BP 2014 Annual Report Download - page 154

28. Derivative financial instruments – continued
Level 3 derivatives
The following table shows the changes during the year in the net fair value of derivatives held for trading purposes within level 3 of the fair value
hierarchy.
$ million
Oil
price
Natural gas
price
Power
price Other Total
Net fair value of contracts at 1 January 2014 (18) 313 86 475 856
Gains recognized in the income statement 350 152 141 94 737
Settlements (86) (56) (13) (180) (335)
Transfers out of level 3 – (228) – – (228)
Net fair value of contracts at 31 December 2014 246 181 214 389 1,030
$ million
Oil
price
Natural gas
price
Power
price Other Total
Net fair value of contracts at 1 January 2013 105 304 (43) 71 437
Gains (losses) recognized in the income statement (47) 62 81 – 96
Purchases 110 1 – – 111
New contracts – – – 475 475
Settlements (143) (52) 10 (71) (256)
Transfers out of level 3 (43) (1) 36 – (8)
Exchange adjustments – (1) 2 – 1
Net fair value of contracts at 31 December 2013 (18) 313 86 475 856
The amount recognized in the income statement for the year relating to level 3 held for trading derivatives still held at 31 December 2014 was a
$456 million gain (2013 $110 million gain related to derivatives still held at 31 December 2013).
The most significant gross assets and liabilities categorized in level 3 of the fair value hierarchy are US natural gas contracts. At 31 December 2014, the
gross US natural gas price instruments dependent on inputs at level 3 of the fair value hierarchy were an asset of $586 million and liability of $526
million (net fair value of $60 million), with $126 million, net, valued using level 2 inputs. US natural gas price derivatives are valued using observable
market data for maturities up to 60 months in basis locations that trade at a premium or discount to the NYMEX Henry Hub price, and using internally
developed price curves based on economic forecasts for periods beyond that time. The significant unobservable inputs for fair value measurements
categorized within level 3 of the fair value hierarchy for the year ended 31 December 2014 are presented below.
Unobservable inputs
Range
$/mmBtu
Weighted average
$/mmBtu
Natural gas price contracts Long-dated market price 3.44-6.39 4.64
If the natural gas prices after 2019 were 10% higher (lower), this would result in a decrease (increase) in derivative assets of $85 million, and decrease
(increase) in derivative liabilities of $64 million, and a net decrease (increase) in profit before tax of $21 million.
Derivative gains and losses
Gains and losses relating to derivative contracts are included within sales and other operating revenues and within purchases in the income statement
depending upon the nature of the activity and type of contract involved. The contract types treated in this way include futures, options, swaps and
certain forward sales and forward purchases contracts, and relate to both currency and commodity trading activities. Gains or losses arise on contracts
entered into for risk management purposes, optimization activity and entrepreneurial trading. They also arise on certain contracts that are for normal
procurement or sales activity for the group but that are required to be fair valued under accounting standards. Also included within sales and other
operating revenues are gains and losses on inventory held for trading purposes. The total amount relating to all these items (excluding gains and losses
on realized physical derivative contracts that have been reflected gross in the income statement within sales and purchases) was a net gain of
$6,154 million (2013 $587 million net gain and 2012 $411 million net loss). This number does not include gains and losses on realized physical
derivative contracts that have been reflected gross in the income statement within sales and purchases or the change in value of transportation and
storage contracts which are not recognized under IFRS, but does include the associated financially settled contracts. The net amount for actual gains
and losses relating to derivative contracts and all related items therefore differs significantly from the amount disclosed above.
Embedded derivatives
The group is a party to certain natural gas contracts containing embedded derivatives. Prior to the development of an active gas trading market, UK gas
contracts were priced using a basket of available price indices, primarily relating to oil products, power and inflation. After the development of an active
UK gas market, certain contracts were entered into or renegotiated using pricing formulae not directly related to gas prices, for example, oil product
and power prices. In these circumstances, pricing formulae have been determined to be derivatives, embedded within the overall contractual
arrangements that are not clearly and closely related to the underlying commodity. The resulting fair value relating to these contracts is recognizedon
the balance sheet with gains or losses recognized in the income statement.
Key information on the natural gas contracts is given below.
At 31 December 2014 2013
Remaining contract terms 5 months to 3 years and 9 months 1 year and 5 months to 4 years and 9 months
Contractual/notional amount 70 million therms 153 million therms
150 BP Annual Report and Form 20-F 2014