huge stock market scam following flagrant violation of the Reserve Bank of India guidelines on portfolio management services and ended up paying fines totalling 21 million dollars.

The Sri Lankan crisis came to the fore two weeks ago after newspaper reports hinted that the CPC may default on its October (monthly) payment to the banks due to a cash problem, and that the banks had not properly advised the CPC on the risks involved in the hedging contract.

De Mel then called a press conference where, flanked by the CEOs of the two banks, denied claims that the CPC planned to default while also saying the corporation was made fully aware of the risks by the banks.

After the SCB and Citibank got involved in the futures contracts, three others banks also followed suit -- on a smaller scale however - to get into oil futures contracts with the CPC.

The deals were made through a `zero cost collar` instrument where no premium is paid by the customer and the risks shared with the banks. The CPC decision to hedge on oil as a protection against volatile oil prices came in January 2007 when there was speculation in the market that oil prices would rise to as much as 200 dollars a barrel in the coming months.

Under the zero cost collar option, whenever the price rises between 100 dollars and 135 dollars per barrel, the banks pay an agreed amount (upto a maximum of 1.5 million dollars a month) to the CPC. Any fall in prices below 100 dollars (without any restriction unlike on the topside) means the CPC pays the banks.

Since January the CPC gained 24 million dollars (payment from the two banks) but lost 38.5

million dollars -- paid out just in two months -- and is set to pay another 300 million dollars (if the oil prices remain in the 50-60 dollar per barrel range) or more if it falls further. De Mel admitted that payment at current prices would be over 300 million dollars.

On Friday, the benchmark Brent world crude price fell to 46.47 dollars per barrel, a stunning drop of almost 100 dollars per barrel from 143.33 dollars on Jul. 11 this year.

According to international news agency reports, crude oil prices are poised to fall by another 15 percent in the next week while recording its lowest price since May 2005. Even though OPEC is cutting down production to stem the sharp price fall, demand growth has fallen to its lowest in 23 years due to the world economic crisis, international market analysts say.

Dayasiri Jayasekera, Opposition legislator and member of the Parliamentary Committee on Public Enterprises (COPE), described the issue as serious. `Someone must be accountable for this huge loss to the country. We will be fully questioning Asantha de Mel (chief of CPC) on Thursday (at a COPE meeting) to get to the bottom of this,` he told IPS.

Newspapers and analysts have clearly indicated that the CPC went for the wrong hedging (futures) option where the payment on the downside (borne by the CPC) was unlimited while on the topside (liability for banks) was restricted and accuse the banks of selling the wrong option and not advising the CPC of the risks.

Upul Arunajith, a derivatives specialist based in Canada, told IPS over e-mail that if the wrong instrument is used, the hedge will sooner or later go in the wrong direction and will lead into a crisis. `This is what happened in this case.`

Arunajith, a Sri Lankan who initially made a proposal to the Sri Lankan government at the end of 2002 to introduce hedging, said that there were warning signals that the zero cost dollar instrument was the wrong strategy. `I had personally informed them of the impending disaster, he said. Neither SCB nor Citibank are specialised energy traders nor do they have the wherewithal to provide a hedge to the CPC for a huge exposure of two billion dollars .

At de Mel s press conference Citibank chief Dennis Hussey said the Sri Lankan government started the hedging process following a special cabinet approval, which has been carefully documented.

SCB s Sri Lanka chief Clive Haswell said the bank had received a written undertaking from the CPC that the latter was aware of the risks.

But CPC s board of directors said no such undertaking was given and are blaming de Mel, a political appointee and associate of President Mahinda Rajapaksa and Petroleum Resources Minister Mohamed Fowzie, for taking decisions without full board authority.

Issues of impropriety are also surfacing with claims that some CPC officials got `favours` from the banks. Attorney General Priyadas Dep told The Sunday Times newspaper that his department -- which normally scrutinises state contracts to check its legality -- was not consulted.

As pressure mounted on the government, Rajapakse summoned de Mel for a meeting. A Parliamentary committee had also summoned de Mel for a hearing but the latter did not turn up, requesting time for proper preparation.

Political observers say while de Mel and the finance minister must take the rap for undertaking to use a hedging option where the downside risks were greater, the powerful CPC chairman`s political connections will come to his rescue.

This was clearly seen when CB officials, who had initially threatened to rap the banks for not following guidelines, seemed to relent later under pressure and are now guiding a re-negotiation of the payments.

As demands are being heard from some sections of the government to default payment on the basis that the banks misled the CPC, pressure has been mounting to pay up or face international repercussions.

Market analysts said that the two main foreign banks have hedged these instruments with the New York Mercantile Exchange (NYMEX). `Any default to the NYMEX by the banks will be perceived as default of a sovereign debt which will be disastrous to the country`s international rating and jeopardise Sri Lanka`s standing internationally to seek foreign commercial loans,` one analyst said.

The government has resorted to large scale borrowings in the international market over the past two years to fund state spending, including for costly war against separatist Tamil rebels in the island nation s north.

http://uk.reuters.com/article/oilRpt/idUKCOL16516120070207

INTERVIEW-Sri Lanka Ceypetco aims to hedge diesel at $67-$74Wed Feb 7, 2007 12:56pm GMT By Simon Gardner

COLOMBO, Feb 7 (Reuters) - Sri Lanka's state oil company Ceylon Petroleum Corp. is poised to hedge up to 1.2 million barrels of diesel on Singapore's OTC market over the next three months at between $67 and $74 a barrel, it said on Wednesday.

Chief Financial Officer Lalith Karunaratne said the "zero cost collar", an option contract without a premium to be paid, which guarantees the government it can buy fuel within a specific price range, would be sealed by early Thursday at the latest.

It is the first such hedging operation by the Sri Lankan state, aimed at insulating it from international oil price volatility, which has been hard for the economy to cope with.

"The price is unbearable, really I get hurt. So what is the bottom price I can give up?" Karunaratne said in a telephone interview.

"We decided a sort of a band -- a cost collar," he added. "I am really looking at the bottom at the moment for the next three months of $67-$68 (per barrel of diesel), and $72-$74 the upper part of the band," he added.

The amount of diesel to be hedged on Singapore's over-the-counter (OTC) market -- 400,000 barrels per month over three months -- represents around 40 percent of Sri Lanka's overall diesel requirements.

The hedge will enable the state -- which produces no crude oil of its own and had to fork out $2.07 billion on oil imports in 2006 -- to be sure of its financial commitments in worst and best case scenarios.

DIVIDING UP THE BUSINESS

Deutsche Bank (DBKGn.DE), Standard Chartered (STAN.L) and Citibank (C.N) are each competing for the business, but Karunaratne said he was thinking of dividing the business up between the three as it was the company's first ever such deal.

"We are waiting for the final confirmation from the banks," he said. "By the latest it will be tomorrow morning."

"We thought of giving all three banks quantities ... because of this first deal," he added.

Sri Lanka is the first Asian country to announce openly that it will hedge.

Central Bank Governor Ajith Nivard Cabraal hopes the hedging will help curb inflation and stabilise the rupee and wants to see the annual oil bill brought down to $1.8 billion or less.

Inflation is running at its highest level in over four years -- hitting 14.8 percent in January as measured on a 12-month moving average -- and the Central Bank is scrambling to find ways to brake it without having to raise interest rates.

The government said this month seismic data showed more than a billion barrels of oil lie under the sea off Sri Lanka's northwest coast. It is set to launch exploration tenders in April.

Any proven oil find would be welcome relief for a land that has become increasingly reliant on diesel generators, which are costly to run, to supplement hydroelectric output that suffers from cyclical droughts. (US$1 = 108.70 rupees)

http://www.themalaysianinsider.com.my/index.php/business/14549-dispute-over-petrol-prices-in-sri-lanka-creates-shortage

Dispute over petrol prices in Sri Lanka creates shortage Monday March-9-2009

COLOMBO, Dec 20 — The Sri Lankan government ignored a Supreme Court order to reduce state-set petrol prices, declaring yesterday that soaring fuel prices would remain unchanged.

The standoff between the court and the government has created an artificial fuel shortage and long lines at the pump.

Many filling stations, unsure what price to charge, did not fill tanks on Thursday, fearing they would end up buying gas at the higher price and be forced to sell it at the court-ordered discount. Stations across Colombo ran out of fuel, and lines stretched into the streets for those that had some left.

The government, expecting oil prices to continue climbing, agreed earlier this year to buy all of its fuel at the price of US$134 a barrel until next summer. In recent months, however, the price of oil has plummeted to under US$50 a barrel.

A recent document submitted in court estimated the deal could cost as much as US$775 million, economist Harsha de Silva said.

With oil prices plunging, the Supreme Court ordered the government on Wednesday to immediately reduce the state-set price of gas from 122 rupees to 100 rupees (about RM3.60).

But instead, the court's efforts have created a black market that sent the price in some places skyrocketing to 145 rupees a litre.

The government ignored the order, with Trade and Consumer Affairs Minister Bandula Gunawardena saying the Cabinet can't act because it never received an official copy of the court order. The court has said it delivered the ruling to the appropriate government officials.

Chandana Alutge, a university teacher, said he stopped driving his car because of the shortage.

"This is not good for the country," he said.

The opposition United National Party claimed the government won't reduce the gas prices so it can use the extra profits to cover the losses from the oil hedge.

The court has made no comment on the dispute. — AP

http://srilankatoday.com/index.php?option=com_content&task=view&id=904&Itemid=52

Fuel crisis SC annuls all interim ordersSource : dailymirror.lk WEDNESDAY, 28 JANUARY 2009

o Nov.11- CPC says hedging deals will be restructured

o Nov.19- Cabinet discusses oil hedging deals

o Nov. 21- Minister A.H.M. Fowzie tells Parliament hedging deals will continue

o Nov. 26- CPC Chief comes under fire from ministers

o Nov. 27- Cabinet reviews oil hedging deals

o Nov. 28-SC takes up petition filed against hedging deals and delivers dramatic judgment

o Dec 17-SC issues interim order directing to reduce the price of petrol to Rs100 a lire

In view of the persistent non compliance with the interim order directing the reduction of the price of petrol to Rs 100 per litre, the Supreme Court, yesterday, vacated the said interim order issued in respect of the impugned hedging deal implemented bythe Ceylon Petroleum Corporation.

Bench comprising Chief Justice Sarath N.Silva PC, Justices Shiranee Tilakawardane and K. Sripavan terminated all proceedings in respect of the impugned deal to revert to the earlier position.

The Chief Justice said there were a number of interim orders issued in this matter, and if the State did not comply with the concerned interim order, others too would follow suit.

The Chief Justice said that the pricing formula was submitted to the executive but there was no indication of the executive complying with the said pricing formula.

Deputy Solicitor General Sanjay Rajaratnam submitted at the outset that there was a possibility of reducing the price of petrol from the present price tariff, and moved for time; submitting that he needed time to consider the modalities and structures of the formula for a price tariff.

Justice Shiranee Tilakawardane said that the State must first comply and then complain.

The Chief Justice observed that, although one months' time had been given, the executive had not complied with the interim order and that no papers had been filed by the Treasury Secretary and the chairman of the Ceylon Petroleum Corporation on the basis of the said interim order on the reduction in the price of petrol.

Petitioners informed Court that they had filed their application in the interests of the public and, in view of the non compliance with the interim order, they did not wish to pursue their application.

The Chief Justice, on January 13, had said that, if the Executive did not implement the interim orders issued by Court relating to this case, Court would set aside all of the interim orders and terminate the proceedings to revert to the earlier position.Court had also granted time till January 17 for the Deputy Solicitor General Sanjay Rajaratnam, who appeared for the Treasury Secretary, to obtain instructions as to whether or not the interim order made by the Court could be complied with.

The Supreme Court, on December 17, issued an interim order directing that the price of petrol be reduced to Rs 100 per litre, on the basis of a formula worked out pursuant to the direction of Court.

Deputy Solicitor General Sanjay Rajaratnam had, on January 13, submitted that the Cabinet of Ministers had taken cognizance of the interim orders made by the Supreme Court on December 17 and, at a meeting on December 30, the Cabinet had decided that the benefit to be passed on to the people should reach a larger segment of the public, and decided to reduce the price of diesel, kerosene and furnace oil by Rs 10.

He had also said that, as a result of the Court order, this relief package would be given to the people and that there was substantial compliance with the Supreme Court order.

Having heard the submissions, the Chief Justice had said that the Executive could not interpret decisions made by the Supreme Court and that, under Article 118 of the Constitution; the Supreme Court shall be the highest court.

The Chief Justice said that the pricing formula was prepared by the Treasury Secretary and the Court had made the interim order based on the said formula.

The Supreme Court had earlier issued interim orders halting the impugned hedging agreement and restraining the Ceylon Petroleum Corporation from making any payments to Standard Bank, Deutsche Bank, CitiBank, People’s Bank or any other bank or institution on the impugned hedging agreement.

Court had also issued interim orders suspending the services of Lalith Karunaratne, the deputy general manager of the CPC, who was one of the signatories to the controversial hedging agreement, and Mr. Asantha de Mel from the office of chairman of the CPC.

The Fundamental Rights application seeking the reduction of oil prices and petroleum related products in keeping with the prices prevailing at the world market was supported by Viran Corea instructed by G.G.Arulpragasam.

The Ven. Thiniyawala Palitha Thero, Ravi Karunanayaka MP and Ravi Jayawardena of “Corruption Watch” filed the petition. M.A.Sumanthiran appeared for the intervenient petitioner Vasudeva Nanayakkara.

Uditha Egalahewa appeard for W.K.H.Wegapitiya who is chairman of Laugfs Holdings Ltd. Faisz Musthapha PC appeared for the Petroleum Minister. Ikram Mohamed PC appeared for the CPC chairman.

Petitionera cited Petroleum & Petroleum Resources Development Minister A.H.M.Fowzie, the Ceylon Petroleum Corporation (CPC), its chairman Ashantha de Mel, Treasury Secretary Sumith Abeysinghe, Export Development & International Trade Minister G.L.Peiris and the Attorney General as respondents.

Petitioners stated that the CPC imports, sells and distributes 70%, 75% and 100% of the country’s necessity of petrol, diesel and kerosene respectively and that the 70%, 35% and 100% of out of the total imports of respective items were being produced locally out of oil imported in crude form by the CPC.

The CPC decides on the prices of petroleum products imported, refined, distributed and sold on its pricing formula and the prices of these items depend on the price in the world market and various charges imposed when the importing the same and taxes levied by the government.

World oil prices had been soaring for 18 months or so, till the downward trend in the price started in July 2008. Although the price soared as high as US $ 157, the CPC had never paid more than US $ 130 per barrel of crude oil, the petitioners stated.They stated that as the cost of imports of oil rises, it directly impacts upon the country’s foreign exchange reserves which are, at present, only sufficient for imports for 3 months. In a bid to minimize the impact of the soaring prices, the CPC hedged purchases of petroleum products, both crude oil and refined products, from the international market.

The hedging deal was concluded by the CPC in February 2007 and under the said deal, oil price was capped as US $ 130 a barrel and floor price was at US $ 100 a barrel.

According to the hedging agreement, if the price rises above $ 130 for 3 months, the hedge agreement terminates allowing the CPC buy only 100,000 barrels per month at a price $ 130 whereas the CPC is compelled to buy 200,000 barrels per month at a price of $ 100 as the hedge agreement only terminates after lapse of 12 months if the price of oil were to dip below $ 100.

Petitioners contended that therefore the CPC was obliged to continue with the current hedge agreements till June 2009 which would end up with the CPC paying as much as $ 300 million, causing huge loss to the CPC.

They also maintained that according to the current hedging agreements, liability on the upside is limited while liability on the downside is unlimited, and argue that the CPC had made an ill considered decision to enter into hedge deals without properly evaluating and understanding the risks involved.

They also stated that the CPC had increased the oil prices since 2004, and despite its claims, the price had not been adjusted in line with the current world market price and that there were seven occasions in 2007 alone and two in 2008, when the price of oil was increased inconveniencing the public.

They also complained that oil procured in terms of an agreement from the Iranian Oil Company has worsened the financial situation and increased the debt of the CPC.

They said that, since July 2008, the oil price had decreased drastically in the world market owing to the global financial crisis and it was hovering below $ 50 per barrel as at November 10 as compared to the high of $ 157 per barrel in late June 2008.

They maintained that, owing to the taxes imposed by the government and the mismanagement of the Petroleum Minister and the CPC, the fuel prices remain very high and the benefit of the low prices prevailing at present in the world market were not passed on to the public.

They contended that the failure to reduce the fuel prices in keeping with the decrease in the price in the world market was illegal, unreasonable, arbitrary and irrational, and violative of their fundamental right to equality and equal protection under the law.

Govt.responsible for financial loss - JVP

The JVP charged yesterday that the government should take full responsibility for the financial loss that the country would suffer due to the cancellation of the interim order given against the Hedging deal by the Supreme Court.

It added that disregarding Court decisions by the Executive and the Legislative set a very bad precedent for the future.

The statement from the JVP Politburo said: “The government did not act to implement the order given by the Supreme

Court regarding the petrol prices. The Supreme Court that reviewed the situation has cancelled all interim orders given in this regard. Earlier the Hedging deal was suspended by a court order. But with the cancellation of the interim orders the Hedging deal will resume again. Due to the Hedging deal that was signed in a hugely disadvantageous manner to the country, Sri Lanka is bound to suffer a loss of about US Dollars 700 million. The country is bound to lose a large amount of money due to this in the future. We believe that the government is absolutely responsible for the financial loses due to ignoring the court orders in an arrogant manner.

“The Supreme Court gave an order to reduce the petrol price to Rs.100 after the government side itself showed that it was possible. The government ignored the court order after giving various excuses such as that they had not received the court order and that it could be considered later. Disregarding Court decisions by the Executive and the Legislative sets a very bad precedent for the future. It could lead to a major political crisis. Such a political crisis was created in Pakistan some time ago due to the differences between the President and Supreme Court of that country.

“The government disregarding court orders would only belittle the laws of the country. It sets a bad precedent in the law and order situation of the country. The country would slide towards a sad situation if the government continues to disregard court orders and act in an arrogant manner. Democracy, discipline and the law and order situation in the country would move towards a crisis due to the actions of the government.

“We urge the government to respect the laws of the country and protect democracy, and call on the concerned public to come forth to defeat the sad situation that has arisen.”

HTTP://WWW.IHT.COM/ARTICLES/2008/11/13/BUSINESS/AIR.PHP

INTERNATIONAL HEROLD TRIBUNE

Airlines find it difficult, and perhaps unwise, to hedge fuel pricesBy John Bowker ReutersPublished: November 13, 2008

Major European airlines are deciding not to seek new fuel hedging agreements for next year because the global credit crisis and the collapse of Lehman Brothers have raised the cost of such deals.

British Airways, Ryanair and Lufthansa have said their hedging deals will be significantly reduced in the new year, ceding the opportunity to lock in fuel prices that have fallen to 22-month lows.

Oil has come down from highs of $147 a barrel in June to around $55, leaving current airline hedging policies for the price of oil at around $90 looking well out of date.

Analysts and airlines have said that it is far harder and more expensive to make new hedging deals with banks during the credit crisis, especially after the collapse of Lehman Brothers, a big player in the market.

"The hedging market is very illiquid at the moment - it's hard to find a counterparty in the deal," said Mark Thompson, an airlines analyst at Morgan Stanley.

In releasing its third-quarter results late last month, Lufthansa said that its hedging for the current year had been cut to 72 percent from 85 percent of its total fuel bill as a result of the loss of a contract with Lehman Brothers.

Its hedging for 2009 is down to 57 percent, at an average of $91 a barrel.

Lehman became the biggest investment banking casualty of the credit crisis in September. Many airline hedging deals collapsed when the firm filed for bankruptcy.

Michael Cawley, deputy chief executive at Ryanair, confirmed the banking crisis had affected the type of deals the airlines could get.

"There is a far less liquid market for futures in all parts, including oil, so when we go to hedge it's not as easy as just making a phone call," Cawley said.

Neil Glynn, an analyst at the Dublin brokerage firm NCB, said jet fuel itself had become much more expensive in relation to the price of crude.

The spread between the two has in recent weeks widened from the historic norm of 27 percent to as much as 60 percent.

British Airways has had 35 percent of its fuel bill for next year hedged at $100 a barrel since the summer, but when it released its half-year results last week the airline said it remained hedged at less than 40 percent of its total fuel bill, despite the changing conditions.

British Airways' finance director, Keith Williams, said that if oil averaged $75 a barrel and the pound was worth an average $1.65, the carrier would lower its fuel bill to £2.8 billion in the 2009-2010 fiscal year, from around £3 billion this year. One pound is worth $1.47.

"The oil price is connected to economic downturn," said Andrew Fitchie, an analyst in London for Collins Stewart. "The airlines are mindful that the economic outlook is looking substantially weaker, and that takes the pressure off."

Air France-KLM uniquely hedges five years in advance, but at a recent informational sessions for investors, the finance director, Philippe Calavia, said he agreed with British Airways' policy of making no major changes to existing hedging policy.

"In spite of the recent drop in the oil price, a positive factor for the economy and the group," the company "will pursue its hedging policy," he said. He added that any future hedging contracts would reflect the recent fall in prices.

Ryanair was about a year too early with its strategy of not hedging fuel, losing millions of euros as oil reached new highs over the summer.

The company then hedged at triple figures a barrel for the current quarter, but is now switching back to an unhedged approach because of the sharp fall in oil's price.

The Irish airline has a hedge for 25 percent of its fuel needs for the first half of the 2009-10 fiscal year at an average $77 per barrel, but is willing to leave the rest to chance.

"The absence of fuel hedging, so long a handicap for profitability, is now proving to be an asset," Edward Stanford, an analyst for Cazenove, said in a note to investors of Ryanair.

