The Price Risk Problem
The Problem for Miners
Market Price Risk is the risk to a company’s profitability from
fluctuations in market price of key inputs or outputs.
At is simplest, a mining company is exposed to the risk of a
falling market prices for the commodity being produced.
Equity shareholders in a mining company may welcome this
exposure to the underlying commodity, but other
stakeholders such as lending banks will be keener on
mitigating these risks to the company’s cashflow. A variety of
standard traded or customised over the counter derivative
products can be used to hedge against market price risk.
Whilst some sources of a company’s market price risk are
obvious, others may be hidden within contractual terms, so
are less clear, for example in:
• Royalties
• Permits
• Offtake agreements
• Sale agreements
• Warrants and convertibles
• Production sharing agreements
When additional risks are considered from adverse
movements in interest rates or foreign exchange,
successfully meeting the hedging expectations of all
stakeholders and managing risk from hedged positions going
forwards can pose significant danger to a mining company
focussed on delivering on the mining plan.
The Problem for Banks
Whilst mining companies may seek to manage price risk,
banks seek to profit from providing or underwriting the
instruments used to manage price risk.
This can lead to a different set of problems, as the net
position of a complex portfolio can be difficult to compute and
control, and fluctuate significantly with changes in the price
and price volatility of commodities.
Failure of system controls, local override of controls by
employees and failure to understand complex positions has
led to significant losses or in extreme cases the failure of
large financial institutions. |
