Introduction
Mining and quarrying are capital-intensive activities, and many factors affect the pace of diffusion of new technologies: research and development (R&D) budgets, commodities markets and profit margins, regulatory and community requirements, the ability of firms to acquire and assimilate information, available technology options, the variability in cost structures among firms, and industry attitudes (Bartis, Latourrette & Peterson 2001). In recent years, the organization of the mining industry has changed substantially as a result of enterprise restructuring, consolidation, and globalization. Many industry representatives noted that as a buyer of goods and services, mining is relatively small in comparison with other industries, and its ability to finance R&D specific to mining is limited. As a result, many technology innovations in mining are adopted from other sectors such as construction, automobiles, and aerospace. The mining industry purchases relatively few pieces of equipment. Economic factors tend to favor risk-averse technology decisions in mining. The volatility and uncertainty inherent in commodities markets raise the perceived cost of long-term planning and investment (Bartis, Latourrette & Peterson 2001). In the mining industry two companies stand out. These two companies include Barrick Gold and Newmont Mining Company. The paper will provide background for the two companies. The paper intends to analyze how the No hedging policy has affected the company it terms of the figures in their financial statements. The paper intends to analyze the company’s derivative tools before and After the Policy was implemented.
Barrick Gold
Barrick is in gold mining exploration, development, and operations. It began operations in 1983 when it acquired an interest in two small mining companies in Alaska. By 1985, Barrick had built a small portfolio of mines and the operating capabilities needed for domestic expansion. Revenue in 1996 totaled US .3 billion it made Barrick the second-biggest gold producer in the world. With the lowest cost structure of any gold producer in North America, it also became the world’s most profitable gold mining company. Even as gold prices fell in 1997, Barrick was divesting its higher-cost mines to position itself better for continued profitable growth. Together with a sophisticated hedging strategy, this resulted in a 33 percent increase in 1998 first-quarter profits over the previous year. As 1993 approached, Barrick found its stock price discounted relative to that of other gold producers because of its exclusive focus on North America (Baghai, Coley & White 2000).
The market perceived it as having limited options for future growth. In response, the company began an international expansion program. As the market was made aware of Barrick’s growth opportunities and plans, its stock took a sharp turn upward (Baghai, Coley & White 2000). Barrick has used gold bonds that index interest to the gold price as a means of financing new mines. It has also conducted an extremely successful hedging program. Through clever financial engineering, it narrows the risk of developing new mines to operational and geological uncertainties (Baghai, Coley & White 2000). Barrick Gold is considered to be the largest pure gold mining company in the world. Its success can be derived from the company’s use of management, human resource and financial strategies. The figure will illustrate the financial statements of the company.
Consolidated Balance Sheet of Barrick Gold Corporation
At December 31 (In millions of US dollars)
2007 2006
Assets
Current Assets
Cash and equivalents ,207 ,043
Accounts receivable 256 234
Inventories 1,118 931
Other current assets 707 588
4,288 4,796
Non-current assets
Investments 142 646
Equity method investments 1,074 327
Property, plant and equipment 8,596 8,390
Intangible assets 68 75
Goodwill 5,847 5,855
Other assets 1,936 1,421
Total assets ,951 ,510
Liabilities and Shareholders’ Equity
Current liabilities
Accounts payable 8 6
Short-term debt 233 863
Other current liabilities 255 303
1,296 1,852
Non-current liabilities
Long-term debt 3,153 3,244
Asset retirement obligations 892 843
Deferred income tax liabilities 841 798
Other liabilities 431 518
Total liabilities 6,613 7,255
Non-controlling interests 82 56
Shareholders’ equity
Capital stock 13,273 13,106
Retained earnings 1,832 974
Accumulated other comprehensive income 151 119
Total shareholders’ equity 15,256 14,199
Total liabilities and shareholders’ equity $ 21,951 ,510
*From http://www.barrick.com/Theme/Barrick/files/docs_annual/2007
Newmont Mining Company
The Newmont Mining Corporation engaged in many transactions so that it can gain its current standing in the industry. It outbid the rival Homestake Mining Company and it agreed to acquire the Santa Fe Pacific Gold Corporation for .43 billion, and similar takeover efforts are made in other gold industries (Gianaris 1998). To break up the merger agreement between Santa Fe and the Homestate Mining Company, the Newmont Mining Corporation based in Denver raised its offer for the Santa Fe Pacific Gold Corporation from .04 billion to .15 billion. If the acquisition is completed, Newmont, with an annual production of about 3.5 million ounces of gold and exploration projects in the former Soviet Union, will be the second-largest mining company in the world, after the Barrick Gold Corporation of Canada (Gianaris 1998). The Colorado-based Newmont Mining Company have established a roughly million joint venture with the Navoi Mining and Metallurgical Combine and the State Committee for Geology and Mineral Resources of Uzbekistan to produce gold at the Muruntau mine near Zarafshan. The venture was expected to cost 0 million in start-up costs; it started producing in 1994, and it yielded an output of about 270,000 ounces of gold per year (Pryde1995). Newmont Mining Corporation is one the largest gold producing companies. The company has active mines in Nevada, Australia, Indonesia, New Zealand, Ghana and Peru. The company makes sure that it has the highest standards for environmental protection and work safety. The next figure will illustrate the financial statement of Newmont. This was taken from www.newmont.com/en/investor/releases/media/newmont/2007.
