Occidental Petroleum 2008 Annual Report Download - page 44

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In September 2006, the FASB issued SFAS No. 157, which establishes a framework for measuring fair value and expands
disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for periods beginning after November
15, 2007. In February 2008, the FASB issued FSP FAS 157-2, which defers the effective date of SFAS No. 157 for non-financial assets and
liabilities that are not recorded at fair value on a recurring basis until periods beginning after November 15, 2008. Occidental adopted the non-
deferred portion of SFAS No. 157 on January 1, 2008 on a prospective basis. See Note 11 to the Consolidated Financial Statements for
further information. In October 2008, the FASB issued FSP FAS 157-3, which became effective immediately and clarified the application of
SFAS No. 157 in a market that is not active. The adoption of FSP FAS 157-3 has not had a material impact on Occidental’s financial
statements.
DERIVATIVE ACTIVITIES AND MARKET RISK
General
Occidental is exposed to risk that is inherent with changing commodity price risk. In order to mitigate price risk, Occidental, from time
to time, enters into derivative transactions. A derivative is an instrument that, among other characteristics, derives its value from changes in
another instrument or variable.
In general, the fair value recorded for derivative instruments is based on quoted market prices, dealer quotes and the Black Scholes or
similar valuation models, as applicable.
Commodity Price Risk
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Occidental’s results are sensitive to fluctuations in oil and natural gas prices. Based on current levels of production, if oil prices vary by
$1 per barrel, it would have an estimated annual effect on pre-tax income of approximately $150 million. If domestic natural gas prices vary
by $0.50 per Mcf, it would have an estimated annual effect on pre-tax income of approximately $93 million. If production levels change in the
future, the sensitivity of Occidental’s results to oil and gas prices also would change.
Occidental’s results are also sensitive to fluctuations in chemical prices. If chlorine and caustic soda prices vary by $10 per ton, it
would have a pre-tax annual effect on income of approximately $10 million and $30 million, respectively. If PVC prices vary by $.01 per lb, it
would have a pre-tax annual effect on income of approximately $30 million. If ethylene dichloride (EDC) prices vary by $10 per ton, it would
have a pre-tax annual effect on income of approximately $5 million. Historically, product price changes either precede or follow raw material
and feedstock product price changes; therefore, the margin effect of price changes are generally mitigated over time. According to Chemical
Market Associates, Inc., December 2008 average contract prices were: chlorine—$220 per ton, caustic soda—$1,080 per ton, PVC—$0.44
per lb and EDC—$40 per ton.
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Occidental periodically uses different types of derivative instruments to achieve the best prices for oil and gas. Derivatives have been
used by Occidental to reduce its exposure to price volatility on a small portion of its production. Occidental enters into low-risk marketing and
trading activities through its separate marketing organization, which operates under established policy controls and procedures. Occidental's
marketing and trading operations utilize a combination of futures, forwards, options and swaps to mitigate the price risk associated with
various physical transactions.
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Occidental conducts its risk management activities for energy commodities (which include buying, selling, marketing, trading, and
hedging activities) under the controls and governance of its risk control policy. The President and Chief Financial Officer and the Risk
Management Committee, comprising members of Occidental's management, oversee these controls, which are implemented and enforced
by a Trading Control Officer. The Trading Control Officer provides an independent and separate check on marketing and trading activities.
Controls for energy commodities include limits on value at risk, limits on credit, limits on trading, segregation of duties, delegation of
authority and a number of other policy and procedural controls.
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The following tables show the changes in the net fair value of Occidental’s marketing and trading derivative contracts, a portion of
which are hedges, during 2008 and 2007, and segregate the open contracts at December 31, 2008 by maturity periods.
In millions 2008 2007
Fair value of contracts outstanding at
beginning of year – unrealized losses $(576)$(355)
Losses on contracts realized or otherwise settled during the
year 101 106
Changes in fair value attributable to changes in valuation
techniques and assumptions (1) —
Gains (Losses) or other changes in fair value(a) 337 (327)
Fair value of contracts outstanding at end of year
– unrealized losses $(139)$(576)
(a) Primarily relates to price changes on existing production hedges.
Maturity Periods
Source of Fair Value –
unrealized (losses) gains
(in millions) 2009
2010
and 2011
2012
and 2013
2014
and
thereafter
Total
Fair
Value
Prices actively quoted $(87)$ 3 $ — $ — $(84)