XML 83 R15.htm IDEA: XBRL DOCUMENT v2.4.0.6
Derivatives and Hedging Instruments
 12 Months Ended
Dec. 31, 2011
Derivatives and Hedging Instruments  
Derivatives and Hedging Instruments

Note 6—Derivatives and Hedging Instruments

 

We identify the risks that underlie our core business activities and use risk management strategies to mitigate those risks when we determine that there is value in doing so. Our policy is to use derivative instruments for risk management purposes and not for the purpose of speculating on commodity price changes. We use various derivative instruments to (i) manage our exposure to commodity price risk as well as to optimize our profits, (ii) manage our exposure to interest rate risk and (iii) manage our exposure to currency exchange rate risk. Our commodity risk management policies and procedures are designed to help ensure that our hedging activities address our risks by monitoring NYMEX, ICE and over-the-counter positions, as well as physical volumes, grades, locations, delivery schedules and storage capacity. Our interest rate and currency exchange rate risk management policies and procedures are designed to monitor our positions and ensure that those positions are consistent with our objectives and approved strategies. Our policy is to formally document all relationships between hedging instruments and hedged items, as well as our risk management objectives for undertaking the hedge. This process includes specific identification of the hedging instrument and the hedged transaction, the nature of the risk being hedged and how the hedging instrument’s effectiveness will be assessed. Both at the inception of the hedge and on an ongoing basis, we assess whether the derivatives used in a transaction are highly effective in offsetting changes in cash flows or the fair value of hedged items.

 

Commodity Price Risk Hedging

 

Our core business activities contain certain commodity price-related risks that we manage in various ways, including the use of derivative instruments. Our policy is (i) to only purchase product for which we have a market, (ii) to structure our sales contracts so that price fluctuations do not materially affect our operating income and (iii) not to acquire and hold physical inventory or derivatives for the purpose of speculating on commodity price changes. The material commodity-related risks inherent in our business activities can be summarized into the following general categories:

 

Commodity Purchases and Sales — In the normal course of our operations, we purchase and sell commodities. We use derivatives to manage the associated risks and to optimize profits. As of December 31, 2011, net derivative positions related to these activities included:

 

·                  An approximate 177,300 barrels per day net long position (total of 5.3 million barrels) associated with our crude oil purchases, which was unwound ratably during January 2012 to match monthly average pricing.

 

·                  A net short spread position averaging approximately 30,800 barrels per day (total of 10.3 million barrels), which hedges a portion of our anticipated crude oil lease gathering purchases through January 2013. These derivatives are time spreads consisting of offsetting purchases and sales between two different months. Our use of these derivatives does not expose us to outright price risk.

 

·                  Approximately 9,200 barrels per day on average (total of 6.7 million barrels) of WTS/WTI crude oil basis swaps through December 2013, which hedge anticipated sales of crude oil (WTI). These derivatives are grade spreads between two different grades of crude oil. Our use of these derivatives does not expose us to outright price risk.

 

·                  Approximately 6,000 barrels per day on average (total of 2.2 million barrels) of LLS/WTI crude oil basis swaps January 2012 through December 2012, which hedge anticipated sales of crude oil (LLS). These derivatives are grade spreads between two different grades of crude oil. Our use of these derivatives does not expose us to outright price risk.

 

·                  A short swap position of approximately 14.6 Bcf through April 2012 related to anticipated sales of natural gas.

 

·                  A long swap position of approximately 0.6 Bcf through April 2013 related to anticipated purchases of natural gas.

 

Storage Capacity Utilization — We own approximately 80 million barrels of crude oil, LPG and refined products storage capacity other than that used in our transportation operations. This storage may be leased to third parties or utilized in our own supply and logistics activities, including for the storage of inventory in a contango market. For capacity allocated to our supply and logistics operations, we have utilization risk if the market structure is backwardated. As of December 31, 2011, we used derivatives to manage the risk of not utilizing approximately 3.7 million barrels per month of storage capacity through 2012. These positions are a combination of calendar spread options and futures contracts. These positions involve no outright price exposure, but instead represent potential offsetting purchases and sales between time periods (first month versus second month for example).

