More facts on the Barrick hedgebook,...
What is a spot deferred sales contract?
Expressed simply, Barrick’s spot deferred sales contract is an agreement that we will sell gold to the contract counterparty, also referred to as a bullion bank, on a delivery date in the future at an agreed price.
How does a spot deferred sales contract work?
A spot deferred contract represents a commitment to sell a fixed number of ounces of gold at a future date established by Barrick over a period of up to 10 to 15 years from inception of the contract. The selling price under the contract is based on the spot gold price on the date the contract is entered into plus a premium (commonly referred to as "contango") that accrues until the future delivery date under the contract. The amount of this premium is determined by reference to the price differential between the current market price of gold and the forward price of gold based on the gold market. The rate at which contango accrues is determined by reference to market LIBOR rates (i.e., US$ interest rates) less gold lease rates. Thus, as long as the US$ interest rate is higher than the gold lease rate, Barrick can arrange to deliver gold to the bullion bank in the future at a higher contract price than the spot price on the date we enter into a contract. See Section V "Where Barrick Stands" for a discussion on gold lease rates.
How different are Barrick’s spot deferred contracts from other companies’ hedge contracts?
Not all "spot deferred" contracts are created equal. Barrick is the only major gold producer with an A-rated balance sheet. Barrick's strong credit rating and quality, long-life, low-cost asset base has meant that counterparties are prepared to enter into gold hedging transactions with Barrick on conditions that are more favorable than the conditions we understand are available to other gold producers. To our knowledge, no other gold producer has available to it the combination of margin-free hedging, 10 to 15 year terms and flexible delivery dates that are available to Barrick. Our contracts are exceptional not only for their length but also their flexibility. At any time up until the Termination Date, we can choose to deliver gold under the contract at the contract price or sell gold into the spot gold market at the then current spot price, whichever is higher.
Why are Barrick’s contracts described as "evergreen"? And why does this work in Barrick’s favor?
Our master trading agreements have terms of from 10 to 15 years. In most cases, these 10 to 15 year terms are automatically extended or kept "evergreen". This means that, with each year that passes, the Termination Date is extended into the future by one year. Where we have an evergreen agreement with a 10-year term, for example, this means that on the first anniversary of the day we signed the agreement, rather than the remaining term being only 9 years, the term is refreshed so it is 10 years from the anniversary date (and 11 years from the original contract date).
By providing Barrick with notice prior to any anniversary date, our counterparties have the right to override future automatic extensions of our master trading agreement Termination Dates. Practically, this means the counterparty in the above example must provide the notice 9 years in advance of the Termination Date. No counterparty has ever provided Barrick with such notice declining extension.
Do Barrick’s contracts establish inflexible delivery dates and contract prices for its gold?
No.
Barrick’s agreements have terms from 10 to 15 years from inception, and Barrick has the flexibility to deliver gold under the contract at any time during this period. The price Barrick receives when it delivers gold is a function of the period of time from the date a contract is entered into to the actual delivery date. The longer the period of time, the greater the affect of contango and, so long as US$ interest rates are higher than gold lease rates, the greater the increase in the contract price.
For example, we could enter into a forward sale in 2002 that establishes a 2007 delivery price of $350/oz. For this example, even though the Termination Date under the contract is 10 years, we have chosen to fix the price for only 5 years based on production schedules and then forecasted delivery dates. We would disclose the 2007 expected delivery and the $350/oz. price in our financial statements. Importantly, however, Barrick has the ability to choose, in 2007, either to (a) deliver gold into the spot market at then prevailing market prices, in which case we could establish an alternative delivery date under the contract or (b) deliver into the contract and receive the contract price. If, in 2007, we choose to deliver under the sales contract at a later date, a new contract price would be established based on the $350 price for 2007 plus an additional premium amount (i.e., contango) calculated with reference to US$ interest rates and gold lease rates in effect at the time.
Under normal market conditions, US$ interest rates are higher than gold lease rates, which results in the future price of gold being higher than the spot price. There is a possibility that market gold lease rates, which are effectively part of the contango return received by Barrick, can become greater than the LIBOR rates of return. The forward price of any new gold hedges entered into or repriced in such circumstances will be lower than the spot price (i.e., a negative premium). Such a market situation, referred to as "backwardation", rarely occurs in respect of gold. When gold backwardation has occurred in the past, it has only existed for short periods of time. See Section V below for a discussion of how Barrick manages any risks associated with gold lease rates.
Are spot deferred contracts the only kind of gold hedging contract used by Barrick?
No. As set out in detail in the notes to our financial statements, Barrick's gold hedging program involves a range of different types of contracts, including variable price sales contracts and options. However, the spot deferred contract described above is the most important type of contract we enter into under our master gold trading agreements. Approximately 90% of the gold ounces subject to our hedging program are governed by spot deferred sales contracts.
What is a variable price sales contract?
A "variable price" sales contract is a version of our "spot deferred" sales contract with the only difference being that the price of gold is not fixed, but remains variable within certain limits.
As a version of our spot deferred contract, the variable price sales contracts enjoy all the benefits and flexibility as our other gold sales contracts: we can deliver gold against our variable price sales contracts up to 10-15 years in the future, the contracts are "evergreen", no margin calls, etc. In fact, the variable price sales contracts are included in the same Master Trading Agreement as our spot deferred contracts.
While most of our spot deferred contracts are to sell gold at a fixed price in the future, the "variable price" sales contracts have a variable price for gold, typically either i) locked within a range, or ii) capped to a maximum level at a certain date.
There is no requirement to cash settle (i.e. settle with cash instead of delivering gold production) in any of our gold hedge contracts (including variable sales contracts). |
