BP 2014 Annual Report Download - page 111

1. Significant accounting policies, judgements, estimates and assumptions – continued
Significant estimate or judgement: valuation of derivatives
In some cases the fair values of derivatives are estimated using internal models due to the absence of quoted prices or other observable, market-
corroborated data. This applies to the group’s longer-term derivative contracts and certain options, as well as to the majority of the group’s
embedded derivatives. These embedded derivatives arise primarily from long-term UK natural gas contracts that use pricing formulae not related to
gas prices, for example, oil product and power prices. The majority of these contracts are valued using models with inputs that include price curves
for each of the different products that are built up from active market pricing data and extrapolated to the expiry of the contracts using the maximum
available external pricing information. Additionally, where limited data exists for certain products, prices are interpolated using historic and long-term
pricing relationships. Price volatility is also an input for the models.
Changes in the key assumptions could have a material impact on the fair value gains and losses on derivatives and embedded derivatives recognized
in the income statement. For more information see Note 28.
Offsetting of financial assets and liabilities
Financial assets and liabilities are presented gross in the balance sheet unless both of the following criteria are met: the group currently has a legally
enforceable right to set off the recognized amounts; and the group intends to either settle on a net basis or realize the asset and settle the liability
simultaneously. A right of set off is the group’s legal right to settle an amount payable to a creditor by applying against it an amount receivable from the
same counterparty. The relevant legal jurisdiction and laws applicable to the relationships between the parties are considered when assessing whether
a current legally enforceable right to set off exists.
Provisions, contingencies and reimbursement assets
Provisions are recognized when the group has a present legal or constructive obligation as a result of a past event, it is probable that an outflow of
resources embodying economic benefits will be required to settle the obligation and a reliable estimate can be made of the amount of the obligation.
Where appropriate, the future cash flow estimates are adjusted to reflect risks specific to the liability.
If the effect of the time value of money is material, provisions are determined by discounting the expected future cash flows at a pre-tax risk-free rate
that reflects current market assessments of the time value of money. Where discounting is used, the increase in the provision due to the passage of
time is recognized within finance costs. A provision is discounted using either a nominal discount rate of 2.75% (2013 3.25%) or a real discount rate of
0.75% (2013 1%), as appropriate. Provisions are split between amounts expected to be settled within 12 months of the balance sheet date (current)
and amounts expected to be settled later (non-current). Contingent liabilities are possible obligations whose existence will only be confirmed by future
events not wholly within the control of the group, or present obligations where it is not probable that an outflow of resources will be required or the
amount of the obligation cannot be measured with sufficient reliability.
Contingent liabilities are not recognized in the financial statements but are disclosed unless the possibility of an outflow of economic resources is
considered remote.
Where the group makes contributions into a separately administered fund for restoration, environmental or other obligations, which it does not control,
and the group’s right to the assets in the fund is restricted, the obligation to contribute to the fund is recognized as a liability where it is probable that
such additional contributions will be made. The group recognizes a reimbursement asset separately, being the lower of the amount of the associated
restoration, environmental or other provision and the group’s share of the fair value of the net assets of the fund available to contributors.
Significant estimate or judgement: provision relating to the Gulf of Mexico oil spill
Detailed information on the Gulf of Mexico oil spill, including the financial impacts, is provided in Note 2.
The provision recognized is the reliable estimate of expenditures required to settle certain present obligations at the end of the reporting period.
There are future expenditures, however, for which it is not possible to measure the obligation reliably. These are not provided for and are disclosed
as contingent liabilities. Accounting judgement is required to identify when a provision can be measured reliably, which can be especially challenging
when complex litigation activities are ongoing.
In addition, for those provisions which are recognized, there is significant estimation uncertainty about the amounts that will ultimately be paid,
especially with regard to amounts payable under the Deepwater Horizon Court Supervised Settlement Program (DHCSSP). A provision is made for
these costs when the amount can be measured reliably; this requires an analysis of claims received and processed and consideration of the status
of ongoing legal activity.
The provision for penalties under the US Clean Water Act is based on the estimated civil penalty for strict liability. This provision is calculated based
on the assumption that BP did not act with gross negligence or engage in wilful misconduct. However, in September 2014 the district court ruled
that the discharge of oil was the result of BP’s gross negligence and wilful misconduct and it is not now possible to determine a reliable estimate of
the liability. The existing provision has been maintained as explained in Note 2 and a contingent liability has been disclosed in relation to the potential
for a higher penalty due to this ruling. The amount that will become payable by BP is subject to a very high level of uncertainty since it will depend
on the outcome of BP’s appeal of the September 2014 gross negligence ruling as well as what is determined by the court in the federal multi-district
litigation proceedings in New Orleans (MDL 2179) with respect to the application of statutory penalty factors. See Note 2 for additional information.
Decommissioning
Liabilities for decommissioning costs are recognized when the group has an obligation to plug and abandon a well, dismantle and remove a facility or
an item of plant and to restore the site on which it is located, and when a reliable estimate of that liability can be made. Where an obligation exists for a
new facility or item of plant, such as oil and natural gas production or transportation facilities, this liability will be recognized on construction or
installation. Similarly, where an obligation exists for a well, this liability is recognized when it is drilled. An obligation for decommissioning may also
crystallize during the period of operation of a well, facility or item of plant through a change in legislation or through a decision to terminate operations;
an obligation may also arise in cases where an asset has been sold but the subsequent owner is no longer able to fulfil its decommissioning
obligations, for example due to bankruptcy. The amount recognized is the present value of the estimated future expenditure determined in accordance
with local conditions and requirements. The provision for the costs of decommissioning wells, production facilities and pipelines at the end of their
economic lives is estimated using existing technology, at current prices or future assumptions, depending on the expected timing of the activity, and
discounted using the real discount rate. The weighted average period over which these costs are generally expected to be incurred is estimated to be
approximately 20 years.
An amount equivalent to the decommissioning provision is recognized as part of the corresponding intangible asset (in the case of an exploration or
appraisal well) or property, plant and equipment. The decommissioning portion of the property, plant and equipment is subsequently depreciated at the
same rate as the rest of the asset.
Financial statements
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