Depreciation and amortisation
Depreciation and amortisation was £57 million for the year ended 31 December 2011 and £52 million for the year ended 31 December 2010. 2011 includes a full year of depreciation for the co-firing facility, which was commissioned part-way through 2010.
Unrealised gains and losses on derivative contracts
The Group recognises unrealised gains and losses on forward contracts which meet the definition of derivatives under IFRSs. Where possible, we take the own use exemption for derivative contracts entered into and held for our own purchase, sale or usage requirements, including forward domestic coal and biomass contracts.
As such, the movement in the net unrealised gains and losses recognised in the balance sheet principally relate to the mark-to-market of our forward contracts for power. The following table shows the movements in unrealised gains and losses and where they are recorded in our financial statements.
The trends in forward power prices, which largely determine the movements in our net unrealised gains and losses position are described within the Commodity markets section.
During 2010, power prices increased, such that the difference between power that had been contracted but had yet to be delivered and the market price had narrowed considerably at 31 December 2010, reducing the unrealised gain in the balance sheet. In addition, following a period of coal price stability during the first half of 2010, prices increased significantly in the final months of the year, driving an increase in the unrealised losses on our financial coal contracts, which expose us to floating prices. Together these factors resulted in an unrealised loss in the balance sheet of £61 million at 31 December 2010.
During 2011, power prices fell significantly in the final quarter. As a result, the average price of power that had been contracted but had yet to be delivered at 31 December 2011 was higher than market prices, driving an increase in the unrealised gain in the balance sheet. Coal prices also continued to rise during the first quarter of 2011, before stabilising over the remainder of the year. A number of the financial coal contracts in place at 31 December 2010 unwound during the year as the contracts matured, thereby reducing the unrealised losses at 31 December 2011.
This combination of factors drove the recognition of an unrealised gain of £31 million in the balance sheet at 31 December 2011.
The unrealised gains recognised in the income statement of £90 million for the year ended 31 December 2011 and unrealised losses of £61 million in 2010 arise from mark-to-market movements on our derivative contracts which do not qualify for hedge accounting; largely financial coal and foreign exchange.
Mark-to-market movements on most of our derivative contracts, considered to be effective hedges, have been recognised through the hedge reserve, a component of shareholders’ equity in the balance sheet. Movements in unrealised gains and losses recognised in the hedge reserve are mainly the result of unwinding mark-to-market positions relating to power delivered during a reporting period, and the recording of mark-to-market positions on power yet to be delivered at the end of that period. The net unrealised gain recognised through the hedge reserve in the year ended 31 December 2011 was £3 million, compared to net unrealised losses of £233 million in 2010.
In considering mark-to-market movements, it is important to recognise that profitability is driven by our strategy to deliver market level dark green spreads, not by the absolute price of electricity at any given date.
After allowing for the unrealised gains and losses on derivative contracts, depreciation and amortisation, operating profit for the year ended 31 December 2011 was £366 million compared to £279 million in 2010.