HTTP://NEWS.BBC.CO.UK/2/HI/BUSINESS/7464258.STM

Page last updated at 23:48 GMT, Tuesday, 24 June 2008 00:48 UK

What is it like working for a hedge fund?By Anthony Reuben Business reporter, BBC News

It makes a certain amount of sense for a hedge fund to be based somewhere leafy, but even

by usual standards, Tony Tresigne works in a quiet spot.

Hedge funds tend to be based well away from London's financial hotspots such as the City and

Canary Wharf, in districts such as Mayfair.

But his employer, Lionhart Investments, is based next door to the golf club in Wimbledon.

It is a relaxed environment on the edge of Wimbledon Common, where at least one mobile

phone network has no signal at all, but do not let that fool you.

"I have a mobile phone that rings all the time - and on family holidays, it quite often becomes a

source of contention," he says.

"It's a standing joke with my wife that every time I go on holiday, something catastrophic

happens in the markets that requires my presence on conference calls.

"If I say that my five-year-old son knows how to use a Bloomberg screen, you'll know what I

mean."

Managing risk

The idea of a hedge fund is that it will judge itself on the absolute amount of money it makes for

its investors, not the amount it makes relative to the way markets have gone up, as would be

the case with other funds.

The way it does that is that people like Tony identify investments such as shares, which they

believe will rise or fall significantly.

Then they take out other investments to hedge against the risk of other factors coming into

play, such as the overall market falling.

In that way, a hedge fund manager can isolate the effect he or she is predicting and make

money if it happens, almost regardless of what else is going on in the market.

Enjoying volatility

That is the theory in a normal market, but market conditions have been very unusual of late.

"I'm from more of a trading background than a research background, so I do love volatility - it's

my favourite days in the office when we get volatility," Tony says.

"What you've seen over the last few months is different to volatility, because you've seen an

almost systematic collapse of the financial system.

"Volatility is Bear Stearns moving 7% in a day, not falling 100%."

There is certainly the impression around the office that there is no frantic trading going on.

The funds are currently in a defensive state, with the amount of money borrowed low and

everyone concentrating on their research.

"You can be the best sailor in the world, but if you get in a force 10 gale, your mast might

break," Tony says.

"You have to recognise when you're moving from a point where you're actually trading to where

you're, in the vernacular, punting - where you really have no idea where things are going to end

up."

Normal day

Tony generally gets to the office at about 0630 in the morning.

Like most hedge funds, there are no ties to be seen. Jeans and untucked shirts are the uniform.

The office is small, shared with the other European trader, researchers and the staff paid to talk

to the investors, who have given them at least $1m (£500,000) of their money to trade with.

Like many office workers, the first job in the morning is to wade through the e-mails that will

have turned up during the night.

"The vast majority of the mornings are really about controlling information flow," he says.

"When you come in in the morning, you'd really be inundated with information from hundreds

of sources."

He also needs to catch up with what his colleagues at the fund's other offices in Toronto, New

York and Singapore have been up to.

'Money to be made'

He specialises in trading in companies in what are called special situations, such as restructuring

programmes or takeover deals, so the next thing to do is look at any big deals that have been

done.

"You can look at it and say, 'Well, I understand the regulatory process, I understand the people

involved in this, I can look at the valuation of the company and say that there's a chance of a

counter-bid,' so there's money to be made."

Once he has focused on areas in which he's interested, it is time to move onto the next stage.

"A lot of what special situations is, is talking to people, because you never really know what's

going to be important for a particular deal."

He may speak to brokers, analysts or journalists, or he may call on the services of consultants,

industry insiders or technical experts.

He also looks for companies that he believes have been incorrectly valued by the market.

He says that happens particularly often in diversified companies.

"You may find if a company that's involved in property, for example, has an asset that's not

directly related to property, property investors may miss it."

Running home

At the end of the day, Tony runs home through the park.

It is easy to see the attraction of the relaxed surroundings.

"It allows the traders who are developing the strategies to get away from the noise," says

investor relations manager Greg Froese.

But hedge fund traders can never really be relaxed, because they tend to have so much of their

own money invested in their funds.

Privately, older traders say that the current market conditions are a good thing for them,

because they have highlighted the value of their experience.

Nonetheless, many in the industry will be relieved when things settle down a bit. "I feel in certain points, this market has become so unpredictable as to almost cease to function as a market," Tony complains.

http://www.srilankanewsfirst.com/Financial/103.html

Central Bank advises Govt. to hedge oil prices30 September, 2006 01:30:00

COLOMBO: Sri Lanka should hedge oil prices to mitigate negative effects on the economy, by entering into contracts with foreign banks, the country's Central Bank said in a statement. The

Central Bank said it had made a presentation in early September to the President and Cabinet of Ministers to explain schemes available in the global market to hedge oil prices. "Such forward contracts or hedging arrangements would have to be entered into with international banks of high reputation, who have the experience and ability to manage risks of this nature," the Central Bank's Economic Research Department said in a statement Thursday. Crude oil is imported in Sri Lanka by the Ceylon Petroleum Corporation, which is a state-owned enterprise, while a subsidiary of the Indian Oil Corporation which has a third share of the market, only imports refined products. The Bank said it had made the presentation to the government because, 'in the view of the Central Bank, it would be imprudent for any organisation or a government not to pursue an insurance scheme such as a hedging mechanism, when dealing with a highly volatile market, which if left unchecked, could result in a high foreign exchange drain that could even destabilise the entire economy.' The Central Bank said Sri Lanka's oil bill went up by 37 percent in 2005 to 1,655 million dollars on top of a 45 per cent in crease in 2005. In 2006, the Bank is projecting the oil bill to rise to 2,200 million dollars, which was equal to 31 per cent of export earnings compared to 17 per cent in 2002. As percentage of imports, the share of oil is expected to rise to 21 per cent in 2006 (13 per cent in 2002). Economists have pointed out that Sri Lanka's policy of heavily subsidising oil since 2004 has boosted demand and blunted the incentive make better use of energy by sending the wrong price signals. Central Bank said Sri Lanka could either pay a premium and buy futures contracts, getting a cap for oil imports; or go for other hedging mechanisms that gives protection within a price band or a 'collar'. "For example, under this mechanism, if Sri Lanka purchases a cap at (say) US$ 60 per barrel, the country need not to pay a higher price even if world market prices reach US$ 100 per barrel or beyond," the Bank said. "In such a situation, Sri Lanka would be free to purchase oil at the prevailing market price if prices fall below US$ 60 per barrel. Another mechanism is a "Zero-cost Collar" that can provide similar protection without Sri Lanka having to pay a premium." Collars can be built by selling an option at one price and using the proceeds to buy an option at a different price. "However, in this method, Sri Lanka would have to commit to a minimum price, below which Sri Lanka would not benefit by the reduction," the Bank said. The Bank said oil prices have risen with high demand from China, India and USA, capacity limitations in refineries, supply disruptions in some oil exporting countries and general geopolitical unrest. "With the easing of certain pockets of geopolitical unrest, oil prices seem to have declined but several other factors, which could raise oil prices, are still present," the bank said. "In that background, it would be prudent for Sri Lanka to contract for oil at a reasonable price with a protection from future increases, as that would lead to greater economic stability."

http://www.srilankanewsfirst.com/General/7982.html

SC suspends another CPC official, orders bank documents to be protected

16 December, 2008 02:50:52

The Supreme Court on Monday suspended a second senior Ceylon Petroleum Corporation (CPC) official and ordered the Central Bank, with the assistance of the Criminal Investigation Department if need, to protect documents at two foreign banks pertaining to favours given to CPC officials in the controversial oil hedging case.

The court, headed by Chief Justice Sarath N Silva, also ordered that petrol prices should not exceed around Rs 100 per litre based at the rate of $56 per barrel of crude oil.

The 3-judge bench directed the Treasury Secretary Sumith Abeysinghe to devise a petroleum pricing formula to pass the benefit of the suspension of payments due to banks, and reduced oil prices. The Court suspended CPC Deputy General Manager (Finance) Lalith Karunaratne as counsel for the petitioners in the case expressed concern that there is a risk of concealing evidence of oil hedging by officials involved in the deal. Earlier CPC Chairman Asantha de Mel was suspended by court. The new pricing formula is to be submitted to court on Wednesday, December 17.

http://www.srilankanewsfirst.com/General/8784.html

Colombo indices high on low-priced shares 29 January, 2009 09:08:50

The Colombo share market saw a slight climb, showing early gains at Thursday’s opening on low-priced shares, brokers said.

“Retailers are highly active on low priced shares such as Lanka Cement, which is likely to be seen throughout today,” a broker said. He said that Lanka Cement was the main contributor to the Rs 55 million turnover during the early hours with Rs 19 million. The All Share was 13 points up at 1,825.24 with the Milanka at 2,015.11, up 5.03 points at the time.

Analysts said that following the Supreme Court order on the oil hedging deal by the Ceylon Petroleum Corporation (CPC) and the Central Bank’s subsequent statement saying that it found "substantial non-compliance" with its prudential directions on derivatives and "non-compliance with best market practices and prudential norms generally applicable to such transactions on the said deal that the banks (Citibank, Standard Chartered, Deutsche Bank, People's Bank and Commercial Bank) had entered into, has affected the Commercial Bank’s share price as there is speculation that they may not recover the money People’s Bank owes them amounting to Rs.893 million on the reverse hedge. “Right now People’s Bank is said to be at a bad liquidity position and this is the main reason this speculation is in the market,” an analyst said. Commercial was Rs 1 down to Rs 95 during early trades.

http://www.srilankanewsfirst.com/General/7522.html

CB to meet banks on controversial hedging deals19 November, 2008 08:46:05

The Central Bank (CB) has summoned three commercial banks including Standard Chartered this morning (Wednesday) for separate meetings to ascertain why the ‘due process’ was not followed in hedging deals with the Ceylon Petroleum Corporation (CPC), CB officials said.

Standard Chartered Bank (SCB), Citibank and Commercial Bank – who issued a joint statement last week saying the CPC was well aware of the risks – will be asked to explain which CB guidelines were not followed in the transactions. The Sunday Times two weeks back brought to the fore how the oil hedging deals have gone wrong with the CPC now facing a possible payout of $300 million in the next few months. Proper risk management procedures were not followed, CB officials say. The newspaper stories in the past two weeks has triggered a CB investigation and led to a series of high level meetings to ascertain why proper risk management procedures were not followed.

http://www.lankanewspapers.com/news/2008/12/36104_space.html

Hedging Deal - Minister Fowzie Hits Back At Ajit Kabarala of Central BankWednesday, 3 December 2008 - 7:24 PM SL Time

Minister Fowzie exposed hedging deal in parliament (Lanka-e-News, December 03, 2008, 6.00PM) Petroleum Minister A.H.M. Fowzie has distanced himself from the concept of hedging, telling Parliament today.

I am grateful to you for giving me the opportunity to place before the House of the true position relating to the now much maligned hedging arrangements.

Let me at the outset say that the oil hedging concept was not my concept at all. It was initiated by no less a person than the Governor of the Central Bank himself.

Mr.Ajid Nivard Capral the governor of the Central Bank made a presentation personally to the Cabinet on 6th Sept 2006.

He advised to the Government to enter into hedging arrangement. Thereupon the Cabinet decided that the subject should be further studied by a group of officials from the Central Bank of Sri lanka , the Ministry of Finance and Planning, the Ministry of petroleum and petroleum Resources Development, Ministry of Power and Energy and other agencies and present a report to the Cabinet.

In terms of the decision, the Secretary to the Treasury selected several officials to study and submit a report on the governor`s presentation to the cabinet.

This Study Group came out with the following recommendation and submitted its report to the following recommendations and submitted its reports on the Secretary Ministry of Finance on 16th November 2006.

1. CPC to hedge purchase of petroleum products, both crud oil and refined products in the international market.

2.Use Zero-Cost Collar as the hedging instrument with the upper bound based on market developments.

3. Commence hedging with smaller quantities for shorter period and gradually increase the quantity and the duration.

4.Grant authority to the CPC to call for quotations for oil hedging, decide on future prices and purchase instruments from reputed banks

5. Grant authority to CPC to change instruments based on the development in the market.

On the 17th, January 2007 , the cabinet deferred its decision for the next meeting awaiting the observations of the Finance Ministry. On 24th January , the cabinet decide that oil hedging be implement without delay as suggested the Central Bank of Srilanla. I would draw the attention of the House to that part of the Cabinet decision that the suggestion be implemented without delay as suggested by the Central Bank. Said Fawzi

Source(s)LeN

http://www.srilankanewsfirst.com/General/7736.html

No-faith motion against cabinet over hedging deal – Ranil01 December, 2008 14:28:30

Monday, 01 December 2008 16:39The UNP will move a no-confidence motion against the entire government over the hedging agreement signed between Ceylon Petroleum Corporation and private foreign banks, said opposition leader Ranil Wickremesinghe.

He told the media today (Dec. 01st) that the cabinet-approved pact results in each Sri Lankan citizen getting into a Rs. 10,000 debt.

According to him, the CPC, already Rs. 200,000 million in debt, will have to be either sold or closed down, after the hedging agreement.

As the cabinet had given its consent to the paper presented by Petroleum Minister A.H.M. Fowzie on 24th January 2007, the no-faith motion by the opposition would be against the finance minister and all other members of the cabinet, he said.

The Mahinda Rajapaksa regime will definitely have to go for a general election to cover up the hedging agreement that takes the national economy to further ruin and squanders a massive amount of public funds, said Mr. Wickremesinghe.

Most media had been attempting to whitewash the government, without exposing corrupt deals like the hedging agreement, he charged.

The opposition leader said, "We accept the Supreme Court ruling that suspends the hedging agreement signed by the CPC that prevents a reduction of local prices when world market prices decline. However, according to what we have found out, not only minister Fowzie, but also the entire cabinet had known about it."

"We also have come to know about an attempt to destroy important documents relating to this hedging agreement. Therefore, I requested the Speaker today to take measures to protect all documents relating to this agreement at institutions like the Finance Ministry, Central Bank, Petroleum and Petroleum Resources Ministry and the CPC."

Mr. Wickremesinghe also said, "This agreement was based on a letter written by one Upul Arunjith on behalf of Concept Development Consortium of Canada to economic advisor Ajith Nivard Cabraal on 30th December 2005."

On 01st January 2006, another letter to Ajith Cabraal asked that the hedging agreement be implemented. This person called Upul Arunjith had again spoken with the Central Bank governor about this hedging deal on 05th October, 2006."

"Thereafter, Dr. H.N. Thenuwara, writing on behalf of the Central Bank, had informed him about the receipt of his letter, and that no outside help or advice is needed, since the Central Bank has all the knowledge needed to act in this regard."

"Then, Ajith Cabraal, on 06th September 2006, submitted to the Cabinet a proposal on how to maintain stability in the face of rising fuel prices in the world market."

"The cabinet decided to appoint a special committee to inquire into this. It comprised assistant governor of Central Bank Y.M.W.B. Weerasekara, Dr. H.N. Thenuwara, chief finance officer of Bank of Ceylon Saliya Rajakaruna, head of People's Bank's corporate banking Kapila Ariyaratne, Kanthi Wijetunga of the Ministry of Petroleum and Petroleum Resources, deputy director (finance) of CPC Lalith Karunaratne and finance management consultant of Finance Ministry V. Kanagasabapathi."

"This committee submitted its report in November 2006 to Dr. P.B. Jayasundara. In that, it proposed that hedging activities should begin and advised the use of 'zero cost collar' method for the purpose," Mr. Wickremesinghe said.

"Accordingly, the cabinet paper for its implementation was submitted by minister A.H.M. Fowzie in January 2007."

Before that, on 10th January 2007, Central Bank governor Ajith Nivard Cabraal had advised Asantha de Mel to begin the hedging activities with immediate effect."

"Thereafter, minister A.H.M. Fowzie submitted a cabinet paper on 13th January 2007 and the cabinet approved it."

"The cabinet said it had approved the agreement, to be implemented immediately, as the Central Bank had proposed."

"Therefore, the Cabinet, Petroleum Ministry, Central Bank, Finance Ministry and all others are involved in this deal."

"In the meantime, minister A.H.M. Fowzie submitted a cabinet paper on 17th November requesting the appointment of a committee to inquire into the situation that has arisen."

This committee comprised ministry secretary W.D. Ganegala, deputy secretary of the Treasury Dr. R.H.S. Amaratunga, director of the Public Accounts Department D. Widanagamachchi, CPC chairman Asantha de Mel, chief economics advisor to Central Bank Dr. P.N. Weerasinghe, additional director of Central Bank R.A.A. Jayalath, deputy general manager of CPC Lalith Karunaratne and others."

"As matters stand thus, it is clear that the entire cabinet is to blame for this. It is also clear that CPC is Rs. 200,000 m in debt."

"This Rs. 200,000 m has to be paid by the innocent, suffering people of this country. It is true the SC has ordered the suspension of payments to the banks. This hedging agreement is very disadvantageous for us."

"The president, as the finance minister, the entire cabinet, the Central Bank and the person who holds an unofficial ministerial portfolio are responsible for this agreement that brings massive loss to the country."

Responding to a question, Mr. Wickremesinghe said, "Under a UNP regime, such corrupt agreements will not continue. Everything will be terminated."

"Even after questioning about the steps under a future UNP regime, Kesara Gunawardena of 'Daily Mirror' writes that I am a weak leader. He writes that the UNP cannot gain power under my leadership. I would like to ask the media about what it had written about the hedging deal. After 'The Sunday' Times' reported about it, 'Daily Mirror' had to follow suit. 'Daily Mirror' has become the official newspaper of the JHU today," he added.

http://kaputunews.com/article/politics/455/

Cabinet 'approved' hedging deals Saturday, 12.06.2008, 07:39am (GMT+5.5)

Central Bank of Sri Lanka (CBSL) says that the controversial hedging deals on purchasing fuel were approved by the Cabinet of Ministers.

In a statement issued on Friday, the CBSL says the Cabinet granted approval to hedge purchase of petroleum products on 13 January 2007.

The CBSL was responding to allegations by Petroleum Resources Minister AHM Fowzie that the concept of hedging was initially suggested by CBSL Governor, Ajith Nivard Cabraal.

“Let me at the outset say that the oil hedging concept was not my concept at all. It was initiated by no lesser person than the Governor of Central Bank himself,” he told the parliament on Wednesday.

Cabinet 'granted approval'

The minister however, admitted that the Cabinet granted the approval for hedging deals but Minister Lakshman Yapa Abeywardene has repeatedly told media that no such approval was granted.

“The Governor of Central Bank urged in writing even before the Cabinet approval go for hedging,” Minister Fowzie added.

He made the special announcement after the Supreme Court suspended the services of the chairman of the Ceylon Petroleum Corporation (CPC) and recommend President Rajapaksa replace Minister Fowzie, who "safeguarded corrupt officials".

The court made the interim ruling after considering petitions against controversial hedging deals signed by the CPC chairman to control increasing fuel prices.

Sri Lanka is losing millions of dollars as a result of the deals, the court was told.

'Economic advisor'

The CBSL does not deny Minister Fowzie’s remarks that it advised the government to enter into hedging deals “as the economic advisor to the government”.

However, once the Cabinet approval was granted, the CBSL says, the advisory role was completed and the CPC was the sole authority to carry out its implementation.

“Accordingly, the CBSL was not, and indeed did not need to be, involved in the hedging transactions of the CPC,” the CBSL statement said.

It added that the CBSL has taken steps to examine the role of the commercial banks in hedging transactions.

“Nevertheless, at present, since hedging related issues are the subject of matter of judicial proceedings, the CBSL would refrain from making any comments in relation to current investigations,” it said.

BBC Sihnala.com

http://www.lankanewspapers.com/news/2008/12/35980_space.html

CPC tried to transfer all accounts to foreign banksMonday, 1 December 2008 - 5:10 PM SL Time

The controversial oil hedging crisis has taken a new turn with reports of a possible multi-faceted complicity between foreign banks and Ceylon Petroleum Corporation (CPC) officials where in one case there was an attempt to transfer all CPC accounts to the two foreign banks now at the centre of a Central Bank probe, an investigation by The Sunday Times Business Desk shows.

Initial investigations reveal that just before the hedging contracts were signed in 2007, the CPC chairman without the consent of its board of directors had taken a decision to withdraw all its deposits from the two state banks, the Bank of Ceylon and People`s Bank, and transfer them to the Standard Chartered Bank (SCB) and Citibank.

This request was turned down by President Mahinda Rajapaksa after considering objections made by a senior official of the Petroleum Resources Ministry during a meeting of the National Economic Council chaired by the President, informed sources said. It has also been revealed that the CPC Chairman had submitted a paper with legal advice claiming that the CPC was not covered under the Finance Act and therefore its financial transactions and accounts were not under the purview of the Auditor General. The then Secretary to the Ministry referred the matter to the Attorney General (AG) who overruled the CPC chairman, the sources said.

Incidentally Auditor General S. Swarnajothi was summoned before the Parliamentary Committee on Public Enterprises (COPE) earlier this week for the hearing into the oil hedging crisis but his evidence was not recorded as opposition and government legislators, in particular Minister Susil Premajayantha, were heavily involved in grilling CPC Chairman Asantha de Mel over the transaction.

The sources said at the hearing where Mr Premajayantha was armed with plenty of documents including articles from The Sunday Times, Mr. de Mel and other CPC directors had appeared to be surprised at the understanding of hedging and the contracts that were shown by the committee.

Hedging, not clear to many people in Sri Lanka, is like an insurance policy where one pays a premium to protect against any losses incurred in a business or individually. In the present CPC issue, the hedging mechanism required no premium but a payment by both parties (CPC and the banks) when oil prices swing either way up or down.

The problem was that while the banks had to pay the CPC anything above $135 per barrel (and this payment was restricted to $1.5 million a month) and confined at this level, the CPC was forced to pay the banks any price below $100 per barrel. Thus even if the oil price falls to $10 per barrel, the CPC must pay a fixed rate to the banks.

