Wellcome back Terry. Guess you have read the excellent and informative posts from 'timboucto' who has clarified for us all on this thread the potential of PGD & MDN and especially the Tulawaka play.
On Ashanti since several of us are 'talking ' about thier
JV properites with PGd thought I would post a interesting read on Ashanti that was just posted on the Ashanti Thread.
<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<To: Kai Peter Joens who wrote (250)
From: Ram Rao Saturday, Oct 30 1999 6:31PM ET
Reply # of 251
This long Article by Ashanti is a well worth reading, not only because it exquisitely explains the plight of ASL but because of the underlying merit in its teachings of the value, risks, and general teachings of hedging.
Ashanti explains gold hedging crisis
Introduction
Ashanti Goldfields Company Limited ( "AGC" or "the Group" ) has noted the public concern on recent developments which have resulted from the effect of the sudden increase in the gold price on the hedge book of the Group. As a result, the employees of the Company and its many subsidiaries have been requested through a number of telephone calls and personal enquiries for updates. The following is a formal attempt to answer the key issues involved in the recent developments.
What is the current state of the AGC mines?
We must first of all establish the fact that our six mines in Ghana, Guinea and Zimbabwe are all operating strongly and that the Group is on track to attain its production targets and improved cash costs by the end of the year. At our Obuasi mine, steps have been taken by management to reduce the negative impact of the recent strike on production and costs. A major life of mine plan which has just been completed, should make the mine a profitable concern in about two years, to reverse the trend of losses which last year alone amounted to over $26 million.
Our mine at Iduapriem, known as the Ghanaian-Australian Goldfields, of which Ashanti has 80% ownership, was scheduled for closure at the end of this year. With persistent cost-cutting and other operational initiatives, the mine has remarkably turned the corner sufficiently enough for an extension of the mine life for a further 18 months.
Bibiani mine is on track to attain its production and cash cost targets in much the same way as our Siguiri mine in Guinea and the Freda-Rebecca mine in Zimbabwe. Recently, we reported the effects of record rainfall, which seriously diluted our solutions for processing gold at our Siguiri mine in Guinea. Production has since been stepped up and the planned expansion of that mine will be completed by the end of this year as scheduled.
In Tanzania, the Geita mine which is currently under construction, is to commence the annual production of over 500,000 ounces of gold by the third quarter of next year. This is going to be the sixth mine to be added to the Obuasi mine, since the flotation of the Company in May 1994. Thus, on the basis of the 62% of our unhedged reserves, and the successful geographical diversification of its gold production from one site to seven sites in four countries, fundamentally, Ashanti Goldfields is in a much stronger position. With the improved gold price, these operations are even more robust.
The falling gold price and the recent rally
The current challenges faced by the Company are therefore, simply stated, the results of the effect of the sudden rise in the spot price of gold on Ashanti's hedge book and not a function of production inefficiencies within the group. It is also noteworthy that the Company has never defaulted on its obligations relating to the corporate debt of US$440 million which resulted from the cost of corporate growth explained above.
The rise in gold prices from its lows of US$250 to the current US$300 per ounce, makes Ashanti Goldfields a much stronger company for the long-term and a more valuable asset to all its shareholders.
The Objectives of AGC?s Hedging programme
AGC started its hedging programme eight years ago when the trend in the gold markets indicated a steady decline in the gold price. In order to modernise, expand and build a world-class company into an attractive portfolio for the potential investor, the management of Ashanti had to explore avenues to minimise the effects of a declining gold price. In the prevailing uncertainties, the hedging programme was structured to achieve the following objectives:
to guarantee a minimum price for future production of gold and allow at the same time, shareholders to participate in potential increases in the gold price
to guarantee debt servicing obligations, which were contracted to modernise and expand the existing mines to guarantee minimum future cash-flows to support capital expenditure commitments
to provide, as much as possible, job security for the Company's employees to ensure additional resources for the future growth of Ashanti
to provide additional income to make for a decent return on shareholders' investments.
Drivers for AGC?s hedging policies
Ashanti's gold hedging policy over the last three years has been driven by two aims:
To protect the Company's cash flows so that it can meet its commitments in respect of operating costs, capital expenditure and debt service.
To conduct the hedging policy in a way such that the Company can benefit from the normal increases in the price of gold.
Generally, the gold price has been declining steadily over the last six to seven years and this has prompted the Company to hedge a percentage of its reserves in order to sustain its modernisation and growth programmes. The quantity of reserves hedged by Ashanti, currently quoted at 38% of reserves, is within the industry norms as shown in the graph below.
Note: This information has been obtained from external sources
The remaining 62% which is unhedged, has benefited from the recent increases in the gold price and has accordingly brightened the future of the group as a world-class gold producer.
