Hedging Alaska's oil: disaster insurance.

• Author: Lindahl, Mary

Here's one way the state could avoid economic catastrophes when oil prices fall.

The statistics are sobering. Oil revenues fund 85 percent of our state budget, and oil prices are extremely hard to predict. In the last two years, Alaska North Slope (ANS) oil prices have been as high as $21.19 and as low as $9.76 per barrel. Alaska, one of the biggest speculators in the oil commodities market, needs disaster insurance.

The state budget passed by the Alaska Legislature for the upcoming fiscal year is based on a best guess of future oil revenues. As the year unfolds, we compare actual oil revenues to our projections and hope that the money already budgeted will materialize.

During the last decade, three forms of oil price insurance -- futures, swaps and options -- have been created to minimize the risk from price swings. A hedging strategy tailor-made to Alaska's unique situation using one or more of these tools could enable the state to better forecast future oil revenues, plan state expenditures, and insure against an oil price disaster.

State representative Joe Green, chairman of the House Special Committee on Oil & Gas, says "If we had done it (oil-price hedging) this time last year, we'd have been real smart. It's more of a safety net than a way of making money."

Oil-dependent governments are joining the private sector as active hedgers. Mexico hedged its oil during the Persian Gulf crisis and locked in higher oil prices for up to a year. Alberta, Canada, has been hedging short-term since 1987. Texas completed a pilot program in 1993 and passed expanded legislation to double the size of its hedging program. And on the consuming end, Delaware began hedging after the 1990 oil-price run-up to guard against fuel price increases.

Several types of disaster insurance plans have been presented that involve the use of futures, options, swaps, or combinations of these three basic hedging tools.

FUTURES FIX PRICES

The futures market is used to fix a price on oil to be sold up to three years in the future. One contract represents 1,000 barrels of West Texas Intermediate (WTI) oil. Alaska can use futures prices to forecast the upcoming fiscal year budget and to protect that budget by selling futures contracts.

For example, in March 1993, Alaska could have locked in futures prices of between $19.90 and $19.98 per barrel for the '94 fiscal year by selling futures contracts. As ANS oil is sold in the normal way, the WTI futures contracts would then be...