The liability to the CPC ranges from 400 to 700 million dollars. Emerging evidence clearly shows that neither the Cabinet (barring Minister Fowzie) nor the CPC Board (barring Mr. de Mel) gave proper sanction to the contracts.

Our investigation also reveals that the Ministry of Petroleum Resources had not been properly informed about the CPC`s decision to hedge on oil.

The then ministry secretary who is also the chief accounting officer of all institutions coming under the purview of the ministry, was not even given time to go through the Cabinet memorandum seeking approval of the Cabinet to go for oil hedging. The deal was made without any transparency, the sources said.

All decisions were taken by Minister Fowzie and the CPC Chairman and some officials in a room allocated to the Minister at the CPC, they said. Investigations reveal that normally Ministers do not have rooms in corporations but in this case an exception was made. Senior Ministry officials including the secretary were not consulted in the decision-making process of the CPC in this instance. The Sunday Times reliably learns that former Treasury Secretary P. B. Jayasundara and Central Bank Governor Ajith Nivard Cabraal had given their fullest backing to the CPC Chairman to go ahead with the controversial hedging deal and they spoke in favour of the deal at top level official meetings claiming that that oil prices would rise to as much as $200 a barrel in the future.

De Mel At the parliamentary committee meeting on Tuesday, The Sunday Times learns, Mr. de Mel was severely reprimanded by several senior Cabinet ministers for the deal.

When COPE members queried about the CPC`s `self-claimed` expertise in hedging, CPC Deputy General Manager (Finance) Lalith Karunaratne said he didn`t know much about hedging. Asked about his background he said he was formerly an accountant at Samuel & Sons which analysts said was a Rs. 350 million turnover company compared to the Rs. 350 billion turnover at the CPC.

He was ordered to submit all documents pertaining to the deal while the banks are being asked to submit details of bank-funded overseas trips of Mr. de Mel and Mr. Karunaratne. The committee was also of the view that Central Bank Governor Cabraal should also bear the responsibility for recommending oil hedging to the CPC and should be questioned on this matter.

Mr. de Mel had said board approval was given to him and Mr Karunaratne to go ahead with oil hedging based on only a Cabinet memorandum submitted by Minister A.H.M. Fowzie.

Parliamentarians were also critical of the foreign banks for their role in this scandal saying it was swallowing the country`s valuable foreign reserves. The CPC Chairman had given an assurance to COPE that they will renegotiate the hedging deal in consultation with the Cabinet sub-committee and the CPC board of directors.The day before (Monday), SCB representatives from India and the bank`s local global markets head made a presentation to the CPC board and a Cabinet risk committee with a restructured hedge structure which refers to an extended payment of $250 million.

While Laugfs Gas Chairman W.K. H. Wegapitiya and a joint petition by three others, including UNP MP Ravi Karunanayake, were taken up in court on Friday, at least two other public interest groups are preparing to go to court saying this `national calamity` has worsened the plight of the ordinary consumer. With oil prices going down sharply in the past few months, there is no change in local prices. The consumers are suffering, said Christine Perera, a public interest activist. This is a terrible situation. The benchmark Brent world crude price was pegged at $49 per barrel on Friday, down by almost $100 per barrel from 143.33 dollars on July 11 this year.

Prices were reduced in the November Budget by the Government but consumers say it was a cosmetic reduction triggered by political consideration and consumer demands rather than proper decision-making.

The issue is threatening to drain the country`s meagre foreign exchange resources, currently estimated at only around 2.7 billion dollars or equal to more than two months` worth of imports, and has put the economy under additional pressure at a time of global economic crisis.

Adding to the woes was the withdrawal of $400 million by foreigners who invested in Treasury Bills and bonds, according to Governor Cabraal. He says the Government is appealing to the Sri Lankan diaspora to invest in Sri Lanka in a bid to raise around $500 million to ward off bigger repercussions from the international economic crisis.

Businessmen and economists have warned that Sri Lanka, still not seriously affected by the international crisis, will feel the effects of the crisis in the coming months as consumer spending drops in key markets like the US, Europe and the Gulf region. Sri Lanka`s main exports are garments and tea while remittances, another key foreign exchange component for the country, are also expected to be affected.

The Supreme Court on Friday ordered the Government to submit a report within a week on the possibility of reducing local fuel prices by reviewing the taxes levied on petroleum products. The Opposition says taxes on fuel, as much as 50% of the shelf price, are also responsible for the high prices.

In court, the Chief Justice said the hedging contracts were in favour of the banks and according to the deals, the country would have to pay US$675.7 million to the banks in the coming months

if this deal was allowed to continue.

Mr. de Mel has been accused of defending the banks in this fiasco, and at one point during the Supreme Court hearing he admitted that it was the banks which had asked him to state at a news conference and in later statements that any default of the payments would be considered a sovereign debt.

Such a statement at the November 10 news conference which was called by the CPC but sponsored by SCB also annoyed officials at the Central Bank, it is learnt.

Fowzie still there Petroleum Resources Minister A.H.M. Fowzie last evening said he had so far not received any instructions from President Mahinda Rajapaksa about his status, after the Supreme Court on Friday recommended the removal of the minister from his portfolio.

Mr. Fowzie said he had no comment about the developments. The Supreme Court on Friday also ordered the removal of Ceylon Petroleum Corporation (CPC) Chairman Asantha de Mel and that all petroleum activities including purchases and distribution be handled by the government.

Massive forex drain

Growing public interest and a flurry of fundamental rights petitions against the controversial oil hedging deals by the Ceylon Petroleum Corporation (CPC) are turning into probably the biggest-ever foreign exchange scam in Sri Lanka involving two foreign banks and the CPC.

Both Standard Chartered Bank (SCB) and Citibank have been accused of misrepresenting facts and not adequately informing the CPC of the risks involved in this transaction, a charge vehemently denied by the banks.

On Friday, the Supreme Court hearing one of the petitions -- ordered the suspension of CPC Chairman Asantha de Mel and directed President Mahinda Rajapak...

Source(s)http://www.sundaytimes.lk/081130/News/sundaytimesnews_02.html

http://sundaytimes.lk/090222/FinancialTimes/ft307.html

Hedging banks on topThe Sunday Times: Sunday February 22, 2009

CEOs of the five commercial banks involved in the disastrous oil hedging deals with the Ceylon Petroleum Corporation (CPC) must be rubbing their hands with glee these days. For all purposes

it points to the government ignoring the serious ramifications of the one-sided deals, and agreeing to pay off the banks who are demanding its share of the pie.

While the two officials at the CPC involved in these transactions – former CPC Chairman Asantha de Mel and former Deputy General Manager (Finance) Lalith Karunaratne – are on the mat and have not been re-appointed or returned to their positions after the Supreme Court dismissed the case, other bank officials involved in the deal are going scott free.

The article below on the hedging fiasco lists out the ‘unethical’ canvassing that took place to get these lucrative contracts, how banks funded officials in other banks on joyrides, how CPC officials and ministers were taken on fully-paid, virtually vacation-trips, and so on. All this will be consigned to the dustbin of history even though the careers of some of these officials have been sullied by these happenings. As fresh winds blow over the saga, acutely absent is corporate governance, transparently and accountability that every Dick, Tom and Harry in the corporate world likes to talk about and professes to practice. Where were these obligations in the hedging deals -- with the exception of a few, national-minded citizens who didn’t want the country and its people taken for a costly ride?

The Central Bank has clearly said banking regulations have been violated and that the agreements should not be proceeded with. The Attorney General, whose advise was not sought in the first place as one would expect when contracts like this are signed, has recommended that the CPC should refrain from making payments which may be as high as $800 million – even though the Supreme Court has vacated all interim orders in the case.

As far as the five banks – Standard Chartered, Citi, Deutsche, Commercial and People’s – are concerned, they want the CPC to keep their bargain of the agreements and one has also filed action in an international tribunal. Soon after the court case ended, the CEOs of Standard Chartered and Citi met President Mahinda Rajapaksa to canvass their case for CPC repayments to be made. Deutsche was also interested in a meeting, it is learnt.

Rajapaksa, worried about international repercussions over the issue, had referred them to a ministerial committee appointed to investigate the issue. The committee, whose chief spokesman is Prof G. L. Peiris and includes Nimal Siripala de Silva, Dr Sarath Amunugama and A.H.M. Fowzie, told reporters on Thursday (through Prof Peiris) that they met the banks this week and was trying to come up with an amicable settlement of the issue. “The response from the banks is encouraging,” he was quoted as saying.

Let’s make it clear … an amicable settlement means the CPC has to pay and ‘an encouraging response’ from the banks is more that what the government can expect. From a near zero position after the Supreme Court suspended payments and – after the Central Bank said the contracts were flawed, the banks must be relieved that they will get their money. After all they have also hedged with an overseas party and that payment has to be made, even if the CPC didn’t pay up.

As repeatedly stated in the past, non implementation of contracts due to flawed deals cannot offend the international community. If it’s illegal, it’s illegal. People can get annoyed only if there is a deliberate attempt to stall payments without any valid reason. Thus, one fails to understand

why the government got involved instead of allowing the issue to be dealt with by the correct authority – the regulator (Central Bank). There are two ways of looking at the issue of repayment. While one school of thought recognises the fact that holding back payments to foreign banks (or foreign investors) is bad for business and sentiment particularly at a time when Sri Lanka needs many friends overseas, the other view is that the state interfering in a regulatory function sets a bad precedent and could have serious repercussions in the future.

The committee’s mandate is to settle a matter in which a group of banks have been accused by the Central Bank of violating the rules. It is like saying, “okay … they have committed a crime, but let’s be lenient.”

The Central Bank, it is understood, has not been called upon to explain to the committee on its decision, a step which should have been done – amd still not too late. The oil hedging fiasco will ultimately go down in history for two reasons – where the government failed to implement orders of the Supreme Court and interfering in the functions of the Central Bank.

http://www.lankabusinessonline.com/fullstory.php?nid=1113196271

Mon, 09 March 2009 11:03:24 Domino Effect

08 Dec, 2008 08:39:11

Sri Lanka oil derivatives crisis spreads into banksDec 08, 2008 (LBO) - The effects of a payment halt on derivatives by a state-run oil distributor is spreading far into Sri Lanka's banking sector, hurting capital, interbank transaction integrity and international relationships, market participants say.The crisis began when payments under exotic derivatives bought by state-run Ceylon Petroleum Corporation (CPC) was halted by court to foreign and local banks. But the banks themselves were not party to the court action and are exposed to counter-parties.

The burden of paying an estimated 400 to 700 million dollars in payments over the next nine months has now passed from CPC to the banking sector, including a state-run bank.

Interbank Integrity

After close of business Friday, information filtered into financial markets that state-run People's Bank had not made a payment to Commercial Bank on a 50,000 barrel deal which had gone to CPC via People's, pending advice from the Attorney General.

With shock waves from the oil derivatives now spreading to the domestic market, market participants fear that the integrity of interbank transactions would be damaged if People's Bank finally fails to make payment.

A spokesman for People's Bank said the bank had no comment to make. A senior Commercial Bank official also declined to comment.

Market players say ordinarily, a deal between Commercial Bank and People's would have been as good as gold with transactions worth hundreds of million rupees being closed verbally, on the basis that a dealer's 'word' is their 'bond'.

The crisis began with three foreign banks, Citi, Standard Chartered and Deutsche as well as state-run People's Bank and public listed Commercial Bank providing oil derivatives to Ceylon Petroleum Corporation.

Two weeks ago, CPC chairman Ashantha de Mel said outstanding exposures of Citibank to CPC were 400,000 barrels, Standard Chartered 300,000 and Commercial Bank 20,000 barrels.

Estimates of the total marked-to-market exposure to banks' counterparties abroad have been estimated at between 400 to 700 million US dollars, to the duration of the contracts which run till next year.

Ratings

Meanwhile another crisis is brewing.

Earlier Commercial Bank shares fell after it disclosed to the Stock Exchange that it owed a foreign counterparty 982 million rupees (8.9 million dollars) on a 20,000 barrel contract. The bank however has capital to cover the possible loss.

The People's Bank had two contracts of 50,000 barrels each with CPC, with one contract going through Commercial Bank. Analysts say exposure to People's Bank could be around 1.5 billion rupees or slightly higher.

Both Commercial Bank and People's Bank are rated by Fitch. Standard Chartered and Citbank local branches also have top AAA (lka) ratings. Commercial Bank has AA+(lka), just one notch below.

The impact on the ratings of the concerned banks is not yet known.

"We are awaiting greater clarity on the financial impact and accounting nature of these liabilities," Fitch Ratings chief Chanaka Wickramasuriya said.

"We are also awaiting the final Supreme Court ruling."

People's Bank's capital has been depleted due to past bad loans but the bank had worked hard over the past few years to steadily strengthen its capital. Fitch Ratings has earlier put the outlook on People's Bank's A-(lka) rating on 'positive', pending a possible upgrade.

People's Bank also had another 50,000 barrel deal.

Emerging information suggests that there is at least 820,000 barrels of contracts outstanding. CPC imports about 2.5 million barrels of petroleum a month.

Zero-Cost

Market players believe local banks were asked to provide hedges because foreign banks had run out of limits to the CPC.

Market participants say one bank that had a narrow escape, was state-run Bank of Ceylon, which was already a big financier of CPC.

It was saved because a derivative deal for CPC had been shot down by its chief financial officer, Saliya Rajakaruna, a former Citibanker, according to market sources.

CPC was also looking for a particular type of 'zero-cost' instrument from local banks - a leveraged target redemption forward - and were not entertaining alternative proposals, according to market sources.

CPC was also limited to 'zero-cost' derivatives which carried downside risk, by a cabinet directive, on the advice of Sri Lanka's central bank, which believed hedging would help foreign exchange management.

By going for 'in-the-money' structures its upside had been limited. To get extra upside protection CPC had 'leveraged' the deals, taking on even more downside risk.

Available information suggest that all the transactions were structured in the same way, with 'leveraging' which eventually doubled the notional value of the contract from 15 percent to about 30 percent of volumes.

Central Bank says it is looking into the deals and is examining the banks' books. There have been reports that the derivatives violated central bank guidelines.

Correspondent Banks

Meanwhile another crisis is brewing. A top importer says questions are being asked by foreign suppliers about the reliability of banking transactions in Sri Lanka, especially related to letters of credit.

A demand for confirmed letters of credit, especially for oil imports could increase transaction costs.

While the court ruling affected Ceylon Petroleum Corporation, the banks were not party to the case. If banks do not pay, their credit standing as well as the general perception about banks in Sri Lanka could be hurt.

Even if the transactions are proved to have been mis-sold, analysts say the foreign counterparties of People's Bank, Commercial Bank and foreign banks may still demand payment, and the liability would fall on the capital of Sri Lanka's banking sector rather than the CPC.

Market players say banks have always considered Ceylon Petroleum Corporation to be a good risk as it had long years of banking history despite going through various cash flow crises, due to political manipulation of prices.

Market players say at least one foreign bank may have closed-off or 'crystallized' the transactions, with oil prices expected to fall further.

They say non-payments can trigger automatic cross-default clauses in banks after their head office credit departments fully assess the impact of halted payments. This may affect the future credit access of CPC.

Relationships built with foreign correspondent banks over decades both by state and private banks in Sri Lanka are also at stake, bankers say.

At least some of the deals could also end up in courts in other countries, bankers say. Some contracts have specified English law.

There are also fears that jittery commercial lenders to Sri Lanka may pullout money either using put options or MAC (material adverse change) clauses in loans and credit lines.

The damage to the local banking sector may be 'irrevocable' one banker said, unless the problem is resolved early.

READER COMMENT(S)

5. W.T.J.S.Kaviratne Dec 20 Corruption will not last long at last the cat is out of the bag.. There is no one above law let us respect the Supreme Court judgement.Power hungry politicians have ruined Sri Lanka4. Jack Point Dec 09 This is a serious problem, the last thing we need now is a banking crisis.3. Polkichcha Dec 09 Roll out the barrel, we'll have a barrel of oil Roll out the barrel, we've got the banks on the run Zing boom tararrel, ring out a song of good cheer Now's the time to roll the barrel, for the gang's all here2. Polkichcha Dec 09 Hurrah! He's solved all our problems. Now we can all sing Roll out the barrel, roll out the barrel of fun... etc etc1. DocK Dec 08 Bankers are worried about the effect of the Supreme Court ruling on the local banking system and the local banks' standing in the international financial markets?

Why were these bankers not worried and much concerned about the effect on the welfare of the nation as a whole when CPC was poised to enter in to a clearly lopsided deal?

why did not these bankers point out that CPC/Sri Lanka was clearly at a disadvantage in these 'deals'?

did they lack the guts to stand up against any authoritarian persons?

did they not want transparency in the transactions?

were they blinded by greed?

The Supreme Court is there to safeguard Sri Lanka and its people. not to safeguard any particular entity even when caught with their hands in the cookie jar. all this mess could have been avoided if the banks had the guts to be transparent in these hedging transactions. but please keep in mind, they chose NOT to be transparent. are they now crying because of the consequences?

as the saying goes.....

if you do the crime, do the time

Hopefully this particular court ruling will act as a deterrent to the banking system in Sri Lanka not to do shady deals with the government in power to the detriment of Sri Lankan citizens.

http://globalgeopolitics.net/wordpress/2008/12/08/sri-lanka-oil-hedging-deal-turning-into-billion-dollar-scam/

SRI LANKA: Oil Hedging Deal Turning Into Billion-Dollar Scam

December 8, 2008Global Geopolitics Net Sites / IPSFeizal Samath

COLOMBO, Dec 8 (IPS) - As global oil prices dive, the Sri Lankan government finds itself saddled with a complicated oil hedging deal with two foreign banks that could cost the country close on one billion US dollars and has brought charges of high corruption upon state officials.Banking sources said the foreign banks involved, CitiBank and Standard Chartered Bank (SCB), 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 (UNP) 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, UNP parliamentarian Dayasiri Jayasekera, who has been raising many issues of state corruption in the legislature, told IPS.Transparency International (TI) - 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 alert on questionable deals in thecountry. ”The state-owned Ceylon Petroleum Corporation (CPC) entered into contracts with five banks led by SCB,since January 2007, to protect itself against rising prices. When prices were over 135 dollars per barrel in mid-2008, the CPC was benefited as it had sought protection on the upside.But with prices crashing after that and now reigning at 41 dollars per barrel, the CPC ended up owing the banks and the latest liability could be as high as 1 billion dollars 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 the investment bank Merril 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 is on Dec. 15.Under fire, the government on Thursday reduced petrol prices and said it was preparing a new fuel pricing formula, in response to criticism that the benefits of 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 the CPC on the hedging deals.After the crisis blew, the cabinet, on Nov. 17, appointed a risk management committee to review all hedging contracts and minimise the losses.But petroleum industry officials say 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,” said TI’s Weliamuna.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 with the participation of Peter Eigen, founder and former chair of the Berlin-based anti-corruption watchdog.Mihin Air is a government budget airline set up two years ago which has been swirling in debt of more than 50 million dollars 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 defence secretary and Basil is presidential advisor.Local bankers, unconnected to the deal, say foreign trips funded 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 would think twice before pursuing any legal action for non payments since 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 which has a smaller exposure in the hedging contracts, said in a statement on 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 dollars”.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 only stopped payments 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 Courtjudgment, I don’t think anything is wrong.”All rights reserved, IPS – Inter Press Service, 2008.

http://uk.biz.yahoo.com/28012009/323/update-1-s-lanka-banks-demand-hedging-payments-cbank.html

Wednesday January 28, 01:29 PM UPDATE 1-S.Lanka banks cannot demand hedging payments-cbank

By Shihar Aneez COLOMBO, Jan 28 (Reuters) - Sri Lanka's central bank on Wednesday said oil hedging payments to five banks that would cost the state oil company at least $300 million cannot proceed despite a court ruling saying they should.

'The hedging transactions were materially affected and substantially tainted,' Central Bank Governor Ajith Nivard Cabraal told Reuters. He declined to say whether the central bank would allow any renegotiation of the terms of the hedging agreements to allow a compromise, or insist they be scrapped. The case has been closely watched because it has raised questions about the validity of commercial contracts in Sri Lanka, local and global financial analysts have said. 'Our view is, in the interest of transparency and good governance, such tainted contracts should not go through. It is not a question about the validity of all commercial contracts in Sri Lanka,' Cabraal said. The central bank in a statement late on Tuesday, responding to the supreme court's ruling earlier in the day, said its investigation revealed the hedging deal did not comply with central bank rules about derivative transactions.

'The Supreme Court made an order terminating the judicial proceedings. Nevertheless, the instructions and directions issued by the central bank to the respective banks in accordance with the law will continue to be in force,' it said. The central bank on Dec. 16 had instructed the respective banks not to demand payments owed to them worth millions, after oil prices dropped and put the state-owned Ceylon Petroleum Company (CPC) out of money on the hedges. The zero-cost collar hedging deal between CPC and five banks -- Citibank, Standard Chartered Bank, Deutsche Bank (Xetra: DBK.DE - news) and two local banks -- ended up in court after opposition parties sued to get the government to cut fuel prices. They had argued that the government had not cut fuel prices in line with falling global crude prices to pay for the hedges, which had no downside protection and only anticipated higher crude prices. The Supreme Court on Tuesday made good on its ultimatum to terminate the case if the government did not adhere to its November ruling, ordering it to drop the fuel prices according to a formula the court specified. Standard Chartered Bank and Deutsche Bank in Sri Lanka declined comment, while CitiBank was not available for comment. One of the local banks involved in the deal, Commercial Bank of Ceylon, said it is still studying the impact of the central bank's decision to halt payments. The other bank, People's Bank, is state-owned and did not comment. The Supreme Court in November suspended the oil hedging payments to banks and ordered the government to reduce retail petrol prices in line with falling global oil prices. (Editing by Bryson Hull) Keywords: SRILANKA OIL/HEDGING

http://www.lankaenews.com/English/news.php?id=6773President and Central Bank Chief linked to corrupt hedging deal, Ranil exposes

(Lanka-e-News, December 02, 2008, 9.15 AM) Opposition Leader Ranil Wickramasinghe charges that the President as the Minister f Finance, all cabinet Ministers including Minister of Petroleum and Petroleum Resources A.H.M. Fowsie, non-cabinet Ministers and Central bank Governor Ajith Nivard Cabral are answerable for the hedging deal that caused a multi million rupee loss to the country.

