BHP - Enterprise Risk Management
Content
#BHP
Risk Management Strategy Briefing
Charles W Goodyear
Chief Financial Officer
Rowen H Bainbridge
Vice President Market Risk Management
December 2000
Agenda
• Introduction • Strategy • Rationale • Strategy in practice • Communications
#BHP
Market Risk Management Strategy
#BHP
• Market Risk Strategy is consistent with BHP’s overall strategy • The outcome is simple, but its based on complex, quantitative analysis • Strategy works for BHP due to its low cost, diversified asset base • Tools become building blocks for decision-making beyond the market risk strategy
Agenda
• Introduction • Strategy • Rationale • Strategy in practice • Communications
#BHP
‘Portfolio Risk Management’
Market Risk Management Objective
#BHP
• To support the delivery of BHP’s financial targets, while protecting the Company’s future financial security and flexibility.
Market Risk Management Strategy
• To manage risk at the portfolio level through the natural diversification in the BHP Portfolio. • To only hedge when the residual risk in the portfolio may compromise the delivery of corporate objectives. • To a limited extent capture value when a market within the portfolio deviates significantly from long run expectations. • To communicate BHP's policy and resultant risk profile to stakeholders in a clear, precise and responsive manner.
‘Portfolio Risk Management’ Strategy
• Manage risk at the portfolio level
#BHP
Understand portfolio characteristics Link capital allocation to portfolio risk
• Manage risk to an acceptable level
Self insurance model Only hedge if you have to
• Limited strategic financial transactions
Markets under/over valued within agreed limits
• Raise bar on communications
Clear, precise and responsive
Agenda
• Introduction • Strategy • Rationale • Strategy in practice • Communications
#BHP
Elements of our rationale
• • • • • • • BHP has a diversified portfolio There is no value in reducing volatility
#BHP
Valuations reflect corporate strategy not earnings volatility Good communication is highly valued by investors Costs of hedging are high for BHP's key risks Only hedge if you have to Financial markets provide opportunities to improve returns
Rationale
• BHP has a diversified portfolio
#BHP
Rationale
• BHP has a diversified portfolio • There is no value in reducing volatility
#BHP
There is no value in reducing volatility
Total Shareholder Return vs. Volatility (last 4 years)
Source: Thompson FIR May 2000, BHP Team analysis
#BHP
50 Total Shareholder Return (%) 40 30 20 10 0 -10 -20 -30 0 10 20 30 40 Volatility (%) 50 60
BHP
BHP's Peer Companies Hedger Non-hedger
Rationale
#BHP
• BHP has a diversified portfolio • There is no value in reducing volatility • Valuations reflect corporate strategy not earnings volatility
Valuations reflect corporate strategy not earnings volatility
Comparison of Premium Return to Premium Value
Source: Goldman Sachs ‘Essential Oils’
#BHP
1.2
Exxon Mobil
BPAmoco Chevron Texaco Royal Dutch Shell
Market Multiple
1.0 0.8 0.6
OMV Lasmo 0.4
TotalFinaElf
Norsk Hydro
CEPSA ENI Repsol YPF Enterprise
0.2
-3
-2
-1
0
1
2
3
4
Economic Value Added
Valuations reflect corporate strategy not earnings volatility
#BHP
1999 Actual Comparison of Premium Return to Premium Value
2.50 2.00 Market Multiple 1.50 1.00 0.50 0.00 -6.00% -4.00% -2.00% 0.00% 2.00% Economic Value Added 4.00% 6.00%
BHP's Peer Companies Hedger Non-hedger
Valuations reflect corporate strategy not earnings volatility
Source: BHP Team analysis
#BHP
1999 Actual Comparison of Premium Return to Premium Value
