China should follow Mexico’s oil hedging strategy, says CNPC researcher

(Bloomberg) --A researcher at China’s biggest oil company said the country’s drillers should copy the hedging strategies of Mexico and shale firms in the U.S., which use financial derivatives to protect against falling oil prices.

Most of China’s oil production is unhedged, leaving the stability of the sector exposed to global market fluctuations, according to Dai Jiaquan, director of the oil market research department at China National Petroleum Corp.’s Economics & Technology Research Institute.

Chinese firms should use derivatives to ensure stable returns on the crude they sell, Dai said in a panel interview published in CNPC-owned China Petroleum Daily. The process is easier with yuan-denominated futures on Shanghai International Energy Exchange, he said.

“Now that Shanghai crude oil futures are listed and functioning well, it is necessary to make full use of financial means to hedge the risk of price fluctuations,” he said.

Oil prices are down by about half so far this year, straining the finances of China’s state oil firms, which have all decided to trim spending. Despite the billions of dollars annually they pour into old, high-cost fields to keep China’s reliance on overseas oil in check, the country has still grown to become the world’s largest importer.

Derivatives could also help China’s government take advantage of lower prices to build its strategic reserves, Bai Ming, deputy director of the Ministry of Commerce’s international market research institute, said in the same panel interview.

“If we want to expand our reserves, on the one hand, we can buy real oil, and on the other hand, we must purchase futures to lock in low-cost sources in advance,” he said.

CNPC declined to comment. Nobody answered calls to the country’s other two big state oil firms -- China Petrochemical Corp., known as Sinopec, and China National Offshore Oil Corp. The listed units of all three firms didn’t immediately respond to requests for comment.

The use of energy derivatives by Chinese firms has come under government scrutiny after Sinopec’s trading arm suffered an operating loss of nearly $700 million in 2018, which it blamed on “inappropriate hedging techniques” and “misjudgment” of prices. In January, the state asset regulator tightened rules on commodities derivatives trading, capping hedging at 80% of physical volume, down from 90%. It also reiterated that derivatives trading should be purely for the purpose of hedging, rather than speculation.

Mexico’s hedging program, which includes using put options to set a price floor, has shielded it during every downturn over the last 20 years. It made $5.1 billion when prices crashed in 2009 during the global financial crisis, and it received $6.4 billion in 2015 and another $2.7 billion in 2016 as Saudi Arabia flooded the market.

China produced about 3.8 million barrels a day of crude oil in 2018, compared to almost 2.1 million daily by Mexico, according to data from the BP Statistical Review of World Energy. Virtually all of China’s output is consumed domestically. Mexico has in the past hedged around 250 million barrels, or about 680,000 barrels a day, which is equal to nearly all its net oil exports.