Mexico signals bottom of oil price drop

Posted by Tim

November 19, 2008

Mexico Hedges All Oil Exports in ‘09 at $70 - WSJ.com.

The above article from last week at the WSJ.com (subscription required) detailed how Mexico has purchased puts against its entire 2009 oil production to guarantee an 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 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.