Mexico changes its oil hedging strategy

Mexico is revamping its massive sovereign oil hedge, copying some of the tactics that U.S. shale producers use to keep their market presence under the radar and secure better prices. The changes are among the most significant since Mexico introduced the modern version of the country's strategy for pricing its crude, a closely watched deal that costs its government about $1 billion in commissions to big banks and commodity traders. It is considered the largest annual deal of its kind on Wall Street.

The Latin American nation traditionally sought to protect government revenues that rely heavily on oil by buying insurance from big banks and commodities traders a year in advance, 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 for which it is protected.

Even as Mexico seeks to become a more discreet presence in the market, the change in strategy is likely to attract some attention, particularly among options traders, as often oil hedging alters prices when banks selling insurance to Mexico seek to reinsure themselves.

Herrera said there was "no legal impediment to buying the hedge during the same year" that Mexico was trying to protect. In the past, Mexico had set prices the year before, always finalizing the deal no later than November. To implement its hedge, Mexico buys put options, contracts that give it the right to sell at a predetermined price, with banks such as Goldman Sachs and energy companies such as Royal Dutch Shell.

The new approach, which the country is already using to hedge its revenues for 2021, is similar to that used by most other major oil hedgers, including airlines and US shale producers. Instead of buying options in one big swoop over just a few months, as Mexico had done until now, companies tend to be in the market almost constantly, spreading out their purchases and buying only a little at a time to avoid ripples in the market. Herrera said the more patient approach has already benefited the country with better prices for 2021.

When asked if Mexico was mimicking the tactics of U.S. airlines and oil producers to have a near-permanent presence in the market, Herrera said, "That's it."

Mexico is seeking to hide its market presence as best it can because it fears hedge funds and others could use any data to try to trade ahead of the country. Key data on its sovereign oil hedge has already been made a state secret to protect the information from speculators. "Several institutions outside the hedge could use the information to speculate, buying the same financial instruments ahead of the government, significantly increasing their price," the Bank of Mexico said at the time.

Although Mexico first hedged its oil revenues during the first Gulf War, the country did not introduce the current annual program until a decade later. Since then, it has hedged every year, except 2003 and 2004, when it skipped the agreement because oil prices were rising. The agreement has been paid out several times since then, including in 2009, after the global financial crisis caused oil prices to drop sharply, and again in 2015, when a record $6 billion-plus was reaped, as well as in 2016. Last year, Mexico earned 2.38 billion dollars from hedging.

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