HollyFrontier 2015 Annual Report Download - page 55

Table of Content
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Inventory Valuation
Inventories are stated at the lower of cost, using the LIFO method for crude oil, unfinished and finished refined products and the
average cost method for materials and supplies, or market. In periods of rapidly declining prices, LIFO inventories may have to
be written down to market value due to the higher costs assigned to LIFO layers in prior periods. In addition, the use of the LIFO
inventory method may result in increases or decreases to cost of sales in years that inventory volumes decline as the result of
charging cost of sales with LIFO inventory costs generated in prior periods. At December 31, 2015 and 2014, market values had
fallen below historical LIFO inventory costs and, as a result, we recorded lower of cost or market inventory valuation reserves of
$624.5 million and $397.5 million, respectively.
At December 31, 2015, our lower of cost or market inventory valuation reserve was $624.5 million. This amount, or a portion
thereof, is subject to reversal as a reduction to cost of products sold in subsequent periods as inventories giving rise to the reserve
are sold, and a new reserve is established. Such a reduction to cost of products sold could be significant if inventory values return
to historical cost price levels. Additionally, further decreases in overall inventory values could result in additional charges to cost
of products sold should the lower of cost or market inventory valuation reserve be increased.
Goodwill
We have goodwill that primarily arose from our merger with Frontier Oil Corporation on July 1, 2011. Goodwill represents the
excess of the cost of an acquired entity over the fair value of the assets acquired and liabilities assumed. Goodwill is not subject
to amortization and is tested annually or more frequently if events or circumstances indicate the possibility of impairment.
We performed our annual goodwill impairment testing as of July 1, 2015, which entailed an assessment of our reporting unit fair
values relative to their respective carrying values that were derived using a combination of both income and market approaches.
Our income approach utilizes the discounted future expected cash flows. Our market approach, which includes both the guideline
public company and guideline transaction methods, utilizes pricing multiples derived from historical market transactions of other
like-kind assets. Our discounted cash flows reflect estimates of future cash flows based on both historical and forward crack-
spreads, forecasted production levels, operating costs and capital expenditures. Our goodwill is allocated by reporting unit as
follows: El Dorado, $1.7 billion; Cheyenne, $0.3 billion; and HEP, $0.3 billion. Based on our testing as of July 1, 2015, the fair
value of our Cheyenne reporting unit exceeded its carrying cost by approximately 8%. The fair value of our El Dorado and HEP
reporting units substantially exceeded their respective carrying values. There were no impairments of goodwill during the years
December 31, 2015, 2014 and 2013.
Historically, the refining industry has experienced significant fluctuations in operating results over an extended business cycle
including changes in prices of crude oil and refined products, changes in operating costs including natural gas and higher costs of
complying with government regulations. It is reasonably possible that at some future downturn in refining operations that the
goodwill related to our Cheyenne Refinery will be determined to be impaired. A prolonged, moderate decrease in operating margins
could potentially result in impairment to goodwill allocated to our Cheyenne reporting unit. Such impairment charges could be
material.
Contingencies
We are subject to proceedings, lawsuits and other claims related to environmental, labor, product and other matters. We are required
to assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses. A
determination of the amount of reserves required, if any, for these contingencies is made after careful analysis of each individual
issue. The required reserves may change in the future due to new developments in each matter or changes in approach such as a
change in settlement strategy in dealing with these matters.
RISK MANAGEMENT
We use certain strategies to reduce some commodity price and operational risks. We do not attempt to eliminate all market risk
exposures when we believe that the exposure relating to such risk would not be significant to our future earnings, financial position,
capital resources or liquidity or that the cost of eliminating the exposure would outweigh the benefit.
Commodity Price Risk Management
Our primary market risk is commodity price risk. We are exposed to market risks related to the volatility in crude oil and refined
products, as well as volatility in the price of natural gas used in our refining operations. We periodically enter into derivative
contracts in the form of commodity price swaps and futures contracts to mitigate price exposure with respect to:
• our inventory positions;
• natural gas purchases;