Freeport-McMoRan 2014 Annual Report Download - page 126

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
124
Valuation Techniques
Money market funds are classified within Level 1 of the fair value
hierarchy because they are valued using quoted market prices in
active markets.
Fixed income securities (U.S. core fixed income funds,
government securities, corporate bonds, asset-backed securities
and municipal bonds) are valued using a bid evaluation price or a
mid-evaluation price. A bid evaluation price is an estimated price
at which a dealer would pay for a security. A mid-evaluation price
is the average of the estimated price at which a dealer would sell
a security and the estimated price at which a dealer would pay for
a security. These evaluations are based on quoted prices, if
available, or models that use observable inputs and, as such, are
classified within Level 2 of the fair value hierarchy.
Equity securities are valued at the closing price reported on the
active market on which the individual securities are traded and, as
such, are classified within Level 1 of the fair value hierarchy.
FCX’s embedded derivatives on provisional copper concentrate,
copper cathode and gold purchases and sales have critical
observable inputs of quoted monthly LME or COMEX copper
forward prices and the London gold forward price at each reporting
date based on the month of maturity; however, FCX’s contracts
themselves are not traded on an exchange. As a result, these
derivatives are classified within Level 2 of the fair value hierarchy.
FCX’s derivative financial instruments for crude oil options are
valued using an option pricing model, which uses various
observable inputs including IntercontinentalExchange, Inc.
crude oil prices, volatilities, interest rates and contract terms.
FCX’s derivative financial instruments for natural gas swaps were
valued using a pricing model that had various observable inputs,
including NYMEX price quotations, interest rates and contract
terms (classified within Level 2 of the fair value hierarchy).
Valuations are adjusted for credit quality, using the
counterparties’ credit quality for asset balances and FCX’s credit
quality for liability balances (which considers the impact of
netting agreements on counterparty credit risk, including whether
the position with the counterparty is a net asset or net liability).
For asset balances, FCX uses the credit default swap value for
counterparties when available or the spread between the risk-free
interest rate and the yield rate on the counterparties’ publicly
traded debt for similar instruments. The crude oil options are
classified within Level 3 of the fair value hierarchy because the
inputs used in the valuation models are not observable for
substantially the full term of the instruments. The significant
unobservable inputs used in the fair value measurement of the
crude oil options are implied volatilities and deferred premiums.
Significant increases (decreases) in implied volatilities in
isolation would result in a significantly higher (lower) fair value
measurement. The implied volatilities range from 34 percent to
53 percent, with a weighted average of 39 percent. The weighted-
average cost of deferred premiums totals $6.89 per barrel at
December 31, 2014. Refer to Note 14 for further discussion of
these derivative financial instruments.
FCX’s derivative financial instruments for copper futures and
swap contracts and copper forward contracts that are traded on
the respective exchanges are classified within Level 1 of the fair
value hierarchy because they are valued using quoted monthly
COMEX or LME prices at each reporting date based on the month
of maturity (refer to Note 14 for further discussion). Certain of
these contracts are traded on the over-the-counter market and are
classified within Level 2 of the fair value hierarchy based on
COMEX and LME forward prices.
Long-term debt, including current portion, is not actively traded
and is valued using prices obtained from a readily available
pricing source and, as such, is classified within Level 2 of the fair
value hierarchy.
The techniques described above may produce a fair value
calculation that may not be indicative of net realizable value or
reflective of future fair values. Furthermore, while FCX believes its
valuation techniques are appropriate and consistent with other
market participants, the use of different techniques or
assumptions to determine fair value of certain financial
instruments could result in a different fair value measurement at
the reporting date. There have been no changes in the techniques
used at December 31, 2014.
A summary of the changes in the fair value of FCX’s most
significant Level 3 instruments, crude oil options, follows:
Fair value at January 1, 2013 $ —
Crude oil options assumed in the PXP acquisition (83)
Net realized losses (38)
a
Net unrealized losses included in earnings related
to liabilities still held at the end of the period (230)
b
Settlement payments 42
Fair value at December 31, 2013 (309)
Net realized losses (42)
a
Net unrealized gains included in earnings related
to assets still held at the end of the period 430
b
Settlement payments 237
Fair value at December 31, 2014 $ 316
a. Includes net realized losses of $37 million recorded in revenues in 2013 and $41 million
in 2014, and $1 million of interest expense associated with deferred premiums in 2013
and 2014.
b. Includes unrealized losses (gains) of $228 million recorded in revenues in 2013 and
$(432) million in 2014, and $2 million of interest expense associated with deferred premiums
in 2013 and 2014.
Refer to Note 2 for the levels within the fair value hierarchy
associated with other assets acquired, liabilities assumed and
redeemable noncontrolling interest related to PXP and MMR
acquisitions and the goodwill impairment.