 

Inventory Storage — At times, we elect to purchase and store crude oil, LPG and refined products inventory in conjunction with our supply and logistics activities. When we purchase and store inventory, we enter into physical sales contracts or use derivatives to mitigate price risk associated with the inventory. As of December 31, 2011, we had derivatives totaling approximately 5.0 million barrels hedging our inventory. These positions are a combination of futures, swaps and option contracts.

 

Pipeline Loss Allowance Oil — As is common in the pipeline transportation industry, our tariffs incorporate a loss allowance factor that is intended to, among other things, offset losses due to evaporation, measurement and other losses in transit. We utilize derivative instruments to hedge a portion of the anticipated sales of the allowance oil that is to be collected under our tariffs. As of December 31, 2011, our PLA hedges included (i) a net short position consisting of crude oil futures and swaps for an average of approximately 1,500 barrels per day (total of 2.2 million barrels) through December 2015, (ii) a long put option position of approximately 0.4 million barrels through December 2012 and (iii) a long call option position of approximately 0.9 million barrels through December 2015.

 

Base Gas Management –– Our gas storage facilities require minimum levels of base gas to operate. For our natural gas storage facilities that are under construction, we anticipate purchasing base gas in future periods as construction is completed. We use derivatives to hedge such anticipated purchases of natural gas. As of December 31, 2011, we have a long swap position of approximately 3.0 Bcf through April 2013 related to anticipated base gas purchases.

 

All of our commodity derivatives that qualify for hedge accounting are designated as cash flow hedges. We have determined that substantially all of our physical purchase and sale agreements qualify for the NPNS exclusion. Physical commodity contracts that meet the definition of a derivative but are ineligible, or not designated, for the NPNS scope exception are recorded on the balance sheet at fair value, with changes in fair value recognized in earnings.

 

Interest Rate Risk Hedging

 

We use interest rate derivatives to hedge interest rate risk associated with anticipated debt issuances and outstanding debt instruments. The derivative instruments we use to manage this risk consist primarily of interest rate swaps and treasury locks. As of December 31, 2011, AOCI includes deferred losses of $133 million that relate to open and terminated interest rate derivatives that were designated for hedge accounting. The terminated interest rate derivatives were cash-settled in connection with the issuance or refinancing of debt agreements. The deferred gain related to these instruments is being amortized to interest expense over the terms of the hedged debt instruments.

 

During the second and third quarters of 2011, we entered into forward starting interest rate swaps to hedge the underlying benchmark interest rate related to forecasted debt issuances through 2015. The following table summarizes the terms of our forward starting interest rate swaps (notional amounts in millions):

 

Hedged Transaction

 

Number and Types of

Derivatives Employed

 

Notional

Amount

 

Expected

Termination Date

 

Average Rate

Locked

 

Accounting

Treatment

 

Anticipated debt offering

 

4 forward starting swaps (10-year)

 

$

200

 

6/15/2012

 

3.46

%

Cash flow hedge

 

Anticipated debt offering

 

6 forward starting swaps (30-year)

 

$

250

 

6/17/2013

 

4.24

%

Cash flow hedge

 

Anticipated debt offering

 

2 forward starting swaps (30-year)

 

$

50

 

6/16/2014

 

3.94

%

Cash flow hedge

 

Anticipated debt offering

 

10 forward starting swaps (30-year)

 

$

250

 

6/15/2015

 

3.60

%

Cash flow hedge

 

 

During June 2011 and August 2011, PNG entered into three interest rate swaps to fix the interest rate on a portion of PNG’s outstanding debt. The swaps have an aggregate notional amount of $100 million with an average fixed rate of 0.95%. Two of these swaps terminate in June 2014 and the remaining swap terminates in August 2014. These swaps are designated as cash flow hedges.

