Financial Instruments and Risk Management

9 Months Ended

Sep. 30, 2011

Financial Instruments and Risk Management

Note K – Financial Instruments and Risk Management

Murphy periodically utilizes 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. 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 Income. As described below, certain interest rate derivative contracts are accounted for as hedges and the gain or loss associated with recording the fair value of these contracts has been deferred in Accumulated Other Comprehensive Income until the anticipated transactions occur.

Commodity Purchase Price Risks

The Company is subject to commodity price risks related to crude oil feedstocks previously held in inventory at U.S. refineries. The Company had no open crude oil derivative contracts at September 30, 2011. Short-term derivative instruments were outstanding at September 30, 2010 to manage the cost of about 0.9 million barrels of crude oil and other feedstocks at the Company’s U.S. refineries. Also, at September 30, 2010, the Company had open derivative contracts covering 0.4 million barrels of intermediate feedstock inventories which were to be processed at the Company’s refineries. The total impact of marking to market these contracts decreased income before taxes by $3.8 million in the nine-month period ended September 30, 2010. There was an accounts receivable of $7.3 million related to matured but unsettled crude oil derivative contracts at September 30, 2011.

The Company is also subject to commodity price risk related to corn that it will purchase in the future for feedstock and to wet and dried distillers grain that it will sell in the future at its ethanol production facilities in the United States. At September 30, 2011 and 2010, the Company had open physical delivery fixed-price commitment contracts for purchase of approximately 7.9 million and 5.4 million bushels of corn, respectively, for processing at its ethanol plants. The Company also had outstanding derivative contracts to sell a similar volume of these fixed-price quantities and buy them back at future prices in effect on the expected date of delivery under the purchase commitment contracts. Also, at September 30, 2011, the Company had open physical delivery fixed-price commitment contracts for sale of approximately 1.6 million equivalent bushels of wet and dried distillers grain with outstanding derivative contracts to purchase a similar volume of these fixed-price quantities and sell them back at future prices in effect on the expected date of delivery under the sale commitment contracts. Additionally, at September 30, 2011, the Company had outstanding derivative contracts to sell 2.3 million bushels of corn and buy them back when certain corn inventories are expected to be processed at the Hereford, Texas facility. The impact of marking to market these commodity derivative contracts increased income before taxes by $1.9 million in the nine-month period ended September 30, 2011 and was insignificant for the nine-month period ended September 30, 2010.

Foreign Currency Exchange Risks

The Company is subject to foreign currency exchange risk associated with operations in countries outside the U.S. Short-term derivative instruments were outstanding at September 30, 2011 and 2010 to manage the risk of certain future income taxes that are payable in Malaysian ringgits. The equivalent U.S. dollars of Malaysian ringgit derivative contracts open at September 30, 2011 and 2010 were approximately $123.3 million and $194.0 million, respectively. Short-term derivative instrument contracts totaling $38.0 million and $107.0 million U.S. dollars were also outstanding at September 30, 2011 and 2010, respectively, to manage the risk of certain U.S. dollar accounts receivable associated with sale of crude oil production in Canada. The impact from marking to market these foreign currency derivative contracts increased income before taxes by $4.6 million and $29.7 million for the nine-month periods ended September 30, 2011 and 2010, respectively.

At September 30, 2011 and December 31, 2010, the fair value of derivative instruments not designated as hedging instruments are presented in the following table.

	September 30, 2011					December 31, 2010
(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 receivable	$	9,228		Accounts receivable	$	750
Commodity		—		—		Accounts payable		(626	)
Foreign exchange		Accounts payable		(2,609	)	Accounts receivable		7,261

For the three-month and nine-month periods ended September 30, 2011 and 2010, the gains and losses recognized in the Consolidated Statements of Income for derivative instruments not designated as hedging instruments are presented in the following table.

		Gain (Loss)
		Three Months Ended September 30,						Nine Months Ended September 30,
(Thousands of dollars)	Statement of Income Location	2011			2010			2011		2010
Type of Derivative Contract
Commodity	Crude oil and product purchases	$	7,381			(1,695	)		5,900		(1,085	)
Foreign exchange	Interest and other income		(7,376	)		13,954			4,614		29,681
		$	5			12,259			10,514		28,596

Interest Rate Risks

The Company has ten-year notes totaling $350 million that mature on May 1, 2012. The Company currently anticipates replacing these notes at maturity with new ten-year notes, and it therefore has risk associated with the interest rate associated with the anticipated sale of these notes in 2012. To manage this risk, in the third quarter 2011 the Company entered into a series of derivative contracts known as forward starting interest rate swaps that mature in May 2012. The Company utilizes hedge accounting to defer any gain or loss on these contracts until the payment of interest on these anticipated notes occurs. There was no impact in the 2011 Consolidated Statements of Income associated with accounting for these interest rate derivative contracts.

At September 30, 2011, the fair value of these interest rate derivative contracts, which have been designated as hedging instruments for accounting purposes, are presented in the following table.

	September 30, 2011
(Thousands of dollars)	Asset (Liability) Derivatives
Type of Derivative Contract	Balance Sheet Location		Fair Value
Interest rate		Accounts Payable	$	(20,722	)

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, 2011 and December 31, 2010 are presented in the following table.

	September 30, 2011											December 31, 2010
(Thousands of dollars)	Level 1			Level 2			Level 3		Total			Level 1			Level 2			Level 3		Total
Assets
Foreign exchange derivative contracts	$	0			0			0		0			0			7,261			0		7,261
Commodity derivative contracts		0			9,228			0		9,228			0			750			0		750
	$	0			9,228			0		9,228			0			8,011			0		8,011
Liabilities
Nonqualified employee savings plans	$	(6,980	)		0			0		(6,980	)		(7,672	)		0			0		(7,672	)
Foreign exchange derivative contracts		0			(2,609	)		0		(2,609	)		0			0			0		0
Commodity derivative contracts		0			0			0		0			0			(626	)		0		(626	)
Interest rate derivative contracts		0			(20,722	)		0		(20,722	)		0			0			0		0
	$	(6,980	)		(23,331	)		0		(30,311	)		(7,672	)		(626	)		0		(8,298	)

The fair value of commodity derivative contracts was determined based on market quotes for West Texas Intermediate crude oil and for No. 2 yellow corn. The fair value of foreign exchange and interest rate derivative contracts was based on market quotes for similar contracts at the balance sheet date. The income effect of changes in fair value of commodity derivative contracts is recorded in Crude Oil and Product Purchases in the Consolidated Statements of Income and changes in fair value of foreign exchange derivative contracts is recorded in Interest and Other Income. There was no income effect for the change in fair value of interest rate derivative contracts. The nonqualified employee savings plan is an unfunded savings plan through which the 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 nonqualified employee savings plan is recorded in Selling and General Expenses.