Continuing our popular series of interviews with senior figures in the world of treasury and finance, this month talking to John O’Driscoll, Group Director of Treasury & Corporate Finance, BG Group.

BG is an integrated gas major, and its core business is the development, management and supply of existing and newly emerging gas markets around the world. It is active in all aspects of the gas chain, including exploration and production (which represents between 60% and 70% of the business), transmission and distribution, liquefied natural gas (‘LNG’) and power.

BG is active in over 20 countries worldwide. The UK is still important with the North Sea still representing close to half of the group’s production. It also has major activities in Latin America, Kazakhstan, Egypt, Trinidad and India. In market capitalisation terms, at approximately £9.5 billion, BG ranks 26^th in the FTSE-100 and is the largest of the three successor companies to British Gas – the others being Lattice Group (Transco) and Centrica.

As treasurer, for what are you responsible? How have you structured the treasury?

There are five main sections within the BG treasury. The first two are what would be considered the core treasury functions.

1. Funding and investment.

   This has responsibility for all core funding, bank relationships, credit ratings and interest rate and foreign exchange risk management.

2. The core back office.

   Including banking operations and settlement.

   We then have three further sections that, whilst not unique to BG, do assume a higher profile here:

3. A structured finance team.

   Because of the nature of our business, we use a lot of project finance. For example, where we are developing an LNG facility (that cools gas into a liquefied form so that it can be transported by ship), we may choose to use non-recourse finance. This work can provide a different emphasis for the BG treasury compared to treasuries elsewhere.

4. Corporate finance.

   This covers anything that we are doing on the equity or balance sheet structuring side – such as doing buy-backs, convertibles and the dividend policy (although this is determined by the board with input from ourselves).

5. Insurance.

   I am also responsible for the Group’s insurance programme, which takes up about 15% of my time.

We also have treasury managers in Brazil and Singapore, who look after any treasury issues in those regions. Although as a treasury we are very centralised, where necessary they will coordinate activity locally, for example for any project financing.

Although British Gas has been around for a long time, BG Group in its current form only came into existence in late 2000. This meant that we had the opportunity to start the treasury effectively from scratch, which was a major part of the initial challenge of this job. For example, all of the policies on foreign exchange risk management had to be rewritten and revised to make them fit the shape of the new group. This is because whereas the old group was completely dominated by sterling cash flows, BG has more foreign currency flows and so foreign exchange risk is a huge issue.

How are you held accountable?

I report to the Finance Director, who is on the main board. There is also a Finance Committee of the board, consisting of the Chairman, Chief Exec and Finance Director, which has remit for treasury and finance issues. I report to them at quarterly meetings. The board has delegated most of its finance responsibilities to its Finance Committee.

As a treasury, we act as a cost centre. What derivative activity we do have here is for hedging existing positions; we don’t trade on our own account.

As a new entity, how have you approached funding issues?

The former British Gas had a huge debt book, most of which went on demerger to Transco, the regulated utility. As a result, BG has got relatively low levels of debt – our gearing at the end of the third quarter of 2001 was 17%.

Because we are essentially a new credit, we have had to establish ourselves since we demerged. The first step was to get credit ratings. We have three – at the moment we have low single A from Moody’s and Fitch and from S&P, BBB+ , with a positive outlook that we are hoping will translate into an upgrade before very long.

We then put in place the key components of the funding structure. They are:-

• Committed lines.

  The first thing we put in place was a series of bilateral committed lines ($1.25 billion) from a group of relationship banks. I might say here that relationship banking is key to the way we manage treasury operations in BG; we do try and put business wherever possible to this group of banks.

• A USCP programme, $1 billion in size.
• Our portfolio of uncommitted lines is about $750m, which enables us to do bills and acceptances and money market borrowing.
• A Euro CP programme, also for $1 billion, was established.
• Finally, we made our debut in the bond market as BG, with a 7-year £200m sterling issue in June 2001.

The next step is to set up an EMTN programme.

In quite a short period of time, we have put all the basic building blocks in place that we need to be able to access whatever markets we want. Virtually all of our debt is denominated in dollars, because many of our assets are US dollar assets; the gas and oil that is sold on world markets is usually either priced in US dollars or linked to dollars through indices.

At the moment our debt is quite low, so most of our assets have been funded by equity, and a fair amount of the debt that we do have is carried as short-term debt. We do have some long-term debt, such as the seven-year bond we issued last year. As the debt of BG grows, I would expect to have a more evenly spread profile. In addition, we have very strict refinancing risk constraints, set by the board’s Finance Committee, such that we don’t allow more than a specified amount of debt to mature within defined periods.

Is the low debt gearing a function of the relative youth of the company?

Partly, yes. But the nature of the company is such that we wouldn’t have a very high gearing anyway – the exploration business is quite high risk where one wouldn’t expect to have a lot of debt. Secondly, as a group, we have an objective to have a rating in the single A category. That is important to us – not necessarily from the treasury viewpoint – because BG is a company doing business all around the world and has to represent itself to governments and potential joint venture partners as a partner of choice. It is important that we are perceived to be financially strong to make sure that we are chosen to work on the projects we want to be. Having an A rating is an important part of that strategy, although it will mean some financial constraints, such as operating with a lower gearing for any particular business mix.

