Is hedging making a comeback?

At the end of January, Australian gold producer Northern Star Resources (ASX: NST) announced a hedge program of 100,000 oz. gold production for one year at an average gold price of A$1,462.16 (US$1,295.28) per oz., calling its decision a “prudent strategy” given the volatile gold price and the company’s $50-million revolving credit facility with Investec.

The hedge program represents forward-selling 28% of the company’s gold production forecast over the next year from its Paulsens gold mine, and from the Plutonic, East Kundana joint-venture and Kanowna Belle mines it recently acquired from Barrick Gold (TSX: ABX; NYSE: ABX).

Analysts at Macquarie Equities Research in Australia described the decision as “a common-sense and pragmatic business decision,” and explained that the company is “hedging against any unforeseen cost or production issues that may develop.” They also noted that the Plutonic mine is the highest-cost producer of all four of the company’s mines, and estimated that all-in sustaining costs at Plutonic are A$1,180 (US$1,045.33) per oz. 

Northern Star Resources isn’t the first company in recent months to unveil hedging schemes, nor is it likely to be the last. In early December, British banking giant Barclays noted in a research report that there have been signs of hedging as the margin between costs and gold prices has narrowed. According to their figures, gold cash costs have more than trebled over the last decade, while gold prices in 2013 dropped by a third.

Northern Star’s announcement followed that of OceanaGold’s (TSX: OGC; ASX: OGC; US-OTC: OGDCF) earlier in the month, when it told shareholders that because of the prolonged and sustained drop in the gold price, it  had entered into a hedging program for 208,000 oz. gold, which partly covers its Macraes open-pit and Frasers underground mines in New Zealand over the next two years. The company had already implemented a similar hedging program at its Reefton mine in June 2013, and had a prior history of hedging.

In both cases, OceanaGold entered into what is called a zero-cost collar-hedging program, where it buys put options at a specific exercise price and finances it by selling an equal number of call options. Under the hedge program at Macraes and Fraser, a series of bought-put options create a floor of NZ$1,500 (US$1,230) per oz. for 208,000 oz. gold starting in January 2014 through to December 2015. The company explained that it was financed through the sale of an equal number of sold gold call options creating a ceiling over the same period, with a strike price of NZ$1,600 (US$1,312) per oz.

“With the drop in the price of gold in 2013, the company, along with the rest of the mining sector, was faced with new economic realities and required a proactive approach to ensure a healthy business plan,” Sam Pazuki, OceanaGold’s manager of investor relations, explains in an email.  

Management reviewed its operations in detail and made adjustments to the mine schedules at Reefton and Macraes, cutting the mine life at Reefton from 2017 to mid-2015 and at Macraes from 2020 to the end of 2017. Pazuki says that the company has no intention of hedging production from its Didipio gold-copper mine in the Philippines.

“The company’s philosophy — or reasoning for hedging — is that we believe the last couple of years of mine life is the most marginal,” he continues. “We invest capital today for pre-stripping in order to mine the ore two years out. And each operation must generate sufficient risk-weighted returns in order to remain sustainable.”  

With this in mind, and the fact that management has a good understanding of its costs over two years, Pazuki says the hedge covers the company’s operating costs and sustaining capital costs, including pre-stripping, rehabilitation costs and a profit margin.

“This was a prudent, risk-management decision in a volatile gold environment,” he says. “The company does not believe in hedging to lock in a specific commodity price while not protecting the upside for assets that have a long life . . . the hedge/zero-cost collar is a prudent mechanism to ensure sustainable operations over a short [two-year] period of time for a mine that under the status quo is entering the final years of operation.” Other companies that have announced hedging strategies in the last eight months include Evolution Mining (ASX: EVN; US-OTC: CAHPF), Norton Gold Fields (ASX: NGF; US-OTC: NGLDF) and St. Barbara (ASX: SBM; US-OTC: STBMF).

In November 2013, St. Barbara, a Melbourne-based gold miner, said it had hedged some of its production (240,000 oz. gold at A$1,390 per oz.) over the next 10 months, explaining in a statement that “by protecting short-term cash margins, the company can confidently complete the planned programs of capital investment into the Pacific operations, to establish long-life, lower-cost, cash-generative operations.”

In September 2013 Evolution Mining reported that it had sold forward 156,281 oz. gold at an average price of A$1,598 per oz., with scheduled deliveries for June 30, 2016. The objective, it outlined in a press release, is “to underpin the projected returns from the Edna May gold mine and ensure that the mine not only generates sufficient cash flow to self-fund all of its near-term capital expenditure, but also provides an appropriate return on the capital commitment.” The gold hedge covers 85% of the expected gold production from the Edna May open-pit mine and less than 20% of the company’s total expected gold production for fiscal 2016.

