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Derivative Financial Instruments
 12 Months Ended
Dec. 31, 2018
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative Financial Instruments
Derivative Financial Instruments

We use derivative instruments to manage market price risks associated with inventories, interest rates, tank bottoms and certain forecasted transactions. For those instruments that qualify for hedge accounting, the accounting treatment depends on their intended use and their designation. We divide derivative financial instruments qualifying for hedge accounting treatment into two categories: (1) cash flow hedges and (2) fair value hedges. We execute cash flow hedges to hedge against the variability in cash flows related to a forecasted transaction and execute fair value hedges to hedge against the changes in the value of a recognized asset or liability. At the inception of a hedged transaction, we document the relationship between the hedging instrument and the hedged item, the risk management objectives and the methods used for assessing and testing hedge effectiveness. We also assess, both at the inception of the hedge and on an on-going basis, whether the derivatives that are used in our hedging transactions are highly effective in offsetting changes in cash flows or fair value of the hedged item. If we determine that a derivative originally designated as a cash flow or fair value hedge is no longer highly effective, we discontinue hedge accounting prospectively and record the change in the fair value of the derivative in current earnings. The changes in fair value of derivative financial instruments that are not designated as hedges for accounting purposes, which we refer to as economic hedges, are included in current earnings.
 
As part of our risk management process, we assess the creditworthiness of the financial and other institutions with which we execute financial derivatives. Such financial instruments involve the risk of non-performance by the counterparty, which could result in material losses to us.

Our policies prohibit us from engaging in speculative trading activities.

Interest Rate Derivatives

We periodically enter into interest rate derivatives to hedge the fair value of debt or hedge against variability in interest rates. For interest rate cash flow hedges, we record the noncurrent portion of unrealized gains or losses as an adjustment to other comprehensive income with the current portion recorded as an adjustment to interest expense. For fair value hedges on long-term debt, we record the noncurrent portion of gains or losses as an adjustment to long-term debt with the current portion recorded as an adjustment to interest expense. Adjustments resulting from discontinued hedges continue to be recognized in accordance with their historic hedging relationships.
 
During 2018, we entered into $250.0 million of treasury lock agreements to protect against the risk of variability of future interest payments on a portion of debt we anticipate issuing in 2019. The fair values of these contracts at December 31, 2018 were recorded on our balance sheet as other current liabilities of $8.4 million and other current assets of $0.3 million, with the net offset recorded to other comprehensive income. We account for these agreements as cash flow hedges.

During 2018, we terminated and settled $200.0 million of interest rate derivative agreements with cumulative gains of $24.6 million. These agreements were previously entered into to protect against the risk of variability of future interest payments on debt we anticipated issuing in 2018 or early 2019 and were accounted for as cash flow hedges. The gains were recorded to other comprehensive income and will be recognized into earnings as an adjustment to our periodic interest expense upon issuance of the associated notes. These gains were also reported as a net receipt on financial derivatives in the financing activities of our consolidated statements of cash flows in 2018.

During 2015 and 2016, we entered into $250.0 million of forward-starting interest rate swap agreements to protect against the risk of variability of future interest payments on a portion of debt we anticipated issuing in 2016. We accounted for these agreements as cash flow hedges. When we issued $500.0 million of 4.25% notes due 2046 in third quarter 2016, we settled the associated interest rate swap agreements for a cumulative loss of $19.3 million. The loss was recorded to other comprehensive income and will be recognized into earnings as an adjustment to our periodic interest expense accruals over the first ten years of the associated notes. This loss was also reported as a net payment on financial derivatives in the financing activities of our consolidated statements of cash flows in 2016.

Commodity Derivatives

Our butane blending activities produce gasoline, and we can reasonably estimate the timing and quantities of sales of these products. We use a combination of exchange-based commodities futures contracts and forward purchase and sale contracts to help manage commodity price changes and mitigate the risk of decline in the product margin realized from our butane blending activities. Further, certain of our other commercial operations generate petroleum products, and we also use futures contracts to hedge against price changes for some of these commodities.

Forward physical purchase and sale contracts that qualify for and are elected as normal purchases and sales are accounted for using traditional accrual accounting, whereby changes in the mark-to-market values of such contracts are not recognized in income, rather the revenues and expenses associated with such transactions are recognized during the period when commodities are physically delivered or received. Physical forward commodity contracts subject to this exception are evaluated for the probability of future delivery and are periodically tested once the forecasted period has passed to determine whether similar forward contracts are probable of physical delivery in the future.

