Hedging Positions Vital for Traders Riding Out the Storm

Q: How has the price collapse impacted Indimex’s ability to import and export its refined products?

A: Black Monday, where oil prices hit negative-40, was a shock to the industry at large. The drop was driven by the delayed production cut agreements between OPEC and OPEC+ and because demand has decreased around the world. In Mexico, retail has seen decreased demand of up to 70 percent while in distribution there has been around a 30 to 40 percent drop-off. There is a significant decrease in population mobility across the country. As a result, we have an oversupply of refined products coming from the US and a lack of consumers in Mexico.

Countries in Asia that are net importers have been able to take advantage of the low prices because they are able to store extra product. In Mexico, with only three to five days of refined products storage, this has not been possible. As a result, there are major issues occurring with commitments from PEMEX to pull barges coming in from the US to Mexico and then not having anywhere to store the product. While many Mexicans had hoped they would be buying cheap fuel, that is not necessarily the case when the mileage fees and the lack of access to local storage to keep product on site are taken into account.

The Official Gazette announced that COVID-19 would be considered a pandemic and could therefore implicate force majeure. This allowed companies to justify their inability to move product, which has a cumulative effect on contracts and where they are written. Though pandemics are not usually included in contracts in the US, in Mexico it has been more common since the Swine Flu outbreak in 2009.

What is important for Indimex is to understand the letter of the law and how contracts can impact us. Both of these events justify companies’ inability to supply and buy products, which has affected the entire supply chain and our ability to carry out our work. This includes obtaining, importing and taking the risk on and distributing refined products to the consumer in Mexico. When suppliers in the US are afraid of taking risks due to the depressed prices or because they bought a barge when the prices were higher and have not hedged their tank position, then we arrive to a situation of lack of supply despite there being an effective oversupply in the market. The lack of storage backs up maritime supply and roads at the border are slow due to the current lack of custom agents. Indimex, which is committed to both buying and selling, can be exposed on either side if our clients decide that they do not wish to commit to us.

While in theory we have cheaper pricing as a net importer of refined products, the prices of products may not necessarily reflect that all around the country. The Houston Gulf Coast produces 40-45 percent of refined products in the US and Mexico, particularly for the three mains areas of Guadalajara, Monterrey and Mexico City. Therefore, if more people are purchasing fuel again then the prices balance out, demand rises and fuel can shift. This then has a cumulative effect on the logistics network.

Q: How has Indimex limited damages and attempted to turn the crisis into a business opportunity?

A: From disaster comes opportunity and there are small opportunities that have been presented to us. It’s a situation whereby those companies that have understood the moment and hedged their risk positions well, will be less exposed to those that have taken big swings at the market.

To secure our position, Indimex has restructured some of its contracts and analyzed whether it makes more sense to bring railcars into Mexico or to keep them in the US and wait for the market to respond. It is superfluous to pay rail rates to move rail cars and have product sitting at a facility if there is no one to buy it.

Many people do not understand that when a trader hedges their position it is not to make money but to limit losses. A trader has a physical position but that is hedged from a financial standpoint or from a decision made from an optimization or operational standpoint. Making money from a hedge is great, but that is not the primary objective. We are hedging our position by understanding how best to optimize our assets, whether that is by buying product that has already been imported locally, importing our own, or holding our assets in position, paying demurrage but understanding that the market will pick up in a few weeks.

Q: What could governments do to help hasten cross-border transactions during the pandemic?

A: We are going through a natural process in reaction to an event of this size. The government is implementing a strategy to confront the pandemic. Mexico is going through Phase 3, which is some weeks behind the US along the curve of the pandemic. While Phase 3 was supposed to last until the end of May, the way the virus has spread around the country means different regions will pick up at different times.

There is little either government can do at this moment to alleviate the health concerns around COVID-19. People must stay at home as advised by experts. This is an unfortunate event but one we must ride out. Though there are political agendas that should be considered, including the consequences of the US picking up Mexico’s production cut shortfall from the OPEC+ agreement, the health and security of the population is primary.

Q: How has Indimex progressed in developing the secondary distribution market in Mexico?

A: Indimex is not in the position where it is comfortable announcing rack prices in different locations within Mexico. This is because storage facilities have been delayed and we have been delayed in attaining the investment we need for the distribution terminals. This has a great deal to do with the fact that last year was the first full year of the current government and there was uncertainty in terms of what the market would dictate.

We still focus on the secondary market but rather than having our own distribution terminals, we are delivering into transloading terminals for railcars and post prices delivered into the client’s trucks. We have a local rack price for the secondary market of consumers, including smaller and medium-sized companies. This is just the first step into developing the secondary market further with truck racks and terminal racks in different national locations.

Q: What will Indimex be focusing on in the wake of the COVID-19 pandemic?

A: In the immediate future, Indimex will be working to realign our contracts, and to assuring our customers that we are capable of doing the job that we promised to do. We must focus on survival, on riding the storm out, and covering all of our risk positions in the best way possible. Indimex intends to come out of the pandemic in a stronger position, with the capacity to start taking larger positions as we were doing at the beginning of 2020, prior to the crisis. At the moment, however, we are limiting losses.

The legal aspect of our work is also important to understand, in terms of what is safe to discuss with providers and customers. With this, it is very important for Indimex to show its human side. Few people discuss the importance of the humanistic and emotional side of trading. Dealing with others at a time like this, in this highly-pressured environment, means people can react strongly and can make decisions based on emotions rather than business acumen. Managing this entire process is multifaceted and difficult.

We are all trying to understand what the “new normal” will look like in terms of how to generate and maintain customers. Indimex is thinking about how we can strategize ourselves to be customer-facing in the new normal. For example, I will likely be traveling a lot less, which means we will probably hire a few local people. We will be holding more video conferences. From a Mexican business standpoint, being customer-facing and being trusted is absolutely key. The emotional context is tantamount in this.

In the new normal, more decisions will need to be made remotely and this demands greater integration of technologies. Decision-making matrixes of companies are going to change, and this is an issue Indimex is considering. It is an ambiguous time.

Indimex Group trades and markets crude and refined petroleum products from the US into Mexico. The company, which has a presence on both sides of the border, distributes its products via an extended and efficient logistics network