Mexico Could Tap More Oil, Store It as Loan Collateral

There is no end of suggestions about how to help Mexico solve its financial crisis. Some of the proposals are tied to Mexican oil, and somehow involve paying a price that is above the world market price.

But why distort energy markets by paying such a hidden subsidy? It wouldbe better to discuss a direct subsidy for Mexican debt relief--one that Congress could vote either up or down.

Pressuring Mexico to sell more oil in order to increase its revenues would also be the wrong approach. First of all, the decision concerning how much oil to produce is Mexico’s alone--the wise management of its patrimony is the prerogative of any sovereign state. And increasing its output of oil during the prevailing glut might depress the world price further and therefore might not be in Mexico’s economic and political interest. Even if the price were not affected, it might pay Mexico to postpone the sale of much of its oil until a later date--after the world price has recovered.

Mexico’s problem is not a lack of natural resources or a lack of wealth, but a lack of cash flow. This mode of thinking suggests a possible solution. Let Mexico lift its oil, but store part of it and use it as collateral for bank loans. This plan would allow the country to produce as much oil as it wanted to without further depressing the current world price. Instead, the oil could be sold when prices are again rising.

The proposal makes economic sense when it is viewed as a speculation by Mexico on its own oil--essentially buying low and selling high, but with cash flow maintained by loans during periods of reduced oil sales. The amortized cost of lifting and storing a barrel of oil should not exceed 50 cents per year, and could be as low as 20 cents if the oil is stored in underground caverns. Mexico could therefore make substantial profits, even if the world price does not quite reach the $30 level predicted for 1995.

If Mexico were to adopt the storage scheme, it could make even greater profits by selling on price peaks. Such peaks are almost certain to occur from time to time, considering the unstable political situation in the Persian Gulf area. Alternatively, Mexico could sell options against its oil, thereby assuring additional profits in case there are no price peaks. Options could have durations of, say, half a year to several years, and bring prices of, say, $25 to $40 a barrel. So, instead of selling oil today at $10 a barrel, Mexico might be able to borrow $10 and then garner as much as $40 per barrel, partly by selling options over, say, the next 10 years.

This operation, while profitable for Mexico, would make sense for the United States, too. It would bring about a more stable and predictable world oil price as Mexico withheld oil during price collapses and sold off during price peaks. A stable price, increasing from $20 to $30 over the next 10 years, would preserve the investment of U.S. producers of oil, gas and coal as well as the conservation investment that industries and householders made when oil prices were high. Oil conservation also leads to lower oil consumption, reduced oil imports and improved national security. And if a higher price could be established now, it would inevitably mean lower prices in the 1990s and beyond.

Further, the price stabilization that would be achieved if Mexico should undertake such a storage operation would also make moot a U.S. tariff on imported oil--in particular, a variable import fee designed to provide a domestic price floor of $20 would automatically be phased out if the world price should stay above $20. But all of the benefits of a more stable price would be preserved; not only oil companies but also all other industries could make their business plans with greater certainty. In particular, oil development--both onshore and offshore--would again resume, although not at the high level of the early 1980s.

Other oil-exporting countries could join with Mexico or carry out independent storage operations. Norway, in fact, has announced its intention to put 10% of its oil into its strategic reserve instead of selling it on the world market. Of course, U.S. domestic producers could also withhold some oil from sale now in order to profit from a higher price later--as indeed some gas producers are now doing. But, because of their higher production cost, their economics may not be favorable.

Had an oil producer like Saudi Arabia adopted a storage scheme in the mid-1970s, it could have forced a moderation of the 1979-80 price increase, which took oil from $12 to $36 a barrel. Without that increase there would have been no subsequent glut and price collapse. The world would have spared itself this roller-coaster experience on oil prices and much needless investment in expensive oil and gas, synthetic fuels and alternative energy sources.