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Derivative Instruments and Hedging
9 Months Ended
Sep. 30, 2011
Derivative Instruments and Hedging [Abstract] 
Derivative Instruments and Hedging
3.
Derivative and hedging instruments

The following table provides the fair value and balance sheet classification of our derivatives:

Fair Value of Derivative Assets and Liabilities
 
 
Balance sheet location
 
September 30, 2011
  
December 31, 2010
 
DERIVATIVE ASSETS:
        
Primary aluminum put option contracts
Due from affiliates
 $4,035  $1,979 
Primary aluminum put option contracts
Prepaid and other current assets
  3,148   2,712 
Natural gas forward financial contracts
Prepaid and other current assets
  —   79 
Power contract
Prepaid and other current assets
  122   72 
TOTAL
   $7,305  $4,842 
            
DERIVATIVE LIABILITIES:
          
Aluminum sales premium contracts – current portion
Accrued and other current liabilities
 $760  $436 
E.ON contingent obligation
Other liabilities
  13,605   13,091 
Aluminum sales premium contracts – less current portion
Other liabilities
  367   347 
TOTAL
   $14,732  $13,874 
 
The natural gas forward financial contracts are derivatives that qualified for cash flow hedge treatment.   During the three and nine months ended September 30, 2011 and 2010, the changes in our accumulated other comprehensive loss resulting from realized and unrealized gains and losses on these derivatives were not significant to our financial statements.

Natural gas forward financial contracts
 
To mitigate the volatility of our natural gas cost due to the natural gas markets, we have entered into fixed-price forward financial purchase contracts which settle in cash in the period corresponding to the intended usage of natural gas.  These forward contracts are designated as cash flow hedges and qualify for hedge accounting under ASC 815.  The critical terms of the contracts essentially match those of the underlying exposure.
 
The effective portion of the natural gas forward financial contracts is reported in accumulated other comprehensive loss, and the ineffective portion is reported currently in earnings.  Each month, when we settle the natural gas forward financial contracts, the realized gain or loss is recognized in income as part of our cost of goods sold.


 
We had the following outstanding forward financial contracts to hedge forecasted transactions:

 
September 30, 2011
December 31, 2010
Natural gas forward financial contracts (in MMBTU)
40,000
250,000

 
Foreign currency forward contracts
 
As of September 30, 2011 and December 31, 2010, we had no foreign currency forward contracts outstanding.  We are exposed to foreign currency risk due to fluctuations in the value of the U.S. dollar as compared to the euro, the Icelandic krona (“ISK”) and the Chinese yuan.  The labor costs, maintenance costs and other local services at our facility in Grundartangi, Iceland (“Grundartangi”) are denominated in ISK and a portion of its anode costs are denominated in euros.  As a result, an increase or decrease in the value of those currencies relative to the U.S. dollar would affect Grundartangi’s operating margins.

 
We manage our foreign currency exposure by entering into foreign currency forward contracts when management deems such transactions appropriate.  We had foreign currency forward contracts to manage the currency risk associated with the Grundartangi expansion, Grundartangi operating costs and the Helguvik project capital expenditures.  These contracts were designated as cash flow hedges and qualified for hedge accounting under ASC 815.  The realized gain or loss for our cash flow hedges for the Grundartangi expansion and Helguvik project capital expenditures was recognized in accumulated other comprehensive loss and is reclassified to earnings as part of the depreciation expense of the capital assets (for the Helguvik project this would occur when Helguvik is put into service).
 
Power contract
 
We are party to a power supply agreement at our facility in Ravenswood, West Virginia (“Ravenswood”) that contains LME-based pricing provisions that are an embedded derivative.  The embedded derivative does not qualify for cash flow hedge treatment and is marked to market quarterly.  We estimate the fair value of the embedded derivative based on our expected power usage over the remaining term of the contract (which was extended in 2011) gains and losses associated with the embedded derivative are recorded in net gain (loss) on forward contracts in the consolidated statements of operations.  We have recorded a derivative asset of $122 and $72 for the embedded derivative at September 30, 2011 and December 31, 2010, respectively.
 
