CASE STUDY Managing Exposure to Oil Price Volatility in Uruguay OVERVIEW Uruguay is a net importer of crude oil. A significant hike in oil prices could have a negative impact on the country’s economic activity and public sector finances, putting pressure on the government to divert fiscal resources away from priority areas. An oil price hedging program implemented with the World Bank in 2016 will help Uruguay mitigate the impact of significant oil price increases on the fiscal budget and overall economy, as part of the government’s comprehensive strategy to manage macroeconomic risks. increase production costs for businesses that rely on Background oil and its derivative products. Uruguay is paving the way with an ambitious renewable energy program, which provides close to Risk Management Objectives 95% of its electricity needs from clean energy Increasingly, countries like Uruguay are facing sources. While oil makes up a declining share of the uncertainty from volatile global economic energy mix, Uruguay still relies on oil imports to meet conditions and seeking support to reduce fiscal its total annual energy demand. In 2015, Uruguay exposure to commodity price shocks. Uruguay’s imported 14 million barrels of oil. finance ministry wanted to insulate the budget from abrupt and significant increases in oil prices. It also An unexpected increase in oil prices could force the wanted to continue to underpin macro-financial government to divert budgetary resources from resiliency in line with the government’s risk priority areas. Adverse oil price shocks also management strategy. negatively impact individual consumers and FINANCIAL ADVISORY & BANKING – UPDATED SEPTEMBER 2016 IBRD Financial Solution Outcome The World Bank Treasury and the Debt Working closely with the Uruguayan Debt Management Office of the Ministry of Finance of Management Office, the Bank provided the expertise Uruguay worked together to design an oil hedging in derivative execution and the flexibility needed by program, as part of the government’s the government to execute this transaction at comprehensive risk-management framework to competitive pricing, in a fast-changing environment. protect the economy against global volatility. At the same time, preparation of the transaction in close collaboration with the Debt Office and market In June 2016, the government gave the go-ahead to counterparties helped to build institutional capacity for the World Bank to intermediate the execution of a future risk management transactions. series of derivative transactions with market counterparties. The oil hedging program is part of a broader engagement between Uruguay and the World Bank This hedging program, which covers around half of to manage fiscal risks, which includes the innovative Uruguay’s total annual oil imports for 12 months, will weather and oil derivative transaction completed in help moderate the negative impact of significant oil 2013 to mitigate the negative impact of drought on the price increases on Uruguay’s fiscal budget and the energy production and financials of the state hydro- overall economy. power company. With this transaction, Uruguay once again took up The World Bank Treasury customizes financial the helm of trailblazer among emerging market solutions to meet clients’ unique financing or risk countries, becoming the first sovereign to execute a management needs at the project or portfolio level. commodity hedge with the World Bank. The Bank can execute derivatives and other capital markets transactions across sectors —e.g. energy, Transaction Details agriculture or disaster risk management— as an intermediary for sovereigns, sub-nationals or state- Role of Collaboration and technical owned enterprises in both IBRD and IDA countries. World assistance in the design of the Bank: hedging program and intermediation between the Working with the World Bank country and the market As a transaction intermediary, the World Bank leverages its triple-A credit rating to provide member Financial IBRD commodity hedge (a call instrument: option which gives the buyer countries with improved market access and the right, but not the obligation, financial terms, while helping to build capacity and to purchase a set amount of strengthen confidence in the implementation of barrels of oil at a pre-agreed hedging programs. price (“strike” price)) Potential candidates for replication would include Barrels 6 million/ approximately half of member countries whose economies are highly of oil: Uruguay’s annual oil imports exposed (as an exporter/importer) to a specific commodity or groups of commodities, which make a Period: 12 months country’s fiscal position and economic activity vulnerable to international commodity Price/fees: Premium for the call option and price fluctuations. IBRD hedging transaction fees For information: Miguel Navarro-Martin Head of Banking Products mnavarromartin@worldbank.org +1 (202) 458 4722