We record the effective portion of the gains or losses for commodity-based contracts designated as fair value hedges as adjustments to the assets being hedged and the ineffective portions as well as amounts excluded from the assessment of hedge effectiveness as adjustments to other income or expense. We recognize the change in fair value of economic hedges that hedge against changes in the price of petroleum products that we expect to sell or purchase in the future currently in earnings as adjustments to product sales revenue, cost of product sales, or operating expenses, as applicable.

Our open futures contracts at December 31, 2018 were as follows:
Type of Contract/Accounting Methodology
 
Product Represented by the Contract and Associated Barrels
 
Maturity Dates
Futures - Economic Hedges
 
4.1 million barrels of refined products and crude oil
 
Between January and June 2019
Futures - Economic Hedges
 
0.9 million barrels of butane
 
Between January and April 2019


Energy Commodity Derivatives Contracts and Deposits Offsets

At December 31, 2018, we held margin deposits of $37.3 million for our futures contracts with our counterparties, which were recorded as a current liability under energy commodity derivatives deposits on our consolidated balance sheets. At December 31, 2017, we had made margin deposits of $36.7 million for our futures contracts with our counterparties, which were recorded as a current asset under energy commodity derivatives deposits on our consolidated balance sheets.We have the right to offset the combined fair values of our open futures contracts against our margin deposits under a master netting arrangement for each counterparty; however, we have elected to present the combined fair values of our open futures contracts separately from the related margin deposits on our consolidated balance sheets. Additionally, we have the right to offset the fair values of our futures contracts together for each counterparty, which we have elected to do, and we report the combined net balances on our consolidated balance sheets. A schedule of the derivative amounts we have offset and the deposit amounts we could offset under a master netting arrangement are provided below as of December 31, 2017 and 2018 (in thousands):
 
 
Gross Amounts of Recognized Assets (Liabilities)
 
Gross Amounts of Assets (Liabilities) Offset in the Consolidated Balance Sheets
 
Net Amounts of Assets (Liabilities) Presented in the Consolidated Balance Sheets(1)
 
Margin Deposit Amounts Not Offset in the Consolidated Balance Sheets
 
Net Asset Amount(2)
As of December 31, 2017
 
$
(38,936
)
 
$
12,851

 
$
(26,085
)
 
$
36,690

 
$
10,605

As of December 31, 2018
 
$
62,166

 
$
(7,155
)
 
$
55,011

 
$
(37,328
)
 
$
17,683

 
 
 
 
 
 
 
 
 
 
 

(1) Net amount includes energy commodity derivative contracts classified as current liabilities of $25,694 and noncurrent liabilities of $391 at December 31, 2017.

(2) Amount represents the maximum loss we would incur if all of our counterparties failed to perform on their derivative contracts.
  

Impact of Derivatives on Our Financial Statements
Comprehensive Income
The changes in derivative activity included in AOCL for the years ended December 31, 2016, 2017 and 2018 were as follows (in thousands):
 
 
Year Ended December 31,
Derivative Gains (Losses) Included in AOCL
 
2016
 
2017
 
2018
Beginning balance
 
$
(30,126
)
 
$
(34,776
)
 
$
(33,755
)
Net gain (loss) on interest rate contract cash flow hedges
 
(6,699
)
 
(1,937
)
 
4,317

Reclassification of net loss on cash flow hedges to income
 
2,049

 
2,958

 
2,958

Ending balance
 
$
(34,776
)
 
$
(33,755
)
 
$
(26,480
)


The following is a summary of the effect on our consolidated statements of income for the years ended December 31, 2016, 2017 and 2018 of derivatives that were designated as cash flow hedges (in thousands):
 
 
Interest Rate Contracts
 
 
Amount of Gain (Loss) Recognized in AOCL on  Derivatives
 
Location of Loss Reclassified from AOCL into Income
 
Amount of Loss Reclassified from AOCL into Income
 
 
 
 
 
Year Ended December 31, 2016
 
 
$
(6,699
)
 
 
Interest expense
 
 
$
(2,049
)
 
 
Year Ended December 31, 2017
 
 
$
(1,937
)
 
 
Interest expense
 
 
$
(2,958
)
 
 
Year Ended December 31, 2018
 
 
$
4,317

 
 
Interest expense
 
 
$
(2,958
)
 
 


As of December 31, 2018, the net loss estimated to be classified to interest expense over the next twelve months from AOCL is approximately $2.2 million. This amount relates to the amortization of losses on interest rate swap contracts over the life of the related debt instruments.

