Mexico’s "legendary" oil hedgers (profiled her emost recently one year ago and by Bloomberg in this exhaustive article) are confident that prices won’t linger above $50 a barrel, which is why the world’s most-active sovereign oil-trading desk spent a near record $1.25 billion on put options to lock in export prices for next year, Bloomberg reported, citing data from the country’s Ministry of Finance.
The news is especially notable because, as we pointed out yesterday, with WTI prices holding at 6-month highs around $54 (and Brent at $60), hedge funds have never been more bullish on the entire energy complex, having accumulated a record 1.189 billion barrel equivalent long positions in the five major petroleum contracts (Brent, WTI (x2), RBOB, HO)...
Source: Reuters, John Kemp
...and that surge comes as oil analysts are following the trend and raising their oil-price forecasts.
Last year, Mexican hedging desk spent $1.03 billion to protect itself from a downturn in prices, according to data released in the quarterly budget balance. In recent years, Mexico has spent an average $1 billion buying the hedges. The hedge first appeare in 2001, when Mexico made a tentative showing, spending just $217.3 million on put options, a fraction of the approximately $1 billion a year it would spend later. In 2003 and 2004, with oil prices rising, the country opted not to hedge at all. The strategy came into its own in 2005: Mexico has hedged every year since without interruption. Agustín Carstens, who later became head of the central bank, was finance minister when a massive $5.1 billion payout came in 2009; some government officials also refer to the annual oil bet as “the Agustínian hedge.”
As previously discussed, Mexico's uncanny ability to hedge ahead of major price moves has left rival traders marveling at the traders’ market-reading prowess, dubbing the desk a “legendary” participant in global commodity markets.
News of Mexico’s massive hedge - the mere "net" direction of which moves markets - comes as the narrative in the oil market has experienced a surprising shift since Mexico started buying up hedges, a shift that, ironically, would’ve made those options much cheaper if the traders had just waited. The Mexican finance industry proposed a 2018 public budget in September projecting oil exports revenue at $46 per barrel. Lawmakers increased that assumption earlier this month to $48.5.
Just a few of months ago, analysts and investment banks slashed their oil price forecasts as OPEC’s production cuts drew down the global oil oversupply slower than initially expected, and rising U.S. shale production capped any short-lived oil price gains.
But by the end of the summer, as OPEC and the IEA - once again - magically started reporting stronger-than expected global oil demand growth and an accelerated pace of inventory declines, the market sentiment began to change... just as the discussion of Aramco's mega-IPO started swirling again (and which, as a reminder, will simply not take place, if oil is not above a given threshold price). As 2018 and the November 30 OPEC meeting draw nigh, the cartel is said to be favoring a 9-month extension of the deal through the end of next year.
The possibility of such supply restriction throughout the whole of 2018 - combined with expectations of strong oil demand growth and concerns over few new sources of supply due to years of underinvestment after the 2014 oil price crash - has prompted some analysts to warn that fear of the glut will turn into fear of a supply crunch next year. Some investment banks expect the U.S. crude oil production in 2018 to underperform forecasts, which could remove some part of the cap on oil prices that American shale has kept since the start of this year.
The Mexicans, however, don't think so.
Circling back to the desk's hedging activities, Mexican Finance Minister Vanessa Rubio had previously revealed in mid-October that Mexico had completed its annual oil hedge for 2018.
We reported in June that Mexico’s trading desk had begun the process of checking with Wall Street banks for final rates on put options for next year. The hedging deal, conducted through a handful of banks, is typically the New York investment community’s largest annual oil deal. And, like any forward transaction, the government then has the option to sell oil at the price determined in the contract, or the higher rate determined by market supply and demand.
Mexico, via its state-owned oil company Pemex, is one of the few sovereign oil producers that hedges export prices. Other producers that have tried it, such as Ecuador, which hedged oil sales in 1993, have experienced losses that triggered a political backlash. More recently, oil importers Morocco, Jamaica and Uruguay bought protection against rising energy prices.
As Bloomberg pointed out, Mexican Finance Minister Jose Antonio Meade said in an interview in September that Mexico would likely expand its oil hedge marginally for 2018 as it liberalizes gasoline prices. Meade has said the cost of the hedge for 2018 would likely be about the same as last year, but on this, he miscalculated: This year’s hedge was roughly 25% higher. The Mexican oil hedge runs from the beginning of December until the end of November. The country has made money three times on the hedge since it started to lock-in prices every year in 2000, including a record payout of $6.4 billion in 2015 after oil prices crashed.
Given the price of the put options, the trading desk’s reputation as savvy operators could be at risk. If oil prices continue to climb, the whole hedge could expire worthless, possibly triggering the type of political fallout that other exporters who have tried the strategy have experienced. Right now, analysts at Jeffries see WTI at $55 a barrel by end 2018 and Brent at $58 - both well above the government's projections over the summer, when the hedging program was ongoing.
That said, Mexico isn't alone in bracing for a drop in prices.