Mexico Prepares for Falling Oil Prices, Hedges Oil Exports

Posted by Kyle Hammond on December 10, 2009 at 11:12 am

Agustin Carstens, Mexico’s Finance Minister, has hedged his country’s oil exports for the second year. (image: wikipedia.org)

Mexican officials were wise to distrust last year’s high crude prices. Believing prices would eventually fall, Mexico hedged all of its 2009 oil exports at $70 a barrel, which cost the oil exporter $1.5 billion dollars. According to the Financial Times this move paid off handsomely, resulting in over $5 billion in profit when the price of oil collapsed. On Tuesday, the Houston Chronicle reported that Mexico will be making the same move for the second year in a row in order to protect itself from price fluctuations. This time, Mexico “bought put options to sell crude for $57 a barrel.”

In a nutshell, a put option gives a seller the right to sell a product at an agreed-upon price. This gives the seller insurance in the case of a sharp drop in prices, and in exchange for this insurance the seller pays a fee. In this case, Mexico has bought options to sell its oil at $57 a barrel. Ultimately what Mexico has done is insure itself against the possibility that crude prices could drop substantially next year. Mexican Finance Minister Agustin Carstens asserts that this year’s hedging is not motivated by hopes of another massive payoff but is merely an insurance policy, noting “if we don’t collect any resources from this transaction, it’s OK with us.”

Mexico’s concern with protecting itself against price drops stems from the fact that oil is Mexico’s largest source of foreign revenue. According to the Houston Chronicle, “revenue from state oil monopoly Petroleos Mexicanos accounts for nearly 40 percent of the federal budget.” Because of its heavy reliance on petro dollars, dramatic falls in crude prices could prove devastating for the Mexican economy. However, it should be noted that a miscalculation in hedging could also prove devastating. The Financial Times noted that Ecuador lost nearly $20 million when it hedged its commodities exports in 1993. Either way, because of its reliance on oil revenue, Mexico treads a fine line when much of its financial well-being rests on something as tenuous and unpredictable as the price of oil.

Mexico’s decision to again hedge its oil exports is merely the latest chapter in a larger story focused on what next year’s oil markets will look like. HeatingOil.com has noted that predictions for future oil prices are all over the map, with some (like OPEC) arguing that prices will increase, others believing that prices will remain stable, and many energy experts asserting that oil prices are artificially high and bound to drop. By hedging its exports, Mexico lends credence to those who forecast a decline in oil prices in 2010.