Hedging survey shows high derivatives usage

A survey prepared by Price Waterhouse shows that mining companies make significant use of derivatives to create positions in the commodities of their primary and co-products.

A total of 41 North American precious and base metal producers participated in the study, along with three industry analysts. Of the 41 mining companies, 36 are currently active in metals price hedging.

The main objective of the companies is to maintain minimum price protection and participation at higher prices. Only a small percentage were required by financial institutions to hedge price risk, and even those companies said they would conduct a hedging program, regardless of the requirements.

The more predominant instruments represented in the survey are forward sales contracts and purchased put options. However, 23 respondents write option contracts and 18 enter into forward purchases and long futures contracts. The survey showed that the use of options with exotic features is minimal.

The survey also showed that a large majority of producers regularly close out and settle their hedge contracts, rather than let them roll forward. Nearly half of the precious metals producers maintained long-term forward sales contracts, compared with only a few base-metal producers.

Gold was the predominant metal hedged, followed by copper, silver, zinc and lead. The survey showed that four of the producers hedged less than 5% of their anticipated 5-year production, and four hedged more than 60%. Eight producers hedged between 11% and 20%, while seven hedged 21-30% of their anticipated 5-year production. Most described their hedging strategy as moderate, relative to their production profile and reserve position.

The typical term of the forward sales contract was 6-12 months (14 producers) and 1-3 years (15 producers) for precious metals. Base metal producers opted for shorter terms, typically fewer than six months (six producers) and 6-12 months (seven producers).

The survey also focused on accounting issues related to metals hedging and the use of derivatives.