 

Concurrent with our January 2011 senior notes issuance, we terminated three forward starting interest rate swaps.  These swaps had an aggregate notional amount of $100 million and an average fixed rate of 3.6%. We received cash proceeds of $12 million associated with the termination of these swaps.

 

During July 2009, we entered into four interest rate swaps for which we receive fixed interest payments and pay floating-rate interest payments based on three-month LIBOR plus an average spread of 2.42% on a semi-annual basis. The swaps have an aggregate notional amount of $300 million with fixed rates of 4.25%. Two of the swaps terminated in September 2011, and two of the swaps will terminate in September 2012. The swaps that terminate in 2012 are designated as fair value hedges.

 

Currency Exchange Rate Risk Hedging

 

Because a significant portion of our Canadian business is conducted in CAD and, at times, a portion of our debt is denominated in CAD, we use foreign currency derivatives to minimize the risks of unfavorable changes in exchange rates. These instruments include foreign currency exchange contracts, forwards and options. As of December 31, 2011, AOCI includes net deferred gains of approximately $10 million that relate to open and settled foreign currency derivatives that were designated for hedge accounting. These foreign currency derivatives hedge the cash flow variability associated with CAD-denominated interest payments on CAD-denominated intercompany notes as a result of changes in the exchange rate.

 

As of December 31, 2011, our outstanding foreign currency derivatives also include derivatives we use to hedge USD-denominated crude oil purchases and sales in Canada. In addition, we may from time to time hedge the commodity price risk associated with a CAD-denominated commodity transaction with a USD-denominated commodity derivative. In conjunction with entering into the commodity derivative, we may enter into a foreign currency derivative to hedge the resulting foreign currency risk. These foreign currency derivatives are generally short-term in nature and are not designated for hedge accounting.

 

The following table summarizes our open forward exchange contracts that exchange CAD for USD on a net basis (in millions):

 

 

 

CAD

 

USD

 

Average Exchange Rate

 

2012

 

$

15

 

$

15

 

CAD $1.01 to USD $1.00

 

2013

 

$

9

 

$

9

 

CAD $1.00 to USD $1.00

 

 

Summary of Financial Impact

 

For derivatives that qualify as a cash flow hedge, changes in fair value of the effective portion of the hedges are deferred to AOCI and recognized in earnings in the periods during which the underlying physical transactions impact earnings. For our interest rate swaps that qualify as a fair value hedge, changes in the fair value of the derivative and changes in the fair value of the underlying hedged item, attributable to the hedged risk, are recognized in earnings each period. Derivatives that do not qualify for hedge accounting and the portion of cash flow hedges that are not highly effective in offsetting changes in cash flows of the hedged items are recognized in earnings each period. Cash settlements associated with our derivative activities are reflected as operating cash flows in our consolidated statements of cash flows.

 

A summary of the impact of our derivative activities recognized in earnings for the years ended December 31, 2011 and 2010 is as follows (in millions):

 

 

 

Year Ended December 31, 2011

 

Year Ended December 31, 2010

 

 

 

 

 

Derivatives

 

 

 

 

 

Derivatives

 

 

 

 

 

Derivatives in

 

Not

 

 

 

Derivatives in

 

Not

 

 

 

 

 

Hedging

 

Designated

 

 

 

Hedging

 

Designated

 

 

 

Location of gain/(loss)

 

Relationships (1)(2)(3)(5)

 

as a Hedge (4)

 

Total

 

Relationships (1)(2)(3)

 

as a Hedge (4)

 

Total

 

Commodity Derivatives

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Supply and Logistics segment revenues

 

$

(161

)

$

99

 

$

(62

)

$

14

 

$

 2

 

$

16

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Transportation segment revenues

 

—

 

—

 

—

 

2

 

—

 

2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Facilities segment revenues

 

11

 

—

 

11

 

—

 

—

 

—

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Purchases and related costs

 

