Mexico says hedge covers oil income, government should accelerate spending

MEXICO CITY (Reuters) - Mexico’s finance minister said on Tuesday a $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.

Mexico's Finance Minister Arturo Herrera gives a speech after he presented the 2020 national budget to Laura Angelica Rojas (not pitured) president of the Lower House of Congress at the Congress building in Mexico City, Mexico September 8, 2019. REUTERS/Luis Cortes

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.

International crude oil prices suffered the biggest rout in nearly 30 years on Monday, 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.

The government of President Andres Manuel Lopez 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 $1.37 billion. It has not disclosed how many barrels the hedge covers, but said it had secured the price of $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 Petroleos 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 $54-$56 a barrel and hedged Maya at $42.

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

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.

Reporting by Anthony Esposito in Mexico City; Additional reporting by Stefanie Eschenbacher in Mexico City and Devika Kumar in New York; Editing by Matthew Lewis and Kenneth Maxwell