Reasons for pain despite the gain
The drop in the price of crude oil and, generally speaking, its derivatives has fired hopes that, in due course and other things remaining equal, inflation will begin to ease off. The extent to which that will happen and how remains to be seen.
The drop in the price of crude oil and, generally speaking, its derivatives has fired hopes that, in due course and other things remaining equal, inflation will begin to ease off. The extent to which that will happen and how remains to be seen. Policymakers will hope that the sharp drop of crude, by a third from its peak of $147, will dampen and perhaps reverse inflationary expectations.
Such expectations have been very much on the mind of central bankers who are resisting calls to cut interest rates to try to counter the slowdown in economic activity, even outright recession, evident in various important economies. Central bankers continue to resist the pressure on them even though interest rate changes work with a lag of up to one year.
They will want to see harder signals going to employees and consumers to show that inflation should be slowing down. Some signals are in fact appearing. Pump prices of petrol in countries where market forces do work are reflecting the decline in the price of crude.
That is not the case in Malta. Over here there is a mixture of bewilderment and disappointment that downward crude oil movements are not reflected in any easing of the burdens of sharply increased fuel and energy costs.
There has been widespread expectation that the hike in the surcharge will be reversed, in line with the decline in the price of a barrel of crude.
Such expectation has been repeatedly pricked by our central authorities. Using very tortuous reasoning, quite distant from any form of linear thinking, they have been asserting that the surcharge is still below the energy supply price justified by the present $100 or so cost of crude per barrel. They are also making it clear that hedging contracts cover requirements to the end of the year and beyond.
The very obvious is being left to consumers to work out. It is that fuel supplies have been covered forward at prices higher than those available on the spot or immediate markets.
That is no cause at all for criticism of those charged with securing Malta's fuel requirements, in the manner they think best in the circumstances. Rather, this particular development - spot prices falling well below hedged costs - brings to clearer light a fallacy that has prevailed in many people's minds for many years, induced to a considerable extent through irresponsible political statements.
Political exchanges and criticism generated the false impression that oil derivative prices could be lowered through hedging. The authorities suggested this even in their most recent statements. That is way off the mark. What buying forward does, whatever technique is used, is to establish a forward price at a given time and for a given date or period. The forward price is influenced by interest rates, risk premiums and expectations. The price that is struck is in turn influenced by the dollar exchange rate against the domestic currency.
The first part of what remains a riddle to most is tested when the price trend turns, as has happened with crude oil. When the trend is upward the spot price tends to pass the hedged cost at some point in time. When the trend reverses, various buyers may be caught on the wrong foot. To criticise them for that is to expect traders to be prophets. Bold and technically sound they may be. Always correct they cannot ever become.
That is why it is wise not to go to extremes. Also, safe strategies, such as buying forward gradually but regularly to establish a moving price that follows the market, may be less exciting and have narrower swings than bold ones. But that's what playing safe is all about.
Alternatively, the procurers and suppliers of fuel could price on the basis of opportunity cost, setting the price at what it would cost to replace the supplied volume today. That technique has worked for many years in the gold market. It is also in good evidence in many countries when it comes to pricing at the pump.
With partial privatisation taking place it remains to be seen when petrol and diesel prices, to mention but two, will move in line with the market. That would require a change in the present pricing methodology, as well as in attitudes. But the time will come when such pricing will be introduced with suppliers competing with their margins. It will make the pain of rising prices more immediate, when crude oil and its derivatives are moving upwards, but similarly relief will kick in much faster when the trend turns.
Through this system there will be room for relief through cushioning certain prices. But there is nothing to show that such cushioning is superior, as a social instrument, to assisting lower-income groups directly. Cushioning simply distorts the market with unclear consequences.
We are on the road to privatisation, but dismantling the existing rigging and focusing aid policies in favour of the truly deserving will not be carried out overnight.
Meanwhile, our procurers have to grapple with the implications of dropping oil prices and the recovery of the dollar exchange rate against the euro. They cannot be having an easy time of it.
Such expectations have been very much on the mind of central bankers who are resisting calls to cut interest rates to try to counter the slowdown in economic activity, even outright recession, evident in various important economies. Central bankers continue to resist the pressure on them even though interest rate changes work with a lag of up to one year.
They will want to see harder signals going to employees and consumers to show that inflation should be slowing down. Some signals are in fact appearing. Pump prices of petrol in countries where market forces do work are reflecting the decline in the price of crude.
That is not the case in Malta. Over here there is a mixture of bewilderment and disappointment that downward crude oil movements are not reflected in any easing of the burdens of sharply increased fuel and energy costs.
There has been widespread expectation that the hike in the surcharge will be reversed, in line with the decline in the price of a barrel of crude.
Such expectation has been repeatedly pricked by our central authorities. Using very tortuous reasoning, quite distant from any form of linear thinking, they have been asserting that the surcharge is still below the energy supply price justified by the present $100 or so cost of crude per barrel. They are also making it clear that hedging contracts cover requirements to the end of the year and beyond.
The very obvious is being left to consumers to work out. It is that fuel supplies have been covered forward at prices higher than those available on the spot or immediate markets.
That is no cause at all for criticism of those charged with securing Malta's fuel requirements, in the manner they think best in the circumstances. Rather, this particular development - spot prices falling well below hedged costs - brings to clearer light a fallacy that has prevailed in many people's minds for many years, induced to a considerable extent through irresponsible political statements.
Political exchanges and criticism generated the false impression that oil derivative prices could be lowered through hedging. The authorities suggested this even in their most recent statements. That is way off the mark. What buying forward does, whatever technique is used, is to establish a forward price at a given time and for a given date or period. The forward price is influenced by interest rates, risk premiums and expectations. The price that is struck is in turn influenced by the dollar exchange rate against the domestic currency.
The first part of what remains a riddle to most is tested when the price trend turns, as has happened with crude oil. When the trend is upward the spot price tends to pass the hedged cost at some point in time. When the trend reverses, various buyers may be caught on the wrong foot. To criticise them for that is to expect traders to be prophets. Bold and technically sound they may be. Always correct they cannot ever become.
That is why it is wise not to go to extremes. Also, safe strategies, such as buying forward gradually but regularly to establish a moving price that follows the market, may be less exciting and have narrower swings than bold ones. But that's what playing safe is all about.
Alternatively, the procurers and suppliers of fuel could price on the basis of opportunity cost, setting the price at what it would cost to replace the supplied volume today. That technique has worked for many years in the gold market. It is also in good evidence in many countries when it comes to pricing at the pump.
With partial privatisation taking place it remains to be seen when petrol and diesel prices, to mention but two, will move in line with the market. That would require a change in the present pricing methodology, as well as in attitudes. But the time will come when such pricing will be introduced with suppliers competing with their margins. It will make the pain of rising prices more immediate, when crude oil and its derivatives are moving upwards, but similarly relief will kick in much faster when the trend turns.
Through this system there will be room for relief through cushioning certain prices. But there is nothing to show that such cushioning is superior, as a social instrument, to assisting lower-income groups directly. Cushioning simply distorts the market with unclear consequences.
We are on the road to privatisation, but dismantling the existing rigging and focusing aid policies in favour of the truly deserving will not be carried out overnight.
Meanwhile, our procurers have to grapple with the implications of dropping oil prices and the recovery of the dollar exchange rate against the euro. They cannot be having an easy time of it.