Note 8: 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 June 30, 2018 and December 31, 2017, we did not have any carbon credits or related contractual obligations.

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 financing transaction relating to the Senior Secured Notes and the letter agreement relating to the Series E Redeemable Preferred as discussed in Notes 6 and 10, we estimate that the contingent redemption features have fair value at June 30, 2018 since we estimate that it is probable that a portion of the shares of this preferred stock would be redeemed prior to October 25, 2023. For certain other embedded features, we estimate no fair value at June 30, 2018 based on our assessment that there is a remote probability that these features will be exercised.

At June 30, 2018, the fair value of the embedded derivative was valued using discounted cash flow models and primarily based on the difference in the present value of estimated future cash flows with no redemptions prior to October 25, 2023 compared to certain redemptions deemed probable during the same period and applying the effective dividend rate of the Series E Redeemable Preferred (At December 31, 2017, we estimated that contingent redemption features had no fair value based on a remote probability of redeeming any shares of this preferred stock prior to previous put date). In addition, at June 30, 2018 and December 31, 2017, the fair value of the embedded derivative included the valuation of the participation rights, which was based on the equivalent of 303,646 shares of our common stock at $5.30 and $8.76 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 June 30, 2018 and December 31, 2017, 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 June 30, 2018 and December 31, 2017, 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 June 30, 2018 and December 31, 2017, 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.

Note 8: Derivatives, Hedges, Financial Instruments and Carbon Credits (continued)

The following details our liabilities that are measured at fair value on a recurring basis at June 30, 2018 and December 31, 2017:

				Fair Value Measurements at June 30, 2018 Using
Description (1)	Total Fair Value at June 30, 2018			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, 2017
	(In Thousands)
Liabilities - Current and noncurrent accrued and other liabilities:
Embedded derivative	$	(1,838	)	$	—	$	—	$	(1,838	)	$	(2,660	)
Total	$	(1,838	)	$	—	$	—	$	(1,838	)	$	(2,660	)

(1)

There were no assets that were measured at fair value on a recurring basis at June 30, 2018 or December 31, 2017.

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. 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						Six Months Ended						Six Months Ended
	June 30,						June 30,						June 30,						June 30,
	2018			2017			2018			2017			2018			2017			2018			2017
	(In Thousands)
Beginning balance	$	534		$	867		$	(2,395	)	$	(3,715	)	$	—		$	—		$	(2,660	)	$	(2,557	)
Transfers into Level 3		—			—			—			—			—			—			—			—
Transfers out of Level 3		—			—			—			—			—			—			—			—
Total realized and unrealized gains (losses) included in operating results		—			—			358			(109	)		534			867			623			(1,267	)
Purchases		—			—			—			—			—			—			—			—
Issuances		—			—			(229	)		—			—			—			(229	)		—
Sales		(534	)		(867	)		—			—			(534	)		(867	)		—			—
Settlements		—			—			428			687			—			—			428			687
Ending balance	$	—		$	—		$	(1,838	)	$	(3,137	)	$	—		$	—		$	(1,838	)	$	(3,137	)

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	$	—		$	—		$	252		$	(289	)	$	—		$	—		$	1,051		$	(580	)

Note 8: Derivatives, Hedges, Financial Instruments and Carbon Credits (continued)

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

	Three Months Ended					Six Months Ended
	June 30,					June 30,
	2018		2017			2018			2017
	(In Thousands)
Total net gains (losses) included in operating results:
Other income - Carbon credits	$	—	$	—		$	534		$	867
Other expense - Contractual obligations relating to carbon credits		106		180			(428	)		(687	)
Non-operating other income (expense) - embedded derivative		252		(289	)		1,051			(580	)
Total net gains (losses) included in operating results	$	358	$	(109	)	$	1,157		$	(400	)

At June 30, 2018 and December 31, 2017, we did not have any financial instruments with fair values significantly different from their carrying amounts (excluding issuance costs, if applicable). 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.