The Opposition Leader stated that a no confidence motion would be brought by the opposition against the government in this regard.

Mr. Wickramasinghe made these comments at a press briefing held in the office of the Opposition Leader to expose the corrupt hedging deal and the proponents of it.

He thanked the trade unions including Jathika Sevaka Sangamaya for exposing the corruptions of the Ceylon Petroleum Corporation (CPC) that had led to the corporaton to near bankruptcy.

Accepting the Supreme Court ruling that Minister Fowsie was responsible for this corrupt deal, the Opposition Leader said that not only he but also the President in his capacity as the Minister of Finance, the entire cabinet and the Central bank Governor were aware of this deal and they were responsible for it.

He said that he made a special request to the Speaker through a parliamentary privileges question to protect the documents of the Finance Ministry, the Central bank and CPC that are pertaining to the hedging deal since they are prone to be destroyed.

Opposition Leader Ranil Wickramasinghe stated that he tabled in the parliament a letter dated December 30, 2005 sent to the President?s Economics Adviser Ajith Nivard Cabral by a Sri Lankan origin Canadian called Upul Arunjith regarding hedging and a reply written by Cabral on June 01, 2006.

Upul Arunjith replied the Central Bank boss in October 2006 and the letter went to the hands of Central Bank?s Economics Adviser Dr. H.M. Thenuwara. He informed the authorities that the expertise for hedging is available in Central bank and no outsourcing was needed. On the invitation of the President Mahinda Rajapakse, Central bank Governor Ajith Nivard Cabral, assisted by two other Central bank officials, made a presentation to the cabinet prior to its agenda was taken up on September 06, 2006. Using audio visual equipment, he explained the ways the petroleum prices could be sustained amidst rising fuel prices in the world markets.

A cabinet paper was submitted and the cabinet decided to appoint a committee of officials to study it. The letter in this regard was sent to the former Secretary of the Ministry of Finance P.B. Jayasundara. A committee comprised of Central Bank Assistant Governors Y.M.W.V. Weerasekara, Dr. H.M. Thenuwara, Central Bank Chief Financial Officer Saliya Rajakaruna, People?s Bank?s Kapila Ariyarathna, Additional Secretary of the CPC Kanthi Wijethunga, CPC Deputy Finance Secretary Lalith Karunarathna and Finance Ministry Adviser on Financial Regulation V. Kanakasabapathi recommended ?zero collar method? for hedging. The report in this regard was sent to the Finance ministry Secretary on November 16, 2006.

On January 09, 2007, Central bank Governor instructed over the phone to the CPC Chairman Asantha de Mel to hasten the hedging business and a directive was sent in writing in this regard on January 10. On January 13, the Minister of Petroleum and Petroleum Resources A.H.M. Fowsie tabled a cabinet paper stating that the Ministry would agree with the committee recommendations to commence hedging on the instructions of the Central bank Governor. The cabinet paper was endorsed.

On November 17, 2008, Minister Fowsie submitted another cabinet paper seeking appointment of a committee to manage forward risks. Ministry Secretary W.B. Ganegala, Treasury Deputy Secretary Dr. R.H.S. Samarathinga, Director of Fiscal Department D. Vidanagamachchi. CPC Chairman Asantha de Mel, Central Bank Additional Secretary R.A.A. jayalath and CPC Dputy Manager of Finance Lalith Karunarathna were appointed the committee. The cabinet collectively endorsed these appointments, pointed out Mr. Wickramasinghe.

Due to hedging agreements, due to debt to the Iran and Indian oil companies and due to the debt the state institutes owe to the CPC, the debt burden on the shoulder of the CPC is now Rs. 218 billion. This amount is as big as Rs. 10,000 per head of Sri Lanka?s population and the CPC

has to be auctioned to settle it, said the Opposition Leader. The president would have to go for an election to cover this massive fraud since war would not provide enough cover for it, he said.

The Opposition Leader said that the deal is linked with corruption and nourishment, devoid of white vans but oil vans.

Annexture 01: A copy of the letter sent by Central bank Governor Ajith nivard Cabral to the CPC Chairman Asantha de Mel instructing to commence oil hedging without delay.

Annexture 02: A copy of the endorsed cabinet paper tabled by Minister of Petroleum and Petroleum Resources A.H.M. Fowsie seeking appointment of a forward risk management committee.

Annexture 03: A copy of the letter pertaining to the cabinet decision regarding the consultation of Central bank Chief Ajith Novard Cabral on the invitation of the President Mahinda Rajapakse, sent by Cabinet Secretary D. Wijesinghe to the President, the prime Minister and the secretaries of the Ministries.

http://sundaytimes.lk/081130/FinancialTimes/ft305.html

CPC hedging: The drama continuesThe Sunday Times: Sunday November 30, 2008

If fuel prices rise, it will save CPC Chairman Asantha De Mel and his organisation: if it continues to fall as seen in recent weeks, the CPC debt will continue to zoom.

In this equation, the consumer doesn’t benefit: either prices going up or coming down. Now, what kind of rational explanation is this .. one may ask. Simply put … this is how the controversial oil hedging deal has been structured that has created a storm across the island.

Calls for De Mel’s resignation are growing as the government grapples with a near $400 million payout if oil prices remain at current levels while equal pressure is on to stop payment to the banks who have been accused of misleading the CPC. While the enormity of the problem is just seeping in – all due to the efforts of this newspaper to raise awareness over an economic calamity – the CPC chairman was stumped by a deep understanding of oil hedging at a recent probe meeting where he was summoned in the presence of several ministers and opposition legislators. Education Minister Susil Premjayanth in particular, armed with stacks of documents which included a detailed version of The Sunday Times exposure of this one-sided deal, literally pounced on the chairman with facts and figures to which the latter had little answers.

Apart from the oil hedging scam which essentially is because the CPC was sold an instrument that was heavily weighed in favour of the banks, the whole fiasco has opened a can of worms with the newspaper being privy to ‘unheard of’ happenings at the CPC that would further stun this nation.

Much of that would also be dealt with in the raft of fundamental rights petitions already filed or being contemplated. After hearing one case, the Supreme Court on Friday called for the suspension of both Minister A.H.M. Fowzie and De Mel. The Sunday Times FT desk has been besieged with calls ‘for action’ from consumers and citizen rights’ groups seeking more information on this saga. “Could you provide a simple explanation of hedging” or “do you have details of the contracts” were some of the questions asked as more groups prepared to appeal to the Supreme Court to exercise their right. What is clear then and now is that few people (apart from a few experts) had no clue about hedging, which if properly explained (as we have learnt now) is not difficult to understand. Hedging is like an insurance policy – taking a policy so that if things go bad for the business or an individual, one is protected. Hedging is not a bad idea and used extensively across the world mainly in commodity trading but the problem here was that the CPC lacked expertise apart from De Mel and CPC DGM Lalith Karunaratne, as they claimed!

The problem in the present case is that the CPC resorted to the wrong hedging instrument and there lies the story. Across The Sunday Times today there are more details of this episode – in which among the main issues are the lack of transparency and accountability – in addition to a series of events that unfolded this week.

De Mel continues to say that he was misquoted in an interview with The Sunday Times over the lack of understanding of hedging by the Ministers. For the record, this is what he says (from the newspaper’s verbatim recording of the interview): “In hedging, he (Mr Karunaratne) and I have the most experience in hedging today. Name one person who has had this exposure? Our politicians, our government has not understood hedging. How do I explain to them? We have gone and explained to the president, the governor, the treasury, the minister, the consultative committee?”

De Mel says he got cabinet approval – waving a paper at the ‘infamous’ press conference flanked by CEO’s of Standard Chartered Bank, Citibank and Commercial Bank – and expressed the same point at The Sunday Times interview by providing a cabinet memorandum as proof. Ministers at this week’s probe committee confirmed that no approval was given. Neither did the board of directors give approval, its members told the committee.

While the issue triggered a series of developments, it has brought together both the government and opposition in seeking the truth – for the public good. The banks – who claim to have informed the CPC of the risks -- shouldn’t also be allowed to go scott free for a deal that has dearly cost the country.

http://www.lbo.lk/fullstory.php?nid=322594399

Mon, 09 March 2009 13:03:15 Hedge Statement 6 Comment(s)05 Dec, 2008 14:52:43

Sri Lanka central bank defends itself from hedging fire

Nov 05, 2008 (LBO) – Sri Lanka's central bank, under fire for advising a state-run petroleum firm to hedge oil imports using derivatives in the belief that it helped the balance of payments, has issued a statement defending its actions.The full statement is reproduced below:

Hedging : A Clarification re. the Central Bank’s Role

The attention of the Central Bank of Sri Lanka (CBSL) has been drawn to recent media reports wherein it had been claimed that the government was trying to protect certain officials including the Central Bank Governor, Ajith Nivard Cabraal. While, as a policy, the CBSL does not respond to individual statements, since the tone and nature of some of these remarks and analysis appears to impute impropriety of the conduct of the Governor and certain other officials of the CBSL and thereby to tarnish the image and credibility of the institution, the Central Bank wishes to issue this statement in order to set the record right.

(1) Towards the latter part of 2006, oil prices started to increase sharply and that resulted in Sri Lanka's expenditure on petroleum imports to rise from US dollars 837 million in 2003 to an estimated US dollars 2.1 billion in 2006. The following Table that was prepared around end 2006, sets out this position:

The predictions in the market towards end 2006 were also that the oil prices would increase further in 2007 and beyond in view of the high demand from the China and India and this development was expected to exert severe pressure on Sri Lanka’s balance of payments and the exchange rate.

(2) Accordingly, in order that the Ceylon Petroleum Corporation (CPC) would be able to withstand the impending worldwide oil shock, the CBSL was of the view that it would be useful to introduce hedging techniques within the CPC. In line with such view and the CBSL’s role as the Economic Advisor to the Government, on 6th September 2006, the Governor of the CBSL made a presentation that was prepared by the Economic Research Department of the CBSL, to the Cabinet of Ministers on the subject ‘Maintaining Stability in a Volatile Global Oil Market’, in which the importance of hedging to achieve stability in oil prices was highlighted. In that presentation, the CBSL explained to the Cabinet, that there are financial instruments to reduce exposure to risk from volatile commodity prices and that in order to do so, the CPC may need to enter into forward agreements for future oil imports with reputed banks or pay a premium so

that agreed prices could be held firm. Two possible hedging instruments were also specifically proposed in that presentation, as follows:

(a) Crude Oil CapCPC sets the maximum price: i.e., the Cap. If the market price rises above the Cap, the hedging bank will pay the difference to the CPC. If the market price drops below the Cap, CPC is free to buy from the open market. As consideration, CPC needs to pay a premium for each barrel.

(b) Zero-cost CollarCPC sets the maximum price: i.e. the Higher Collar. In response, the bank sets the floor price: Lower Collar. If the market price is above the higher collar price, the hedging bank will pay the CPC, the difference between the higher collar price and the market price. If the market price is below the lower collar price, the CPC will pay the hedging Bank, the difference between the lower collar price and the market price. No premium is involved.

(3) Consequent on the presentation, the Cabinet of Ministers decided that a committee comprising officials from the CBSL, Bank of Ceylon, People’s Bank, Ministry of Finance & Planning, Ministry of Petroleum and Petroleum Resources Development and CPC be appointed to study the subject further, and to present a report to the Cabinet. This committee, duly studied the subject and presented a report to the Secretary to the Ministry of Finance & Planning on 16th November, 2006.

(4) By early January 2007, since hedging had still not commenced and Sri Lanka’s vulnerability was increasing, the Governor sent a letter to the Chairman of the CPC, dated 10th January 2007, in which he stated as follows:

“As you are aware, the Central Bank of Sri Lanka was instrumental in promoting hedging as a means of purchasing petroleum and made a presentation to His Excellency the President and the Cabinet of Ministers on 6th September 2006. The Central Bank has also made available to the CPC, certain technical details and options for hedging. However, we note that the CPC has so far not been able to enter into any form of hedging or other acceptable financing arrangement to ensure that Sri Lanka’s petroleum bill will be at manageable levels in 2007.

As you may agree, petroleum prices have now reduced to about US $ 55 per barrel, this may appear to be the opportune time to enter into suitable arrangements to hedge at least a part of our country’s total requirements. Hence, in the interest of the national economy, I would urge you to take the necessary steps to ensure that expenditure on fuel prices will not cause undesirable effects on the macro-economy in 2007.”

Such advice to the country’s largest single importer was obviously, sensible and timely. Accordingly, it is clear that the advice cannot, in any way, be considered imprudent or irresponsible. In fact, the events of 2007 and 2008 clearly indicate how vital and important this advice had been.

In response, the Chairman of the CPC, on 11th January 2007, assured the CBSL that the CPC is “in the process of working out necessary details in getting the hedging process expedited as quickly as possible”. To such letter, the Governor of the Central Bank responded on 16th January

2007 by stating that the CBSL is pleased that the CPC is “working out the necessary details in relation to implementing the hedging processes as quickly as possible”. Such a response was made in the context that, at that time in January 2007, it was highly desirable and opportune for Sri Lanka to make use of the depressed prices to commence hedging.

(5) On 13th January 2007, the Hon Minister of Petroleum and Petroleum Resources Development presented a Cabinet Memorandum setting out the recommendations of the study group seeking the approval of the Cabinet. Subsequently, approval was duly granted by the Cabinet for the following actions:

(i) CPC to hedge purchase of petroleum products, both crude oil and refined products in the international market. (ii) Use Zero-Cost Collar as the hedging instrument with the upper bound based on market developments.(iii) Commence hedging with smaller quantities for a shorter period and gradually increase the quantity and the duration.(iv) Grant authority to the CPC to call for quotations for oil hedging, decide on future prices and purchase hedging instruments from reputed banks.(v) Grant authority to CPC to change instruments based on the developments in the market.

(6) Once the Cabinet of Ministers approved the concept of hedging and permitted the CPC to commence hedging operations, the role of the CBSL in this exercise which it initiated as the economic advisor to the Government, was completed. Accordingly, the CBSL was not, and indeed did not need to be, involved in the hedging transactions of the CPC. In this context, it should also be noted that the CBSL regularly provides policy advice to the government and government institutions by way of observations to Cabinet Memoranda and the September 15th Report prior to the announcement of the Budget. Upon the acceptance or otherwise of such policy advice, the responsibility of either implementing or not implementing such proposals, lies entirely with the implementing agency.

At the same time, in order to create greater awareness among the public, the CBSL published a Technical Box Article in its Annual Report of 2006, issued on 31st March 2007, on the topic: Hedging Oil Imports against Price Volatility. (Vide Page 47 of the Central Bank Annual Report 2006). In this article, the CBSL discussed the many aspects of hedging as well as the generally available instruments worldwide, to undertake hedging. The following extract from the Box Article confirms that hedging, if properly carried out, could still be a useful instrument to mitigate the impact of adverse price fluctuations: “Like an insurance policy, hedging is used to protect against unexpected negative events. This does not prevent the negative event from occurring, but if it does happen and if it is properly hedged, the impact of the event is reduced. Thus, the hedging is not aimed at generating profits, but mainly protecting from losses that could arise from adverse price fluctuations.”

(7) From the above actions of the CBSL, it would be clear that the Governor and other officials of the CBSL have carried out their duties and responsibilities in a prudent and professional manner, in complete contrast to the allegations and insinuations made.

(8) After the recent developments in relation to hedging were known, the CBSL has already taken several steps in the effective fulfillment of its role as the regulator of the commercial banks. In fact, the CBSL had commenced its examinations into the banks’ roles in hedging transactions in early November 2008, well before any petition or plaint had been filed in Courts. Nevertheless, at present, since hedging related issues are the subject matter of judicial proceedings before the Supreme Court, the CBSL would refrain from making any comments in relation to its current investigations.

In conclusion, the CBSL wishes to assure the public that it would discharge its duties in accordance with the law and the directions that have been issued to the Monetary Board by the Supreme Court, in a professional, fair and forthright manner.

READER COMMENT(S)6. TRUTH Dec 08 I'm curious, based on what economic logic have all of you'll made your allegations.1) Why do you'll think it's better for CPC to be privatised?2) CBSL Governor has done more economic damage to the economy than the terrorist Prabakaran - can you please share the calculation you used in coming to this conclusion.

"Future Banker" even if oil prices had hit USD200 these officials would have never been viewed as heroes. SLs very sparingly give due credit to the government, but are extremely quick and persistent on catching onto every mistake and making mountains out of moulds.

5. Future Banker Dec 07 I can't understand why so many people are against hedging in this country. If the prices went up to say $200 these officials could have been viwed as heros. Hedging is not gambling. It is a way of reducing uncertainity/risk of adverse impacts. By removing risk/uncertainity officials can plan for better. Having said that I do not think that the Zero cost structure was the best alternative. Ideally CPC should have retained the upside by entering into a option contract.

I would like to hear others comments on this. We can learn something from the whole episode...not just pointing fingers.

4. Upul Arunajith Dec 06 Dr DahanayakeThis was discussed with the present Governor end of 2005 when he was in charge of SEMA.Reason being this is something that I had discussed with the former chief of SEMA Mr. Tittawela who was to implement this mechanism under a world bank funded ERTA project.

However, with his departure, and Mr Cabraal taking over SEMA assuming that he was a very forthright and above all a professional I discussed the proposal. It took me almost six months to convince him of the validity of Hedging.

He was all the time asking me who is going to provide protection when the price ofthe commodity is going up.

Eventually to get me over his back, he once said that Upul, we get so many project propsals and I can put your hedging proposal too in that category and see what can be done but hold no guarantees.

However, I gave him detailed papers that gave the fundamentals and no sooner he became the governor he went public with the Propsal as if it was coming from him and not from me. That is how bad this person is.

Above all gone against all established ethics. But, when things go wrong he is not assuming responsibility but do the "blame game' and point fingers at others.

As the project architect, while I was at the CPC with the Chairman, Mr Cabraal sent a fax and hand delivered a letter around the 9th Jan 2007 instructing the CPC Chief to immediately implement Hedging as per the the discussion discussion held with Cabraal and if it is not done on a timely manner that he will be held accountable if the price went up.

The Zero Cost Collar hedge is his idea and he is accountable for this wrong advice. I had advised them all that the Zero Cost was wrong and the local banks cannot provide hedge to the CPC.

But fools don't take advice and smart people don't need advice. If he was smart, we will not be in this dire state today.

3. marti Dec 06 Since the minister of petroleum fowzie has gone on record to say that hedging of oil was done as per the directive of CBSL , needless to say that the governor was unaware of these deals or presumably done with his blessings.

While there are so many forms of hedging instruments to cap oil exposure, what puzzles me is why these goons permitted CPC to engage in Zero cost structures, with CPC writing an option and using the premium to buy one, where the liability on the upside ( banks pays CPC) is limited while liability on the downside (when fuel prices fall and the CPC pays banks) is unlimited?

Since these deals were entered with the blessing of CBSL and now that CPC has to cough up USD750 mio, it appears that governor has done more damage to the economy than the terrorist prabakaran!

2. Jack Dec 06 What the!! How stupid is it to come up with a 'Hedging' concept at this scale.. Hedging would have worked out in some countries with certain other industries, but at a time where the fuel price went up and down even when the deals were made, it is one of the worst deals that was ever done! If this was not there, the price of a liter would have been less than 80 rupees...1. Dr Sirisena Dahanayake Dec 06 This is what happens when a government tries run a business that could be better handled by the private sector. No doubt the CB is to be blamed if it advised the Petroleum Corporation to hedge its oil imports.

I can remember reading some time back that the present CB Governor having proposed petroleum import hedging. If he was behind the hedging proposal, I think he sould resign.

He is a political appointee with no adequate previous monetary policy experience. After his appointment, the SLCB has lost its credibility.

http://www.lankabusinessonline.com/fullstory.php?nid=475292913

Mon, 09 March 2009 13:03:31 Gravy Train 1 Comment(s)21 Nov, 2008 15:11:12 By Riyad Riffai

Sri Lanka hikes tax on petrol importsNov 21, 2008 (LBO) – The Sri Lankan government has increased the customs duty on imported petrol by 10 rupees per litre to 35 rupees from yesterday, a senior Treasury official says.

“We are increasing the taxes to trim the extra profits the two petroleum companies are making with the sudden drop in world energy markets,” says S R Attygalle, Director General Fiscal Policy of the Treasury.

“This will not have an impact on the price of petrol at the pump.”

The government's budget for 2009 reduced the price of petrol by 15 rupees which included a 10 rupee duty waiver

The price of diesel was reduced by 30 rupees.

“We have removed the 10 rupee duty waiver on petrol,” says Attygalle.

Currently, the retail price of petrol is at 142 rupees, and diesel at 80 rupees per litre.

From the day of the budget speech two weeks ago global energy prices have dropped by a further 10 dollars, to 48 dollars a barrel.

This phenomenon is known as a deflationary price collapse where commodity markets collapse after bubbles created in the financial system due to excessive money printing by central banks such as the Federal Reserve.

Pricing woes

With the latest increase in import tax the government would earn 73 rupees on a litre of imported petrol and 18 rupees for a litre of diesel oil, says an industry official.

The treasury says Sri Lanka’s annual fuel consumption is 700 million litres of petrol and 2000 million litres of diesel.

Sri Lanka on average imports 550 million litres of petrol a year which would bring in 40.15 billion rupees into government coffers, according to an analysis of import volumes and tax rates.

Almost 50 percent of the country’s diesel is imported, which would generate a further 18 billion rupees to the government.

According to Central Bank data the Singaporean Platt price (foreign selling) for a barrel of petrol is 40.90 dollars and 65.80 dollars a barrel for diesel.