6

 

—

 

6

 

8

 

(12

)

(4

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Field operating costs

 

—

 

1

 

1

 

—

 

3

 

3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest Rate Derivatives

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

1

 

—

 

1

 

1

 

2

 

3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign Exchange Derivatives

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Supply and Logistics segment revenues

 

—

 

1

 

1

 

—

 

2

 

2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Purchases and related costs

 

—

 

—

 

—

 

—

 

2

 

2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other income/(expense), net

 

6

 

—

 

6

 

—

 

(1

)

(1

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Gain/(Loss) on Derivatives Recognized in Income

 

$

(137

)

$

101

 

$

(36

)

$

25

 

$

 (2

)

$

23

 

 

(1)

Amounts represent derivative gains and losses that were reclassified from AOCI to earnings during the period to coincide with the earnings impact of the respective hedged transaction.

(2)

Amounts include losses of approximately $8 million and $1 million for the years ended December 31, 2011 and 2010, respectively, that represent the ineffective portion of our cash flow hedges. These amounts relate to commodity derivatives and were recognized in Supply and Logistics segment revenues during the respective periods.

(3)

Interest expense includes net gains of approximately $2 million and approximately $1 million for the years ended December 31, 2011 and 2010, respectively, associated with outstanding interest rate swaps, which are designated as a fair value hedge.

(4)

Includes realized and unrealized gains or losses for derivatives not designated for hedge accounting during the period.

(5)

Includes unrealized gains of approximately $6 million reclassified from AOCI to earnings during the period to offset a lower of cost or market adjustment relating to the carrying value of PNG’s inventory.

 

The following table summarizes the derivative assets and liabilities on our consolidated balance sheet on a gross basis as of December 31, 2011 (in millions):

 

 

 

Asset Derivatives

 

 

Liability Derivatives

 

 

 

Balance Sheet

 

 

 

 

Balance Sheet

 

 

 

 

 

Location

 

Fair Value

 

 

Location

 

Fair Value

 

Derivatives designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

Commodity derivatives

 

Other current assets

 

$

72

 

 

Other current assets

 

$

(47

)

 

 

Other long-term assets

 

20

 

 

Other long-term assets

 

(2

)

Interest rate derivatives

 

Other current assets

 

1

 

 

Other current liabilities

 

(24

)

 

 

 

 

 

 

 

Other long-term liabilities

 

(114

)

Foreign currency derivatives

 

Other current assets

 

1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total derivatives designated as hedging instruments

 

 

 

$

94

 

 

 

 

$

(187

)

 

 

 

 

 

 

 

 

 

 

 

Derivatives not designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

Commodity derivatives

 

Other current assets

 

$

87

 

 

Other current assets

 

$

(39

)

 

 

Other long-term assets

 

6

 

 

Other long-term assets

 

(3

)

 

 

 

 

 

 

 

Other current liabilities

 

(1

)

Total derivatives not designated as hedging instruments

 

 

 

$

93

 

 

 

 

$

(43

)

 

 

 

 

 

 

 

 

 

 

 

Total derivatives

 

 

 

$

187

 

 

 

 

$

(230

)

 

The following table summarizes the derivative assets and liabilities on our consolidated balance sheet on a gross basis as of December 31, 2010 (in millions):

 

 

 

Asset Derivatives

 

 

Liability Derivatives

 

 

 

Balance Sheet

 

 

 

 

Balance Sheet

 

 

 

 

 

Location

 

Fair Value

 

 

Location

 

Fair Value

 

Derivatives designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

Commodity derivatives

 

Other current assets

 

$

71

 

 

Other current assets

 

$

(70

)

 

 

 

 

 

 

 

Other long-term assets

 

(1

)

 

 

 

 

 

 

 

Other current liabilities

 

(1

)

Interest rate derivatives

 

Other current assets

 

10

 

 

 

 

 

 

Total derivatives designated as hedging instruments

 

 

 

$

81

 

 

