Can OPEC producers hedge the remaining oil in the ground?
The historic OPEC+ output cuts agreement has kept vast quantities of oil in the ground.
This represents an opportunity for hedging these remaining barrels in their reservoirs and selling them at specified prices in the future.
Mexico may be one of the few, if not the only, producer whose budget was not affected by the Black April price crash when crude tumbled to unprecedented lows.
That was because hedging gave Mexico the right to sell its oil at a pre-set price, and in turn gave it security when prices collapsed.
Recent reports have linked the country to the world’s largest oil hedge with top Wall Street banks submitting quotes.
Mexico has long been active in hedging, and the government has been successful in securing the funds needed to properly manage the national budget.
For the 2020 hedge, various sources estimated that two-thirds of the options Mexico bought were indexed to the international Brent crude benchmark, shifting away from the Maya oil Mexico mainly produces. It is widely believed that this was done for “liquidity” reasons.
If the expectation is for prices to fall, Mexico waits until the “volatility index” or “vix” decreases to its liking, and then pulls the trigger on the hedge.
This has a huge impact on the cost of the operation: The higher the “vix,” the higher their cost.
Clearly the banks will also add their margin, so many producers, who have their own trading companies, are at a massive advantage.
The question for other big producers is can they also succeed in oil hedging like Mexico?
If a careful technical program for risk management is established, this could generate enormous income, especially if the oil retained is hedged, which may constitute a small portion of total production (with some producers, it may be equivalent to Mexico’s total production hovering around 1.7 million barrels per day).
Hedging this could generate massive returns and ensure diversification of income sources.
But it needs to be done properly.
Producers should have the correct corporate governance and a wise risk management program in place.
So keeping some oil in the ground to hedge is indeed an option for other producers. Moreover, it would not impact the OPEC+ agreement or the stability of global oil markets.
Instead hedging holds the potential to yield higher income through diversification.
• Faisal Faeq is an energy and oil marketing adviser. He was formerly with OPEC and Saudi Aramco. Twitter:@faisalfaeq