A barrel can hold approximately 160 litres of fuel.

Transport and insurance costs are on average two dollars a barrel.

This would put the Cost Insurance Freight (CIF) value for a litre of petrol at 29.5 rupees, at 110 rupees to the dollar.

Diesel would cost 46.6 rupees per litre.

Other costs would include domestic distribution costs, insurance, financing costs, retailers' margin and profits.

In Sri Lanka diesel is sold cheaper than petrol

Currently state owned Ceylon Petroleum Corporation is losing nearly 30 million dollars a month on a hedging contract that had not taken into account the downside risks.

The hedging deal that was inked with Standard Chartered Bank, Citibank, Deutsche Bank, Commercial Bank and People's Bank covers 30 percent of Sri Lanka’s fuel imports.

If global energy prices continue their downward spiral the CPC’s hedging loss payments would increase.

"If prices drop to levels that were seen a decade ago we’ll end up paying more for the hedge than the oil," says a senior banker.

Peoples money

However Sri Lankan policy makers can not pass on the full benefit to its citizens of lower energy prices due to ballooning budget deficits that have financed subsidies and social safety nets that have done little to uplift living standards of the rural poor.

Subsidies are used as a populist method to grab votes in rural constituencies even though it costs billions of tax payer’s money.

The budget for 2009 has allocated 41 billion rupees as subsidy and Samurdhi welfare payments.

Despite the subsidy payments Sri Lanka imported 8,000 metric tons of rice from Burma as domestic rice retail prices neared to an unheard of 100 rupees per kilo.

READER COMMENT(S)1. Nazim Nov 22 Indication that a petrol price hike on the pumps is in the offing. I totally agree with the writer who wrote in one of our national newspapers - quote "When the world market price on oil increases, the same day oil price increases in Sri Lanka sharp at midnight. When the world market oil prices are reduced - the same day oil price increase sharp at midnight.Quote. Talk about altruism

http://www.nation.lk/2009/02/01/busi1.htm

The Nation:Re-negotiations the only way to come out of hedging pit

By Indika SakalasooriyaThe Ceylon Petroleum Corporation (CPC) and the banks involved in the controversial hedging deal, should resort to a negotiated solution as the country’s Supreme Court last week terminated the interim order that ruled the hedging transactions null and void, analysts say.

CPC will have three options to choose from, they point out. “CPC can either honour the hedging deal that it entered with five banks and which is due to expire in May 2009, or it can just walk away from it, though the implications would be appalling. These are both extreme choices that would harm either party negatively”

“The third solution, which can more or less be called a win-win situation, is for both parties to go for a negotiated solution, by re-structuring the original hedging deal.” an analyst who preferred to be unnamed, told The Bottom Line.

As he further explained, given the current situation of the country’s external reserve position, the Treasury is unlikely to opt for the first choice by paying the hedging contracts as agreed, which is of course, estimated to be a whopping USD 300 to 500 million.The stance of the Monetary Board of the country, which was expressed in a press release issued by Central Bank last week, said the transactions CPC has entered with a number of banks were “materially affected and substantially tainted”.

“This directly tells the banks not to proceed with hedging transactions until further notice. But it would be interesting to see whether these banks can go by this directive as when they entered into to these hedging transactions, they had transferred the risk associated with the deal with one or several counter-party financiers. So the interesting question is can they not honour these

inter-bank relationships?” he remarked.

According to a Fitch Rating report a couple weeks back, the banks involved in the hedging deal were acting as intermediaries, as the banks structured the deals with corresponding positions, with offshore counterparties, earning a fee or commission and carrying only counterparty default risk.

As the above analyst further pointed out, Standard Chartered Bank and Citi Bank and Deutsch Bank branches in Colombo can hold on to the Monetary Board decision as they’ll be able to settle the transactions with their mother banks relatively easily.

“But we are yet to know the complexities the two Sri Lankan banks, Commercial Bank and People’s Bank are exposed to when entering the hedging transactions with CPC. We don’t know how these banks have dealt with the risk element involved with the transaction. They might have transferred the risk element partially to several other local and international banks and institutions. In other words, both the banks are exposed to counter party risks” said.

Another analyst who too wanted to be unnamed, brought out the point that a possible non-payment as proposed by the Monetary Board can even trigger a systemic effect given the nature of inter-bank dealings the two Lankan banks had with other banks related to the hedging deal. For example the People’s Bank entered the CPC hedging transactions through ComBank” he said. However so far there have been no claims either by the ComBank or the people’s Bank over an inter-bank transaction with any other local bank pertaining to the hedging deal.

Dr. Harsha De Silva, one of country’s most vociferous economists told The Nation Economist that he believes it is unlikely that international counter-party financial transactions will be reneged as the country is seeking to raise increased funds from foreign markets in order to tackle its impending Balance of Payment crisis.“Therefore whether we like or not, the hedging transactions have to be re-negotiated with the participation and corporation of both parties involved in it,” De Silva said.

He also pointed out that if the CPC resorts to not paying the banks, the three international banks, Standard Chartered, Deutsch Bank and Citi Bank can even seek the assistance of an international arbitration court, like Prima Ceylon Limited did recently.

Impact on ComBank

According to a research report issued by CT Smith Stock Brokers last week the total counter-party exposure of the ComBank would amount to approximately USD 25.53 million (including the November and December dues based on a WTI crude oil price of USD 35 per barrel) if People’s Bank continue to dishonour its payments in the counter-party hedge agreement.Though earlier it was understood ComBank had a relatively low exposure to the CPC hedge, the Bank disclosed on December 2, that it was liable to pay its international counter-party to the hedge a sum of USD 8.93 million in order to honour its position.In addition ComBank subsequently disclosed that People’s Bank which entered hedging deals through ComBank also failed to honour its November and December 2008 payments, to Combank in respect of this counter-party hedge agreement amounting to USD 3.93 million.

http://sundaytimes.lk/081214/FinancialTimes/ft320.htmlThe Sunday Times: Sunday December 14, 2008

Reckless oil hedging by the CPC – experts report

A committee of experts analysing the recent oil hedging debacle says in its report that the zero collar hedge, recommended by the Central Bank (CB) has been adopted recklessly by the Ceylon Petroleum Corporation (CPC), not understanding the limitations and not including safeguards to protect the CPC's interests.

Here are extracts of the report that was compiled and edited by Mr.Daham Wimalasena :The CPC signed eight hedging transaction contracts, totalling 14,160,000 barrels of oil, covering 12 calendar months with Standard Chartered Bank (SCB), CitiBank, Deutsche Bank, People’s Bank and Commercial Bank. The traded cost of oil on transaction dates are estimated at over $2,000 million. The transactions have exposed the CPC to financial obligations that could range from a low of $700 million to as high as $1,000 million if the decline of crude oil prices to $25 per barrel were to occur as now projected by Merrill Lynch Energy Research.

The group examined the steps and processes leading to the potential debacles and likely remedies. Rising pricesIn September 2006, faced with the rapidly increasing price of crude oil and petroleum products, the Governor of the Central Bank (CB) made a presentation to the Cabinet of Ministers to identify strategies to 'Maintain Stability in a Volatile Global Oil Market.' Oil-costs hedging instruments were proposed. Commodities hedging is a useful tool in the commodities trade but should be engaged in with great caution.

On 13th January 2007, the Minister submitted a Cabinet paper requesting approval for the following:- CPC to hedge purchase of petroleum products both crude oil and products in the international market. - Use zero-cost collar as the hedging instrument with the upper bound based on market developments (the floor prices are set by the Banks-please see definition of floor price below) - Commence hedging with smaller quantities and gradually increase the quantity and duration. - Grant authority to the CPC to call for quotations for oil hedging, decide on future prices and purchase hedging instruments from reputed banks based on market developments.

- Grant authority to the CPC to change instruments based on the developments in the market. The Cabinet approved the Ministers request on January 24th 2007. The Minister and CPC Chairman thereupon arrogated the procurement of hedges and circumvented established procedures on the basis of authority granted to the CPC to call for quotations for oil hedging, decide on future prices and purchase hedging instruments from reputed banks based on market developments.

StrategyThe option recommended by the CB was to adopt a strategy referred to as a "Zero-Cost Collar" hedge. Under this strategy the CPC would set a maximum price and if the market price were to exceed this ceiling, the Banks would pay the difference in price multiplied by the quantities hedged. With regard to the lower limit, the Banks would set the price, referred to as the floor price and if prices were to fall below the floor price the CPC would pay the difference in prices multiplied by the quantities hedge to the Banks.

There is no crystal ball to set either price but this is generally based on knowledge of global conditions such as economic, political and petroleum supply and demand. There is much uncertainty in the oil markets due to ongoing wars in Iraq and Afghanistan and political tensions in the Middle East. The CB suggested the zero collar hedging but the details were left to the CPC to develop.

Under normal and required procedures the CPC, since it did not have the necessary expertise, should have engaged consultants to develop the terms of reference and establish the ceiling and floor prices and review contracts.

The CPC Chairman apparently decided this was not necessary and he and the Deputy General Manager (Finance) trained themselves as 'experts' by attending seminars and meetings with representatives of the very banks who were potential sellers of hedge instruments and claimed that he and his DGM have become the foremost experts in the company on hedging instruments.

Upper limitThe CPC Chairman set the upper price limit. The Banks stipulated the maximum dollar risk they would bear and also specified a contract life time limit of three months if events were not to favour the banks' position. The Banks set the floor price and other conditions also specified that the quantities hedged would double if it is in their favour without a dollar limit.

The contract periods in all transactions were 12 months. The potential loss on current prices because of the structuring of contracts is over $1,000 million based on December 5, 2008 prices. None of the risks was explained to the Cabinet, the CPC Board or any other party or approved by the Cabinet. The CATB (Cabinet Appointed Tender Board) was totally ignored.

Mandatory Procurement ProceduresThe authority granted by the Cabinet was to the CPC and not to the CPC Chairman. The CPC is required to follow cabinet approved procedures for procurement of crude oils and products for which purposes a permanent CATB which comprises the Deputy Secretary to the Treasury, Secretary Petroleum and an Assistant Governor of the Central Bank, is established to be convened when required. The CATB also has to consult the TEC (Technical Evaluation Committee) before making a decision after which the decision is sent to the Cabinet for approval.

The CPC Chairman dispensed with these procedures relying on the Cabinet decision wherein the CPC was authorized to negotiate hedging contracts. The mistake here was that the Chairman's

apparent interpretation that CPC is synonymous with Chairman and the authority was granted to him. In the light of the procedures described in the preceding paragraph, how could the CPC Chairman who is not even a member of the CATB, undertake hedging instrument purchases on crude oil and gas oil which are enormously higher in value and riskier than those considered by the relevant CATB without the final approval of the Minister and the Cabinet? The Minister had no authority to do so and also did not seek Cabinet approval of the terms negotiated by the CPC Chairman outside accepted purchase procedures. It would appear that the exposure now faced by the CPC is a result of lack of experience and knowledge on the part of the Chairman and the Chairman identifying himself as the CPC. Decisions were taken by the Chairman unilaterally, presumably with the blessings of the Minister, who has defended every action of the Chairman. The Minister and Chairman have hence to bear sole responsibility for the hedging debacle and not shift the blame for recommendations to hedge to either the Cabinet or the Central Bank. It is not hedging that is at fault but what was in the hedging contracts – the terms and conditions. The Chairman entered into eight contracts unilaterally, without the approval of the Cabinet, the CPC Board and the Attorney General.

CATB/TECThe Chairman is not synonymous with the CPC. The CPC could make decisions as listed in cabinet resolution but the decisions have to be consistent with CPC procedures and limits of financial responsibility vested in the corporation and hence should have followed established procurement procedures, which the Chairman did not. As far as the Chairman was concerned it appeared that the CATB and the TEC did not exist.

The permanent CATB is to procure crude oil and products and the TEC is to provide transparency and the necessary checks and balances to safeguard the public interest. The hedging instruments ultimately totaled 14.16 million barrels of oil with an intrinsic value between $1,500 million and $2,000 million. How could the Chairman have unilaterally signed contracts aggregating over $1,500 million? The transactions should have been processed through the CATB and the TEC.

The CPC team worked directly with the Minister of Petroleum and the Banks, made decisions without informing the CATB and did not obtain Cabinet approval. The Minister became a one-man Cabinet. As pointed out by the Chief Justice, there was no supervision by the Minister of the activities of the CPC Chairman. Belatedly, when the hedging debacles made headlines on November 18th 2008, eleven months after the purposed approval in principle by the Cabinet of the hedging concept proposal, the Minister of Petroleum submitted a memorandum seeking approval for the appointment of a Hedging Risk Management Committee – please note that eight hedging contracts with five banks had by this time been signed between April 2008 and completed November 2008.

Costly mistakeNot working with the CATB and the TEC was a costly mistake both in financial terms and propriety. It is a well known fact that hedge funds compensate their managers based on performance. Bonuses on large transactions run to millions of dollars. On the CPC transactions, if the Banks were to prevail and the CPC has to pay, bonuses to hedge fund managers could range from $50 million to $100 million or more depending on the quantities to which the CPC has foolishly committed and market prices. Fund Managers are known to wine and dine their

clients. Spreading part of their bonuses around also is not uncommon. Considerations such as these should have weighed heavily for the protection of the officials, the CPC, the Minister and the transactions' integrity. The Minister should have followed accepted procedures and directed the Chairman to work with the CATB.

In summary the financial claims facing the CPC result primarily from the following reasons:- Circumventing the CATB and the TEC - Unrealistic Floor Prices in Hedging Contracts that safeguarded and enhanced the profits to the Banks. - The total lack of appreciation of market developments by the CPC team and the Minister who acted as a one-man Cabinet.

- Understanding the nature of oil markets and that oil is one of the most volatile of any commodity. - Signing relatively long term contracts for a highly volatile commodity –oil. Lack of an affordable exit strategy.

- Approval for hedging was given primarily for the purpose of 'Maintaining - - Stability in a Volatile Global Oil Market' as explained by the CB. Volatility is measured by how rapidly crude oil and product prices change.

In order to monitor volatility and take preventive action the following precautions should have been taken:

-Contracts should have been short term, not more than 3 months and certainly not 12 months for a product that is the most volatile of all commodities. -Developments in the oil markets globally and price perturbations should have been continuously and rigorously monitored – not even the CPC Commercial Manager was consulted. Lessons to be learnt:

The CPC appears to have over the past three years systematically dismantled established procurement procedures, judging from the several instances of malpractices that have been reported in the media. The hedging disasters have exposed the deft circumventing of procedures that may never have been revealed if not for media vigilance. There are two other reported cases of likely improper procurement already committed or in the process of being hatched. These are rumoured to be a proposed refinery project and a bunkering deal.

With a vigilant press misdeeds cannot be supported for too long. In the interest of the President’s good name and for the country's sake, a major cleansing of the CPC may be needed from the top down.

http://www.thebottomline.lk/2008/11/26/index%205.htm

The Bottom Line: Wednesday, November 26, 2008

‘CPC loses over hedging deals’: They lost ‘how’ … Doing ‘what’?

By Chrishmal WarnasuriyaBA (Colombo), P Dip. (Hons), LLM (Hons) (London)

When newspaper headlines carry such titles in large, bold font, naturally (of course, greatly assisted by the fact that we are by pedigree a ‘chat friendly’ people) almost every conversation countrywide appears to centre round this new topic – ‘hedging deals’of the Ceylon Petroleum Corporation (CPC). The latter, of course, has constantly been the subject of discussion since the CPC and its actions (as indeed that of all fuel producers/distributors) has by and large a direct correlation to our everyday lives one way or the other; be it the fuel we pump into our vehicles, the liquid petroleum gas that lights up our dinner, the electricity that is primarily generated by turbines run on fuel, or, even in the simple case of citizens ‘Bandara, Silva or Sinnadurai’ (as the case maybe, separated only by geographical location but certainly not by their need for basic necessities) who purchase that one pint of kerosene oil to light up the solitary kuppi lampuwa in order that their kids may read their lessons. But what the dickens is this ‘hedging’ that they have apparently gone and done? How exactly did that cause a loss to state coffers? I’ve noticed from several conversations that ‘hedging’ appears to be new lingo for many. It would have been utter French to an everyday town idiot like myself as well a few years back, if not for the gracious intervention of fortunate education on the subject, which I felt I must share with my fellow citizens; at least for a basic elucidation of the area of ‘derivatives’ or commonly used hedging mechanisms, particularly in the larger financial capitals, together with some passing references or ‘hints’ at how to minimise our own ‘risk’ when dealing with these ‘risk instruments.’

Given the fact that I am not privy to the specific details or terms upon which the CPC contracted and my understanding of their particulars are therefore minimal and limited to what I have gathered from the news, I shall endeavour to refer to the subject more generally allowing the reader to relate that ‘theory’ to whatever details known by them. You will also note that the term ‘derivative’ and ‘hedging’ have been used loosely and interchangeably although technically, as for instance where a contract based upon the future delivery of a product is intended, the term ‘derivative’ is not generally used since it is more a ‘financial contract,’ as there is ‘actual delivery’ envisaged; a ‘derivative’ does not contemplate such a ‘physical delivery.’ However, for our instant purposes, we do not need to get bogged down by such academic intricacies, general references will suffice. Also, most references may be to UK and US practices particularly where reference is made to documents like ISDA (International Swaps and Derivatives Association), since these are what I am familiar with mostly and I admit in all humility that I am unaware of any similar regime dealing with the derivatives market locally.

There is also another ‘legal angle’ that I’ve touched on whilst on this subject of ‘government expenditure’ (or cases of losses caused to the State). Modern democracies have seen a radical transformation of the traditional relationship between the individual and the state, making the citizen a consumer and the State a service provider, or in most cases the state becoming a facilitator for the provision of required services; as for instance the CPC that carries out certain functions on behalf of the government. Whilst the government decides on the benefits through an ‘appropriation bill’ (policy), its distribution and administration are handed over to such agencies (implementation). Most of these agencies are not run by ‘public servants’ in the traditional sense but officers such as Chief Executives. Therefore a question lies as to their ‘accountability’ and the ability of a citizen to reach them by way of traditional administrative law remedies and review?

What are ‘Derivatives’?For a keen reader wishing to gather more ‘technical’ knowledge on the subject, I recommend ‘Law of derivatives’ by Simon Jones or ‘Henderson on Derivatives’ by Schuy Henderson. For the

moment, let us attempt to discern a basic insight and define derivatives by reference to some of their common features as below:

Derivatives are commonly used to protect against a risk or to take on risk;They are financial instruments/transactions, usually a bilateral contract/payments exchange mechanism ‘deriving,’ as the name implies, its value from an underlying asset, rate or index.

It is a hedge mechanism against market risk such as interest rate volatility in the financial markets or, as in our case, oil price fluctuation.

These risks are generally economic (such as commodity prices) BUT legal issues may also form the basis for such derivatives.

The ‘reference asset’ is the source from which the derivative derives its existence and usually precedes the name, such as a ‘security derivative.’

The derivatives market usually comprises of:Those seeking to hedge an underlying risk (e.g. Sri Lanka or the CPC)Those trading in derivatives (bank or other financial institution), and the speculators who deal in them with a view to gaining a profit (could be individuals, corporate entities and various others).

The theory, though not this simple in operation, could perhaps be explained at a basic level through a few examples. A person may wish to borrow money six months into the future for some purpose (say for a wedding of their daughter) but fearful of prevalent economic trends or inter bank lending rate fluctuations may wish to ‘fix his interest rate’ now, at some figure that he would like to borrow against six months hence and therefore could use an instrument referred to as a ‘swap’ or an ‘option’ to lock that interest rate. Similarly, a producer who expects his product to be ready for sale in 6 months but fearful of market conditions at the time, or speculating a drop in price, may wish to secure a fixed market price now and thus enter what is referred to as a ‘futures contract.’ The latter is technically a ‘financial contract’ and not a ‘derivative’ per se as stated above, since physical delivery of an item is actually intended; however the principle of operation remains the same.

The ISDA recognises several kinds of derivatives, which may loosely be categorised as:Exchange traded futures and options – those traded in exchanges such as the LSEOTC – over the counter risk solving derivatives.For our present discussion, to get an idea on how these derivatives operate, it may be of interest to note some discernible criteria of the following OTC’s.

Interest rate swap Say for instance Company X operating in London enjoys facilities to borrow money at a floating rate of LIBOR (London Inter Bank Offer Rate) + 0.75% and at a fixed rate of 8% interest. Similarly, if Company Y which has better credit ratings (in commercial capitals your borrowing ability is dependant on your ‘“credit rating,’ something similar to the ‘CRIB’ here) could borrow at floating rate of LIBOR +0.5%, and at a fixed rate of 7.25%. In this situation, they could enter what is referred to as a ‘Swap’ in reference to a notional amount of borrowing, whereby ‘Y’ would end

up paying ‘X’ only LIBOR + 0.25%, thus either party gaining with a benefit of 0.25% through their swap.

Equity Swaps These do not involve an exchange of principal like in a currency swap but there is an ‘exchange of cash flows,’ at least one of which is determined by reference to the performance of a particular stock or more frequently a stock index (e.g. FTSE). An example could be of an investor needing cash flow and wishing to realise some of his stock for this purpose. In doing so, however, he would naturally open himself out to market commissions as well as possible taxations. An alternative, therefore, would be to enter into a ‘swap on his equity,’ if for instance his stocks mirrored the FTSE, then he would guarantee either the stock (at a price) or the FTSE fluctuation for 6 months, in return for a 6 months guarantee on the LIBOR of that time. He can therefore borrow the money he needs without actually disposing of his stock, and as regards the interest rates he does not expose himself to a floating rate of the bank directly, but at the end of say every 6 months, the change in the index (or stocks) would be measured and netted off against the sum due on the LIBOR. Similarly, an investor in the stock markets wishing to move away from the Sri Lankan exchange and invest in the UK could, technically, without going through the process of selling stock here and buying it there; enter into a swap for the change in the FTSE index for a change in the equivalent Sri Lankan index.

