Royal Dutch Shell plc | CIK:0001306965 | 3

  • Filed: 3/15/2018
  • Entity registrant name: Royal Dutch Shell plc (CIK: 0001306965)
  • Generator: Donnelley Financial Solutions
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  • ifrs-full:DisclosureOfDerivativeFinancialInstrumentsExplanatory

     

    19 FINANCIAL INSTRUMENTS AND OTHER DERIVATIVE CONTRACTS

    Financial instruments and other derivative contracts in the Consolidated Balance Sheet comprise investments in securities (see Note 10), cash and cash equivalents (see Note 13), debt (see Note 14) and certain amounts reported within trade and other receivables (see Note 11) and trade and other payables (see Note 15), which include derivative contracts.

     

    RISKS

    In the normal course of business, financial instruments of various kinds are used for the purposes of managing exposure to interest rate, foreign exchange and commodity price movements.

     

    Treasury standards are applicable to all subsidiaries and each subsidiary is required to adopt a treasury policy consistent with these standards. These policies cover: financing structure; interest rate and foreign exchange risk management; insurance; counterparty risk management; and use of derivative contracts. Wherever possible, treasury operations are carried out through specialist regional organisations without removing from each subsidiary the responsibility to formulate and implement appropriate treasury policies.

     

    Apart from forward foreign exchange contracts to meet known commitments, the use of derivative contracts by most subsidiaries is not permitted by their treasury policy.

     

    Other than in exceptional cases, the use of external derivative contracts is confined to specialist trading and central treasury organisations that have appropriate skills, experience, supervision, control and reporting systems.

     

    Shell’s operations expose it to market, credit and liquidity risk, as described below.

     

    Market risk

    Market risk is the possibility that changes in interest rates, foreign exchange rates or the prices of crude oil, natural gas, LNG, refined products, chemical feedstocks, power and carbon-emission rights will adversely affect the value of assets, liabilities or expected future cash flows.

     

    Interest rate risk

    Most debt is raised from central borrowing programmes. Shell’s policy continues to be to have debt principally denominated in dollars and to maintain a largely floating interest rate exposure profile; however, Shell has issued a significant amount of fixed rate debt in recent years, taking advantage of historically low interest rates available in US debt markets. As a result, a substantial portion of the debt portfolio at December 31, 2017, is at fixed rates and this reduces Shell’s exposure to the dollar LIBOR interest rate.

     

    The financing of most subsidiaries is structured on a floating-rate basis and, except in special cases, further interest rate risk management is discouraged.

     

    On the basis of the floating rate net debt position at December 31, 2017, (both issued and hedged), and assuming other factors (principally foreign exchange rates and commodity prices) remained constant and that no further interest rate management action was taken, an increase in interest rates of 1% would have decreased 2017 income before taxation by $174 million (2016: $210 million, based on the floating rate position at December 31, 2016).

     

    The carrying amounts and maturities of debt and borrowing facilities are presented in Note 14. Interest expense is presented in Note 6.

     

    Foreign exchange risk

    Many of the markets in which Shell operates are priced, directly or indirectly, in dollars. As a result, the functional currency of most Integrated Gas and Upstream entities and those with significant cross-border business is the dollar. For Downstream entities, the functional currency is typically the local currency. Consequently, Shell is exposed to varying levels of foreign exchange risk when an entity enters into transactions that are not denominated in its functional currency, when foreign currency monetary assets and liabilities are translated at the balance sheet date and as a result of holding net investments in operations that are not dollar-functional. Each entity is required to adopt treasury policies that are designed to measure and manage its foreign exchange exposures by reference to its functional currency.

     

    Foreign exchange gains and losses arise in the normal course of business from the recognition of receivables and payables and other monetary items in currencies other than an entity’s functional currency. Foreign exchange risk may also arise in connection with capital expenditure. For major projects, an assessment is made at the final investment decision stage whether to hedge any resulting exposure.

