A Proposed Fuel Price Stabilization Mechanism through the Use of Financial Derivatives

Mar 2012
This is the context in which this study has been designed, which proposes a discussion of the fundamentals of employing a mechanism based on the use of financial hedging instruments to mitigate the impact of oil price volatility on the cost of oil derivatives. For the purpose of contributing to the consideration of alternatives, the possibility of supplementing these financial instruments with the implementation of price stabilization funds is also examined, in view of some existing experiences with the latter in the region. The document seeks to support the analysis by modeling the possible results of applying these mechanisms to a regional economy. To this end, the authors received the assistance and collaboration of authorities and officials from the Government of Peru, which made it possible to base the modeling exercise on the behavior of real regional market variables. Furthermore, the study simulates a price stabilization scheme "suggested" for such market aimed at mitigating the volatility of the prices of oil refinery by-products, and quantifies the possible results on the basis of a simplified theoretical simulation.

The purpose of this study is to serve as a basic working paper, the main aim of which is to open a window of interest and support a dialogue on the application of stabilization mechanisms that help discuss specific proposals, analyze regulatory frameworks, and develop models to be applied to the price of oil and its derivatives in the countries of the region.