Commodity Swaps Having thus gained a basic idea of ‘hedging’ mechanisms, let us now turn to commodities dealing, say for instance in ‘Oil.’ They follow the same pattern of other swaps, a series of payments based on the price of a commodity. An airline (or indeed a ‘Petroleum Corporation’) could ‘hedge’ itself or insulate themselves against an un-estimated future rise in fuel costs by entering into a swap, where it would agree with the dealer on a ‘fixed rate’ for a notional quantity of oil, thus whilst actually receiving or paying on the ‘spot rate’ (or prevailing price). If prices go up as seen they would ultimately regain that difference between the ‘spot rate’ and the ‘fixed rate.’ Although in the case of many other swaps the price is fixed on a given date, it is common for commodities such as Oil for the prices to be fixed by reference to an average over a period of time; thereby alleviating room for sudden upward or downward movements that may be unrealistic on the longer scale. As to how exactly CPC fixed the price are details unknown to me. There is also a concept referred to as a Floating Price Index (FPI), which refers to the spot price per barrel of oil at a future, semi annual rate. These concepts could perhaps be illustrated as follows:

So how do you ‘hedge’ against your ‘hedging risks’?The idea, as in the above example, is that you ‘hedge’ that risk of having to pay more in the future by an upward price fluctuation in the market by agreeing to some other rate (be it at FPI or fixed rate) at present, thus if things go smoothly as per your speculation then you gain by what you have provided for; however, as we are well aware (more so in this paradise isle of ours) things don’t always seem to go right do they? What you do in hedging in my opinion is take on a ‘calculated risk’ at most, in some countries they refer to it as ‘speculative dealing/trading’ and in some others, it borders on attracting ‘anti gambling/gaming regulations’ due to its very nature based on speculative gain (or loss to another); the bottom line being that these are funds invested based on ‘speculation.’ Our above referred citizens ‘Bandara, Silva or Sinnadurai’ might actually equate it in common village parlance to nothing but a ‘Suuduwa’(gamble), and they may not be far wrong. Hedging does not completely remove the

risk of what you fear, it will even things out if things go according to your plan, but if they don’t as on this CPC instance; it does ultimately end by cleaning you up at the roulette table.

So what happened? Based on news reports instead of the upward fluctuation predicted by CPC the prices fell even below the fixed rate (or the average or FPI, depending on what they actually contracted on) and when that happens, unless the dealer is your uncle or grandfather (which they obviously were not) you still have to pay at the rate which you have agreed to pay, which in fact is now below the actual rates prevailing in the market. So, now we have a situation where although we are in effect buying our oil at lower rates, we still end up paying the difference (or that gain if you like) back to our dealers with whom we have contracted to hedge our risks.

The derivatives market itself has come up with certain solutions allowing its players to negate their own risk, or this ‘speculative element’ as much as possible. For instance, the ISDA Master Document provides its own ‘Risk Reduction Methodology’ for financial derivative products and several ways in which a party can provide for events such as counterparty bankruptcy or your own insolvency; and advocates concepts such as ‘termination netting’ or ‘close out netting.’ There is also provision to provide ‘termination events’or for ‘early termination’ under which certain circumstances allow the derivatives contract to be terminated, and the rights and obligations standing as at such date be settled, set off or netted. Similar methodologies are also available in commodity risk hedging, though I hasten to reiterate that I have absolutely no idea on what terms the CPC contracted with their dealers and/or others, what advice they obtained beforehand and whether in fact their particular kind of dealing allowed them to provide for these mechanisms in their contract; as such, I am not entitled to state, nor do I wish to be an armchair critic and pontificate on whether they could have ‘done this and not that.’ I am simply noting down below a few methods by which the risks inherent in derivatives (not necessarily oil alone) can be minimised:

Options An option is a right (to buy or sell) but does not constitute an obligation. For instance, if someone anticipates a need to purchase a particular currency in the future and wishes to hedge against any depreciation, he may enter into a ‘Forwards’ agreement. This, however, would oblige him to purchase that currency and not avail him the benefit of any appreciation in the intervening period. In contrast, however, if he were to enter into an ‘Option’ it would allow him to purchase that currency if he still needs to, but for whatever reason (such as market depreciation) he is disinclined to do so, then he can exercise his ‘Option’ not to buy same. In view of this added flexibility in this type of hedging, you are usually charged a premium by whoever underwrites that option, but it is still better than losing more at the end. There are several hybrids of this type of hedging referred to by wonderfully attractive terminology such as ‘Put Options,’ its converse the ‘Call Option,’ ‘Knock In’ or ‘Knock Out’ etc which possibly may be a digression of our present theme.

Caps, Floors and Collars A ‘Cap’ is where in the event the index (interest rate, commodity price etc) exceeds a specified limit, the dealer will only have to pay that difference between that ‘capped amount’ which you have pre-designated and the actual rate of the day, based on a notional principal amount; as at such predetermined day when the derivative is deemed to materialise. A ‘Floor’ is the converse of the above, a hedging mechanism to provide for that commodity index falling below a specified amount, such as providing for oil prices making a downward fluctuation beyond a

predetermined price. What you do (in laymen terms) is that you decide on advice available as to what you would estimate the price to fall at its lowest and name that as your ‘Floor’ rate.

These two can also be used together and is referred to as a ‘Collar,’, which is a combination of the ‘Cap’ and the ‘Floor.’ As in our earlier example, if we were to hedge against the oil prices moving upwards beyond what we perceived to be an unmanageable amount, we could hedge for that risk by ‘Capping’ it and we could also ‘Floor’ it, thus not allowing ourselves to be placed in a situation where we would end up losing our advantage of the hedging itself and not having to pay the difference between a steep fall in future.

And what can ‘citizen ME’ do other than ‘just watching’?This brings us to an interesting juncture. If indeed there is some financial mismanagement or failure to adopt sufficient safeguards in government spending, or if indeed it is felt by some citizen that such ‘speculative dealing’should not have been ventured into at all by the State or one of its organs; ‘what do you do’ (as that movie ‘Speed’ repeats ad nauseum)? Does an everyday citizen like you and I have any control over government spending? Is there a way in which we can hold it accountable in the interim, until such time a democracy gets the obvious choice of voting it out? Can one question such spending before Courts of Law? What is the rationale behind that? These are obvious mumblings in several corners these days, and I daresay this article would be incomplete without at least a passing reference to these questions.

There has always been a ‘policy argument’ of constitutional impropriety based on the principle of separation of powers – that courts must not adjudicate upon the merits or demerits of policy; which ideally must be left in the hands of the executive and legislature (government) who have been elected for such purpose by the people.

However, an equally cogent but contrary argument lies that the citizen has specifically vested all powers of adjudication in the judiciary of a country, which is not limited to disputes between private individuals but also includes the acts of the State. Then arises the question “Quis custodiet ipsos custodes,” the sentiments with which Deshamanya Dr. R.K.W. Goonesekere has ended up his oration at the recently concluded 60th anniversery celebrations of the Law Faculty at Colombo. Although traditionally, especially English Administrative Courts, have maintained that unless based on accepted grounds of review such as illegality, irrationality and procedural error, other ‘policy issues’ will generally remain a ‘no go area’ for courts and judges, latterly, the law on its own has found timely ways of counteracting various attempts by governments to immunise themselves against review by courts by shrouding behind this ‘policy argument.’

There has been an advent of innovative approaches such as ‘public interest litigation’ (PIL) where the traditional levels of locus standi or ‘standing to sue’ is not evaluated as rigorously at a threshold level as it was the case at one time; thus allowing even reasonably affected parties (such as citizens) to bring ‘public matters’ before courts exercising administrative jurisdiction over public authorities.

Theories behind ‘Public Expenditure’ in a Democracy?Public Money is generally (in theory) spent by an elected government in a Parliamentary democracy involving the following basic steps:

Expenditure planning by the Executive – where limited resources are allocated to their best possible use on a scale of competing interests.

Parliamentary debate and approval – our (elected) representatives (and therefore in theory the people) then evaluate it and either grant approval to the ‘Appropriation Bill’ (budget – in common parlance) or defeat it;

Spending of what is voted/approved – if voted in favour then the Executive proceeds to spend the monies in the manner stated and approved by us, which expenditure is also incurred by Corporations such as the CPC.

Accounting for monies spent – thereafter, the Executive is expected to be called upon to account for money that was spent, as to whether it was utilised in the manner they sought and obtained permission to spend it.

As regards possible ‘review’ of public spending, the general assumption has been that rules that are not statutory (such as treasury authorisation for spending) must remain matters of convention or practice, and that Courts have generally left such spending to the checks by the system itself; by institutions such as the Treasury, Public Accounts Committees and the Auditor General. But what of the ‘legal basis’ for incurring this expenditure of public funds, shouldn’t someone or some process afford legality to this spending? There is a theory of a Constitutional principle behind this spending through the appropriation bill, that any government spending must be authorised by law and law on this occasion being Parliamentary approval. The ‘power over the purse’ (of the government) provides the legal basis for this constitutional subordination of the executive to Parliament.

An extension of this theory is that legality for spending derives from the votes of Parliament. The appropriation bill alone does not attribute this legality, whilst it sets out the quantitative parameters for spending, permanent legislation such as the Ceylon Petroleum Corporation Act No. 28 of 1961 (as amended) provide the qualitative legal basis for that authorisation of spending. If that is so, whilst Parliamentary expenditure is subjected to review by the Auditor General etc, should not also the expenditure of such Corporations and whoever it is that functions as its Chief Accounting Officer be subjected to similar review?

Changing Function of Judicial Review:As noted earlier the ‘policy argument’ conventionally left to government alone, has gradually given way in favour of more intervention by Courts, who have been prompt to act with the changing times, yet treading cautiously between lines of ‘policy’ and ‘justiciability;’ with due deference to ages of traditional rectitude displayed by generations of judges who have seldom indulged in such review, and whenever they did, with extreme reluctance and caution. The review of a government’s dominium powers conventionally excluded by courts in UK was first given a different interpretation in the case of R Vs Secretary of State for Foreign Affairs, ex p. World Dev. Movement reported at (1995) 1 AER 611, more popularly known as the ‘Pergau Dam Affair’ where the applicants successfully challenged governmental expenditure which Courts held as being “… so economically unsound that there is no economic argument in favour of it….there is no material distinction between questions of propriety and regularity and questions

of economy and efficiency of public expenditure…” thus equating ‘uneconomic spending’ to the level of ‘illegality.’

A similar line of argument is perhaps the ‘Public Trust’ doctrine that has been adopted by their Lordships of the Supreme Court in recent Fundamental Rights applications challenging primarily uneconomic or non-transparent transactions relating to public monies or assets; the argument being that dealings with public assets even by the Executive must be carried out ‘in trust’ for and on behalf of the peoples of this Republic and where there is a failure to do so, the judiciary would be prompt to rectify such fault.

Conclusion As to whether the reported losses to CPC as a result of the hedging contracts entered would be construed as uneconomic expenditure, if so whether the State (or its officials) should be held accountable and if so to whom and through what mechanism at the instance of whom – I suppose all this only time will unravel in due course.

Perhaps we must also bear in mind that whilst being strengthened by the ‘leap’ of judicial and public activism on checking governmental spending, using bases of audit etc as a ground for review, traditionally ‘economy and efficiency’ have seldom been typical language of Courts; they were always left alone as matters of policy. Decisions such as Pergau above have brought ‘uneconomic spending’ to the same level as ‘illegality,’ thus forming ‘a ground of judicial review.’ This must be a welcome change in Sri Lanka.

However, we as citizens exercising this ‘weapon’ over governmental expenditure must also tread with extreme caution in seeking such review, so as not to endanger the very fabric of a Constitutional democracy (such as the separation of powers) upon which our systems of governments have been built, for very good reason; always ensuring to bring such actions within the purport and ambit of the Law, to use ‘the Law’as a basis for seeking such review and not for ourselves also to act arbitrarily in our own self interest. Such an unhealthy trend may ultimately end up being no different to the actions complained of against an arbitrary and free spending government or their officials in the first place.

http://www.dailynews.lk/2008/04/29/bus01.asp

Daily News: Tuesday, 29 April 2008

Oil hedging to continue

CPC, STANDARD CHARTERED ARRANGEM ENT BENEF I TS CONSU M ERS :

Hiran H. Senewiratne

Standard Chartered Bank will go ahead with the oil hedging arrangement with the Ceylon

Petroleum Corporation (CPC) despite the current volatile oil prices in the international market,

Chief Executive Officer Clive Haswell said.

"When the market is highly predictable and volatile only are the oil hedging arrangements

important. Therefore, the CPC has a good relationship with us which they hope to continue in

the future," Haswell told the Daily News Business.

Oil struck a record high of more than US$ 118 boosted by a jump in oil demand last month from

China, the world second biggest energy consumer and worries about supply from key producers

Russia and Nigeria.

Haswell said their bank has customers and where the oil industry is a huge market we are

dealing with international companies.

Therefore, the CPC has short to medium term perspective for oil hedging arrangements to

provide petroleum at a competitive price, he said.

Haswell said many companies investing in oil features, depreciation of US dollar and increase of

consumer pattern in India and China have contributed to international oil prices to jack up.

Meanwhile, Citi Bank Sri Lanka successfully structured a fuel hedging solution for CPC in

February this year. CPC has made hedging gains of US$ 5.4 million from these transactions for

the month of March and these gains have contributed to their efforts in maintaining local price

stability.

These structures helped CPC to manage its price volatility and provide relief from the prevailing

high oil price environment, for a part of its oil imports.

Minister A. H. M. Fowzie said CPC has earned US$ 10 million through hedging and this has

helped CPC to cover some of its losses. However CPC has made a Rs. 7 billion loss from January

to April this year.

"We had our last price increase in January and till April CPC did not go for any price increase

even though the oil prices increased by US$ 20. CPC is making a Rs. 31 loss from every diesel

litre and Rs. 40 loss from a kerosene oil litre. CPC is making Rs. 5 profit through every petrol litre

but it is not sufficient in covering our losses, the Minister said.

At the request of CPC, Citi Bank examined the company's requirements and specific market

views, and using its global expertise, worked with CPC to structure a number of solutions that

utilised CPC's view on oil prices.

Under these solutions CPC is able to buy oil at lower prices at the prevailing global prices while

assuming risks to an extent if prices should fall below certain levels.

http://sundaytimes.lk/081123/FinancialTimes/ft331.html

The Sunday Times: Sunday November 23, 2008

Tender procedures deviated in oil deals By an Industry Analyst

“Crisis over oil hedging deals and CPC in debt up to $20 million a month” were the headlines, respectively in The Sunday Times and The Sunday Times FT on November 9. Chairman/CPC Asantha de Mel in response had admitted the existence of the hedging contracts with the banks and also that CPC was fully “educated by the banks” of the consequences of such hedging contracts. He also had accepted that several

millions of US Dollars were due to the banks as a result of hedging contracts and that such contractual obligations would be honoured by the CPC. Therefore the concerned banks cannot be accused of any unethical and/or sharp practices as implied in the articles at issue.

The banks had marketed their products and the CPC had purchased them with the full knowledge of the implications inherent in such deals. The doctrine “Caveat Emptor” holds good in this case as well. The fact is that the officials of the relevant committee, who recommended the “Hedging Contract”, had not recommended to the Cabinet the most suitable option - the correct “Instrument” - obviously due to ignorance and had thereby created the present financial crisis at the CPC as well as the country as a whole. The present crisis will worsen when the CPC starts settling the payments due to the Iranian government for the crude oil the CPC had purchased several months back on deferred payment basis, which will be within a couple of weeks.

When purchasing petroleum products the CPC is expected to follow a certain tender board procedure. For the CPC to go through the formalities of the procedure and to purchase a parcel of petroleum products from a foreign supplier it will at least take a minimum lead time of a month. According to the procedure the purchase price of a petroleum product will be based on the prices prevailing in Singapore on the date of the Bill of Lading of the Tanker carrying the particular cargo. As an example I may point out that in the declining market if the CPC was able to arrange purchases of petroleum products, without a hedging contract of course, to be loaded, say in the second week (for example October 17), the position would have been as follows:

The Singapore based FOB prices of Gas Oil (Diesel) and Gasoline (Petrol) on Friday 17-10-2008 were:

1.Gas Oil (Diesel) with 0.25% sulphur content was US$79.70 a barrel FOB. Assuming the freight cost would be US$2 per barrel the landed cost of a barrel would have been approximately US$81.70, which when converted to rupees at Rs.109 a US Dollar the landed cost of a barrel of Gas Oil would have been Rs.8905.30. Therefore, a litre of Gas Oil would have cost the CPC approximately Rs.56.

2.92 RON Unleaded Gasoline (Petrol) was US$71 a barrel. Assuming the freight cost would be the same as (1) above the landed cost of a barrel would have been approximately US$73 which when converted to rupees at Rs.109 a US Dollar the landed cost of a barrel of Gasoline would have been Rs.7957. Therefore, a litre of Gasoline (Petrol) would have cost the CPC approximately Rs.50. A “barrel” of products contain 42 US gallons and a US gallon contains 3.785 litres. Therefore, 42 x 3.785 = 158.97 litres for a barrel – say 159 litres. Another contributory factor for the crisis at the CPC is due to resultant adverse effects of deviations from time-tested tender procedures followed by CPC for several decades. The said procedures ensured the credibility of the suppliers that the CPC was dealing with. With the assumption of office by the current Chairman/CPC, these time-tested tender procedures were changed and/or amended to suit certain “dubious suppliers of Petroleum products and Ship brokers”, who presumably enjoyed the patronage of certain unscrupulous politicians. The very first deal the Chairman/CPC put through having deviated from the time-tested “Petroleum products purchasing tender procedure”, which ensured the credibility of the suppliers, was a disaster to the CPC, the details of which appeared in The Sunday Times FT of October 7, 2007, under the caption “CPC to lose Rs.1.5 billion in one year”. The supplier concerned - Titis Sampurna of Indonesia- , who was not pre-qualified and with whom CPC have had no previous dealings, failed to perform the contract.

The CPC entered into a 1-year contract in August 2008 for the carriage of crude oil from Kharg Island, Iran to Colombo at a rate of US$12.20 per MT. That was the best rate received for the subject tender at that time but was a price that CPC is contractually obliged to continue paying until July 2009, i.e., for fourteen (14) voyages. While the average prices received for the previous years for the same purpose were much less than the aforesaid rate, the incumbent Chairman/CPC, in his wisdom, had thought it proper to enter into a long term contract without any proper knowledge of future markets. Today the price the world over will pay for a Suez Max size parcel, 135,000 MT cargo, for ”Kharg Island – Colombo” is less than US$ 1 million, whereas the CPC is contractually obliged to pay US$1.65 million for the same freight until July next year.

That deal it is understood had been rejected by the relevant Cabinet Appointed Tender Board but the incumbent Chairman/CPC having by-passed all the relevant procedures had obtained the assistance of the then Secretary to the Treasury, who was unceremoniously unseated from that prestigious seat at the Finance Ministry, to steer through successfully another questionable Cabinet Paper, perhaps misleading the Cabinet of Ministers too, and to obtain the Cabinet approval for that questionable award.So far only two voyages had been completed against this contract and with the performance of the balance twelve (12) voyages CPC will stand to lose around US$6 million or Rs.654 million at the current rate of exchange. A perusal of the average freight rates for similar size vessels during the past years will prove this point.

Another apparent miscalculation by Minister Fowzie and Chairman/CPC – a coincidence or by design? A joint venture – CPC/GAC Shipping – came into being and its activities are to supply bunker fuels to ships calling at the Colombo Port.

Certain remarks made by Chairman/CPC to the media in justification of the formation of the aforesaid JV are given below:

1.CPC will provide fuel.2.GAC Shipping will provide barges and do the marketing3.CPC will have a small profit margin and as a result the price of bunker fuel in Colombo will come down and the bunker sales will be increased.

Has the Chairman/CPC achieved the above objectives?

Items one and two above have been fulfilled. However, neither the Chairman/CPC nor Minister Fowzie, who is said to have blessed the project, has been able to achieve the desired results.

The CPC never earned a profit, whether a small margin or otherwise. CPC delivers the bunker fuel to Interocean Shipping Pvt. Ltd., the local arm of GAC Shipping, at prices below the imported cost of the fuel thus making a loss to the CPC.

In the “Bunker Delivery Notes” prepared by Interocean Pvt. Ltd., which carry the emblem of the CPC, for the purpose of delivering bunker fuels to seagoing vessels it is shown that the delivery of fuel is being done “For and on Behalf of Ceylon Petroleum Corporation” thus binding the CPC for the transactions effectuated by this third party. Can a third party thus bind the CPC? This note is the proof of physical supply of bunker fuel to a vessel. However, it is understood that such Bunker Delivery Notes or their copies never reach the CPC for any further action. No reconciliation of Bunker fuel sales by CPC to GAC Shipping vis-à-vis bunker fuel sales by GAC Shipping to seagoing vessels is done at the CPC.

Therefore the possibility that bunker fuels, such as Gas Oil, thus sold, passing on to unauthorised hands, such as terrorist organizations, cannot be ruled out. The Chairman/CPC should clarify as to on whose authority the Interocean Pvt Ltd displays the CPC emblem on their invoices/correspondence and as to how Interocean Pvt Ltd transacts business “for and on behalf of the CPC”.

For further clarification I may point out that the Gas Oil sold to GAC Shipping in August 2008 by CPC based on the “July 2008 MOPS prices” was at US$1,057 per MT whereas the price at which Gas Oil was sold to the local public was at US$1207 per MT (at Rs.109 for a U.S. Dollar). In turn GAC Shipping had sold Gas Oil as bunkers to vessels at US$1355 per MT thus making a whopping profit of US$298 per MT.

