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Bootstrap Mining, an independent coal mining company, wants to expand its mining operations in central Appalachia. The company wants reliable cash flows in order to determine its ability to capitalize on mining opportunities for the next three years.
To help accomplish this objective, Bootstrap enters into a three-year swap agreement with Enron to hedge 25% of its current production at a fixed price of 108¢/MMBtu (Bootstrap sells the fixed price leg of a financial swap to Enron).
With this cash flow assurance, Bootstrap can better leverage its existing resources to build its future production capacity.
During the life of this swap:
- Bootstrap continues to sell coal to its customers at market price.
- Bootstrap and Enron exchange payments on a quarterly basis equal to the difference between the fixed price of 108¢/MMBtu and the floating index price, as specified in the swap agreement.
For example, if the index price for a given month is 102¢/MMBtu, Bootstrap will receive $0.06/MMBtu from Enron. However, if the index price is 112¢/MMBtu, Bootstrap will pay Enron $0.04/MMBtu.
- Bootstrap has stabilized a portion of its operating cash flow with the swap. This swap gives the company a fixed margin for a portion of their production and opens up financing opportunities that allow for participation in additional mining opportunities.
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