SRI LANKA COULD LOSE $1+ BILLION AS BET ON HIGH OIL PRICE COLLAPSES

by Feizal Samath

(IPS) -- As global oil prices dive, the Sri Lankan government finds itself saddled with a complicated oil hedging deal with two foreign banks that could cost the country close on one billion dollars and has brought charges of high corruption upon state officials.

Banking sources said the foreign banks involved, CitiBank and Standard Chartered Bank (SCB), are trying to restructure the hedging transactions with the government to minimize losses to the state. However one proposal, being prepared by SCB could worsen the state petroleum agency's plight.

Putting further pressure on the controversial oil deal is a no-confidence motion being brought up against the government by the main opposition United National Party (UNP) citing several corruption issues, including the oil hedging deal and one over a bankrupt budget airline.

The government is under "severe pressure' over this issue, UNP parliamentarian Dayasiri Jayasekera, who has been raising many issues of state corruption in the legislature, told IPS.

Transparency International (TI) -- Sri Lanka's executive director J.C. Weliamuna said the deals have exposed poor governance and corruption in the state mechanism. Neither the regulatory mechanism nor the cabinet have grappled with them nor were alert on questionable deals in the country. "

The state-owned Ceylon Petroleum Corporation (CPC) entered into contracts with five banks led by SCB, since January 2007, to protect itself against rising prices. When prices were over $135 per barrel in mid-2008, the CPC was benefited as it had sought protection on the upside.

But with prices crashing after that and now reigning at $41 per barrel, the CPC ended up owing the banks and the latest liability could be as high as $1 billion by May 2009, at current crude prices. If it falls to $25, as reported in the British Financial Times on Friday, based on a report by the investment bank Merril Lynch, the liability would be higher.

The Supreme Court, on Nov. 28, temporarily stopped CPC payments to the banks until two petitions, alleging fraud and corruption in the hedging deals, were dealt with. The next hearing is on Dec. 15.

Under fire, the government on Thursday reduced petrol prices and said it was preparing a new fuel pricing formula, in response to criticism that the benefits of of falling oil prices were not being passed on to consumers.

The court suspended the CPC chairman and asked President Mahinda Rajapaksa to consider replacing Mohamed Fowzie as petroleum minister. Fowzie has been accused of not properly supervising the CPC on the hedging deals.

After the crisis blew, the cabinet, on Nov. 17, appointed a risk management committee to review all hedging contracts and minimize the losses.

But petroleum industry officials say this was like closing the stable after the horse has bolted and point to the fact that two CPC officials, implicated in the deal, are also on the committee.

"Should not such a committee have been appointed at the beginning when hedging took place after January 2007? Isn't there a serious conflict of interest in appointing officials implicated in the deal?' one analyst asked.

After the court's intervention the committee stopped functioning.

'All these (hedging and Mihin Air) are gambles at a huge cost to the country. This corruption won't stop until the government shows political will to stem the rot. No one is accountable,' said TI's Weliamuna.

TI is marking Anti-Corruption Day this week with a seminar in Colombo on Tuesday on governance issues relating to the global financial crisis and its impact in Sri Lanka with the participation of Peter Eigen, founder and former chair of the Berlin-based anti-corruption watchdog.

Mihin Air is a government budget airline set up two years ago which has been swirling in debt of more than $50 million and was forced to suspend operations earlier this year. It is to be re-started this month with a fresh injection of millions of rupees from the Treasury Department.

Allegations of widespread corruption has dogged President Mahinda Rajapakse's government, centering around his three brothers, Chamal, Gotabaya and Basil. Chamal is aviation and ports minister, Gotabaya is defense secretary and Basil is presidential advisor.

Local bankers, unconnected to the deal, say foreign trips funded by foreign banks for CPC officials to learn about hedging were unethical.

A senior banking industry official, who declined to be named, expressed the view that impropriety accusations in the hedging agreements entered into with SCB and CitiBank are valid. "If it is a proper commercial transaction, you don't need to take the CPC chairman on foreign trips," one official said.

The official added that head offices of these international banks would think twice before pursuing any legal action for non payments since these are highly questionable deals and raise ethical issues.

If the CPC fails to make the payments, the local branches of SCB and CitiBank may lose millions of dollars, bankers say.

Commercial Bank, a local bank which has a smaller exposure in the hedging contracts, said in a statement on Friday, that if the suspension of CPC payments continues, "our liability under our contract to make payments to our back-to-back market risk counterparty would total $8.93 million.'

On the question of whether the suspended payments could result in Sri Lanka being perceived as a country that defaults payments, Chandra Jayaratne, a former chairman of the Ceylon Chamber of Commerce said the Court has only stopped payments temporarily.

"If the Court holds that the hedging agreements are tainted with grand corruption, fraud or misrepresentation, then a contract is invalid," Jayaratne said. "If the contract is determined to be void after the Supreme Court judgment, I don't think anything is wrong.'