The secret weapon that empowers Mexico in the oil price war

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(Bloomberg) – While Mexico and Saudi Arabia are fighting over an agreement to end the oil price war, Mexico has a powerful defense: huge coverage of Wall Street protecting it from low prices.

While talks are in their third day, coverage of Mexican sovereign oil, which secures the Latin American country against low prices and is considered a state secret, is one factor that can make the country less prone to accept the OPEC + agreement.

In the past two decades, Mexico has purchased so-called Asian-style put options from a small group of investment banks and oil companies, in what is considered the most important – and the more closely watched – annual Wall Street agreement.

These options give Mexico the right to sell its oil at a predetermined price. They are the equivalent of an insurance policy: the country’s banks all benefit from higher prices but benefit from the security of a minimum floor. So, if oil prices remain low or plunge further, Mexico will continue to book higher prices.

Coverage isn’t the only reason Mexico resists. But it strengthens the hand of the country and makes it less desperate than the countries whose budgets have been ravaged by the collapse in oil prices since the beginning of the year – first because of the coronavirus, then because of the price war launched by Saudi Arabia Saudi.

The main reason for President Andrés Manuel Lopez Obrador, a leftist populist, to resist the deal is his commitment to restart oil production through the state-owned Petroleos Mexicanos. Cutting 400,000 barrels a day to comply with the OPEC + deal, rather than the 100,000 barrels a day that Mexico counter-offered to Saudi Arabia, would put an end to its ambitious plan to return Pemex in its former glory.

The cover has protected Mexico from every downturn in the past 20 years: it made $ 5.1 billion when prices collapsed in 2009 during the global financial crisis, and it received $ 6.4 billion in 2015 and $ 2.7 billion in 2016 after Saudi Arabia waged another price war.

The operation comes at a cost. In recent years, Mexico has spent approximately $ 1 billion annually to buy options.

“Insurance policies are not cheap,” Mexican finance minister Arturo Herrera told Televisa on March 10. Our budget budget will not be affected. ”

Pemex, the Crown corporation, has its own separate, smaller oil cover. This year, Pemex covered 234,000 barrels per day at an average of $ 49 per barrel.

State secret

Mexico has released very few details of its insurance for 2020 after declaring that sovereign coverage is a state secret. However, based on limited public information, as well as historical data from previous years, it is possible to make a rough estimate of the potential payment if prices remain low.

The government has told lawmakers that it has guaranteed revenues to support the oil price assumptions made in the country’s budget – of $ 49 per barrel for the Mexican oil export basket, equivalent to about $ 60 – 65 $ per barrel for Brent crude.

It blocks these incomes via two elements: the cover and the country’s oil stabilization fund. Historically, the fund has only supplied 2 to 5 dollars a barrel, so it is realistic to assume that Mexico has covered at least 45 dollars a barrel for its crude oil. In the past, Mexico has covered about 250 million barrels, or almost all of its net oil exports, in a transaction that runs from December 1 to November 30.

Using all of these elements, a rough calculation suggests that if the Mexican oil export basket were to remain at current levels, the country would receive a multi-billion dollar payment. Since December, the basket of Mexican oil has averaged $ 42 per barrel.

If the current low prices for Mexican oil continue until the end of November, the average would drop to just over $ 20 a barrel and coverage would cost nearly $ 6 billion, according to calculations by Bloomberg News.

Representatives of the Ministry of Finance and the Ministry of Energy declined to comment.

(Updates the tenth paragraph with the Pemex coverage volume and the last paragraph with comments from the Ministry of Finance and the Ministry of Energy.)

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