Risk Management and Trading Activities

9 Months Ended

Sep. 30, 2011

Risk Management and Trading Activities [Abstract]

Risk Management and Trading Activities

13. 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, natural gas, refined petroleum products and electricity, as well as to changes in interest rates and foreign currency values. In the disclosures that follow risk management activities are referred to as energy marketing and corporate risk management activities. The Corporation also has trading operations, principally through a 50% voting interest in a consolidated partnership, that trades energy-related commodities, securities and derivatives. These activities are also exposed to commodity price risks primarily related to the prices of crude oil, natural gas, refined petroleum products and electricity.

     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 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.

     Energy Marketing Activities: In its energy marketing activities the Corporation sells refined petroleum products, natural gas and electricity principally to commercial and industrial businesses at fixed and floating prices for varying periods of time. Commodity contracts such as futures, forwards, swaps and options, together with physical assets such as storage and pipeline capacity, are used to obtain supply and reduce margin volatility or lower costs related to sales contracts with customers.

     The table below shows the gross volume of the Corporation’s energy marketing commodity contracts outstanding:

	September 30,		December 31,
	2011		2010
Crude oil and refined petroleum products (millions of barrels)		27		30
Natural gas (millions of mcf)		2,532		2,210
Electricity (millions of megawatt hours)		242		301

     The changes in fair value of certain energy marketing commodity contracts that are not designated as hedges are recognized currently in earnings. Revenues from the sales contracts are recognized in Sales and other operating revenues, while supply contract purchases and net settlements from financial derivatives related to these energy marketing activities are recognized in Cost of products sold. Net realized and unrealized pre-tax gains on derivative contracts not designated as hedges amounted to $8 million and $50 million for the three months ended September 30, 2011 and 2010, respectively, and $36 million and $162 million for the nine months ended September 30, 2011 and 2010, respectively.

     At September 30, 2011, a portion of energy marketing commodity contracts are designated as cash flow hedges to hedge variability of expected future cash flows of forecasted supply transactions. The length of time over which the Corporation hedges exposure to variability in future cash flows is predominantly two years or less. For contracts outstanding at September 30, 2011, the maximum duration was approximately three years. The Corporation records the effective portion of changes in the fair value of cash flow hedges as a component of other comprehensive income. Amounts recorded in Accumulated other comprehensive income are reclassified into Cost of products sold in the same period that the hedged item is recognized in earnings. The ineffective portion of changes in the fair value of cash flow hedges is recognized immediately in Cost of products sold.

     At September 30, 2011, the after-tax deferred losses relating to energy marketing activities recorded in Accumulated other comprehensive income were $71 million ($147 million at December 31, 2010). The Corporation estimates that a loss of approximately $48 million will be reclassified into earnings over the next twelve months. During the three months ended September 30, 2011 and 2010, the Corporation reclassified after-tax losses from Accumulated other comprehensive income of $24 million and $56 million, respectively, and $77 million and $257 million for the nine months ended September 30, 2011 and 2010, respectively. The amounts reflected in earnings due to hedge ineffectiveness were a loss of $2 million and a gain of approximately $1 million for the three months ended September 30, 2011 and 2010, respectively, and a loss of $4 million and a gain of approximately $1 million for the nine months ended September 30, 2011 and 2010, respectively. As a result of changes in the fair value of energy marketing cash flow hedge positions, after-tax deferred losses increased by $4 million and $34 million for the three months ended September 30, 2011 and 2010, respectively, and $1 million and $193 million for the nine months ended September 30, 2011 and 2010, respectively.

     Corporate Risk Management Activities: Corporate risk management activities include transactions designed to reduce risk in the selling prices of crude oil, refined petroleum products 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, refined petroleum products 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 including the British Pound and Thai Baht. Interest rate swaps may be used to convert interest payments on certain long-term debt from fixed to floating rates.

