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Financial Instruments, Derivatives and Hedging Activities | 12 Months Ended
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Dec. 31, 2018
Financial Instruments, Derivatives and Hedging Activities |
Financial Instruments, Derivatives and Hedging Activities | NOTE 6 – Financial Instruments, Derivatives and Hedging Activities The Company is exposed to market risk stemming from changes in commodity prices (primarily corn and natural gas), foreign currency exchange rates and interest rates. In the normal course of business, the Company actively manages its exposure to these market risks by entering into various hedging transactions, authorized under established policies that place clear controls on these activities. These transactions utilize exchange-traded derivatives or over-the-counter derivatives with investment grade counterparties. Derivative financial instruments currently used by the Company consist of commodity-related futures, options, and swap contracts, foreign currency-related forward contracts, interest rate swaps and T-Locks. Commodity price hedging: The Company’s principal use of derivative financial instruments is to manage commodity price risk in North America relating to anticipated purchases of corn and natural gas to be used in the manufacturing process, generally over the next 12 to 24 months. The Company maintains a commodity-price risk management strategy that uses derivative instruments to minimize significant, unanticipated earnings fluctuations caused by commodity-price volatility. For example, the manufacturing of the Company’s products requires a significant volume of corn and natural gas. Price fluctuations in corn and natural gas cause the actual purchase price of corn and natural gas to differ from anticipated prices. To manage price risk related to corn purchases in North America, the Company uses corn futures and options contracts that trade on regulated commodity exchanges to lock-in its corn costs associated with firm-priced customer sales contracts. The Company uses over-the-counter natural gas swaps to hedge a portion of its natural gas usage in North America. These derivative financial instruments limit the impact that volatility resulting from fluctuations in market prices will have on corn and natural gas purchases and have been designated as cash flow hedges. The Company also enters into futures contracts to hedge price risk associated with fluctuations in the market price of ethanol. Unrealized gains and losses associated with marking the commodity hedging contracts to market (fair value) are recorded as a component of other comprehensive income (“OCI”) and included in the equity section of the Consolidated Balance Sheets as part of AOCI. These amounts are subsequently reclassified into earnings in the same line item affected by the hedged transaction and in the same period or periods during which the hedged transaction affects earnings, or in the month a hedge is determined to be ineffective. The Company assesses the effectiveness of a commodity hedge contract based on changes in the contract’s fair value. The changes in the market value of such contracts have historically been, and are expected to continue to be, highly effective at offsetting changes in the price of the hedged items. The amounts representing the ineffectiveness of these cash flow hedges are not significant. As of December 31, 2018, AOCI included $2 million of losses (net of tax of $2 million) pertaining to commodities-related derivative instruments designated as cash flow hedges. As of December 31, 2017, AOCI included $12 million of losses (net of tax of $7 million) pertaining to commodities-related derivative instruments designated as cash flow hedges. Interest rate hedging: The Company assesses its exposure to variability in interest rates by identifying and monitoring changes in interest rates that may adversely impact future cash flows and the fair value of existing debt instruments, and by evaluating hedging opportunities. The Company maintains risk management control systems to monitor interest rate risk attributable to both the Company’s outstanding and forecasted debt obligations as well as the Company’s offsetting hedge positions. The risk management control systems involve the use of analytical techniques, including sensitivity analysis, to estimate the expected impact of changes in interest rates on future cash flows and the fair value of the Company’s outstanding and forecasted debt instruments. Derivative