Mexico Revamps Oil Hedge Strategy to Mirror Shale’s Approach

Mexico is revamping its massive sovereign oil hedge, copying some of the tactics that U.S. shale producers use in an effort to keep its presence in the market under the radar and secure better prices.

The changes are among the most important since Mexico introduced the modern version of the country’s strategy to lock in prices for its crude, a closely watched deal that costs its government about $1 billion in fees to big banks and commodity traders. It’s considered the largest annual deal of its kind on Wall Street.

The Latin American nation traditionally sought to protect government revenues that are heavily dependent on oil by purchasing insurance from big banks and commodity traders one year ahead, usually during a relatively short period between May and September. Now, Mexico is taking a new approach, aiming to spread its purchases over time, even being open to buying insurance during the same year the protecting is for.

“We needed to plan a new strategy,” Arturo Herrera, the country’s finance minister, said in an interview. “We needed to be more careful and spread the hedge over time.”

Mexico Revamps Oil Hedge Strategy to Mirror Shale’s Approach

Even as Mexico seeks to become a more discrete presence in the market, the strategy shift is likely to attract some attention, particularly among option traders, as often the oil hedge roils prices when the banks that sell the insurance to Mexico seek to re-insure themselves.

Herrera said there was “no legal impediment to buy the hedge during the same year” that Mexico was trying to protect. In the past, Mexico had locked in prices the previous year, always finishing the deal no later than in November. To implement its hedge, Mexico buys put options -- contracts that give it the right to sell at a predetermined price -- with banks including Goldman Sachs Group Inc. and energy companies like Royal Dutch Shell Plc.

The new approach, which the country already is using to hedge its revenue for 2021, is akin to the one used by most other big oil hedgers, including airlines and U.S. shale producers. Rather than purchase the options in a big swoop over only a few months, as Mexico had done until now, companies usually are in the market almost constantly, spreading their purchases over time and buying each time just a little to avoid ripples in the market. Herrera said that the more patient approach has already benefited the country with better prices for 2021.

Asked if Mexico was mirroring the tactics of airlines and U.S. oil producers to have a near-permanent presence in the market, Herrera said: “That’s it.”

Mexico is seeking to conceal its presence in the market the best it can because it’s fearful that hedge funds and others may use any piece of data to try to trade ahead of the country. Key data on its sovereign oil hedge has already been made into a state secret to shield the information from speculators. “Several institutions outside the hedge could use the information to speculate, buying the same financial instruments ahead of the government, increasing considerably their price,” the Mexican central bank said at the time.

Although Mexico first hedged its oil revenue during the first Gulf War, the country didn’t introduce the current annual program until a decade later. Since then, it has hedged every year, with the exception of 2003 and 2004, when it skipped the deal as oil prices were rising. The deal has paid several times since, including in 2009 -- after the global financial crisis sent oil prices sharply lower -- and again in 2015, when a record of more than $6 billion was reaped, as well as in 2016. Last year, Mexico earned $2.38 billion from the hedge.

Since 2001, Mexico has spent $15.1 billion in fees buying put options, but has earned $16.5 billion thanks to the four times that the hedge came in the money, according to Bloomberg News estimates based on government data.

©2021 Bloomberg L.P.

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