Apache Company: Risk Management Strategies

Risk Management at Apache

Apache’s hedging strategy crafted several benefits for the firm. First, like other firms that hedge major price risks, Apache was able to reduce the amount of equity needed to support their operations and reduce their overall cost of capital since they are comfortable with more leverage. Also, hedging makes it easier for the firm performance to be evaluated with a value-creation focus. Apache’s hedging method of using “costless collars” protected Apache from a potential price downturn, but still left a potential upside for the firm. CFO Roger Plank stated the hedging program yielded production levels on par with projection levels in 2001, exceeding the prior year’s production by at least 25% and causing record financial results when combined with low US production and robust pricing. Plank described these benefits as assuring Apache a “double-digit” return, and through hedging, Plank believed Apache would be able to purchase properties of high quality at low cash flow multiples. More subtly, Apache’s managers claimed hedging raised the firm’s credibility in the acquisition process by promoting the firm’s ability to go through on deals quickly and its reputation as a reliable deal-closer, netting a big advantage for Apache and its ability to swiftly execute. This is supported by Standard & Poor’s upgrade of Apache’s debt to A-, citing Apache’s hedging practices and overall conservative financial practices. S&P explained that even in the event of a price downturns, Apache retains likely ability to fund fixed charges and necessary capital expenditures to replace production. Apache’s favorable hedging reputation eased investors who were previously opposed to hedging, boosting Apache’s investment attractiveness, as well as its access to capital and the terms thereof.

Apache’s hedging strategy also posed potential hazards. Foremost, Apache would forgo any additional accruing profits if prices were to increase too much in their hedging strategy. This risk was realized in March 2001, when gas prices rose above Apache’s call price of $5.26. Also, the hedging strategy Apache utilized can be very costly to routinely execute, especially when there is no guarantee that the hedging will prevent Apache from losing money from both losses and potential gains. Hedging could also create more volatility reported earnings, especially in the advent of FAS 133 reporting requirements. Speculating price movements and hedging for them is risky as the price will eventually move unexpectedly against the hedging strategy. Also, many investors are not fond of hedging and unfavorable hedging results could not only taint the firm’s reputation, but could drive away current and potential investors.