Part IV
Item 15.
Exhibits and Financial Statement Schedules
XTO ENERGY INC. Notes to Consolidated Financial Statements
7. Financial Instruments
We use commodity-based and financial derivative contracts to manage exposures to commodity price and interest rate fluctuations. We do not hold or issue derivative financial instruments for speculative or trading purposes. We also may enter gas physical delivery contracts to effectively provide gas price hedges. Because these contracts are not expected to be net cash settled, they are considered to be normal sales contracts. Therefore, these contracts are not recorded in the financial statements.
All derivatives are recorded on the balance sheet at estimated fair value. Fair value is generally determined based on the difference between the fixed contract price and the underlying market price at the determination date, and/or the value confirmed by the counterparty. Changes in the fair value of effective cash flow hedges are recorded as a component of accumulated other comprehensive income (loss), which is later transferred to earnings when the hedged transaction occurs. Changes in the fair value of derivatives that are not designated as hedges, as well as the ineffective portion of the hedge derivatives, are recorded in derivative fair value (gain) loss in the income statement.
Btu Swap Contracts
In 1995, we entered a contract to sell gas based on crude oil pricing, also referred to as the Enron Btu swap contract. This contract was terminated as a result of the Enron bankruptcy in December 2001. Because the contract pricing was not clearly and closely associated with natural gas prices, it was considered a non-hedge derivative financial instrument, with changes in fair value recorded as a derivative (gain) loss in the income statement.
Prior to termination of the Enron Btu swap contract, we entered Btu swap contracts with another counterparty to effectively defer until August 2005 through July 2006 any cash flow impact related to 25,000 Mcf of daily gas deliveries in 2002 that were to be made under the Enron Btu swap contract. Changes in fair value of these contracts were recorded as a derivative (gain) loss in the income statement.
Btu swap contracts outstanding at December 31, 2005 had a net fair value loss of $23 million. As of February 28, 2006, we terminated the remaining portion of these contracts, resulting in total payments to the counterparty of $7 million in first quarter 2006.
Commodity Price Hedging Instruments
We periodically enter into futures contracts, energy swaps, collars and basis swaps to hedge our exposure to price fluctuations on natural gas, crude oil and natural gas liquids sales. When actual commodity prices exceed the fixed price provided by these contracts, we pay this excess to the counterparty, and when actual commodity prices are below the contractually provided fixed price, we receive this difference from the counterparty. See Note 8.
Derivative Fair Value (Gain) Loss
The components of derivative fair value (gain) loss, as reflected in the consolidated income statements are:
(in millions) |
2007 |
2006 |
2005 |
|||
| Change in fair value of Btu swap contracts | $ | – | $ | (16) | $ | 23 |
| Change in fair value of other derivatives that do not qualify for hedge accounting | – | (19) | (37) | |||
| Ineffective portion of derivatives qualifying for hedge accounting | (11) | (67) | 1 | |||
| Derivative fair value (gain) loss | $ | (11) | $ | (102) | $ | (13) |
The gains in 2006 and 2005 related to derivatives that do not qualify for hedge accounting are primarily related to natural gas basis swap agreements. Except to the extent basis swap agreements are utilized in conjunction with NYMEX future contracts, they cannot qualify for hedge accounting.
Derivative fair value (gain) loss comprises the following realized and unrealized components related to Btu swap contracts, nonhedge derivatives and the ineffective portion of hedge derivatives:
(in millions) |
2007 |
2006 |
2005 |
|||
| Net cash (received from) paid to counterparties | $ | (54) | $ | (63) | $ | 26 |
| Non-cash change in derivative fair value | 43 | (39) | (39) | |||
| Derivative fair value (gain) loss | $ | (11) | $ | (102) | $ | (13) |
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Fair Value of Financial Instruments
Because of their short-term maturity, the fair value of cash and cash equivalents, accounts receivable and accounts payable approximates their carrying values at December 31, 2007 and 2006. The following are estimated fair values and carrying values of our other financial instruments at each of these dates:
Asset (Liability) |
||||||||
December 31, 2007 |
December 31, 2006 |
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(in millions) |
Carrying Amount |
Fair Value |
Carrying Amount |
Fair Value |
||||
| Derivative Assets: | ||||||||
| Fixed-price natural gas futures and basis swaps | $ | 198 | $ | 198 | $ | 669 | $ | 669 |
| Fixed-price crude oil futures and differential swaps | 1 | 1 | 191 | 191 | ||||
| Derivative Liabilities: | ||||||||
| Fixed-price natural gas futures and basis swaps | (13) | (13) | (37) | (37) | ||||
| Fixed-price crude oil futures and differential swaps | (208) | (208) | (1) | (1) | ||||
| Fixed-price natural gas liquids futures | (22) | (22) | – | – | ||||
| Net derivative (liability) asset | $ | (44) | $ | (44) | $ | 822 | $ | 822 |
| Long-term debt | $ | (6,320) | $ | (6,438) | $ | (3,451) | $ | (3,427) |
The fair value of futures, swaps and differential agreements is estimated based on the exchange-trade value of NYMEX, basis and differential contracts and market commodity prices for the applicable future periods. The fair value of bank and commercial paper borrowings approximates their carrying value because of short-term interest rate maturities. The fair value of senior notes is based on current market quotes.
Changes in fair value of derivative assets and liabilities are the result of changes in natural gas, crude oil and natural gas liquids prices. Futures and swaps are generally designated as hedges of commodity price risks, and accordingly, changes in their values are predominantly recorded in accumulated other comprehensive income (loss) until the hedged transaction occurs.
Concentrations of Credit Risk
Although our cash equivalents, accounts receivable and derivative assets are exposed to the risk of credit loss, we do not believe such risk to be significant. Cash equivalents are high-grade, short-term securities, placed with highly rated financial institutions. Most of our receivables are from a diverse group of companies including major energy companies, pipeline companies, local distribution companies and end-users in various industries. We currently have the majority of our credit exposure with several A- or better rated integrated energy companies. Financial and commodity-based swap contracts expose us to the credit risk of nonperformance by the counterparty to the contracts. This exposure is diversified among major investment grade financial institutions, and we have master netting agreements with counterparties that provide for offsetting payables against receivables from separate derivative contracts. Letters of credit or other appropriate security are obtained as considered necessary to limit risk of loss. Our allowance for collectibility of all accounts receivable was $7 million at December 31, 2007 and $5 million at December 31, 2006.