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 purchased gas and oil for our discontinued Ravenswood generation station prior to 31 December 2007 when we entered a tolling agreement with a third party. We also engage in the sale of gas that is produced primarily by our West Virginia gas fields. In the US substantially all of our costs of purchasing electricity and gas for supply to customers are typically 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. The most significant gas purchases for our own use relate to the operation of our gas transmission and gas distribution networks, mainly in the UK, while we also purchase fuel for our vehicle fleets in the UK and the US.
We enter into forward contracts for the purchase of commodities; some of these do not meet the normal purchase, sale or usage exemption for accounting purposes and hence are reported as derivatives. We also enter into derivative instruments including indexlinked swaps and futures contracts linked to commodity prices. These derivatives are used to reduce market price volatility and are carried at fair value in the balance sheet. Mark-to-market changes in these contracts are reflected through earnings with the exception of electricity and gas futures contracts, and gas sales swaps which 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 the policy is to ensure that our US operating companies participate in the physical and financial markets only for those commodities that we or our customers have a physical market requirement, and will transact only within predefined risk parameters approved by the Energy Procurement Risk Management Committee.
The fair value of our commodity contracts by type can be analysed as follows:
| 2008 | 2007* | |||
|---|---|---|---|---|
| Assets £m |
Liabilities £m |
Total £m |
Total £m |
|
| Commodity purchase contracts accounted for as derivative contracts |
||||
| Forward purchases of electricity | – | (47) | (47) | (132) |
| Forward purchases of gas | 116 | (39) | 77 | – |
| Forward purchases of electricity capacity | 1 | (12) | (11) | – |
| Derivative financial instruments linked to commodity prices |
||||
| Electricity swaps | – | (26) | (26) | (136) |
| NYMEX gas and electricity futures | 19 | – | 19 | – |
| 136 | (124) | 12 | (268) | |
The maturity of commodity contracts measured at fair value can be analysed as follows:
| 2008 | 2007* | |||
|---|---|---|---|---|
| Assets £m |
Liabilities £m |
Total £m |
Total £m |
|
| In one year or less | 78 | (36) | 42 | (138) |
| Current | 78 | (36) | 42 | (138) |
| In more than one year, but not more than two years | 40 | (36) | 4 | (42) |
| In more than two years, but not more than three years | 14 | (12) | 2 | (11) |
| In more than three years, but not more than four years | 4 | (18) | (14) | (12) |
| In more than four years, but not more than five years | – | (12) | (12) | (12) |
| In more than five years | – | (10) | (10) | (53) |
| Non-current | 58 | (88) | (30) | (130) |
| Total | 136 | (124) | 12 | (268) |
*In 2007 all commodity contracts were liabilities
For each class of commodity contract, our exposure, based on the notional quantities is as follows:
| 2008 | 2007 | |
|---|---|---|
| Forward purchases of electricity (i) | Nil | Nil |
| Forward purchases of gas (ii) | 197m Dth | n/a |
| Forward purchases of electricity capacity | 23 GWh | n/a |
| Electricity swaps | 5,466 GWh | 6,845 GWh |
| NYMEX electricity futures | 581 GWh | n/a |
| NYMEX gas futures | 19m Dth | n/a |
i) Forward electricity purchases have terms up to 12 years but do not have specified notional quantities as these are defined by a percentage of unit output. The future obligations of these contracts are £316m (2007: £389m).
(ii) Forward gas purchases have terms up to seven years. The future obligations of these contracts are £873m (2007: n/a).
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:
| 2008 | 2007 | |||
|---|---|---|---|---|
| Income statement £m |
Other equity reserves £m |
Income statement £m |
Other equity reserves £m |
|
| 10% increase in commodity prices | 25 | (1) | 10 | – |
| 10% reduction in commodity prices | (22) | 1 | (10) | – |
The income statement sensitivities will impact commodity remeasurements.