BP 2007 Annual Report Download - page 38

36
business in North America. Our NGLs activity is underpinned by our
upstream resources and serves third-party markets for chemicals and
clean fuels as well as supplying BP’s refining activities.
Globally, the power sector is the largest source of greenhouse gas
(GHG) emissions, responsible for around twice the emissions of
transport, so creating low-carbon power is critical in the effort to stabilize
global GHG levels. BP is focused on power generation activities with low-
carbon emissions through its Alternative Energy business, extending
significantly our capabilities in solar, wind power, hydrogen power and
gas-fired power generation.
Capital expenditure and acquisitions in 2007 was $874 million,
compared with $688 million in 2006 and $235 million in 2005. In 2007,
we acquired Wasatch Energy L.L.C. in the US and in 2006 our
acquisitions included Orion Energy, LLC and Greenlight Energy, Inc. In
2005 there were no acquisitions.
Marketing and trading activities
Gas and power marketing and trading activity is undertaken primarily in
the US, Canada, the UK and Europe to market BP’s gas and power
production and manage market price risk as well as to create incremental
trading opportunities through the use of commodity derivative contracts.
Additionally, this activity generates fee income and enhanced margins
from sources such as the management of price risk on behalf of third-
party customers. These markets are large, liquid and volatile and the
group enters into these transactions on a large scale to meet these
objectives.
The group also has an NGLs trading activity in the US for delivering
value across the overall NGLs supply chain, sourcing optimal feedstock
for our processing assets and securing access to markets with flexible
and competitive supply.
In connection with the above activities, the group uses a range of
commodity derivative contracts and storage and transport contracts.
These include commodity derivatives such as futures, swaps and options
to manage price risk and forward contracts used to buy and sell gas and
power in the marketplace. Using these contracts, in combination with
rights to access storage and transportation capacity, allows the group to
access advantageous pricing differences between locations, time periods
and arbitrage between markets. Gas futures and options are traded
through exchanges, while over-the-counter (OTC) options and swaps are
used for both gas and power transactions through bilateral arrangements.
Futures and options are primarily used to trade the key index prices such
as Henry Hub, while swaps can be tailored to price with reference to
specific delivery locations where gas and power can be bought and sold.
OTC forward contracts have evolved in both the US and UK markets,
enabling gas and power to be sold forward in a variety of locations and
future periods. These contracts are used both to sell production into the
wholesale markets and as trading instruments to buy and sell gas and
power in future periods. Capacity contracts allow the group to store,
transport gas and transmit power between these locations. Additionally,
activity is undertaken to risk-manage power generation margins related
to the Texas City co-generation plant using a range of gas and power
commodity derivatives.
The range of contracts that the group enters into is described below in
more detail:
– Exchange-traded commodity derivatives
Exchange-traded commodity derivatives include gas and power
futures contracts. Though potentially settled physically, these
contracts are typically settled financially. Gains and losses, otherwise
referred to as variation margins, are settled on a daily basis with the
relevant exchange. Realized and unrealized gains and losses on
exchange-traded commodity derivatives are included in sales and
other operating revenues for accounting purposes.
– OTC contracts
These contracts are typically in the form of forwards, swaps and
options. OTC contracts are negotiated between two parties and are
not traded on an exchange. These contracts can be used both as part
of 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. Highly-developed
markets exist in North America and the UK where gas and power 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.
Although these contracts specify delivery terms for the underlying
commodity, in practice a significant volume of these transactions are
not settled physically. This 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 contractual obligations to exchange cash flows between
two parties. One usually references a floating price and the other 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
natural gas products or power at a specified price on or before a
specific future date. Amounts under these derivative financial
instruments are settled at expiry, typically through netting agreements
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 the delivery date when title to the inventory
passes. 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 relate typically to purchases of
third-party gas and sales of the group’s gas production to third parties.
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.
See Financial and operating performance – Gas, Power and
Renewables on page 50.
Trading investigations
See Legal proceedings on page 84 for details regarding investigations
into various aspects of BP’s trading activities.
During 2007, the group has taken a series of measures in relation to its
trading compliance processes, systems and controls. These measures
include increasing its compliance resources in the US and elsewhere,
continuing to implement an enhanced compliance framework and
programme that includes compliance monitoring of trading operations,
and the ongoing development and implementation of operating standards
and processes. In the US, the deferred prosecution agreement (DPA)
between BP America Inc. (BP America) and the US Department of
Justice has resulted in the appointment of an independent monitor to
oversee compliance with the DPA. The independent monitor has
authority to investigate and report alleged violations of the US
Commodity Exchange Act or US Commodity Futures Trading
Commission regulations and to recommend corrective action.
North America
BP has a significant wholesale gas and power marketing and trading
business in North America. Our business has been built on the
foundation of our position as one of the continent’s leading producers of
gas based on volumes. Our gas activity in the US and Canada has grown
during the past few years as the group increased its scale through both
organic growth of operations and the acquisition of smaller marketing
and trading companies, increasing reach into additional markets. At the
same time, the overall volumes in these markets have also increased.
The group also trades power, in addition to selling and risk managing
production from the Texas City co-generation facility in the US.
Our North American natural gas marketing and trading strategy seeks
to provide unconstrained market access for BP’s equity gas. Our
marketing strategy targets high-value customer segments through fully
utilizing our rights to store and transport gas. These assets include those