Putin Considers Mexico-Style Oil Hedge as Insurance Against Slumps

(Bloomberg) -- President Vladimir Putin gave his government the go ahead to consider hedging Russia’s massive oil and gas export revenues to protect the country from drops in prices, according to a senior official.

The hedge would be an additional tool to support the sovereign wealth fund when oil prices fall, the official said, asking not to be named because discussions are private.

The powerful Finance Ministry opposes the plan, which isn’t likely to be adopted, though it could be discussed at length, according to two other government officials who spoke on condition of anonymity.

Mexico has used a similar system for the past two decades via put options the government buys from a small group of investment banks and oil companies. The country banks all gains when oil rallies but enjoys the security of a minimum floor and may recoup as much as $6 billion this year. Russia has considered the hedging idea in the past but never adopted the plan.

Under the latest proposal, the government would use money from its wealth fund to buy the put options, which would generate profits if oil prices fell, Interfax reported Wednesday. Officials will produce a more detailed plan by the end of this month, according to Interfax.

Big Hit

Russia’s finances took a big hit this year when oil prices collapsed amid global coronavirus lockdowns and a price war with Saudi Arabia. The budget deficit will mostly be covered by extra borrowing to avoid eroding currency reserves that may be needed in future oil price slumps.

Spokesmen for the Kremlin and the Finance and Energy Ministries didn’t immediately respond to requests for comment.

The Finance Ministry already has a system for protecting the budget against swings in oil prices, using revenue when crude trades above $40 a barrel to buy foreign exchange for the national wealth fund and spending from it to finance the budget when oil prices are lower. This system has significantly reduced the ruble’s vulnerability to commodity markets and helped Russia build up the fourth-biggest foreign exchange reserves in the world.

“It would probably too expensive to rely entirely on hedging,” said Dmitry Dolgin, an analyst at ING Bank in Moscow. “Mexico is paying around $1 billion per year to hedge exports that are around 25% of Russia’s.”

The Mexican oil hedge cost the government about $1 billion annually in recent years, but it meant that the country received massive windfalls in every downturn over the last 20 years.

Despite Mexico’s success, no other major oil-producing country has followed suit with a similarly large hedge. Russia held advanced talks with Goldman Sachs and Morgan Stanley in 2009 on a similar deal but ended up opting out of the proposal, according to people familiar with the talks.

If Russia followed the Mexican model, it could create a headache for the U.S. shale industry, where dozens of small- and medium-sized companies rely on hedging to finance their drilling budgets. The arrival of a big player like Russia in the hedging market would likely push up costs for everyone else.

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