     

    Assuming other factors (principally interest rates and commodity prices) remained constant and that no further foreign exchange risk management action were taken, a 10% appreciation against the dollar at December 31 of the main currencies to which Shell is exposed would have the following effects:

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    $ million

     

     

     

    Increase/(decrease)

    in income before taxation

     

     

    Increase in net assets

     

     

     

    2017

     

     

    2016

     

     

    2017

     

     

    2016

     

    10% appreciation against the dollar of:

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Canadian dollar

     

     

    (43

    )

     

     

    (53

    )

     

     

    1,111

     

     

     

    1,666

     

    Euro

     

     

    130

     

     

     

    (75

    )

     

     

    1,086

     

     

     

    845

     

    Australian dollar

     

     

    (24

    )

     

     

    45

     

     

     

    786

     

     

     

    669

     

    Sterling

     

     

    (77

    )

     

     

    (141

    )

     

     

    632

     

     

     

    549

     

     

     

     

    The above sensitivity information was calculated by reference to carrying amounts of assets and liabilities at December 31 only. The effect on income before taxation arises in connection with monetary balances denominated in currencies other than an entity’s functional currency; the effect on net assets arises principally from the translation of assets and liabilities of entities that are not dollar-functional.

     

    Foreign exchange gains and losses included in income are presented in Note 5.

     

    Commodity price risk

    Certain subsidiaries have a mandate to trade crude oil, natural gas, LNG, refined products, chemical feedstocks, power and carbon-emission rights, and to use commodity derivative contracts (forwards, futures, swaps and options) as a means of managing price and timing risks arising from this trading activity. In effecting these transactions, the entities concerned operate within procedures and policies designed to ensure that risks, including those relating to the default of counterparties, are managed within authorised limits.

     

    Risk management systems are used for recording and valuing instruments. Commodity price risk exposure is monitored, and the acceptable level of exposure determined, by market risk committees. There is regular reviewing of mandated trading limits by senior management, daily monitoring of market risk exposure using value-at-risk (VAR) techniques, daily monitoring of trading positions against limits, and marking-to-fair value of trading exposures with a department independent of traders reviewing the market values applied. Although trading losses can and do occur, the nature of the trading portfolio and its management are considered adequate mitigants against the risk of significant losses.

     

    VAR techniques based on variance/covariance or Monte Carlo simulation models are used to make a statistical assessment of the market risk arising from possible future changes in market values over a 24-hour period and within a 95% confidence level. The calculation of potential changes in fair value takes into account positions, the history of price movements and the correlation of these price movements. Models are regularly reviewed against actual fair value movements to ensure integrity is maintained. The VAR year-end positions in respect of commodities traded in active markets, which are presented in the table below, are calculated on a diversified basis in order to reflect the effect of offsetting risk within combined portfolios.

     

     

     

     

     

     

     

     

     

     

    Value-at-risk (pre-tax)

     

    $ million

     

     

     

    Dec 31, 2017

     

     

    Dec 31, 2016

     

    Global oil

     

     

    25

     

     

     

    29

     

    North America gas and power

     

     

    11

     

     

     

    12

     

    Europe gas and power

     

     

    3

     

     

     

    2

     

    Carbon-emission rights

     

     

    1

     

     

     

    3

     

     

     

     

    Credit risk

    Policies are in place to ensure that sales of products are made to customers with appropriate creditworthiness. These policies include detailed credit analysis and monitoring of trading partners against counterparty credit limits. Credit information is regularly shared between business and finance functions, with dedicated teams in place to quickly identify and respond to cases of credit deterioration. Mitigation measures are defined and implemented for high-risk business partners and customers, and include shortened payment terms, collateral or other security posting and vigorous collections. In addition, policies limit the amount of credit exposure to any individual financial institution. There are no material concentrations of credit risk, with individual customers or geographically, and there has been no significant level of counterparty default in recent years.

     

    Surplus cash is invested in a range of short-dated, secure and liquid instruments including short-term bank deposits, money market funds, reverse repos and similar instruments. The portfolio of these investments is diversified to avoid concentrating risk in any one instrument, country or counterparty. Management monitors the investments regularly and adjusts the investment portfolio in light of new market information where necessary to ensure credit risk is effectively diversified.

