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Derivatives, Hedging Programs and Other Financial Instruments | 9 Months Ended
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Sep. 30, 2017
Derivative Instruments and Hedging Activities Disclosure [Abstract] |
Derivative Financial Instruments and Related Hedging Programs | Derivatives, Hedging Programs and Other Financial Instruments Overview. In conducting our business, we enter into derivative transactions, including forward contracts and options, to limit our exposure to: (i) metal price risk related to our sale of fabricated aluminum products and the purchase of metal used as raw material for our fabrication operations; (ii) energy price risk relating to fluctuating prices of natural gas and electricity used in our production processes; and (iii) foreign currency requirements with respect to our foreign subsidiaries and cash commitments for equipment purchases denominated in foreign currency. Our derivative activities are overseen by a hedging committee ("Hedging Committee"), which is composed of our chief executive officer, chief operating officer, chief financial officer, chief accounting officer, treasurer and other officers and employees selected by the chief executive officer. The Hedging Committee meets regularly to review commodity price exposure, derivative positions and strategy, and management reports to our Board of Directors on the scope of its activities. We are exposed to counterparty credit risk on all of our derivative instruments, which we manage by monitoring the credit quality of our counterparties and allocating our hedging positions among multiple counterparties to limit exposure to any single entity. Our counterparties are major, investment grade financial institutions or trading companies. Hedging transactions are governed by negotiated reciprocal credit lines, which generally require collateral to be posted above specified credit thresholds. We believe the risk of loss is remote and contained due to counterparty credit quality, our diversification practice and collateral requirements. In a majority of our hedging counterparty agreements, our counterparty offers us a credit line that adjusts up or down, depending on our liquidity. Below specified liquidity thresholds, we may have to post collateral if the fair value of our net liability with such counterparty exceeds our reduced credit line. We manage this risk by allocating hedging transactions among multiple counterparties, using options as part of our hedging activities, or both. The aggregate fair value of our derivative instruments that were in a net liability position was insignificant at both September 30, 2017 and December 31, 2016, and we had no collateral posted as of those dates. Additionally, our firm-price customer sales commitments create incremental customer credit risk related to metal price movements. Under certain circumstances, we mitigate this risk by periodically requiring cash collateral from them, which we classify as deferred revenue and include as a component of Other accrued liabilities. At September 30, 2017, we had no cash collateral posted from any of our customers. For more information about concentration risks concerning customers and suppliers, see Note 11. Notional Amount of Derivative Contracts. The following table summarizes our derivative positions at September 30, 2017:
Aluminum | Maturity Period (month/year) |  | Notional Amount of contracts (mmlbs)
Purchased put option contracts | 10/17 through 12/17 |  | 13.4 |
Fixed price purchase contracts | 10/17 through 12/21 |  | 151.9 |
Fixed price sales contracts | 10/17 through 11/19 |  | 1.8 |
Midwest premium swap contracts 1 | 10/17 through 12/21 |  | 150.1 |
Alloying Metals | Maturity Period (month/year) |  | Notional Amount of contracts (mmlbs)
Fixed price purchase contracts | 10/17 through 6/18 |  | 4.6 |
Natural Gas 2 | Maturity Period (month/year) |  | Notional Amount of contracts (mmbtu)
Fixed price purchase contracts | 10/17 through 12/20 |  | 3,650,000 |
Euro | Maturity Period (month/year) |  | Notional Amount of contracts (euro)
Fixed price purchase contracts | 10/17 through 4/18 |  | 301,304 |
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1 | Regional premiums represent the premium over the London Metal Exchange price for primary aluminum which is incurred on our purchases of primary aluminum.
2 | As of September 30, 2017, we had derivative and/or physical delivery commitments with energy companies in place to cover exposure to fluctuations in prices for approximately 72% of the expected natural gas purchases for the remainder of 2017, 71% of the expected natural gas purchases for both 2018 and 2019 and 39% of the expected natural gas purchases for 2020.
