BP 2012 Annual Report Download - page 224

26. Financial instruments and financial risk factors continued
For these embedded derivatives the sensitivity of the net fair value to an immediate 10% favourable or adverse change in the key assumptions is as
follows.
$ million
At 31 December 2012 2011
Discount Discount
Gas price Oil price Power price rate Gas price Oil price Power price rate
Favourable 10% change 16 90 10 2 100 74 4 5
Unfavourable 10% change (33) (95) (10) (2) (109) (77) (4) (5)
The sensitivities for risk management activity and embedded derivatives are hypothetical and should not be considered to be predictive of future
performance. In addition, for the purposes of this analysis, in the above table, the effect of a variation in a particular assumption on the fair value ofthe
embedded derivatives is calculated independently of any change in another assumption. In reality, changes in one factor may contribute to changes in
another, which may magnify or counteract the sensitivities. Furthermore, the estimated fair values as disclosed should not be considered indicativeof
future earnings on these contracts.
(ii) Foreign currency exchange risk
Where the group enters into foreign currency exchange contracts for entrepreneurial trading purposes the activity is controlled using trading value-at-risk
techniques as explained above. This activity is included within oil price trading in the value-at-risk table above.
Since BP has global operations, fluctuations in foreign currency exchange rates can have significant effects on the group’s reported results. The effects
of most exchange rate fluctuations are absorbed in business operating results through changing cost competitiveness, lags in market adjustment to
movements in rates and translation differences accounted for on specific transactions. For this reason, the total effect of exchange rate fluctuations is
not identifiable separately in the group’s reported results. The main underlying economic currency of the group’s cash flows is the US dollar. This is
because BP’s major product, oil, is priced internationally in US dollars. BP’s foreign currency exchange management policy is to minimize economic and
material transactional exposures arising from currency movements against the US dollar. The group co-ordinates the handling of foreign currency
exchange risks centrally, by netting off naturally-occurring opposite exposures wherever possible, and then dealing with any material residual foreign
currency exchange risks.
The group manages these exposures by constantly reviewing the foreign currency economic value at risk and aims to manage such risk to keep the
12-month foreign currency value at risk below $200 million. At 31 December 2012, the foreign currency value at risk was $71 million (2011 $100 million).
At no point over the past three years did the value at risk exceed the maximum risk limit. The most significant exposures relate to capital expenditure
commitments and other UK and European operational requirements, for which a hedging programme is in place and hedge accounting is claimed as
outlined in Note 33.
For highly probable forecast capital expenditures the group locks in the US dollar cost of non-US dollar supplies by using currency forwards and futures.
The main exposures are sterling, euro, Norwegian krone, Australian dollar and Korean won and at 31 December 2012 open contracts were in place for
$853 million sterling, $104 million euro, $172 million Norwegian krone, $112 million Australian dollar and $153 million Korean won capital expenditures
maturing within seven years, with over 68% of the deals maturing within two years (2011 $1,242 million sterling, $158 million euro, $118 million
Norwegian krone, $210 million Australian dollar and $230 million Korean won capital expenditures maturing within five years, with over 69% of the deals
maturing within two years).
For other UK, European and Australian operational requirements the group uses cylinders and currency forwards to hedge the estimated exposures on a
12-month rolling basis. At 31 December 2012, the open positions relating to cylinders consisted of receive sterling, pay US dollar, purchased call and
sold put options (cylinders) for $2,886 million (2011 $2,683 million); receive euro, pay US dollar cylinders for $1,636 million (2011 $1,304 million); receive
Australian dollar, pay US dollar cylinders for $522 million (2011 $312 million).
In addition, most of the group’s borrowings are in US dollars or are hedged with respect to the US dollar. At 31 December 2012, the total foreign
currency net borrowings not swapped into US dollars amounted to $361 million (2011 $371 million). Of this total, $142 million was denominated in
currencies other than the functional currency of the individual operating unit being entirely Canadian dollars (2011 $129 million, being entirely Canadian
dollars). It is estimated that a 10% change in the corresponding exchange rates would result in an exchange gain or loss in the income statement of
$14 million (2011 $13 million).
(iii) Interest rate risk
Where the group enters into money market contracts for entrepreneurial trading purposes the activity is controlled using value-at-risk techniques as
described above. This activity is included within oil price trading in the value-at-risk table above.
BP is also exposed to interest rate risk from the possibility that changes in interest rates will affect future cash flows or the fair values of its financial
instruments, principally finance debt. While the group issues debt in a variety of currencies based on market opportunities, it uses derivatives to swap
the debt to a floating rate exposure, mainly to US dollar floating, but in certain defined circumstances maintains a US dollar fixed rate exposure for a
proportion of debt. The proportion of floating rate debt net of interest rate swaps and excluding disposal deposits at 31 December 2012 was 65% of
total finance debt outstanding (2011 65%). The weighted average interest rate on finance debt at 31 December 2012 is 2% (2011 2%) and the weighted
average maturity of fixed rate debt is four years (2011 five years).
The group’s earnings are sensitive to changes in interest rates on the floating rate element of the group’s finance debt. If the interest rates applicable to
floating rate instruments were to have increased by 1% on 1 January 2013, it is estimated that the group’s finance costs for 2013 would increase by
approximately $311 million (2011 $289 million increase in 2012). This assumes that the amount and mix of fixed and floating rate debt, including finance
leases, remains unchanged from that in place at 31 December 2012 and that the change in interest rates is effective from the beginning of the year.
Where the interest rate applicable to an instrument is reset during a quarter it is assumed that this occurs at the beginning of the quarter and remains
unchanged for the rest of the year. In reality, the fixed/floating rate mix will fluctuate over the year and interest rates will change continually.
Furthermore, the effect on earnings shown by this analysis does not consider the effect of any other changes in general economic activity that may
accompany such an increase in interest rates.
222 Financial statements
BP Annual Report and Form 20-F 2012