To: Prof. Chalmers From: Travis Ramme & Meghan Smith Re: Risk Management at Apache Date: May 15th, 2007
Apache Corporation is currently evaluating is risk management strategies in order to increase firm and shareholder value. To properly take into account all facets of their risk assessment and management program, several observations must be made and suggestions given. Current Risks Faced by Apache Apache is currently facing several forms of risk stemming from various sources. The first and most important of these is the inherent volatility of the oil industry with regard to price. Systematic, industry wide risk is very large and active within the industry. Prices are constantly fluctuating with varying degree. These fluctuations can often times be quite large, and constitute major changes in oil prices. More specifically, Apache faces many risks ranging from political uncertainty of a region to geological uncertainty of a prospective drilling area. Generally, these risks are much lower within the North American markets. This is due to the maturity and stability of North American fields and reserves, as well as the expertise and experience that companies have with the area. Apache is a mid to large size independent oil company. Independents deal with a different part of the extraction and production process than major oil companies do. Because of this, Apache faces some risks that larger oil companies do not. Namely, when a field has matured and is sold to an independent such as Apache, extraction becomes harder and more costly. This changing cost represents a significant risk to Apache in that it can fluctuate. Apache’s operating strategy works on the mantra of “maximizing production and minimizing costs.” To be able to have control over its development and operations, Apache prefers to operate its own properties. Subsequently, Apache has roughly 80% of it proven reserves located within North America. Apache is exploratory as well, and is constantly searching out new reserves in developing markets. However, unlike the smaller oil independents, Apache prefers to find a proven location through research, and then to become the dominant producer in that region. Through this strategy, Apache lowers its exposure to the risks associated with drilling in exotic or untested locations. The majority of Apache’s reserves are within the more stable Northern American market, and reserves that are located in other regions are researched and analyzed before receiving significant attention. QUANTIFY EXPOSURES? Current Risk Management at Apache Recently, Apache has begun a practice of hedging the production of new acquisitions. By hedging away future production, Apache is able to “lock in” profits on as of yet produced
product regardless of the changing market prices. In this way, Apache can lock in guaranteed proceeds that are independent of the large volatility of the oil and gas industries. Apache’s competitors are taking similar steps, using futures to hedge away the risks associated with the fluctuating prices of their products. Benefits Created by Risk Management Hedging away risk with contracts has many benefits for Apache. Reduced risk allows for decreased cost of capital and greater lending power and access to capital. Risk management also allows for better assessment of managers. By reducing the volatility of oil and gas prices, a variable that managers cannot control, Apache can assess the performance of its managers in a much more reliable way by dealing with factors that are directly influenced a particular manager. On top of this, risk management created a more stable company that was easier to value and to gauge. The massive changes in oil and gas prices caused the companies financials to change drastically. By hedging away risk, these statements became more stable. On the downside