Pricing-in and pricing-out of crude and products creates and inherent currency mismatch risk due to averaging periods used. In a typical refining cycle, domestic sales are priced out prior to pricing-in of crude, thereby creating an apparent need to buy dollars forward in the shorter term merely to manage mismatch risk on crude payments.
In a typical refining cycle, domestic sales are priced out prior to pricing-in of crude, thereby creating an apparent need to buy dollars forward in the shorter term.
Extended credit periods from suppliers and availing of buyer’s credit further enhance the mismatch risk, thereby, enhancing the apparent need to increase the tenor of buy dollar positions.
While buying dollars forward to manage mismatch risk may help track pricing-in and pricing-out of individual shipments, it poses the following challenges:
- Increase in hedging costs is attributable to buying dollars forward.
- Since future dollar payments will be made out of dollarized earnings, hedging mismatch risk for each transaction enhances the value of US$ receivable position. Appreciation in INR vis-à-vis US$ will reduce INR value of receivables on a portfolio basis.
Efficient management of mismatch risk will involve monitoring of net mismatches in US$ receipts and payments for defined time buckets. Where the focus remains on pricing-in and pricing-out of individual shipments, separating the financing transaction of crude purchase from the underlying commercial transaction, it is important for efficient currency risk management.
The financing transaction includes the extended credit period from suppliers and buyer’s credit whereas the underlying commercial transaction terminates at the end of the normal credit period.
The financing transaction is then likely to act as a synthetic hedge against forecasted dollarized value of GRMs, thereby providing for a lock-in of refining margins in rupee terms. Consequently, the cost of hedging is significantly reduced.
*Refer to the attached PDF for source information