Sunoco 2007 Annual Report Download - page 32

Company does not anticipate substantial costs associated with the future treatment of exist-
ing wells. Under the settlement, Sunoco was assigned an allocation percentage and will be
required to make a cash payment of approximately $28 million. In addition to the cash
payment, Sunoco will participate on the same basis in any costs of future treatment of
existing wells. Sunoco is attempting to recover the amount it is required to pay in settle-
ment from its insurance carriers. In connection with the settlement, the Company estab-
lished a $17 million after-tax accrual in 2007 which is reported as part of the Asset Write-
Downs and Other Matters shown separately in Corporate and Other in the Earnings
Profile of Sunoco Businesses (see Note 2 to the consolidated financial statements).
For the group of MTBE cases that are not covered by the settlement, there has been in-
sufficient information developed about the plaintiffs’ legal theories or the facts that would
be relevant to an analysis of the ultimate liability to Sunoco. Based on the current law and
facts available at this time, no accrual has been established for any potential damages at
December 31, 2007 and Sunoco believes that these cases will not have a material adverse
effect on its consolidated financial position.
Conclusion
Management believes that the environmental matters discussed above are potentially sig-
nificant with respect to results of operations or cash flows for any one year. However, man-
agement does not believe that such matters will have a material impact on Sunoco’s
consolidated financial position or, over an extended period of time, on Sunoco’s cash flows
or liquidity.
Quantitative and Qualitative Disclosures about Market Risk
Commodity Price Risk
Sunoco uses swaps, options, futures, forwards and other derivative instruments to hedge a
variety of commodity price risks. Derivative instruments are used from time to time to
achieve ratable pricing of crude oil purchases, to convert certain expected refined product
sales to fixed or floating prices, to lock in what Sunoco considers to be acceptable margins
for various refined products and to lock in the price of a portion of the Company’s elec-
tricity and natural gas purchases or sales. Sunoco does not hold or issue derivative instru-
ments for trading purposes.
Beginning in the second quarter of 2006, Sunoco increased its use of ethanol as an oxygen-
ate component in gasoline in response to the new renewable fuels mandate for ethanol and
the discontinuance of the use of MTBE as a gasoline blending component. Since then, most
of the ethanol purchased by Sunoco has been through normal fixed-price purchase con-
tracts. To reduce the margin risk created by these fixed-price contracts, the Company en-
tered into derivative contracts to sell gasoline at a fixed price to hedge a similar volume of
forecasted floating-price gasoline sales over the term of the ethanol contracts. In effect,
these derivative contracts have locked in an acceptable differential between the gasoline
price and the cost of the ethanol purchases for gasoline blending during this period.
As a result of changes in the price of gasoline, the fair value of the fixed-price gasoline
contracts decreased $97 million ($58 million after tax) in 2007 after increasing $82 million
($48 million after tax) in 2006. As these derivative contracts have been designated as cash
flow hedges, these changes in fair value are not initially included in net income but rather
are reflected in the net hedging losses component of comprehensive income. The fair value
of these contracts at the time the positions are closed is recognized in net income when the
hedged items are recognized in net income, with Sunoco’s margin reflecting the differential
between the gasoline sales prices hedged to a fixed price and the cost of fixed-price ethanol
purchases. Net gains (losses) totaling $(14) and $11 million ($(8) and $6 million after tax)
were reclassified to net income in 2007 and 2006, respectively, when the hedged items
were recognized in net income.
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