DERIVATIVE AND NON-DERIVATIVE FINANCIAL INSTRUMENTS

Overview of Hedging Programs

The Company is exposed to market risks, such as changes in foreign currency exchange rates, commodity prices, and interest rates. To mitigate these market risks and their effects on the cash flows of the underlying transactions and investments in foreign subsidiaries, the Company uses various derivative and non-derivative financial instruments when appropriate in accordance with the Company's hedging strategy and policies. Designation is performed on a specific exposure basis to support hedge accounting. The Company does not enter into derivative transactions for speculative purposes.

Cash Flow Hedges

Cash flow hedges are derivative instruments designated as and used to hedge the exposure to variability in expected future cash flows that are attributable to a particular risk. The derivative instruments that are designated and qualify as a cash flow hedge are recorded on the balance sheet at fair value and the changes in fair value of these hedging instruments are offset in part or in whole by corresponding changes in the anticipated cash flows of the underlying exposures being hedged. The effective portion of qualifying hedges are reported as a component of AOCI located in the Consolidated Statements of Financial Position and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivatives representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.

Foreign Currency Exchange Rate Hedging

The Company manufactures and sells its products in a number of countries throughout the world and, as a result, is exposed to changes in foreign currency exchange rates. To manage the volatility relating to these exposures, the Company nets the exposures on a consolidated basis to take advantage of natural offsets. To manage the remaining exposure, from time to time, the Company enters into currency option and forward cash flow hedges to hedge probable anticipated, but not yet committed, export sales and purchase transactions expected within a rolling three year period and denominated in foreign currencies (principally the euro and Japanese yen). Additionally, the Company enters into forward exchange contract cash flow hedges to hedge certain firm commitments denominated in foreign currencies.

Commodity Hedging

Certain raw material and energy sources used by the Company, as well as sales of certain commodity products by the Company, are subject to price volatility caused by weather, supply and demand conditions, economic variables and other unpredictable factors. This volatility is primarily related to the market pricing of propane, ethane, natural gas, paraxylene, ethylene, and benzene. In order to mitigate expected fluctuations in market prices, from time to time the Company enters into option and forward contracts and designates these contracts as cash flow hedges. The Company currently hedges commodity price risks using derivative financial instrument transactions within a rolling three year period beyond its current fiscal year. The Company weights its hedge portfolio more heavily in the first year with declining coverage over the remaining periods.

Interest Rate Hedging

The Company's policy is to manage interest expense using a mix of fixed and variable rate debt. To manage interest rate risk effectively, the Company, from time to time, enters into cash flow interest rate derivative instruments, primarily forward starting swaps and treasury locks, to hedge the Company's exposure to movements in interest rates prior to anticipated debt offerings. These instruments are designated as cash flow hedges and are typically 100 percent effective. As a result, there is normally no impact on earnings due to hedge ineffectiveness.

Fair Value Hedges

Fair value hedges are defined as derivative or non-derivative instruments designated as and used to hedge the exposure to changes in the fair value of an asset or a liability or an identified portion thereof that is attributable to a particular risk. The derivative instruments that are designated and qualify as fair value hedges are recorded on the balance sheet at fair value and the changes in fair value of these hedging instruments are offset in part or in whole by corresponding changes in the anticipated cash flows of the underlying exposures being hedged. The effective portion of qualifying hedges are reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivatives representing hedge ineffectiveness are recognized in current earnings.

Interest Rate Hedging

The Company's policy is to manage interest expense using a mix of fixed and variable rate debt. To manage the Company's mix of fixed and variable rate debt effectively, the Company, from time to time, enters into interest rate swaps in which the Company agrees to exchange the difference between fixed and variable interest amounts calculated by reference to an agreed upon notional principal amount. These swaps are designated as hedges of the fair value of the underlying debt obligations and the interest rate differential is reflected as an adjustment to interest expense over the life of the swaps. As these instruments are 100 percent effective, there is normally no impact on earnings due to hedge ineffectiveness.

In second quarter 2016, the Company entered into a fixed-to-floating interest rate swap on a portion of the 3.8% notes due March 2025 in order to manage the Company's mix of fixed and variable rate debt.

Net Investment Hedges

Net investment hedges are defined as derivative or non-derivative instruments designated as and used to hedge the foreign currency exposure of the net investment in certain foreign operations. The effective portion of the gain or loss on the net investment hedges are reported as a component of the CTA within OCI located in the Consolidated Statements of Earnings, Comprehensive Income and Retained Earnings. Gains and losses representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.

