by Stephen McPhie, CA
Partner, RSD Solutions Inc.
Saudi Arabia’s oil minister recently commented that he thinks the world crude oil market is oversupplied. His Kuwaiti counterpart agrees. They believe that prices are driven by speculation. This is not much comfort to you and me when we fill our cars up at the petrol (gas) pump. (Actually I personally can barely afford to fill my tank any more but that is more to do with the tax regime in Britain than world oil prices.)
One thing that appears apparent is that when prices of anything go up or down very fast, especially if it appears that speculation is a major factor, rather than demand and supply fundamentals, they tend to overshoot and come back off their peak or low point.
The last time oil prices peaked at a higher level than where they are now and they come off quite quickly and quite a long way. A client who came to us after this and who suffered major losses would have been all right if their derivatives intended as hedges had matured a couple of months later. After all, as they said, nobody would have expected prices to do what they did! However, their “hedges” actually increased their risk. They were unsuitable and the company did not understand them properly.
The client would also have been better off had they done nothing. But they would have been best off with a properly conceived hedging approach. They should have avoided expecting or not expecting anything out of the ordinary. The only thing that will inevitably happen is “unknown unknowns” and a risk management system should be designed with this in mind.
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