Risk Management at Apache Case Solution & Answer

Risk Management at Apache Case Solution

1.     Reasons why oil and gas producers had made deliberate decisions to avoid managing oil and gas price risk.

The two reasons why the oil and gas producers had made deliberate decisions to avoid managing oil and gas price risk are:

1. Due to the very costly nature of hedging
2. Due to the risky nature of hedging itself

The hedging requires hiring the specialists who charge a lot. Not only investing money and internal resources, however there is no guaranteed outcome that hedging can save money. Hedging is widely used as a mean of speculations rather than as insurance. It requires effective monitoring of the oil and gas prices prevailing in the market as well as the hedgers.

Hedging itself is also very risky asthere is no guarantee of prices reducing which means that Apache can substantially lose the profitability if they went reverse. TheHedger should, thus, focus on the opportunity cost associated with it to come up with a final decision. Through hedging, a firm could also lose a lot of its investors.

2.     Three strategies that Apache is using now to manage risk excluding derivatives.

The current strategies that are adopted by Apache in managing the risk are:

1. Through diversifying their investment by not putting all the eggs in one basket.
2. Through the size of the firm
3. Through operating in areas where the risk is less

With the help of diversification, by investing in different projects including the exploratory drilling, development of existing projects and selection of various property acquisition, Apache can manage its risk efficiently as well as this would in achieving the prime objective of maximizing the return and minimizing the cost. Apache also manages virgin fields in addition to the more mature property, which results in the diversity of holdings the company has.

Through the large size of Apache, it can help to manage its risk by bulk allowing for benefits, associated with the liquidity, diversity, stability and above all the technology risk. Apache can reap all these “benefits” by using its scale to undertake many projects at a time.

Lastly, Apache also strategically manages its risk by considering the potential areas to operate where the risk is minimal and avoids potentially unstable international areas. Political risk arises from these areas which complicate the risk position of the company.

3.     Let’s suppose that Apache’s manager do not have any skill at predicting the future price of oil and gas. Does this mean that Apache should not hedge?

This is not the case because of the benefits associated with the hedging strategies. Apache should do hedging even if the manager is not very good at forecasting.

The hedging as stated above is not only helping the firm in growing its credit rating but it is also contributing in building its reputation of “closing the deal always” whichitthem the advantages in the acquisition market. As a result, this“financial flexibility” increases Apache’s ability to execute faster.

4.     What do Exhibit 10 and 11 tell us about the oil and gas price risk exposure of Apache?

Exhibit 10

It gives the betas of various comparable companies for the percentage change in oil and gas prices. By focusing on the Apache’s exposure to risk, this exhibit gives the beta for the % change in oil is 0.24 whereas, the value of beta is 0.42 for the percentage change in gas price. This reveals the fact that Apache’s return will increase/decrease by 0.24% per 1% increase/decrease in the oil price, keeping the gas price constant. In turn, this indicates that the firm’s return will increase/decrease by 0.42% per 1% increase/decrease in the gas price, holding the gas price constant……..

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