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Derivatives, Hedges, Financial Instruments and Carbon Credits | 6 Months Ended
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Jun. 30, 2012
Derivatives, Hedges, Financial Instruments and Carbon Credits [Abstract] |
Derivatives, Hedges, Financial Instruments and Carbon Credits | Note 9: Derivatives, Hedges, Financial Instruments and Carbon Credits Note 9: Derivatives, Hedges, Financial Instruments and Carbon Credits We have three classes of contracts that are accounted for on a fair value basis, which are commodities futures/forward contracts (“commodities contracts”), foreign exchange contracts and interest rate contracts as discussed below. All of these contracts are used as economic hedges for risk management purposes but are not designated as hedging instruments. In addition as discussed below, we are issued carbon credits, which a certain portion of the carbon credits are to be sold and the proceeds given to Bayer Material Science LLC (“Bayer”). The carbon credits are accounted for on a fair value basis as discussed below. Also the contractual obligations associated with these carbon credits are accounted for on a fair value basis (as discussed below) unless we enter into a firm sales commitment to sell the carbon credits as discussed in Note 1 — Summary of Significant Accounting Policies. The valuations of these assets and liabilities were determined based on quoted market prices or, in instances where market quotes are not available, other valuation techniques or models used to estimate fair values. The valuations of contracts classified as Level 1 are based on quoted prices in active markets for identical contracts. The valuations of contracts classified as Level 2 are based on quoted prices for similar contracts and valuation inputs other than quoted prices that are observable for these contracts. At June 30, 2012, the valuations of contracts classified as Level 2 related to a foreign exchange contract and an interest rate swap contract. For foreign exchange and interest rate swap contracts, we utilize valuation software and market data from a third-party provider. For foreign exchange contracts, these contracts are valued using the foreign currency exchange rate pursuant to the terms of the contracts and using market information for foreign currency exchange rates. At June 30, 2012, the valuation inputs included the contractual weighted-average exchange rate (U.S. Dollar/Euro) of approximately 1.27 and the estimated market weighted-average exchange rate of approximately 1.27. For interest rate contracts, these contracts are valued using a discounted cash flow model that calculates the present value of future cash flows pursuant to the terms of the contracts and using market information for forward interest-rate yield curves. At June 30, 2012, the valuation inputs included the contractual weighted-average pay rate of 3.23% and the estimated market weighted-average receive rate of 0.71%. No valuation input adjustments were considered necessary relating to nonperformance risk for the contracts. The valuations of assets and liabilities classified as Level 3 are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. At June 30, 2012, the valuations ($3.15 per carbon credit) of the carbon credits and the contractual obligations associated with these carbon credits are classified as Level 3 and are based on the range of prices ($1.00 to $4.00) per carbon credit obtained from brokers involved in this low volume market and an offer from a potential customer. At December 31, 2011, the valuations ($3.15 per carbon credit) of the carbon credits and the contractual obligations associated with these carbon credits are classified as Level 3 and are based on the range of ask/bid prices ($1.00 to $3.00) per carbon credit obtained from a broker involved in this low volume market, the sales price of a December 2011 transaction and an offer received from a potential customer. The valuations are using undiscounted cash flows based on management’s assumption that the carbon credits would be sold and the associated contractual obligations would be extinguished in the near term. In addition, no valuation input adjustments were considered necessary relating to nonperformance risk for the carbon credits and associated contractual obligations. Commodities Contracts Raw materials for use in our manufacturing processes include copper used by our Climate Control Business and anhydrous ammonia and natural gas used by our Chemical Business. As part of our raw material price risk management, we periodically enter into futures/forward contracts for these materials, which contracts may be required to be accounted for on a mark-to-market basis. At December 31, 2011, our futures/forward copper contracts were for 375,000 pounds of copper through May 2012 at a weighted-average cost of $3.42 per pound. At June 30, 2012, our futures/forward copper contracts