Crude Realities

Mexico's $1 billion oil hedge may pay economic dividends

A worker looks up while changing a drill pipe on the Laurus oil drilling rig operated by Petroleos Mexicans (Pemex) in the Ku-Maloob-Zaap oilfield at Campeche Bay off the coast of Ciudad del Carmen, Mexico.
Susana Gonzalez | Bloomberg | Getty Images

As the world in general and oil producers in particular continue to navigate a world awash in cheap crude, Mexico is trying to get ahead of the game — and potentially reap a big reward in the process.

Home to oil reserves of at least 10 billion barrels according to U.S. Energy Information Administration figures, Mexico has traditionally done very well by hedging oil in global markets. The derivatives strategy reaped the country a record $6.4 billion last year, and just last month Mexican officials announced a $1 billion bet on crude markets that would price the commodity at $42 per barrel in 2017.

The objective is to help the government offset a sustained drop in oil prices, the likes of which has sent the economies of Nigeria, Venezuela and other crude-producing nations reeling. Recently, the International Energy Agency warned a sustained drop in prices was a risk given shaky global demand.

To be certain, Mexico has already taken a hit from falling oil revenue, which has eroded public finances and sent the government scrambling to carve out billions in savings in both 2016 and 2017 budget proposals. The impact to public investment has also prompted Mexico to lower its ambitions on energy reform, in a year that analysts initially believed would be pivotal to attracting more private investment into the sector.

"The decline in oil prices has also hurt growth, particularly through unrealized potential, as energy reform — formerly big sources of optimism, has been much slower to progress due to lower oil prices and their impact on oil company capex [capital expenditure] budgets," Eduardo Suarez, co-head of Latin America strategy at Scotiabank told CNBC in an interview.

An engineer opens valves on the Petroleos Mexicanos (PEMEX) Bicentennial deep sea crude oil platform in the waters off Tamaulipas, Mexico.
Susana Gonzalez | Bloomberg | Getty Images

With its latest move, the government locked in a $42 barrel price for 250 million barrels of crude, a larger-than-normal amount and far greater than the 212 million barrels hedged last year. If oil rallies, the government would look to reap a large reward on its investment.

Still, there are many moving parts, including the difference in price between gasoline — which may be released from government control as early as next year — and oil.

Mexico, Suarez explains, is less reliant on commodities than other countries in Latin America, with its economy being primarily manufacturing. The country exports 1.7 times as much manufactured goods as the rest of Latin American nations combined. However, weak crude prices are a major factor behind the deterioration in public finances, which are comprised of about 20 percent oil revenue.

"The problem Mexico faces is that it's getting close to the point where fiscal space — for using countercyclical policy — is done, or it may already be there," Suarez said.

Pemex, Mexico's sate-owned oil company, is struggling. With the government already having had to contribute capital so that the company can pay back its suppliers, the commodities slump has not been kind to Mexico.

After decades of mismanagement, in part of it due to restrictive regulation, the company remains overstaffed and lags its competitors. Although Pemex is slowly reforming its operations, Mexico watchers point to its weak balance sheet as a factor complicating the government's efforts of trying to balance public demands while reining in costs.

"The expectation is that most of its downstream and midstream will be spun off or sold," Suarez told CNBC. "And it's starting to show some signs that it can move forward with new tools such as alliances and farm-outs. There is a huge list of challenges, but some are being addressed."

— Reuters contributed to this article.