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Fair Value Measurements
 6 Months Ended
Jun. 30, 2017
Fair Value Disclosures [Abstract]  
Fair Value Measurements
Fair Value Measurements

Fair Values – Recurring

Fair value measurements and disclosures relate primarily to the Partnership’s derivative positions as discussed in Note 13. Money market funds, which are included in Cash and cash equivalents on the Consolidated Balance Sheets, are measured at fair value and are included in Level 1 measurements of the valuation hierarchy. Level 2 instruments include crude oil and natural gas swap contracts. Level 3 instruments include all NGL transactions and embedded derivatives in commodity contracts. The following table presents the financial instruments carried at fair value classified by the valuation hierarchy:
 
June 30, 2017
 
December 31, 2016
(In millions)
Assets
 
Liabilities
 
Assets
 
Liabilities
Significant other observable inputs (Level 2)
 
 
 
 
 
 
 
Commodity contracts
$
—

 
$
—

 
$
—

 
$
—

Significant unobservable inputs (Level 3)
 
 
 
 
 
 
 
Commodity contracts
2

 
—

 
—

 
(6
)
Embedded derivatives in commodity contracts
—

 
(43
)
 
—

 
(54
)
Total carrying value in Consolidated Balance Sheets
$
2

 
$
(43
)
 
$
—

 
$
(60
)


The following table provides additional information about the significant unobservable inputs used in the valuation of Level 3 instruments as of June 30, 2017. The market approach is used for valuation of all instruments.
Level 3 Instrument
 
Balance Sheet Classification
 
Unobservable Inputs
 
Value Range
 
Time Period
Commodity contracts
 
Assets
 
Forward ethane prices (per gallon)(1)
 
$0.25 - $0.26
 
July 17 - Dec. 17
 
 
 
 
Forward propane prices (per gallon)(1)
 
$0.53 - $0.63
 
July 17 - Dec. 18
 
 
 
 
Forward isobutane prices (per gallon)(1)
 
$0.66 - $0.76
 
July 17 - Dec. 18
 
 
 
 
Forward normal butane prices (per gallon)(1)
 
$0.59 - $0.74
 
July 17 - Dec. 18
 
 
 
 
Forward natural gasoline prices (per gallon)(1)
 
$1.03 - $1.06
 
July 17 - Dec. 18
 
 
 
 
 
 
 
 
 
Embedded derivatives in commodity contracts
 
Assets
 
ERCOT Pricing (per MegaWatt Hour)
 
$24.62 - $45.42
 
July 17 - Dec. 17
 
 
Liabilities
 
Forward propane prices (per gallon)(1)
 
$0.52 - $0.63
 
July 17 - Dec. 22
 
 
 
 
Forward isobutane prices (per gallon)(1)
 
$0.64 - $0.76
 
July 17 - Dec. 22
 
 
 
 
Forward normal butane prices (per gallon)(1)
 
$0.59 - $0.74
 
July 17 - Dec. 22
 
 
 
 
Forward natural gasoline prices (per gallon)(1)
 
$1.03 - $1.10
 
July 17 - Dec. 22
 
 
 
 
Forward natural gas prices (per MMBtu)(2)
 
$2.26 - $3.14
 
July 17 - Dec. 22
 
 
 
 
Probability of renewal(3)
 
50.0%
 
 
 
 
 
 
Probability of renewal for second 5-yr term(3)
 
75.0%
 
 

(1)
NGL prices used in the valuations decrease in the early years and increase over time.
(2)
Natural gas prices used in the valuations decrease in the early years and increase over time.
(3)
The producer counterparty to the embedded derivative has the option to renew the gas purchase agreement and the related keep-whole processing agreement for two successive five-year terms after 2022. The embedded gas purchase agreement cannot be renewed without the renewal of the related keep-whole processing agreement. Due to the significant number of years until the renewal options are exercisable and the high level of uncertainty regarding the counterparty’s future business strategy, the future commodity price environment, and the future competitive environment for midstream services in the Southern Appalachian region, management determined that a 50 percent probability of renewal for the first five-year term and 75 percent for the second five-year term are appropriate assumptions. Included in this assumption is a further extension of management’s estimates of future frac spreads through 2032.

Fair Value Sensitivity Related to Unobservable Inputs

Commodity contracts (assets and liabilities) – For the Partnership’s commodity contracts, increases in forward NGL prices result in a decrease in the fair value of the derivative assets and an increase in the fair value of the derivative liabilities. The forward prices for the individual NGL products generally increase or decrease in a positive correlation with one another.

Embedded derivatives in commodity contracts – The Partnership has two embedded derivatives in commodity contracts, as follows:

•
A single embedded derivative liability comprised of both the purchase of natural gas at prices impacted by the frac spread and the probability of contract renewal (the “Natural Gas Embedded Derivative”), as discussed further in Note 13. Increases (decreases) in the frac spread result in an increase (decrease) in the fair value of the embedded derivative liability. An increase in the probability of renewal would result in an increase in the fair value of the related embedded derivative liability.
•
An embedded derivative related to utilities costs discussed further in Note 13. Increases in the forward ERCOT prices result in a decrease in the fair value of the embedded derivative liability.

Level 3 Valuation Process

The Partnership’s Risk Management Department (the “Risk Department”) is responsible for the valuation of the Partnership’s commodity derivative contracts and embedded derivatives in commodity contracts, except for the Natural Gas Embedded Derivative. The Risk Department reports to the Chief Financial Officer and is responsible for the oversight of the Partnership’s commodity risk management program. The members of the Risk Department have the requisite experience, knowledge and day-to-day involvement in the energy commodity markets to ensure appropriate valuations and understand the changes in the valuations from period to period. The valuations of the Level 3 commodity derivative contracts are performed by a third-party pricing service and are reviewed and validated on a quarterly basis by the Risk Department by comparing the pricing and option volatilities to actual market data and/or data provided by at least one other independent third-party pricing service.