2.50 2.00 Market Multiple 1.50 1.00 0.50 0.00 -6.00% -4.00% -2.00% 0.00% 2.00% Economic Value Added 4.00% 6.00%
Rio Tinto
BHP's Peer Companies Hedger
Enron Woodside
Non-hedger
Western Mining
Shell Freeport Copper Devon BHP Chevron Phelps Dodge Suncor Energy North Ltd Total Fina Nucor Corp Phillips Petroleum Unocal Corp Enterprise Oil Lasmo
Exxon
BP Amoco
Barrick Gold
USX-US Steel Group
Valuations reflect corporate strategy not earnings volatility
Source: BHP Team analysis
#BHP
1999 Actual Comparison of Premium Return to Premium Value
2.50 2.00 Market Multiple 1.50 1.00 0.50 0.00 -6.00% -4.00% -2.00% 0.00% 2.00% Economic Value Added 4.00% 6.00%
BHP's Peer Companies
Risk Management as Intellectual Capital
Strategy 1
Simplicity, clarity and low cost strategy
Strategy 2
Hedger Non-hedger
Rationale
• BHP has a diversified portfolio • There is no value in reducing volatility
#BHP
• Valuations reflect corporate strategy not earnings volatility • Good communication is highly valued by investors
Rationale
• BHP has a diversified portfolio • There is no value in reducing volatility
#BHP
• Valuations reflect corporate strategy not earnings volatility • Good communication is highly valued by investors • Costs of hedging are high for BHP’s key risks
Costs of hedging high for key risks
Source: BHP Team analysis
#BHP
Average
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Average
3,000 2,800 2,600 2,400 2,200 2,000 1,800 1,600 1,400 1,200 1,000 Cash
A Copper Example
3 month 15 month 27 month
LME Futures Contracts
Rationale
• BHP has a diversified portfolio • There is no value in reducing volatility
#BHP
• Valuations reflect corporate strategy not earnings volatility • Good communication is highly valued by investors • Costs of hedging are high for BHP’s key risks • Only hedge if you have to
Only hedge if you have to
#BHP
Illustrative
Cashflow Call on Cash
$AUS MILLION
2001
2002
2003
2004
FINANCIAL YEAR
How Market Risk effects gearing
US Industrials
MEDIAN UPPER QUARTILE 51.4 Single ‘A’ Rating
#BHP
Prob. (Key ratio > 51.4%) Unhedged Current hedge 100% hedgeable <1% <1% <1%
39.2
30.3 LOWER QUARTILE
0.8 0.7 0.6
Probability
0.5 0.4 0.3 0.2 0.1 0 80 60 40 20 0
Unhedged Current hedge 100% hedgeable
Gearing (percent) 2001
Source: BHP Team analysis
How Market Risk effects financial plans #BHP
Gearing distribution 2003
MEDIAN UPPER QUARTILE
Prob. (Key ratio > 51.4%) Unhedged 30.3 LOWER QUARTILE 100% Hedged After management action Possible Management Actions 15% 14% 1%
51.4
39.2
Single ‘A’ Rating
0.3
• Discretionary CAPEX • Acquisitions • Exploration • Funding requirements • Divided policy • Share buy-backs • Discretionary investments/distribution
Probability
0.25 0.2 0.15 0.1 0.05 0 80 60 40 20 0
Unhedged After management action 100% hedgeable
Gearing (percent)
Source: BHP Team analysis
Rationale
• BHP has a diversified portfolio • There is no value in reducing volatility
#BHP
• Valuations reflect corporate strategy not earnings volatility • Good communication is highly valued by investors • Costs of hedging are high for BHP’s key risks • Only hedge if you have to • Financial markets provide opportunities to improve returns
Financial markets provide opportunities to improve returns
#BHP
10 Year Histogram of 15 Month Futures Contract
15 Month Contract as at 17/10/00 = $27.39 USD/bbl
Probability
Percentile > P99
10
12
14
16
18
20
22
24
26
28
30
More
15 Month Contract For Oil (USD/bbl)
Agenda
• Introduction • Strategy statement • Rationale • Strategy in practice • Communications
#BHP
Strategy in practice
#BHP
Strategy in practice
What is the potential range of risk?
