Part II
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
We only enter derivative financial instruments in conjunction with our hedging activities. These instruments principally include commodity futures, collars, swaps and interest rate swap agreements. These financial and commodity-based derivative contracts are used to limit the risks of fluctuations in interest rates and natural gas, crude oil and natural gas liquids prices. Gains and losses on these derivatives are generally offset by losses and gains on the respective hedged exposures.
Our Board of Directors has adopted a policy governing the use of derivative instruments, which requires that all derivatives used by us relate to an underlying, offsetting position, anticipated transaction or firm commitment, and prohibits the use of speculative, highly complex or leveraged derivatives. Risk management programs using derivatives must be authorized by the Chairman of the Board and the Senior Executive Vice President and Chief of Staff. These programs are also reviewed quarterly by our internal risk management committee and annually by the Board of Directors.
Hypothetical changes in interest rates and prices chosen for the following estimated sensitivity effects are considered to be reasonably possible near-term changes generally based on consideration of past fluctuations for each risk category. It is not possible to accurately predict future changes in interest rates and product prices. Accordingly, these hypothetical changes may not necessarily be an indicator of probable future fluctuations.
Interest Rate Risk
We are exposed to interest rate risk on short-term and long-term debt carrying variable interest rates. At December 31, 2007, our variable rate debt had a carrying value of $1.1 billion, which approximated its fair value, and our fixed rate debt had a carrying value of $5.2 billion and an approximate fair value of $5.4 billion. We attempt to balance variable rate debt, fixed rate debt and debt maturities to manage interest cost, interest rate volatility and financing risk. This is accomplished through a mix of bank debt with short-term variable rates and fixed rate senior and subordinated debt, as well as the occasional use of interest rate swaps.
The following table shows the carrying amount and fair value of long-term debt and the hypothetical change in fair value that would result from a 100-basis point change in interest rates. Unless otherwise noted, the hypothetical change in fair value could be a gain or a loss depending on whether interest rates increase or decrease.
(in millions) |
Carrying Amount |
Fair |
Hypothetical Change in Fair Value |
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| December 31, 2007 Long-term debt | $ | (6,320) | $ | (6,438) | $ | 422 |
| December 31, 2006 Long-term debt | $ | (3,451) | $ | (3,427) | $ | 220 |
(a) Fair value is based upon current market quotes and is the estimated amount required to purchase our long-term debt on the open market. This estimated value does not include any redemption premium. |
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Commodity Price Risk
We hedge a portion of our price risks associated with our natural gas, crude oil and natural gas liquid sales. As of December 31, 2007, our outstanding futures contracts and swap agreements had a net fair value loss of $44 million. The following table shows the fair value of our derivative contracts and the hypothetical change in fair value that would result from a 10% change in commodities prices or basis prices at December 31, 2007. The hypothetical change in fair value could be a gain or a loss depending on whether prices increase or decrease.
(in millions) |
Fair |
Hypothetical Change in Fair Value |
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| Natural gas futures and sell basis swap agreements | $ | 185 | $ | 253 |
| Natural gas purchase basis swap agreements | $ | – | $ | 1 |
| Crude oil futures and differential swaps | $ | (207) | $ | 101 |
| Natural gas liquids futures | $ | (22) | $ | 10 |
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Because most of our futures contracts and swap agreements have been designated as hedge derivatives, changes in their fair value generally are reported as a component of accumulated other comprehensive income (loss) until the related sale of production occurs. At that time, the realized hedge derivative gain or loss is transferred to product revenues in the consolidated income statement. None of our derivative contracts have margin requirements or collateral provisions that could require funding prior to the scheduled cash settlement date.