BP 2014 Annual Report Download - page 155

28. Derivative financial instruments – continued
The commodity price embedded derivatives relate to natural gas contracts and are categorized in levels 2 and 3 of the fair value hierarchy. The
contracts in level 2 are valued using inputs that include price curves for each of the different products that are built up from active market pricing data.
Where necessary, the price curves are extrapolated to the expiry of the contracts (the last of which is in 2018) using all available external pricing
information; additionally, where limited data exists for certain products, prices are interpolated using historical and long-term pricing relationships.
These valuations are categorized in level 3. Transfers from level 3 to level 2 occur when the valuation no longer depends significantly on extrapolatedor
interpolated data. Valuations use observable market data for maturities up to 36 months, and internally developed price curves based on economic
forecasts for periods beyond that time.
The fair value gain on commodity price embedded derivatives was $430 million (2013 gain of $459 million, 2012 gain of $347 million).
The following table shows the changes during the year in the net fair value of embedded derivatives, within level 3 of the fair value hierarchy.
$ million
2014 2013
Commodity
price
Commodity
price
Net fair value of contracts at 1 January (379) (1,112)
Settlements 24 316
Gains recognized in the income statement 219 142
Transfers out of level 3 –258
Exchange adjustments 10 17
Net fair value of contracts at 31 December (126) (379)
The amount recognized in the income statement for the year relating to level 3 embedded derivatives still held at 31 December 2014 was a
$220 million gain (2013 $67 million gain related to derivatives still held at 31 December 2013).
Cash flow hedges
At 31 December 2014, the group held currency forwards and futures contracts and cylinders that were being used to hedge the foreign currency risk of
highly probable forecast transactions. Note 27 outlines the group’s approach to foreign currency exchange risk management. For cash flow hedges the
group only claims hedge accounting for the intrinsic value on the currency with any fair value attributable to time value taken immediately to the
income statement. The amounts remaining in equity at 31 December 2014 in relation to these cash flow hedges consist of deferred losses of
$160 million maturing in 2015, deferred losses of $10 million maturing in 2016 and deferred gains of $3 million maturing in 2017 and beyond.
At 31 December 2012, BP had entered into three agreements to sell its 50% interest in TNK-BP and acquire 18.5% of Rosneft. During the period from
signing until completion on 21 March 2013, these agreements represented derivative financial instruments that were required to be measured at fair
value. BP designated two of the agreements, for the acquisition of a 5.66% shareholding in Rosneft from Rosneftegaz, and for the acquisition of a
9.80% shareholding from Rosneft, as hedging instruments in a cash flow hedge, and so changes in the fair values of these agreements were
recognized in other comprehensive income. The third agreement, under which BP sold its 50% interest in TNK-BP in exchange for cash and a 3.04%
shareholding in Rosneft, was also a derivative financial instrument, but its fair value could not be reliably measured. An asset of $1,410 million related
to these agreements was recognized on the balance sheet at 31 December 2012, of which $1,339 million related to the fair value of the cash flow
hedge derivatives. The derivatives measured at fair value at 31 December 2012 were categorized in level 3 of the fair value hierarchy using inputs that
included the quoted Rosneft share price. During 2013, a charge of $2,061 million was recognized in other comprehensive income in relation to these
agreements and $4 million was recognized in the income statement. The resulting cumulative charge of $651 million recognized in other
comprehensive income would only be recognized in the income statement if the investment in Rosneft were either sold or impaired. The cash flow
hedge derivatives were valued using the quoted Rosneft share price at the time the deal completed, of $7.60 per share.
Fair value hedges
At 31 December 2014, the group held interest rate and cross-currency interest rate swap contracts as fair value hedges of the interest rate risk on fixed
rate debt issued by the group. The loss on the hedging derivative instruments recognized in the income statement in 2014 was $14 million (2013
$1,240 million loss and 2012 $536 million gain) offset by a gain on the fair value of the finance debt of $8 million (2013 $1,228 million gain and 2012
$537 million loss).
The interest rate and cross-currency interest rate swaps mature within one to twelve years, and have the same maturity terms as the debt that they
are hedging. They are used to convert sterling, euro, Swiss franc, Australian dollar, Canadian dollar, Norwegian Krone and Hong Kong dollar
denominated fixed rate borrowings into floating rate debt. Note 27 outlines the group’s approach to interest rate and foreign currency exchange risk
management.
Financial statements
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