Note L – Financial Instruments and Risk Management

DERIVATIVE INSTRUMENTS – Murphy often uses derivative instruments to manage certain risks related to commodity prices, foreign currency exchange rates and interest rates. The use of derivative instruments for risk management is covered by operating policies and is closely monitored by the Company’s senior management. The Company does not hold any derivatives for speculative purposes and it does not use derivatives with leveraged or complex features. Derivative instruments are traded primarily with creditworthy major financial institutions or over national exchanges such as the New York Mercantile Exchange (NYMEX). The Company has a risk management control system to monitor commodity price risks and any derivatives obtained to manage a portion of such risks. For accounting purposes, the Company has not designated commodity and foreign currency derivative contracts as hedges, and therefore, it recognizes all gains and losses on these derivative contracts in its Consolidated Statements of Operations. Certain interest rate derivative contracts were accounted for as hedges and the gain or loss associated with recording the fair value of these contracts was deferred in AOCL until the anticipated transactions occur.

Commodity Purchase Price Risks

The Company is subject to commodity price risk related to crude oil it produces and sells. During the last three years, the Company had West Texas Intermediate (WTI) crude oil price swap financial contracts to economically hedge a portion of its United States production. Under these contracts, which matured monthly, the Company paid the average monthly price in effect and received the fixed contract prices.

At December 31, 2017, the Company had 21,000 barrels per day in WTI crude oil swap financial contracts maturing ratably during 2018 at an average price of $54.88. At December 31, 2017, the fair value of these WTI contracts of $39.1 million was included in Accounts payable in the Consolidated Balance Sheet. The impact of marking to market these commodity derivative contracts reduced the income before income taxes by $34.0 million for the year ended December 31, 2017.

During 2016, the Company had WTI crude oil price swap financial contracts to hedge a portion of its United States production for 2016 and 2017. At December 31, 2016, the Company had 22,000 barrels per day in WTI crude oil swap financial contracts maturing ratably during 2017. At December 31, 2016, the fair value of WTI contracts of $48.9 million was included in Accounts payable in the Consolidated Balance Sheet. The impact of marking to market these commodity derivative contracts increased the loss before income taxes by $47.7 million for the year ended December 31, 2016.

Foreign Currency Exchange Risks

The Company is subject to foreign currency exchange risk associated with operations in countries outside the U.S. At December 31, 2016, short-term derivative instruments were outstanding in Canada for approximately $14.2 million to manage the currency risk of U.S. dollar accounts receivable balances associated with the sale of Canadian crude oil.

At December 31, 2017 and 2016, the fair value of derivative instruments not designated as hedging instruments are presented in the following table. Also shown is the fair value of open foreign currency derivative contracts at December 31, 2016.



	December 31, 2017			December 31, 2016
(Thousands of dollars)	Asset (Liability) Derivatives			Asset (Liability) Derivatives
Type of Derivative Contract	Balance Sheet Location		Fair Value	Balance Sheet Location		Fair Value
Commodity	Accounts payable	$	(39,093)	Accounts payable	$	(48,864)
Foreign exchange	–		–	Accounts payable	$	(73)

For the years ended December 31, 2017 and 2016, the gains and losses recognized in the Consolidated Statements of Operations for derivative instruments not designated as hedging instruments are presented in the following table.



		Gain (Loss)
(Thousands of dollars)			Year Ended December 31,
Type of Derivative Contract	Statement of Operations Locations	2017		2016
Commodity	Sales and other operating revenues	$	9,567	$	(63,412)
Foreign exchange	Interest and other income (loss)		–		26,714
		$	9,567	$	(36,698)

Interest Rate Risks

Under hedge accounting rules, the Company deferred the net cost associated with derivative contracts purchased to manage interest rate risk associated with 10-year notes sold in 2012 to match the payment of interest on these notes through 2022. During each of the three years ended December 31, 2017, $3.0 million of the deferred loss on the interest rate swaps was charged to Interest expense in the Consolidated Statements of Operations. The remaining loss (net of tax) deferred on these matured contracts at December 31, 2017 was $8.4 million, which is recorded, net of income taxes of $4.5 million, in Accumulated other comprehensive loss in the Consolidated Balance Sheets. The Company expects to charge approximately $3.0 million of this deferred loss to Interest expense in the Consolidated Statements of Operations during 2018.

CREDIT RISKS – The Company’s primary credit risks are associated with trade accounts receivable, cash equivalents and derivative instruments. Trade receivables arise mainly from sales of oil and natural gas in the U.S., Canada and Malaysia, and cost sharing amounts of operating and capital costs billed to partners for oil and natural gas fields operated by Murphy. The credit history and financial condition of potential customers are reviewed before credit is extended, security is obtained when deemed appropriate based on a potential customer’s financial condition, and routine follow-up evaluations are made. The combination of these evaluations and the large number of customers tends to limit the risk of credit concentration to an acceptable level. Cash equivalents are placed with several major financial institutions, which limit the Company’s exposure to credit risk. The Company controls credit risk on derivatives through credit approvals and monitoring procedures and believes that such risks are minimal because counterparties to the majority of transactions are major financial institutions.