BP 2008 Annual Report Download - page 145

BP Annual Report and Accounts 2008
Notes on financial statements
28. Financial instruments and financial risk factors continued
As described above, the group also carries out risk management of certain short-term natural business exposures using over-the-counter swaps and
exchange futures contracts with a duration of less than three years. In past periods commodity price risk relating to this activity has been managed
using value-at-risk measures. For 2008 a separate control framework is now used as described under market risk above. For these derivative contracts
the sensitivity of the net fair value to an immediate 10% increase or decrease in all reference prices would have been $90 million at 31 December
2008. This figure does not include any corresponding economic benefit or disbenefit that would arise from the natural business exposure which would
be expected to largely offset the gain or loss on the derivatives.
In addition, the group has embedded derivatives relating to certain natural gas and crude oil contracts. The net fair value of these embedded
derivatives was a liability of $1,867 million at 31 December 2008 (2007 liability of $2,085 million). Key information on the natural gas contracts is
given below.
At 31 December 2008 2007
Remaining contract terms 1 year 9 months to 9 years 9 months 9 months to 11 years
Contractual/notional amount 3,585 million therms 3,889 million therms
Discount rate – nominal risk free 2.5% 4.5%
For these embedded derivatives the sensitivity of the net fair value to an immediate 10% favourable or unfavourable change in the key assumptions is
as follows.
$ million
At 31 December 2008 2007
Discount Discount
Gas price Oil price Power price rate Gas price Oil price Power price rate
Favourable 10% change 291 81 27 16 317 72 37 31
Unfavourable 10% change (289) (81) (27) (16) (368) (84) (34) (32)
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 of the
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 indicative of
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 described as currency 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 conversion 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 managing such risk to keep
the 12-month foreign currency value at risk below $200 million. At 31 December 2008, the foreign currency value at risk was $70 million (2007
$60 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 34.
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, Korean won and Canadian dollar, and at 31 December 2008
open contracts were in place for $949 million sterling, $553 million euro, $392 million Norwegian krone, $303 million Australian dollar, $187 million
Korean won and $712 million Canadian dollar capital expenditures maturing within seven years, with over 65% of the deals maturing within two years
(2007 $732 million sterling, $931 million euro, $479 million Norwegian krone, $38 million Australian dollar, $243 million Korean won and $7 million
Canadian dollar capital expenditures maturing within eight years with over 80% of the deals maturing within two years).
For other UK, European, Canadian 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 2008, the open positions relating to cylinders consisted of receive sterling, pay
US dollar, purchased call and sold put options (cylinders) for $1,660 million (2007 $2,800 million); receive euro, pay US dollar cylinders for $1,612 million
(2007 $1,400 million); receive Canadian dollar, pay US dollar cylinders for $250 million (2007 nil); and receive Australian dollar, pay US dollar cylinders for
$455 million (2007 $382 million). At 31 December 2008, the open positions relating to currency forwards consisted of buy sterling, sell US dollar,
currency forwards for $816 million (2007 nil); buy euro, sell US dollar currency forwards for $141 million (2007 nil); buy Canadian dollar, sell US dollar,
currency forwards for $50 million (2007 nil); and buy Australian dollar, sell US dollar, currency forwards for $90 million (2007 nil).
In addition, most of the group’s borrowings are in US dollars or are hedged with respect to the US dollar. At 31 December 2008, the total
foreign currency net borrowings not swapped into US dollars amounted to $1,037 million (2007 $1,045 million). Of this total, $92 million was
denominated in currencies other than the functional currency of the individual operating unit being entirely Canadian dollars (2007 $268 million, being
$191 million in Canadian dollars and $77 million in Trinidad & Tobago 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 $9 million (2007 $27 million).
144