Occidental Petroleum 2001 Annual Report Download - page 36

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qualifies as a normal purchase or sale contract. Changes in the derivative
instrument's fair value must be recognized in earnings unless specific hedge
accounting criteria are met. Changes in the fair value of derivative instruments
that meet specific cash-flow hedge accounting criteria are reported in other
comprehensive income (OCI). The gains and losses on cash-flow hedge transactions
that are reported in OCI are reclassified to earnings in the periods in which
earnings are affected by the variability of the cash flows of the hedged item.
Gains and losses from derivatives that qualify for fair-value hedge accounting
are recorded in earnings along with the change in fair value of the hedged item.
The ineffective portions of all hedges are recognized in current period
earnings. Prior to the adoption of SFAS No. 133, gains and losses on commodity
futures contracts that qualified for hedge accounting, essentially those
associated with equity production or purchases, were deferred until recognized
as an adjustment to sales revenue or purchase costs when the related transaction
being hedged was finalized.
Occidental's initial adoption of SFAS No. 133, as amended, resulted in a
first quarter after-tax reduction in net income of $24 million recorded as a
cumulative effect of a change in accounting principles and an after-tax
reduction in OCI of approximately $27 million. The adoption also increased total
assets by $588 million and total liabilities by $639 million as of January 1,
2001.
COMMODITY PRICE DERIVATIVES
GENERAL
With respect to derivatives used in its oil and gas marketing operations,
Occidental used a combination of futures, options and swaps to offset various
open price positions.
The fair value recorded for derivative instruments is based on quoted
market prices, dealer quotes or synthetic price curves established from quoted
prices (adjusted for time, location and quality differentials).
CASH-FLOW COMMODITY HEDGES
Occidental used cash-flow hedges for the sale of crude oil and natural gas
in 2001, with the objective of mitigating price risk arising from fluctuating
values for
27
these commodities. Crude oil hedges were executed for Occidental's West Texas
production. Its strategy to achieve these objectives included a combination of
purchased put options and written call options resulting in no net premium
received for crude oil hedging. Purchased put options were used for natural gas
hedging and were executed for the Mid-continent production area to establish a
minimum sales price for its production. Occidental used no fair-value hedges for
crude oil or natural gas production during 2001.
Occidental's cash-flow-hedging instruments, which consist of natural gas
put option contracts, are highly effective. During 2001, net gains of $0.6
million were recorded to OCI relating to changes in current cash-flow hedges and
net losses of $7.6 million were reclassified from OCI into earnings as a
reduction to net sales revenue, as the forecasted transactions actually
occurred. The fair value at December 31, 2001 of derivative financial
instruments that have been designated and have qualified as cash-flow-hedging
instruments was $0.2 million. The gain was recorded as an increase to OCI and
will be reclassified into earnings during 2002 when the forecasted transactions
actually occur.
MARKETING AND TRADING OPERATIONS
The fair value at December 31, 2001 of derivative instruments used in
marketing and trading operations is a net gain of $9 million. Gains of $24
million were recorded in earnings due to the change in fair value of these
financial derivative instruments during 2001. Offsetting the value of these
instruments are related physical positions with a fair value of $2 million loss
at December 31, 2001. Gains of $15 million were recorded in earnings due to the
change in the fair value of related physical positions during 2001. The net
positions mostly expire in 2002. Additionally, a long-term sales contract volume
commitment is 38,100 MMBtu per day through October 2010. The approximate $39
million net gain from the change in fair value during 2001 of derivative
instruments used in marketing and trading operations was reflected in the income