We have physical delivery commitments at firm prices covering approximately 54% of our expected electricity purchases for the remainder of 2017, 55% of the expected electricity purchases for both 2018 and 2019 and 18% of the expected electricity purchases for 2020. Non-Designated Hedges of Operational Risks. Our pricing of fabricated aluminum products is generally intended to lock in a conversion margin (representing the value added from the fabrication process(es)) and to pass through metal price fluctuations to our customers. For some of our higher value added products sold on a spot basis, the pass through of metal price movements can sometimes lag by as much as several months, with a favorable impact to us when metal prices decline and an adverse impact to us when metal prices increase. Additionally, in certain instances, we enter into firm-price arrangements with our customers for stipulated volumes to be delivered in the future. Because we generally purchase primary and secondary aluminum on a floating price basis, the lag in passing through metal price movements to customers on some of our higher value added products sold on a spot basis and the volume that we have committed to sell to our customers under a firm-price arrangement create metal price risk for us. We use third-party hedging instruments to limit exposure to metal price risk related to the metal pass through lag on some of our products and firm-price customer sales contracts. We are exposed to risk of fluctuating prices for natural gas and electricity. We, from time to time, in the ordinary course of business, enter into hedging transactions and/or physical delivery commitments with third parties to mitigate our risk from fluctuations in natural gas and electricity prices. We are also exposed to foreign currency exchange risk related to firm-price agreements for equipment purchases from foreign manufacturers. We use foreign currency forward contracts designed to line up with the timing and amounts of scheduled payments to the foreign equipment manufacturers to mitigate our exposure to currency exchange rate fluctuations on these purchases. Realized and unrealized periodic gains and losses of non-designated foreign currency forward contracts are reflected as a reduction or increase in Other income (expense), net. Designated Alloying Metal Hedges. We enter into agreements with suppliers to purchase alloying metals (zinc and copper) used as raw materials in our fabrication operations at fluctuating prices that we are unable to pass along to our customers. We mitigate our exposure to metal price risk by entering into Alloy Hedges with third-party financial institutions at predetermined/fixed prices at stated delivery dates. Our Alloy Hedges are expected to be highly effective because monthly settlements correspond to forecasted physical purchases of alloying metals by our manufacturing facilities. The effective portion of the fair value on these Alloy Hedges is recorded within Other comprehensive income, net of tax, and is reclassified into the Statements of Consolidated Income during the month of settlement to Cost of products sold (See Note 14). As of September 30, 2017, we estimate the net gain of $0.5 million will be reclassified from Accumulated other comprehensive income into Net income within the next 12 months. We incurred no ineffectiveness on these hedges during the quarter and nine months ended September 30, 2017. Realized and Unrealized Gain and Loss. Realized and unrealized (gain) loss included on the Statements of Consolidated Income associated with all derivative contracts consisted of the following for each period presented (in millions of dollars):
| Quarter Ended |  | Nine Months Ended
| September 30, |  | September 30,
| 2017 |  | 2016 |  | 2017 |  | 2016
Realized (gain) loss: |  |  |  |  |  |  |
Aluminum | $ | (4.0 | ) |  | $ | 0.4 |  |  | $ | (13.8 | ) |  | $ | 4.1 |
Natural gas | 0.2 |  |  | 0.9 |  |  | 0.3 |  |  | 4.2 |
Alloy Hedges | (0.3 | ) |  | — |  |  | (0.2 | ) |  | — |
Foreign exchange | (0.1 | ) |  | — |  |  | (0.1 | ) |  | — |
Total realized (gain) loss 1 | $ | (4.2 | ) |  | $ | 1.3 |  |  | $ | (13.8 | ) |  | $ | 8.3 |
Unrealized (gain) loss: |  |  |  |  |  |  |
Aluminum | $ | (10.6 | ) |  | $ | (1.7 | ) |  | $ | (15.3 | ) |  | $ | (11.7 | )
Natural gas | (0.2 | ) |  | (0.3 | ) |  | 1.3 |  |  | (5.2 | )
Total unrealized gain 2 | $ | (10.8 | ) |  | $ | (2.0 | ) |  | $ | (14.0 | ) |  | $ | (16.9 | )
______________________
1 | Recorded within Cost of products sold, excluding depreciation, amortization and other items within the Fabricated Products segment.
2 | Recorded within Unrealized gain on derivative instruments within the Fabricated Products segment.
Fair Values of Derivative Contracts. The fair values of our derivative contracts are based upon trades in liquid markets. Valuation model inputs can be verified, and valuation techniques do not involve significant judgment. The fair values of such financial instruments are classified within Level 2 of the fair value hierarchy. The following table presents our financial instruments, classified under the appropriate level of the fair value hierarchy, as of the period presented (in millions of dollars):
| September 30, 2017
| Level 1 |  | Level 2 |  | Level 3 |  | Total
DERIVATIVE ASSETS: |  |  |  |  |  |  |
Non-Designated Hedges: |  |  |  |  |  |  |
Aluminum – |  |  |  |  |  |  |
Fixed price purchase contracts | $ | — |  |  | $ | 18.4 |  |  | $ | — |  |  | $ | 18.4 |
Midwest premium swap contracts | — |  |  | 0.8 |  |  | — |  |  | 0.8 |
Natural gas – Fixed price purchase contracts | — |  |  | 0.4 |  |  | — |  |  | 0.4 |
Designated Hedges: |  |  |  |  |  |  |
Alloying metals – Fixed price purchase contracts | — |  |  | 0.9 |  |  | — |  |  | 0.9 |
Total derivative assets 1 | $ | — |  |  | $ | 20.5 |  |  | $ | — |  |  | $ | 20.5 |
| September 30, 2017
| Level 1 |  | Level 2 |  | Level 3 |  | Total
DERIVATIVE LIABILITIES: |  |  |  |  |  |  |
Non-Designated Hedges: |  |  |  |  |  |  |
Aluminum – |  |  |  |  |  |  |
Fixed price sales contracts | $ | — |  |  | $ | (0.1 | ) |  | $ | — |  |  | $ | (0.1 | )
Midwest premium swap contracts | — |  |  | (0.8 | ) |  | — |  |  | (0.8 | )
Natural gas – Fixed price purchase contracts | — |  |  | (0.5 | ) |  | — |  |  | (0.5 | )
Total derivative liabilities 2 | $ | — |  |  | $ | (1.4 | ) |  | $ | — |  |  | $ | (1.4 | )
____________
1 | Of the $20.5 million in total derivative assets, $15.8 million and $4.7 million were recorded within Prepaid expenses and other current assets and Other assets, respectively.
