FINANCIAL INSTRUMENTS

The carrying amounts of the Company’s financial instruments by category were as follows:



	2018
Asset (liability)	Financial assets at amortized cost		Fair value through profit or loss			Derivatives used for hedging		Financial liabilities at amortized cost			Total
Accounts receivable	$	1,148	$	—		$	—	$	—		$	1,148
Investments	—		524			—		—			524
Other long-term assets	591		12			361		—			964
Accounts payable	—		—			—		(779		)	(779		)
Accrued liabilities	—		—			—		(2,356		)	(2,356		)
Other long-term liabilities ⁽¹⁾	—		(17		)	—		(118		)	(135		)
Long-term debt ⁽²⁾	—		—			—		(20,623		)	(20,623		)
	$	1,739	$	519		$	361	$	(23,876	)	$	(21,257	)



	2017
Asset (liability)	Financial assets at amortized cost		Fair value through profit or loss			Derivatives used for hedging			Financial liabilities at amortized cost			Total
Accounts receivable	$	2,397	$	—		$	—		$	—		$	2,397
Investments	—		893			—			—			893
Other long-term assets	510		—			204			—			714
Accounts payable	—		—			—			(775		)	(775		)
Accrued liabilities	—		—			—			(2,597		)	(2,597		)
Other long-term liabilities ⁽³⁾	—		(38		)	(65		)	(469		)	(572		)
Long-term debt ⁽²⁾	—		—			—			(22,458		)	(22,458		)
	$	2,907	$	855		$	139		$	(26,299	)	$	(22,398	)


(1)	Includes $118 million of deferred purchase consideration payable over the next five years.


(2)	Includes the current portion of long-term debt.


(3)	Includes $469 million (US$375 million) of deferred purchase consideration which was paid to Marathon in March 2018.

The carrying amounts of the Company’s financial instruments approximated their fair value, except for fixed rate long-term debt. The fair values of the Company’s investments, recurring other long-term assets (liabilities) and fixed rate long-term debt are outlined below:



		2018
	Carrying amount				Fair value
Asset (liability) ^{(1) (2)}					Level 1			Level 2			Level 3 ^{(4) (5)}
Investments ⁽³⁾		$	524		$	524		$	—		$	—
Other long-term assets		$	964		$	—		$	373		$	591
Other long-term liabilities		$	(135	)	$	—		$	(17	)	$	(118	)
Fixed rate long-term debt ^{(6) (7)}		$	(15,620	)	$	(15,952	)	$	—		$	—



		2017
	Carrying amount				Fair value
Asset (liability) ^{(1) (2)}					Level 1			Level 2			Level 3 ⁽⁵⁾
Investments ⁽³⁾		$	893		$	893		$	—		$	—
Other long-term assets		$	714		$	—		$	204		$	510
Other long-term liabilities		$	(103	)	$	—		$	(103	)	$	—
Fixed rate long-term debt ^{(6) (7)}		$	(15,989	)	$	(17,259	)	$	—		$	—


(1)	Excludes financial assets and liabilities where the carrying amount approximates fair value due to the short-term nature of the asset or liability (cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, and purchase consideration paid to Marathon in March 2018).


(2)	There were no transfers between Level 1, 2 and 3 financial instruments.


(3)	The fair values of the investments are based on quoted market prices.


(4)	The fair value of the deferred purchase consideration is based on the present value of future cash payments.


(5)	The fair value of Redwater Partnership subordinated debt is based on the present value of future cash receipts.


(6)	The fair value of fixed rate long-term debt has been determined based on quoted market prices.


(7)	Includes the current portion of fixed rate long-term debt.

Risk Management

The Company periodically uses derivative financial instruments to manage its commodity price, interest rate and foreign currency exposures. These financial instruments are entered into solely for hedging purposes and are not used for speculative purposes.

The following provides a summary of the carrying amounts of derivative financial instruments held and a reconciliation to the Company’s consolidated balance sheets.



Asset (liability)	2018			2017
Derivatives held for trading
Foreign currency forward contracts	$	8		$	(38	)
Crude oil WCS ⁽¹⁾ differential swaps	(17		)	—
Natural gas AECO basis swaps	1			—
Natural gas AECO fixed price swaps	3			—
Cash flow hedges
Foreign currency forward contracts	70			(71		)
Cross currency swaps	291			210
	$	356		$	101

Included within:
Current portion of other long-term assets	$	92		$	—
Current portion of other long-term liabilities	(17		)	(103		)
Other long-term assets	281			204
	$	356		$	101

(1) Western Canadian Select.

