Mexico Locks in Oil Price for 2017 at $42 Per Barrel

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Prescient hedge or foolish waste of money?

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Recent history has been on Mexico’s side on that one. As a significant oil producer, Mexico’s oil price hedging program has been the worst kept secret in the market recently, although it has been going on for a dozen years according to Reuters.

Trimming the Hedges

When it started, disclosure requirements were more lax and the volumes were lower making it easier to keep it under wraps, but the Dodd-Frank Act and success of the program has resulted in larger volumes that just can’t be kept under wraps. The 2015 hedge netted Mexico a record windfall of more than $6 billion last year as oil prices continued a three-year slide.

This year, Mexico has covered 250 million barrels of crude, more than last year’s 212 million but has been forced to accept a lower price at $42/barrel for 2017. The hedge is covered by 46 trades, the article states, with $38 per barrel covered by put options with seven derivatives traders. The remaining $4 per barrel is to be covered from money set aside in a government stabilization fund.

Why Hedge?

With some 20% of government revenue coming from oil, the purpose of the hedges is to help protect public finances for an economy which has already twice downgraded growth estimates for this year and is acutely sensitive to potential rate rises in the U.S. and the forthcoming U.S. presidential elections.

With previous years hedged at $76.40 in 2015 and $49.00 for this year, 2017 is already certain to show a lower revenue than this, yet time will tell if Mexico’s insurance policy is going to pay off. It has cost them over a $1 billion in fees but, arguably, the confidence it gives international bond investors in Mexico’s finances as a result of having the hedge in place has helped lower financing costs by a significant amount.

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It is not unlike major gold miners forward selling or hedging output, there is the potential to lose out if prices rise, sure, but of more importance to investors is the confidence of knowing revenues will meet budget commitments. That keeps ratings agencies grades up and borrowing costs down.

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