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The Billion Dollar Bet On An Oil Price Crash

Mexico’s billion dollar oil hedge…

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Chevron and Occidental are facing…

Irina Slav

Irina Slav

Irina is a writer for Oilprice.com with over a decade of experience writing on the oil and gas industry.

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Wall St. Gears Up For The World’s Biggest Oil Trade

International banks are preparing for the Hacienda Hedge – the secretive oil deal that has seen Mexico earn billions from successful bets on future oil prices. Detailed in an analysis by Javier Blas for Bloomberg, the history of the Hacienda Hedge is certainly impressive and might incite other countries to try their hand at betting on future oil prices. Or then again, it might not, as Mexico’s success story seems to be kind of unique.

Blas interviewed Mexican government officials, traders, brokers, and bankers, and reviewed thousands of documents to compile the history of the bet that bankers await every year and that, contrary to what the Mexican authorities say, could swing the oil market.

The story began in 1990, when Iraq’s invasion of Kuwait took one-tenth of the global oil supply off the market, raising prices. The government then accurately predicted that the high prices wouldn’t last, betting on a decline. This accuracy has been remarkably consistent through the years, with Mexico making money most of the time when it has placed the bet. And it hasn’t been alone.

The first bank that Mexico hired to purchase put options for crude oil was Goldman Sachs. Then Morgan Stanley followed, and by the next decade, the two banks were known as “the Wall Street refineries.” Soon enough other banks smelled the sweet scent of profits and joined the party—most notably Barclays, which had no experience with commodities before the mid-2000s. Other banks that got on board for the Hacienda hedge include HSBC, BNP Paribas and Citigroup—but not UBS or Credit Suisse, which seem to be more risk-averse despite the potential for fat profits. Related: U.S. Threatens OPEC As Oil Exports Hit Record High

Now, oil and gas hedging is standard practice for airlines and energy producers, among others, as they seek to either insure themselves against higher prices or lock in future profits. With the Hacienda hedge, Mexico seeks to make a buffer for its budget in case of rough oil market waters, Blas notes. Even so, the deal has a huge disruption capacity simply because of its size: last year, Mexico made $2.7 billion from the hedge and the year before it made $6.4 billion.

Of course, the banks are keeping mum on the details, but knowing about the hedge gives them insight into future oil market developments that other players in the oil field lack, enabling them to place their own bets on the commodity and affect prices.

Here’s a fresh example of this coming from the U.S. oil industry. Shale producers have been hedging eagerly of late, to lock in $50+ prices per barrel. However, this means they have to pump the amount of oil they are hedging on, and as a result, drilling activity is rising. This would ultimately increase supply but maintain futures prices at higher levels even if crude on the spot market takes a dive. That’s what Wood Mackenzie writes in a new report, warning the oversupply situation could continue longer than expected.

The results of this year’s Hacienda hedge will only become public in December. A lot of things could happen between now and then, and few are confident enough to predict where oil prices will go with any degree of certainty. That said, it may be a good idea to follow oil price forecast updates from Goldman Sachs and Morgan Stanley.

By Irina Slav for Oilprice.com

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