     

    In commodity trading, counterparty credit risk is managed within a framework of credit limits with utilisation being regularly reviewed. Credit risk exposure is monitored and the acceptable level is determined by a credit committee. Credit checks are performed by a department independent of traders, and are undertaken before contractual commitment. Where appropriate, netting arrangements, credit insurance, prepayments and collateral are used to manage specific risks.

     

    Shell routinely enters into offsetting, master netting and similar arrangements with trading and other counterparties to manage credit risk. Where there is a legally enforceable right of offset under such arrangements and Shell has the intention to settle on a net basis or realise the asset and settle the liability simultaneously, the net asset or liability is recognised in the Consolidated Balance Sheet, otherwise assets and liabilities are presented gross. These amounts, as presented net and gross within trade and other receivables and trade and other payables in the Consolidated Balance Sheet at December 31, were as follows:

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    2017

     

    $ million

     

     

    Amounts offset

     

    Amounts not offset

     

     

     

     

    Gross amounts

    before offset

     

    Amounts

    offset

     

    Net amounts

    as presented

     

    Cash collateral

    received/pledged

     

    Other offsetting

    instruments

     

    Net amounts

    Assets:

     

     

     

     

     

     

     

     

     

     

     

     

    Within trade receivables

     

    10,642

     

    6,486

     

    4,156

     

    42

     

    51

     

    4,063

    Within derivative contracts

     

    6,987

     

    2,387

     

    4,600

     

    186

     

    2,326

     

    2,088

    Liabilities:

     

     

     

     

     

     

     

     

     

     

     

     

    Within trade payables

     

    10,442

     

    6,486

     

    3,956

     

    41

     

    51

     

    3,864

    Within derivative contracts

     

    7,315

     

    2,392

     

    4,923

     

    300

     

    2,326

     

    2,297

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    2016

     

    $ million

     

     

    Amounts offset

     

    Amounts not offset

     

     

     

     

     

    Gross amounts

    before offset

     

    Amounts

    offset

     

    Net amounts

    as presented

     

    Cash collateral

    received/pledged

     

    Other offsetting

    instruments

     

    Net amounts

     

    Assets:

     

     

     

     

     

     

     

     

     

     

     

     

     

    Within trade receivables

     

    9,844

     

    6,539

     

    3,305

     

    1

     

    12

     

    3,292

     

    Within derivative contracts

     

    6,309

     

    2,197

     

    4,112

     

    107

     

    2,126

    [A]

    1,879

    [A]

    Liabilities:

     

     

     

     

     

     

     

     

     

     

     

     

     

    Within trade payables

     

    9,489

     

    6,535

     

    2,954

     

     

    12

     

    2,942

     

    Within derivative contracts

     

    9,434

     

    2,197

     

    7,237

     

    86

     

    2,126

    [A]

    5,025

    [A]

    [A] As revised.

     

    Amounts not offset principally relate to contracts where the intention to settle on a net basis was not clearly established at December 31.

     

    The carrying amount of financial assets pledged as collateral for liabilities or contingent liabilities at December 31, 2017, presented within trade and other receivables, was $1,890 million (2016: $1,815 million). The carrying amount of collateral held at December 31, 2017, presented within trade and other payables, was $282 million (2016: $173 million). Collateral mainly relates to initial margins held with commodity exchanges and over-the-counter counterparty variation margins.

     

    Liquidity risk

    Liquidity risk is the risk that suitable sources of funding for Shell’s business activities may not be available. Management believes that it has access to sufficient debt funding sources (capital markets), and to undrawn committed borrowing facilities to meet foreseeable requirements. Information about borrowing facilities is presented in Note 14.

     

    DERIVATIVE CONTRACTS AND HEDGES

    Derivative contracts are used principally as hedging instruments, however, because hedge accounting is not always applied, movements in the carrying amounts of derivative contracts that are recognised in income are not always matched in the same period by the recognition of the income effects of the related hedged items.

