Russia set to copy Mexico’s oil price insurance policy

The Bell

During heated negotiations this spring between major oil producers, Mexico held out longest against a coordinated output cut. The reason? The country’s two-decade strategy of oil price hedging means it is largely immune to the effects of an oil price collapse. State-owned oil giant Rosneft has now recommended to President Vladimir Putin that Russia set up a similar scheme. 

  • The idea of hedging against a potential oil price fall has never been voiced in Russia — at least not publicly. But this changed very quickly. News agency Interfax cited sources Wednesday that Putin had ordered such a proposal to be looked at after a suggestion from Rosneft. The next day, the Kremlin officially confirmed the news.  
  • Both Rosneft and Kremlin economic advisor Maksim Oreshkin have calculated that, if Russia had purchased put options for two consecutive years on the same terms as Mexico, it would have made an extra $120 million in the first half of 2020.  
  • But oil sector analysts told The Bell that it wasn’t quite that simple: you need to look at more than two years worth of data to make such predictions, and there is no guarantee oil prices will fall significantly in the coming decade. Moreover, it’s possible that the option price could be more than the profit from exercising the option itself.
  • The only example Russia can follow is that of Mexico. International Monetary Fund analysts who studied Mexico’s program in 2018 concluded that, over 15 years, its options were only executed three times, and the effect was most likely positive. But the benefits were also a result of falls in the cost of raising government debt. This would not be the case for Russia, which has only a tiny external debt. 
  • The money for the program would come from Russia’s sovereign fund, the National Wealth Fund, which is currently worth $165.4 billion. This is an odd choice as the fund was created to protect Russia’s currency, its budget, and its economy from dramatic changes in commodity prices.  
  • The National Wealth Fund (NWF) is topped up with all the profits made when the oil price is above $42.40 per barrel. Last year, the amount in the NWF passed the threshold at which the government can begin spending it, and there are long-running discussions over how best to do this. The main idea has been to invest money in infrastructure projects in the hope that this will stimulate economic growth. 
  • Not everyone is happy with aping Mexico’s example. Central Bank Elvira Nabiullina said Friday that such a scheme would be “very expensive” (Russia exports far more oil than Mexico so it would be on a far bigger scale) and that this outlay is “not the best way to spend the NWF’s money” (which could, instead, be invested).  
  • The irony of the whole idea is that Rosneft, which made the proposal to Putin, was reportedly responsible for Russia’s decision to abandon its cooperation with OPEC earlier this year that led to tumbling crude prices. Perhaps if Rosneft had not been so keen to cut ties with OPEC, it’s possible there wouldn’t be any need to hedge. 

Why the world should care 

You might not be concerned about Russia’s budget, but there is a risk this proposal could destabilize global markets. The value of the recent OPEC+ deal is not so much in the output cuts, but rather fostering predictability and containing speculators. If Russia begins buying options it will almost certainly mean opportunities for insider trading and market manipulation.

Support The Bell!

The Bell's Newsletter

An inside look at the Russian economy and politics. Exclusively in your inbox every week.