Mexico's Hedge Signals Bottom of Oil Price Drop

by: Tim Plaehn November 21, 2008 | about stocks: DBO / USO    
Tim Plaehn

Tim Plaehn

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The following article from last week at the WSJ.com (subscription required) detailed how Mexico has purchased puts against its entire 2009 oil production to guarantee a minimum of $70 per barrel. They purchased puts at a cost of $1.5 billion to cover 330 million barrels of oil. My math puts (pun intended) the cost of the protection against lower than $70 oil at approximately $4.50 per barrel of oil.

When a major player in any market takes a large position against a price move in one direction, I am tempted to believe the next move will be in the opposite. Witness the locking in of corn prices by VeraSun Energy (VSE) at the grain’s peak and the subsequent bankruptcy when prices fell precipitously. Fear can drive people to irrational and ill timed decisions. I quote from the WSJ article:

But the steep fall in the price of oil from last year’s highs alarmed Mexican officials.

Buying puts does allow the Mexicans to profit if oil prices rise significantly. They would just let the put expire worthless and have a loss of their initial purchase. If you are a believer that large institutions are very good at making the absolute wrong decision at the wrong time, this action would predict that oil prices will trade in a range of $70 to $75 for most of 2009.

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This article has 6 comments:

  •  
    Nov 21 02:03 AM
    Uptick rule NOW...
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  •  
    Nov 21 02:31 AM
    Very perceptive and contrarian -- I'm now going to track Tim Plaehn in my watchlist.
    Reply | Link to Comment
  •  
    Nov 21 08:10 AM
    I think the decline of Mexico's major oil field, Cantarell, will have a much bigger effect on raising the price of oil. Cantarell's decline will also push down the value of the peso, since the field is a major source of revenue for the Mexican government. I think the puts are a way for the Mexican government to guarantee their revenue stream - if oil goes down, they make money on the puts. if it goes up they make money selling oil. They minimize their gains and losses.
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  •  
    Nov 21 08:46 AM
    yes we need uptick rule NOW.
    > jack
    Reply | Link to Comment
  •  
    Nov 22 02:15 AM
    Agree with Barry Robbins 100%. Socially, Mexico (among others) is a powder keg with a pretty short fuse. They can't afford a major financial hit (affecting social programs).
    Reply | Link to Comment
  •  
    Nov 24 07:00 AM
    Interesting contribution, but with Cantarell declining, why would the Mexican decision makers waste their time with puts. Why not just hop a plane to....and explain to them what it takes to make life sweet and mellow.

    Uptick rule? Do you mean the crazy idea that Steve Forbes is trying to sell - or the opposite. In any event, where oil is concerned, Mr Forbes' advice is of little or no value, although his publication if great.
    Reply | Link to Comment
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