Note 9: Derivatives, Hedges, Financial Instruments and Carbon Credits

For the periods presented, the following significant instruments are accounted for on a fair value basis:

Carbon Credits and Associated Contractual Obligation

Periodically, we are issued climate reserve tonnes (“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 sold and the proceeds given to Covestro 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 September 30, 2017 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.

Note 9: Derivatives, Hedges, Financial Instruments and Carbon Credits (continued)

Embedded Derivative

Certain embedded features (“embedded derivative”) relating to the redemption of the Series E Redeemable Preferred, which includes certain contingent redemption features and the participation rights value have been bifurcated from the Series E Redeemable Preferred and recorded as a liability. As the result of the Indenture Amendments in connection with the previously reported redemption of a portion of our Senior Secured Notes and the redemption of the portion of Series E Redeemable Preferred, we estimate that the contingent redemption feature has no fair value at September 30, 2017 based on low probability that the remaining shares of Series E Redeemable Preferred would be redeemed prior to August 2, 2019. At September 30, 2017 and December 31, 2016, the fair value of the participation rights was based on the equivalent of 303,646 shares of our common stock at $7.94 and $8.42 per share, respectively.

The following is a summary of the classifications of valuations of fair value:

Level 1 - The valuations of contracts classified as Level 1 are based on quoted prices in active markets for identical contracts. At September 30, 2017 and December 31, 2016, we did not have any contracts classified as Level 1.

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 September 30, 2017 and December 31, 2016, we did not have any significant contracts classified as Level 2.

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 September 30, 2017, the valuation ($2.35 per carbon credit) of the carbon credits and the contractual obligations associated with these carbon credits is classified as Level 3 and is 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. At December 31, 2016, we did not have any carbon credits or related contractual obligations associated with carbon credits. The valuation is 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 September 30, 2017 and December 31, 2016, the valuations of the embedded derivative are 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 embedded derivative.

The following details our assets and liabilities that are measured at fair value on a recurring basis at September 30, 2017 and December 31, 2016:

				Fair Value Measurements at September 30, 2017 Using
Description	Total Fair Value at September 30, 2017			Quoted Prices in Active Markets for Identical Contracts (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)			Total Fair Value at December 31, 2016
	(In Thousands)
Assets - Supplies, prepaid items and other:
Carbon credits	$	1,164		$	—	$	—	$	1,164		$	—
Total	$	1,164		$	—	$	—	$	1,164		$	—

Liabilities - Current and noncurrent accrued and other liabilities:
Contractual obligations - carbon credits	$	(1,164	)	$	—	$	—	$	(1,164	)	$	—
Embedded derivative		(2,411	)		—		—		(2,411	)		(2,557	)
Foreign exchange contracts		—			—		—		—			(1	)
Total	$	(3,575	)	$	—	$	—	$	(3,575	)	$	(2,558	)

Note 9: Derivatives, Hedges, Financial Instruments and Carbon Credits (continued)

None of our liabilities measured at fair value on a recurring basis transferred between Level 1 and Level 2 classifications for the periods presented below. As the result of entering into the stock purchase agreement relating to the sale of the Climate Control Business in 2016 as discussed in Note 2, the valuation of the embedded derivative transferred from Level 2 to Level 3 since the probability increased 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						Assets						Liabilities
	Three Months Ended					Three Months Ended						Nine Months Ended						Nine Months Ended
	September 30,					September 30,						September 30,						September 30,
	2017		2016			2017			2016			2017			2016			2017			2016
	(In Thousands)
Beginning balance	$	—	$	6		$	(3,137	)	$	(1,871	)	$	—		$	1,154		$	(2,557	)	$	(1,154	)
Transfers into Level 3		—		—			—			—			—			—			—			(5,817	)
Transfers out of Level 3		—		—			—			—			—			—			—			—
Total realized and unrealized gains (losses) included in operating results		1,164		1,196			(438	)		(3,395	)		2,031			1,256			(1,705	)		754
Purchases		—		—			—			—			—			—			—			—
Issuances		—		—			—			—			—			—			—			—
Sales		—		(1,202	)		—			—			(867	)		(2,410	)		—			—
Settlements		—		—			—			2,661			—			—			687			3,612
Ending balance	$	1,164	$	—		$	(3,575	)	$	(2,605	)	$	1,164		$	—		$	(3,575	)	$	(2,605	)

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	$	1,164	$	—		$	(438	)	$	(2,199	)	$	1,164		$	—			(1,018	)	$	(816	)

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

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2017			2016			2017			2016
	(In Thousands)
Total net gains (losses) included in operating results:
Cost of sales - Undesignated commodities contracts	$	—		$	18		$	—		$	81
Cost of sales - Undesignated foreign exchange contracts		—			1			—			7
Other income - Carbon credits		1,164			1,196			2,031			1,513
Other expense - Contractual obligations relating to carbon credits		(1,164	)		(922	)		(1,851	)		(982	)
Non-operating other income (expense) - embedded derivative		726			(2,474	)		146			(1,031	)
Total net gains (losses) included in operating results	$	726		$	(2,181	)	$	326		$	(412	)

Note 9: Derivatives, Hedges, Financial Instruments and Carbon Credits (continued)

At September 30, 2017 and December 31, 2016, 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.

	September 30, 2017				December 31, 2016
	Carrying		Estimated		Carrying		Estimated
	Amount		Fair Value		Amount		Fair Value
	(In Millions)
Senior Secured Notes (1)	$	375	$	369	$	375	$	356

(1)	Based on a quoted price of 98.50 at September 30, 2017 and 94.88 at December 31, 2016.

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 certain assets and liabilities initially accounted for on a fair value basis under Note 6 - Asset Retirement Obligations.