P90 Riding the waves Agreed strategy Choppy waters
#BHP
P5 Rating Agency disaster case P1
Strategy in practice
Risk limits for the portfolio
• • • Cashflow at Risk limit; The risk that BHP gearing will exceed target gearing Ratio of Cashflow at Risk to projected Cashflow
#BHP
NOTE: Other risks are also included to keep total risk within an acceptable level
Risk limits for strategic financial transactions
• • Stop loss Value at Risk Annual, Monthly and Quarterly $25m
Strategy in practice
Responsibility Governance and Policy Setting Authority Board
#BHP
Strategy Setting
Policy Committee supported by Market Risk Management function CFO for strategic financial transactions All activities subject to Board approved limits and monitoring
Execution*
Treasury Petroleum
Summary
• Manage risk at the portfolio level
#BHP
Understand portfolio characteristics Link capital allocation to portfolio risk
•
Manage risk to an acceptable level
Self insurance model Only hedge if you have to
•
Limited Strategic financial transactions
Markets under/over valued within agreed limits
•
Raise bar on communications
Clear, precise and responsive
Agenda
• Introduction • Strategy statement • Rationale • Strategy in practice • Communications
#BHP
What we will communicate
Will be disclosed Portfolio Risk • Policies – Annual statement, or as major policy changes occur; • Exposure profile; and • Information on outstanding hedge book – Quarterly update. Will not be disclosed
#BHP
• CFaR limits; • Modelling assumptions; and • Detailed transactions and transaction counterparties.
For strategic financial transactions • Quarterly performance • Rationale behind strategies; and update; and • Stop Loss Limits. • Value at Risk (VaR) and VaR limit – Quarterly Update.
Market Risk Management Strategy
#BHP
• Market Risk Strategy is consistent with BHP’s overall strategy • The outcome is simple, but its based on complex, quantitative analysis • Strategy works for BHP due to its low cost, diversified asset base • Tools become building blocks for decision-making beyond the market risk strategy
QUESTIONS
#BHP
Risk Management Strategy Briefing
Charles W Goodyear
Chief Financial Officer
Rowen H Bainbridge
Vice President Market Risk Management
December 2000
Agenda
• Introduction • Strategy • Rationale • Strategy in practice • Communications
#BHP
Market Risk Management Strategy
#BHP
• Market Risk Strategy is consistent with BHP’s overall strategy • The outcome is simple, but its based on complex, quantitative analysis • Strategy works for BHP due to its low cost, diversified asset base • Tools become building blocks for decision-making beyond the market risk strategy
Agenda
• Introduction • Strategy • Rationale • Strategy in practice • Communications
#BHP
‘Portfolio Risk Management’
Market Risk Management Objective
#BHP
• To support the delivery of BHP’s financial targets, while protecting the Company’s future financial security and flexibility.
Market Risk Management Strategy
• To manage risk at the portfolio level through the natural diversification in the BHP Portfolio. • To only hedge when the residual risk in the portfolio may compromise the delivery of corporate objectives. • To a limited extent capture value when a market within the portfolio deviates significantly from long run expectations. • To communicate BHP's policy and resultant risk profile to stakeholders in a clear, precise and responsive manner.
