12. Derivatives, Hedges, Financial Instruments and Carbon Credits

Periodically, 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 climate reserve tonnes (“carbon credits”), of which a certain portion of the carbon credits are to be sold and the proceeds given to Covestro. The assets for carbon credits are accounted for on a fair value basis as discussed below. Also, the contractual obligations to give the related proceeds to Covestro 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. In addition, certain embedded features (“embedded derivative”) included in the Series E Redeemable Preferred required bifurcation and are discussed Note 13. 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.

Level 1 - The valuations of contracts classified as Level 1 are based on quoted prices in active markets for identical contracts.

Level 2 - 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 December 31, 2016, the valuations of contracts classified as Level 2 related to a foreign exchange contract. At December 31, 2015, the valuations of contracts classified as Level 2 related to certain futures/forward natural gas contracts, a foreign exchange contract, an interest rate swap contract and an embedded derivative. For the natural gas contracts, these contracts were valued using the prices pursuant to the terms of the contracts and using market information for futures/forward natural gas prices. For foreign exchange contracts, these contracts are valued using the foreign currency exchange rates pursuant to the terms of the contract and using market information for foreign currency exchange rates. The valuation inputs included the total contractual exchange rate of 1.12 and the total estimated market exchange rate of 1.05 (U.S. Dollar/Euro). For interest rate swap contracts, we utilized valuation software and market data from a third-party provider. These contracts were 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 December 31, 2015, the valuation inputs included the contractual weighted-average pay rate of 3.23% and the estimated market weighted-average receive rate of 0.61%. The interest rate swap contract matured in 2016. For the embedded derivative at December 31, 2015, the derivative was valued using the underlying number of shares as defined in the terms of the Series E Redeemable Preferred and the market price of our common stock. No valuation input adjustments were considered necessary relating to nonperformance risk for the contracts as discussed above.

Level 3 - 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 December 31, 2016, we did not have any carbon credits or related contractual obligations associated with carbon credits. At December 31, 2015, the valuation ($2.35 per carbon credit, none for 2016) of the carbon credits and the contractual obligations associated with these carbon credits are classified as Level 3 and are based on the most recent sales transaction and reevaluated for market changes, if any, and on the range of ask/bid prices obtained from a broker adjusted for minimal market volume activity, respectively. 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. At December 31, 2016, the valuation of the embedded derivative is classified as Level 3. This derivative is valued using market information, management’s redemption assumptions, the underlying number of shares as defined in the terms of the Series E Redeemable Preferred, and the market price of our common stock. In addition, no valuation input adjustments were considered necessary relating to nonperformance risk for the carbon credits or the instruments discussed above.

Commodities Contracts

Raw materials for use in our manufacturing processes include natural gas. 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, 2016, we did not have any futures/forward natural gas contracts subject to mark-to-market accounting. At December 31, 2015, our futures/forward natural gas contracts included 1,820,000 MMBtu of natural gas, extend through December 2016 (includes contractual costs indexed to future NYMEX prices) at a weighted-average cost of $2.35 per MMBtu. The cash flows relating to these contracts are included in cash flows from continuing operating activities.

12. Derivatives, Hedges, Financial Instruments and Carbon Credits (continued)

Foreign Exchange Contracts

One of our subsidiaries purchases industrial machinery and related components from vendors outside of the U.S. As part of our foreign currency risk management, we periodically enter into foreign exchange contracts, which set the U.S. Dollar/Euro exchange rates. At December 31, 2016 and 2015, our foreign exchange contract was for the receipt of approximately 16,000 and 280,000 Euros, respectively, through February 2017 at the contractual exchange rate of 1.12 (U.S. Dollar/Euro). These contracts are free-standing derivatives and are accounted for on a mark-to-market basis. The cash flows relating to these contracts are included in cash flows from continuing operating activities.

Interest Rate Contracts

In February 2011, we entered into an interest rate swap at no cost, which set 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 and ended in March 2016. This contract was a free-standing derivative and was accounted for on a mark-to-market basis. During each of the three years ended December 31, 2016, no cash flows occurred relating to the purchase or sale of interest rate contracts. The cash flows associated with the interest rate swap payments were 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 Covestro, 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 Covestro and EDN. We have no obligation to reimburse Covestro 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 assets for 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 sales commitment to sell the carbon credits). At December 31, 2015, we had approximately 495,000 carbon credits (none at December 31, 2016), 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.

Embedded Derivative

The embedded derivatives relating to the redemption of the Series E Redeemable Preferred, which includes certain contingent redemption features and the participation rights value as discussed in Note 13, has been bifurcated from the Series E Redeemable Preferred and recorded as a liability. As the result of the Indenture Amendments in connection with the Consent Solicitation relating to the Senior Secured Notes as discussed in Note 9, including the redemption of the portion of Series E Redeemable Preferred discussed in Notes 9 and 13, we estimate that the contingent redemption feature has no fair value at December 31, 2016 based on low probability that the remaining shares of Series E Redeemable Preferred would be redeemed prior to August 2, 2019. At December 31, 2016 and 2015, the fair value of the participation rights was based on the equivalent of 303,646 and 456,225 shares, respectively of our common stock at $8.42 and $7.25 per share, respectively.

