Where INR is the functional currency of the refiner and/or retained earnings are held in rupees, after managing mismatch risk, dollarized refining margins are exposed to risk of appreciation in INR vis-à-vis the US$.
Given potential correlation between oil and US$-INR movements, it is important to quantify risk at a portfolio level and determine risk reduction levels on a holistic basis.
Traditionally, refiners have been skeptical about locking in the INR value of refining margins due to the following:
- Uncertainty in dollarized value of GRMs due to volatility in cracks makes it difficult to quantify dollarized earnings at a given point of time.
- There are considerations about opportunity gains given up in case INR depreciates vis-à-vis the US$.
Uncertainty in dollarized value of earnings due to volatile cracks may be partially addressed through an effective oil price risk management program. However, the most important reason to lock in rupee value of cash flows is to ensure that servicing of rupee debt obligations is not adversely affected by movements in US$-INR rates.
Further, volatile rupee earnings of refiners have dented investor confidence. Giving up the opportunity gain merely acts as an insurance against unprecedented rupee appreciation. Refiners have not put in place appropriate risk quantification techniques to measure the risk-return from not insuring against such appreciation.
Managing cash flow stability through locking in rupee value of refining margins can be effected in the following manner:
- Dollarization of borrowings through swapping rupee obligations into dollars and/or availing foreign currency borrowings on an unhedged basis. Dollarizing borrowings provides carry (i.e., difference between INR and US$ interest rates) thereby reducing the debt servicing costs. It also acts as a synthetic hedge.
Given that debt servicing will always take place through net earnings and net earnings are dollarized, uncertainty in crack margins should not deter dollarization of borrowings.
- For residual dollarized earnings not covered by debt servicing, it is important to quantify the risk on account of currency movements in conjunction with risk on account of volatile crack margins.
Given potential correlation between oil and US$-INR movements, it is important to quantify risk at a portfolio level and determine risk reduction levels on a holistic basis covering both currency and commodity price risk.
*Refer to the attached PDF for source information