‘Portfolio Risk Management’ Strategy
• Manage risk at the portfolio level
#BHP
Understand portfolio characteristics Link capital allocation to portfolio risk
• Manage risk to an acceptable level
Self insurance model Only hedge if you have to
• Limited strategic financial transactions
Markets under/over valued within agreed limits
• Raise bar on communications
Clear, precise and responsive
Agenda
• Introduction • Strategy • Rationale • Strategy in practice • Communications
#BHP
Elements of our rationale
• • • • • • • BHP has a diversified portfolio There is no value in reducing volatility
#BHP
Valuations reflect corporate strategy not earnings volatility Good communication is highly valued by investors Costs of hedging are high for BHP's key risks Only hedge if you have to Financial markets provide opportunities to improve returns
Rationale
• BHP has a diversified portfolio
#BHP
Rationale
• BHP has a diversified portfolio • There is no value in reducing volatility
#BHP
There is no value in reducing volatility
Total Shareholder Return vs. Volatility (last 4 years)
Source: Thompson FIR May 2000, BHP Team analysis
#BHP
50 Total Shareholder Return (%) 40 30 20 10 0 -10 -20 -30 0 10 20 30 40 Volatility (%) 50 60
BHP
BHP's Peer Companies Hedger Non-hedger
Rationale
#BHP
• BHP has a diversified portfolio • There is no value in reducing volatility • Valuations reflect corporate strategy not earnings volatility
Valuations reflect corporate strategy not earnings volatility
Comparison of Premium Return to Premium Value
Source: Goldman Sachs ‘Essential Oils’
#BHP
1.2
Exxon Mobil
BPAmoco Chevron Texaco Royal Dutch Shell
Market Multiple
1.0 0.8 0.6
OMV Lasmo 0.4
TotalFinaElf
Norsk Hydro
CEPSA ENI Repsol YPF Enterprise
0.2
-3
-2
-1
0
1
2
3
4
Economic Value Added
Valuations reflect corporate strategy not earnings volatility
#BHP
1999 Actual Comparison of Premium Return to Premium Value
2.50 2.00 Market Multiple 1.50 1.00 0.50 0.00 -6.00% -4.00% -2.00% 0.00% 2.00% Economic Value Added 4.00% 6.00%
BHP's Peer Companies Hedger Non-hedger
Valuations reflect corporate strategy not earnings volatility
Source: BHP Team analysis
#BHP
1999 Actual Comparison of Premium Return to Premium Value
2.50 2.00 Market Multiple 1.50 1.00 0.50 0.00 -6.00% -4.00% -2.00% 0.00% 2.00% Economic Value Added 4.00% 6.00%
Rio Tinto
BHP's Peer Companies Hedger
Enron Woodside
Non-hedger
Western Mining
Shell Freeport Copper Devon BHP Chevron Phelps Dodge Suncor Energy North Ltd Total Fina Nucor Corp Phillips Petroleum Unocal Corp Enterprise Oil Lasmo
Exxon
BP Amoco
Barrick Gold
USX-US Steel Group
Valuations reflect corporate strategy not earnings volatility
Source: BHP Team analysis
#BHP
1999 Actual Comparison of Premium Return to Premium Value
2.50 2.00 Market Multiple 1.50 1.00 0.50 0.00 -6.00% -4.00% -2.00% 0.00% 2.00% Economic Value Added 4.00% 6.00%
BHP's Peer Companies
Risk Management as Intellectual Capital
Strategy 1
Simplicity, clarity and low cost strategy
Strategy 2
Hedger Non-hedger
Rationale
• BHP has a diversified portfolio • There is no value in reducing volatility
#BHP
• Valuations reflect corporate strategy not earnings volatility • Good communication is highly valued by investors
Rationale
• BHP has a diversified portfolio • There is no value in reducing volatility
#BHP
• Valuations reflect corporate strategy not earnings volatility • Good communication is highly valued by investors • Costs of hedging are high for BHP’s key risks
Costs of hedging high for key risks
Source: BHP Team analysis
#BHP
Average
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Average
3,000 2,800 2,600 2,400 2,200 2,000 1,800 1,600 1,400 1,200 1,000 Cash
A Copper Example
3 month 15 month 27 month
LME Futures Contracts
Rationale
• BHP has a diversified portfolio • There is no value in reducing volatility
#BHP
• Valuations reflect corporate strategy not earnings volatility • Good communication is highly valued by investors • Costs of hedging are high for BHP’s key risks • Only hedge if you have to