Consolidated Balance Sheet of Newmont Mining Corporation
At December 31 (In millions of US dollars)
2007 2006
Assets
Cash and equivalents $1,231 ,166
Marketable securities and other short-term investments 61 109
Trade receivables 177 142
Accounts receivable 168 206
Inventories 463 376
Stockpiles and ore on leach pads 373 377
Deferred income tax assets 112 156
Other current assets 87 93
Total Current Assets 2,672 2,625
Property, plant and mine development, net 9,140 6,544
Investments 1,527 1,319
Long-term stockpiles and ore on leach pads 788 812
Deferred income tax assets 1,027 793
Other long-term assets 234 178
Goodwill 186 1,338
Assets of operations held for sale 24 1,992
Total assets $15,598 ,601
Liabilities and Shareholders’ Equity
Current portion of long-term debt 5 9
Accounts payable 339 340
Employee-related benefits 153 182
Derivative instruments 3 174
Income and mining taxes 88 337
Other current liabilities 662 515
Total Current liabilities 1,500 1,707
Non-current liabilities
Long-term debt 2,683 1,752
Reclamation and remediation liabilities 623 521
Deferred income tax liabilities 1,025 626
Employee-related benefits 226 309
Other long-term liabilities 150 135
Liabilities of operations held for sale 394 116
Total liabilities 6,601 5,166
Commitments and contingencies
Minority interest in subsidiaries 1,449 1,098
Shareholders’ equity
Common stock 696 677
Additional paid-in capital 6,696 6,703
Accumulated other comprehensive income 957 673
Retained (deficit) earnings (801) 1,284
Total shareholders’ equity 7,548 9,337
Total liabilities and shareholders’ equity ,598 ,601
Non Hedging and its effects
The principle behind the modern theory of pricing and hedging of derivatives or contingent claims is as follows. The future payoff to a claim, such as an option on a stock, will in general depend on the price paths of one or more basic securities. Using those basic securities, one can try to construct a trading strategy which replicates the payoff in the sense that in every possible future scenario, its value at the time of maturity of the claim will equal the payoff to the claim. The trading strategy should be self-financing and satisfy an admissibility condition which is imposed in order to rule out the possibility of arbitrage. If such a replicating trading strategy can be found, then the current price of the claim will be equal to the initial amount of money needed to start off the trading strategy. It turns out that if the claim can be replicated like this, then its discounted value is a martingale under the so-called risk-adjusted probabilities (Nielsen 1999). Hence, its present value can be calculated as the conditional expectation of the future payoff discounted back to the present. This valuation procedure is called the martingale method or the martingale valuation principle (Nielsen 1999).
In many cases, the conditional expectation can be calculated fairly explicitly, because we know the probability distributions that are involved. For example, the payoff is often a function of a random variable which is known to be normally distributed under the risk-adjusted probabilities. A variant of the martingale method uses the so-called state prices or pricing kernel. If the claim can be replicated, then its value multiplied by the state prices is a martingale, not under the risk-adjusted but under the original probabilities. Again, the claim can be valued by calculating a conditional expectation. The surprising and powerful complete markets theorem says that in a wide range of situations, every contingent claim can be replicated by a trading strategy, and therefore it can be priced by the martingale method (Nielsen 1999). Barrick Gold‘s balance sheet illustrated above was highly valued. This helped the company to have its gold stock be sought by individuals. Barrick was not keen in using the no hedging policy, hedging helped Barrick increase its revenue even if the price of gold reduced in some instances. The next figure compares how the price of gold is affected by hedging.
Barrick gold used the no hedging policy to take some risks in their investments. This policy did not prove to be useful for the company since the amount of investment for the company decreased. On the other hand the no hedging policy helped the company increase the value of its capital stock and it gave the company higher retained earnings. Before the policy was adopted the company the company had 6 million worth of investments after the policy was adopted the investments lowered to $ 142 million. This shows that the risk taken by the company did not work for the benefit of the company.
Newmont Mining Corporation initiated the no hedging policy because they believe that hedging and other financial instruments are used by some commodity producers to protect themselves. The company wants to use the no hedging policy to provide to investors a maximum flow through to the gold price. The company believes that the policy will be premised on a belief in gold’s long-term value. Newmont Mining Corporation used the no hedging policy to maintain the financial status of the company. This policy proves to be unwanted for the company since the use of the policy did not help the company improve its financial status. Although the worth of investment for the company improved its other financial status did not increase. Before the policy was adopted the investment for the company was worth $ 1,319 million after the policy was implement it increased to ,527 million. This shows that the risk taken by the company after the implementation of the risk was helpful in increasing the worth of the investments of the mining firm.
