Time to hedge – BDO

Time to hedge – BDO

BDO is urging the State’s miners to consider taking out hedges as commodity prices continue to fall and they continue to battle tighter margins as a result.

The audit and tax advisory firm says the further fall in commodity prices, combined with a fall in interest rates, volatility of the Australian dollar and the introduction of a new accounting standard, have all contributed to the appeal of hedging.

BDO International Financial Reporting Standards Leader for Asia Pacific, Wayne Basford, said that, the new accounting standard AASB 9, in particular, has made hedge accounting a feasible option for mining companies in the current market.

“Previously hedging was often perceived to be very complicated and as a consequence put in the ‘too hard’ basket,” Mr Basford said.

“For many companies the risk of earnings instability when combined with taking out derivatives on commodities or foreign exchange which did not qualify for hedge accounting was a major deterrent against entering into hedges,” Mr Basford said.

“This was often off the back of a strengthening Australian dollar, ever increasing commodity prices and falling interest rates, so there did not appear to be an immediate need to hedge.”

However, the new accounting standard has made hedging a lot easier and brings benefits including removal of the 80/125 effectiveness rule.

“In many cases hedge accounting could not be achieved for the purchase of diesel, as there is not a perfect correlation between  the price of diesel and the gas oil derivatives“, Mr Basford explained.

Furthermore, it allows companies to hedge only the commodity element of a sale or purchase contract. For example, in an iron ore sales contract the hedge can be applied solely to the iron in the sales contract rather than having to be applied to the whole sales contract which includes freight costs, as per the previous standard.

The new accounting standard also allows the use of options products, including swap options, or, “swaptions”, which affords companies the option to swap fixed rates on interest, foreign exchange or commodities.

“Australia now sees itself with historically low interest rates and low oil prices – miners should consider whether it is in their best interests to be locking in these low prices now,” Mr Basford said.

Historically there has always been a very strong correlation between AUD and commodity prices as stated in USD effectively creating a natural hedge.

With the current volatility in global currency and commodity prices, this correlation may not be as strong, and therefore miners should consider whether locking into current exchange rates may be appropriate.

Mr Basford said some miners needed to protect themselves against further commodity price falls and locking into current prices for some of their production could be part of a risk management strategy to enable them to service debt and overheads.