     

     

    Carrying amounts, maturities and hedges

    The carrying amounts of derivative contracts at December 31 (see Notes 11 and 15), designated and not designated as hedging instruments for hedge accounting purposes, were as follows:

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    2017

     

    $ million

     

     

     

    Assets

     

     

    Liabilities

     

     

     

     

     

     

     

    Designated

     

     

    Not

    designated

     

     

    Total

     

     

    Designated

     

     

    Not

    designated

     

     

    Total

     

     

    Net

     

    Interest rate swaps

     

     

     

     

     

    16

     

     

     

    16

     

     

     

    165

     

     

     

    34

     

     

     

    199

     

     

     

    (183

    )

    Forward foreign exchange contracts

     

     

    22

     

     

     

    403

     

     

     

    425

     

     

     

     

     

     

    591

     

     

     

    591

     

     

     

    (166

    )

    Currency swaps and options

     

     

    483

     

     

     

    208

     

     

     

    691

     

     

     

    815

     

     

     

    76

     

     

     

    891

     

     

     

    (200

    )

    Commodity derivatives

     

     

     

     

     

    4,929

     

     

     

    4,929

     

     

     

     

     

     

    4,428

     

     

     

    4,428

     

     

     

    501

     

    Other contracts

     

     

     

     

     

    162

     

     

     

    162

     

     

     

     

     

     

    125

     

     

     

    125

     

     

     

    37

     

    Total

     

     

    505

     

     

     

    5,718

     

     

     

    6,223

     

     

     

    980

     

     

     

    5,254

     

     

     

    6,234

     

     

     

    (11

    )

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    2016

     

    $ million

     

     

     

    Assets

     

     

    Liabilities

     

     

     

     

     

     

     

    Designated

     

     

    Not

    designated

     

     

    Total

     

     

    Designated

     

     

    Not

    designated

     

     

    Total

     

     

    Net

     

    Interest rate swaps

     

     

    38

     

     

     

    15

     

     

     

    53

     

     

     

    136

     

     

     

    38

     

     

     

    174

     

     

     

    (121

    )

    Forward foreign exchange contracts

     

     

     

     

     

    469

     

     

     

    469

     

     

     

    10

     

     

     

    348

     

     

     

    358

     

     

     

    111

     

    Currency swaps and options

     

     

    3

     

     

     

    280

     

     

     

    283

     

     

     

    3,241

     

     

     

    545

     

     

     

    3,786

     

     

     

    (3,503

    )

    Commodity derivatives

     

     

     

     

     

    5,480

     

     

     

    5,480

     

     

     

     

     

     

    5,230

     

     

     

    5,230

     

     

     

    250

     

    Other contracts

     

     

     

     

     

    77

     

     

     

    77

     

     

     

     

     

     

    185

     

     

     

    185

     

     

     

    (108

    )

    Total

     

     

    41

     

     

     

    6,321

     

     

     

    6,362

     

     

     

    3,387

     

     

     

    6,346

     

     

     

    9,733

     

     

     

    (3,371

    )

     

     

     

    Net losses before tax on derivative contracts, excluding realised commodity contracts and those accounted for as hedges, were $1,321 million in 2017 (2016: $414 million gains; 2015: $4,107 million gains).

     

    In 2015, certain cash and cash equivalents and forward foreign exchange contracts were designated as cash flow hedges of a significant portion of the forecast cash consideration for the acquisition of BG (see Note 29). Losses of $411 million were recognised in other comprehensive income in 2016 (2015: $537 million) and the accumulated losses were reclassified to the balance sheet in 2016 (see Note 22).

     

    In addition, certain contracts, mainly to hedge price risk relating to forecast commodity transactions which mature in 2018-2020, were designated in cash flow hedging relationships. In 2017, $29 million net losses for ineffectiveness were recognised in income (2016: $nil; 2015: $1 million net gains). The net carrying amount of commodity derivative contracts designated as cash flow hedging instruments at December 31, 2017, was a liability of $620 million (2016: $115 million), and was presented after the offset of related margin balances maintained with exchanges.

