Alcoa 1998 Annual Report Download - page 36

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approximately 933,000 mt and 1,084,000 mt, respectively. These
contracts act to fix the purchase price for these metal purchase
requirements, thereby reducing Alcoa’s risk to rising metal prices.
A hypothetical 10% change from the 1998 year-end, three-month
LME aluminum ingot price of $1,244 per mt would result in a pretax
gain or loss to future earnings of $110 related to all of the futures
and options contracts noted above. However, it should be noted that
any change in the value of these contracts, real or hypothetical,
would be significantly offset by an inverse change in the value of
the underlying metal purchase transactions.
Earnings were selected as the measure of sensitivity due to the
historical relationship between aluminum ingot prices and Alcoa’s
earnings. The hypothetical change of 10% was calculated using a
parallel shift in the existing December 31, 1998 forward price curve
for aluminum ingot. The price curve takes into account the time
value of money, as well as future expectations regarding the price
of aluminum ingot. The model also assumes there will be no alumi-
num smelter capacity restarted by Alcoa.
The futures and options contracts noted above are with credit-
worthy counterparties and are further supported by cash, treasury
bills or irrevocable letters of credit issued by carefully chosen banks.
The expiration dates of the options and the delivery dates of the
futures contracts noted above do not always coincide exactly with
the dates on which Alcoa is required to purchase metal to meet
its contractual commitments with customers. Accordingly, some
of the futures and options positions will be rolled forward. This
may result in significant cash inflows if the hedging contracts are
‘‘in-the-money’’ at the time they are rolled forward. Conversely,
there could be significant cash outflows if metal prices fall below
the price of contracts being rolled forward.
In addition to the above noted aluminum positions, Alcoa had
29,000 mt and 259,000 mt of futures and options contracts outstand-
ing at year-end 1998 and 1997, respectively, that cover long-term,
fixed-price commitments to supply customers with metal from
internal sources. Accounting convention requires that these contracts
be marked-to-market, which resulted in after-tax charges to earn-
ings of $45 in 1998, $13 in 1997 and $57 in 1996. A hypothetical 10%
change in aluminum ingot prices from the year-end 1998 level of
$1,244 per mt would result in a pretax gain or loss of $3 related to
these positions. The hypothetical gain or loss was calculated using
the same model and assumptions noted earlier.
Alcoa also purchases certain other commodities, such as gas and
copper, for its operations and enters into futures contracts to elimi-
nate volatility in the prices of such products. None of these contracts
are material. For additional information on financial instruments,
see Notes A and T to the financial statements.
Foreign Exchange Risks — Alcoa is subject to significant exposure
from fluctuations in foreign currencies. As a matter of company
policy, foreign currency exchange contracts, including forwards and
options, are sometimes used to limit the risk of fluctuating exchange
rates. A hypothetical 10% change in applicable 1998 year-end
forward rates would result in a pretax gain or loss of approximately
$135 related to these positions. However, it should be noted that any
change in value of these contracts, real or hypothetical, would be
significantly offset by an inverse change in the value of the under-
lying hedged item. The model assumes a parallel shift in the
forward curve for the applicable currencies and includes the foreign
currency impacts of Alcoa’s cross-currency interest rate swaps.
SeeNotesAandTforinformationrelatedtotheaccountingpolicies
and fair market values of Alcoa’s foreign exchange contracts at
December 31, 1998 and 1997.
In early 1999, Brazil experienced a devaluation of its currency,
the real. Based on information currently available, Alcoa does not
believe that the devaluation will have a material impact on Alcoa’s
1999 results of operations.
Interest Rate Risks — Alcoa attempts to maintain a reasonable
balance between fixed- and floating-rate debt and uses interest
rate swaps and caps to keep financing costs as low as possible.
At December 31, 1998 and 1997, Alcoa had $3,489 and $1,952 of debt
outstanding at effective interest rates of 6% and 7%, respectively,
after the impact of interest rate swaps and caps is taken into
account. A hypothetical change of 10% in Alcoa’s effective interest
rate from year-end 1998 levels would increase or decrease interest
expense by $21. The interest rate effect of Alcoa’s cross-currency
interest rate swaps has been included in this analysis. For more
information related to Alcoa’s use of interest rate instruments, see
Note s A and T.
Risk Management — All of the aluminum and other commodity
contracts, as well as the various types of financial instruments,
are straightforward and are held for purposes other than trading.
They are used primarily to mitigate uncertainty and volatility, and
principally cover underlying exposures.
Alcoa’s commodity and derivative activities are subject to the
management, direction and control of the Strategic Risk Manage-
ment Committee
(SRMC) . SRMC is composed of the chief executive
officer, the president, the chief financial officer and other officers and
employees that the chief executive officer may select from time to
time.
SRMC reports to the board of directors at each of its scheduled
meetings on the scope of its derivative activities.
Material Limitations — The disclosures, with respect to aluminum
prices and foreign exchange risk, do not take into account the
underlying anticipated purchase obligations and the underlyingtrans-
actional foreign exchange exposures. If the underlying items were
included in the analysis, the gains or losses on the futures and
options contracts may be offset. Actual results will be determined
by a number of factors that are not under Alcoa’s control and could
vary significantly from those disclosed.
Environmental Matters
Alcoa continues to participate in environmental assessments and
cleanups at a number of locations, including at operating facilities
and adjoining properties, at previously owned or operated facilities
and at Superfund and other waste sites. A liability is recorded