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Message: Interesting article on Barricks hedge book - incredible
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Barrick’s Hedges; WTF-S! |
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For those taking offense to the title it refers to an article which has stuck with me penned by the brilliant Antal E. Fekete, Professor Emeritus at Memorial University of Newfoundland. The following paragraph clarifies the title and may shock some as to how Barrick got their name. “At an early brain-storming session, as described in the authorized biography of Munk, the question was raised how to name the fledgling company. Munk, who was obsessed with big and quick success had no patience with such trivial details, exclaimed: ‘Call it Baszik, Szarik, Barrick, as you will; I couldn't care less’. The name Barrick stuck. Knowledge of the Hungarian language helps the etymologist. The first two words’ English equivalents are ‘f...ck’ and ‘sh...t’. In Hungarian four-letter words have six letters to sport and, as verbs, they are also distinguished by their ‘-ik’ ending, forming a special conjugation class of their own.” The full article can be found here and is titled “TO BARRICK OR TO BE BARRICKED, THAT IS THE QUESTION”. I was baffled recently by a Mineweb article found here mentioning closing of hedges and Barrick’s conversion from fixed-hedges to floating-hedges. I had never heard of this before as fixed and floating usually refers to interest rates. The following is an email exchange between myself and Susan Muir, Senior Director of Investor Relations. Good Day, I am seeking clarification on a recent Mineweb article linked here where they state; “Barrick converted 1.1m ounces of fixed-rate contracts to floating-rate contracts” Could you explain exactly what this means, as from my understanding fixed and floating refer to interest rates only. Best Regards, Warren Bevan www.preciousmetalstockreview.com Dear Mr. Bevan,
In response to your email to Joyce Davies, the following is an explanation of the floating price mechanism as it applies to our project hedge book of 9.5 million ounces. I trust this should provide sufficient clarity on your question.
Barrick has positioned a portion of the project gold sales book at floating prices to participate in higher spot gold prices. We also have the option to convert the floating price contracts back to fixed price contracts and ‘lock-in’ the value generated from taking advantage of certain movements in the gold price.
When we reset a fixed contract price to a floating price contract, we regain leverage to market gold prices. Future increases and decreases in market gold prices directly impact the final contract price. As at March 31, 2008, our total project book of 9.5 million ounces includes 2.84 million ounces of floating price contracts. To date, the floating price contracts have improved the average break-even price of our project gold sales contracts. Fixed Price Contract Example: Consider a fixed project gold sales contract with a break-even price of $350/oz. Assume a contango (US LIBOR minus the gold lease rate) of 2% per year and a one year period. In this example, contango would improve the fixed price to ~$357/oz at the end of one year. Floating Price Contract Example: Rising Spot Price Under this scenario, we have the opportunity to improve the price of the contract (assuming the gold price appreciates at a rate greater than contango) and participate in higher gold prices, by converting a fixed price contract to a floating price contract. Assume a spot price of $850/oz at the time of conversion. As shown in the example, if gold prices were to appreciate from $850/oz to $950/oz, the floating contract price would improve to ~$450/oz from $350/oz. When we convert to a floating price contract, we ‘lock-in’ the loss of $500/oz on the original fixed price ($850-$350) and, thereafter, are leveraged to rising spot prices.
We then have the option to leave it as a floating price contract or, at any time, reset the floating price to a fixed price. Under this option, the ~$100/oz benefit in our example, gained from the increase in the spot price to $950/oz, would be ‘locked-in’ to the contract and immune to further movement in the spot price. Falling Spot Price Should the spot gold price decline $100/oz to $750/oz, the floating contract price would be ~$250/oz on the ‘locked-in’ loss of $500/oz ($750-$500). Again, we have the option to leave the contract at a floating price or reset to a fixed price at any time. Susan Muir
The response came back in under five minutes which is highly suspect of a form type response. I guess this question has been asked before and they have had a response drafted. I quickly analysed the response and dug deeper hoping to stay on good terms and possibly get the truth or some clues to the true nature of their hedge position. Dear Susan, May I call you that? First I must compliment you on your quick, detailed and candid response, thank you. However a few questions have arisen. First, I understand most if not all of your 9.5 million hedge is on Pascua Lama, am I right to imply the 2.84 million ounce floating rate hedge is all on that project which hopefully will, but may or may not come to fruition? Secondly, may I inquire as to who you hold the contract with? Why would they give you the chance to raise your hedge price when such an obvious bull market exists? Is it your choice when to convert back to fixed? Or if price falls can the counterparty call you and set it at fixed? Is there a penalty or fee of any kind when converting to/from fixed/floating? Thirdly, you said; “We then have the option to leave it as a floating price contract or, at any time, reset the floating price to a fixed price. Under this option, the ~$100/oz benefit in our example, gained from the increase in the spot price to $950/oz, would be ‘locked-in’ to the contract and immune to further movement in the spot price.” So under this scenario you would be able to in effect raise your fixed rate hedge after floating from $350 to $450. There must be some kind of incentive for the counterparty here, what is it? Lastly, why is this the first time I have heard of this hedge structure? When