BP 2011 Annual Report Download - page 113

BP Annual Report and Form 20-F 2011 111
Business review: BP in more depth
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part of a larger portfolio of similar transactions. Gains and losses arising
are recognized in the income statement from the time the derivative
commodity contract is entered into.
IFRS requires that inventory held for trading be recorded at its
fair value using period end spot prices whereas any related derivative
commodity instruments are required to be recorded at values based on
forward prices consistent with the contract maturity. Depending on market
conditions, these forward prices can be either higher or lower than spot
prices resulting in measurement differences.
BP enters into contracts for pipelines and storage capacity, oil
and gas processing and liquefied natural gas (LNG) that, under IFRS, are
recorded on an accruals basis. These contracts are risk-managed using a
variety of derivative instruments, which are fair valued under IFRS. This
results in measurement differences in relation to recognition of gains and
losses.
The way that BP manages the economic exposures described
above, and measures performance internally, differs from the way these
activities are measured under IFRS. BP calculates this difference for
consolidated entities by comparing the IFRS result with management’s
internal measure of performance. Under management’s internal measure
of performance the inventory, capacity, oil and gas processing and LNG
contracts in question are valued based on fair value using relevant forward
prices prevailing at the end of the period and the commodity contracts for
business requirements are accounted for on an accruals basis. We believe
that disclosing management’s estimate of this difference provides useful
information for investors because it enables investors to see the economic
effect of these activities as a whole. The impacts of fair value accounting
effects, relative to management’s internal measure of performance and a
reconciliation to GAAP information is shown on page 58.
Commodity trading contracts
BP’s Exploration and Production and Refining and Marketing segments
both participate in regional and global commodity trading markets in order
to manage, transact and hedge the crude oil, refined products and natural
gas that the group either produces or consumes in its manufacturing
operations. These physical trading activities, together with associated
incremental trading opportunities, are discussed further in Exploration and
Production on pages 88-89 and in Refining and Marketing on page 98.
The range of contracts the group enters into in its commodity trading
operations is as follows.
Exchange-traded commodity derivatives
These contracts are typically in the form of futures and options traded on
a recognized exchange, such as Nymex, SGX and ICE. Such contracts
are traded in standard specifications for the main marker crude oils, such
as Brent and West Texas Intermediate, the main product grades, such
as gasoline and gasoil, and for natural gas and power. Gains and losses,
otherwise referred to as variation margins, are settled on a daily basis
with the relevant exchange. These contracts are used for the trading and
risk management of crude oil, refined products, natural gas and power.
Realized and unrealized gains and losses on exchange-traded commodity
derivatives are included in sales and other operating revenues for
accounting purposes.
Over-the-counter contracts
These contracts are typically in the form of forwards, swaps and options.
Some of these contracts are traded bilaterally between counterparties;
others may be cleared by a central clearing counterparty. These contracts
can be used both for trading and risk management activities. Realized and
unrealized gains and losses on OTC contracts are included in sales and
other operating revenues for accounting purposes.
The main grades of crude oil bought and sold forward using
standard contracts are West Texas Intermediate and a standard North
Sea crude blend (Brent, Forties and Oseberg or BFO). Although the
contracts specify physical delivery terms for each crude blend, a significant
number are not settled physically. The contracts typically contain standard
delivery, pricing and settlement terms. Additionally, the BFO contract
specifies a standard volume and tolerance given that the physically settled
transactions are delivered by cargo.
Gas and power OTC markets are highly developed in North America and
the UK, where the commodities can be bought and sold for delivery in
future periods. These contracts are negotiated between two parties to
purchase and sell gas and power at a specified price, with delivery and
settlement at a future date. Typically, these contracts specify delivery
terms for the underlying commodity. Certain of these transactions are not
settled physically, which can be achieved by transacting offsetting sale
or purchase contracts for the same location and delivery period that are
offset during the scheduling of delivery or dispatch. The contracts contain
standard terms such as delivery point, pricing mechanism, settlement
terms and specification of the commodity. Typically, volume and price are
the main variable terms.
Swaps are often contractual obligations to exchange cash flows
between two parties: a typical swap transaction usually references a
floating price and a fixed price with the net difference of the cash flows
being settled. Options give the holder the right, but not the obligation, to
buy or sell crude, oil products, natural gas or power at a specified price on
or before a specific future date. Amounts under these derivative financial
instruments are settled at expiry. Typically, netting agreements are used to
limit credit exposure and support liquidity.
Spot and term contracts
Spot contracts are contracts to purchase or sell a commodity at the market
price prevailing on or around the delivery date when title to the inventory
is taken. Term contracts are contracts to purchase or sell a commodity at
regular intervals over an agreed term. Though spot and term contracts may
have a standard form, there is no offsetting mechanism in place. These
transactions result in physical delivery with operational and price risk. Spot
and term contracts typically relate to purchases of crude for a refinery,
purchases of products for marketing, purchases of third-party natural
gas, sales of the group’s oil production, sales of the group’s oil products
and sales of the group’s gas production to third parties. For accounting
purposes, spot and term sales are included in sales and other operating
revenues, when title passes. Similarly, spot and term purchases are
included in purchases for accounting purposes.