How does the work of the structured finance section fit?

For a number of reasons, it can often make sense for us to raise project finance to fund certain developments such as, for example, a gas-fired power station or a liquefied natural gas facility.

1. First it is difficult to project finance the ‘upstream’ work – i.e. exploration in the North Sea. Therefore we want to preserve the core debt capacity of the group for this. For ‘midstream’ work – i.e. power or LNG – there is nonrecourse finance available and it makes sense to raise it.
2. Secondly, we have a lot of joint ventures with the other big players in the energy sector. For example, Atlantic LNG (our LNG facility in Trinidad) is a joint venture between BG, BP and Repsol. With such a group, it may make sense to raise finance at the entity level or joint venture level.
3. The other advantage is that project financing can bring a certain amount of political risk mitigation. In emerging markets, if the banks have a stake in the project, if something goes wrong, they can bring additional pressure to bear to make sure it works.

At the moment, for example, we want to raise project finance for an LNG facility in Egypt, from where the gas will be transported by ship to Italy, Spain or even the United States. In any such project, there will be commercial contracts e.g. the LNG will be sold on a long-term contract, and these can be structured in different ways. The ideal way will depend on the circumstances of each particular venture and will also determine the financeability of the project.

Because a successful project financing will be dependent on the structure of the commercial contracts, it is important that treasury people are involved in this structuring from the beginning. Because of this, the structured finance people have to be very close to the business, so that they can understand the issues, including the interests of the banks offering the project finance. Our people tend to spend a lot of time outside the UK with the local teams, with the projects often having a gestation period of a couple of years.

Are there any other distinctive features in the financing of BG?

The structure of our activities also has implications for treasury. There are three types of business within BG:

• There are the businesses that we fully own and run ourselves.
• We have interests in a number of joint ventures around the world. These can often be financed by non-recourse debt, so, for example, much of what we did in Trinidad was actually financed by the banks at the joint venture level.
• Finally BG controls, but does not completely own, several of our large assets. These tend to be the ‘downstream’, gas distribution companies. The three main ones are Comgas (distribution for Sao Paolo, Brazil), MetroGas (distribution for Buenos Aires, Argentina) and Gujarat Gas (India).

This third category of majority-owned assets provides me with a different challenge. In all three companies (Comgas, MetroGas and Gujarat Gas), although we consolidate the company’s debt on our balance sheet each company has its own treasury and borrowing programme. There is a governance issue here. Whilst the individual company treasurers need to do what they have to do, I need to influence them to make sure that their policies are aligned with those of BG and they are not taking on any risks in their treasury operations that we, as principal shareholders, would be unhappy with. In theory, we influence them through the directors we have on their boards. In practice, we also have good close working relationships with their treasuries. An example would be Comgas in Brazil – its revenue is almost completely in Brazilian Reals and we would not want them to take on debt in anything else apart from Reals. So even should they be offered good terms on US dollar debt, we would not want them to take on that exchange risk. This does not prevent them borrowing in other currencies provided that it is swapped into Reals.

What are the main risks that you face?

We face four main risks; foreign exchange risk, interest rate risk, counterparty risk and refinancing risk.

How do you measure and manage foreign exchange risk?

Given the international portfolio that we have, foreign exchange risk is key. US Dollar risk is the main risk that we have; we mitigate that primarily by having the debt that we have denominated in dollars, so if it is raised in anything else, it is swapped into USD. There is still some residual risk there but we understand our shareholders to be happy with that.

We also have other foreign exchange risks, which arise primarily from Brazil, Argentina and India. In these countries, the downstream companies sell gas locally and receive local revenues. In these cases, we influence the treasury to make sure that they don’t take on undue foreign exchange risk. Clearly the recent failure of the convertibility regime in Argentina is a big concern for us, and we are working with the business to try to mitigate the consequences of this.

How about interest rate risk?

Interest rate risk is much more straightforward. We actively manage the interest rate risk that we have. The Finance Committee of the board sets a benchmark, which will vary from time to time, but which could be, say, 60% floating, 40% fixed. Treasury then has discretion to move away from that – we may have a band so if the benchmark was 60% floating then we might be able to move between 45% and 75%. We would then through a formal risk management process form our own views as to where rates are going and position accordingly. Our performance is then compared with what would have been the case had we just stuck with the benchmark that had been set.

We mainly use swaps, although we also use FRAs to a certain extent. But usually we will just put on or take off swaps as the case may be. Obviously wherever we can we will take off swaps rather than put them on, because of the counterparty risk.

When we look at interest rate risk, we are aiming to minimise the total financing charge, i.e. the interest charge plus the change in the market value of the debt.

How much of an issue have you found the FAS 133 regulations?

We have had to introduce it in the reconciliation between the US and UK GAAP. It is a lot of work. We recognise that it’s the trend and, even if the UK standard doesn’t go quite that far now, it will move some way in the same direction. We need to mark all of our liabilities and associated derivatives to market anyway for the purposes of the benchmarking system that we have, so we already have the technology in place to do that.