Hess 2014 Annual Report Download - page 94

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HESS CORPORATION AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
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21. Financial Risk Management and Trading Activities
In the normal course of its business, the Corporation is exposed to commodity risks related to changes in the prices of crude oil and
natural gas as well as changes in interest rates and foreign currency values. In the disclosures that follow, corporate risk management
activities refer to the mitigation of these risks through hedging activities. The Corporation is also exposed to commodity price risks
primarily related to crude oil, natural gas, refined petroleum products and electricity, as well as foreign currency values from a 50%
voting interest in a consolidated energy trading joint venture. The energy trading joint venture was sold in February 2015.
In conjunction with the sale of the energy marketing business in the fourth quarter of 2013, certain derivative contracts, including
new transactions following the closing date, (the “delayed transfer derivative contracts”) were not transferred to the acquirer, Direct
Energy, a North American subsidiary of Centrica plc (Centrica), as required customer or regulatory consents had not been obtained.
However, the agreement entered into between Hess and Direct Energy on the closing date transferred all economic risks and rewards
of the energy marketing business, including the ownership of the delayed transfer derivative contracts, to Direct Energy. The transfer
of these remaining contracts was completed during 2014.
The Corporation maintains a control environment for all of its financial risk management and trading activities under the direction
of its chief risk officer and through its corporate risk policy, which the Corporation’s senior management has approved. Controls
include volumetric, term and value at risk limits. The chief risk officer must approve the trading of new instruments and commodities.
Risk limits are monitored and reported on a daily basis to business units and senior management. The Corporation’s financial risk
management department also performs independent price verifications (IPV’s) of sources of fair values and validations of valuation
models. The Corporation’s treasury department is responsible for administering foreign exchange rate and interest rate hedging
programs using similar controls and processes, where applicable.
The Corporation’s financial risk management department, in performing the IPV procedures, utilizes independent sources and
valuation models that are specific to the individual contracts and pricing locations to identify positions that require adjustments to
better reflect the market. This review is performed quarterly and the results are presented to the chief risk officer and senior
management. The IPV process considers the reliability of the pricing services through assessing the number of available quotes, the
frequency at which data is available and, where appropriate, the comparability between pricing sources.
The following is a description of the Corporation’s activities that use derivatives as part of their operations and strategies.
Derivatives include both financial instruments and forward purchase and sale contracts. Gross notional amounts of both long and
short positions are presented in the volume tables beginning below. These amounts include long and short positions that offset in
closed positions and have not reached contractual maturity. Gross notional amounts do not quantify risk or represent assets or
liabilities of the Corporation, but are used in the calculation of cash settlements under the contracts.
Corporate Financial Risk Management Activities: Financial risk management activities include transactions designed to reduce
risk in the selling prices of crude oil or natural gas produced by the Corporation or to reduce exposure to foreign currency or interest
rate movements. Generally, futures, swaps or option strategies may be used to fix the forward selling price of a portion of the
Corporation’s crude oil or natural gas production. Forward contracts may also be used to purchase certain currencies in which the
Corporation does business with the intent of reducing exposure to foreign currency fluctuations. These forward contracts comprise
various currencies, primarily the British Pound and Danish Krone. Interest rate swaps may be used to convert interest payments on
certain long-term debt from fixed to floating rates.
The gross volumes of the financial risk management derivative contracts outstanding at December 31, were as follows:
2014 2013
Commodity, primarily crude oil (millions of barrels) ...................................................................................... — 9
Foreign exchange (millions of USD*) .............................................................................................................
$ 1,189 $ 220
Interest rate swaps (millions of USD) ..............................................................................................................
$ 1,300 $ 865
* Denominated in U.S. dollars (USD).
Crude oil price hedging contracts increased E&P Sales and other operating revenues by $193 million ($121 million after income taxes)
and $39 million ($25 million after income taxes) in 2014 and 2013, respectively, and reduced E&P Sales and other operating revenues
by $688 million ($431 million after income taxes) in 2012. The amount of ineffectiveness from crude oil hedges that was recognized
immediately in Sales and other operating revenues was immaterial in 2014 and 2013, and a loss of $9 million in 2012. At December 31,
2014, the Corporation has no after-tax deferred gains in Accumulated other comprehensive income (loss) related to Brent crude oil
and West Texas Intermediate (WTI) crude oil hedges.
At December 31, 2014 and 2013, the Corporation had interest rate swaps with gross notional amounts of $1,300 million and
$865 million, respectively, which were designated as fair value hedges. Changes in the fair value of interest rate swaps and the
hedged fixed-rate debt are recorded in Interest expense in the Statement of Consolidated Income. For the years ended December 31,
2014 and 2013, the Corporation recorded an increase of $1 million and a decrease of $35 million (excluding accrued interest)
respectively, in the fair value of interest rate swaps and a corresponding adjustment in the carrying value of the hedged fixed-rate debt.