Limiting risks to keep a mining business viable

Having been engaged by our client to oversee execution of a sizeable gold hedge, we had concerns that their hedging approach didn’t go far enough in protecting their other commodity exposures. As a base metals producer with gold credits, their financing group required the substantial gold hedge to underwrite the revenue for their debt repayments for the project.

After looking at the revenue model, we were concerned that failure to hedge the primary product could leave the whole business vulnerable to a worst case scenario – base metal price falling and gold prices rising. Even if the mine became unviable under these circumstances, the proposed hedging arrangement would require our client to continue operating to honour their commitment to deliver gold.

A holistic approach to managing exposure

To manage this risk, Noah’s Rule suggested a new approach, combining reduced production commitments, a later starting period and a larger notional value of gold put options. Although this strategy would still meet the finance syndicate’s revenue protection requirement, they weren’t in favour of the changes initially. Documentation was ready to go and they would be accepting a lower overall return on the deal by replacing forwards with options. Noah’s Rule led the way with commercial negotiations to achieve acceptable returns and security of finance for the banks, and reduce the future commitments and risks for the mining business.

The original goal of the new approach was to reduce our client’s gold delivery commitment and the associated risks. However, gold prices did rise in the subsequent year and by the time the mine opened, the modified hedging was $15 million less out of the money than the initial strategy proposed by the banks. This outcome represents a substantial benefit to the client’s bottom line across a number of years.