12. Derivatives, Hedges, Financial Instruments and Carbon Credits (continued)

The following details our assets and liabilities associated with continuing operations that are measured at fair value on a recurring basis at December 31, 2016 and 2015:

			Fair Value Measurements at December 31, 2016 Using
Description	Total Fair Value at December 31, 2016		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, 2015
	(In Thousands)
Assets - Supplies, prepaid items and other:
Commodities contracts (1)	$	—	$	—	$	—	$	—	$	195
Carbon credits		—		—		—		—		1,154
Total	$	—	$	—	$	—	$	—	$	1,349

Liabilities - Current and noncurrent accrued and other liabilities:
Commodities contracts (1)	$	—	$	—	$	—	$	—	$	202
Contractual obligations - carbon credits		—		—		—		—		1,154
Embedded derivative		2,557		—		—		2,557		3,308
Interest rate contracts		—		—		—		—		126
Foreign exchange contracts		1		—		1		—		6
Total	$	2,558	$	—	$	1	$	2,557	$	4,796

(1)	The $195,000 was subject to an agreement that allowed net settlement of contracts; however, we have chosen to present the fair values of our commodities contracts under master netting agreements using a gross fair value presentation.

12. Derivatives, Hedges, Financial Instruments and Carbon Credits (continued)

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 except for certain futures/forward natural gas contracts during 2014. As discussed above under “Embedded Derivative”, as the result of entering into the Stock Purchase Agreement relating to the subsequent sale of the Climate Control Business, the valuation of the embedded derivative transferred from Level 2 to Level 3 as the result of the changes in probability relating to contingent redemption features requiring the use of significant unobservable inputs. The classification transfer of this derivative was deemed to occur at the beginning of the second quarter of 2016. 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
	2016			2015			2014			2016			2015			2014
	(In Thousands)
Beginning balance	$	1,154		$	2,779		$	1,284		$	(1,154	)	$	(2,779	)	$	(1,284	)
Transfers into Level 3		—			—			—			(5,817	)		—			—
Transfers out of Level 3		—			—			—			—			—			—

Total realized and unrealized gains (losses) included in operating results		1,256			2,351			3,089			802			(1,447	)		(2,799	)
Purchases		—			—			—			—			—			—
Issuances		—			—			—			—			—			—
Sales		(2,410	)		(3,976	)		(1,594	)		—			—			—
Settlements		—			—			—			3,612			3,072			1,304
Ending balance	$	—		$	1,154		$	2,779		$	(2,557	)	$	(1,154	)	$	(2,779	)

Total gains (losses) for the period included in operating results attributed to the change in unrealized gains or losses on assets and liabilities still held at the reporting date	$	—		$	1,143		$	2,110		$	(983	)	$	(1,143	)	$	(2,110	)

Net gains (losses) included in operating results and the statement of operations classifications are as follows:

	2016			2015			2014
	(In Thousands)
Total net gains (losses) included in operating results:
Cost of sales - Undesignated commodities contracts	$	140		$	(3,376	)	$	(947	)
Cost of sales - Undesignated foreign exchange contracts		5			(72	)		(49	)
Other income - Carbon credits		1,514			3,663			3,089
Other expense - Contractual obligations relating to carbon credits		(982	)		(2,759	)		(2,799	)
Non-operating other expense - embedded derivative		(983	)		(520	)		—
Interest expense - Undesignated interest rate contracts		—			(47	)		(71	)
Total net losses included in operating results	$	(306	)	$	(3,111	)	$	(777	)

12. Derivatives, Hedges, Financial Instruments and Carbon Credits (continued)

At December 31, 2016 and 2015, we did not have any financial instruments with fair values significantly different from their carrying amounts (which excludes issuance costs, if applicable), except for the Senior Secured Notes as shown below.

	2016				2015
	Carrying		Estimated		Carrying		Estimated
	Amount		Fair Value		Amount		Fair Value
	(In Millions)
Senior Secured Notes (1)	$	375	$	356	$	425	$	355

(1)	Based on a quoted price of 94.88 at December 31, 2016 and 83.65 at December 31, 2015.

The Senior Secured Notes valuations are classified as Level 2. The valuations of our other long-term debt agreements 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 measurements of our other 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 our 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.

Also, see discussions concerning the utilization of fair value in conjunction with the evaluation of goodwill for impairment under Note 1 – Summary of Significant Accounting Policies and certain assets and liabilities initially accounted for on a fair value basis under Note 8 – Asset Retirement Obligations.