The Impact of the Government’s Hedging Strategies on Petrol Prices in South Africa
Date
2011-04-13
Authors
Gumede, Nhlanhla
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Abstract
Since 2003, petrol prices in South Africa have increased to unprecedented levels, due largely to global increases in crude oil prices. Although there are different opinions on the causes of high crude oil prices, there is consensus that high fuel prices have a negative impact on global economies, in general, and on developing economies in particular. The impact of high petrol prices on economic development has, in some countries, required that governments derive mechanisms of mitigating their impact. One way to lessen the impact of petrol price increases and volatility is through hedging at a national level. Up until 2003, the South African government used to manage petrol price increases for the petrol consumer through use of an equalisation fund mechanism. However, in 2004 the practice was discontinued and a number of attempts to find a replacement have had limited success. This study seeks to provide an ex post empirical analysis of the impact of hedging South Africa‟s petrol prices. The analysis shows the beneficial impact of the use of derivatives in reducing the consumer price risk. It examines the impact of the unhedged strategy against hedging petrol prices in order to evaluate the overall cost of petrol to the consumer that would result from hedging. The hedging strategy considered in this research involves purchasing artificial call options using a strategy that is known commonly as “writing reverse calls”. In the study, these options are priced through use of the Black-Scholes formula. The total cost of petrol to the consumer with the hedge is then compared against the situation where there is no hedge. The study found that the proposed hedging strategy could result in lower consumer prices and lower petrol price volatility. Lower prices also imply that the inflationary impact of fuel prices could be reduced.
Description
MBA - WBS
Keywords
Petrol pricing, Hedging strategies