2 | Of the $1.4 million in total derivative liabilities, $0.9 million and $0.5 million were recorded within Other accrued liabilities and Long-term liabilities, respectively.
The following table presents our financial instruments, classified under the appropriate level of the fair value hierarchy, as of the period presented (in millions of dollars):
| December 31, 2016
| Level 1 |  | Level 2 |  | Level 3 |  | Total
DERIVATIVE ASSETS: |  |  |  |  |  |  |
Non-Designated Hedges: |  |  |  |  |  |  |
Aluminum – |  |  |  |  |  |  |
Fixed price purchase contracts | $ | — |  |  | $ | 3.3 |  |  | $ | — |  |  | $ | 3.3 |
Midwest premium swap contracts | — |  |  | 0.9 |  |  | — |  |  | 0.9 |
Natural gas – Fixed price purchase contracts | — |  |  | 1.6 |  |  | — |  |  | 1.6 |
Total derivative assets 1 | $ | — |  |  | $ | 5.8 |  |  | $ | — |  |  | $ | 5.8 |
DERIVATIVE LIABILITIES: |  |  |  |  |  |  |
Non-Designated Hedges: |  |  |  |  |  |  |
Aluminum – |  |  |  |  |  |  |
Fixed price purchase contracts | $ | — |  |  | $ | (1.1 | ) |  | $ | — |  |  | $ | (1.1 | )
Midwest premium swap contracts | — |  |  | (0.2 | ) |  | — |  |  | (0.2 | )
Natural gas – Fixed price purchase contracts | — |  |  | (0.4 | ) |  | — |  |  | (0.4 | )
Designated Hedges: |  |  |  |  |  |  |
Alloying metals – Fixed price purchase contracts | — |  |  | (0.1 | ) |  | — |  |  | (0.1 | )
Total derivative liabilities 2 | $ | — |  |  | $ | (1.8 | ) |  | $ | — |  |  | $ | (1.8 | )
____________
1 | Of the $5.8 million in total derivative assets, $5.0 million and $0.8 million were recorded within Prepaid expenses and other current assets and Other assets, respectively.
2 | Of the $1.8 million in total derivative liabilities, $0.8 million and $1.0 million were recorded within Other accrued liabilities and Long-term liabilities, respectively.