     The table below shows the gross volume of the Corporate risk management derivative contracts outstanding:

	September 30,		December 31,
	2011		2010
Commodity, primarily crude oil (millions of barrels)		22		35
Foreign exchange (millions of U.S. Dollars)	$	940	$	1,025
Interest rate swaps (millions of U.S. Dollars)	$	895	$	310

     During 2008, the Corporation closed Brent crude oil cash flow hedges covering 24,000 barrels per day through 2012, by entering into offsetting contracts with the same counterparty. As a result, the valuation of those contracts is no longer subject to change due to price fluctuations. The deferred hedge loss as of the date that the hedges were closed is being recorded in earnings as the hedged transactions occur. There were no other open hedges of crude oil or natural gas production at September 30, 2011. Hedging activities decreased Exploration and Production Sales and other operating revenues by $131 million and $134 million for the three months ended September 30, 2011 and 2010, respectively ($82 million and $85 million after-tax, respectively), and $387 million and $398 million for the nine months ended September 30, 2011 and 2010, respectively ($244 million and $252 million after-tax, respectively). Hedging activities decreased Exploration and Production Sales and other operating revenues by $533 million for the year ended December 31, 2010 ($338 million after-tax). At September 30, 2011, the after-tax deferred losses in Accumulated other comprehensive income relating to the closed Brent crude oil hedges were $400 million ($638 million at December 31, 2010). The Corporation estimates that a loss of approximately $325 million will be reclassified into earnings over the next twelve months.

     At September 30, 2011, the Corporation had interest rate swaps with a gross notional amount of $895 million, which were designated as fair value hedges. Changes in fair value of interest rate swaps and the hedged fixed-rate debt are recorded in Interest expense. During the three months ended September 30, 2011 and 2010, the Corporation recorded an increase of $42 million and $5 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. During the nine months ended September 30, 2011 and 2010, the Corporation recorded an increase of $45 million and $12 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.

     Foreign exchange contracts are not designated as hedges. Gains or losses on foreign exchange contracts are recognized immediately in Other, net in Revenues and non-operating income.

     Net realized and unrealized pre-tax gains (losses) on derivative contracts used for corporate risk management activities and not designated as hedges amounted to the following:

	Three Months					Nine Months
	Ended September 30,					Ended September 30,
	2011			2010		2011			2010
				(Millions of dollars)
Commodity	$	—		$	—	$	1		$	(7	)
Foreign exchange		(25	)		48		(12	)		(4	)
Total	$	(25	)	$	48	$	(11	)	$	(11	)

     Trading Activities: Trading activities are conducted principally through a trading partnership in which the Corporation has a 50% voting interest. This consolidated entity intends to generate earnings through various strategies primarily using energy-related commodities, securities and derivatives. The Corporation also takes trading positions for its own account. The information that follows represents 100% of the trading partnership and the Corporation’s proprietary trading accounts.

     The table below shows the gross volume of derivative contracts outstanding relating to trading activities:

	September 30,		December 31,
	2011		2010
Commodity
Crude oil and refined petroleum products (millions of barrels)		2,966		3,328
Natural gas (millions of mcf)		4,910		4,699
Electricity (millions of megawatt hours)		268		79
Foreign exchange (millions of U.S. Dollars)	$	621	$	506
Other
Interest rate (millions of U.S. Dollars)	$	127	$	205
Equity securities (millions of shares)		34		35

     Pre-tax gains (losses) recorded in Sales and other operating revenues from trading activities amounted to the following:

	Three Months						Nine Months
	Ended September 30,						Ended September 30,
	2011			2010			2011			2010
				(Millions of dollars)
Commodity	$	(5	)	$	(118	)	$	45		$	26
Foreign exchange		7			2			(1	)		8
Other		(52	)		12			(42	)		(5	)
Total	$	(50	)	$	(104	)	$	2		$	29

     Fair Value Measurements: The Corporation determines fair value in accordance with the fair value measurements accounting standard which established a hierarchy that categorizes the sources of 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). 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, 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 financial asset or liability presented below is based on the lowest significant input level within this fair value hierarchy.

