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. Last Updated: 07/27/2016

Oil Options Seen as Hedging Economy

The Central Bank has proposed buying options to sell crude delivery contracts to hedge the economy from a fall in oil prices, a senior Central Bank official said Friday.

"There are examples of governments hedging their oil price risks through derivatives," said Sergei Shvetsov, head of open market operations at the Central Bank.

"So why should we ban it? ... Let it be written in the Budget Code," he said, adding that a proposal to use options as part of windfall management strategies had been rejected but that he hoped it could be revived in future discussions.

The country's new three-year budget foresees the average price for Urals, the country's main crude oil export blend, falling to $50 per barrel in 2010 from $61 in 2006, cutting the budget surplus and slowing economic growth.

A put option gives the holder a right but not an obligation to sell the underlying crude delivery contract at an agreed price within a certain period of time.

Russia sold $102.3 billion worth of oil in 2006 and remains heavily dependent on its oil and gas sectors, which accounted for 45 percent of its budget revenues last year. In a bid to cut this dependency, Russia plans to stash away energy revenues in a new oil and gas fund from February 2008.

The new fund will replace a $108 billion stabilization fund set up in 2004 to cushion the budget from slumps in oil prices.

The fund will then be split into two sub-funds -- a conservatively invested reserve fund that the government could draw on to cover budget deficits, and a growth-oriented fund for future generations.

Under the Budget Code, approved by the State Duma in a third reading Friday, the reserve fund, amounting to 10 percent of GDP, can only be invested in sovereign bonds or deposited in foreign banks. The code leaves it to the government to decide on the investment strategy for the fund of future generations, where Russia will stash away over $24 billion on Feb. 1 next year.

Shvetsov said the Central Bank's proposal to include options in the list of documents allowed for the reserve fund placement has so far been rejected. The new code will go into force after being signed by President Vladimir Putin.

"It is a pity our proposal is not there. I hope there will be a possibility to include options in the list during the next round of Budget Code discussions," Shvetsov said.

Shvetsov said his calculations showed that Russia could buy crude options with a strike price at $34 per barrel to protect the budget, which is currently balanced at $27 per barrel.

Market analysts estimate a fair price of an option to sell a barrel of Brent crude at a current price of $66 within half a year at $4.50 to $5. Shvetsov said that with the strike price at $34 per barrel, the premium would be much lower.

He said buying put options could have allowed the government to keep less money in the low-yielding reserve fund, sending them to the higher-yielding fund of future generations instead.