Hedging Risk in Apache
Many of the possible hazards encountered in the global oil and gas business are highlighted in the Harvard Business Review case “Risk Management at Apache,” both on an industry-wide and firm-specific level. Oil and gas is inherently hazardous because to huge changes in commodity pricing caused by a variety of external variables beyond the control of any single organization. Before the lawsuit is heard, Apache should assess a few of these concerns at a time when petroleum have witnessed tremendous highs and lows in the previous two decades. Due to this new repetitive cycle in extremities, several businesses recommended against substantial spending during periods of high prices based on prior experience rather than careful planning and risk mitigation, which might improve the results. Apache maintains part of its expenditures and stocks against potential future risk by using the present state of the oil market circa 2000. It is critical to assess their strategy, industry dangers, and how certain risks might be managed.
Hedging Risk in Apache
Apache Corporation was a separate entity that specialized with oil and gas production and exploration. It decided to begin a hedging program in order to decrease its exposure to the volatility of oil and gas prices. Nevertheless, this method created a risk to the corporation because there was a possibility of incurring more than the allocated amount in the production and exploration of gas and oil. Apache must continue to hedge to lessen its exposure to volatility in oil and natural gas prices. While it demands more management and resource time, it guarantees that Apache employs the optimal hedging approach while keeping market circumstances in mind. Statoil in Norway has had great success with a similar technique. They have substantially invested in their risk management teams to guarantee that they properly manage the risk of their business. Even though there is a danger that Apache and other oil and gas companies may lose money if commodity prices rise on production forward contracts, this is compensated by the confidence that is offered when commodity prices are low. Because of the effectiveness of Apache’s hedging method, businesses outside of the oil and gas industry (particularly airlines) have adopted Apache’s option-based hedging procedures.
Many issues arose for Apache’s management regarding risk and whether the business should continue to hedge income from acquisitions. Liquid at affordable pricing are in short supply. Long-term hedging has become prohibitively expensive, necessitating constant balance. Price fluctuation is at risk since the hedge does not cover the whole market. Contract jumps and backflow, Logistical transport became expensive since they were unable to get gas to the needed delivery point, implying that hedging did not cover the entire front to back flow on contracts. Other mitigating factors. Apache has started hedging the projected output from its new acquisitions. According to Apache, the existing situation provided a chance for the corporation to negotiate the purchase of exceptional assets at potentially affordable pricing. Apache’s managers were able to lock in these high gas prices through hedging. The hedges focused on predicted output over the next two to three years, whereas the markets demonstrated liquidity for up to five years, or even longer in certain cases. Apache’s risk management were adamant that their hedging strategy aligned with and was firmly based in the market’s perception. Apache’s short-term outlook was described as “bullish.”
Challenges in Managing Properties and Production
In a subtle sense, the hedging had benefitted the business by improving the firm’s credibility in the purchase process. The possibility of losing any extra earnings if prices rise drastically under the collar method. When it comes to leveraging certain risks, big organizations must use hedging measures while making effective use of their intellectual resources. Hedging also allows for more accurate performance evaluations, allowing investors to assess the firm’s entire performance.
Apache Corporation, like any other corporation, recognized that hedging had produced its own dangers. The fact that Apache Corporation held more than 80% of its output posed a significant danger to the corporation. It made logical for the corporation to desire to manage its own properties and production, but also increased the organization’s total responsibilities. Having said that, eighty percent of the company’s owned reserves were in North America, with the remaining twenty percent in foreign nations. Because overseas properties were less developed than those in North America, Apache Corporation saw international activities as riskier than domestic operations. Another reason Apache Corporation saw its worldwide reserves as riskier than those in North America was political risk. The corporation identified political danger in other nations, such as West Africa and former Soviet Union territories. However, Apache Corporation valued its international territories, but it assessed the possible political dangers and only targeted international countries where it had production interests, such as Egypt or Australia.
Even with political dangers in mind, the corporation expressed interest in additional nations. Another key firm risk was tied to its management’ power over gas and oil pricing. Apache had a strategy to enhance reserves and output while keeping costs down, which was known as as their ‘compensation program.’ To reach this aim, the corporation needed to ensure that its manufacturing was efficient and that its margins were enough. Apache Corporation needed to meet their sales objective in order to complete their incentive program. This initiative poses a danger to the business because management were unable to regulate oil and gas prices as well as revenue statistics. Financial risk in the form of purchase was another corporate risk that Apache Corporation experienced. Even for a firm the size of Apache, the company’s property acquisitions totaled more over $1 billion. Before purchasing firms such as Repsol, the corporation predicted the possible advantages, but after the acquisitions were completed, Apache Corporation faced real-time financial risk in the company. Because Apache Corporation is such a huge and inventive corporation, it had power when weighing its risks and advantages (Leo et al., 2019).
The oil and gas sector is particularly dangerous since it is impossible to foresee price changes, which impact demand and can either hinder or enhance sales. When Apache Corporation first joined the sector, it faced industry hazards, which it continued to face as it began to purchase assets and properties worth more than $4 billion (Ullah et al., 2021). For employment outside of the United States, they carefully selected nations with enough stability to not jeopardize their business while still having cheap salaries that will not deplete their bottom line. Even with effective risk management for global development, though, the majority of Apache’s operations was in the United States. In order to limit risk, they had decided to utilize financial instruments to hedge against the shifting price of oil. Futures contracts for gas and crude oil became introduced in 1978 and 1983, accordingly. Apache had taken full advantage of put options that could be placed against rising gas and oil prices, with mixed outcomes. While their hedging approach was successful, they also faced long calls that resulted in worthless assets on their books as a result of such significant unanticipated spikes in gas and oil prices after 2000. Despite their mixed performance, their financial approach got them a higher credit rating, which allowed for more favorable financing for their expansion, resulting in better earnings than if they had not hedged. In retrospect, Apache was lauded for their meticulous risk management and financial processes.
In sectors with significant inherent risk, it is critical to handle internal and external elements as meticulously as a business is able. The oil and gas industry, in particular, sees frequent price changes and regional stability, creating a difficult-to-manage economic environment. To effectively cope with an ever-changing sector, it is critical to make strategic decisions while keeping long-term concerns in mind, as well as attempting to mitigate current risk. Apache had opted to hedge their chances with financial instruments, and while not every wager paid off, they had favorable returns with modest performance and a robust financial model.
The Apache Corporation has been capable of managing its risk in order to give prospects for the development of new resources and increased profitability. The introduction of hedging tactics allowed firm compensation to be maximized by eliminating the price totality of oil from consideration and focused on output in order to fairly measure the success of top management. This method also helped Apache to lock in greater gas pricing and capitalize on possibilities when oil prices were low. So, the use of a hedging strategy to manage risk benefited Apache in the sense that it was able to offset the inherent risk of the oil business’ pricing shifts by hedging against future increases in the cost of operations and allowing the company’s near term goals to continue to be met, even when oil prices would normally have been prohibitive to growth and acquisitions.
References
Leo, M., Sharma, S., & Maddulety, K. (2019). Machine learning in banking risk management: A literature review. Risks, 7(1), 29.
Ullah, F., Qayyum, S., Thaheem, M. J., Al-Turjman, F., & Sepasgozar, S. M. (2021). Risk management in sustainable smart cities governance: A TOE framework. Technological Forecasting and Social Change, 167, 120743.
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