Getting a fair price for a barrel of oil is a key issue for exporting countries. This was one of the main factors that led to the establishment of the Organisation of Petroleum Exporting Countries (Opec). In 1960, oil was extremely cheap, not more than $2 per barrel.

Since then, oil prices have seen sharp fluctuations. Opec has constantly struggled to stabilise prices at fair levels that reflect the importance of oil as a source of energy and of revenue that can be utilised to develop producing countries.

In response to Opec, major oil-consuming countries established the International Energy Agency (IEA) in the mid-1970s, after oil prices rose from $2 per barrel to $11 in just a few months.

The conflict over oil prices has taken many forms, during which prices varied significantly and reflected both positively and negatively on oil dependent economies.

While most oil exporting countries have — more or less — abided by market prices, others have taken steps to ensure consistent returns by adopting hedging policies regardless of spot market prices. These hedging policies allow these countries to avoid committing to prevailing market prices.

Pioneer

So far, Mexico is the only oil exporting country which follows the policy of insuring the sale price through "put options", which is a contract giving the owner the right, but not the obligation, to sell at a fixed price.

Mexico has recently fixed the sell put option price at $75 per barrel. Accordingly, if the price falls below $75, to reach $60 for example, then Mexico will earn $15 per barrel.

In the event that oil prices exceed $75 per barrel — as is the case with Nymex (New York Mercantile Exchange) crude at $93 — then Mexico has the freedom to determine its options, according to its interests.

Due to an expectation by Qatar's decision makers of a decrease in oil prices next year, the country has decided to join Mexico in taking out an insurance policy against falling prices by hedging some of its production for 2012.

It decided to hedge about 200,000 barrels per day, a quarter of its annual oil output, through option contracts at a fixed price which is yet to be revealed. This constitutes a new approach to oil policies by the Gulf Cooperation Council (GCC) states and Arab countries in general. The important question here is what this new approach means for the stability of oil revenue, and the subsequent impact on annual budgets and economic conditions in producing countries, including the GCC.

In principle, business activities cannot be spared from risk, although some gains can still be made if expectations are objectively managed.

In the case of hedging policies, there are high insurance and commission costs. It is important to take these into account while adopting these policies.

Qatar is justified in attempting to secure the sale price of its oil through option contracts and in agreement with global investment banks. By adopting this conservative policy, some gains can be achieved in the event of prices falling next year.

At the same time, it is important to determine the period of hedging contracts in general, because oil prices are not subject to commercial considerations only. Political and security events, as well as levels of strategic reserves and speculation, play an important role in determining price levels, making them difficult to predict in the long run.

In any case, it is vital for Qatar and the rest of the GCC and Arab countries to consider the Mexican experience, which must be evaluated and utilised for the greatest possible gains.

It is also important for GCC countries to establish oil industry research centres. These will study price trends and make sure they are not subject to speculation. They need to adopt objective and scientific indicators to determine price trends.

In the past, many countries and major companies suffered massive losses as a result of dealing in some types of hedging contracts, such as future contracts. Extreme caution and close monitoring of market developments are required before any hedging policies, aimed at reducing the negative effects of fluctuations in oil prices, are adopted.

 

The writer is a UAE economic expert.