Hess 2008 Annual Report Download - page 51

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value hedges). The effective portion of changes in fair value of derivatives that are designated as cash flow hedges is
recorded as a component of other comprehensive income (loss). Amounts included in accumulated other
comprehensive income (loss) for cash flow hedges are reclassified into earnings in the same period that the
hedged item is recognized in earnings. The ineffective portion of changes in fair value of derivatives designated as
cash flow hedges is recorded currently in earnings. Changes in fair value of derivatives designated as fair value
hedges are recognized currently in earnings. The change in fair value of the related hedged commitment is recorded
as an adjustment to its carrying amount and recognized currently in earnings.
Derivatives that are designated as either cash flow or fair value hedges are tested for effectiveness
prospectively before they are executed and both prospectively and retrospectively on an on-going basis to
determine whether they continue to qualify for hedge accounting. The prospective and retrospective
effectiveness calculations are performed using either historical simulation or other statistical models, which
utilize historical observable market data consisting of futures curves and spot prices.
Fair Value Measurements: The Corporation’s derivative instruments and supplemental pension plan
investments are carried at fair value, with changes in fair value recognized in earnings or other comprehensive
income each period. In determining fair value, the Corporation uses various valuation approaches, including the
market and income approaches. The Corporation’s fair value measurements also include non-performance risk and
time value of money considerations. Counterparty credit is considered for receivable balances, and the
Corporation’s credit is considered for accrued liabilities.
The Corporation adopted the provisions of FAS 157, Fair Value Measurements (FAS 157), effective January 1,
2008. FAS 157 establishes a hierarchy for the inputs used to measure fair value based on the source of the input,
which generally range from quoted prices for identical instruments in a principal trading market (Level 1) to
estimates determined using related market data (Level 3). Multiple inputs may be used to measure fair value,
however, the level of fair value for each financial asset or liability is based on the lowest significant input level
within this fair value hierarchy. Details on the methods and assumptions used to determine the fair values of the
financial assets and liabilities are as follows:
Fair value measurements based on Level 1 inputs:
Measurements that are most observable are based on quoted prices of identical instruments obtained from
the principal markets in which they are traded. Closing prices are both readily available and representative of fair
value. Market transactions occur with sufficient frequency and volume to assure liquidity. The fair value of certain
of the Corporation’s exchange traded futures and options are considered Level 1. In addition, fair values for the
majority of the Corporation’s supplemental pension plan investments are considered Level 1, since they are
determined using quotations from national securities exchanges.
Fair value measurements based on Level 2 inputs:
Measurements derived indirectly from observable inputs or from quoted prices from markets that are less
liquid are considered Level 2. Measurements based on Level 2 inputs include over-the-counter derivative
instruments that are priced on an exchange traded curve, but have contractual terms that are not identical to
exchange traded contracts. The Corporation utilizes fair value measurements based on Level 2 inputs for certain
forwards, swaps and options. The liability related to the Corporation’s crude oil hedges is classified as Level 2.
Fair value measurements based on Level 3 inputs:
Measurements that are least observable are estimated from related market data, determined from sources
with little or no market activity for comparable contracts or are positions with longer durations. For example, in its
energy marketing business, the Corporation sells natural gas and electricity to customers and offsets the price
exposure by purchasing forward contracts. The fair value of these sales and purchases may be based on specific
prices at less liquid delivered locations, which are classified as Level 3.
Income Taxes: Judgments are required in the determination and recognition of income tax assets and
liabilities in the financial statements. These judgements include the requirement to only recognize the financial
statement effect of a tax position when management believes that it is more likely than not, that based on the
technical merits, the position will be sustained upon examination.
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