In fourth quarter 2016, contemporaneous with its November 2016 sale of additional euro-denominated 1.50% notes due May 2023 in the principal amount of €200 million ($213 million) and euro-denominated 1.875% notes due November 2026 in the principal amount of €500 million ($534 million), the Company designated these borrowings as non-derivative hedges of a portion of their net investment in one of their euro functional currency denominated subsidiaries to protect the designated net investment against foreign currency fluctuations.

In second quarter 2016, contemporaneous with its May 2016 sale of euro-denominated 1.50% notes due May 2023 in the principal amount of €550 million ($614 million), the Company designated these borrowings as a non-derivative hedge of a portion of its net investment in one of its euro functional currency denominated subsidiaries to protect the designated net investment against foreign currency fluctuations.

Summary of Financial Position and Financial Performance of Hedging Instruments

The following table shows the notional amounts outstanding at December 31, 2016 and 2015 associated with the Company's hedging programs.



Notional Outstanding		December 31, 2016	December 31, 2015

Derivatives designated as cash flow hedges:
Foreign Exchange Forward and Option Contracts (in millions)
	EUR/USD (in EUR)	€378	€618
	EUR/USD (in approximate USD equivalent)	$398	$689
	JPY/USD (in JPY)	¥1,800	¥2,400
	JPY/USD (in approximate USD equivalent)	$15	$20
Commodity Forward and Collar Contracts
	Feedstock (in million barrels)	11	22
	Energy (in million million british thermal units)	23	32
Interest rate swaps for the future issuance of debt (in millions)		—	$500

Derivatives designated as fair value hedges:
Fixed-for-floating interest rate swaps (in millions)		$75	—

Non-derivatives designated as net investment hedges:
Foreign Currency Net Investment Hedges (in millions)
	EUR/USD (in EUR)	€1,238	—

The following table shows the financial assets and liabilities valued on a recurring and gross basis as of December 31, 2016 and 2015. Additionally, the table below represents where the derivatives are included within the Consolidated Statements of Financial Position. During the periods presented, there were no transfers between fair value hierarchy levels.



The Financial Position and Gross Fair Value Measurements of Hedging Instruments
(Dollars in millions)
Derivative Type	Statements of Financial Position Location	December 31, 2016 Level 2		December 31, 2015 Level 2
Derivatives designated as cash flow hedges:
Commodity contracts	Other current assets	$	5	$	—
Commodity contracts	Other noncurrent assets	2		—
Foreign exchange contracts	Other current assets	49		65
Foreign exchange contracts	Other noncurrent assets	47		79

Derivatives designated as fair value hedges:
Fixed-for-floating interest rate swap	Other current assets	1		—
Total Derivative Assets on Gross Basis		$	104	$	144

Derivatives designated as cash flow hedges:
Commodity contracts	Payables and other current liabilities	$	62	$	194
Commodity contracts	Other long-term liabilities	69		242
Forward starting interest rate swaps	Other long-term liabilities	—		30

Derivatives designated as fair value hedges:
Fixed-for-floating interest rate swap	Long-term borrowings	4		—
Total Derivative Liabilities on Gross Basis		$	135	$	466
Total Net Derivative Liabilities on Gross Basis		$	31	$	322

In addition to the fair value associated with derivative instruments designated as cash flow hedges and fair value hedges noted in the table above, the Company had a carrying value of $1,305 million associated with non-derivative instruments designated as foreign currency net investment hedges as of December 31, 2016. There were no non-derivative instruments designated as foreign currency net investment hedges outstanding as of December 31, 2015. The designated foreign currency-denominated borrowings are included as part of "Long-term borrowings" within the Consolidated Statements of Financial Position.

All of the Company's derivative contracts are subject to master netting arrangements, or similar agreements, which provide for the option to settle contracts on a net basis when they settle on the same day and in the same currency. In addition, these arrangements provide for a net settlement of all contracts with a given counterparty in the event that the arrangement is terminated due to the occurrence of default or a termination event. The Company has elected to present the derivative contracts on a gross basis in the Consolidated Statements of Financial Position. Had it chosen to present the derivatives contracts on a net basis, it would have a derivative in a net asset position of $103 million and a derivative in a net liability position of $134 million as of December 31, 2016. The Company does not have any cash collateral due under such agreements.

Fair Value Measurements

For additional information on fair value measurement, see Note 1, "Significant Accounting Policies".

The fair value principles prioritize valuation inputs across three broad levels. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroborations, for substantially the full term of the financial instrument. Level 3 inputs are unobservable inputs based on the Company's assumptions used to measure assets and liabilities at fair value.