financial instruments that have been used by the Company to manage its interest rate risk consist of interest rate swaps and T-Locks. The Company periodically enters into T-Locks to hedge its exposure to interest rate changes. The T-Locks are designated as hedges of the variability in cash flows associated with future interest payments caused by market fluctuations in the benchmark interest rate until the fixed interest rate is established, and are accounted for as cash flow hedges. Accordingly, changes in the fair value of the T-Locks are recorded to AOCI until the consummation of the underlying debt offering, at which time any realized gain (loss) is amortized to earnings over the life of the debt. The Company also has an interest rate swap agreement that effectively converts the interest rates on $200 million of its $400 million of 4.625 percent senior notes, due November 1, 2020, to variable rates. This swap agreement calls for the Company to receive interest at the fixed coupon rate of the respective notes and to pay interest at a variable rate based on the six-month U.S. LIBOR rate plus a spread. The Company has designated this interest rate swap agreement as a hedge of the changes in fair value of the underlying debt obligations attributable to changes in interest rates and accounts for it as fair value hedges. Changes in the fair value of interest rate swaps designated as hedging instruments that effectively offset the variability in the fair value of outstanding debt obligations are reported in earnings. These amounts offset the gain or loss (the change in fair value) of the hedged debt instrument that is attributable to changes in interest rates (the hedged risk), which is also recognized in earnings. The fair value of the interest rate swap agreement as of December 31, 2018 was a $1 million loss, and is reflected in the Consolidated Balance Sheets within non-current liabilities, with an offsetting amount recorded in long-term debt to adjust the carrying amount of the hedged debt obligations. As of December 31, 2017, the fair value of the interest rate swap agreement was a $1 million gain, and is reflected in the Consolidated Balance Sheets within other assets, with an offsetting amount recorded in long-term debt to adjust the carrying amount of hedged debt obligations. The Company did not have any T-Locks outstanding as of December 31, 2018, or 2017. As of December 31, 2018 and 2017, AOCI included $2 million of losses (net of income taxes of $1 million) and $2 million of losses (net of income taxes of $1 million), respectively, related to settled T-Locks. These deferred losses are being amortized to financing costs over the terms of the senior notes with which they are associated. Foreign currency hedging: Due to the Company’s global operations, including operations in many emerging markets, it is exposed to fluctuations in foreign currency exchange rates. As a result, the Company has exposure to translational foreign exchange risk when the results of its foreign operations are translated to U.S. dollars and to transactional foreign exchange risk when transactions not denominated in the functional currency are revalued. The Company primarily uses derivative financial instruments such as foreign currency forward contracts, swaps and options to manage its transactional foreign exchange risk. As of December 31, 2018, the Company had foreign currency forward sales contracts that are designated as fair value hedges with an aggregate notional amount of $621 million and foreign currency forward purchase contracts with an aggregate notional amount of $165 million that hedged transactional exposures. As of December 31, 2017, the Company had foreign currency forward sales contracts with an aggregate notional amount of $447 million and foreign currency forward purchase contracts with an aggregate notional amount of $121 million that hedged transactional exposures. The fair values of these derivative instruments were assets of $5 million and $11 million at December 31, 2018 and December 31, 2017, respectively. The Company also has foreign currency derivative instruments that hedge certain foreign currency transactional exposures and are designated as cash flow hedges. The amount included in AOCI related to these hedges at December 31, 2018 was not significant. As of December 31, 2017, AOCI included $1 million of gains (net of income taxes of $1 million) related to these hedges. By using derivative financial instruments to hedge exposures, the Company exposes itself to credit