National Grid 2016 Annual Report Download - page 157

30. Financial risk management continued
(g) Fair value analysis continued
Our level 3 derivative financial instruments include cross-currency swaps, inflation linked swaps and equity options, all of which are traded
onilliquid markets. In valuing these instruments a third-party valuation is obtained to support each reported fair value.
Our level 3 commodity contracts primarily consist of our forward purchases of electricity and gas where pricing inputs are unobservable,
aswell as other complex transactions. Complex transactions can introduce the need for internally developed models based on reasonable
assumptions. Industry standard valuation techniques such as the Black-Scholes pricing model and Monte Carlo simulation are used for
valuingsuch instruments. Level 3 is also applied in cases when optionality is present or where an extrapolated forward curve is considered
unobservable. All published forward curves are verified to market data; if forward curves differ from market data by 5% or more they are
considered unobservable.
The changes in value of our level 3 derivative financial instruments are as follows:
Derivative financial
instruments
Commodity
contracts Total
2016
£m
2015
£m
2016
£m
2015
£m
2016
£m
2015
£m
At 1 April (166) (100) (42) (58) (208) (158)
Net gains/(losses) for the year1,2 (20) (63) (27) (53) (47) (116)
Purchases31–13 38 14 38
Settlements (11) (3) 29 28 18 25
Reclassification/transfers out of level 3 –––3–3
At 31 March (196) (166) (27) (42) (223) (208)
1. Loss of £17m (2015: £63m loss) is attributable to derivative financial instruments held at the end of the reporting period and has been recognised in finance costs in the income statement.
2. Loss of £28m (2015: £48m loss) is attributable to commodity contract financial instruments held at the end of the reporting period.
3. Purchases in the year relate to equity options.
The impacts on a post-tax basis of reasonably possible changes in significant level 3 assumptions are as follows:
Derivative financial
instruments
Commodity
contracts
2016
Income
statement
£m
2015
Income
statement
£m
2016
Income
statement
£m
2015
Income
statement
£m
10% increase in commodity prices¹ ––44
10% decrease in commodity prices1–––(3)
Volume forecast uplift2––(1) (2)
Volume forecast reduction2–– 12
+10% market area price change ––(2) (4)
–10% market area price change ––24
+20 basis point change in Limited Price Inflation (LPI) market curve3(83) (77) ––
–20 basis points change in LPI market curve380 75 ––
1. Level 3 commodity price sensitivity is included within the sensitivity analysis disclosed in note 33.
2. Volumes were flexed using maximum and minimum historical averages, or by >10% where historical averages were not available.
3. A reasonably possible change in assumption of other level 3 derivative financial instruments is unlikely to result in a material change in fair values.
The impacts disclosed above were considered on a contract by contract basis with the most significant unobservable inputs identified.
Financial Statements
155National Grid Annual Report and Accounts 2015/16 Financial Statements