During 2018, the Company recognized a gain of $2 million (2017 – gain of $5 million, 2016 – gain of $7 million) related to ineffectiveness arising from cash flow hedges.

The estimated fair value of derivative financial instruments in Level 2 at each measurement date have been determined based on appropriate internal valuation methodologies and/or third party indications. Level 2 fair values determined using valuation models require the use of assumptions concerning the amount and timing of future cash flows and discount rates. In determining these assumptions, the Company primarily relied on external, readily-observable quoted market inputs as applicable, including crude oil and natural gas forward benchmark commodity prices and volatility, Canadian and United States forward interest rate yield curves, and Canadian and United States foreign exchange rates, discounted to present value as appropriate. The resulting fair value estimates may not necessarily be indicative of the amounts that could be realized or settled in a current market transaction and these differences may be material.

The changes in estimated fair values of derivative financial instruments included in the risk management asset were recognized in the financial statements as follows:



Asset (liability)	2018			2017
Balance – beginning of year	$	101		$	489
Net change in fair value of outstanding derivative financial instruments recognized in:
Risk management activities	35			(37		)
Foreign exchange	260			(375		)
Other comprehensive (loss) income	(40		)	24
Balance – end of year	356			101
Less: current portion	75			(103		)
	$	281		$	204

Net (gain) loss from risk management activities for the years ended December 31 were as follows:



	2018			2017			2016
Net realized risk management (gain) loss	$	(99	)	$	(2	)	$	8
Net unrealized risk management (gain) loss	(35		)	37			25
	$	(134	)	$	35		$	33

Financial Risk Factors


a)	Market risk

Market risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices. The Company’s market risk is comprised of commodity price risk, interest rate risk, and foreign currency exchange risk.

Commodity price risk management

The Company periodically uses commodity derivative financial instruments to manage its exposure to commodity price risk associated with the sale of its future crude oil and natural gas production and with natural gas purchases.

At December 31, 2018, the Company had the following derivative financial instruments outstanding to manage its commodity price risk:



	Remaining term			Volume	Weighted average price				Index
Crude Oil
WCS differential swaps	Jan 2019	-	Mar 2019	28,000 bbl/d		US	$	17.65	WCS
WCS differential swaps	Jan 2019	-	Sep 2019	8,000 bbl/d		US	$	23.57	WCS

Natural Gas
AECO basis swaps	Jan 2019	-	Mar 2019	10,000 MMbtu/d		US	$	1.39	AECO
AECO fixed price swaps	Jan 2019	-	Mar 2019	30,000 GJ/d			$	2.30	AECO
AECO fixed price swaps ⁽¹⁾	Apr 2019	-	Oct 2019	10,000 GJ/d			$	1.30	AECO


(1)	As at March 6, 2019, the Company has hedged an additional 105,000 GJ/d of currently forecasted natural gas volumes using AECO fixed price swaps, at a weighted average price of $1.32/GJ, for April to October 2019.

The Company's outstanding commodity derivative financial instruments are expected to be settled monthly based on the applicable index pricing for the respective contract month.

Interest rate risk management

The Company is exposed to interest rate price risk on its fixed rate long-term debt and to interest rate cash flow risk on its floating rate long-term debt. The Company periodically enters into interest rate swap contracts to manage its fixed to floating interest rate mix on long-term debt. Interest rate swap contracts require the periodic exchange of payments without the exchange of the notional principal amounts on which the payments are based. At December 31, 2018, the Company had no interest rate swap contracts outstanding.

Foreign currency exchange rate risk management

The Company is exposed to foreign currency exchange rate risk in Canada primarily related to its US dollar denominated long-term debt and working capital. The Company is also exposed to foreign currency exchange rate risk on transactions conducted in other currencies and in the carrying value of its foreign subsidiaries. The Company periodically enters into cross currency swap contracts and foreign currency forward contracts to manage known currency exposure on US dollar denominated long-term debt and working capital. The cross currency swap contracts require the periodic exchange of payments with the exchange at maturity of notional principal amounts on which the payments are based.

At December 31, 2018 the Company had the following cross currency swap contracts outstanding:



	Remaining term			Amount	Exchange rate (US$/C$)	Interest rate (US$)		Interest rate (C$)
Cross currency
Swaps	Jan 2019	—	Nov 2021	US$500	1.022	3.45	%	3.96	%
	Jan 2019	—	Mar 2038	US$550	1.170	6.25	%	5.76	%

All cross currency swap derivative financial instruments were designated as hedges at December 31, 2018 and were classified as cash flow hedges.