We used futures contracts designated as fair value hedges to hedge against changes in the fair value of crude oil that was contractually reserved as tank bottoms and included with other noncurrent assets on our consolidated balance sheets. During September 2017, as a result of contract renegotiations, we sold a portion of the tank bottoms, settled the related hedges and transferred the permanent portion of the tank bottoms from noncurrent assets to PP&E. The effective portions of the fair value gains or losses on these futures contracts were offset by fair value gains or losses on the crude oil, and there was no ineffectiveness recognized. The cash flows from settled contracts were recorded in operating activities in our consolidated statements of cash flows. The gains (losses) on these futures contracts and the underlying crude oil were as follows (in thousands):
 
 
Year Ended December 31,
 
 
2016
 
2017
 
2018
Gain (loss) recognized in other income/expense on derivative (futures contracts)
 
$
(8,988
)
 
$
4,806

 
$
543

Gain (loss) recognized in other income/expense on hedged item (tank bottoms)
 
$
8,988

 
$
(4,806
)
 
$
(543
)


The differential between the current spot price and forward price was excluded from the assessment of hedge effectiveness for these fair value hedges. During 2016 and 2017, we recognized a gain of $5.2 million and $2.4 million, respectively, for the amounts we excluded from the assessment of effectiveness of these fair value hedges, which we reported as other (income) expense on our consolidated statements of income.
The following table provides a summary of the effect on our consolidated statements of income for the years ended December 31, 2016, 2017 and 2018 of derivatives accounted for as economic hedges (in thousands):
 
 
 
 
Amount of Gain (Loss)
Recognized on Derivative
 
 
 
 
Year Ended December 31,
Derivative Instrument
 
Location of Gain (Loss)
Recognized on Derivatives
 
2016
 
2017
 
2018
Futures contracts
 
Product sales revenue
 
$
(38,584
)
 
$
(56,338
)
 
$
85,012

Futures contracts
 
Cost of product sales
 
10,998

 
25,566

 
(15,947
)
Futures contracts
 
Operating expenses
 
(5,000
)
 
3,002

 
—

 
 
Total
 
$
(32,586
)
 
$
(27,770
)
 
$
69,065


The impact of the derivatives in the above table was reflected as cash from operations on our consolidated statements of cash flows.
Balance Sheets
The following tables provide a summary of the fair value of derivatives, which are presented on a net basis in our consolidated balance sheets, that were designated as hedging instruments as of December 31, 2017 and 2018 (in thousands):
 
 
December 31, 2017
 
 
Asset Derivatives
 
Liability Derivatives
Derivative Instrument
 
Balance Sheet Location
 
Fair Value
 
Balance Sheet Location
 
Fair Value
Futures contracts
 
Energy commodity derivatives contracts, net
 
$
—

 
Energy commodity derivatives contracts, net
 
$
173

Interest rate contracts
 
Other noncurrent assets
 
12,177

 
Other noncurrent liabilities
 
—

 
 
Total
 
$
12,177

 
Total
 
$
173

 
 
 
 
 
 
 
 
 
 
 
December 31, 2018
 
 
Asset Derivatives
 
Liability Derivatives
Derivative Instrument
 
Balance Sheet Location
 
Fair Value
 
Balance Sheet Location
 
Fair Value
Futures contracts
 
Energy commodity derivatives contracts, net
 
$
462

 
Energy commodity derivatives contracts, net
 
$
—

Interest rate contracts
 
Other current assets
 
312

 
Other current liabilities
 
8,438

 
 
Total
 
$
774

 
Total
 
$
8,438


 
The following tables provide a summary of the fair value of derivatives, which are presented on a net basis in our consolidated balance sheets, that were not designated as hedging instruments as of December 31, 2017 and 2018 (in thousands):
 
 
December 31, 2017
 
 
Asset Derivatives
 
Liability Derivatives
Derivative Instrument
 
Balance Sheet Location
 
Fair Value
 
Balance Sheet Location
 
Fair Value
Futures contracts
 
Energy commodity derivatives contracts, net
 
$
12,605

 
Energy commodity derivatives contracts, net
 
$
38,126

Futures contracts
 
Other noncurrent assets
 
246

 
Other noncurrent liabilities
 
637

 
 
Total
 
$
12,851

 
Total
 
$
38,763

 
 
 
 
 
 
 
 
 
 
 
December 31, 2018
 
 
Asset Derivatives
 
Liability Derivatives
Derivative Instrument
 
Balance Sheet Location
 
Fair Value
 
Balance Sheet Location
 
Fair Value
Futures contracts
 
Energy commodity derivatives contracts, net
 
$
61,704

 
Energy commodity derivatives contracts, net
 
$
7,155


 
See Note 17 – Fair Value Disclosures for additional details regarding our derivative contracts.