     The following table provides the Corporation’s net financial assets and (liabilities) that are measured at fair value based on this hierarchy:

										Collateral
										and
										counterparty
	Level 1			Level 2			Level 3			netting			Balance
				(Millions of dollars)
September 30, 2011
Assets
Derivative contracts
Commodity	$	283		$	1,288		$	320		$	(305	)	$	1,586
Foreign exchange		—			1			—			—			1
Interest rate and other		2			71			1			(1	)		73
Collateral and counterparty netting		(58	)		(220	)		(20	)		(133	)		(431	)
Total derivative contracts		227			1,140			301			(439	)		1,229
Other assets measured at fair value on a recurring basis		10			90			—			(1	)		99
Total assets	$	237		$	1,230		$	301		$	(440	)	$	1,328
Liabilities
Derivative contracts
Commodity	$	(490	)	$	(1,645	)	$	(557	)	$	305		$	(2,387	)
Foreign exchange		—			(36	)		—			—			(36	)
Other		—			(61	)		(7	)		1			(67	)
Collateral and counterparty netting		58			220			20			85			383
Total derivative contracts		(432	)		(1,522	)		(544	)		391			(2,107	)
Other liabilities measured at fair value on a recurring basis		—			(58	)		(1	)		1			(58	)
Total liabilities	$	(432	)	$	(1,580	)	$	(545	)	$	392		$	(2,165	)
December 31, 2010
Assets
Derivative contracts
Commodity	$	65		$	1,308		$	883		$	(304	)	$	1,952
Foreign exchange		—			1			—			—			1
Interest rate and other		—			17			—			—			17
Collateral and counterparty netting		(1	)		(274	)		(19	)		(213	)		(507	)
Total derivative contracts		64			1,052			864			(517	)		1,463
Other assets measured at fair value on a recurring basis		20			49			3			—			72
Total assets	$	84		$	1,101		$	867		$	(517	)	$	1,535
Liabilities
Derivative contracts
Commodity	$	(324	)	$	(2,519	)	$	(474	)	$	304		$	(3,013	)
Foreign exchange		—			(12	)		—			—			(12	)
Other		—			(10	)		—			—			(10	)
Collateral and counterparty netting		1			274			19			34			328
Total derivative contracts		(323	)		(2,267	)		(455	)		338			(2,707	)
Other liabilities measured at fair value on a recurring basis		—			—			—			—			—
Total liabilities	$	(323	)	$	(2,267	)	$	(455	)	$	338		$	(2,707	)

     The following table provides changes in financial assets and liabilities that are measured at fair value based on Level 3 inputs:

	Three Months						Nine Months
	Ended September 30,						Ended September 30,
	2011			2010			2011			2010
				(Millions of dollars)
Balance at beginning of period	$	372		$	41		$	412		$	84
Unrealized gains (losses)
Included in earnings		(85	)		105			19			163
Included in other comprehensive income		13			(18	)		30			62
Purchases		415			347			1,932			782
Sales		(536	)		(397	)		(2,131	)		(745	)
Settlements		(162	)		(1	)		(194	)		(46	)
Transfers into Level 3		(222	)		215			(211	)		57
Transfers out of Level 3		(39	)		12			(101	)		(53	)
Balance at end of period	$	(244	)	$	304		$	(244	)	$	304

     Purchases and sales in the table above primarily represent option premiums paid or received, respectively, during the reporting period. Settlements represent realized gains and losses on derivatives settled during the reporting period.

     The following table provides net transfers into and out of each level of the fair value hierarchy:

	Three Months						Nine Months
	Ended September 30,						Ended September 30,
	2011			2010			2011			2010
				(Millions of dollars)
Transfers into Level 1	$	(4	)	$	95		$	(12	)	$	123
Transfers out of Level 1		39			89			318			23
	$	35		$	184		$	306		$	146
Transfers into Level 2	$	28		$	(8	)	$	34		$	121
Transfers out of Level 2		198			(403	)		(28	)		(271	)
	$	226		$	(411	)	$	6		$	(150	)
Transfers into Level 3	$	(222	)	$	215		$	(211	)	$	57
Transfers out of Level 3		(39	)		12			(101	)		(53	)
	$	(261	)	$	227		$	(312	)	$	4

     The Corporation’s policy is to recognize transfers in and transfers out as of the end of the reporting period. Transfers between levels result from the passage of time as contracts move closer to their maturities, fluctuations in the market liquidity for certain contracts and/or changes in the level of significance of fair value measurement inputs.

