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Derivatives and Risk Management Activities | 6 Months Ended
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Jun. 30, 2020
Derivative Instruments and Hedging Activities Disclosure [Abstract] |
Derivatives and Risk Management Activities | Derivatives and Risk Management Activities 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 hydrocarbon commodity (referred to herein as “commodity”) price changes. We use various derivative instruments to manage our exposure to (i) commodity price risk, as well as to optimize our profits, (ii) interest rate risk and (iii) currency exchange rate risk. Our commodity price risk management policies and procedures are designed to help ensure that our hedging activities address our risks by monitoring our derivative 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 derivative positions and ensure that those positions are consistent with our objectives and approved strategies. When we apply hedge accounting, 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. At the inception of the hedging relationship, we assess whether the derivatives employed are highly effective in offsetting changes in cash flows of anticipated hedged transactions. Throughout the hedging relationship, retrospective and prospective hedge effectiveness is assessed on a qualitative basis. We record all open derivatives on the balance sheet as either assets or liabilities measured at fair value. Changes in the fair value of derivatives are recognized currently in earnings unless specific hedge accounting criteria are met. For derivatives designated as cash flow hedges, changes in fair value are deferred in AOCI and recognized in earnings in the periods during which the underlying hedged transactions are recognized in earnings. Derivatives that are not designated as a hedging instrument and derivatives that do not qualify for hedge accounting are recognized in earnings each period. Cash settlements associated with our derivative activities are classified within the same category as the related hedged item in our Condensed Consolidated Statements of Cash Flows. Our financial derivatives, used for hedging risk, are governed through ISDA master agreements and clearing brokerage agreements. These agreements include stipulations regarding the right of set off in the event that we or our counterparty default on performance obligations. If a default were to occur, both parties have the right to net amounts payable and receivable into a single net settlement between parties. At June 30, 2020 and December 31, 2019, 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. Although we may be required to post margin on our exchange-traded derivatives transacted through a clearing brokerage account, as described below, we do not require our non-cleared derivative counterparties to post collateral with us. Commodity Price Risk Hedging Our core business activities involve certain commodity price-related risks that we manage in various ways, including through the use of derivative instruments. Our policy is to (i) only purchase inventory for which we have a sales market, (ii) structure our sales contracts so that price fluctuations do not materially affect our operating income and (iii) not 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 divided 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 June 30, 2020, net derivative positions related to these activities included: •A net long position of 10.2 million barrels associated with our crude oil purchases, which was unwound ratably during July 2020 to match monthly average pricing. •A net short time spread position of 6.6 million barrels, which hedges a portion of our anticipated crude oil lease gathering purchases through September 2021. •A net crude oil basis spread position of 7.9 million barrels at multiple locations through December 2021. These derivatives allow us to lock in grade basis differentials. •A net short position of 33.2 million barrels through December 2022 related to anticipated net sales of crude oil and NGL inventory. Natural Gas Processing/NGL Fractionation — We purchase natural gas for processing and operational needs. Additionally, we purchase NGL mix for fractionation and sell the resulting individual specification products (including ethane, propane, butane and condensate). In conjunction with these activities, we hedge the price risk associated with the purchase of the natural gas and the subsequent sale of the individual specification products. The following table summarizes our open derivative positions utilized to hedge the price risk associated with anticipated purchases and sales related to our natural gas processing and NGL fractionation activities as of June 30, 2020:
