The solution to improved transaction risk management lies in improved liquidity management.
Managing currency transaction risk generally supersedes the measurement of real impact on cash flows
Measuring and managing transaction risk becomes a difficult proposition because of the following:
- Exposures are fragmented over multiple oil blocks which are managed by different operators
- Managing transaction risk on capex imports by buying dollars forward can become counter-productive because it presumes that import payments are serviced out of INR borrowings or earnings
While dealing in a dollarized commodity and where foreign currency denominated borrowings are a key source of funding, transaction risk largely arises due to mismatches in timing of cash flows.
The solution to improved transaction risk management lies in improved liquidity management as opposed to use of derivatives to manage currency risk.
Improved liquidity management is the key to addressing transactional currency risk.
Blocks generally expend in US$ and the local currency. Invariably, oil and gas blocks are exposed to currency risk on account of non-US$ denominated expenses as there is a mismatch in the currency in which calls are made and expenditure is incurred.
This risk is generally mitigated by the block operator by making a higher cash call on the participants.
The blocks operators are also likely to hold the amount received as a result of cash calls in the domestic currency until actual US$ expenditure is incurred.
Mismatch in timing of cash flows, therefore, affects block operators eventually leading to higher cash calls.
Liquidity management strategy to address currency risk should ideally focus on the following:
- Coinciding the draw-down dates of loans with dates of making cash calls or payments for capex imports
- Timing cash calls with payment commitment dates at a block level thereby reducing surplus liquidity at a block level.
Structural changes to improve management of transaction risk
*Refer to the attached PDF for source information.