What is hedging?
Hedging is defined as a strategy to protect a company's revenue against uncertainties due to fluctuations in market prices. Virtually every gold producer has established a gold price risk management programme and a Board-approved hedging policy, which involves entering into contracts with banks or counter-parties to deliver gold on certain future dates and at agreed prices. These agreed prices are usually higher than the spot gold price, or the price which could otherwise be obtained on the gold market. This assures for the company in question a predictable flow of usually higher income despite falling or volatile gold prices. The decline in the gold price over the last fifteen to twenty years has highlighted the advantages of hedging for gold companies, such as AGC.
Hedging can also be compared to a car insurance policy. In this case, the premium paid is the cost involved in hedging against heavy casualty losses and other liability claims. Companies like Ashanti, facing uncertain price changes or exchange rate risks, insure themselves, as much as possible against losses originating from these risks. Ashanti, therefore, hedges part of its gold production against the risk of falling prices and this enables the Company to continue its operations and planned investments. The Ashanti Goldfields Company is not the only Ghanaian company which engages in hedging. Recently, the Cocobod announced its own hedging policy as a safeguard against low cocoa prices.
Has Ashanti benefited from the policy at all?
Leading gold analysts from Goldman Sachs, Merrill Lynch, Nesbitt Burns, Scotia McLeod, T D Securities etc have all acknowledged Ashanti's hedging policy as one of the very best and most transparent in the industry. Indeed, in his Sessional Address on Thursday, 15th January, 1998, His Excellency President J J Rawlings, stated among other things that:
"The continuing fall in the price of gold has led to the retrenchment of hundreds of people employed in the gold industry in other countries. Fortunately, we have not got to such a point, thanks to the competitive nature of most of our firms on the world gold market and the Ashanti Goldfields Corporation's hedging mechanism. However the crippling effect of the collapse of gold price on export earnings, employment generation and economic growth should not be underestimated".
For instance, in the 1998 Annual Report, we reported on page 45 that, three of our Ghanaian mines reported operating losses of a total of US$35.9 million. These were Obuasi US$26.7 million, Ayanfuri US$4.9 million and Iduapriem US$4.3 million. On the other hand, hedging alone brought in US$139 million which helped to keep these three mines in business and thereby saving the jobs of over 10,000 Ghanaians.
Indeed, as a result of the sophistication and effectiveness of the hedging policy, Ashanti has realised nearly $700 million from hedging activities over the past five years. Developing Bibiani mine in Ghana, Siguiri mine in Guinea, and the Geita project in Tanzania into gold producing mines required huge financing. Banks that were ready to lend to Ashanti sought to reassure themselves of repayment by requiring the Company to hedge part of the gold to be produced. Banks could not risk losing part or all of their capital in the event of falling gold prices. Ashanti's hedge book therefore provided the security and comfort the banks were seeking before they financed over US$100 million for the Bibiani and Siguiri mine development. Hedging income provided a further US$50 million from internal funds for both these projects.
The financing of Bibiani and Siguiri proved so successful that the Company was able to raise another US$270 million at world-class rates to help it develop its new Geita mine in Tanzania. This funding came in the form of a Revolving Credit Facility.
By using receipts from hedging to grow the Company, we avoided the issue of more shares for funding Ashanti's growth, which would then have diluted the value of the Company available to the current shareholders. In other words, issuing shares would be similar to inviting new shareholders to share the same size cake, leaving less for the old shareholders.
The current hedge book will realise an additional US$300 million over the next 15 years.
Why is there a problem then?
Even though hedging has been beneficial to Ashanti, especially in the declining gold price environment, the Group is currently exposed to margin calls as a result of the sudden increase in the gold price.
What occurred in the week of 27th September 1999 had not been experienced in the gold market for over twenty years. Gold prices increased by US$75 per ounce over a four-day period after the announcement that the members of the European Central Banks would limit their gold sales to 400 tonnes annually, and 2,000 tonnes over a five-year period. Market analysts have stated that the chance of this event happening was 1 in 1000.
What is a Margin Call?
A gold producer can enter into a contract through the hedging of its mineral reserves to be delivered at a future date at an agreed price. Events such as strikes, perceived instability of location, strength of balance sheet etc can give the bullion dealers or the other party, some doubts as to the ability of the producing company to deliver its product under the agreed terms of the contract. In such circumstances, the bullion dealer who had already committed himself to other arrangements with bullion banks, may request the mineral producing company to place a deposit or a collateral against any default in delivery. This request is what is known as the margin call.
Margin calls are usually placed in a temporary deposit which earn interest. Should the factors affecting the value of the contract become more favourable, for example, a decrease in the gold price, part or all of the funds placed on deposit will be returned to the Company together with the interest earned.