|  | Notional Volume |  |
|  | (Short)/Long |  | Remaining Tenor
Natural gas purchases |  | 23.8 Bcf |  | December 2020
Propane sales |  | (4.1) MMbls |  | December 2020
Butane sales |  | (1.3) MMbls |  | December 2020
Condensate sales (WTI position) |  | (0.5) MMbls |  | December 2020
Fuel gas requirements (1) |  | 17.4 Bcf |  | December 2022
Power supply requirements (1) |  | 0.9 TWh |  | December 2022
(1)Positions to hedge a portion of our power supply and fuel gas requirements at our Canadian natural gas processing and fractionation plants. Physical commodity contracts that meet the definition of a derivative but are ineligible, or not designated, for the normal purchases and normal sales scope exception are recorded on the balance sheet at fair value, with changes in fair value recognized in earnings. We have determined that substantially all of our physical commodity contracts qualify for the normal purchases and normal sales scope exception. Our commodity derivatives are not designated as a hedging relationship, as such, changes in the fair value are reported in earnings. A summary of the impact of our commodity derivatives recognized in earnings as follows (in millions):
| Three Months Ended June 30, |  |  |  | Six Months Ended June 30, |  |
| 2020 |  | 2019 |  | 2020 |  | 2019
Supply and Logistics segment revenues | $ | (134) |  |  | $ | 56 |  |  | $ | 15 |  |  | $ | 231 |
Field operating costs | (1) |  |  | 4 |  |  | — |  |  | 11 |
Net gain/(loss) from commodity derivative activity | $ | (135) |  |  | $ | 60 |  |  | $ | 15 |  |  | $ | 242 |
Our accounting policy is to offset derivative assets and liabilities executed with the same counterparty when a master netting arrangement exists. Accordingly, we also offset derivative assets and liabilities with amounts associated with cash margin. Our exchange-traded derivatives are transacted through clearing 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. The following table provides the components of our net broker receivable/(payable) (in millions):
| June 30, 2020 |  | December 31, 2019
Initial margin | $ | 140 |  |  | $ | 73 |
Variation margin posted/(returned) | (20) |  |  | (45) |
Letters of credit | (75) |  |  | (73) |
Net broker receivable/(payable) | $ | 45 |  |  | $ | (45) |
The following table reflects the Condensed Consolidated Balance Sheet line items that include the fair values of our commodity derivative assets and liabilities and the effect of the collateral netting. Such amounts are presented on a gross basis, before the effects of counterparty netting. However, we have elected to present our commodity derivative assets and liabilities with the same counterparty on a net basis on our Condensed Consolidated Balance Sheet when the legal right of offset exists. Amounts in the table below are presented in millions.
|  | June 30, 2020 |  |  |  |  |  |  |  |  | December 31, 2019 |  |  |  |  |  |
|  |  |  |  |  | Effect of Collateral Netting |  | Net Carrying Value Presented on the Balance Sheet |  |  |  |  |  |  | Effect of Collateral Netting |  | Net Carrying Value Presented on the Balance Sheet
|  | Commodity Derivatives |  |  |  |  |  |  |  |  | Commodity Derivatives |  |  |  |  |  |
|  | Assets |  | Liabilities |  |  |  |  |  |  | Assets |  | Liabilities |  |  |  |
Derivative Assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Other current assets |  | $ | 171 |  |  | $ | (83) |  |  | $ | 39 |  |  | $ | 127 |  |  |  | $ | 179 |  |  | $ | (37) |  |  | $ | (45) |  |  | $ | 97 |
Other long-term assets, net |  | 64 |  |  | (3) |  |  | — |  |  | 61 |  |  |  | 24 |  |  | — |  |  | — |  |  | 24 |
Derivative Liabilities |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Other current liabilities |  | 118 |  |  | (149) |  |  | 6 |  |  | (25) |  |  |  | 32 |  |  | (56) |  |  | — |  |  | (24) |
Other long-term liabilities and deferred credits |  | 16 |  |  | (51) |  |  | — |  |  | (35) |  |  |  | — |  |  | (12) |  |  | — |  |  | (12) |
Total |  | $ | 369 |  |  | $ | (286) |  |  | $ | 45 |  |  | $ | 128 |  |  |  | $ | 235 |  |  | $ | (105) |  |  | $ | (45) |  |  | $ | 85 |
Interest Rate Risk Hedging We use interest rate derivatives to hedge the benchmark interest rate associated with interest payments occurring as a result of debt issuances. The derivative instruments we use to manage this risk consist of forward starting interest rate swaps and treasury locks. These derivatives are designated as cash flow hedges. As such, changes in fair value are deferred in AOCI and are reclassified to interest expense as we incur the interest expense associated with the underlying debt. The following table summarizes the terms of our outstanding interest rate derivatives as of June 30, 2020 (notional amounts in millions):
