Mexico’s new ‘C’ for commodity banker

Posted by Izabella Kaminska on Dec 10 09:35.

Mexican Finance Minister Agustin Carstens — the man who netted Mexico a profit of more than $5bn by shrewdly hedging 2009 oil output at $70 per barrel — has been nominated by Mexico’s president Felipe Calderón on Wednesday to head the country’s central bank, Banxico.
According to RBC Capital Markets, that move should be welcomed by the market as Carstens has proved himself more than capable for the position. Nevertheless, the tougher job is still that of finance minister — meaning it might have made more sense to have left Carstens in his old position, according to the RBC analysts.
As they noted earlier this week:Our view is that the tougher job is the FinMin post, so Carstens should stay there (he seems the most capable), with Ortiz or Garcia Tames heading up Banxico; this is the base-case, in either variation, signalling that President Calderon has listened to the most important economic stakeholders (industry, financial markets, congressional leaders, etc.) in Mexico. A second-best option is Alonso Garcia Tames at the MinFin, with either Carstens or Ortiz at Banxico. Ernesto Cordero (Secretary of Social Development in the current government) assigned to the FinMin would be the least-favoured option in our mind (15% probability), and should be read as Calderon looking for a yes-man at Hacienda, and it would make negotiations on structural reforms with Congress harder.
On Wednesday, however, it transpired that RBC’s least desired candidate for Finance Minister, Ernesto Cordero, was named by Calderon as the country’s finance minister.
This is a touch painful because Mexico’s S&P BBB+ rating very much depends on the success of tax reforms passed this year. Cordero, meanwhile, is seen by many analysts as a `yes man’ unlikely to move Mexico away from its over-dependence on oil revenues in the short term.
S&P lowered Mexico’s outlook to negative in May precisely because of concerns that declining oil revenue and tax collection could swell the country’s budget deficit. Fitch, meanwhile, delivered a rating downgrade to BBB in November based on structural weakness in the country’s fiscal accounts.
As BNP Paribas wrote on the matter earlier this week:
The combination of the structural decline in oil production and the worse than expected fall in economic activity and tax revenues generated a financing gap for the government of more than 4% of GDP in 2009. The government was able to lean on its successful oil price hedge, the transfer of unrealized CB profits, its existing oil stabilization funds and budget cuts to make ends meet.For 2010, however, with the government still expecting a large 3.0% of GDP shortfall and with many of those extraordinary revenues either depleted or non-applicable, the administration has been forced to push through a tax reform in the midst of one of the worst recessions in Mexico’s history.Much has been written about this recently approved tax reform, and clearly, it was not enough to impress one of the rating agencies. Fitch delivered the first rating downgrade by any agency in the last 14 years with a one-notch move to BBB, citing the structural weakness in the fiscal accounts as the key reason behind the decision (S&P maintains its BBB+ rating on negative outlook while Moody’s recently affirmed its Baa1 rating with stable outlook).
In other words, putting too much faith in oil hedging isn’t necessarily a wise strategy. Not that that has stopped Mexico from putting on more hedges.
As the FT reported on Wednesday, Mexico has taken out a $1bn insurance policy against oil prices falling below $57 a barrel next year, a sign it believes the world is still at risk of a double-dip recession.
The hedge, however, goes against expectations from institutions like Goldman Sachs who see prices rising to as much as $92 per barrel next year.
The following chart from BNP Paribas, however, might explain some of the strategy. It suggests at $75 per barrel, oil prices would generate substantial extra revenues for the government, which has actually budgeted for $60 per barrel prices in 2010:
In other words, why not play it safe? While it would lose out on additional revenues if prices went above $90 per barrel, that’s not half as costly to the country as prices going substantially below $60.

Related links:Mexico buys $1bn insurance policy against falling oil prices - FT
Oil sector watches Mexican strategy for pricing clues - FT