Hess 2014 Annual Report Download - page 57

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while the expected return on plan assets is developed from the expected future returns for each asset category, weighted by
the target allocation of pension assets to that asset category. Changes in these assumptions can have a material impact on the
amounts reported in the Corporation’s financial statements.
Derivatives: The Corporation utilizes derivative instruments for both financial risk management and trading activities. In
financial risk management activities, the Corporation uses futures, forwards, options and swaps, individually or in
combination to mitigate its exposure to fluctuations in the prices of crude oil and natural gas, as well as changes in interest
and foreign currency exchange rates. In trading activities, the Corporation, principally through a consolidated partnership,
trades energy-related commodities and derivatives, including futures, forwards, options and swaps, based on expectations of
future market conditions. The energy trading joint venture, HETCO, was sold in the first quarter of 2015.
All derivative instruments are recorded at fair value in the Corporation’s Consolidated Balance Sheet. The Corporation’s
policy for recognizing the changes in fair value of derivatives varies based on the designation of the derivative. The changes
in fair value of derivatives that are not designated as hedges are recognized currently in earnings. Derivatives may be
designated as hedges of expected future cash flows or forecasted transactions (cash flow hedges) or hedges of firm
commitments (fair value hedges). The effective portion of changes in fair value of derivatives that are designated as cash
flow hedges is recorded as a component of other comprehensive income (loss). Amounts included in Accumulated other
comprehensive income (loss) for cash flow hedges are reclassified into earnings in the same period that the hedged item is
recognized in earnings. The ineffective portion of changes in fair value of derivatives designated as cash flow hedges is
recorded currently in earnings. Changes in fair value of derivatives designated as fair value hedges are recognized currently
in earnings. The change in fair value of the related hedged commitment is recorded as an adjustment to its carrying amount
and recognized currently in earnings.
Derivatives that are designated as either cash flow or fair value hedges are tested for effectiveness prospectively before
they are executed and both prospectively and retrospectively on an on-going basis to determine whether they continue to
qualify for hedge accounting. The prospective and retrospective effectiveness calculations are performed using either
historical simulation or other statistical models, which utilize historical observable market data consisting of futures curves
and spot prices.
Fair Value Measurements: The Corporation uses various valuation approaches in determining fair value for financial
instruments, including the market and income approaches. The Corporation’s fair value measurements also include non-
performance risk and time value of money considerations. Counterparty credit is considered for receivable balances, and the
Corporation’s credit is considered for accrued liabilities.
The Corporation also records certain nonfinancial assets and liabilities at fair value when required by generally accepted
accounting principles. These fair value measurements are recorded in connection with business combinations, qualifying
non-monetary exchanges, the initial recognition of asset retirement obligations and any impairment of long-lived assets,
equity method investments or goodwill.
The Corporation determines fair value in accordance with the fair value measurements accounting standard which
established a hierarchy for the inputs used to measure fair value based on the source of the inputs, which generally range
from quoted prices for identical instruments in a principal trading market (Level 1) to estimates determined using related
market data (Level 3). Measurements derived indirectly from observable inputs or from quoted prices from markets that are
less liquid are considered Level 2.
When Level 1 inputs are available within a particular market, those inputs are selected for determination of fair value over
Level 2 or 3 inputs in the same market. To value derivatives that are characterized as Level 2 and 3, the Corporation uses
observable inputs for similar instruments that are available from exchanges, pricing services or broker quotes. These
observable inputs may be supplemented with other methods, including internal extrapolation or interpolation, that result in
the most representative prices for instruments with similar characteristics. Multiple inputs may be used to measure fair value,
however, the level of fair value for each physical derivative and financial asset or liability is based on the lowest significant
input level within this fair value hierarchy.
Details on the methods and assumptions used to determine the fair values are as follows:
Fair value measurements based on Level 1 inputs: Measurements that are most observable are based on quoted
prices of identical instruments obtained from the principal markets in which they are traded. Closing prices are both readily
available and representative of fair value. Market transactions occur with sufficient frequency and volume to assure liquidity.