Optimizing the hedging strategy for oil refining companies
Hedge accounting under IND-AS 109 bridges the risk management strategy and the reported earnings
Oil refining companies have traditionally been at the forefront of financial risk management
With a wide range of financial risks impacting them including oil price risk, currency risk and interest rate risk, oil refining companies have put in place a fairly elaborate hedging programs. While most hedging programs are mature, it has always been difficult to assess whether the hedging programs have reduced volatility and assured cash flow stability to the enterprise. Hedging programs of oil refining companies have typically evolved with the dual objective of protection of cash flow margins and protection of reported earnings in financial statements.
Over the past few years, as the evolution in accounting standards didn’t always keep pace with innovation in hedging strategies and instruments, the dual objectives of cash flow protection and reported earnings protection tended to be at cross purpose. This led to hedging strategies addressing either of the two objectives or at times wavering between the two. The net result was that the stakeholder confidence in hedging programs was challenged at each reporting date. It also led a number of organizations to scale back their hedging programs thereby exposing gross refining margins to the vagaries of financial markets.