Margin-free Limits - How are they determined?
Before Ashanti commences hedging activities with any international bank or bullion house, referred to as counter-parties, it negotiates a credit limit, which is similar to an overdraft facility referred to in the gold industry as a margin-free limit. This limit is the maximum amount of credit, which the counter-party will permit before asking for a deposit or making a margin call.
Ashanti's aggregate margin-free limit is US$300 million. This is in contrast to the limits for its peers in South Africa, North America and Australia, many of whom have margin-free limits of US$1 billion and above, or in some cases, have no limits at all.
Determination of margin-free limits: Country Risk
The location of Ashanti's headquarters and its key assets in Africa, where there is a perception of greater political and economic uncertainty, poses a problem for Ashanti's credit rating. Due to this risk profile, the counter-parties tend to limit their total exposure to Ghana, and the margin limits set by the banks form a cap on that exposure. If Ashanti was incorporated in the UK, North America or Australia, it would have been granted greater margin-free limits, similar to other senior gold producers in the world, as stated above.
Determination of margin-free limits: Operational Risk
The margin-free limit is also a reflection of a company's ability to produce and deliver gold continuously for the duration of the contract. Under Ashanti Goldfields Company's hedging arrangement, the Company has a contract with its counter-parties or the bullion dealers under which the Company is to deliver gold at an agreed price at a future date. As a result of the recent strike action at Obuasi during which the delivery of gold was interrupted, and other matters, the perception of the counter-parties which related to the ability of Ashanti to fulfil its legal obligations, has been questioned, thus making the possibility of a margin call more imminent.
Example of a margin call
Let us assume Ashanti has a margin-free limit of US$4.5 million, it then enters into a three-year contract for the sale of 100,000 ounces at a price of US$400 per ounce. If the gold price increases subsequently after the contract has been entered into, and a three-year contract now has a prevailing price of US$430
per ounce, then Ashanti has lost US$30 per ounce ( US$400 - US$430 ) on this contract. The opportunity cost of this loss is therefore US$3 million ( i.e. US$30 per ounce times 100,000 ounces ) . Since this amount is within the US$4.5 million limit, there is no margin call. On the other hand, should the three-year forward price rise higher than US$450 per ounce, ( e.g. ( US$400 - US$450 ) by 100,000 ounces = US$ 5 million ) , then there will be a margin call of US$500,000 ( US$5 million ? US$4.5 million ) required by the parties to the transaction.With the recent US$75 per ounce spike in the gold price, the value of Ashanti's hedge-contracts moved from a positive value of US$250 million to a negative value of US$570 million ( US$270 million above the Company's total margin-free limit of US$300 per ounce ) . The counter-parties therefore threatened to issue a formal request for Ashanti to place US$270 million on deposit with them as the margin call. Due to continuous dialogue with the counter-parties that has been taking place, the formal request has not been made and Ashanti has not been requested to place the deposit.
The recent slide of the gold price down to US$300 per ounce has also reduced the margin call required by the counter-parties from the original US$270 million to less than US$50 million. This has, in turn, reduced the pressure felt by the counter-parties to request a margin to be posted by Ashanti.
However, the gold price could just as quickly rise again increasing the margin call required. That is why Ashanti has been working hard to put in place a longer-term solution to the current requirement to post large margin calls.
Options and solutions being investigated by Ashanti Management
Ashanti's management, together with its advisers, has been reviewing all possible options available to it. These include:
i. Ignore or challenge margin calls from counter-parties
ii. Seek an extension to the Standstill Agreement
iii. Raise new financing through debt or equity offerings
iv. Seek financing and/or guarantees from the Government of Ghana
v. Procure political risk insurance
vi. Seek supranational guarantees
vii. Seek Central Bank intervention of the gold market
viii. Sell part or all of the Company
ix. Seek a possible merger ( share for share ) .
Ignoring or challenging the margin calls is deemed most inadvisable. It will take only one of the many counter-parties to decide that the best course of action under the circumstances would be to call a margin from Ashanti. If a margin were unpaid on account of the size of the payment required, the counter-party would be legally entitled to initiate proceedings against the Company and allow it to recover monies owed to it.
Whilst this would be a long and drawn out process, the counter-party would be well within its legal rights under the trading agreements it has entered into with the Company, and Ashanti would be powerless to prevent it. To prevent such a course of action, or even open up the risk to such a course of action, would be highly irresponsible for Ashanti's management to do. This is why it is imperative that Ashanti finds an acceptable solution with the counter-parties.
Ashanti has also been working hard to gain extensions to the current Standstill Agreement in which the counter-parties have agreed not to call margin for a limited period of time. However, the counter-parties have made it clear that this can only be a short-term solution while Ashanti looks for more long-term solutions to the problem. Accordingly, despite very strong pleas to the contrary, the counter-parties have been unwilling to maintain the standstill for more than a number of days, and only on condition that longer-term solutions were being diligently worked on.
