Citi and Deutsche Lost Some Money to Pemex for a Change

At first, this Wall Street Journal story about how some banks lost money in one corner of their energy trading operations struck me as sort of a nothing. All banks always lose money in some corner of their trading operations; they make it up in volume. But if you don't read it as a gotcha, then it's actually a nice story about what banks do and why.

The story is that every year Pemex, the Mexican state oil company, hedges its oil production by entering contracts with banks. I gather that these contracts are mainly floors (put options): Pemex is more or less guaranteed a price of at least, say, $81 a barrel;1 if it can sell its oil for more, it keeps the excess, but if it sells for less than $81, the banks make up the difference. In exchange for this floor, it pays the banks an up-front premium, $450 million in 2013.