DERIVATIVES AND RISK MANAGEMENT ACTIVITIES

We utilize various derivative instruments to: (i) manage our exposure to commodity price risk, (ii) manage our exposure to interest rate risk and (iii) attempt to profit from market fluctuations. Our risk management policies and procedures are designed to monitor interest rates, futures and swap positions and over-the-counter positions, as well as physical volumes, grades, locations and delivery schedules to help ensure that our hedging activities address our market risks. Our risk management committee oversees our trading controls and procedures and certain aspects of commodity and trading risk management. Our risk management committee also reviews all new commodity and trading risk management strategies in accordance with our risk management policy, as approved by our board of directors.

Interest Rate Risk

We are a party to certain interest rate swap agreements to manage our exposure to changes in interest rates. We entered into fixed-to-floating interest rate swap agreements associated with a portion of our fixed-rate senior notes. We account for our fixed-to-floating interest rate swaps as fair value hedges. During the year ended December 31, 2011, we entered into and terminated a fixed-to-floating interest rate swap agreement with a notional amount of $40.0 million related to the 7.65% senior notes issued in April 2008. We also terminated interest rate swap agreements with an aggregate notional amount of $617.5 million associated with our 4.80%, 6.05% and 6.875% senior notes during the year ended December 31, 2011. We received $33.4 million in connection with the terminations, which we are amortizing into "Interest expense, net" over the remaining lives of the associated senior notes. We included the proceeds from the termination of interest rate swap agreements in cash flows from financing activities on the consolidated statements of cash flows.

In the fourth quarter of 2011, we entered into fixed-to-floating interest rate swap agreements with an aggregate notional amount of $270.0 million related to the 4.80% senior notes. Under the terms of these interest rate swap agreements, we receive a fixed 4.8% and will pay a variable rate based on one month USD LIBOR plus a percentage that varies with each agreement. As of December 31, 2011 and 2010, the total aggregate notional amount of the fixed-to-floating interest rate swaps was $270.0 million and $617.5 million, respectively. As of December 31, 2011 and 2010, the weighted-average interest rate that we paid under our fixed-to-floating interest rate swaps was 3.1% and 2.4%, respectively.

We are also a party to forward-starting interest rate swap agreements with an aggregate notional amount of $500.0 million as of December 31, 2011 and 2010 related to forecasted probable debt issuances in 2012 and 2013. Under the terms of the swaps, we will pay a fixed rate and receive a rate based on three month USD LIBOR. We entered into the swaps in order to hedge the risk of changes in the interest payments attributable to changes in the benchmark interest rate during the period from the effective date of the swap to the issuance of the forecasted debt. These swaps qualified and we designated them as cash flow hedges. The following table summarizes information about our forward-starting swaps as of December 31, 2011:



Notional Amount	Period of Hedge	Weighted-Average Fixed Rate
(Thousands of Dollars)

$125,000	03/13 – 03/23	3.5	%
150,000	06/13 – 06/23	3.5	%
225,000	02/12 – 02/22	3.1	%
$500,000		3.3	%

Commodity Price Risk

We are exposed to market risks related to the volatility of crude oil and refined product prices. In order to reduce the risk of commodity price fluctuations with respect to our crude oil and finished product inventories and related firm commitments to purchase and/or sell such inventories, we utilize commodity futures and swap contracts, which qualify and we designate as fair value hedges.

During the second quarter of 2011, we entered into commodity swap contracts to hedge the price risk associated with the San Antonio Refinery. These contracts fix the purchase price of crude oil and sales prices of refined products for a portion of the expected production of the San Antonio Refinery, thereby attempting to mitigate the risk of volatility of future cash flows associated with hedged volumes. These contracts qualified and we designated them as cash flow hedges.

During the fourth quarter of 2011, we decided to adjust the refinery's operations, which caused a shift in the future production yields of the San Antonio refinery. This change caused certain forecasted sales of gasoline products to be replaced with distillate sales; therefore, we concluded these forecasted gasoline sales were probable not to occur, and we discontinued cash flow hedging treatment for the related commodity contracts that had previously qualified and were designated as cash flow hedges. We recorded gains of $16.4 million to "Cost of products sales" on our consolidated statements of income related to these contracts for the year ended December 31, 2011, including $15.1 million which we reclassified from accumulated other comprehensive income.

