How will Mexico overcome the global markets crash?
Investors reflected on a window in front of an electronic stock board - Photo: Dado Galdieri/AP

How will Mexico overcome the global markets crash?

12/03/2020
13:03
Reuters
Mexico City
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International crude oil prices suffered the biggest rout in nearly 30 years on Monday, after top producers Saudi Arabia and Russia began an oil price war

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On Tuesday, Mexico’s Finance Minister said a USD $1.4 billion hedge program completely covered 2020 national oil income following a steep drop in crude prices, adding the government needed to accelerate spending to help stimulate a flagging economy.

The oil hedging program, the world’s largest financial oil deal, is designed to protect Latin America’s second-largest economy against oil price crashes.

“The hedge is usually not cheap, it is expensive, but it is for occasions just like this. The income part is covered, we will not have a direct impact on the budget,” Finance Minister Arturo Herrera said in an interview with broadcaster Televisa.

“But it is still a worrying situation,” he added.

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On Monday, international crude oil prices suffered the biggest rout in nearly 30 years after top producers Saudi Arabia and Russia began a price war that threatens to inundate global oil markets with supply.

Despite the protection from the hedge, Herrera said the government would have to re-evaluate economic growth projections as “conditions have clearly changed.”

Ratings agency S&P Global said on Tuesday that the crude crash and fallout from coronavirus would hurt Mexico’s economy and exacerbate pressure points on the country’s credit profile.

Mexico’s economy suffered a slight recession last year, its first in a decade. The central bank has already cut its growth outlook for 2020 to between 0.5% and 1.5%.

Herrera said he did not have much room for a spending stimulus. Instead, he said, the government should accelerate its budgeted spending to help drive the economy.

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The government of President Andrés Manuel López Obrador has maintained strict fiscal targets, maintaining a primary budget surplus.

In January, the government said the Finance Ministry’s hedge had a total cost of USD $1.37 billion. It has not disclosed how many barrels the hedge covers but said it had secured the price of USD $49 a barrel set in the 2020 budget.

Mexico produces some 1.7 million barrels of crude per day.

The protection is largely provided by put options, a financial instrument, but most years also include backing from a budget stabilization fund to guarantee government revenue.

The fall in crude prices has intensified pressure on the finances of Mexican state oil firm Petróleos Mexicanos (Pemex), which faces the threat of a ratings downgrade after posting one of its worst-ever losses last year.

Reuters has reported that for 2020, Mexico bought put options on Brent on the Intercontinental Exchange (ICE) at USD $54-$56 a barrel and hedged Maya at USD $42.

Those options are likely to cover any shortfalls for Mexico now that Brent is well below that level, ending Tuesday’s session at USD $37.22 a barrel, market sources said.

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However, it was unclear how many barrels per day the hedge covers, since Hacienda has refrained from disclosing the information in recent years. This makes it challenging to determine precisely how well protected the Finance Ministry is.

Mexico uses Asian-style options, which means the payoff depends on the average oil price over a certain period of time, compared to American and European options where the payout depends on the price of oil at a specific point in time.

Meanwhile, Mexico and other nations are seeking to mediate between Russia and Saudi Arabia to end a price war that has battered world markets, Mexico’s Finance Minister said on Tuesday, citing his country’s prior experience in calming a crude producer feud.

“We along with some other countries are looking to be a type of third party to build bridges,” Herrera said at a news conference.

Oil producer Mexico is part of a group of countries that together with the Organization of the Petroleum Exporting Countries (OPEC) had kept a lid on production in recent years to support prices.

In 1998, after a year of secret diplomacy and hushed-up private talks around the world, Saudi Arabia and then important producer Venezuela were persuaded to cut a deal by non-OPEC Mexico, overcoming mutual acrimony and leading to a rise in oil prices.

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Herrera mentioned that negotiation as a model of what the countries were seeking to do this time.

“Mexico was a country that mediated, it requires certain diplomatic abilities,” he said, without giving details of the other nations he said were looking to help.

Herrera said Mexico has already started to look at possible channels to reach the two sides.

Twenty-two years ago, Mexico and others agreed to output cuts to end the feud. Mexico is not the player it was, however. It currently produces 1.7 million barrels a day (BPD) of crude. Back then, it was a much larger producer, with an output of more than 3 million BPD.

Last week, a three-year pact between Russia and Riyadh collapsed, leading to the scrapping of all restrictions on output in a market already awash with oil.

Mexico was present at the meeting in Vienna where the so-called OPEC+ group failed to reach an agreement.

With most OPEC countries heavily reliant on oil income, the price rout puts a huge strain on state finances. At Monday’s low of nearly USD $31 a barrel, OPEC members were estimated to be losing about USD $500 million a day in revenues.

Mexico’s budget is better protected than most thanks to a large hedge it takes out to insure oil production against price drops. State-oil company Pemex, however, already teetering on a ratings downgrade to junk, is less well insulated.

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Likewise, Mexico will soon invite private firms to invest in oil and gas projects to help a flagging economy hit by the fallout of coronavirus, Finance Minister Arturo Herrera said on Wednesday, but cautioned energy auctions were not on the cards for now.

Herrera said a long-awaited energy plan will be unveiled soon that will detail where and how much private firms can invest.

“It’s not just a general outline, we’re going to tell them this project here, here, and here, this amount and size is open to investment,” Herrera said in an interview on the sidelines of a banking conference in Acapulco.

Under President Andrés Manuel López Obrador, Mexico has pursued a more statist approach to the energy sector and suspended auctions of oil fields.

López Obrador said last week the energy plan could be unveiled in March, after weeks of delays. The balance of public and private investment the plan will aim for has not been clear because of differences of opinion in the cabinet over energy policy.

Also last week, Mexico’s private sector presented the government with a broad package of proposed energy investments worth almost USD $92 billion. Herrera’s comments suggest at least some of those proposals could be adopted.

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Some members of the government believe attracting more private capital is vital for lifting growth and that restarting auctions would send a strong message to investors that Mexico is open for business.

In the past, Herrera has signaled the issue should be reconsidered, despite the ongoing suspension.

But Herrera said even auctions for joint venture projects with Pemex were not viable, after a rout in oil markets this week caused by a drop in fuel demand from the coronavirus outbreak and the collapse of a production cutting deal between major producers.

He said he did not “think it makes sense considering where oil prices are.”

Prices fell again on Thursday amid a broader market drop after the United States restricted travel from Europe following a declaration that the coronavirus outbreak is now a pandemic.

Layla Vargas, director of energy consultancy Muvoil Consulting said that while some oil companies may view Herrera’s invitation with skepticism in the current economic climate, the right terms could attract them.

“What the country needs right now is investment,” Vargas said.

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