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Derivatives, Hedges, Financial Instruments and Carbon Credits
 3 Months Ended
Mar. 31, 2013
Derivatives, Hedges, Financial Instruments and Carbon Credits

Note 10: Derivatives, Hedges, Financial Instruments and Carbon Credits We have two classes of contracts that are accounted for on a fair value basis, which are commodities futures/forward contracts (“commodities 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 climate reserve tonnes (“carbon credits”), of 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. 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 March 31, 2013 and December 31, 2012, the valuations of contracts classified as Level 2 related to interest rate swap contracts. For interest rate swap contracts, we utilize valuation software and market data from a third-party provider. 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 March 31, 2013, the valuation inputs included the contractual weighted-average pay rate of 3.23% and the estimated market weighted-average receive rate of 0.51%. 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 March 31, 2013 and December 31, 2012, the valuations ($0.50 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 obtained from a broker adjusted downward due to minimal market volume activity. 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 March 31, 2013 and December 31, 2012, our futures/forward copper contracts were for 625,000 pounds of copper through May 2013 at a weighted-average cost of $3.53 per pound. At March 31, 2013 and December 31, 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, when applicable.

Interest Rate Contracts

As part of our interest rate risk management, we periodically purchase and/or enter into various interest rate contracts. 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 three months ended March 31, 2013 and 2012, 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 its 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 March 31, 2013, we had approximately 625,000 carbon credits (a minimal amount at December 31, 2012), all of which were subject to contractual obligations. The cash flows associated with the carbon credits and the associated contractual obligations are included in cash flows from continuing investing activities, when applicable.

The following details our assets and liabilities that are measured at fair value on a recurring basis at March 31, 2013 and December 31, 2012:

 

     Fair Value Measurements at
March 31, 2013 Using		         
            Quoted Prices                       
            in Active      Significant                
     Total Fair      Markets for      Other      Significant      Total Fair  
     Value At      Identical      Observable      Unobservable      Value at  
     March 31,      Assets      Inputs      Inputs      December 31,  

Description

    2013      (Level 1)      (Level 2)      (Level 3)      2012  
     (In Thousands)  

Assets—Supplies, prepaid items and other:

               

Commodities contracts

    $ —         $ —         $ —         $ —         $ 79   

Carbon credits

      312         —           —           312         91   
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

  

Total

    $ 312       $ —         $ —         $ 312       $ 170   
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

  

Liabilities—Current and noncurrent accrued and other liabilities:

               

Commodities contracts

    $ 83       $ 83       $ —         $ —         $ —     

Contractual obligations—carbon credits

      312         —           —           312         91   

Interest rate contracts

      1,706         —           1,706         —           1,874   
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

  

Total

    $ 2,101       $ 83       $ 1,706       $ 312       $ 1,965   
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

  

None of our assets or liabilities measured at fair value on a recurring basis transferred between Level 1 and Level 2 classifications for the periods presented below. 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  
     Three Months Ended      Three Months Ended  
     March 31,      March 31,  
     2013     2012      2013     2012  
     (In Thousands)  

Beginning balance

    $ 91      $ 42       $ (91 )    $ (42 ) 

Transfers into Level 3

      —          —           —          —     

Transfers out of Level 3

      —          —           —          —     

Total realized and unrealized gain (loss) included in operating results

      233        —           (233 )      —     

Purchases

      —          —           —          —     

Issuances

      —          —           —          —     

Sales

      (12 )      —           —          —     

Settlements

      —          —           12        —     
  

 

 

    

 

 

     

 

 

    

 

 

  

Ending balance

    $ 312      $ 42       $ (312 )    $ (42 ) 
  

 

 

    

 

 

     

 

 

    

 

 

  

Realized and unrealized net gains (losses) included in operating results and the classifications within the statement of operations are as follows:

 

     Three Months Ended  
     March 31,  
     2013     2012  
     (In Thousands)  

Total net gains (losses) included in operating results:

     

Cost of sales—Commodities contracts

    $ (162 )    $ 142   

Other income—Carbon credits

      233        —     

Other expenses—Contractual obligations relating to carbon credits

      (233 )      —     

Interest expense—Interest rate contracts

      1        (96 ) 
  

 

 

    

 

 

  
   $ (161 )    $ 46   
  

 

 

    

 

 

  

 

     Three Months Ended  
     March 31,  
     2013     2012  
     (In Thousands)  

Change in unrealized gains (losses) relating to contracts still held at period end:

     

Cost of sales—Commodities contracts

    $ (162 )    $ 142   

Other income—Carbon credits

      221        —     

Other expense—Contractual obligations relating to carbon credits

      (221 )      —     

Interest expense—Interest rate contracts

      168        270   
  

 

 

    

 

 

  
   $ 6      $ 412   
  

 

 

    

 

 

  

At March 31, 2013 and December 31, 2012, 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.