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Challenges slow Mexico's billion-dollar oil hedge this year

Armando Veve for Bloomberg

Year after year, Mexico places a multi-billion-dollar bet in a deal that big banks lust after.

By Devika Krishna Kumar, Stefanie Eschenbacher, Marianna Parraga / Reuters

Petroleumworld 06 11 2019

The world's biggest and most secretive financial oil trade is facing unusual roadblocks this year.

Mexico typically buys as much as $1 billion worth of financial positions to protect its revenues from oil sales for the coming year against price fluctuation. It is the most widely anticipated hedging deal in oil markets, and can make or break an investment bank's dealbook.

But the Mexican government, under new President Andres Manuel Lopez Obrador, has been slower than usual to start testing the waters for its first round of hedging due to volatile oil prices, trade tensions and new rules for marine fuel usage, seven financial industry sources told Reuters.

By early May, Mexico is usually at least sounding out banks, attempting to discreetly secure the best price using financial instruments such as put options, which give the holder the right to sell oil at a certain price in the future a protection against falling prices.

This year the ministry has so far been largely absent from markets where options are negotiated, according to sources at banks, brokerages and trading firms.

Mexico uses the hedge to protect oil revenues because they are a primary source of government revenue. Mega-payouts in 2009, 2015 and 2016 were enough to cover the cost of hedging for more than a decade-and-a-half, public data shows, which the government considers a success.

Mexico hedged its 2019 sales at an average of $55 per barrel, spending $1.23 billion on put options to protect against prices falling below that level. State-owned oil company Pemex also separately hedges its own sales, resuming the practice in 2017 for the first time in 11 years.

Mexico has been coping with price volatility since last year. Maya heavy crude, the country's primary oil for export, has unusually traded at a premium to benchmark U.S. crude for the last eight months.

That has made calculations for the hedge more difficult because it is harder for parties to agree on a reasonable price for 2020. Mexico would want to hedge at a higher level to lock in the greatest profit, but that risks exposure to downside for banks.

U.S. President Donald Trump's trade disputes with Mexico and China are making the market choppier, which makes hedging riskier and more difficult to execute, the sources added.

U.S. crude futures slumped nearly 45% late last year following U.S. waivers on purchases of Iranian oil after Washington imposed sanctions against that country. Following that, crude rallied 56% before swerving lower in late April, subsequently falling 18%.

Higher volatility makes the trade more of a gamble for the Mexican government as well as for the banks and oil companies on the other side of the trade, sources said.

The price of Maya crude has strengthened amid a global shortage of heavy oil following sanctions on Venezuela and Iran as well as transportation bottlenecks in Canada. Trump administration clashes with Mexico could squeeze supplies more if tariffs are imposed this month.

The Mexican finance ministry was not immediately able to comment on Reuters' questions.


Stricter rules, including a near-total ban on proprietary trading for banks in the United States, have dampened risk appetite for operations such as the oil hedges the Mexican finance ministry aims to buy, banking sources said.

Last year, at least two firms that executed the hedge for Mexico were caught off-guard after oil prices crashed in the fourth quarter. That wrong-footed the companies, which often take on an opposing position to offset the risk of the put options they write for the Mexican hedge program, three sources familiar with the money flows said.

“The Maya hedges almost blew them up,” one banking source said of the firms that executed the trades.

Also affecting the hedging: New fuel standards from the International Maritime Organization (IMO) that will require vessels to use a lower sulfur content are set to come into effect in 2020 in an effort to cut pollution.

High-sulfur fuel oil has generally been a component of Mexico's export mix, but brokers and traders have asked the country to replace the type of heavy oil it has been using for calculating the formula for the hedge, sources said.


Reporting by Devika Krishna Kumar in New York and Stefanie Eschenbacher and Marianna Parraga in Mexico City; Editing by David Gregorio from Reuters. / 06 10 2019


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