In addition to the cross currency swap contracts noted above, at December 31, 2018 the Company had US$3,506 million of foreign currency forward contracts outstanding, with terms of up to 90 days, including US$3,058 million designated as cash flow hedges.

Financial instrument sensitivities

The following table summarizes the annualized sensitivities of the Company’s 2018 net earnings and other comprehensive income (loss) to changes in the fair value of financial instruments outstanding as at December 31, 2018, resulting from changes in the specified variable, with all other variables held constant. These sensitivities are prepared on a different basis than those sensitivities disclosed in the Company’s other continuous disclosure documents, are limited to the impact of changes in a specified variable applied to financial instruments only and do not represent the impact of a change in the variable on the operating results of the Company taken as a whole. Further, these sensitivities are theoretical, as changes in one variable may contribute to changes in another variable, which may magnify or counteract the sensitivities. In addition, changes in fair value generally cannot be extrapolated because the relationship of a change in an assumption to the change in fair value may not be linear.



	2018						2017
	Increase (decrease) to net earnings			Increase (decrease) to other comprehensive income			Increase (decrease) to net earnings			(Increase) decrease to other comprehensive loss
Commodity price risk ⁽¹⁾
Increase WCS differential US$1.00/bbl	$	(5	)	$	—		$	—		$	—
Decrease WCS differential US$1.00/bbl	$	5		$	—		$	—		$	—
Increase AECO $0.10/Mcf ⁽²⁾	$	(1	)	$	—		$	—		$	—
Decrease AECO $0.10/Mcf ⁽²⁾	$	1		$	—		$	—		$	—
Interest rate risk
Increase interest rate 1%	$	(33	)	$	(21	)	$	(42	)	$	(16	)
Decrease interest rate 1%	$	33		$	25		$	42		$	19
Foreign currency exchange rate risk
Increase exchange rate by US$0.01	$	(114	)	$	—		$	(105	)	$	—
Decrease exchange rate by US$0.01	$	113		$	—		$	101		$	—


(1)	Based on the Company's contracted AECO basis swap volumes at December 31, 2018, a movement of US$0.10/Mcf would not have a significant impact on net earnings or other comprehensive income.


(2)	Movements in AECO are based on the Company's contracted AECO fixed price swap volumes at December 31, 2018.

b) Credit Risk

Credit risk is the risk that a party to a financial instrument will cause a financial loss to the Company by failing to discharge an obligation.

Counterparty credit risk management

The Company’s accounts receivable are mainly with customers in the crude oil and natural gas industry and are subject to normal industry credit risks. The Company manages these risks by reviewing its exposure to individual companies on a regular basis and where appropriate, ensures that parental guarantees or letters of credit are in place to minimize the impact in the event of default. At December 31, 2018, substantially all of the Company’s accounts receivable were due within normal trade terms and the average expected credit loss was approximately 1% of the Company's accounts receivable balance.

The Company is also exposed to possible losses in the event of nonperformance by counterparties to derivative financial instruments; however, the Company manages this credit risk by entering into agreements with counterparties that are substantially all investment grade financial institutions. At December 31, 2018, the Company had net risk management assets of $361 million with specific counterparties related to derivative financial instruments (December 31, 2017 – $187 million).

The carrying amount of financial assets approximates the maximum credit exposure.

c) Liquidity risk

Liquidity risk is the risk that the Company will encounter difficulty in meeting obligations associated with financial liabilities.

Management of liquidity risk requires the Company to maintain sufficient cash and cash equivalents, along with other sources of capital, consisting primarily of cash flow from operating activities, available credit facilities, commercial paper and access to debt capital markets, to meet obligations as they become due. The Company believes it has adequate bank credit facilities to provide liquidity to manage fluctuations in the timing of the receipt and/or disbursement of operating cash flows.

The maturity dates of the Company’s financial liabilities were as follows:



	Less than 1 year		1 to less than 2 years		2 to less than 5 years		Thereafter
Accounts payable	$	779	$	—	$	—	$	—
Accrued liabilities	$	2,356	$	—	$	—	$	—
Other long-term liabilities	$	42	$	24	$	69	$	—
Long-term debt ^{(1) (2)}	$	1,141	$	5,996	$	3,812	$	9,793


(1)	Long-term debt represents principal repayments only and does not reflect interest, original issue discounts and premiums or transaction costs.

(2)

In addition to the financial liabilities disclosed above, estimated interest and other financing payments related to long-term debt are as follows: less than one year, $836 million; one to less than two years, $755 million; two to less than five years, $1,668 million; and thereafter, $5,327 million. Interest payments were estimated based upon applicable interest and foreign exchange rates as at December 31, 2018.