BP 2013 Annual Report Download - page 274

part of a larger portfolio of similar transactions. Gains and losses arising
are recognized in the income statement from the time the derivative
commodity contract is entered into.
IFRS requires that inventory held for trading be recorded at its fair value
using period-end spot prices whereas any related derivative commodity
instruments are required to be recorded at values based on forward
prices consistent with the contract maturity. Depending on market
conditions, these forward prices can be either higher or lower than spot
prices resulting in measurement differences.
BP enters into contracts for pipelines and storage capacity, oil and gas
processing and liquefied natural gas (LNG) that, under IFRS, are recorded
on an accruals basis. These contracts are risk-managed using a variety of
derivative instruments, which are fair valued under IFRS. This results in
measurement differences in relation to recognition of gains and losses.
The way that BP manages the economic exposures described above, and
measures performance internally, differs from the way these activities
are measured under IFRS. BP calculates this difference for consolidated
entities by comparing the IFRS result with management’s internal
measure of performance. Under management’s internal measure of
performance the inventory and capacity contracts in question are valued
based on fair value using relevant forward prices prevailing at the end of
the period, the fair values of certain derivative instruments used to risk
manage LNG and oil and gas processing contracts are deferred to match
with the underlying exposure and the commodity contracts for business
requirements are accounted for on an accruals basis. We believe that
disclosing management’s estimate of this difference provides useful
information for investors because it enables investors to see the
economic effect of these activities as a whole.
Commodity trading contracts
BP’s Upstream and Downstream segments both participate in regional
and global commodity trading markets in order to manage, transact and
hedge the crude oil, refined products and natural gas that the group
either produces or consumes in its manufacturing operations. These
physical trading activities, together with associated incremental trading
opportunities, are discussed further in Upstream on page 25 and in
Downstream on page 31. The range of contracts the group enters into in
its commodity trading operations is described below. 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.
Exchange-traded commodity derivatives
These contracts are typically in the form of futures and options traded on
a recognized exchange, such as Nymex, SGX and ICE. Such contracts are
traded in standard specifications for the main marker crude oils, such as
Brent and West Texas Intermediate, the main product grades, such as
gasoline and gasoil, and for natural gas and power. Gains and losses,
otherwise referred to as variation margins, are settled on a daily basis
with the relevant exchange. These contracts are used for the trading and
risk management of crude oil, refined products, natural gas and power.
Realized and unrealized gains and losses on exchange-traded commodity
derivatives are included in sales and other operating revenues for
accounting purposes.
Over-the-counter contracts
These contracts are typically in the form of forwards, swaps and options.
Some of these contracts are traded bilaterally between counterparties or
through brokers; others may be cleared by a central clearing
counterparty. These contracts can be used both for trading and risk
management activities. Realized and unrealized gains and losses on over-
the-counter (OTC) contracts are included in sales and other operating
revenues for accounting purposes. Many grades of crude oil bought and
sold use standard contracts including US domestic light sweet crude oil,
commonly referred to as West Texas Intermediate, and a standard North
Sea crude blend (Brent, Forties and Oseberg or BFO). Forward contracts
are used in connection with the purchase of crude oil supplies for
refineries, purchases of products for marketing, sales of the group’s oil
production and refined product. The contracts typically contain standard
delivery and settlement terms. These transactions call for physical
delivery of oil with consequent operational and price risk. However,
various means exist, and are from time to time used, to settle obligations
under the contracts in cash rather than through physical delivery.
Additionally, the BFO contract specifies a standard volume and tolerance
given that the physically settled transactions are delivered by cargo.
Gas and power OTC markets are highly developed in North America and
the UK, where the commodities 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. Typically, these contracts specify delivery
terms for the underlying commodity. Certain of these transactions are not
settled physically, which 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, price and
term (e.g. daily, monthly and balance of month) are the main variable
contract terms.
Swaps are often contractual obligations to exchange cash flows between
two parties: a typical swap transaction usually references a floating price
and 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
crude, oil products, natural gas or power at a specified price on or before
a specific future date. Amounts under these derivative financial
instruments are settled at expiry. Typically, netting agreements are used
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 or around the delivery date when title to the
inventory is taken. 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 typically relate to
purchases of crude for a refinery, purchases of products for marketing,
purchases of third-party natural gas, sales of the group’s oil production,
sales of the group’s oil products and sales of the group’s gas production
to third parties. For accounting purposes, 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.
Associate
An entity, including an unincorporated entity such as a partnership, over
which the group has significant influence and that is neither a subsidiary
nor a joint arrangement of the group. Significant influence is the power to
participate in the financial and operating policy decisions of the investee
but is not control or joint control over those policies.
Joint arrangement
A joint arrangement is an arrangement of which two or more parties have
joint control.
Joint control
Joint control is the contractually agreed sharing of control over an
arrangement, which exists only when decisions about the relevant
activities require the unanimous consent of the parties sharing control.
Joint operation
A joint operation is a joint arrangement whereby the parties that have
joint control of the arrangement have rights to the assets, and obligations
for the liabilities, relating to the arrangement.
Joint venture
A joint arrangement whereby the parties that have joint control of the
arrangement have rights to the net assets of the arrangement.
Subsidiary
An entity that is controlled by the BP group. Control of an investee exists
when an investor is exposed, or has rights, to variable returns from its
involvement with the investee and has the ability to affect those returns
through its power over the investee.
270 BP Annual Report and Form 20-F 2013