Given the vulnerable position the Company finds itself in, Ashanti has been informed in no uncertain terms by its banks and brokers that raising financing to help it through the current crisis is almost impossible, and will only happen after a solution to the hedge crisis is found, but not before and as long as the Company and its various other creditors are exposed to uncapped margin calls.
Similarly, Ghana Government guarantees, if they were available, would not be sufficient to solve the problem. This is because from the counter-parties' perspective, they are already over-exposed to Ghana risk. In the same vein, the counter-parties have felt that what little political risk insurance is available does not adequately cover their risk which currently runs into the hundreds of millions of US dollars, and is also unacceptable.
Some effort has also gone into exploring forms of a supranational guarantee relying on special relationships between Ghana's central bank and those of the US or UK. However, it appears that such facilities are unavailable at the present time. Further, given the unprecedented decision by the European Central Banks to limit sales of gold in the future, on account of intense lobbying by developing gold producing countries, of which Ghana was one, it was unlikely that the banks would not revert themselves on account of Ashanti's problems.
The most viable options remaining have been those relating to the partial sale of assets to raise cash or a merger with another company to create an entity with a much stronger balance sheet and credit position, and with the financial resources to post collateral or margin calls if necessary.
Accordingly, the advisers are still pursuing discussions with other gold producers to arrive at the best possible outcome. These have included Anglogold, Barrick Gold, Lonmin and other possibilities. Currently, Ashanti's 62% of her unhedged reserves have almost doubled in value due to the rise in gold price. Ashanti could therefore be persuaded to sell a proportion of its assets, now at a higher value, into a joint venture for the required cash to strengthen its balance sheet to be able to meet the present margin calls. The tendency is that offers for this kind of solution have tended to
come from sources which want to pick the most profitable mines such as Bibiani, Siguiri and Geita, the proposed mine to be commissioned in Tanzania next year and leave Ashanti with the loss making operations such as Obuasi, Iduapriem and Ayanfuri.
Further, a sale of assets, while raising cash in the short-term reduces the production capacity of the Company in the long-term, and the Company's long term ability to produce cash flows and profits.
The advisers have also been considering a possible combination of a merger and asset disposal as the basis for convincing the lenders and capital markets of a stronger company.
Priorities and Next Steps
Negotiation with counter-parties for extension of margin-free limits
The current priority is to negotiate higher and/or unlimited margin limits for a period of time in exchange for a consideration to the counter-parties that is still under negotiation. Ultimately this is only possible because Ashanti has the underlying assets and management capability to produce and deliver the gold under contract. Should Ashanti be allowed to deliver gold into its existing contracts, with no need to post margin, the Group will net a positive cash flow from hedging over the next fourteen years ( approx. US$300 million ) .
Restructuring the hedge-book to reduce its sensitivity to spot price movements Ashanti has been working with the counter-parties over the last three weeks to restructure the portfolio, to reduce its sensitivity to gold price and also to reduce the size so that all lenders and counter-parties are comfortable with the limits to the hedge-books' contingent liabilities or margins. Significant progress has been made in this area, and the counter-parties seem to be gaining greater comfort with the entire book.
Negotiation for roll-over of various debt instruments maturing this quarter Ashanti currently has debt instruments to the tune of US$125 million, which are maturing within the next month. The Group was in the final stages of refinancing all these debt instruments when the crisis emerged. Management is therefore continuing to seek means of refinancing the different debt instruments or at least agreeing short-term rollovers of the various facilities. This has not been smooth sailing as the lenders/creditors have now raised concern about Ashanti's ability to repay the facilities with the current margin calls still outstanding. Fortunately, Ashanti has always insisted that all its hedging counter-parties also participate in its Credit Facilities. The wisdom of this has been proven, since the hedging counter-parties together hold a bulk of the US$270 million Revolving Credit Facility, and are therefore more willing to approve a rollover.
Which institutions make up the team of counter-parties and lenders?
These are some of the leading natural resources banks ( both hedging counter-parties and lending banks ) in the world with which the Group's finance team has, over a period of time, developed strong relationships. It is this cordial relationship which has ensured a continued dialogue in these difficult weeks. They include Chase Manhattan, J Aron/Goldman Sachs, Barclays Capital/Barclays Bank, Union Bank of Switzerland ( UBS ) , N M Rothschild, Societe Generale, Scotia Mocatta, Credit Suisse, Dresdner Bank and Citibank. Among the lenders from Ghana are Stanchart,
Issued by Ashanti Goldfields Ltd, 29th October 1999
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