BP 2011 Annual Report Download - page 229

Financial statements
BP Annual Report and Form 20-F 2011 227
Notes on financial statements
33. Derivative financial instruments continued
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.
http://www.bp.com/downloads/dfi
$ million
Oil
price
Natural
gas price
Power
price Total
Net fair value of contracts at 1 January 2011 164 667 (1) 830
Gains (losses) recognized in the income statement 69 129 11 209
Settlements (71) (110) 3(178)
Transfers out of level 3 –(278) –(278)
Net fair value of contracts at 31 December 2011 162 408 13 583
$ million
Oil
price
Natural
gas price
Power
price Total
Net fair value of contracts at 1 January 2010 215 72 (1) 286
Gains (losses) recognized in the income statement 21 637 (1) 657
Settlements (54) (11) 1(64)
Transfers out of level 3 (18) (38) –(56)
Transfers into level 3 – 4 – 4
Exchange adjustments – 3 – 3
Net fair value of contracts at 31 December 2010 164 667 (1) 830
Transfers out of level 3 of the fair value hierarchy in 2011 relate primarily to the delivery dates for a number of natural gas forward contracts moving into a
time period where market observable prices are available, and therefore being reclassified to level 2 of the fair value hierarchy.
The amount recognized in the income statement for the year relating to level 3 held for trading derivatives still held at 31 December 2011 was a
$204 million gain (2010 $651 million gain relating to derivatives still held at 31 December 2010).
Gains and losses relating to derivative contracts are included either within sales and other operating revenues or 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 of these items was a net loss of
$934 million (2010 $1,738 million net gain and 2009 $4,046 million net gain).
Embedded derivatives
The group has embedded derivatives relating to certain natural gas contracts. 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 recognized on the balance sheet with
gains or losses recognized in the income statement.
All the commodity price embedded derivatives relate to natural gas contracts, are categorized in level 3 of the fair value hierarchy and 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, these 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 historic and long-term pricing relationships.
In addition, at 31 December 2010, BP was party to a collar-backed financing arrangement involving an available-for-sale investment held by the
group. This arrangement contained an embedded derivative whose fair value was related to the equity price of the investment and was categorized in
level 2 of the fair value hierarchy. The arrangement was terminated in 2011.