Note J – Financial Instruments and Risk Management

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 Accumulated Other Comprehensive Loss until the anticipated transactions occur. This deferred cost is being reclassified to Interest expense, net in the Consolidated Statements of Operations over the period until the associated notes mature in 2022.

Commodity Purchase Price Risks

The Company is subject to commodity price risk related to crude oil it produces and sells. During the first nine months 2017 and 2016, the Company had West Texas Intermediate (WTI) crude oil 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 September 30, 2017, the Company had 22,000 barrels per day in WTI crude oil swap financial contracts maturing ratably during the remainder of 2017 at an average price of $50.41 and 6,000 barrels per day in WTI crude oil swap financial contracts maturing ratably during 2018 at an average price of $51.83. At September 30, 2017, the fair value of WTI contracts of $3.2 million was included in Accounts Payable. The impact of marking to market these commodity derivative contracts increased the loss before income taxes by $3.2 million for the nine-month period ended September 30, 2017.

At September 30, 2016, the Company had 25,000 barrels per day in WTI crude oil swap financial contracts maturing ratably during 2016. At September 30, 2016, the fair value of WTI contracts of $0.2 million was included in Accounts Receivable. The impact of marking to market these 2016 commodity derivative contracts decreased the loss before income taxes by $3.9 million for the nine-month period ended September 30, 2016.

Note J – Financial Instruments and Risk Management (Contd.)

Foreign Currency Exchange Risks

The Company is subject to foreign currency exchange risk associated with operations in countries outside the U.S. The Company had no foreign currency exchange short-term derivatives outstanding at September 30, 2017.

At September 30, 2016, short-term derivative instruments were outstanding in Canada for approximately $25.2 million, to manage the currency risks of certain U.S. dollar accounts receivable associated with sale of Canadian crude oil. The fair values of open foreign currency derivative contracts were assets of $0.1 million at September 30, 2016.

At September 30, 2017 and December 31, 2016, the fair value of derivative instruments not designated as hedging instruments are presented in the following table.



	September 30, 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	$	(3,226)	Accounts payable	$	(48,864)
Foreign exchange	Accounts receivable		–	Accounts payable		(73)

For the three-month and nine-month periods ended September 30, 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)
		Three Months Ended			Nine Months Ended
(Thousands of dollars)		September 30,			September 30,
Type of Derivative Contract	Statement of Operations Location		2017	2016	2017	2016
Commodity	Sales and other operating revenues	$	(13,573)	11,871	50,365	(22,678)
Foreign exchange	Interest and other income (loss)		–	143	73	26,929
		$	(13,573)	12,014	50,438	4,251

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 May 2012 to match the payment of interest on these notes through 2022. During each of the nine-month periods ended September 30, 2017 and 2016, $2.2 million of the deferred loss on the interest rate swaps was charged to Interest expense in the Consolidated Statement of Operations. The remaining loss deferred on these matured contracts at September 30, 2017 was $8.9 million, which is recorded, net of income taxes of $4.8 million, in Accumulated other comprehensive loss in the Consolidated Balance Sheet. The Company expects to charge approximately $0.7 million of this deferred loss to Interest expense, net in the Consolidated Statement of Operations during the remaining three months of 2017.

Note J – Financial Instruments and Risk Management (Contd.)

Fair Values – Recurring

The Company carries certain assets and liabilities at fair value in its Consolidated Balance Sheets. The fair value hierarchy is based on the quality of inputs used to measure fair value, with Level 1 being the highest quality and Level 3 being the lowest quality. Level 1 inputs are quoted prices in active markets for identical assets or liabilities. Level 2 inputs are observable inputs other than quoted prices included within Level 1. Level 3 inputs are unobservable inputs which reflect assumptions about pricing by market participants.

The carrying value of assets and liabilities recorded at fair value on a recurring basis at September 30, 2017 and December 31, 2016 are presented in the following table.

September 30, 2017

December 31, 2016

(Thousands of dollars)

Level 1

Level 2

Level 3

Total

Level 1

Level 2

Level 3

Total

Liabilities:

Nonqualified employee
savings plans

15,161

–

15,161

13,904

–

13,904

Commodity derivative contracts

–

3,226

–

3,226

–

48,864

–

48,864

Foreign currency exchange
derivative contracts

–

15,161

3,226

–

18,387

13,904

48,937

–

62,841

The fair value of WTI crude oil derivative contracts in 2017 and 2016 was based on active market quotes for WTI crude oil. The fair value of foreign exchange derivative contracts in each year was based on market quotes for similar contracts at the balance sheet dates. The income effect of changes in the fair value of crude oil derivative contracts is recorded in Sales and other operating revenues in the Consolidated Statements of Operations, while the effects of changes in fair value of foreign exchange derivative contracts is recorded in Interest and other income. The nonqualified employee savings plan is an unfunded savings plan through which participants seek a return via phantom investments in equity securities and/or mutual funds. The fair value of this liability was based on quoted prices for these equity securities and mutual funds. The income effect of changes in the fair value of the nonqualified employee savings plan is recorded in Selling and general expenses in the Consolidated Statements of Operations.

The Company offsets certain assets and liabilities related to derivative contracts when the legal right of offset exists. There were no offsetting positions recorded at September 30, 2017 and December 31, 2016.

Note J – Financial Instruments and Risk Management (Contd.)

Fair Values – Nonrecurring

As a result of the fall in forward commodity prices during the first nine-month period ended September 30, 2016, the Company recognized approximately $95.1 million in pretax non-cash impairment charges related to producing properties. The fair value information associated with these impaired properties is presented in the following table.


	Nine-months ended September 30, 2016
						Total
					Net Book	Pretax
					Value	(Noncash)
	Fair Value				Prior to	Impairment
		Level 1	Level 2	Level 3	Impairment	Expense
(Thousands of dollars)
Assets:
Impaired proved properties
Canada	$	–	–	71,967	167,055	95,088

The fair values were determined by internal discounted cash flow models using estimates of future production, prices from futures exchanges, costs and a discount rate believed to be consistent with those used by principal market participants in the applicable region.