Can Russia and OPEC draw any lessons from Mexico’s oil hedge?
Russia’s renewed interest in hedging its oil export revenues has sparked an old debate on whether macroeconomic policies to mitigate the consequences of commodity price volatility, such as establishing revenue stabilization funds to smooth government expenditure over time, should be augmented (or even substituted) by the use of financial instruments such as futures and options. Mexico’s experience in hedging its oil exports is often used as an example of a successful case that other producers could follow.
This is not only related to the issue of macroeconomic stabilization, but also as to whether the use of such financial instruments can enhance producers’ competitive advantage in oil markets and provide them with added flexibility and additional tools to manage the market. For instance, many have argued that Mexico’s hard stance during the OPEC+ talks in April is directly related to the fact that it had a hedging programme in place. Also, while the world’s biggest producers such as Saudi Arabia, Russia and other OPEC producers possess a comparative advantage in terms of their lower cost of production and hence ability to compete in a low price environment, North American producers have a different kind of advantage in their ability to hedge production forward and potentially lock in higher prices than OPEC+ members could get for spot barrels when the market is in contango. Thus, there have been some suggestions that OPEC+ should consider new tools to influence the shape of the curve, including selling oil forward to push prices downward along the futures curve and discourage small US shale producers from hedging.
In this short Comment, we review the results of the main case study in this area, the large-scale put option buying programme administered by the Government of Mexico and assess whether such a programme can be replicated in Russia. We also discuss whether other low-cost producers could potentially also consider participating in the growing market for oil derivatives and in what ways. We argue that Mexico’s experience is unique in many respects and that Russia and other oil producers with large volumes of production and pricing power face serious limitations in replicating Mexico’s experience. We also find that any direct replication of the Mexican hedging programme at today’s market prices does not make much economic sense for Russia. Buying the hurricane insurance the day after the hurricane is unlikely to be good idea. This does not imply though that Russia and other oil producers should not develop their capabilities and participate more actively in derivatives markets. However, this takes time and requires building institutional, legal, financial, and trading capabilities and developing unique strategies that complement (and do not disrupt) their existing policies and are reflective of their size and influence in the oil market.