The aggregate fair value of our derivatives at September 30, 2017 and December 31, 2016 was a net asset of $19.1 million and a net asset of $4.0 million, respectively. The increase in the net asset position during the nine months ended September 30, 2017 was primarily due to changes in the underlying commodity and energy prices, as well as settlement of positions during the period. Changes in the fair value of our derivative contracts relating to non-designated hedges of operational activities are reflected in Operating income. Offsetting Information. We enter into derivative contracts with counterparties subject to enforceable master netting arrangements and, from time to time, not subject to netting arrangements. We reflect the fair value of our derivative contracts on a gross basis on the Consolidated Balance Sheets. We had no cash collateral pledged or received with our counterparties as of both September 30, 2017 and December 31, 2016. The following tables present offsetting information regarding our derivatives by type of counterparty as of September 30, 2017 (in millions of dollars):
| Gross Amounts of Recognized Assets |  | Gross Amounts Offset in the Consolidated Balance Sheets |  | Net Amounts of Assets Presented in the Consolidated Balance Sheets |  | Gross Amounts Not Offset in the Consolidated Balance Sheets |  | Net Amount
Counterparty (with netting agreements) | $ | 20.5 |  |  | $ | — |  |  | $ | 20.5 |  |  | $ | 1.4 |  |  | $ | 19.1 |
Total | $ | 20.5 |  |  | $ | — |  |  | $ | 20.5 |  |  | $ | 1.4 |  |  | $ | 19.1 |
| Gross Amounts of Recognized Liabilities |  | Gross Amounts Offset in the Consolidated Balance Sheets |  | Net Amounts of Liabilities Presented in the Consolidated Balance Sheets |  | Gross Amounts Not Offset in the Consolidated Balance Sheets |  | Net Amount
Counterparty (with netting agreements) | $ | (1.4 | ) |  | $ | — |  |  | $ | (1.4 | ) |  | $ | (1.4 | ) |  | $ | — |
Total | $ | (1.4 | ) |  | $ | — |  |  | $ | (1.4 | ) |  | $ | (1.4 | ) |  | $ | — |
The following tables present offsetting information regarding our derivatives by type of counterparty as of December 31, 2016 (in millions of dollars):
| Gross Amounts of Recognized Assets |  | Gross Amounts Offset in the Consolidated Balance Sheets |  | Net Amounts of Assets Presented in the Consolidated Balance Sheets |  | Gross Amounts Not Offset in the Consolidated Balance Sheets |  | Net Amount
Counterparty (with netting agreements) | $ | 3.3 |  |  | $ | — |  |  | $ | 3.3 |  |  | $ | 1.0 |  |  | $ | 2.3 |
Counterparty (with partial netting agreements) | 2.5 |  |  | — |  |  | 2.5 |  |  | 0.7 |  |  | 1.8 |
Total | $ | 5.8 |  |  | $ | — |  |  | $ | 5.8 |  |  | $ | 1.7 |  |  | $ | 4.1 |
| Gross Amounts of Recognized Liabilities |  | Gross Amounts Offset in the Consolidated Balance Sheets |  | Net Amounts of Liabilities Presented in the Consolidated Balance Sheets |  | Gross Amounts Not Offset in the Consolidated Balance Sheets |  | Net Amount
Counterparty (with netting agreements) | $ | (1.0 | ) |  | $ | — |  |  | $ | (1.0 | ) |  | $ | (1.0 | ) |  | $ | — |
Counterparty (with partial netting agreements) | (0.8 | ) |  | — |  |  | (0.8 | ) |  | (0.7 | ) |  | (0.1 | )
Total | $ | (1.8 | ) |  | $ | — |  |  | $ | (1.8 | ) |  | $ | (1.7 | ) |  | $ | (0.1 | )
Fair Value of Other Financial Instruments Available for Sale Securities. We hold debt investment securities that are accounted for as available for sale securities. The fair value of the debt investment securities, which consist of commercial paper and corporate bonds, is determined based on valuation models that use observable market data. At September 30, 2017, all of our short-term investments had maturity dates within 12 months. We review our debt investment portfolio for other-than-temporary impairment at least quarterly or when there are changes in credit risk or other potential valuation concerns. At September 30, 2017 and December 31, 2016, the total unrealized loss, net of tax, included in Accumulated other comprehensive income was immaterial and was not other-than-temporarily impaired. We believe that it is probable that the principal and interest will be collected in accordance with the contractual terms, and that the unrealized loss on these securities was due to normal market fluctuations, and not due to increased credit risk or other valuation concerns. The fair value input of our available for sale securities, which are classified within Level 2 of the fair value hierarchy, is calculated based on broker quotes. The amortized cost for available for sale securities approximates their fair value. All Other Financial Assets and Liabilities. We believe that the fair value of our cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate their respective carrying values due to their short maturities and nominal credit risk. See Note 2 for components of cash and cash equivalents. The following table presents our other financial assets, classified under the appropriate level of the fair value hierarchy, as of September 30, 2017 (in millions of dollars):
| Level 1 |  | Level 2 |  | Level 3 |  | Total
Cash and cash equivalents | $ | 17.3 |  |  | $ | 56.6 |  |  | $ | — |  |  | $ | 73.9 |
Short-term investments | — |  |  | 191.4 |  |  | — |  |  | 191.4 |
Total | $ | 17.3 |  |  | $ | 248.0 |  |  | $ | — |  |  | $ | 265.3 |
The following table presents our other financial assets, classified under the appropriate level of the fair value hierarchy, as of December 31, 2016 (in millions of dollars):
| Level 1 |  | Level 2 |  | Level 3 |  | Total
Cash and cash equivalents | $ | 37.9 |  |  | $ | 17.3 |  |  | $ | — |  |  | $ | 55.2 |
Short-term investments | — |  |  | 231.0 |  |  | — |  |  | 231.0 |
Total | $ | 37.9 |  |  | $ | 248.3 |  |  | $ | — |  |  | $ | 286.2 |

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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://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -URI http://asc.fasb.org/topic&trid=2229140 + Details
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