Much has been made lately of how to attract and retain talent in the oil and gas industry (OGJ, Sept. 24, 2001, p. 22).
While there is much ado about employment incentives such as opportunities for career growth, challenging and enriching work assignments, and flexibility on work-life balance, let's face it: A prime motivator is compensation.
Let's face another fact: Those toiling in the oil and gas industry are generally well-paid, especially in comparison with other businesses. So it behooves industry to go beyond salary in order to retain talent with golden handcuffs, and that usually means compensation in the form of stock or stock options.
Stock market plunge
But the massive plunge in stock markets this year has taken some of the luster off stock-related compensation. Everyone from the average Joe, cringing when his 401(k) went south, to Bill Gates-$10 billion lighter this year vs. last, poor fellow-is worried about how much of his or her compensation or net worth is tied up in stocks.
This is especially true of those, ahem, slightly more mature folks of Boomer ilk who now dominate the ranks of the industry. Many such individuals may have a huge chunk of their net worth tied up in a single stock position and are looking at retirement within a decade or so-not counting, of course, all those professionals "retired" into consultancy with severance packages during the latest downturn.
And while oil industry stocks still tend to be undervalued, the extreme volatility of the stock market these days-not to mention oil and gas markets-has a lot of these folks a bit nervous.
Someone close to retirement may need to liquidate his stockholdings only to find them down more than 50% from recent highs.
Managing risk
There's a way to manage risk in a concentrated stock position, says Houston-based UBS PaineWebber financial advisor Amor Atasi: variable prepaid forward contracts, in which an investor agrees to deliver a variable amount of stock (or an equivalent cash amount) in the future but receives proceeds for it today. This entails hedging the stock with an equity collar, which is a combination of purchasing a put option and selling a call option to offset the cost of purchasing the put.
By purchasing a put option, says Atasi, the investor can ensure that he can sell the stock at a specific, predetermined price, even if the market price is lower.
By selling the call option, the investor is obliged to sell the stock for a specific, predetermined price, even if the market price is higher.
If the investor is willing to forgo appreciation of the stock above a certain level, he can sell the call option to generate funds to offset the cost of buying the put option.
Hypothetical investor
Atasi explained using a hypothetical employee of Enron Corp., whose stock gyrations have been the buzz of Wall Street lately.
"Let's say that, a year ago, when Enron stock was around $80/share, an Enron employee owned 25,000 shares of Enron, which makes up about 80% of his net worth," he said. "The em- ployee was several years away from retirement but was worried about his future being dependent on one stock. He wanted to lock in the $80 market value but did not wish to sell the stock because he did not want to pay taxes and because he was bullish on the stock."
Using a variable prepaid forward contract, the employee sells his stock to a broker for $80/share but does not deliver those shares for a number of years, negotiated in the contract. The value on delivery is $2 million.
If he wants payment today for that future sale, he gets the discounted present value of that future amount-at current interest rates, that's $1.7 million.
"In the meantime, the employee gets to invest the proceeds in a diversified portfolio, thus lowering his risk. The employee would also benefit if Enron's stock price increases," Atasi noted. "If the stock goes up, the number of shares the employee will have to deliver will go down because it would take fewer shares to equal the $2 million he has to deliver." That benefit is capped at a predetermined ceiling. But the reverse is not true, Atasi explains: "If Enron's price goes down, the number of shares the employee has to deliver does not go up. It is fixed at 25,000 shares. So the employee has the potential to participate in the upside without any downside risk if the price of Enron declines."
In addition, the employee will not have to pay capital gains taxes until the shares are delivered-and the capital gains would be on the $1.7 million, not the $2 million, Atasi notes.
For those masochists among our readers, that's just enough funds to grubstake another little independent oil and gas company-or for the others, enough for that bed-and-breakfast the better half wants in Toad Suck, Ark.