did you implement this floating contract? Why don’t other companies do this, are they offered this option I wonder? Most importantly, I realize Barrick is bullish on Gold, so why not just buy the hedges back outright? Or, at least a portion of the hedge. I realize you have been to some degree but it seems now stagnant at the 9.5 million ounces, and I have heard company personnel claim “hedge free” status, can you clarify? Best Regards, Warren Bevan www.preciousmetalstockreview.com The project hedge book is completely fungible, meaning it can be allocated to any of the projects in our pipeline and is not dedicated to or locked into Pascua-Lama. We have about 18 counterparties - none have more than 10% of our business. It is our choice when or if to re-fix the floating price contract, not the counterparties' choice. There is an interest rate differential cost to these transactions which is good business for the counterparties but notional to us relative to the opportunity to improve the contract price, which occurs on re-fixing as per your 3rd point. Susan Muir
The response above took about half-hour and was much curter since the original response to my inquiry did not satisfy. Now some actual work and analysis may be required on her part and I got the feeling to leave it alone as they do not have any interest in talking about their hedge book in any depth. The fact that the hedge payback can be applied to any project is also highly suspect as hedges are usually written specific to a project and it’s financing. As much written about by Jim Sinclair, to look for recourse loans on a project rather than non-recourse, I wonder if Barrick could actually stick some of the hedge to any joint venture partners as would happen on a recourse loan basis. Very good, It sounds like reasonable business practice and security although I would, rather see you un-hedged completely. Any comments? It sounds like you are hedged. Why doesn’t your company state it openly? Do you plan on converting more hedges to floating? Or will you play it by ear/POG? Just out of curiosity your roughly 18 counter parties, I assume they are all financial institutions but would any possibly be a private individual entity or any form of official (ie. Governmental) type of designation? I wonder if the Gold price rises as much as I believe, will the counterparties be too pleased to honour their contracts? As you can tell I am very sceptical of hedges especially when they were put on near the beginning of a major bull market in Gold. I assume you all regret this decision, so why not suck it up and buy them back? As well are there any timelines to your hedge book? Or can they run to infinitum? Is this a new type of financial instrument or derivative? Thanks for your clarity. Best Regards, Warren Bevan www.preciousmetalstockreview.com We disclose/restate the fact that we have 9.5 M oz of project-related hedged ounces each quarter with our results and provide detail on the level of floating price contracts as well as the fair value of the book in the MD&A. However, it is important to understand that we are not under any obligation to deliver into the these contracts as their spot deferred nature (with approx 10 year tenors; only Barrick has these sorts of flexible terms because of our A rated balance sheet) enables the Company to roll forward and reset them each year at our discretion. As noted, we are working at improving the average price of the book with the floating contracts and have had some good success thus far. We intend to use project financing for some of our larger projects to mitigate risk and the existing book is expected to optimize terms for this debt. Re additional conversions to floating contracts, we have stated that we are taking advantage of market volatility to capture some additional upside leverage so yes, this is a possibility. Counterparties are all financial institutions and they do not have an issue with allowing us to continue rolling the contracts forward. The buyback question is really a capital allocation issue - we spent ~$3B in cash last year to acquire ~25 million ounces to sustain the company into the future (vs. the -$5B mark to market on the 9.5 M hedged oz). I trust this answers the remainder of your questions. Susan Muir After a day and a short prompt email I received the above response. So it is because of their A rating that they alone can take advantage of this type of hedge structure that seems too good to be true. I wonder as other companies become A rated if they will be offered this deal. The hedges can run forever and never have to be delivered. Now I see why the company refers to themselves in presentations as un-hedged. The hedge can run forever and eventually, when the price of Gold runs high enough they will return to a fixed rate. I imagine this will happen just as Gold crests the far off blow-off peak. Once they fix the rate at say $2,500 and the Gold price comes off to say $2,000, they will be able to sell at a premium to spot making the hedges look genius. Now I understand why they have such a large hedge position, it’s not really a hedge until they fix it again. A quick look through their director’s biographies and connections quickly reveals the depth of their contacts. I have no doubt this was planned years in advance knowing they would acquire an A rating and then create this type of hedge in order to profit massively one day when spot Gold peaks. Initially others followed suit putting on hedges and now are covering. It seems that companies should have not followed Barrick’s lead in the beginning but now they should. The fact that Barrick is first to A rating while others are covering their hedges before that day, reeks of corruption and insider information. To any companies out there with hedges remaining, hang on to them and do as Barrick has done. Shareholders will be richly rewarded and you will look brilliant. And any company soon to be in production please go and see about a floating-rate hedge, it will save the day. It’s a sad day that I admit Barrick has it right, but today is that day. Any company which follows Barrick’s unique model will reap the rewards. Sincerely, Warren Bevan |
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