     In addition to the financial assets and liabilities disclosed in the tables above, the Corporation had other short-term financial instruments, primarily cash equivalents and accounts receivable and payable, for which the carrying value approximated their fair value at September 30, 2011 and December 31, 2010. Fixed-rate long-term debt had a carrying value of $5,583 million, compared with a fair value of $6,723 million at September 30, 2011, and a carrying value of $5,569 million, compared with a fair value of $6,353 million at December 31, 2010.

     The table below reflects the gross and net fair values of the Corporation’s risk management and trading derivative instruments:

	Accounts			Accounts
	Receivable			Payable
	(Millions of dollars)
September 30, 2011
Derivative contracts designated as hedging instruments
Commodity	$	97		$	(281	)
Other		56			(3	)
Total derivative contracts designated as hedging instruments		153			(284	)
Derivative contracts not designated as hedging instruments (*)
Commodity		12,040			(12,657	)
Foreign exchange		6			(41	)
Other		60			(107	)
Total derivative contracts not designated as hedging instruments		12,106			(12,805	)
Gross fair value of derivative contracts		12,259			(13,089	)
Master netting arrangements		(10,897	)		10,897
Cash collateral (received) posted		(133	)		85
Net fair value of derivative contracts	$	1,229		$	(2,107	)
December 31, 2010
Derivative contracts designated as hedging instruments
Commodity	$	225		$	(483	)
Other		10			(2	)
Total derivative contracts designated as hedging instruments		235			(485	)
Derivative contracts not designated as hedging instruments (*)
Commodity		11,581			(12,383	)
Foreign exchange		7			(19	)
Other		31			(32	)
Total derivative contracts not designated as hedging instruments		11,619			(12,434	)
Gross fair value of derivative contracts		11,854			(12,919	)
Master netting arrangements		(10,178	)		10,178
Cash collateral (received) posted		(213	)		34
Net fair value of derivative contracts	$	1,463		$	(2,707	)

(*) Includes trading derivatives and derivatives used for risk management.

     Credit Risk: The Corporation is exposed to credit risks that may at times be concentrated with certain counterparties, groups of counterparties or customers. Accounts receivable are generated from a diverse domestic and international customer base. The Corporation’s net receivables at September 30, 2011 are concentrated with the following counterparty and customer industry segments: Integrated Oil Companies — 26%, Government Entities — 9%, Manufacturing — 8%, Financial Institutions — 7%, Refiners — 7%, Services — 7%, Trading Companies — 7% and Real Estate — 6%. The Corporation reduces its risk related to certain counterparties by using master netting arrangements and requiring collateral, generally cash or letters of credit. The Corporation records the cash collateral received or posted as an offset to the fair value of derivatives executed with the same counterparty. At September 30, 2011 and December 31, 2010, the Corporation held cash from counterparties of $133 million and $213 million, respectively. The Corporation posted cash to counterparties at September 30, 2011 and December 31, 2010 of $85 million and $34 million, respectively.

     At September 30, 2011, the Corporation had a total of $1,671 million of outstanding letters of credit, primarily issued to satisfy margin requirements. Certain of the Corporation’s agreements also contain contingent collateral provisions that could require the Corporation to post additional collateral if the Corporation’s credit rating declines. As of September 30, 2011, the net liability related to derivatives with contingent collateral provisions was approximately $1,059 million before cash collateral posted of $11 million. At September 30, 2011, all three major credit rating agencies that rate the Corporation’s debt had assigned an investment grade rating. If two of the three agencies were to downgrade the Corporation’s rating to below investment grade, as of September 30, 2011, the Corporation would be required to post additional collateral of approximately $333 million.