Financial Instruments and Risk Management

12 Months Ended

Dec. 31, 2012

Financial Instruments and Risk Management

Note K – Financial Instruments and Risk Management

DERIVATIVE INSTRUMENTS – Murphy makes limited use of derivative instruments to manage certain risks related to commodity prices, interest rates and foreign currency exchange 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 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 risk related to corn that it will purchase in the future for feedstock and to wet and dried distillers grain with solubles that it will sell in the future at its ethanol production facilities in the United States. At December 31, 2012 and 2011, the Company had open physical delivery commitment contracts for purchase of approximately 19.2 million and 8.0 million bushels of corn, respectively, for processing at its ethanol plants. Also, at December 31, 2012 and 2011, the Company had open physical delivery commitment contracts for sale of approximately 1.0 million and 1.1 million equivalent bushels of wet and dried distillers grain with solubles, respectively. To manage the price risk associated with certain of these physical delivery commitments which have fixed prices, at December 31, 2012 and 2011, the Company had outstanding derivative contracts with a net volume of approximately 6.3 million and 6.7 million bushels, respectively, to mature at future prices in effect on the expected date of delivery under the commitment contracts. Additionally, at December 31, 2011, the Company had outstanding derivative contracts to sell 2.9 million bushels of corn and buy them back when certain corn inventories are expected to be processed at the Hankinson, North Dakota and Hereford, Texas facilities. The fair value of these open commodity derivative contracts was a net asset of $2,941,000 at December 31, 2012 and a net liability of $292,000 at December 31, 2011.

• Foreign Currency Exchange Risks – The Company is subject to foreign currency exchange risk associated with operations in countries outside the U.S. At December 31, 2012 and 2011, short-term derivative instruments were outstanding in Canada for approximately $154,000,000 and $16,000,000, respectively, to manage the currency risk associated with a U.S. dollar intercompany loan at year-end 2012 plus U.S. dollar accounts receivable balances associated with sale of Canadian crude oil in both years. Also short-term derivative instruments were outstanding at December 31, 2011 to manage the currency risk of approximately $472,000,000 equivalent of ringgit denominated income tax liability balances in the Company’s Malaysian operations. The fair values of open foreign currency derivative contracts were liabilities of $1,031,000 at December 31, 2012 and $8,459,000 at December 31, 2011.

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

December 31, 2012

December 31, 2011

Asset Derivatives

Liability Derivatives

Asset Derivatives

Liability Derivatives

(Thousands of dollars)

Balance Sheet Location

Fair Value

Balance Sheet Location

Fair Value

Balance Sheet Location

Fair Value

Balance Sheet Location

Fair Value

Type of Derivative Contract

Commodity

Accounts Receivable

$3,043

Accounts Payable

$102

Accounts Receivable

$197

Accounts Payable

$489

Foreign exchange

—

—

Accounts Payable

$1,031

—

—

Accounts Payable

$8,459

For the years ended December 31, 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.

	Year Ended December 31, 2012					Year Ended December 31, 2011
(Thousands of dollars)	Location of Gain (Loss) Recognized in Income on Derivative		Amount of Gain (Loss) Recognized in Income on Derivative			Location of Gain (Loss) Recognized in Income on Derivative		Amount of Gain (Loss) Recognized in Income on Derivative
Type of Derivative Contract
Commodity		Crude Oil and Product Purchases	$	(38,283	)		Crude Oil and Product Purchases	$	5,659
Foreign exchange		Interest and Other Income (Loss)		14,156			Interest and Other Income (Loss)		(305	)
			$	(24,127	)			$	5,354

• Interest Rate Risks – The Company had ten-year notes totaling $350,000,000 that matured on May 1, 2012. The Company expected to replace these notes at maturity with new ten-year notes, and it therefore had risk associated with the interest rate related to the anticipated sale of these notes in 2012. To manage this risk, in 2011 the Company entered into a series of derivative contracts known as forward starting interest rate swaps that matured in May 2012. The Company utilized hedge accounting to defer any gain or loss on these contracts until the payment of interest on these anticipated notes occurs between 2012 and 2022. There was no impact in the 2011 Consolidated Statement of Income associated with accounting for these interest rate derivative contracts. During 2012, $1,852,000 of the deferred loss on the interest rate swaps was charged to income. The remaining loss deferred on these matured contracts at December 31, 2012 was $27,778,000, which is recorded, net of income taxes, in Accumulated Other Comprehensive Income in the Consolidated Balance Sheet. The Company expects to charge approximately $2,960,000 of this deferred loss to income in the form of interest expense during 2013.

At December 31, 2011, the fair value of these interest rate derivative contracts, which were designated as hedging instruments for accounting purposes, are presented in the table below.

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

CREDIT RISKS – The Company’s primary credit risks are associated with trade accounts receivable, cash equivalents and derivative instruments. Trade receivables arise mainly from sales of crude oil, natural gas and petroleum products to a large number of customers in the United States and the United Kingdom. The Company also has credit risk for sales of crude oil and natural gas to various customers in Canada, and sales of crude oil to various customers in Malaysia and Republic of the Congo. Natural gas produced in Malaysia is essentially all sold to the country’s national oil company. The credit history and financial condition of potential customers are reviewed before credit is extended, security is obtained when deemed appropriate based on a potential customer’s financial condition, and routine follow-up evaluations are made. The combination of these evaluations and the large number of customers tends to limit the risk of credit concentration to an acceptable level. Cash equivalents are placed with several major financial institutions, which limits the Company’s exposure to credit risk. The Company controls credit risk on derivatives through credit approvals and monitoring procedures and believes that such risks are minimal because counterparties to the majority of transactions are major financial institutions.