Notes to the consolidated financial statements - supplementary information
34. Commodity risk
We purchase electricity and gas in order to supply our customers in the US and also to meet our own energy requirements. We also engage in the sale of gas that is produced primarily by our West Virginia gas fields.
Substantially all of our costs of purchasing electricity and gas for supply to customers are recoverable at an amount equal to cost. The timing of recovery of these costs can vary between financial periods leading to an under- or over-recovery within any particular financial period.
We enter into forward contracts for the purchase of commodities; some of which do not meet the own use exemption for accounting purposes and hence are accounted for as derivatives. We also enter into derivative financial instruments linked to commodity prices, including index-linked swaps and futures contracts. These derivative financial instruments manage market price volatility and are carried at fair value on the balance sheet. The mark-to-market changes in these contracts are reflected through earnings with the exception of those related to our West Virginia gas fields that are designated as cash flow hedges.
Our energy procurement risk management policy and Delegations of Authority govern our US commodity trading activities for energy transactions. The purpose of this policy is to ensure we transact within pre-defined risk parameters and only in the physical and financial markets that we or our customers have a physical market requirement.
The credit policy for commodity transactions is owned and monitored by the energy procurement risk management committee and establishes controls and procedures to determine, monitor and minimise the credit risk of counterparties. The valuation of our commodity contracts considers the risk of credit by utilising the most current default probabilities and the most current published credit ratings. We also use internal analysis to guide us in setting credit and risk levels and use contractual arrangements including netting agreements as applicable.
The counterparty exposure for our commodity derivatives as shown below is £49m (2008: £136m), and after netting agreements it was £43m (2008: £114m).
The fair value of our commodity contracts by type can be analysed as follows:
| 2009 | 2008 | ||||||
| Assets £m |
Liabilities £m |
Total £m |
Assets* £m |
Liabilities* £m |
Total* £m |
||
| Commodity purchase contracts accounted for as derivative contracts |
|||||||
| Forward purchases of electricity | – | (121) | (121) | – | (47) | (47) | |
| Forward purchases/sales of gas | 35 | (34) | 1 | 42 | (30) | 12 | |
| Forward purchases of electricity capacity | – | – | – | 1 | (12) | (11) | |
| Derivative financial instruments linked to commodity prices | |||||||
| Electricity swaps | – | (30) | (30) | – | (26) | (26) | |
| Gas swaps | 14 | (173) | (159) | 73 | (9) | 64 | |
| Gas options | – | (1) | (1) | 1 | – | 1 | |
| NYMEX gas and electricity futures | – | – | – | 19 | – | 19 | |
| 49 | (359) | (310) | 136 | (124) | 12 | ||
- *
- Comparatives have been adjusted to present items on a basis consistent with the current year categories
The maturity of commodity contracts measured at fair value can be analysed as follows:
| 2009 | 2008 | ||||||
| Assets £m |
Liabilities £m |
Total £m |
Assets £m |
Liabilities £m |
Total £m |
||
| In one year or less | 41 | (203) | (162) | 78 | (36) | 42 | |
| Current | 41 | (203) | (162) | 78 | (36) | 42 | |
| In more than one year, but less than two years | 6 | (41) | (35) | 40 | (36) | 4 | |
| In more than two years, but less than three years | 2 | (27) | (25) | 14 | (12) | 2 | |
| In more than three years, but less than four years | – | (17) | (17) | 4 | (18) | (14) | |
| In more than four years, but less than five years | – | (16) | (16) | – | (12) | (12) | |
| In more than five years | – | (55) | (55) | – | (10) | (10) | |
| Non-current | 8 | (156) | (148) | 58 | (88) | (30) | |
| Total | 49 | (359) | (310) | 136 | (124) | 12 | |
For each class of commodity contract, our exposure, based on the notional quantities is as follows:
| 2009 | 2008* | |
|---|---|---|
| Forward purchases of electricity (i) | 4,524 GWh | 5,467 GWh |
| Forward purchases/sales of gas (ii) | 298m Dth | 110m Dth |
| Forward purchases of electricity capacity | – | 23 GWh |
| Electricity swaps | 4,090 GWh | 879 GWh |
| Gas swaps | 88m Dth | 85m Dth |
| Gas options | 1m Dth | 2m Dth |
| NYMEX electricity futures | 18 GWh | 581 GWh |
| NYMEX gas futures (iii) | 30m Dth | 19m Dth |
- *
- Comparatives have been adjusted to present items on a basis consistent with the current year categories
- (i)
- Forward electricity purchases have terms up to 12 years. The contractual obligations of these contracts are £348m (2008: £316m).
- (ii)
- Forward gas purchases have terms up to 7 years. The contractual obligations of these contracts are £700m (2008: £873m).
- (iii)
- In 2009 NYMEX futures have been offset with related margin accounts.
A sensitivity analysis has been prepared on the basis that all commodity contracts are constant from the balance sheet date. Based on this, an illustrative 10% movement in commodity prices would have the following impacts after the effects of tax:
| 2009 | 2008 | ||||
| Income statement £m |
Other equity reserves £m |
Income statement £m |
Other equity reserves £m |
||
| 10% increase in commodity prices | 56 | (1) | 25 | (1) | |
| 10% reduction in commodity prices | (72) | 1 | (22) | 1 | |
The income statement impact illustrated above would affect the commodity remeasurements.