In August 2013, Australian gold producer Norton Gold Fields said it would hedge almost 30% of its projected gold output — 50,000 oz. over one year at a flat-forward price of A$1,601.40.

But it’s not just the smaller-scale producers that are dipping their toes into the hedging pool. Last year, Petropavlovsk (LSE: POG; US-OTC: PPLKY), Russia’s second-largest gold producer, added 16 tonnes of forward sales to protect itself against volatile prices in the sector, according to the 2013 Gold Survey put out by Thomson Reuters GFMS. Petropavlovsk, formerly known as Peter Hambro Mining, produced 741,200 oz. gold in 2013 from four hard-rock gold mines in Russia’s Far Eastern Amur region.

“The recurring theme among strategic hedges has been ironing out volatility and ensuring cash flow to continue investing in operations,” Barclays comments in its research report. “That said, as prices dip further, these types of hedging programmes among small- and medium-sized producers are likely to become more attractive.”

Even Barrick, the world’s largest gold producer — which has followed a strict no-hedging policy since 2009, when it unwound its hedge book at a cost of $5.6 billion — raised the topic recently. In remarks to journalists in January, John Thornton, Barrick’s incoming chairman, admitted that hedging “made great sense.” Although it is unlikely Barrick would consider hedging again after paying so much money to unwind its previous hedges, just talking about it has helped push the topic back into the spotlight.

“Given that much of recent hedging among smaller producers is broadly defined as commodity price risk management, there has been some noticeable strategic hedging by low- and mid-tier primary gold producers seeking to limit downside market and commodity price risks,” Barclays wri
tes in its Dec. 6 research note. “A lower price environment and increased volatility increases the attractiveness of this type of hedging, especially among smaller- and medium-sized undiversified primary gold producers, as they seek protection from further price falls. Although larger producers are yet to do the same, the largest gold producers discussing the possibility of hedging marks a change in dialogue.”

When asked to clarify Barrick’s stance on hedging and Thornton’s comments, Andy Lloyd, Barrick’s vice-president of communications, told The Northern Miner that Thornton’s comments “have been somewhat misconstrued.”

Lloyd said in an email that “he didn’t say Barrick is seriously considering hedging. He said that hedging is a financial tool available to you in your business, it’s something you shouldn’t rule out automatically. But he was quick to say it doesn’t mean that Barrick would hedge. I think it was meant as more of a conceptual comment. Barrick has no plans to hedge.”

In addition to the type of strategic hedging by low- and mid-tier primary gold producers hoping to limit downside market and commodity-price risks, project finance-related hedging and by-product hedging have “also continued” and are “likely to remain attractive in a lower price environment,” the bank’s analysts say, pointing to B2Gold (TSX: BTO; NYSE-MKT: BTG) and Boliden as examples.

Boliden, which operates mines and smelters in Sweden, Finland, Norway and Ireland, established a hedge book of 177,000 oz. gold through 2017 in conjunction with its plans to expand Garpenberg, Barclays notes. In January 2011, the Stockholm-headquartered company decided to increase ore production at the Garpenberg mine from 1.4 million tonnes a year to 2.5 million tonnes a year, with full production capacity expected to be reached by the end of 2015. 

As for B2Gold, Barclays notes that the company entered into “a series of options collar contracts as part of a senior credit facility where the company’s outstanding contracts as of third-quarter 2013 were 32,000 to 57,000 oz. between 2013 and 2015.”

In terms of by-product hedging, Nyrstar sold forward 19,000 oz. gold in the third quarter of 2013 and 17,000 oz. gold in the fourth quarter as a strategic hedge, Barclays says. The Belgium-based company is primarily a producer of base metals such as copper, zinc and lead.

But few if any people believe the mining industry is on the verge of returning to the same kind and scale of hedging activity that took place during the 1990s, when according to Barclays, the global gold hedge book in 1999 reached more than 3,000 tonnes — or 20% above yearly global gold production. At the end of the second quarter of 2013, the global gold hedge book had fallen below 100 tonnes, or less than 5% of annual global gold mine production, the bank says.

“Despite our expectations for prices to remain under pressure over the next couple of years, we do not expect a large-scale hedging of the magnitude seen during the 1990s,” Barclays writes. “The scope for further de-hedging is significantly curtailed, but the current price environment has yet to prompt a return to significant levels of hedging. Of course, given the time and money invested in closing out positions, a decision to hedge again is unlikely to be taken lightly.”