EnCana Corporation, a large Canadian oil and gas company, reported net income of US$ 393 million (EnCana reports in U. S. dollars) for its third quarter, 2004. This compares with net income of $ 290 million for the same quarter of 2003. However, third quarter, 2004, earnings would have been even higher but for a $ 321 million after tax unrealized loss on cash flow hedges of future oil and gas sales charged against operations. In accordance with Canadian GAAP at the time, and consistent with IFRS 9, EnCana accounted for these financial instruments at fair value, with unrealized gains and losses included in net income. The loss was due to the dramatic increase in oil prices during 2004, and illustrates that while hedging may protect the firm from losses if product prices decline, it also shuts them out of gains if prices increase.
a. Explain why EnCana reported a loss on its hedging activities. Assume that IFRS 9 was in effect at the time.
b. Assuming that its hedges qualified for hedge accounting under IFRS 9 or SFAS 133 ( now ASC 815), how would EnCana’s unrealized hedging loss have been accounted for under these standards?
c. Give reasons why firms such as EnCana typically hedge at least part of its price risk of future anticipated sales.