risk and market risk. Credit risk is the risk that the counterparty will fail to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes the Company, which creates credit risk for the Company. When the fair value of a derivative contract is negative, the Company owes the counterparty and, therefore, it does not possess credit risk. The Company minimizes the credit risk in derivative instruments by entering into over-the-counter transactions only with investment grade counterparties or by utilizing exchange-traded derivatives. Market risk is the adverse effect on the value of a financial instrument that results from a change in commodity prices, interest rates or foreign exchange rates. The market risk associated with commodity-price, interest rate or foreign exchange contracts is managed by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken. The fair value and balance sheet location of the Company’s derivative instruments, presented gross in the Consolidated Balance Sheets, are reflected below:
|  | Fair Value of Derivative Instruments as of December 31, 2018 |
Derivatives Designated as Hedging Instruments (in millions): |  | Balance Sheet Location |  | Fair Value |  | Balance Sheet Location |  | Fair Value |
Commodity and foreign currency |  | Accounts receivable, net |  | $ | 22 |  | Accounts payable and accrued liabilities |  | $ | 18 |
Commodity, foreign currency and interest rate contracts |  | Other assets |  |  | 2 |  | Non-current liabilities |  |  | 8 |
|  |  |  | $ | 24 |  |  |  | $ | 26 |
|  | Fair Value of Derivative Instruments as of December 31, 2017 |
Derivatives Designated as Hedging Instruments (in millions): |  | Balance Sheet Location |  | Fair Value |  | Balance Sheet Location |  | Fair Value |
Commodity and foreign currency |  | Accounts receivable, net |  | $ | 11 |  | Accounts payable and accrued liabilities |  | $ | 23 |
Commodity, foreign currency and interest rate contracts |  | Other assets |  |  | 3 |  | Non-current liabilities |  |  | 8 |
|  |  |  | $ | 14 |  |  |  | $ | 31 |
As of December 31, 2018, the Company had outstanding futures and option contracts that hedged the forecasted purchase of approximately 85 million bushels of corn. The Company is unable to directly hedge price risk related to co-product sales; however, it occasionally enters into hedges of soybean oil (a competing product to corn oil) in order to mitigate the price risk of corn oil sales. As of December 31, 2018, the Company had no outstanding futures or option contracts for soybean oil. The Company also had outstanding swap and option contracts that hedged the forecasted purchase of approximately 28 million mmbtu’s of natural gas at December 31, 2018. Additionally, as of December 31, 2018, the Company had no outstanding ethanol futures contracts. Additional information relating to the Company’s derivative instruments is presented below (in millions, pre-tax):
|  | Year Ended December 31, 2018 |
Derivatives in Cash Flow Hedging Relationships |  | Amount of Gains (Losses) Recognized in OCI on Derivatives |  | Location of Gains (Losses) Reclassified from AOCI into Income |  | Amount of Gains (Losses) Reclassified from AOCI into Income |
Commodity contracts |  | $ | 8 |  | Cost of sales |  | $ | (6) |
Foreign currency contracts |  |  | — |  | Net sales/cost of sales |  |  | 1 |
Interest rate contracts |  |  | — |  | Financing costs, net |  |  | (1) |
Total |  | $ | 8 |  |  |  | $ | (6) |
|  | Year Ended December 31, 2017 |
Derivatives in Cash Flow Hedging Relationships |  | Amount of Gains (Losses) Recognized in OCI on Derivatives |  | Location of Gains (Losses) Reclassified from AOCI into Income |  | Amount of Gains (Losses) Reclassified from AOCI into Income |
Commodity contracts |  | $ | (22) |  | Cost of sales |  | $ | (5) |
Foreign currency contracts |  |  | 6 |  | Net sales/cost of sales |  |  | 1 |
Interest rate contracts |  |  | — |  | Financing costs, net |  |  | (2) |
Total |  | $ | (16) |  |  |  | $ | (6) |
|  | Year ended December 31, 2016 |
Derivatives in Cash Flow Hedging Relationships |  | Amount of Gains (Losses) Recognized in OCI on Derivatives |  | Location of Gains (Losses) Reclassified from AOCI into Income |  | Amount of Gains (Losses) Reclassified from AOCI into Income |
Commodity contracts |  | $ | (15) |  | Cost of sales |  | $ | (45) |
Foreign currency contracts |  |  | (2) |  | Net sales/Cost of sales |  |  | (2) |
Interest rate contracts |  |  | — |  | Financing costs, net |  |  | (2) |
Total |  | $ | (17) |  |  |  | $ | (49) |