Derivatives tools before and after the policy
Derivatives embody the synergy of credit risk and market risk better than any other instrument. While regulation and supervision of off-balance-sheet activities differs significantly from one country to another and in some countries it does not exist at all this and similar examples suggest that since the mid-1990s regulators have appreciated both the amount of exposure businesses take with derivatives and the synergy existing between the types of risk (Chorafas 2000). Many people consider that the information about derivatives exposure presently supplied in the published accounts of financial institutions is generally insufficient to give counterparties, shareholders and depositors a reasonable picture of the bank’s health. In matters of public information, particular emphasis must be placed on leveraging through derivatives and other off-balance-sheet financing, with accurate real-time data made available for oversight (Chorafas 2000).
Other reasons which can mean that actual results deviate from those projected are interest rate volatility and other capital market conditions, including significant changes in foreign currency rates. When these factors have been accounted for, what really counts is management’s efficiency or inefficiency (Chorafas 2000). Derivatives cannot exist without the underlying cash market. Companies issue equity when their price/earnings ratio is high and bonds when interest rates are low. Banks prefer fee-earning business when regulators enforce higher capital ratios for conventional lending. And so on. Derivatives are a reasonably coherent group but organizationally divided between exchanges and over-the-counter (OTC). An investor can hedge against the fluctuation with the help of derivatives (Laulajainen 2003). Barrick Gold uses derivative instruments to reduce significant but unanticipated earnings which in turn may arise from volatility in commodity prices. The next figure shows the derivative assets and liabilities of the company.
Derivative Assets and Liabilities
2007 2006
At January 1 8 4
Acquired with Placer Dome – (1,707)
Derivatives cash (inflow) outflow
Operating activities (309) (184)
Financing activities 197 1,840
Investing activities 23 –
Change in fair value of:
Non-hedge derivatives 33 (3)
Cash flow hedges
Effective portion 257 17
Ineffective portion 9 3
Share purchase warrants (1) –
Fair value hedges 2 8
At December 31 9 8
Classification:
Other current assets 4 1
Other assets 220 209
Other current liabilities (100) (82)
Other long-term obligations (65) (150)
9 8
For derivatives, when the fair value is positive, this creates credit risk. When the fair value of a derivative is negative, the company assumes no credit risk. In cases where the company has a legally enforceable master netting agreement with a counterparty, credit risk exposure represents the net amount of the positive and negative fair values for similar types of derivatives (www.barrick.com). Before the policy the derivative tools of Barrick had lower values than after the implementation of the policy. The policy helped in improving the value of the derivative tool of Barrick Gold Corporation. The derivative tools of Barrick Gold Corporation are doing well and contribute to the good standing of the company. The derivative tools of Barrick Gold showed decreases on aspects that includes operating activities, financial activities and fair value hedges. Other aspects in the derivative tool information improved after the policy was used.
According to www.newmont.com, all financial instruments that meet the definition of a derivative are recorded on the balance sheet at fair market value. Changes in the fair market value of derivatives recorded on the balance sheet are recorded in the statements of consolidated (loss) income, except for the effective portion of the change in fair market value of derivatives that are designated as a cash flow hedge and qualify for cash flow hedge accounting. The company’s portfolio of derivatives includes various complex instruments. Management applies significant judgment in estimating the fair value of instruments that are highly sensitive to assumptions regarding commodity prices, market volatilities, foreign currency exchange rates and interest rates. Variations in these factors could materially affect amounts credited or charged to earnings to reflect the changes in fair market value of derivatives (www.newmont.com) In addition, certain derivative contracts are accounted for as cash flow hedges, whereby the effective portion of changes in fair market value of these instruments are deferred in Accumulated other comprehensive income and will be recognized in the statements of consolidated operations when the underlying production designated as the hedged item impacts earnings. All derivative contracts qualifying for hedge accounting are designated against the applicable portion of future foreign currency expenditures or future production from proven and probable reserves, where management believes the forecasted transaction is probable of occurring. To the extent that management determines that such future foreign expenditures or production are no longer probable of occurring, gains and losses deferred in Accumulated other comprehensive income would be reclassified to the statements of consolidated (loss) income immediately (www.newmont.com) The derivative tool of Newmont Mining Corporation has decreased after the policy has been implemented. The derivative instrument’s worth dropped in a huge way. This did not contribute in improving the financial standing of the company. The worth of the derivative instrument was affected by the financial situation of the firm. This shows that use of derivative tool has different effects on a business and its effects vary depending on the financial status of the company.
What company is more hedged?
. Barrick Gold Corporation was more hedged. The company had a better standing and its risks were minimized. Although some of the risk taken did not create positive results, it assisted in changing the financial strategies that the company used to gain a better standing. Barrick gold was able to make use of the minimal risk to make sure that their company will have good financial standing. Barrick Gold Corporation has more revenue than the less hedged company. This adds to the benefits of the policy to Barrick Gold and its financial status. Newmont Mining Corporation used the no hedging policy to maintain the financial status of the company. This policy proves to be unwanted for the company since the use of the policy did not help the company improve its financial status. Although the worth of investment for the company improved its other financial status did not increase. The company was not able to take advantage of the improvements in the aspect of the company’s investment in making a better financial status. Newmont’s financial status had a lower value in most of its aspects after the policy was introduced. It shows that the company needs the hedging process more to improve its situation.
References
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Credit:ivythesis.typepad.com
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