Hedged Transaction |  | Number and Types of Derivatives Employed |  | Notional Amount |  | Expected Termination Date |  | Average Rate Locked |  | Accounting Treatment
Anticipated interest payments |  | 8 forward starting swaps (30-year) |  | $ | 200 |  |  | 6/15/2023 |  | 1.38 | % |  | Cash flow hedge
Anticipated interest payments |  | 8 forward starting swaps (30-year) |  | $ | 200 |  |  | 6/14/2024 |  | 0.73 | % |  | Cash flow hedge
As of June 30, 2020, there was a net loss of $315 million deferred in AOCI. The 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 transactions or (ii) interest expense accruals associated with underlying debt instruments. We reclassified losses of $3 million during each of the three months ended June 30, 2020 and 2019 and losses of $5 million during each of the six months ended June 30, 2020 and 2019, respectively. Of the total net loss deferred in AOCI at June 30, 2020, we expect to reclassify a loss of $13 million to earnings in the next twelve months. We estimate that substantially all of the remaining deferred loss will be reclassified to earnings through 2054 as the underlying hedged transactions impact earnings. A portion of these amounts is based on market prices as of June 30, 2020; thus, actual amounts to be reclassified will differ and could vary materially as a result of changes in market conditions. The following table summarizes the net unrealized gain/(loss) recognized in AOCI for derivatives (in millions):
| Three Months Ended June 30, |  |  |  | Six Months Ended June 30, |  |
| 2020 |  | 2019 |  | 2020 |  | 2019
Interest rate derivatives, net | $ | 19 |  |  | $ | (35) |  |  | $ | (61) |  |  | $ | (58) |
At June 30, 2020, the net fair value of our interest rate hedges, which were included in “Other long-term liabilities and deferred credits” on our Condensed Consolidated Balance Sheet, totaled $5 million. At December 31, 2019, the fair value of these hedges was $44 million and included in “Other current liabilities.” Currency Exchange Rate Risk Hedging Because a significant portion of our Canadian business is conducted in CAD, we use foreign currency derivatives to minimize the risk of unfavorable changes in exchange rates. These instruments include foreign currency exchange contracts, forwards and options. Our use of foreign currency derivatives include (i) derivatives we use to hedge currency exchange risk created by the use of USD-denominated commodity derivatives to hedge commodity price risk associated with CAD-denominated commodity purchases and sales and (ii) foreign currency exchange contracts we use to manage our Canadian business cash requirements. The following table summarizes our open forward exchange contracts as of June 30, 2020 (in millions):
|  |  |  | USD |  | CAD |  | Average Exchange Rate USD to CAD
Forward exchange contracts that exchange CAD for USD: |  |  |  |  |  |  |  |
|  | 2020 |  | $ | 185 |  |  | $ | 252 |  |  | $1.00 - $1.36
Forward exchange contracts that exchange USD for CAD: |  |  |  |  |  |  |  |
|  | 2020 |  | $ | 275 |  |  | $ | 371 |  |  | $1.00 - $1.35
These derivatives are not designated as a hedging relationship. As such, changes in fair value are recognized in earnings as a component of Supply and Logistics segment revenues. For the three months ended June 30, 2020 and 2019, the amounts recognized in earnings for our currency exchange rate hedges were gains of $2 million in each respective period. For the six months ended June 30, 2020 and 2019, the amounts recognized in earnings for our currency exchange rate hedges were a loss of $4 million and a gain of $7 million, respectively. At June 30, 2020, the net fair value of these currency exchange rate hedges, which was included in “Other current liabilities” on our Condensed Consolidated Balance Sheet, totaled $2 million. At December 31, 2019, the net fair value of these currency exchange rate hedges, which was included in “Other current assets” and “Other current liabilities” on our Condensed Consolidated Balance Sheet, totaled $2 million and $1 million, respectively. Preferred Distribution Rate Reset Option A derivative feature embedded in a contract that does not meet the definition of a derivative in its entirety must be bifurcated and accounted for separately if the economic characteristics and risks of the embedded derivative are not clearly and closely related to those of the host contract. The Preferred Distribution Rate Reset Option of the PAA Series A preferred units is an embedded derivative that must be bifurcated from the related host