The consequences of this year’s slump in global oil prices have started to show in Mexico. Pemex which is Mexico’s state-owned oil producer generates $90bn each year from crude which equates to 8% of Mexico’s GDP and employs 126,000 people globally. Given that one company makes up such a huge proportion of the economy the Mexican government hedges Pemex’s projected revenue. The only thing is, banks are charging up to 4 times for the $1bn hedges this time (explained below).  The hedges insure that even if Pemex do not make their expected earnings they have the ‘option’ to receive a similar amount from the bank if necessary.

The Mexican government knows that a situation like Covid-19 where oil prices fall for a prolonged period of time could leave Mexico battling a recession. To prevent this from happening Mexican finance chiefs go out and buy options which are structured and sold by banks such as Goldman Sachs, Morgan Stanley and JP Morgan.The good thing about them is the option owner (Mexico) can exercise this option to get a revenue-matching payout incase it needs to supplement lost revenue. You can look at it as paying for car insurance which gives you the option to call for a new car if you need one. But if you are more likely to crash and call for a new car the insurer(bank) will charge you more – Mexico is likely to need the revenue which is why the the options are up to 4x their original price. If the holder chooses not to exercise the option then the premium paid for the insurance is simply kept by the bank  – and this is how banks make money from writing options.

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