NEW YORK/MEXICO CITY: Mexico is wrapping up purchases for the 2021 edition of an oil hedging program that insures its revenues from oil sales, sources familiar with the legendarily opaque trade said, following a particularly challenging year.
Negotiations to purchase the bulk of the financial contracts that protect Mexico against oil price crashes have now been concluded or are nearing conclusion, two sources with direct knowledge of the matter and three market sources who follow volumes and flows of such contracts closely said.
The Mexican finance ministry declined to comment.
The hedge is crucial for Latin America’s second-largest economy which is at risk of a credit rating downgrade. With oil prices below the hedged level for most of this year, it is almost certainly set to give a sizeable 2020 payout – a lifeline for a country in deep recession.
However, exceptional market volatility has complicated the delicate negotiations with Wall Street banks and oil majors and increased the price for the options the country is purchasing to protect 2021 oil export income.
“Volatility this year was enormous,” said Raul Gonzalez, who worked in the Mexican finance ministry in the early months of the current administration and now lectures economics at the prestigious Tec de Monterrey university.
“The oil hedging program is necessary. It offers stability amid public finance and budget challenges. It’s expensive but has generated benefits, it prevents the country losing its investment grade rating and guarantees solvency,” he said.
Even though the hedge would typically run from Dec. 1 this year through Nov. 30 2021, and the volume of trades has been muted in recent days, Mexico “might still have more to hedge” for 2021, one market source with knowledge of the matter said – citing lower than usual volumes so far this year for trades consistent with the Mexican hedge.
Another possible explanation for the lower volumes: Bankers and officials told Reuters earlier this year they expected a smaller 2021 hedge due to the increased cost of the options Mexico has bought in the past.
Mexico can continue to negotiate trades and layer-in the hedge even after the Dec. 1 start, the sources said, though the country would typically be done by December.
International benchmark Brent crude oil has climbed above $50 a barrel, recovering from the lows touched earlier this year, and could provide Mexico with an opportunity to lock in some sales at higher price levels, the sources said.
The highly secretive trades are usually done in tranches and cover only parts of the year, information relating to earlier oil hedging programs obtained by Reuters through a request under the country’s Freedom of Information Act shows.
TRICKY
Reuters spoke to several market sources who said that putting the oil hedging program into place was especially difficult this year.
The coronavirus pandemic and a brief price war between oil superpowers Russia and Saudi Arabia crushed oil prices in April and sent options volatility surging, making the contracts more expensive than normal, the sources said.
“It was more fragile than the last year considering the already crazy volatility and low prices,” one oil trader said. “They tried to hide it more than usual, but now there’s no more hiding. For sure, it’s there.”
Mexico has in recent years shelled out more than $1 billion annually on the program, which is comprised of put options on Maya and Brent and give it the right to sell the options at a predetermined price in the future.
Mexico also puts aside a part of a special budget stabilization fund to top up the options program and cover the price set out in the country’s budget.
The negotiations have become tougher in recent years as banks shut their commodity trading desks and the number of counterparties has dwindled. So Mexico has further restricted the information it makes publicly available for the program.
It neither disclosed the strike price, the number of barrels hedged, the overall cost of the program or the names of its counterparties for 2020.
The country’s transparency regulator rejected repeated requests for documentation around the oil hedging program arguing that it could give Mexico’s counterparties an advantage and increase the cost of the program.
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