Fri | Aug 18, 2017

Editorial | The larger lesson of the oil hedge

Published:Sunday | October 23, 2016 | 10:00 AM

It is not just the Holness administration's embrace of the economic reform project that was under way when it came to office - including its decision to enter into a new agreement with the International Monetary Fund - that is shoring up our confidence in economic policymaking and the country's prospects for long-term economic growth. For the Government is having to consume hunky forkfuls of political crow and swallow hard in this show of growing maturity.

The latest example of this was last week's appearance before Parliament's Public Administration and Appropriations Committee by Financial Secretary Everton McFarlane and central bank governor, Brian Wynter, to tell legislators that the Government will be seeking money for a new oil hedge, essentially smoothing the path for the politicians.

Hedges of this kind are, essentially, insurance policies. You pay a premium and, if the price of the commodity against which you hedge rises above an agreed rate over a defined period, you are compensated the difference. You, therefore, have a cushion.

The existing oil hedge contract, for 15 months, was initially entered into by the previous administration last June with Citibank NA. It covers Jamaica's purchase, over several contracts, of eight million barrels of oil for which the Government was to pay premiums totalling US$27.9 million, or US$3.48 a barrel. The strike price, or the weighted average price to which oil would have to rise for Jamaica to trigger a compensation payout, was US$66.53 per barrel. At the time, the price of oil was dipping to the mid-50s range, having dropped from more than US$106 in the first quarter of 2014.

 

NOT FOR THE DEAL

 

Initially, the then opposition Jamaica Labour Party was for the hedge via Aubyn Hill, the economic adviser to its leader and current prime minister, Andrew Holness, until Mr Hill was not for the deal when prices began to fall, to end 2015 at a little over US$37, and dipping further to under US$33 in this year's first quarter. Indeed, Mr Hill has said that the premium from the oil hedge would be used by this administration to help finance personal income tax givebacks.

It was not only Mr Hill who criticised the deal. It was also ridiculed by the current finance minister, Audley Shaw, who declared it to have been "ill-advised" and suggested the hedge payments would have been better spent elsewhere in the economy. Mr Shaw, it seems, when he tables supplementary estimates to the current Budget, will have in them a yet-undisclosed amount to pay for a new hedge at an unannounced strike rate. Yet, we support the idea, in principle and in fact.

Oil is back above US$50 a barrel and is projected for further upward movements in 2017 on the likelihood of an 800,000 barrels-a-day gap between production and demand, as producers limit output to stabilise prices, stocks decline, and, hopefully, there is growth in the global economy. But things could happen otherwise, leading to a fall in prices. These things are risks to which policymakers apply the best analysis and advice and prudent judgement, without being fearful that rational economic actions will be politicised.

This move by the administration, similar to its retreat from its ridiculing of the buy-back of the PetroCaribe debt, and the dumping of its original income tax plan, is a good lesson to all of us about the need to apply rationality to economics. We are heartened.