BP 2006 Annual Report Download - page 146

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36 Derivative financial instruments continued
The following tables show the net fair value of derivatives held for trading at 31 December analysed by maturity period and by methodology of fair value
estimation.
$ million
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2006
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Less than
1 year 1-2 years 2-3 years 3-4 years 4-5 years
Over
5 years Total
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Prices actively quoted 191 62 60 33 – 2 348
Prices sourced from observable data or market corroboration 911 29 54 19 36 4 1,053
Prices based on models and other valuation methods 30 (14) (12) (6) (8) 20 10
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1,132 77 102 46 28 26 1,411
$ million
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
2005
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Less than
1 year 1-2 years 2-3 years 3-4 years 4-5 years
Over
5 years Total
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Prices actively quoted (100) (86) 46 42 33 (8) (73)
Prices sourced from observable data or market corroboration 660 (48) (41) 60 (11) – 620
Prices based on models and other valuation methods 3 (2) 3 75 2 46 127
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563 (136) 8 177 24 38 674
Prices actively quoted refers to the fair value of contracts valued solely using quoted prices in an active market. Prices sourced from observable dataor
market corroboration refers to the fair value of contracts valued in part using active quotes and in part using observable, market-corroborated data for
example, swaps and physical forward contracts. Prices based on models and other valuation methods refers to the fair value of a contract valued in part
using internal models due to the absence of quoted prices, including over-the-counter options. The net change in fair value of contracts based on
models and other valuation methods during the year was a loss of $117 million (2005 $130 million gain).
Credit risk
Credit risk is the risk that the counterparty to the contract will fail to perform or fail to pay amounts due. The primary activities of the group are oil and
natural gas exploration and production, gas and power marketing and trading, oil refining and marketing and the manufacture and marketing of
petrochemicals. The group’s principal customers, suppliers and financial institutions with which it conducts business are located throughout the world.
The group has a credit policy that governs the management of credit risk, including the establishment of counterparty credit limits and specific
transaction approvals. The group limits credit risk by assessing creditworthiness of potential counterparties before entering into transactions with them
and continuing to evaluate their creditworthiness after transactions have been initiated. Creditworthiness is assessed using Moody’s Investors Service,
Standard & Poor’s and qualitative and quantitative data. The group attempts to mitigate credit risk by entering into contracts that permit netting and
allow for termination of the contract upon the occurrence of certain events of default. Depending upon the creditworthiness of the counterparty, the
group may require collateral in the form of cash deposits or letters of credit and parent company guarantees.
The maximum exposure of the group to credit risk is represented by the balance sheet carrying amount for all financial instruments within the scope
of IAS 32, principally derivative financial instruments, trade and other receivables and financial guarantees. Financial guarantees in respect of
equity-accounted entities were $1,123 million and financial guarantees in respect of third parties were $789 million at 31 December 2006. The
maximum exposure to credit risk does not take account of collateral of $689 million.
Trade and other derivative assets and liabilities are presented on a net basis where netting arrangements are in place with counterparties are
unconditional and where there is an intent to settle amounts due on a net basis
Market risk
The group measures its market risk exposure, i.e. potential gain or loss in fair values, on its held-for-trading activity using value-at-risk techniques. These
techniques are based on a variance/covariance model or a Monte Carlo simulation and make a statistical assessment of the market risk arising from
possible future changes in market values over a 24-hour period. The calculation of the range of potential changes in fair value takes into account a
snapshot of the end-of-day exposures and the history of one-day price movements, together with the correlation of these price movements. The group
calculates value at risk for the bulk of instruments and exposures in the held-for-trading category, other than the UK North Sea natural gas embedded
derivatives, for which a sensitivity analysis is calculated.
The potential movement in fair values is expressed to 1.65 standard deviations which is equivalent to a 95% confidence level. This means that, in
broad terms, one would expect to see an increase or a decrease in fair values greater than the value at risk on one occasion per month if the portfolio
were left unchanged.
The value-at-risk model takes account of derivative financial instrument types such as interest rate forward and futures contracts, swap agreements,
options and swaptions; foreign exchange forward and futures contracts, swap agreements and options, and oil, natural gas and power price futures,
swap agreements and options. Additionally, where physical commodities are held as part of a trading position, they are also included in these
calculations. For options, a linear approximation is included in the value-at-risk models, when full revaluation is not possible.
The following table shows values at risk for the held-for-trading activities described above.
Value at risk on 1.65 standard deviations $ million
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2006 2005
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
High Low Average Year end High Low Average Year end
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Interest rate trading 1–1–1–––
Currency trading 5–2–5121
Oil price trading 56 16 29 22 80 17 33 31
Natural gas price trading 29 10 19 15 39 6 15 17
Power price trading 1126316279