As of December 31, 2018, AOCI included approximately $1 million of losses (net of an insignificant amount of income taxes), on commodities-related derivative instruments designated as cash flow hedges that are expected to be reclassified into earnings during the next 12 months. Transactions and events expected to occur over the next twelve months that will necessitate reclassifying these derivative losses to earnings include the sale of finished goods inventory that includes previously hedged purchases of corn, natural gas and ethanol. The Company expects the losses to be offset by changes in the underlying commodities costs. Additionally at December 31, 2018, AOCI included $1 million of losses (net of an insignificant amount of income taxes) on settled T-Locks and an insignificant amount of gains related to foreign currency hedges which are expected to be reclassified into earnings during the next 12 months. Cash flow hedges discontinued during 2018 or 2017 were not significant. Presented below are the fair values of the Company’s financial instruments and derivatives for the periods presented:
|  | As of December 31, 2018 |  | As of December 31, 2017 |
(in millions) |  | Total |  | Level 1 (a) |  | Level 2 (b) |  | Level 3 (c) |  | Total |  | Level 1 (a) |  | Level 2 (b) |  | Level 3 (c) |
Available for sale securities |  | $ | 11 |  | $ | 11 |  | $ | — |  | $ | — |  | $ | 10 |  | $ | 10 |  | $ | — |  | $ | — |
Derivative assets |  |  | 24 |  |  | 4 |  |  | 20 |  |  | — |  |  | 14 |  |  | 3 |  |  | 11 |  |  | — |
Derivative liabilities |  |  | 26 |  |  | 6 |  |  | 20 |  |  | — |  |  | 31 |  |  | 11 |  |  | 20 |  |  | — |
Long-term debt |  |  | 1,954 |  |  | — |  |  | 1,954 |  |  | — |  |  | 1,845 |  |  | — |  |  | 1,845 |  |  | — |
| (a) |  | Level 1 inputs consist of quoted prices (unadjusted) in active markets for identical assets or liabilities.
| (b) |  | Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly for substantially the full term of the financial instrument. Level 2 inputs are based on quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability or can be derived principally from or corroborated by observable market data.
| (c) |  | Level 3 inputs are unobservable inputs for the asset or liability. Unobservable inputs shall be used to measure fair value to the extent that observable inputs are not available, thereby allowing for fair value estimates to be made in situations in which there is little, if any, market activity for the asset or liability at the measurement date.
The carrying values of cash equivalents, short-term investments, accounts receivable, accounts payable, and short-term borrowings approximate fair values. Commodity futures, options, and swap contracts are recognized at fair value. Foreign currency forward contracts, swaps, and options are also recognized at fair value. The fair value of the Company’s long-term debt is estimated based on quotations of major securities dealers who are market makers in the securities. Presented below are the carrying amounts and the fair values of the Company’s long-term debt at December 31, 2018 and 2017.
|  | December 31, 2018 |  | December 31, 2017 |
|  | Carrying |  | Fair |  | Carrying |  | Fair |
(in millions) |  | Amount |  | Value |  | Amount |  | Value |
3.2% senior notes due October 1, 2026 |  | $ | 496 |  | $ | 462 |  | $ | 496 |  | $ | 492 |
4.625% senior notes due November 1, 2020 |  |  | 399 |  |  | 409 |  |  | 398 |  |  | 421 |
6.625% senior notes due April 15, 2037 |  |  | 254 |  |  | 295 |  |  | 254 |  |  | 325 |
5.62% senior notes due March 25, 2020 |  |  | 200 |  |  | 205 |  |  | 200 |  |  | 212 |
Term loan credit agreement due April 25, 2019 |  |  | 165 |  |  | 165 |  |  | 395 |  |  | 395 |
Revolving credit facility |  |  | 418 |  |  | 418 |  |  | — |  |  | — |
Fair value adjustment related to hedged fixed rate debt instrument |  |  | (1) |  |  | — |  |  | 1 |  |  | — |
Total long-term debt |  | $ | 1,931 |  | $ | 1,954 |  | $ | 1,744 |  | $ | 1,845 |

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- Definition The entire disclosure for derivative instruments and hedging activities including, but not limited to, risk management strategies, non-hedging derivative instruments, assets, liabilities, revenue and expenses, and methodologies and assumptions used in determining the amounts. + References Reference 1: http://fasb.org/us-gaap/role/ref/legacyRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -URI http://asc.fasb.org/topic&trid=2229140 + Details
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