 

 

$

(72

)

 

 

 

 

 

 

 

 

 

 

 

Derivatives not designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

Commodity derivatives

 

Other current assets

 

$

11

 

 

Other current assets

 

$

(68

)

 

 

Other long-term assets

 

20

 

 

 

 

 

 

 

 

Other current liabilities

 

2

 

 

Other current liabilities

 

(10

)

Interest rate derivatives

 

Other current assets

 

4

 

 

 

 

 

 

 

 

Other long-term assets

 

1

 

 

 

 

 

 

Foreign currency derivatives

 

Other current assets

 

1

 

 

 

 

 

 

Total derivatives not designated as hedging instruments

 

 

 

$

39

 

 

 

 

$

(78

)

 

 

 

 

 

 

 

 

 

 

 

Total derivatives

 

 

 

$

120

 

 

 

 

$

(150

)

 

As of December 31, 2011, there was a net loss of approximately $99 million deferred in AOCI, excluding tax effects. The total amount of deferred net loss recorded in AOCI is expected to be reclassified to future earnings contemporaneously with (i) the earnings recognition of the underlying hedged commodity transaction, (ii) interest expense accruals associated with underlying debt instruments or (iii) the recognition of a foreign currency gain or loss upon the remeasurement of certain CAD-denominated intercompany balances. Of the total net loss deferred in AOCI at December 31, 2011, we expect to reclassify a net gain of approximately $21 million to earnings in the next twelve months. Of the remaining deferred loss in AOCI, a net gain of approximately $9 million is expected to be reclassified to earnings prior to 2015 with the remaining deferred loss of $129 million being reclassified to earnings through 2045. These amounts are predominantly based on market prices at the current period end, thus actual amounts to be reclassified will differ and could vary materially as a result of changes in market conditions.

 

During the year ended December 31, 2011, we reclassified a gain of approximately $2 million from AOCI to earnings as a result of anticipated hedged transactions that are probable of not occurring. During the year ended December 31, 2010, all of our hedged transactions were probable of occurring. The net deferred gain/(loss), excluding tax effects, recognized in AOCI for derivatives during the years ended December 31, 2011 and 2010 are as follows (in millions):

 

 

 

For the Years Ended December 31,

 

 

 

2011

 

2010

 

Commodity derivatives, net

 

$

(15

)

$

(82

)

Foreign exchange derivatives, net

 

—

 

(2

)

Interest rate derivatives, net

 

(136

)

8

 

Total

 

$

(151

)

$

(76

)

 

Our accounting policy is to offset derivative assets and liabilities executed with the same counterparty when a master netting agreement exists. Accordingly, we also offset derivative assets and liabilities with amounts associated with cash margin. Our exchange-traded derivatives are transacted through brokerage accounts and are subject to margin requirements as established by the respective exchange. On a daily basis, our account equity (consisting of the sum of our cash balance and the fair value of our open derivatives) is compared to our initial margin requirement resulting in the payment or return of variation margin. As of December 31, 2011, we had a net broker payable of approximately $7 million (consisting of initial margin of $52 million reduced by $59 million of variation margin that had been returned to us). As of December 31, 2010, we had a net broker receivable of approximately $99 million (consisting of initial margin of $56 million increased by $43 million of variation margin that had been posted by us).  At December 31, 2011 and 2010, none of our outstanding derivatives contained credit-risk related contingent features that would result in a material adverse impact to us upon any change in our credit ratings.

 

Recurring Fair Value Measurements

 

Derivative Financial Assets and Liabilities

 

The following table sets forth by level within the fair value hierarchy our financial assets and liabilities that were accounted for at fair value on a recurring basis as of  December 31, 2011 and 2010. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment, which affects the placement of assets and liabilities within the fair value hierarchy levels.

