When buying oil

I refer to yesterday's press reports quoting me stating "I can guarantee that if the price of oil falls below the $85 (per barrel) mark the surcharge will decrease". This is only part of what I said and left out of context could lead to different interpretations, which need to be corrected.

I stated that the present surcharge at market prices should have been 160 per cent, hedging reduced it to 115 per cent and, because the government had decided to absorb 20 per cent temporarily, the rate in June was established at 95 per cent. I then stated that that hedged surcharge rate was based on an average price of $85 per barrel. Finally, I said that, as had already happened in the past, the surcharge rate would be reviewed (up or down) if the buying price of oil for Enemalta increased or decreased.

This needs some further explaining. There is a general misconception that the daily quoted market price of crude oil (in the above example, the $85) is equivalent to the Enemalta buying price. This is wrong.

Enemalta does not buy crude oil (to which the $85 refers) but only refined fuel oil and gas oil - products traded separately and priced independently from crude. Enemalta does not buy at the price quoted on NYMEX (the $85) but on what is called PLATTS Med - a different price index and the only one used by traders in refined oil in our region.

Finally, hedges do not affect the actual oil that Enemalta buys and, in fact, the PLATTS price that Enemalta buys at is the average monthly market price for products bought. In other words, if the PLATTS Med price for fuel oil in August fluctuated between $650 and $670 (refined oil is priced per metric tonne not per barrel, hence the higher figures) Enemalta pays its supplier $660 less the pre-agreed percentage that would have been tendered for.

Hedges work independently of all this. There is also a major misconception that when you "hedge" you actually commit to buy oil at a future price. Not true at all. Hedges, or more appropriately the "futures market", is simply a money market. While oil traders sell oil, it is bankers who sell "futures", foremost Goldmann Sachs, Mitsui, Barclays and others.

When you buy a "future" you do not buy oil barrels, you buy a monetary instrument - in extremely crude terms, a promissory note that states that if the average market price of crude oil in August is above (say) $100, the bank will pay you the difference - in cash - and if it is below (say $95) Enemalta pays the difference - again in cash - to the bank. Some have called this gambling. There are experts in predicting the market, some work for the banks and some work for the energy companies that are doing the buying. No expert is infallible. I am no such expert but Enemalta's own experts have so far been mostly successful in placing the right bets by following the guidelines contained in the Roderick Chalmers report I tabled in Parliament a few years ago.

Again, one does not simply put in one hedge, one normally prudently puts in different hedges, at different price levels and with different maturities while leaving a part of one's requirements completely un-hedged. Between now and the end of this year, Enemalta has some seven different hedged positions ranging from a low of $84.25 to a high of $130. Positions have also been taken for part of our requirements for the first six months of next year. The aim is for a balanced portfolio.

So when one talks of the surcharge being tied to the "$85 mark" one is actually talking about the average in a period rather than a price at any one point in time.

So when Enemalta "hedges" it plays the financial market and if its bet goes right - as has been happening lately - at the end of the month it gets a nice cheque from the bank which it uses to reduce some of the burden of paying the actual PLATTS market price due to the oil company for fuel oil and gas oil. Enemalta has, in fact, benefited to the tune of some $55 million this year, which sum has been used to drastically lower the surcharge rate had Enemalta simply bought off the market. If this latter policy had been adopted, the surcharge this year would have been around 200 per cent all year. If this sounds like an exaggeration, one should consider that even today Maltese consumers have among the cheapest electricity bills in Europe.

There have also been instances where Enemalta has had to pay the bank - $3 million just this week - and, although the balance is still very much in the black, I have no doubt that there will come a period when decisions made months ago are tested in a falling market and if the market continues to fall then Enemalta will have to start paying out.

The bottom line is - as one commentator put it this week - that we have to pay for what we consume and there is never going to be a magic wand which will change this reality.

Dr Gatt is Minister for Infrastructure, Transport and Communications