All of the Company's derivative assets and liabilities are currently classified as Level 2. Level 2 fair value is based on estimates using standard pricing models. These standard pricing models use inputs that are derived from or corroborated by observable market data such as interest rate yield curves and currency spot and forward rates. The fair value of commodity contracts is derived using forward curves supplied by an industry recognized and unrelated third party. In addition, on an ongoing basis, the Company tests a subset of its valuations against valuations received from the transaction's counterparty to validate the accuracy of its standard pricing models. Counterparties to these derivative contracts are highly rated financial institutions which the Company believes carry minimal risk of nonperformance and the Company diversifies its positions among such counterparties in order to reduce its exposure to counterparty risk and credit losses. The Company monitors the creditworthiness of its counterparties on an on-going basis. The Company did not realize a credit loss during the year ended December 31, 2016 and 2015.

From time to time, the Company holds Level 3 assets for commodity hedges. The fair values of Level 3 instruments are determined using pricing data similar to that used in Level 2 financial instruments described above, and reflect adjustments for less liquid markets or longer contractual terms. Level 3 hedges typically will mature within one year or less. The Company determines the fair value of Level 3 ethylene derivative forward contracts using an average of unadjusted forward ethylene prices provided by industry recognized experts to value its ethylene positions.

The table below presents a rollforward of activity for the level 3 inputs for the period ended December 31, 2016 and 2015:



Fair Value Measurements Using Level 3 Inputs
Commodity Contracts	December 31,
(Dollars in millions)	2016		2015
Beginning balance at January 1	$	—	$	2
Realized gain in sales revenue	—		4
Change in unrealized loss in Other Comprehensive Income	—		(2		)
Purchases, sales and settlements	—		(4		)
Ending balance at December 31	$	—	$	—

The table below presents the effect of hedging instruments on OCI and the financial performance for the twelve months ended December 31, 2016 and 2015:



(Dollars in millions)	Change in amount of after tax gain/(loss) recognized in OCI on Derivatives (effective portion)						Pre-tax amount of gain/(loss) reclassified from Accumulated OCI into income (effective portion)						Additional gain/(loss) recognized in earnings (effective portion)
	December 31						December 31						December 31
Hedging Relationships	2016			2015			2016			2015			2016			2015			Income Statement Classification
Derivatives in cash flow hedging relationships:
Commodity contracts	$	—		$	—		$	—		$	4		$	—		$	—		Sales
Commodity contracts	193			26			(168		)	(217		)	—			—			Cost of sales
Foreign exchange contracts	(29		)	13			63			86			—			—			Sales
Forward starting interest rate and treasury lock swap contracts	(2		)	(4		)	(7		)	(7		)	—			—			Net interest expense
Derivatives in fair value hedging relationships:
Fixed-for-floating interest rate swaps	—			—			—			—			11			13			Net interest expense
Non-derivatives in net investment hedging relationships:
Net investment hedges (pre-tax)	43			—			—			—			—			—			N/A
Nonqualifying derivatives⁽¹⁾:
Foreign Exchange Contracts	—			—			—			—			(34		)	(28		)	Other (income) charges, net


⁽¹⁾	The gains or losses on nonqualifying derivatives or derivatives that are not designated as hedges are marked to market and represent foreign exchange derivatives denominated in multiple currencies and are transacted and settled in the same quarter.

Pre-tax monetized positions and MTM gains and losses from raw materials and energy, currency, and certain interest rate hedges that were included in AOCI included losses of $57 million at December 31, 2016 and losses of $376 million at December 31, 2015. Losses in AOCI decreased in 2016 compared to 2015 as a result of an increase in commodity prices, particularly propane, and a decrease in foreign currency exchange rates, particularly the euro. If realized, approximately $12 million in pre-tax losses will be reclassified into earnings during the next 12 months.

Any ineffective portions associated with the hedging programs are immediately recognized in earnings. The Company recognized pre-tax losses for ineffectiveness of the commodity hedging portfolio of $3 million during the twelve months ended 2016.

In fourth quarter 2016 as a result of the early repayments of borrowings, the Company settled the notional amount of $500 million associated with the 2017 forward starting interest rate swap, which had a MTM loss on the settlement date of $44 million and was included as part of investing activities in the Consolidated Statements of Cash Flows. The early repayment of borrowings resulted in a charge of $18 million for cash flow hedges and a gain of $4 million for fair value hedges, which is included within the $76 million of debt extinguishment costs and related derivatives and hedging items on the Consolidated Statements of Earnings, Comprehensive Income and Retained Earnings. For further information, see Note 9, "Borrowings".

With the exception of the ineffectiveness items previously noted, there was no material ineffectiveness associated with the remaining hedging programs during the twelve months ended 2016 or 2015.