     

    Certain interest rate and currency swaps were designated in fair value hedges, principally in respect of debt for which the net carrying amount of the related derivative contracts, net of accrued interest, at December 31, 2017, was a liability of $826 million (2016: $3,472 million).

     

    In 2016, debt and currency swaps were designated as hedges of net investments in foreign operations, relating to the foreign exchange risk arising between certain intermediate holding companies and their subsidiaries. The total carrying amount of the hedging instruments at December 31, 2016, was a net liability of $5,381 million. On January 1, 2017, these were de-designated as hedges following changes in the functional currency of certain entities to the US dollar.

     

    In the course of trading operations, certain contracts are entered into for delivery of commodities that are accounted for as derivatives. The resulting price exposures are managed by entering into related derivative contracts. These contracts are managed on a fair value basis and the maximum exposure to liquidity risk is the undiscounted fair value of derivative liabilities.

     

    For a minority of commodity derivative contracts, carrying amounts cannot be derived from quoted market prices or other observable inputs, in which case fair value is estimated using valuation techniques such as Black-Scholes, option spread models and extrapolation using quoted spreads with assumptions developed internally based on observable market activity.

     

    Other contracts include certain contracts that are held to sell or purchase commodities and others containing embedded derivatives, which are required to be recognised at fair value because of pricing or delivery conditions, even though they were entered into to meet operational requirements. These contracts are expected to mature in 2018-2025, with certain contracts having early termination rights (for either party). Valuations are derived from quoted market prices for the next six years and, thereafter, from forward gas price formulae used in similar contracts. Future gas price assumptions are the most significant input to this model, and a decrease at December 31, 2017, of 10% in the projected gas price would, assuming other inputs remained unchanged, increase income before taxation by $30 million (2016: $33 million).

     

    The contractual maturities of derivative liabilities at December 31 compare with their carrying amounts in the Consolidated Balance Sheet as follows:

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    2017

     

    $ million

     

     

     

    Contractual maturities

     

     

     

     

     

     

     

     

     

     

     

    Less than

    1 year

     

     

    Between

    1 and 2

    years

     

     

    Between

    2 and 3

    years

     

     

    Between

    3 and 4

    years

     

     

    Between

    4 and 5

    years

     

     

    5 years

    and later

     

     

    Total

     

     

    Difference from carrying amount [A]

     

     

    Carrying

    amount

     

    Forward foreign exchange contracts

     

     

    315

     

     

     

    37

     

     

     

    14

     

     

     

    3

     

     

     

    2

     

     

     

    (39

    )

     

     

    332

     

     

     

    259

     

     

     

    591

     

    Currency swaps and options

     

     

    541

     

     

     

    343

     

     

     

    140

     

     

     

    304

     

     

     

    194

     

     

     

    879

     

     

     

    2,401

     

     

     

    (1,510

    )

     

     

    891

     

    Commodity derivatives

     

     

    3,002

     

     

     

    754

     

     

     

    305

     

     

     

    122

     

     

     

    74

     

     

     

    263

     

     

     

    4,520

     

     

     

    (92

    )

     

     

    4,428

     

    Other contracts

     

     

    146

     

     

     

    115

     

     

     

    56

     

     

     

    18

     

     

     

    1

     

     

     

    3

     

     

     

    339

     

     

     

    (15

    )

     

     

    324

     

    Total

     

     

    4,004

     

     

     

    1,249

     

     

     

    515

     

     

     

    447

     

     

     

    271

     

     

     

    1,106

     

     

     

    7,592

     

     

     

    (1,358

    )

     

     

    6,234

     

    [A] Mainly related to the effect of discounting.

