Risk manager of the year (sovereign): Mexico’s Ministry of Finance and Public Credit

Oil hedging stabilises Mexican state finances amid price crash

Alejandro Díaz de Léon Carrillo, Mexico’s Ministry of Finance and Public Credit

Since the plunge in oil prices in late 2014 and early 2015, petroleum exporting countries such as Iran, Russia and Venezuela have struggled with ballooning budget deficits, weakening currencies and the spectre of social unrest.

The picture is far brighter in Mexico. Despite being a major oil exporter – in 2013, oil industry earnings accounted for 32% of government revenues – Mexico remains a darling of emerging market investors. The country has held onto its long-term local currency rating of A from New York-based credit rating agency Standard & Poor's and has avoided the drastic budget cuts and devaluations of many other oil-dependent economies.

Much of that is due to a secretive process carried out once a year by Mexico's Ministry of Finance and Public Credit. In its annual oil hedging programme, the ministry buys huge volumes of put options to establish a minimum level of oil revenues that the government can expect the next year. Between September and November last year, it paid $773 million to buy 228 million barrels' worth of puts on Mayan crude oil – the blend used for pricing Mexico's exports. The puts had an average strike price of $76.40 per barrel (/bbl).

That price floor looks extremely attractive now, given that benchmark North Sea Brent and West Texas Intermediate crude oil have spent much of the year to date trading below $60/bbl. If the low prices persist, Mexico will enjoy billions of dollars of gains from its hedges this year. In fact, it would be the first time the hedging programme had been profitable since 2009, when rock-bottom crude prices saw Mexico collect more than $5 billion from its put options.

Alejandro Díaz de Léon Carrillo, the ministry's head of public debt, says hedging sets Mexico apart from other oil-exporting countries. The 2015 hedging programme "clearly allowed us to differentiate ourselves in terms of our fiscal policy and expenditures and to have better dynamics in terms of our exchange rate, interest rates and so on", he boasts.

It definitely made it more complex and more challenging to have these new disclosure rules

That isn't the only reason why Mexico's 2015 hedging programme was notable. The ministry used seven dealer counterparties to execute its hedges, the largest number ever, up from five the previous year. Díaz de Léon says the ministry has been expanding its list of counterparties because each individual bank has less capacity to warehouse risk compared with years past.

Luckily, there are still banks willing to participate in the programme. "As we have seen some players dropping back, we have seen more players stepping in," Díaz de Léon says. "That has been very useful because it provided us with an additional number of counterparties to be able to execute the deals of our large programme, in adverse circumstances, last year."

Circumstances were tough because prices were falling rapidly as the ministry was putting on its hedges. Front-month Brent crude fell nearly $20/bbl while the programme was being executed, and sharp daily moves occasionally scared counterparties, Díaz de Léon recalls. "Sometimes there were large falls in the price and literally no appetite for executing the programme," he says. "It was a very choppy market, and you had to pick the right windows of execution. That was definitely hard."

Adding to the challenge, new regulations stemming from the US Dodd-Frank Act threw a wrench into the programme last year. On September 17, one of the ministry's trades was reported to a US swap data repository with details that made it clear the trade was part of Mexico's oil hedging programme. The news was picked up by the financial press – putting a traditionally secretive hedging programme under the glare of public attention.

The ministry, caught by surprise, was not pleased by the new regulatory difficulties. "It definitely made it more complex and more challenging to have these new disclosure rules," Díaz de Léon says. "It is always better for us to go under the radar as much as possible, because that helps our counterparties offload the risk that they assume with the programme. When the market is fully aware of the execution, that complicates life for them, and for us as a consequence."