were for 625,000 pounds of copper through December 2012 at a weighted-average cost of $3.83 per pound. At December 31, 2011 and June 30, 2012, we did not have any futures/forward natural gas contracts requiring mark-to-market accounting. The cash flows relating to these contracts are included in cash flows from continuing operating activities, if any. Foreign Exchange Contracts One of our business operations purchases industrial machinery and related components from vendors outside of the United States. As part of our foreign currency risk management, we periodically enter into foreign exchange contracts, which set the U.S. Dollar/Euro exchange rates. These contracts are free-standing derivatives and are accounted for on a mark-to-market basis. At December 31, 2011, we did not have any foreign exchange contracts. At June 30, 2012, our foreign exchange contract was for the receipt of approximately 344,000 Euros through August 2012 at the contractual weighted-average exchange rate (U.S. Dollar/Euro) of approximately 1.27. The cash flows relating to these contracts are included in cash flows from continuing operating activities, if any. Interest Rate Contracts As part of our interest rate risk management, we periodically purchase and/or enter into various interest rate contracts. In April 2008, we entered into an interest rate swap at no cost, which set a fixed three-month LIBOR rate of 3.24% on $25 million and matured in April 2012. In September 2008, we acquired an interest rate swap at a cost basis of $0.4 million, which set a fixed three-month LIBOR rate of 3.595% on $25 million and matured in April 2012. These contracts were free-standing derivatives and were accounted for on a mark-to-market basis. In February 2011, we entered into an interest rate swap at no cost, which sets a fixed three-month LIBOR rate of 3.23% on a declining balance (from $23.8 million to $18.8 million) for the period beginning in April 2012 through March 2016. This contract is a free-standing derivative and is accounted for on a mark-to-market basis. During the six months ended June 30, 2012 and 2011, no cash flows occurred relating to the purchase or sale of interest rate contracts. The cash flows associated with the interest rate swap payments are included in cash flows from continuing operating activities. Carbon Credits and Associated Contractual Obligation Periodically, we are issued carbon credits by the Climate Action Reserve in relation to a greenhouse gas reduction project (“Project”) performed at the Baytown Facility. Pursuant to the terms of the agreement with Bayer, a certain portion of the carbon credits are to be used to recover the costs of the Project, and any balance thereafter to be allocated between Bayer and EDN. We have no obligation to reimburse Bayer for their costs associated with the Project, except through the transfer or sale of the carbon credits when such credits are issued to us. The carbon credits are accounted for on a fair value basis and the contractual obligations associated with these carbon credits are also accounted for on a fair value basis (unless we enter into a firm sales commitment to sell the carbon credits). At December 31, 2011 and June 30, 2012, we had a minimal amount of carbon credits, all of which were subject to contractual obligations. As a result, changes in the amounts of our unobservable valuation inputs (discussed above) would not result in a significant change in the fair value of the carbon credits and the associated contractual obligations and such changes would not impact net income. The cash flows associated with the carbon credits and the associated contractual obligations are included in cash flows from continuing investing activities. The following details our assets and liabilities that are measured at fair value on a recurring basis at June 30, 2012 and December 31, 2011:
|  | Fair Value Measurements at June 30, 2012 Using |  |  |  |
Description |  | Total Fair Value At June 30, 2012 |  |  | Quoted Prices in Active Markets for Identical Assets (Level 1) |  |  | Significant Other Observable Inputs (Level 2) |  |  | Significant Unobservable Inputs (Level 3) |  |  | Total Fair Value at December 31, 2011 |
|  | (In Thousands) |
Assets — Supplies, prepaid items and other: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commodities contracts |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | 11 |
Carbon credits |  |  | 42 |  |  |  | — |  |  |  | — |  |  |  | 42 |  |  |  | 42 |
Total |  | $ | 42 |  |  | $ | — |  |  | $ | — |  |  | $ | 42 |  |  | $ | 53 |
Liabilities — Current and noncurrent accrued and other liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commodities |  | $ | 208 |  |  | $ | 208 |  |  | $ | — |  |  | $ | — |  |  | $ | — |
Foreign exchange contracts |  |  | 2 |  |  |  | — |  |  |  | 2 |  |  |  | — |  |  |  | — |
Contractual obligations — carbon credits |  |  | 42 |  |  |  | — |  |  |  | — |  |  |  | 42 |  |  |  | 42 |