contract, the PAA partnership agreement, and recorded at fair value on our Condensed Consolidated Balance Sheets. This embedded derivative is not designated as a hedging relationship and corresponding changes in fair value are recognized in “Other income/(expense), net” in our Condensed Consolidated Statement of Operations. For the three months ended June 30, 2020 and 2019, we recognized losses of $9 million and $7 million, respectively. For the six months ended June 30, 2020 and 2019, we recognized net gains of $17 million and $16 million, respectively. The fair value of the Preferred Distribution Rate Reset Option, which was included in “Other long-term liabilities and deferred credits” on our Condensed Consolidated Balance Sheets, totaled $17 million and $34 million at June 30, 2020 and December 31, 2019, respectively. See Note 13 to our Consolidated Financial Statements included in Part IV of our 2019 Annual Report on Form 10-K for additional information regarding the Series A preferred units and Preferred Distribution Rate Reset Option. 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 (in millions):
|  | Fair Value as of June 30, 2020 |  |  |  |  |  |  |  |  | Fair Value as of December 31, 2019 |  |  |  |  |  |
Recurring Fair Value Measures (1) |  | Level 1 |  | Level 2 |  | Level 3 |  | Total |  |  | Level 1 |  | Level 2 |  | Level 3 |  | Total
Commodity derivatives |  | $ | 24 |  |  | $ | 84 |  |  | $ | (25) |  |  | $ | 83 |  |  |  | $ | 42 |  |  | $ | 105 |  |  | $ | (17) |  |  | $ | 130 |
Interest rate derivatives |  | — |  |  | (5) |  |  | — |  |  | (5) |  |  |  | — |  |  | (44) |  |  | — |  |  | (44) |
Foreign currency derivatives |  | — |  |  | (3) |  |  | — |  |  | (3) |  |  |  | — |  |  | 1 |  |  | — |  |  | 1 |
Preferred Distribution Rate Reset Option |  | — |  |  | — |  |  | (17) |  |  | (17) |  |  |  | — |  |  | — |  |  | (34) |  |  | (34) |
Total net derivative asset/(liability) |  | $ | 24 |  |  | $ | 76 |  |  | $ | (42) |  |  | $ | 58 |  |  |  | $ | 42 |  |  | $ | 62 |  |  | $ | (51) |  |  | $ | 53 |
(1)Derivative assets and liabilities are presented above on a net basis but do not include related cash margin deposits. Level 1 Level 1 of the fair value hierarchy includes exchange-traded commodity derivatives and over-the-counter commodity contracts such as futures and swaps. The fair value of exchange-traded commodity derivatives and over-the-counter commodity contracts is based on unadjusted quoted prices in active markets. Level 2 Level 2 of the fair value hierarchy includes exchange-cleared commodity derivatives and over-the-counter commodity, interest rate and foreign currency derivatives that are traded in observable markets with less volume and transaction frequency than active markets. In addition, it includes certain physical commodity contracts. The fair values of these derivatives are corroborated with market observable inputs. Level 3 Level 3 of the fair value hierarchy includes certain physical commodity and other contracts, over-the-counter options and the Preferred Distribution Rate Reset Option contained in PAA’s partnership agreement which is classified as an embedded derivative. The fair values of our Level 3 physical commodity and other contracts and over-the-counter options are based on valuation models utilizing significant timing estimates, which involve management judgment, and pricing inputs from observable and unobservable markets with less volume and transaction frequency than active markets. Significant deviations from these estimates and inputs could result in a material change in fair value. We report unrealized gains and losses associated with these contracts in our Condensed Consolidated Statements of Operations as Supply and Logistics segment revenues. Rollforward of Level 3 Net Asset/(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):
| Three Months Ended June 30, |  |  |  | Six Months Ended June 30, |  |
| 2020 |  | 2019 |  | 2020 |  | 2019
Beginning Balance | $ | (61) |  |  | $ | (10) |  |  | $ | (51) |  |  | $ | (24) |
Net gains/(losses) for the period included in earnings | 18 |  |  | (5) |  |  | 8 |  |  | 18 |
Settlements | 1 |  |  | (3) |  |  | 1 |  |  | (11) |
Derivatives entered into during the period | — |  |  | (8) |  |  | — |  |  | (9) |
Ending Balance | $ | (42) |  |  | $ | (26) |  |  | $ | (42) |  |  | $ | (26) |
Change in unrealized gains/(losses) included in earnings relating to Level 3 derivatives still held at the end of the period | $ | 18 |  |  | $ | (13) |  |  | $ | 8 |  |  | $ | 9 |

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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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