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By Anthony Esposito, Stefanie Eschenbacher and Devika Krishna Kumar
July 12 (Reuters) - Mexico has finished calibrating the formula used as a basis for its massive oil hedging program, a finance ministry official said on Friday, clearing a major obstacle for the hedge, the world’s largest and most secretive Wall Street oil trade.
Mexico buys as much as $1 billion worth of financial derivatives in order to protect its oil-sales revenue for the coming year against price volatility, in a highly anticipated financial trade that can make or break an investment bank’s deal book.
The formula is one of the last pieces Mexico needed to approach banks to solicit quotes for the crude oil options it typically buys to protect against a drop in oil prices, sources familiar with the deal said in late June.
Mexico had faced challenges in executing the hedge this year as oil prices have been volatile and new International Maritime Organization (IMO) standards set to come into effect in 2020 have roiled fuel oil markets.
“On the back of the changes in the maritime rules for the use of fuels, Pemex updated (the formula), trying to include more liquid mixes that could help better model the Mexican mix,” said Gabriel Yorio, a senior finance ministry official. “Those changes have already been done ... (the formula) is ready.”
High-sulfur fuel oil has generally been a component of Mexico’s export mix. Brokers and traders have asked the country to replace the type of heavy fuel oil it has been using for calculating the formula for the hedge, Wall Street sources said, because beginning next year, tankers can no longer use that fuel, which is a heavy pollutant.
This had slowed the program, they said, and until the formula was amended the ministry could not request price quotes from banks and other interested parties for the deal.
Several Wall Street sources who had worked on previous deals said they have not yet been contacted about the deal.
Some said the country has a smaller window to execute the deal efficiently than in previous years, because fuel oil and refined products prices are likely to become distorted as the new year approaches, when the IMO rule change goes into effect.
“They’re going to have to finish the deal by late summer or early fall, basically about 60 days before the IMO effects really start to show,” one industry source said.
Mexico aims to discreetly secure the best price for put options from a handful of Wall Street banks and oil majors in a series of about 50 transactions generally between May and August, documents related to the deals show.
The country garners a large part of its public revenues from selling its Maya crude oil, and therefore uses the put options - which grant them the possibility to sell at a certain price in the future - as a way of protecting against a drop in prices down the road.
Maya heavy crude, the country’s primary oil for export, has unusually traded at a premium to benchmark U.S. crude for the last eight months. Trading has been more volatile following U.S. President Donald Trump’s trade disputes with China and Mexico.
Mexico’s 2019 sales were hedged at an average price of $55 per barrel in a deal worth $1.23 billion on put options. State oil company Pemex separately hedges its own sales, having resumed the practice in 2017 for the first time in 11 years.
The country has been under pressure from various fronts, with its bonds, currency and stock market vulnerable. Recently, credit ratings agency Fitch downgraded state-owned Pemex’s bond rating due to weak finances and underinvestment.
Edgar Cruz, chief credit strategist at BBVA in Mexico City, who has covered Pemex and the broader oil sector for more than 15 years, said this made the hedge program even more important this year.
“Every year it is important to have a hedging program,” Cruz said. “However, it is even more important for the coming year if signs are right and the economies of Mexico and the United States are slowing down.”
Cruz said Mexico would probably seek a strike price of around $55 per barrel, close to what was set out in the 2019 budget, and hedge about half of its exports, most of which go to the United States. He is not involved in the program.
Reporting by Anthony Esposito and Stefanie Eschenbacher in Mexico City; Devika Krishna Kumar in New York; additional reporting by Adriana Barrera and Marianna Parraga in Mexico City Editing by Marguerita Choy