GOVERNOR of the Bank of Jamaica (BOJ) Brian Wynter and Financial Secretary Everton McFarlane yesterday defended Government’s need to continue with insurance contracts to hedge against any sharp increases in oil prices that could impact its economic reform agenda.

Former finance minister, Dr Peter Phillips, had earlier this year indicated that the then Administration intended to continue with the insurance agreement which was implemented in 2014 in the face of spiralling global oil prices.

During a meeting of the Public Administration and Appropriations Committee (PAAC) of Parliament yesterday, the financial secretary explained that the current contracts will provide coverage up to December 2016, but that the Government is “looking to find resources” to buy coverage beyond December.

The committee was discussing the first interim report on the 2016/17 fiscal policy paper.

When asked why the Administration would maintain an insurance contract which would appear to be in the best interest of Venezuela, which owns 49 per cent of the State oil refinery, Petrojam, McFarlane explained that the primary reason for the hedge is for protection against shocks in the crude oil market that could derail the Government’s economic programme. He stressed that the focus is not on protecting Petrojam.

“The contract is an insurance contract to provide a contingent source of resources for balance of payment support or general budgetary support to the Government in the event that oil prices rise. The balance of payment projections themselves, which are part of the whole macro framework, are usually predicated on a price range for oil. So the idea is to be able to protect against price rises…so that the worst effects of the price rise, in terms of the depletion of foreign exchange resources, can be mitigated,” McFarlane said.

He said, too, that similarly for budgetary revenues, if the rise in oil prices is significant enough it could nullify the effects of certain taxes and have a negative effect on the budget. “It’s contract between the Government and a financial intermediary which says that there is a certain volume of oil that is part of the contract, and if prices rise beyond a certain level you will pay us an amount that would give us a certain amount of resources,” he added.

The BOJ governor also emphasised the importance of the hedge, pointing out that, whilst healthy reserves are commendable, this could be slashed in half, as occurred at the height of the oil price crisis a couple years ago.

“… So what’s the answer? One answer is to build the reserves up by an extra billion so that we have that cash sitting up. The other extreme is to pay the US$20 million or US$30 million; if nothing happens you lose the premium, but if that event occurs you get the payout. So we can either self-insure by having more money put aside (in case oil prices go up), or we pay a premium. We have to look at what makes more sense.” He insisted that a healthy balance has been struck by having healthy reserves, backed up by insurance contracts.

There are, however, no funds in the current budget to pay new premiums to allow the contract to continue beyond December. McFarlane indicated that arrangements are being made to find the resources to fit the programme into the upcoming supplementary budget.

They said the cost for the current agreements total US$28 million ($3.3 billion) per annum. Those contracts were based on oil price movements in 2014 and the consensus forecasts. The policy kicks in if oil prices rise above US$66 per barrel.

The financial secretary explained that when the agreement started it covered approximately nine million barrels of oil, but for each month that has passed without a claim from the Government, the monthly volumes covered have reduced.

The amount of oil covered under the remainder of the contracts (up to December) is about 200,000 barrels, Wynter said. “It’s the tail end of what was being edged over a year ago,” he remarked.