 

 

 

Fair Value as of December 31, 2011
(in millions)

 

 

Fair Value as of December 31, 2010
(in millions)

 

Recurring Fair Value Measures (1)

 

Level 1

 

Level 2

 

Level 3

 

Total

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Commodity derivatives

 

$

80

 

$

1

 

$

12

 

$

93

 

 

$

(16

)

$

—

 

$

(30

)

$

(46

)

Interest rate derivatives

 

—

 

(137

)

—

 

(137

)

 

—

 

—

 

15

 

15

 

Foreign currency derivatives

 

—

 

1

 

—

 

1

 

 

—

 

—

 

1

 

1

 

Total

 

$

80

 

$

(135

)

$

12

 

$

(43

)

 

$

(16

)

$

—

 

$

(14

)

$

(30

)

 

(1)       Derivative assets and liabilities are presented above on a net basis but do not include related cash margin deposits.

 

The determination of the fair values above includes not only the credit standing of the counterparties involved and the impact of credit enhancements (such as cash deposits and letters of credit) but also the impact of our nonperformance risk on our liabilities. The fair value of our commodity derivatives, interest-rate derivatives and foreign currency derivatives includes adjustments for credit risk. Our credit adjustment methodology uses market observable inputs and requires judgment. There were no changes to any of our valuation techniques during the period.

 

Level 1

 

Included within level 1 of the fair value hierarchy are exchange-traded commodity derivatives such as futures, options and swaps. The fair value of exchange-traded commodity derivatives is based on unadjusted quoted prices in active markets and is therefore classified within level 1 of the fair value hierarchy.

 

Level 2

 

Included within level 2 of the fair value hierarchy are over-the-counter commodity, interest rate and foreign currency derivatives that are traded in active markets.  The fair value of these derivatives is based on broker or dealer price quotations which are corroborated with market observable inputs.

 

Level 3

 

Included within level 3 of the fair value hierarchy are over-the-counter commodity derivatives that are traded in markets that are active but not sufficiently active to warrant level 2 classification in our judgment and certain physical commodity contracts. The fair value of our level 3 commodity derivatives is based on broker or dealer price quotations or a valuation model. Our valuation models utilize inputs such as forward prices but do not involve significant management judgments.

 

Rollforward of Level 3 Net Liability

 

The following table provides a reconciliation of changes in fair value of the beginning and ending balances for our derivatives classified as level 3 (in millions):

 

 

 

Year Ended December 31,

 

 

 

2011

 

2010

 

Beginning Balance

 

$

(14

)

$

(28

)

Unrealized gains/(losses):

 

 

 

 

 

Included in earnings (1)

 

17

 

(22

)

Included in other comprehensive income

 

2

 

3

 

Settlements

 

21

 

42

 

Derivatives entered into during the period

 

3

 

(9

)

Transfers out of level 3

 

(17

)

—

 

Ending Balance

 

$

12

 

$

(14

)

 

 

 

 

 

 

Change in unrealized gains/(losses) included in earnings relating to level 3 derivatives still held at the end of the periods

 

$

22

 

$

(27

)

 

(1)       We reported unrealized gains and losses associated with level 3 commodity derivatives in our consolidated statements of operations as Supply and Logistics segment revenues. Gains and losses associated with interest rate derivatives are reported in our consolidated statements of operations as Interest expense. Gains and losses associated with foreign currency derivatives are reported in our consolidated statements of operations as either Supply and Logistics segment revenues, Purchases and related costs, or Other income/(expense), net.

 

During the first quarter of 2011, we transferred interest rate and commodity derivatives with an aggregate fair value of $17 million from level 3 to level 2. This transfer resulted from the implementation of additional valuation procedures, using market observable inputs, to validate the broker or dealer price quotations used for fair value measurement. Our policy is to recognize transfers between levels as of the beginning of the reporting period in which the transfer occurred.

 

We believe that a proper analysis of our level 3 gains or losses must incorporate the understanding that these items are generally used to hedge our commodity price risk, interest rate risk and foreign currency exchange risk and will therefore be offset by gains or losses on the underlying transactions.