Financial Instruments and Risk Management

9 Months Ended

Sep. 30, 2012

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. Certain interest rate derivative contracts were accounted for as a hedge and the loss at maturity of these contracts has been deferred in Accumulated Other Comprehensive Income and is being accreted to interest expense over the ten-year term of the associated notes payable.

Commodity Purchase Price Risks

The Company is subject to commodity price risk related to corn that it will purchase in the future for feedstock and for corn that it holds in inventory as feedstock as well as wet and dried distillers grain that it will sell in the future at its ethanol production facilities in the United States. At September 30, 2012 and 2011, the Company had open physical delivery fixed-price commitment contracts for purchase of approximately 8.8 million and 7.9 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. Additionally, at September 30, 2012 and 2011, the Company had outstanding derivative contracts to sell 3.4 million and 2.3 million bushels of corn, respectively, and buy them back when certain corn inventories are expected to be processed at the Hereford, Texas facility. Also, at September 30, 2012 and 2011, the Company had open physical delivery fixed-price commitment contracts for sale of approximately 1.5 million and 1.6 million equivalent bushels of wet and dried distillers grain, respectively, 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. The impact of marking to market these commodity derivative contracts increased income from continuing operations before taxes by $6.3 million and $1.9 million in the nine-month periods ended September 30, 2012 and 2011, respectively. Cash collateral deposits of $9.2 million at September 30, 2012 associated with these commodity derivative contracts were excluded from the fair value of assets and liabilities included below.

Foreign Currency Exchange Risks

The Company is subject to foreign currency exchange risk associated with operations in countries outside the United States. Short-term derivative instruments were outstanding at September 30, 2012 and 2011 to manage the risk of certain income taxes that are payable in Malaysian ringgits. The equivalent U.S. dollars of Malaysian ringgit derivative contracts open at September 30, 2012 and 2011 were approximately $97.6 million and $123.3 million, respectively. Short-term derivative instrument contracts totaling $38.0 million U.S. dollars were also outstanding at September 30, 2011 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 from continuing operations before taxes by $3.1 million for the nine-month period ended September 30, 2012 and decreased income from continuing operations before taxes by $2.6 million for the nine-month period ended September 30, 2011.

At September 30, 2012 and December 31, 2011, the fair value of derivative instruments not designated as hedging instruments are presented in the following table.

	September 30, 2012				December 31, 2011
(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	$	9,496		Accounts receivable	$	197
Commodity	Accounts payable		(3,176	)	Accounts payable		(489	)
Foreign exchange	Accounts receivable		3,612		Accounts payable		(8,459	)

For the three-month and nine-month periods ended September 30, 2012 and 2011, 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)
(Thousands of dollars) Type of Derivative Contract	Statement of Income Location	Three Months Ended September 30,						Nine Months Ended September 30,
		2012			2011			2012			2011
Commodity	Crude oil and product purchases	$	(40,241	)		7,381			(37,978	)		5,900
Foreign exchange	Interest and other income		6,585			(7,376	)		15,782			4,614
		$	(33,656	)		5			(22,196	)		10,514

Interest Rate Risks

The Company had ten-year notes totaling $350 million that matured on May 1, 2012. In May 2012, the Company sold new ten-year notes, and it therefore had risk related to the interest rate associated with the anticipated sale of these notes. To manage this interest rate risk, in 2011 the Company entered into a series of derivative contracts known as forward starting interest rate swaps that matured on May 1, 2012. The Company utilized hedge accounting to defer any gain or loss on these contracts until the payment of interest on these new notes occurs. During the three-month and nine-month periods ended September 30, 2012, $0.7 million and $1.1 million, respectively, of the deferred loss on the interest rate swaps was charged to income. The remaining loss deferred on these contracts at September 30, 2012 was $28.5 million.

At December 31, 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.

	December 31, 2011
	Asset (Liability) Derivatives
(Thousands of dollars) Type of Derivative Contract	Balance Sheet Location	Fair Value
Interest rate	Accounts Payable	$	(25,927	)

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, 2012 and December 31, 2011 are presented in the following table.

	September 30, 2012											December 31, 2011
(Thousands of dollars)	Level 1			Level 2			Level 3		Total			Level 1			Level 2			Level 3		Total
Assets
Commodity derivative contracts	$	0			9,496			0		9,496			0			197			0		197
Foreign currency exchange derivative contracts		0			3,612			0		3,612			0			0			0		0
	$	0			13,108			0		13,108			0			197			0		197
Liabilities
Nonqualified employee savings plans	$	(9,306	)		0			0		(9,306	)		(8,030	)		0			0		(8,030	)
Commodity derivative contracts		0			(3,176	)		0		(3,176	)		0			(489	)		0		(489	)
Foreign currency exchange derivative contracts		0			0			0		0			0			(8,459	)		0		(8,459	)
Interest rate derivative contracts		0			0			0		0			0			(25,927	)		0		(25,927	)
	$	(9,306	)		(3,176	)		0		(12,482	)		(8,030	)		(34,875	)		0		(42,905	)

The fair value of commodity derivative contracts for corn and wet and dried distillers grain was determined based on market quotes 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. The deferred loss on interest rate derivative contracts is being reclassified to Interest Expense in the Consolidated Statement of Income over the life of the $500 million notes payable that mature June 1, 2022. 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.