Primary aluminum put option contracts
 
We entered into primary aluminum put option contracts that settle monthly through June 2012 based on LME prices for primary aluminum.  The volume of put option contracts is summarized below.  These options were purchased to partially mitigate primary aluminum price risk.
 
Our counterparties include Glencore, a related party, and two non-related third parties.  We paid cash premiums to enter into the put option contracts and recorded an asset on the consolidated balance sheets.  We determined the fair value of the put option contracts using a Black-Scholes model with market data provided by an independent vendor and account for the contracts as derivative financial instruments with gains and losses in the fair value of the contracts recorded on the consolidated statements of operations in net gain (loss) on forward contracts.
 


 
Primary Aluminum option contracts outstanding as of September 30, 2011 (in metric tons):
 
   
Glencore
  
Other counterparties
 
Put option contracts, settle monthly in 2011
  11,250   15,750 
Put option contracts, settle monthly in 2012
  18,000   15,000 


Primary Aluminum option contracts outstanding as of December 31, 2010 (in metric tons):
 
   
Glencore
  
Other counterparties
 
Put option contracts, settle monthly in 2011
  46,800   61,800 

 
Aluminum sales premium contracts
 
The Glencore Metal Agreement is a physical delivery contract for 20,400 metric tons per year (“mtpy”) of primary aluminum through December 31, 2013 with variable, LME-based pricing.  Under the Glencore Metal Agreement, pricing is based on market prices, adjusted by a negotiated U.S. Midwest premium with a cap and a floor as applied to the current U.S. Midwest premium.  We account for the Glencore Metal Agreement as a derivative instrument under ASC 815.  Gains and losses on the derivative are based on the difference between the contracted U.S. Midwest premium and actual and forecasted U.S. Midwest premiums.  Settlements are recorded in related party sales.  Unrealized gains (losses) based on forecasted U.S. Midwest premiums are recorded in net gain (loss) on forward contracts on the consolidated statements of operations.

Derivatives not designated as hedging instruments:
 
 
Gain (loss) recognized in income from derivatives
 
     
Three months ended September 30,
  
Nine months ended September 30,
 
 
Location
 
2011
  
2010
  
2011
  
2010
 
Power contract
Net gain (loss) on forward contracts
 $40  $119  $146  $99 
Primary aluminum put option and collar contracts
Net gain (loss) on forward contracts
  4,222   (12,175)  (1,444)  (4,428)
Aluminum sales premium contracts
Related party sales
  364   112   620   358 
Aluminum sales premium contracts
Net gain (loss) on forward contracts
  (99)  (80)  (965)  (485)

 
We had the following outstanding forward contracts that were entered into that were not designated as hedging instruments:

   
September 30, 2011
  
December 31, 2010
 
Power contract (in megawatt hours) (1)
  5,865   4,379 
Primary aluminum sales contract premium (in metric tons) (2)
  47,422   62,252 
Primary aluminum put option contracts (in metric tons)
  60,000   108,600 

(1)
We mark the Ravenswood power contract to market based on our expected usage during the remaining term of the contract. In June 2011, the West Virginia Public Service Commission (the “PSC”) extended the term of this contract through June 2012.
(2)
Represents the remaining physical deliveries under our Glencore Metal Agreement.

 
Counterparty credit risk.  The primary aluminum put option and natural gas forward financial contracts are subject to counterparty credit risk.  However, we only enter into forward financial contracts with counterparties we determine to be creditworthy at the time of entering into the contract.  If any counterparty failed to perform according to the terms of the contract, the impact would be limited to the difference between the contract price and the market price applied to the contract volume on the date of settlement.
 
As of September 30, 2011, income of $127 is expected to be reclassified out of accumulated other comprehensive loss into earnings over the next 12-month period for derivative instruments that have been designated and have qualified as cash flow hedging instruments and for the related hedged transactions.