The hacienda hedge

[sle]

My view is the article cannot cover all actual operational and financial figures, as usual. Simply due to commercial confidential data.

Most likely there should be an expensive cost for buying swaps during upward price trend.? Just my guess. Awaiting comments from commercial professionals.

It's very hard to find out what exactly was the P&L for something like that. Especially for that something that outsized the market and can't be completely laid off. Having been a part of similar corporate trades in equity derivatives, i would guess the P&L was meaningful but what part of it was actually locked in is hard to say.

 

[Pekelo]

Disclosure: I am not a Mexican financial policy maker...

2. Why would they hedge only the export value as a producer's policy? Isn't most producers hedge their whole production, subject to a hedge ration they prefer? Are you implying a grains farmer selling mainly to a local wholesaler, without exporting, does not need any hedge? I doubt it.

I just did the math, that is how the 100 days came out which was about 80% of their export in oil in 2016. So they didn't even hedge the whole export. But I can see why they don't hedge the oil they use up internally, because they can control the price. If the international price drops too much, they can still keep it artificially high inside the country, or if it goes way too high, they can subsidize it, just like Venezuela does. So their internal market is different from their external exposure.

A whole country is different from a local market, where the government can actually set the price. But I am just doing the math, why exactly they do only partial hedge, that is their business decision. Their biggest hedge was 435 mill barrels, but their production is 2.5-3 mill per day through the last few years. So their biggest hedge was only half of the annual production...

 

[Maverick74]

There is no country price of oil. LOL. Oil trades at one world price. And the reason the price they hedged was so low in 2008 is because the market was steeply backwardated at the peak. There are some funny people on this interweb thingy.

 

[sle]

Oil trades at one world price.

I think he means the benchmark.

 

[Maverick74]

I think he means the benchmark.

This is what he said:

"A whole country is different from a local market, where the government can actually set the price." There is no local market. Mexico is part of the free market. They sell their oil at market prices. They can subsidize oil but this becomes an opportunity cost for them then.

 

[sle]

This is what he said:

I take it back then, indeed it sounds wrong.

I think people here do not grock the motivation. It's not about the producers, it's about hedging the possible loss of tax revenue. I am surprised more countries do not do this, it's just a natural way to smooth the economic cycle a little.

 

[JackRab]

This is what he said:

"A whole country is different from a local market, where the government can actually set the price." There is no local market. Mexico is part of the free market. They sell their oil at market prices. They can subsidize oil but this becomes an opportunity cost for them then.

I would agree with @Pekelo... I think he's saying that the local market is the domestic one. And as a large oil producing country, Mexico is likely to set the prices for that, or at least they could/should... just like Venezuela does. It's not really subsidizing, but there is an opportunity cost indeed, by not pumping all oil at higher prices abroad.

But we in Australia are having a similar discussion regarding our gas supply. We export a lot, probably at low prices... I heard Japan for instance makes more money on Australian gas than we do on that export to Japan. But, we could hit a supply shortage due to oversees contracts... than there should be a backstop for domestic use, likely at lower prices....

So I would think Mexico would do the same. They would have some qty of oil dedicated for domestic markets. Any producer should do that.... I'm not sure about petrol prices in Mexico, but I would think they are significantly lower than the US.

 

[OddTrader]

It seems to me that possibly the article's figures for hedge gains would be trying to promote the hedging consultancy company, more than the outcome of actual performance. Just my 6th sense feeling! LOL

http://www.tradingeconomics.com/mexico/gasoline-prices

 

[JackRab]

http://www.tradingeconomics.com/mexico/gasoline-prices

So who's prices are really subsidized?

Weird re Mexico though... I surely thought they would've had lower prices.... Do they have their own refineries?

 

[OddTrader]

Here is a good analysis:

Hacienda Hedges and Unicorn Votes
April 4, 2017

https://www.bloomberg.com/view/articles/2017-04-04/hacienda-hedges-and-unicorn-votes

Here is a fun Bloomberg Markets story about Mexico's annual oil hedge, where Mexican finance officials go out every year and flood a bunch of banks with orders to hedge the country's oil production. They do a surprisingly good job:

" For its part, Mexico has shown a Wall Street-style wizardry in trading oil. It usually makes money on its hedges—sometimes a lot of money, as in 2008-09. From 2001 to 2017, the country made a profit of $2.4 billion; its hedges raked in $14.1 billion in gains and paid out $11.7 billion in fees to banks and brokers. "

On the one hand, it is always heartening to see a client make more from Wall Street banks than it pays them in fees. On the other hand ... is it? Mexico is a giant oil producer that has "relied on oil for about a third of its income" in some years. The oil hedges are meant to reduce the volatility of that income:

" Hedging is like buying insurance, says Guillermo Ortiz, who was governor of the country’s central bank from 1998 to 2009: "You buy it hoping you won’t need it." "

The way you typically think about insurance in daily life is that if you are getting more money from the insurance company than you are paying in premiums, something has gone wrong. You don't want to get your money's worth on term life insurance. Something similar seems to have happened to Mexico. The opening anecdote in the story involves Mexican officials top-ticking the oil market in July 2008, putting on their annual hedge just after oil hit an all-time high. They started that hedging on July 22, when West Texas Intermediate crude was at around $128. They bought puts on 330 million barrels of oil:

" Within minutes they began firing off messages to the oil trading desks of Barclays, Goldman Sachs, Morgan Stanley, and Deutsche Bank. Their instructions were to buy “put” options, contracts giving them the right to sell oil at a predetermined future price, at levels ranging from $66.50 to $87 a barrel. The banks receiving the orders had never seen an oil deal this big. The price tag for the options was $1.5 billion. "

The puts worked out great. They paid off in December 2009. "Official records tracking the money that landed in Account No. 420127 at state-owned Nacional Financiera bank show the tidy sum Mexico made: $5,084,873,500."

Good work! But "In 2009 oil prices would average less than $55, well below the average price of the options of $70." Mexico's 330 million barrels of puts paid out about $15 per barrel, or $5 billion. But selling oil at $55 per barrel, rather than $128, means that Mexico missed out on $73 per barrel, or $24 billion on 330 million barrels. The hedge was a drop in the barrel, as it were. Wall Street paid Mexico, but Mexico paid the oil market a lot more.