Management is responsible for the valuation of the Natural Gas Embedded Derivative discussed in Note 13. Included in the valuation of the Natural Gas Embedded Derivative are assumptions about the forward price curves for NGLs and natural gas for periods in which price curves are not available from third-party pricing services due to insufficient market data. The Risk Department must develop forward price curves for NGLs and natural gas through the initial contract term (July 2017 through December 2022) for management’s use in determining the fair value of the Natural Gas Embedded Derivative. In developing the pricing curves for these periods, the Risk Department maximizes its use of the latest known market data and trends as well as its understanding of the historical relationships between forward NGL and natural gas prices and the forward market data that is available for the required period, such as crude oil pricing and natural gas pricing from other markets. However, there is very limited actual market data available to validate the Risk Department’s estimated price curves. Management also assesses the probability of the producer customer’s renewal of the contracts, which includes consideration of:

•
The estimated favorability of the contracts to the producer customer as compared to other options that would be available to them at the time and in the relative geographic area of their producing assets;
•
Extrapolated pricing curves, using a weighted average probability method that is based on historical frac spreads, which impact the calculation of favorability; and
•
The producer customer’s potential business strategy decision points that may exist at the time the counterparty would elect whether to renew the contracts.

Changes in Level 3 Fair Value Measurements

The tables below include a rollforward of the balance sheet amounts for the three and six months ended June 30, 2017 and 2016, respectively (including the change in fair value), for assets and liabilities classified by the Partnership within Level 3 of the valuation hierarchy.
 
Three Months Ended June 30, 2017
 
Six Months Ended June 30, 2017
(In millions)
Commodity Derivative Contracts (net)
 
Embedded Derivatives in Commodity Contracts (net)
 
Commodity Derivative Contracts (net)
 
Embedded Derivatives in Commodity Contracts (net)
Fair value at beginning of period
$
—

 
$
(44
)
 
$
(6
)
 
$
(54
)
Total gains (realized and unrealized) included in earnings(1)
2

 
—

 
7

 
8

Settlements
—

 
1

 
1

 
3

Fair value at end of period
$
2

 
$
(43
)
 
$
2

 
$
(43
)
The amount of total gains (losses) for the period included in earnings attributable to the change in unrealized losses relating to liabilities still held at end of period
$
2

 
$
(1
)
 
$
5

 
$
7


 
Three Months Ended June 30, 2016
 
Six Months Ended June 30, 2016
(In millions)
Commodity Derivative Contracts (net)
 
Embedded Derivatives in Commodity Contracts (net)
 
Commodity Derivative Contracts (net)
 
Embedded Derivatives in Commodity Contracts (net)
Fair value at beginning of period
$
—

 
$
(34
)
 
$
7

 
$
(32
)
Total (losses) (realized and unrealized) included in earnings(1)
(6
)
 
(7
)
 
(7
)
 
(11
)
Settlements
1

 
1

 
(5
)
 
3

Netting adjustment(2)
1

 
—

 
1

 
—

Fair value at end of period
$
(4
)
 
$
(40
)
 
$
(4
)
 
$
(40
)
The amount of total losses for the period included in earnings attributable to the change in unrealized losses relating to liabilities still held at end of period
$
(5
)
 
$
(8
)
 
$
(6
)
 
$
(11
)

(1)
Gains and losses on Commodity Derivative Contracts classified as Level 3 are recorded in Product sales in the accompanying Consolidated Statements of Income. Gains and losses on Embedded Derivatives in Commodity Contracts are recorded in Purchased product costs and Cost of Revenues.
(2)
Certain derivative positions are subject to master netting agreements; therefore, the Partnership has elected to offset derivative assets and liabilities where legally permissible. The Partnership may hold positions with certain counterparties, which for GAAP purposes are classified within different levels of the fair value hierarchy and may be legally permissible to offset. This adjustment represents the total impact of offsetting Level 2 positions with Level 3 positions as of June 30, 2016.

Fair Values – Reported

The Partnership’s primary financial instruments are cash and cash equivalents, receivables, receivables from related parties, accounts payable, payables to related parties and long-term debt. The Partnership’s fair value assessment incorporates a variety of considerations, including (1) the short-term duration of the instruments, (2) MPC’s investment-grade credit rating and (3) the historical incurrence of and expected future insignificance of bad debt expense, which includes an evaluation of counterparty credit risk. The Partnership believes the carrying values of its current assets and liabilities approximate fair value. The recorded value of the amounts outstanding under the bank revolving credit facility, if any, approximates fair value due to the variable interest rate that approximates current market rates. Derivative instruments are recorded at fair value, based on available market information (see Note 13).

The fair value of the Partnership’s long-term debt is estimated based on recent market non-binding indicative quotes. The fair value of the SMR liability is estimated using a discounted cash flow approach based on the contractual cash flows and the Partnership’s unsecured borrowing rate. The long-term debt and SMR liability fair values are considered Level 3 measurements. The following table summarizes the fair value and carrying value of the long-term debt, excluding capital leases, and SMR liability:
 
June 30, 2017
 
December 31, 2016
(In millions)
Fair Value
 
Carrying Value
 
Fair Value
 
Carrying Value
Long-term debt
$
7,362

 
$
6,687

 
$
4,953

 
$
4,422

SMR liability
106

 
93

 
108

 
96