Interest rate contracts |  |  | 2,015 |  |  |  | — |  |  |  | 2,015 |  |  |  | — |  |  |  | 2,241 |
Total |  | $ | 2,267 |  |  | $ | 208 |  |  | $ | 2,017 |  |  | $ | 42 |  |  | $ | 2,283 |
During the six months ended June 30, 2012 and 2011, none of our assets or liabilities measured at fair value on a recurring basis transferred between Level 1 and Level 2 classifications. In addition, the following is a reconciliation of the beginning and ending balances for assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3):
|  | Assets |  |  | Liabilities |  |  | Assets |  |  | Liabilities |
|  | Six Months Ended June 30, |  |  | Six Months Ended June 30, |  |  | Three Months Ended June 30, |  |  | Three Months Ended June 30, |
| 2012 |  |  | 2011 |  |  | 2012 |  |  | 2011 |  |  | 2012 |  |  | 2011 |  |  | 2012 |  |  | 2011 |
|  | (In Thousands) |
Beginning balance |  | $ | 42 |  |  | $ | 644 |  |  | $ | (42 | ) |  | $ | (644 | ) |  | $ | 42 |  |  | $ | 11 |  |  | $ | (42 | ) |  | $ | — |
Transfers into Level 3 |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |
Transfers out of Level 3 |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |
Total realized and unrealized gains (losses) included in earnings |  |  | — |  |  |  | 1,030 |  |  |  | — |  |  |  | (936 | ) |  |  | — |  |  |  | 990 |  |  |  | — |  |  |  | (896 | )
Purchases |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |
Issuances |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |
Sales |  |  | — |  |  |  | (1,665 | ) |  |  | — |  |  |  | — |  |  |  | — |  |  |  | (992 | ) |  |  | — |  |  |  | — |
Settlements |  |  | — |  |  |  | — |  |  |  | — |  |  |  | 1,573 |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | 889 |
Ending balance |  | $ | 42 |  |  | $ | 9 |  |  | $ | (42 | ) |  | $ | (7 | ) |  | $ | 42 |  |  | $ | 9 |  |  | $ | (42 | ) |  | $ | (7 | )
Realized and unrealized net losses included in earnings and the income statement classifications are as follows:
|  | Six Months Ended June 30, |  |  | Three Months Ended June 30, |
| 2012 |  |  | 2011 |  |  | 2012 |  |  | 2011 |
|  | (In Thousands) |
Total net gains (losses) included in earnings: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cost of sales — Commodities contracts |  | $ | (72 | ) |  | $ | (194 | ) |  | $ | (214 | ) |  | $ | (43 | )
Cost of sales — Foreign exchange contracts |  |  | (8 | ) |  |  | 46 |  |  |  | (8 | ) |  |  | 6 |
Other income — Carbon credits |  |  | — |  |  |  | 1,030 |  |  |  | — |  |  |  | 990 |
Other expenses — Contractual obligations relating to carbon credits |  |  | — |  |  |  | (936 | ) |  |  | — |  |  |  | (896 | )
Interest expense — Interest rate contracts |  |  | (329 | ) |  |  | (1,026 | ) |  |  | (233 | ) |  |  | (688 | )
|  | $ | (409 | ) |  | $ | (1,080 | ) |  | $ | (455 | ) |  | $ | (631 | )
|  | Six Months Ended June 30, |  |  | Three Months Ended June 30, |
| 2012 |  |  | 2011 |  |  | 2012 |  |  | 2011 |
|  | (In Thousands) |
Change in unrealized gains (losses) relating to contracts still held at period end: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cost of sales — Commodities contracts |  | $ | (208 | ) |  | $ | (52 | ) |  | $ | (209 | ) |  | $ | (20 | )
Cost of sales — Foreign exchange contracts |  |  | (2 | ) |  |  | — |  |  |  | (2 | ) |  |  | — |
Other income — Carbon credits |  |  | — |  |  |  | 9 |  |  |  | — |  |  |  | 9 |
Other expenses — Contractual obligations relating to carbon credits |  |  | — |  |  |  | (7 | ) |  |  | — |  |  |  | (7 | )
Interest expense — Interest rate contracts |  |  | 226 |  |  |  | (240 | ) |  |  | (44 | ) |  |  | (292 | )
|  | $ | 16 |  |  | $ | (290 | ) |  | $ | (255 | ) |  | $ | (310 | )
At June 30, 2012 and December 31, 2011, we did not have any financial instruments with fair values significantly different from their carrying amounts. These financial instruments include our long-term debt agreements, which valuations are classified as Level 3 and are based on valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. The fair value measurement of our long-term debt agreements are valued using a discounted cash flow model that calculates the present value of future cash flows pursuant to the terms of the debt agreements and applies estimated current market interest rates. The estimated current market interest rates are based primarily on interest rates currently being offered on borrowings of similar amounts and terms. In addition, no valuation input adjustments were considered necessary relating to nonperformance risk for the debt agreements. The fair value of financial instruments is not indicative of the overall fair value of our assets and liabilities since financial instruments do not include all assets, including intangibles, and all liabilities.

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- Definition The entire disclosure for the entity's entire derivative instruments and hedging activities. 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