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| Derivative Financial Instruments | 4. Derivative Financial Instruments
Objectives and Strategies
Devon periodically enters into derivative financial instruments to manage its exposure to market risks, such as changes in commodity prices, interest rates and currency exchange rates. Devon does not hold or issue derivative financial instruments for speculative trading purposes and has elected not to designate any of its derivative instruments for hedge accounting treatment.
Devon's commodity derivative financial instruments include financial price swaps, basis swaps, costless price collars and call options. Under the terms of the price swaps, Devon receives a fixed price for its production and pays a variable market price to the contract counterparty. For the basis swaps, Devon receives a fixed differential between two regional gas index prices and pays a variable differential on the same two index prices to the contract counterparty. The price collars set a floor and ceiling price for the hedged production. If the applicable monthly price indices are outside of the ranges set by the floor and ceiling prices in the various collars, Devon will cash-settle the difference with the counterparty to the collars. Under the terms of the call options, Devon sold to counterparties the right to purchase production at a predetermined price.
Devon's interest rate swaps include contracts in which Devon receives a fixed rate and pays a variable rate on a total notional amount.
Devon's foreign currency contracts include forward contracts that hedge certain monetary assets denominated in Canadian dollars.
Credit Risk
Through its derivative financial instruments, Devon exposes itself to credit risk, which arises from the failure of the counterparty to perform under the terms of the derivative contract. To mitigate this risk, the hedging instruments are placed with a number of counterparties whom Devon believes are minimal credit risks. It is Devon's policy to enter into derivative contracts only with investment grade rated counterparties deemed by management to be competent and competitive market makers. Additionally, Devon's derivative contracts generally require cash collateral to be posted if either its or the counterparty's credit rating falls below investment grade. The mark-to-market exposure threshold, above which collateral must be posted, decreases as the debt rating falls further below investment grade. Such thresholds generally range from zero to $55 million for the majority of Devon's contracts. As of September 30, 2011, the credit ratings of all Devon's counterparties were investment grade.
Commodity Derivatives
As of September 30, 2011, Devon had the following open oil derivative positions. Devon's oil derivatives settle against the average of the prompt month NYMEX West Texas Intermediate futures price.
As of September 30, 2011, Devon had the following open natural gas derivative positions. Devon's natural gas derivative swaps, collars and call options settle against the Inside FERC first of the month Henry Hub index.
As of September 30, 2011, Devon had the following open NGL derivative positions:
Interest Rate Derivatives
As of September 30, 2011, Devon had the following open interest rate derivative positions:
Foreign Currency Derivative
As of September 30, 2011, Devon had the following open foreign currency derivative position:
Financial Statement Presentation
The following table presents the derivative fair values included in the accompanying consolidated balance sheets.
The following table presents the cash settlements and unrealized gains and losses on fair value changes included in the accompanying consolidated statements of operations associated with these derivative financial instruments. Cash settlements and unrealized gains and losses on fair value changes associated with Devon's commodity derivatives are presented in the "Oil, gas and NGL derivatives" caption in the accompanying consolidated statements of operations. Cash settlements and unrealized gains and losses on fair value changes associated with Devon's interest rate and foreign currency derivatives are presented in the "Interest-rate and other financial instruments" caption in the accompanying consolidated statements of operations.
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