Only hedge if you have to
#BHP
Illustrative
Cashflow Call on Cash
$AUS MILLION
2001
2002
2003
2004
FINANCIAL YEAR
How Market Risk effects gearing
US Industrials
MEDIAN UPPER QUARTILE 51.4 Single ‘A’ Rating
#BHP
Prob. (Key ratio > 51.4%) Unhedged Current hedge 100% hedgeable <1% <1% <1%
39.2
30.3 LOWER QUARTILE
0.8 0.7 0.6
Probability
0.5 0.4 0.3 0.2 0.1 0 80 60 40 20 0
Unhedged Current hedge 100% hedgeable
Gearing (percent) 2001
Source: BHP Team analysis
How Market Risk effects financial plans #BHP
Gearing distribution 2003
MEDIAN UPPER QUARTILE
Prob. (Key ratio > 51.4%) Unhedged 30.3 LOWER QUARTILE 100% Hedged After management action Possible Management Actions 15% 14% 1%
51.4
39.2
Single ‘A’ Rating
0.3
• Discretionary CAPEX • Acquisitions • Exploration • Funding requirements • Divided policy • Share buy-backs • Discretionary investments/distribution
Probability
0.25 0.2 0.15 0.1 0.05 0 80 60 40 20 0
Unhedged After management action 100% hedgeable
Gearing (percent)
Source: BHP Team analysis
Rationale
• BHP has a diversified portfolio • There is no value in reducing volatility
#BHP
• Valuations reflect corporate strategy not earnings volatility • Good communication is highly valued by investors • Costs of hedging are high for BHP’s key risks • Only hedge if you have to • Financial markets provide opportunities to improve returns
Financial markets provide opportunities to improve returns
#BHP
10 Year Histogram of 15 Month Futures Contract
15 Month Contract as at 17/10/00 = $27.39 USD/bbl
Probability
Percentile > P99
10
12
14
16
18
20
22
24
26
28
30
More
15 Month Contract For Oil (USD/bbl)
Agenda
• Introduction • Strategy statement • Rationale • Strategy in practice • Communications
#BHP
Strategy in practice
#BHP
Strategy in practice
What is the potential range of risk?
P90 Riding the waves Agreed strategy Choppy waters
#BHP
P5 Rating Agency disaster case P1
Strategy in practice
Risk limits for the portfolio
• • • Cashflow at Risk limit; The risk that BHP gearing will exceed target gearing Ratio of Cashflow at Risk to projected Cashflow
#BHP
NOTE: Other risks are also included to keep total risk within an acceptable level
Risk limits for strategic financial transactions
• • Stop loss Value at Risk Annual, Monthly and Quarterly $25m
Strategy in practice
Responsibility Governance and Policy Setting Authority Board
#BHP
Strategy Setting
Policy Committee supported by Market Risk Management function CFO for strategic financial transactions All activities subject to Board approved limits and monitoring
Execution*
Treasury Petroleum
Summary
• Manage risk at the portfolio level
#BHP
Understand portfolio characteristics Link capital allocation to portfolio risk
•
Manage risk to an acceptable level
Self insurance model Only hedge if you have to
•
Limited Strategic financial transactions
Markets under/over valued within agreed limits
•
Raise bar on communications
Clear, precise and responsive
Agenda
• Introduction • Strategy statement • Rationale • Strategy in practice • Communications
#BHP
What we will communicate
Will be disclosed Portfolio Risk • Policies – Annual statement, or as major policy changes occur; • Exposure profile; and • Information on outstanding hedge book – Quarterly update. Will not be disclosed
#BHP
• CFaR limits; • Modelling assumptions; and • Detailed transactions and transaction counterparties.
For strategic financial transactions • Quarterly performance • Rationale behind strategies; and update; and • Stop Loss Limits. • Value at Risk (VaR) and VaR limit – Quarterly Update.
Market Risk Management Strategy
#BHP
• Market Risk Strategy is consistent with BHP’s overall strategy • The outcome is simple, but its based on complex, quantitative analysis • Strategy works for BHP due to its low cost, diversified asset base • Tools become building blocks for decision-making beyond the market risk strategy
QUESTIONS
#BHP
