Will COVID-19 Push Other Countries Toward Oil Hedges?

Mexico's sovereign hedging strategy that the federal government uses to protect the country from oil price fluctuations has saved the country billions of dollars over the last decade. Known as the “Hacienda Hedge,” it is the largest sovereign oil hedge of its kind and has proven its worth once again during the COVID-19 pandemic price collapse.

The exact details of Hacienda are closely-guarded. Indeed, so important is the strategy to the oil-rich nation that it is classified as a state secret. While PEMEX has its own hedging practice, which Director Octavio Romero said last month net US$313 million for PEMEX this year, the estimates on Mexico’s sovereign hedge are far larger. As Mexico Business News reported earlier this year, the Hacienda Hedge cost the federal government US$1 billion and, according to Minister of Finance and Public Credit Arturo Herrera, covers revenues generated by oil exports of around 4 percent of national GDP. The hedge is set at US$49 per barrel and could return US$6 billion to the nation due to the recent price collapse, according to Bloomberg estimates.

The cyclical nature of the oil industry means ups and downs are expected. But analysts, including Rystad Energy, have noted briefer time periods between price fluctuations that have been driven by the US shale industry’s massive growth. The responsiveness of shale, in being able to shut in or turn on production so quickly means that the time delays associated with bringing traditional crude production online have vanished and increased the industry’s volatility.

Mexico first implemented the hedging strategy in 2001 when PEMEX was still producing around 3MMb/d, a rate far higher than the 1.746MMb/d it does today. But the historical success of the country’s strategy and the strong protection it has offered Mexico during the unprecedented COVID-19 outbreak and subsequent oil demand destruction event has given other nations pause for thought.

In April, the state-run China National Petroleum Corporation (CNPC) began discussing the possibility of a hedge of its own. The China Petroleum Daily, owned by CNPC, noted the necessity to hedge against the risk of price drops following the hit it has taken from the pandemic that began in China at the start of this year. Back in 2011, Qatar also discussed the sovereign hedge after a US$2 dollar drop in oil prices due to concerns over the Eurozone debt crisis, Gulf News reported.

Mexico is not the only country with a sovereign hedge at present. Ghana, Ecuador and Uruguay, not big hitters in the global oil game, all have sovereign oil hedges according to the IMF.

COVID-19 has caused governments around the world to become involved in the oil and gas industry of their respective nations, even those without national oil companies. According to The Guardian, oil and fracking companies could well receive a chunk of a US$750 billion bond bailout scheme as it looks to rescue the industry. On April 17, Canada’s Prime Minister Justin Trudeau announced a government aid for the country’s shattered oil industry, which would include various environmental measures to reduce the industry’s impact. Meanwhile, Rigzone has reported on the measures presented by Norway’s Prime Minister Erna Solberg to support the industry, including “temporary targeted changes to the taxation system to make it possible to carry out projects.” The country’s oil industry drives Norway’s Government Pension Fund Global, also known as the Oil Fund, is worth over US$1 trillion and is the world’s largest sovereign wealth fund.

Today, Mexico’s regional competitor Argentina announced a US$45 dollar per barrel “shield” for domestic oil production, reports Reuters. The so-called “criollo barrel” policy is intended to protect shale production in the country’s Belgium-sized Vaca Muerta field.

The COVID-19 pandemic is ongoing and it will be a while before the dust can settle. But with the increasing volatility of the oil industry and the demonstrated threats of unforeseen global events, will we see more countries follow Mexico’s footsteps in the future?