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Commodity Hedging Could Help Provinces Manage Sudden Swings From Surplus To Deficit: CIBC

Provincial performance gap narrows as volatile resource markets dampen outlook for some regions, while budding U.S. recovery lifts others

TORONTO, Jan. 29, 2013 /CNW/ - Canada's resource-rich provinces whose fortunes have been dampened by commodity price swings should consider hedging against those risks, even if it means giving up part of the revenue windfall when prices are high, notes a new report from CIBC World Markets Inc.

Canada's "resource bounty has in the past decade been a big winner for government coffers.  But resources are called cyclicals for a reason, and provincial finance ministers are now acutely aware that a bountiful surplus can turn into a gaping deficit in a hurry when commodity prices slip," says Chief Economist Avery Shenfeld at CIBC in the latest Economic Insights report. "The result is that fiscal outcomes in any one year are highly uncertain, leaving finance ministers struggling to explain why they held spending lean when revenues were gushing in, or why a deficit suddenly emerged and forced borrowing up in the process."

In the corporate world, strategies for protecting revenues against adverse swings in commodity prices are routinely used and could be similarly applied by governments, says Mr. Shenfeld.   "To smooth out the bumps and allow time to adjust" to new commodity prices, resource producers and buyers "typically use derivative markets to hedge against some of the price risks in the near term, giving up some of the upside in exchange for protection against large adverse swings.

"There's no reason why provinces couldn't do the same, locking in a range for current year fiscal results, and giving time to make adjustments in revenue or expenditure policies in the following year's fiscal plan should the resource price trend persist. That would clearly be preferable to surprising the bond market with in-year borrowing changes, or rushing to make mid-year spending swings that might not be optimal on other public policy grounds."

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