However, he adds, there is a significant difference between gold and most other commodities. “There is always a forward premium for gold hedging, so we have the confidence of being able to put on hedges that we know will grow in value by about 5 percent a year,” he says. “That allows us to plan for the future with a lot of certainty. In every other extractive industry, there is no such assurance.”
Despite differences between gold and gas, however, both industries find that hedging is a useful acquisition aid. Sokalsky is quick to note that hedging “is a disciplined strategy not related just to acquisitions.” However, he adds, “Our hedging program gives us additional strength to make acquisitions no matter where the gold price is.”
In 1999, Barrick acquired Sutton Resources, owner of the Bulyanhulu gold mine in Tanzania, for $280 million. “That acquisition was made with the equivalent of one year’s hedge gain,” says Sokalsky, providing Barrick with Bulyanhulu’s 10 millionounce reserve.
In fact, over the past 13 years, Barrick’s hedging strategy has earned it an average $68 over the spot price of gold, or an additional $1.8 billion in revenue. “Often people think hedging reduces the upside exposure to the commodity,” says Sokalsky, “but because the additional revenue allows us to buy more reserves, more production, and lowers our cost of capital, we think it ultimately increases our participation in higher gold prices.”
Hedging is considered primarily an acquisition strategy at Apache, notes Plank. “Generally, shareholders have not appreciated hedging,” he says. “Our approach is to leave our base unhedged, but to use hedges on acquisitions to build the company. Acquisition economics are hypersensitive in the first few years of investment, so we try to protect through a period of payout.”
Debt agencies like the strategy. And with almost $1 billion worth of acquisitions closing in the first half of 2001, Apache’s debt rating was upgraded to A-, putting it just behind oil heavyweights ExxonMobil Corp. and Chevron Corp. Likewise, Barrick has the only A credit rating in its industry. “Rating agencies see this as a very sober way to proceed with a growth strategy during this part of the [economic] cycle,” notes Plank.
Indeed, Apache has a reputation for solid financial management. Its production has grown for 24 years in a row, and its tight management of expenses earned it the top mark among oil and gas companies included in CFO’s 2000 Cost Management Survey (December 2000).
CFO Ulm says Pogo has historically grown “through the drill bit”; that is, through exploration and development of its existing asset base. The company’s acquisition of Noric was “a little bit of a departure” from that path, he admits, but “very complementary to our existing strategy.” It was the quality of the Noric assets and not the ability to hedge in a high-priced environment that was the primary impetus for Pogo’s recent acquisition, he says, “but if you can back that up with hedging on the back end, that’s a powerful combination.”
Tim Reason is a staff writer at CFO.