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    2016

     

    $ million

     

     

     

    Contractual maturities

     

     

     

     

     

     

     

     

     

     

     

    Less than

    1 year

     

     

    Between

    1 and 2

    years

     

     

    Between

    2 and 3

    years

     

     

    Between

    3 and 4

    years

     

     

    Between

    4 and 5

    years

     

     

    5 years

    and later

     

     

    Total

     

     

    Difference from carrying amount [A]

     

     

    Carrying

    amount

     

    Forward foreign exchange contracts

     

     

    341

     

     

     

    97

     

     

     

    56

     

     

     

     

     

     

    (27

    )

     

     

     

     

     

    467

     

     

     

    (109

    )

     

     

    358

     

    Currency swaps and options

     

     

    1,062

     

     

     

    1,269

     

     

     

    831

     

     

     

    372

     

     

     

    701

     

     

     

    3,762

     

     

     

    7,997

     

     

     

    (4,211

    )

     

     

    3,786

     

    Commodity derivatives

     

     

    3,889

     

     

     

    706

     

     

     

    344

     

     

     

    111

     

     

     

    47

     

     

     

    204

     

     

     

    5,301

     

     

     

    (71

    )

     

     

    5,230

     

    Other contracts

     

     

    95

     

     

     

    130

     

     

     

    102

     

     

     

    53

     

     

     

    20

     

     

     

    3

     

     

     

    403

     

     

     

    (44

    )

     

     

    359

     

    Total

     

     

    5,387

     

     

     

    2,202

     

     

     

    1,333

     

     

     

    536

     

     

     

    741

     

     

     

    3,969

     

     

     

    14,168

     

     

     

    (4,435

    )

     

     

    9,733

     

    [A] Mainly related to the effect of discounting.

     

     

    Fair value measurements

    The net carrying amounts of derivative contracts held at December 31, categorised according to the predominant source and nature of inputs used in determining the fair value of each contract, were as follows:

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    2017

     

    $ million

     

     

     

    Prices in active markets for identical

    assets/liabilities

     

     

    Other

    observable

    inputs

     

     

    Unobservable

    inputs

     

     

    Total

     

    Interest rate swaps

     

     

     

     

     

    (183

    )

     

     

     

     

     

    (183

    )

    Forward foreign exchange contracts

     

     

     

     

     

    (166

    )

     

     

     

     

     

    (166

    )

    Currency swaps and options

     

     

     

     

     

    (200

    )

     

     

     

     

     

    (200

    )

    Commodity derivatives

     

     

    36

     

     

     

    302

     

     

     

    163

     

     

     

    501

     

    Other contracts

     

     

     

     

     

    (97

    )

     

     

    134

     

     

     

    37

     

    Total

     

     

    36

     

     

     

    (344

    )

     

     

    297

     

     

     

    (11

    )

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    2016

     

    $ million

     

     

     

    Prices in active markets for identical

    assets/liabilities

     

     

    Other

    observable

    inputs

     

     

    Unobservable

    inputs

     

     

    Total

     

    Interest rate swaps

     

     

     

     

     

    (121

    )

     

     

     

     

     

    (121

    )

    Forward foreign exchange contracts

     

     

     

     

     

    111

     

     

     

     

     

     

    111

     

    Currency swaps and options

     

     

     

     

     

    (3,503

    )

     

     

     

     

     

    (3,503

    )

    Commodity derivatives

     

     

    12

     

     

     

    (153

    )

     

     

    391

     

     

     

    250

     

    Other contracts

     

     

    (2

    )

     

     

    (183

    )

     

     

    77

     

     

     

    (108

    )

    Total

     

     

    10

     

     

     

    (3,849

    )

     

     

    468

     

     

     

    (3,371

    )

     

     

     

     

     

     

     

     

     

     

    Net carrying amounts of derivative contracts measured using predominantly unobservable inputs

     

     

    $ million

     

     

     

    2017

     

     

    2016

     

    At January 1

     

     

    468

     

     

     

    607

     

    Net losses recognised in revenue

     

     

    (248

    )

     

     

    (361

    )

    Purchases

     

     

    (252

    )

     

     

    (227

    )

    Sales

     

     

    562

     

     

     

    428

     

    Recategorisations (net)

     

     

    (248

    )

     

     

    56

     

    Currency translation differences

     

     

    15

     

     

     

    (35

    )

    At December 31

     

     

    297

     

     

     

    468

     

     

     

    Included in net losses recognised in revenue in 2017 were unrealised net gains totalling $39 million relating to assets and liabilities held at December 31, 2017 (2016: $333 million).