Currently it is understood that GAC Shipping buys Gas Oil from CPC at US$990 per MT and sells to seagoing vessels at US$1300 per MT thereby making a huge profit of US$310 per MT. On the other hand CPC by selling Gas Oil as bunker fuel to GAC Shipping makes a huge loss when compared to the “Hedged” price at which CPC imports Gas Oil. Who benefits by all these?

The lame excuses given by Minister Fowzie and Chairman/CPC, Asantha de Mel as to why the bunker delivery operations were handed over to GAC Shipping/Interocean had been that the CPC was lacking the necessary infrastructure, such as barges, necessary for these operations. This position of both Minister Fowzie and Mr De Mel cannot be possibly true, for more than 50% of the bunker deliveries transacted by GAC Shipping is being currently done by making use of CPC/CPSTL owned Tank Trucks installed with Power Take-off Pumps.

When a 13,200 litre load of Gas Oil ( 11.2 Metric Tons) is delivered to a ship by a CPC Tank Truck as aforesaid CPC earns no profit but merely incurs a loss, but GAC/Interocean earn a profit of US$300 X 11.2 = US$ 3360 = Rs 366,945.00 at the current rate of exchange. Can anybody imagine the amount of money that the CPC is thus losing and the resultant profit earned by GAC Shipping/Interocean in supplying and delivering about 3000-4000 Metric Tons of Gas Oil monthly on a regular basis. The loss to the CPC will be around Rs. 98 million to Rs. 131 million every month.

Another interesting question that Chairman/CPC should answer is as to why he had permitted the daughter-in-law of Minister Fowzie to attend ‘Stock Review Meetings” of the CPC, especially after the formation of the aforesaid JV. This shows to what extent the CPC has been politicized with Minister Fowzie assuming the Ministerial position covering “Petroleum”.

In the face of the recent Supreme Court judgments, where several high profile public figures, including a one time Head of State, had been exposed of corruption, the government should scrutinize those long term contracts entered into by public officials of the calibre of the incumbent Chairman/CPC, for which the public is committed to pay for the arrogance, incompetence and lack of foresight of those square pegs in round holes.

http://sundaytimes.lk/080316/News/news0010.html

The Sunday Times: ISSN: 1391 – 0531Sunday March 16, 2008Vol. 42 - No 42

Oil hike likely as world prices soar

By Malik Gunatilleke

Record breaking international crude oil prices spark concern for local consumers as the Ceylon Petroleum Corporation (CPC) will purchase fuel at a much higher cost in March and April. International crude oil prices hit a high of US $111 per barrel on Thursday before settling a little below $110, mainly attributed to the interest rate cuts in the US and the weakening US dollar. The CPC, which purchases crude oil at a monthly average rate, will be forced to buy its crude at a higher cost than the $90 per barrel at which price it purchased crude oil in February.

CPC Chairman Ashantha De Mel told The Sunday Times that despite the worrying trend in the world market, domestic fuel prices will be controlled due to the various profits made by the CPC over the past few months.

He said that the CPC had received Rs.600 million in revenue due to futures hedging while an additional profit of around Rs.600 million from the refinery would help the CPC cut down losses of Rs.1.13 billion while subsidizing the rates at which diesel and kerosene should be sold.

Petrol consumers pay Rs.18 above the market price helping the CPC rake in Rs.750 million in profits while petrol consumers also play the dual role of subsidizing diesel and kerosene. The CPC loses Rs.11.47 per litre of diesel and Rs.15.50 per litre of kerosene while making a profit of Rs.18.55 on a litre of petrol. However, the consumption of diesel has sky-rocketed to as much as 145 million litres a month while petrol consumption is only 40 million litres causing even greater losses for the CPC.

The CPC purchases its fuel at an monthly average price which is bound to increase due to the rising international oil prices which Mr. DeMel said would be a huge increase from February.“Still, with the profits we have been making we will be able to keep the current prices unchanged,” he said.

However, he said that the trend in the international market shows that the crude oil prices could well rise above the $120 mark in the near future. Addressing a media gathering, Petroleum and Petroleum Resources Minister A.H.M. Fowzie said that the prices will not be revised until after the Sinhala-Tamil New Year in April.

He said the CPC would cover what losses it would make from keeping the current prices, through its refinery and hedging profits and would assess the situation in April.“We currently have some stock which we purchased at lower rates than the current prices and we will take a decision on whether to revise the prices after the New Year depending on the world market,” he said.

Small mercies from CPC

The CPC announced that it will be able to sell its brand of LP Gas at around Rs.200 cheaper than its competitors in the domestic LPG market.

Despite fervent protests by Laugfs Gas Pvt Ltd (LGPL), the CPC will take efforts to begin production as soon as possible as it has already ordered 10,000 cylinders while an additional 40,000 cylinders will be imported in two months. CPC Chairman Ashantha DeMel said that he is confident that the project will take off by May or June while stating that the profits of the LPG business will be put into further subsidizing fuel for domestic consumers.

The CPC announced that Rs.250 million had been invested in the project while its initial target would be to produce 10% of the domestic demand. LGPL currently purchases 30% of its base product from the CPC while the rest is imported with added freight charges.

With CPC entering the LP Gas market, LGPL will be forced to increase its prices to even higher than Shell Gas as it would be forced to import 100% of its product. However, with the CPC producing only 10% of the market demand and targeting 40% of demand in another three years, the bulk of the consumers may be forced to purchase gas at higher prices.

http://www.lankabusinessonline.com/fullstory.php?newsID=219541551&no_view=1&SEARCH_TERM=4

Mon, 09 March 2009 14:03:21

Monthlies16 Jul, 2007 07:38:46

Sri Lanka to adjust fuel prices monthlyJuly 16, 2007 (LBO) – Sri Lanka will adjust fuel prices monthly on a transparent formula to cut losses in petroleum utilities, an official said, which is expected to reduce exchange rate pressure and avoid the build-up of macro-economic imbalances.Ceylon Petroleum Corporation (CPC) Chairman Ashantha de Mel says a cabinet sub-committee on energy had agreed to monthly price adjustments, and the last price increase was made on that basis.

"The sub-committee agreement was that the price of fuel would be adjusted on a monthly basis," de Mel said.

"Last month the price increased, and it will go on a formula."

Transparent

De Mel says the formula would be published in newspapers and price adjustments made at the beginning of every month.

"We want to put a press advertisement in all the papers and explain to the public how

it works, so that everybody knows the formula," he said.

"There is nothing for us to hide."

Sri Lanka devised a monthly price formula as part of a strategy to bring the country out of a balance of payments crisis in 1999 and 2000, which was made worse by fuel subsidies. Fuel is the single largest imported commodity to the island.

In 2002 and 2003 economic stability was restored partly with the help of the formula, but it was abandoned in 2004 under pressure from the Marxist-Nationalist Janatha Vimukthi Peramuna which called it a 'plug' to the world market.

Sri Lanka promptly went into a balance of payments crisis again with reserves dwindling, while the rupee fell from 96 to the dollar to 105 and inflation shot up from almost zero to double digits within months as the government printed money to import oil.

Formula

The earlier formula gave a margin of five percent to petroleum firms, but the new formula will give just 1.5 percent.

Petrol now costs 109.90 rupees per litre but is sold at 111.00, giving an extra 1.10 rupees to state-owned CPC and also Lanka IOC, a unit of Indian Oil Corporation which has a third of the market.

Diesel is sold at 71.00 while the cost is now 74.00 indicating a loss of 3.00 rupees. Kerosene is sold at 67.00, while the cost is 70.60.

De Mel says CPC is now operating by setting off a part of the losses with refinery profits which is about 200 million rupees a month.

Sri Lanka's rupee has been under pressure in the last two months and the Central Bank had to intervene in the market to keep the rupee stable.

Economists point out that under-pricing fuel for which dollar payments have to be made and funding losses with rupee bank-debt creates pressure on the exchange rate.

Reducing losses at CPC will also prevent pressure building up on the exchange rate, but losses in the power utility Ceylon Electricity Board (CEB), which has not been allowed to raise tariffs, remains a worry.

Debtors

The CPC has debtors of 30.2 billion rupees with 9.8 billion due for over six months and 4.6 billion rupees unpaid for more than a year.

CEB is the biggest debtor with 17.1 billion rupees followed by independent power producers who owe 3.8 billion rupees and the Sri Lanka Navy which owes 3 billion rupees.

The controversial state-owned airline Mihin Air, owes the firm 50 million rupees, though it only has a bank guarantee to cover 20 million rupees worth of fuel. De Mel says the airline has been given time to settle.

CPC is also forced to sell diesel to CEB 25 percent below cost. De Mel says the cost will have to be recovered by overpricing other products if CPC is not allowed to market price products to CEB.

The government says electricity tariffs would not be adjusted till the end of the year. Sri Lanka already overcharges petrol users in order to under-price diesel.

The policy has come under fire from critics, who point out that petrol is used largely by motorcycle users and small cars, while diesel is used by businesses, and richer sections of

society who can afford large diesel SUVs including politicians.

READER COMMENT(S)4. Jul 20 They should cover at least the cost of all products. I think we are moving in the right direction.

However the taxes also shold be of a reasonable and equitable percentage. The Petrol Tax should be gradually reduced and the same increased ( again gradually for political reasons) for diesel and other oils.

3. Dr. V U Ratnayake Jul 17 Sri Lanka seems to be moving in circles in all spheres of activities. In energy, pricing formula came in, abolished, comes again and may also go off again.

Car numbers changed from original English to Sinhala and changed back to English again. Prices were earlier based on market prices, introduced subsidies, restrictions, now moving back to do without the subsidy.

Why on earth administrators play games of this sort? They are supposed to be experts with good literacy rate capable of reading and understanding to introduce the best way of managing the economy.

All other countries in the region are moving ahead but our masters are still on the mats playing games and watching price hikes fuel wastage in traffic jams, private busses dragging feet and holding others, parking at will anywhere they wish, cross cutting lanes, indiscipline driving, use of road ways for holding meetings, selling goods and all human activities on the road side which is meant only for transport.

Can anyone rise and stop these nonesense and try to pull the country up by saving energy. There are thousands to support such efforts.

2. Rohan Samarajiva Jul 16 Deja vu.Recall when the formula was introduced? 2002.

Recall who opposed it? Hint: same person who promised to pull the plug from the world economy.

Wouldn't life be simpler if we were consistent in our infrastructure policies?

Wouldn't it be civilized to admit error in throwing out the formula in the first place?

1. Khizer Jul 16 Finally, some sort of sense has got into the heads of these people. Now its time to clean up the CEB.

http://www.asiantribune.com/?q=node/14503

UNP to censure the Government - Ranil vows in a press meet Tue, 2008-12-02 05:33

By Ruwan Weerakoon – for Asian Tribune

Ranil WickramasingheColombo, 02 December, (Asiantribune.com): The leader of the opposition Ranil Wickramasinghe, in a press conference held today pointed out that, they now have all the documentary evidence to prove that all the Cabinet Ministers including the President as the Finance Minister were aware of this story of the “Hedging Deal” before it was signed and therefore, the UNP will move a no confidence motion against the entire government.

He said that, due to this deal every Sri Lankan citizen will be in debt for Rs.10,000.00 each and that the CPC is already Rs.200,000 million in debt. As such, he says, CPC may have to be sold or closed down and also that this money will have to be paid the innocent people of this country,

The opposition leader further said that, they accept the Supreme Court ruling that suspended the hedging agreement signed by the CPC as this deal prevents the lowering of local prices when world market prices decline.

"We have also found out about an attempt to destroy important documents relating to this agreement and I have requested the Speaker to take action to protect all these documents at the Ministry of Finance, Central Bank, Ministry of Petroleum Resources and the CPC".

The opposition leader, going into details said that, Minister A.H.M.Fowzie submitted the cabinet paper on the 13th January 2007 and the cabinet approved it. He also gave details of many other letters and documents sent by one official to the other regarding this deal.

In replying to a question, Mr. Wickremesinghe said, that under a future UNP regime all such corrupt agreements will be discontinued.

Taking a snipe at the media he said that, most media have stopped short of exposing corrupt deals like this hedging agreement in an attempt at whitewashing the government.

Responding to another question by the Daily Mirror, Ranil Wickramasinghe said that DM journalist Kesara Abeywardena had called him an ‘ineffectual leader’ and said that this journalist had written that “UNP cannot gain power under my leadership and I would like ask the media what they had written about this hedging deal”. And he further asked whether the Daily Mirror belongs to the Wijaya Group or the Jathika Hela Urumaya.

He further adds saying ‘he has more to tell the DM editor but that, he doesn't want to tell it at that moment and place’ and left us guessing.

- Asian Tribune -

http://www.iridaperaliya.com/

Hard response from Supreme Court; hedging ban suspended since people were not given relief

(irida-peraliya-News, January 27, 2009, 4.40 PM) Supreme Court today (27) revoked the interim injunction against fuel hedging.

Chief Justice Sarath N. Silva said that the interim order was revoked since maintaining that injunction was pointless in the context the executive ignoring the judiciary rulings.

The Chief Justice further said that the hearing of the fundamental rights petition against fuel hedging would be suspended. 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, said the Chief Justice.

In line with the interim injunction, the Supreme Court ordered the price of a liter of petrol be reduced to Rs. 100, an order the government turned down. The cabinet of Ministers led by the President decided to grant Rs. 20 subsidy for four liters of petrol per day limited to 70 liters maximum per month to the trishaw owners and to reduce the general retail price of petrol by two rupees.

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

In relation to the hedging agreement signed by the Chairman of the CPC, the government has to pay Rs. 95 per liter of petrol until June 2009. CPC has to purchase 200,000 barrels of fuel per month. Petroleum price declined to $ 37 two months ago. Petroleum price last month was $ 35 per barrel. Current price of a barrel of petroleum is $ 45. The CPC will have to pay a surcharge of $ 50 per barrel this month in accordance with the agreement with the hedgers. Further $ 48 a barrel should be paid for the last month and $ 48 per barrel for the previous month.

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

http://www.sundaytimes.lk/081221/News/sundaytimesnews_01.html

The Sunday Times: Sunday December 21, 2008

Lanka’s petrol price crisis blazes

Indian move compounds Govt.’s dilemma; CPC fuel stations shut

The Government’s dilemma over enforcing a Supreme Court order to lower the price of petrol worsened yesterday as the Lanka-India Oil Company (LIOC) recorded unprecedented sales after it complied with the order and reduced the price to Rs. 100 a litre.

In marked contrast to the actions of the Indian-owned company, the state-owned Ceylon Petroleum Corporation (CPC) is yet to comply with the ruling and is selling petrol at Rs. 122 a litre. As a result, the artificial shortage of petrol continued countrywide yesterday with almost all CPC fuel distribution outlets remaining closed.

LIOC Managing Director Suresh Kumar said yesterday a copy of the Supreme Court determination was delivered to him on Friday afternoon. “It is an order from Sri Lanka’s highest court. We had to comply with it,” he said. Mr. Kumar added that he had met Petroleum Resources Ministry Secretary W.B. Ganegala to apprise him of the LIOC’s decision.

Non-Cabinet Media Minister, Lakshman Yapa Abeywardena, a spokesman for the Government, told The Sunday Times there would be no change in the price of petrol distributed by the CPC. He said the matter would be taken up at the weekly Cabinet meeting on Wednesday and not earlier.

The Government yesterday utilised the services of the Police to persuade CPC fuel stations to replenish their stocks and sell petrol at Rs 122 a litre. They have also been warned by CPC officials that their dealerships would face cancellation if stocks were not immediately obtained. Instead, most distributors said yesterday they were worried they would suffer a loss if the prices changed soon after they acquired new stocks.

Yesterday, the Ceylon Petroleum Common Service Union, a combined body of trade unions, joined in the fray by demanding that the Government should comply with the Supreme Court order. “If the Government does not bring down the price of petrol, CPC distributors will also turn to LIOC to obtain their stocks,” Union Secretary D.J. Rajakaruna warned.

Compounding the issue was the surplus production at the Sapugaskanda Oil Refinery. Officials there warned that the refinery might be forced to shut down until stocks remaining in the tanks were moved out.

Distributors of CPC fuel products were reluctant to obtain new fuel stocks. One of them who spoke on condition of anonymity asked: “What is the use of our buying new stocks, if we cannot sell them?”

“The motorists will go to LIOC outlets where the price is cheaper,” he said. The distributor did not wish to be identified for fears of his dealership being cancelled – a warning which the Marketing Division of the CPC has reportedly issued to its outlets.

Although 73 CPC dealers had placed orders for petrol stocks, they had cancelled them later.

Unions add fire to fuel over new boss

Ceylon Petroleum Corporation (CPC) unions have set a Tuesday deadline for the government to remove the newly-appointed Chairman of the Ceylon Petroleum Storage Terminals Ltd (SPSTL), a subsidiary of the CPC.

The new Chairman, W.B. Ganegala who is also the secretary of the Ministry of Petroleum Resources on Friday visited the premises in Kolonnawa, but employees refused to allow him into the office. The union claimed there was no need for a separate chairman as the CPC chairman could oversee duties of the company which played a vital role in fuel distribution.

They said that having two separate chairmen could complicate the functions of the corporations and they would consider strike action if the new chairman was not removed by Tuesday.

The union leader on Friday also refused to grant Mr. Ganegala time for a discussion, but said they were willing to have a discussion with him at the ministry in his capacity as secretary.

http://www.sempracommodities.com/oil_producers.asp

Hedging Strategies for Oil Producers

Oil producers operate in an environment subject to adverse price movement in the international oil market. This exposure to such risk is enough to increase a company’s costs or dramatically reduce its profits. As risk exposure reduces the producer’s appeal to investors and makes gaining access to debt markets more difficult, the need to efficiently manage exposure to fluctuating commodity prices is clearly one of the greatest challenges facing an exploration and production company today.

In this presentation, we discuss several swap and option based strategies that oil producers can use to manage their market risk. All of these strategies can be structured for a variety of international crudes and products. Hedging periods and protection levels can be customized to fit any maturity and price level.

While the examples in this presentation are denominated in U.S. dollars, Sempra Energy Trading ® Corp. ("SET") can also offer hedgi ng instruments in other major currencies.

Why Hedge?

Figures 1 & 2 show recent historical volatility of crude prices. As can be seen from these figures, forward crude prices are extremely difficult to predict and subject to rapid and significant change. A comparison of crude and heating oil historical volatilities with those of metals or financial assets shows that oil is one of the most volatile of all commodities.

Stake holders prefer companies that perform as planned Hedging stabilizes cash flows

1. Reduces cost of capital 2. Secures company objectives

Enables management to measure performance

Doing nothing to manage risk is in itself a risky move.

Fixed for Floating SwapsParticipation SwapsSpread SwapsCaps and FloorsCollarsHybrid Strategies

Figure 1. WTI 20-Day Moving Average: 1996-2007

Figure 2. Average of 20-Day Historical Volatility (In Percent)

http://www.thehindubusinessline.com/2007/11/28/stories/2007112850990900.htm

Business Daily from THE HINDU group of publicationsWednesday, Nov 28, 2007

Why not hedge away oil price shocks?

T. B. Kapali

The sharp rise in oil and other commodity prices over the past several months and its possible adverse impact on inflation/inflation expectations has been a matter of deep concern to governments and policy makers the world over. This concern has been particularly acute in emerging economies such as India.

How to reconcile the soaring energy requirements of a rapidly expanding economy and the inevitable price pressures brought on by such surging demand with the objective of non-inflationary growth? As has been pointed out by the Reserve Bank of India, the greatest challenge now is to manage the transition to a higher level of economic growth without entrenching higher inflation expectations.

Double-digit economic growth and stable/low inflation (around 4 per cent) may not be mutually exclusive objectives. The exercise to attain that, though, could be painful for many economic agents in the interim — such as the Indian oil companies for instance.

Blind alley

The oil companies possibly are bearing the brunt of the policy-makers’ reluctance to subject the domestic price level to the full force of international/market prices. In a complex social and political environment, it does not appear conceivable that the oil pricing mechanism will move to a market-driven format any time soon.

The APM, for instance, was officially dismantled earlier in this decade but is now again well in operation, de facto. Debate and discussion on oil pricing is endless, though it seems futile as all debate finally zeroes in on a market-driven pricing mechanism as the only panacea.

It (market-determined end product prices) may be the ideal solution. But what is surprising about the oil debate is that there seems to be not much of a focus on interim, alternative solutions, which, incidentally, may also be market-related.

Hedging input costs

In a scenario where there are constraints on end-product prices on the selling side, it is surprising that the oil companies have not attempted to more fully hedge the risks of rising raw material prices and attempted to fix their input costs. An analysis of petroleum statistics shows that only around 3-4 per cent of the total imports of crude oil are being hedged by the oil companies. In 2006-07, Indian crude imports were around 90 million tonnes.

To be sure, the hedging ratio of Indian companies is no different from what prevails globally. Indeed, even though the global oil derivatives markets provide a very good platform for hedging for both oil producers and consumers — with contracts stretching out as far as 10 years — the use of this market for hedging has been historically limited.

For instance, as on November 7, 2007, the total volume of outstanding futures contracts (the open interest) for various forward maturities up to December 2008 on the NYMEX and the ICE amounted to around 1.8 billion barrels. Against that, crude production in the next 12 months will be around 30 billion barrels (assuming a production of 85 million barrels per day – the current figure) giving a hedge ratio of around 6 per cent. This has been the case historically also.

Reasons for low hedging

There are a number of structural reasons for the low level of hedging by both oil producers and consumers globally. As far as consumers are concerned, in a competitive environment, unless all players in an industry hedge their consumption of oil, it does not make sense for individual companies to do so. Companies which do not follow industry practice will be subjecting their earnings to greater variability.

More generally, as far as consumers are concerned, the absence of hedging markets with respect to their end products on the selling side inherently limits their hedging. Airline companies, for instance, do not have forward markets for airline tickets.

Also, the price of airline tickets will vary in future with the spot price of oil. Where input price pressures can be passed on to the selling side, the incentive for hedging is weak.

On the production side, many countries with state-owned producers also do not hedge their future production. Even commercial oil producers such as an Exxon or BP are not in the market for hedging in any noticeable way.

This is quite understandable given the structural trend in oil prices over the past many years. Indeed, oil, more than possibly any other commodity, has proved that the futures price curve — for assets which carry a high degree of positive systematic risk — may be significantly understating the expected future spot price of the asset. That is, while oil (because of the high convenience yields associated with holding physical stocks) displays an inverted forward price curve (backwardation), the curve does not necessarily capture the future spot price to any degree of accuracy.

For instance, the futures price curve in February 2006, when spot oil was quoting around $53/55, indicated the forward price for maturities up to December 2007 to be in the range of $60/62. But where are spot prices now? And such divergences between the futures curve and the realised spot prices have occurred many times in the past also.

Costs and calculation

It is this divergence between the futures curve and realised spot prices which should provide a powerful incentive for big consumers such as India to have a structured hedging programme in place. The “industry competitors” argument does not anyway apply here because of the constraints in end-product pricing.

What are the costs of hedging? Assuming the current margin costs of around $6500 per contract of 1000 barrels, the entire Indian import of 90 million tonnes in 2006-07 would have involved a margin outlay of around $4.5 billion – that is around Rs18,000 crore – if Indian companies had taken long hedges on the NYMEX in early 2006, based on the then spot price of around $55.

This margin deposit would have earned some interest (say 3.5/4 per cent) and given the structural trend in prices, the companies would have been able to take back a good part of the margin deposits as mark-to-market profits on the futures positions (over and above the maintenance margins). Most importantly, the input oil costs would have been hedged and fixed based on the futures price curve which prevailed in February/March 2006. It may have been

possible then to hold the line on end-product prices as the hedging on the input side effectively lowers the costs relative to the prevailing spot market.

And, who is to fund the cash outlay on the margins required on long futures positions? Note that the Government issued oil bonds worth at least Rs 12,000-13,000 crore in 2006-07. More had been issued in the earlier years also. A hedging policy could mean that, instead of oil bonds, an equivalent amount of money goes into margin deposits.

The cash outflow for placing margins, of course, will be immediate. The advantage still is that with hedging, the importer is able to fix his costs. And unless oil prices fall, there would be no more cash outflow on account of margin calls. A policy of “no hedging and issuing oil bonds”, on the other hand, means that the quantum of bonds (to be) issued could be open-ended.

It, of course, is quite easy in hindsight to point out all this. It is also important to remember that hedging need not always provide the most optimal solutions. And there may be a number of operational issues (key among them being the level of hedging interest among oil producers) to be tackled before Indian companies can institute a structured hedging programme. But, still, the absence of a debate on how India as a big consuming nation can hedge its oil price risks is somewhat disconcerting.

(The author is Vice-President (Research), Shriram Group Companies, Chennai. These are his personal views.)

http://www.sundaytimes.lk/090222/FinancialTimes/ft309.html

The Sunday Times: Sunday February 22, 2009

Oil hedging fiasco – need for a bigger probeBy T. Rusiripala

Stunning revelations about an unprecedented deal running into millions of dollars, a court order to reduce the price of petrol, culprits responsible for the sordid transactions walking away ignoring public opinion and escaping the legal net – all in relation to the oil hedging imbroglio is now part of the history of this country. Whether the case will be consigned to the political dustbin is a matter for conjecture. Will the tax payers finally pick-up the bill for clearing up the mess?

The deal

It is no secret now that the CPC (Ceylon Petroleum Corporation) entered into several questionable agreements with some foreign and local banks in respect of oil imports to the country. Further it has come to light that these agreements made CPC a casualty making it liable to pay millions of dollars to the counterparts due to lack of built-in safeguards to cover the risk

exposure of the CPC. For the banks these agreements were like –“ heads I win and tails you lose….” situation!

The impugned oil hedging agreements with five banks viz., Standard Chartered, Citi, Deusche, Commercial and People’s have been concluded after lengthy and protracted negotiations preceding the sealing stage. The modus operandi has been heavily canvassed by the banks on behalf of their hedging principles behind the scene with very generous ex-gratias. Money has allegedly flown in to ‘grease’ those responsible for making the necessary recommendations from top to bottom. Ministerial tours, entertainments and bribes to others, including foreign trips, night clubs, golf games in Singapore, sumptuous meals and hosting for other nefarious activities seem to have crossed the borders. The period during which these niceties and goodies have exchanged perfectly coincide with the brooding and hatching of this heinous operation. The fact that this expenditure bill has been footed by one of the banks involved in the deal is of noteworthy significance.

There is also enough proof in the form of payment vouchers of the air tickets provided to certain public officials. No action appears to have been taken against these officers despite the fact that such activities constitute unethical practices which warrant a reprimand and severe punishments under disciplinary codes. While the reason for not initiating disciplinary action against them is not known, the public vigilantly watching the episode are badly disappointed.

The Supreme Court in no uncertain terms has held that the agreements were flawed and the role of the officials involved were questionable. Although the impugned activities warrant immediate reprimand nothing of the sort seems to be happening. The relevant authorities appear to have ignored and disregarded these pronouncements. The Central Bank of Sri Lanka (CB) too has pointed out several lapses and short comings on the part of the banks in this regard.

Particularly the aspersions cast by the CB on the role of the People’s Bank, being a state owned institution are serious. Two of the payment voucher copies happened to be in respect of air tickets issued to two senior officials of the Peoples Bank both of whom are directly involved in the hedging transactions.

A proper investigation will no doubt trigger events that may lead to shocking violations and gross dereliction of public duty on the part of the officials involved for obvious personal reasons. But the immunity they seem to enjoy appears to be strong to provide them the protection for a scot- free walk away.

The landmark order of the Supreme Court was welcomed with a sigh of relief by the general public. The sordid affairs underlying the transactions as revealed caused shock waves throughout the country. People expected the government to take immediate appropriate action to safeguard the public interest but unfortunately it did not so happen.

Effects of hedging agreements

The agreements entered into with five banks remain in force to date. Their validity continues in some cases till Nov 2009.The huge liability accruing due to these agreements continue to grow

to huge amounts. As reported the current commitment of the CPC is well over $800 million. After the Supreme Court vacated interim decisions made in the hedging case and dismissed the petitions due to the failure of the government to implement the court decisions relating to fuel pricing, the agreements have become valid once again.

Unless they are specifically declared ab-initio bad in law, null and void, all parties become liable under these agreements, which are said to be one sided and heavily in favour of the banks. The resulting loss to the country will be huge and unbearable.

The CB, following a initial examination which commenced on 17th Nov.2008, in terms of Section 29(1) of the Monetary law Act about the hedging agreements between the CPC and several licensed commercial banks, has pointed out that as Authorized Dealers, banks have not been fully compliant with the provisions in their directions issued as far back as December 2005 on financial derivative products. The CB has stated that these non –compliances extend to directions issued by the Controller of Exchange too.

The Central Bank has indicated the following lapses on the part of the banks-:- Failure to carry out the Credit risk, Market Risk and Operational Risk assessments;

- Failure to communicate to CPC the risks of using the underlying hedging contracts for speculative purposes;

- Failure to ascertain CPC’s ability to fulfill its obligations arising from the downside risks associated with these hedging contracts;

- Failure to ensure a high level of transparency with respect to risks and other parameters associated with the contracts;

- Failure to adhere to meet the required eligibility criteria (in the case of the PB only) ;The CPC too as reported has not followed proper procedures before entering into hedging contracts such as by not consulting the AG and obtaining his opinion before going ahead with the sealing of these contracts.

According to newspaper reports the CB has arrived at the conclusion that the CPC should not honour its hedging obligations.

Whether the CB ruling is strong enough to stop the payments due to the banks on these agreements is yet to be seen. Banks are reacting differently in order to get their share and demanding the commitments due to them by the CPC. They may also be applying pressure on the authorities to decide in their favour.

It is also rumoured that the banks are pursuing the possibility of securing these payments even on a delayed basis by offering to reschedule the liability on a restructuring plan. Whether paid immediately or on a staggered basis, the loss to the country on these faulty contracts remains the same. The ostensible extension of a so-called facility to stagger the repayment has to be understood in its correct perspective.

Some economists and experts have opined that a default in these payments by the CPC could shake the investor sentiment in Sri Lanka leading to negative repercussions internationally. This is not a tenable argument.

In the first place no one is suggesting that the CPC should default the payment. But according to the circumstances if the agreement has to be abrogated or cancelled it is a different story.

A private bank committing an error in the preparation of an agreement enforceable in law will have to face the consequences of such lapses or errors when the matters are challenged. It is not an uncommon thing or experience for banks whether local or international to face such eventualities. There are instances where the banks had to abandon claims on customers due to faulty documentations. If it is found that the banks have violated some regulation or practice those officers responsible for the matters would be dealt with by the banks but the banks cannot refuse to absorb the underlying risk liability in such instances.

There is no reason for international investors or donors to get offended on a issue like that. In fact in this instance it is very clear that both banks and CPC have violated procedures, norms, practices and even directives by the regulating authorities,making the agreements bad with regard to their acceptability. The contagion that spread with the revelations of the underlying corruptions related to these transactions is having a worse international critical impact compared to the consequences of an abrogation of such a tainted contract. It is a unilateral, foolhardy action taken by interested parties together in connivance to defraud the country not amounting to a genuine step to safeguard either public interest or even the business interest of the CPC.

It is best that the parties to the agreements resolve the issue amicably among them mutually.On the other hand if due to some public interest intervention a court has to declare the agreements are flawed, bad in law and therefore not valid, what can the parties to the agreements do.

Now a ministerial committee has been appointed to look at the possibility of a re-negotiation of the hedging contracts. From what has transpired so far in this regard, the powers of the government will best be exercised with the Golden Rule of Law as opposed to the uncertain and much doubted cord of discretion. Rule of Law excludes the existence of arbitrariness of prerogative or wide discretionary authority on the part of the government.

It is difficult to exaggerate the severity of the continuing effects of these faulted agreements and the adversity of their direct impact to the economy of the country. While a cancellation may not lead to any crisis or calamity as made out by some, the continuation of the agreements would definitely be disastrous to the country.

(The writer is a former chairman of the Bank of Ceylon and the National Gem and Jewellery Authority, and President of the People’s Bank Pensioners Association).

http://www.lankabusinessonline.com/fullstory.php?nid=2020506078

Tue, 17 March 2009 16:03:09

Flat Rate 06 Mar, 2009 18:50:51

Sri Lanka Commercial Bank net flat in 2008

Mar 06, 2009 (LBO) – Commercial Bank of Ceylon group has reported profits of 4,118.9 million rupees for the year ended December 2008, lower by 0.7 percent, with revenues growing 24.8 percent to 43.9 billion rupees.Group interest income grew 21.9 percent to 37.2 billion rupees, interest expense grew 28.44 percent to 24.3 billion and net interest income grew 11.3 percent to 12.89 billion rupees.

The bank said a charge of 692.1 million rupees was made for petroleum derivatives, and a 405.5 million rupee profit came from the sale of a stake in Commercial Leasing Company.

State-run Ceylon Petroleum Corporation (CPC) stopped payments under oil hedges to Commercial Bank and state-run People's Bank also stopped paying Commercial Bank on a derivative re-sold to CPC.

People's Bank had gone to court to stop Commercial Bank setting off a 15 million US dollar deposit and claim 1.5 percent interest on defaulted payments of 21.02 million US dollars.

The exposure on oil hedging deals were valued at 3,397 million rupees by December 2008.

"We posted a strong performance in 2007 despite the unfavorable economic and political climate," Commercial Bank managing director Amitha Gooneratne said in a statement.

"Trying to carry this same performance into 2008 and to push the bar even higher was a tough task."

Foreign exchange income grew 70.4 percent to 2.63 billion rupees, fees and commissions grew 13.9 percent to 2.71 billion rupees and other income grew 84.1 percent to 1.39 billion rupees including 699.7 million rupees in bad debt recoveries.

The bank's Bangladesh unit brought 1,019 million rupees at pretax level and 539 million rupee after tax to the bottom line.

Commercial Bank's loan loss provisions increased 28.1 percent to 2.27 billion rupees.

The non-performing loans ratio increased from 2.96 per cent to 5.19 percent and its cost to income ratio had risen to 50.461 percent from 47.87 percent.

"Higher provisioning for debt, a slower growth in advances and a significant increase in Financial VAT (value added tax) slowed our growth rate, despite a solid performance in some other areas," Gooneratne.

Banks in Sri Lanka are subject to a high incidence of tax, much higher than most other countries and contrary to international best practices.

In Sri Lanka banks pays a so-called 'financial VAT' which is non-recoverable de facto income tax.

Loans and advances grew 4.7 percent to 167.79 billion rupees.

Total deposits grew 9.1 percent to 199.8 billion rupees. Gross assets grew 4.9 percent to 281.5 billion rupees and net assets grew 7.6 percent to 26.2 billion rupees.

(Error corrected/Total revenue)

http://www.asiantribune.com/?q=node/16020

Sri Lanka: UNP berates on the Governments fiscal policy and current monetary situationWed, 2009-03-11 15:12

By Ravi Ladduwahetty – From Sri Lanka

Colombo, 11 March, (Asiantribune.com): The main Opposition Party- the United National Party today charged that the United People’s Freedom Alliance Government of President Mahinda Rajapaksa was bankrupt and rock bottom without the International Monetary Fund, which it unreservedly condemned while in Opposition.

"The Government members are outright hypocrites as they said that the they would never seek the assistance of the international donor community but they had to go to the IMF with the begging bowl, the very same IMF which it chased out of Sri Lanka three years ago, UNP Kandy District MP and former Plantation Industries Minister in the abridged 2001 -2003 Ranil Wickremesinghe Government, Lakshman Kiriella told a news conference.

Addressing journalists at the party’s Marcus Fernando Mawatha, Colombo 7 office this morning, he said that the Government was in absolute desperation as it needed US$ 4 billion to meet the 2009 expenditure and had no alternative but to go to the IMF in the light of the banks refusing to lend money to the Government and also the state being unable to draw the remittances of the expatriate employees in the Gulf.

He also charged that the Current Account Deficit by the end of the year would be an estimated US$ 2.2 billion with a further US$ 1 billion needed for the repayment of short term debts. There is a further US$ 800 million needed by the Ceylon Petroleum Corporation’s payments to the banks as per the Hedging Agreements for petroleum contracts which will totals to US $ 4 billion.

The MP also noted that the economic scenario would be further dimmer by mid 2009 with the export revenue and foreign remittances likely to take a further dip while the international oil prices were likely to have a further increase.

The Government also borrowed US$ 500 million from HSBC which it lapped up in a fortnight and they asked for a further US$ 600 million from the expatriate community and the Government was unable to raise even 1% of that, he charged.

The Government turned towards India and China and when that too failed it is now turning to Libya, he charged.

The Central Bank Governor Ajit Nivaard Cabraal, who pledged that the Government would never ever seek the assistance of the IMF even two weeks before the funds were pledged, has been caught lying through his teeth, when he is now saying that it is the IMF which offered the assistance without the Central bank and the Government even asking, which is an outright joke, Kiriella claimed.

He also reminded that 52 donors pledged US$ 4.5 billion to the Ranil Wickremesinghe Government after the Cease Fire Agreement was signed and it was this very same Government while in Opposition which alleged that the UNF was compromising the interests of the country.

He said that the UNP will go public when the conditions of the IMF package would be released.

- Asian Tribune -

http://www.sundaytimes.lk/090315/FinancialTimes/ft326.html

The Sunday Times: Sunday March 15, 2009

Commercial Bank resilient in 2008

The Commercial Bank of Ceylon PLC, said it has once again demonstrated its resilience in the financial year ended December 31, 2008 despite global and local volatilities, and an inflation rate that hovered around 20 % for most of the 2008.

Foreign exchange profits recorded a phenomenal growth of 70.46% to reach Rs 2.633 billion mainly due to higher gains realized from forward foreign exchange deals transacted during the year and also due to depreciation of the Rupee against US Dollar by 3.96% in 2008 compared to 0.93% in 2007, a Bank press release said.

Other income recorded a growth of 99.2% over the previous year mainly due to profit made on disposal of shares of Commercial Leasing Company PLC, a former associate of the Bank, and due to higher recovery of loans provided in previous years, it said.

Commercial Bank reported a profit before tax and after financial VAT of Rs.7.520 billion for the year, up by Rs.815 million or 12.16 % over the pre-tax profit for the previous year. The Bank’s profit after tax and financial VAT stood at Rs.4.268 billion compared to Rs 4.104 billion recorded in 2007.

The pre-tax profit of the Bank has been arrived at after charging Rs 692.162 million in payments made on account of oil hedging transactions and after recognizing Rs 405.531 million in profit on sale of Bank’s stake in its shares of Commercial Leasing Company PLC.

“Although the operating environment in Sri Lanka has been tough for many years where rising oil prices, high inflation, the war and low business confidence have made things hard for the industry, that the Bank has managed to perform, and perform creditably in these years is satisfying,” the Chairman of the Commercial Bank Mahendra Amarasuriya said. said.“The Bank is confident it can ride crisis situations by sticking to the fundamentals: strong reserves, optimum liquidity, healthy capital adequacy ratios, product innovation, a lean organisational structure and a motivated management team and workforce. The Bank with its well-structured processes, disciplines and work culture will ride these rough seas and continue to deliver value to all our stakeholders,” he added.

http://www.island.lk/2009/03/08/business1.html

Record earnings for the year, regional expansion in pipelineHNB claims one of the highest commercial banking profit in 2008

Hatton National Bank (HNB) has posted an after-tax profit of Rs.3.2 billion, its highest ever in the year ended December 31, 2008, up from Rs.3 billion a year earlier despite the many constraints and challenges faced during the year.

The bank’s Managing Director/CEO, Mr. Rajendra Theagarajah, said in the annual report that this profit was one of the highest in the entire banking industry for 2008 and said that given the circumstances these earnings were a "remarkable achievement."

Theagarajah said that the group earnings, as expected, were less by Rs.333.2 million than that of the bank. This was due to the divestiture of HNB Stockbrokers, a fully owned subsidiary, and HNB Securities which was 50.01% owned by the bank to a newly formed joint venture with DFCC Bank which had released Rs.475.5 million by way of profit on disposal and dividend income, he said.

The bank’s Chairman, Mr. Rienzie Wijetilleke, reported "a robust performance" in 2008 despite an uneven and negative background.

"Our bank’s inherent strength and values maintained over the years, helped the bank to perform well above normal expectations," he said.

Theagarajah also reported that HNB was continuing efforts to expand its presence overseas with their joint venture in Oman, Majan Exchange LLC in which HNB has a 40% stake, concentrating on remittance business "for the whole of Pan Asia."

"We have just completed regulatory formalities for two more similar operations in the UAE and Canada with the launch of commercial operations due to begin in the first half of 2009 for both," he said.

In South Asia, they have signed a Memorandum of Understanding with the City Union Bank of India and were now awaiting regulatory clearance from the Reserve Bank of India and the Securities and Exchange Board of India to commence investment banking operations.

"We believe the economic meltdown permeating across the region slows regular processes but we have ample faith that we will get the necessary approvals and clearance to start operations soon as HNB has met the required criteria," he said.

The bank is also awaiting clearance for an application to open shop in Bangladesh once it is cleared by the Central Bank of that country. The process has been slowed as a result of political turmoil experienced there for most of 2008 that had slowed down the system.

"However, we are confident that given the change of political regime, we may see accelerated development of the economy, which would require a faster grasping of opportunities," Theagarajah said.

Wijetilleke, in a reference to the oil hedging experience, commented that Sri Lanka had been unable to benefit from the steep decline in the world market price for oil due to some ``irrational decisions creating medium term commitments at exorbitant rates.’’

He saw new opportunities for the bank, with its well established branch network,

from the prospect of peace in the North and the East. This would open a window for participation in the development of these areas, Wijetillake noted.

He urged that the authorities should have in place strategies and a plan for accelerated infrastructure development for the newly liberated areas and get private sector institutions to play a role promoting economic activity particularly in agriculture, small and medium industry and trading.

He also recommended that Sri Lanka should make an effort to obtain, on favorable credit terms or as grants, surplus goods and services available in China, Japan and India due to their decline in exports to the West.

These could be utilized for rural infrastructure development here creating economic activity in those areas.

HNB has a stated capital of Rs.5.06 billion, a statutory reserve fund of Rs.982.7 million, retained earnings of Rs.3 billion and other reserves of Rs.11.5 billion in its books.

Customer deposits had grown to Rs.186.8 billion from Rs.175.7 billion the previous year.

The bank’s net interest income for the year at Rs.12.7 billion was up from Rs.11.1 billion the previous year. It has made Rs.1.16 billion provisions for loan losses, up from Rs.907.9 million the previous year.

Basic earnings per share had grown to Rs.13.67 from Rs.12.83 and the directors have recommended a dividend of Rs.4 per share against Rs.3.50 per share paid the previous year.

HNB’s leading shareholder was the Deutsche Bank Trust Company Americas with 15% but the Browns Group and the Stassen/Distilleries Group were also major shareholders with member companies holding stakes. Browns have 7.29% on its own account and 4.77% through Standard Finance Limited while the Stassen interest was via CBD Exports (6.53%), Milford Exports (6.53%), Stassen Exports (5.66%), Sri Lanka Insurance Corporation Life Fund (4.90%) and the Distilleries Company (2.53%).

Two directors of the bank, Dr. V.P. Vittachi and Mr. R. Sivaratnam, died during the year under review shortly after they had tendered their resignations due to ill health.

The directors of the company are: Messrs. Rienzie T. Wijetilleke (Chairman), Rajendra Theagarajah (MD/CEO), D.H.S. Jayawardena, M.V. Theagarajah, R.K.Obeyesekere, Ms. Pamela C. Cooray, R. Seevaratnam, V.P. Vittachi (Resigned 21.8.2008) and R. Sivaratnam (resigned 24.4.2008).