Derivatives that are intended to hedge our commodity price risk, but fail to qualify as fair value or cash flow hedges, are considered economic hedges, and we record associated gains and losses in net income. We also enter into commodity derivatives in order to attempt to profit from market fluctuations. These derivative instruments are financial positions entered into without underlying physical inventory and are not considered hedges. Changes in the fair values are recorded in net income.

The volume of commodity contracts is based on open derivative positions and represents the combined volume of our long and short positions on an absolute basis, which totaled 27.8 million barrels and 12.8 million barrels as of December 31, 2011 and 2010, respectively.

As of December 31, 2011 and 2010, we had $1.1 million and $17.8 million, respectively, of margin deposits related to our derivative instruments.

The fair values of our derivative instruments included in our consolidated balance sheets were as follows:



		Asset Derivatives				Liability Derivatives
	Balance Sheet Location	December 31,				December 31,
	Balance Sheet Location	2011		2010		2011			2010
		(Thousands of Dollars)
Derivatives Designated as Hedging Instruments:
Commodity contracts	Other current assets	$	36,116	$	—	$	(33,616	)	$	—
Commodity contracts	Other long-term assets, net	86,052		—		(66,175		)	—
Interest rate swaps	Other long-term assets, net	2,335		45,663		—			—
Commodity contracts	Accrued liabilities	—		2,176		—			(2,522		)
Interest rate swaps	Accrued liabilities	—		—		(22,009		)	—
Interest rate swaps	Other long-term liabilities	—		—		(27,190		)	(29,483		)
Total		124,503		47,839		(148,990		)	(32,005		)

Derivatives Not Designated as Hedging Instruments:
Commodity contracts	Other current assets	15,568		—		(5,956		)	—
Commodity contracts	Other long-term assets, net	7,207		—		—			—
Commodity contracts	Accrued liabilities	519		46,632		(5,943		)	(61,027		)
Total		23,294		46,632		(11,899		)	(61,027		)

Total Derivatives		$	147,797	$	94,471	$	(160,889	)	$	(93,032	)

The earnings impact of our derivative activity was as follows:



Derivatives Designated as Fair Value Hedging Instruments	Income Statement Location	Amount of Gain (Loss) Recognized in Income on Derivative (Effective Portion)			Amount of Gain (Loss) Recognized in Income on Hedged Item		Amount of Gain (Loss) Recognized in Income on Derivative (Ineffective Portion)
		(Thousands of Dollars)
Year ended December 31, 2011:
Interest rate swaps	Interest expense, net	$	(55,183	)	$	54,588	$	(595	)
Commodity contracts	Cost of product sales	(10,228		)	9,004		(1,224		)
Total		$	(65,411	)	$	63,592	$	(1,819	)

Year ended December 31, 2010:
Interest rate swaps	Interest expense, net	$	(27,443	)	$	27,443	$	—
Commodity contracts	Cost of product sales	(3,221		)	13,946		10,725
Total		$	(30,664	)	$	41,389	$	10,725

Year ended December 31, 2009:
Interest rate swaps	Interest expense, net	$	(6,661	)	$	6,661	$	—
Commodity contracts	Cost of product sales	(22,939		)	35,512		12,573
Total		$	(29,600	)	$	42,173	$	12,573



Derivatives Designated as Cash Flow Hedging Instruments	Amount of Gain (Loss) Recognized in OCI on Derivative (Effective Portion)			Income Statement Location (a)	Amount of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)			Amount of Gain (Loss) Recognized in Income on Derivative (Ineffective Portion)
	(Thousands of Dollars)				(Thousands of Dollars)
Year ended December 31, 2011:
Interest rate swaps	$	(84,199	)	Interest expense, net	$	—		$	—
Commodity contracts	30,747			Cost of product sales	5,030			(4,010		)
Total	$	(53,452	)		$	5,030		$	(4,010	)

Year ended December 31, 2010:
Interest rate swaps	$	35,000		Interest expense, net	$	—		$	—
Commodity contracts	(1,440		)	Cost of product sales	(1,680		)	—
Total	$	33,560			$	(1,680	)	$	—

Year ended December 31, 2009:
Commodity contracts	$	(240	)	Cost of product sales	$	—		$	—


(a)	Amounts are included in specified location for both the gain (loss) reclassified from accumulated OCI into income (effective portion) and the gain (loss) recognized in income on derivative (ineffective portion).



Derivatives Not Designated as Hedging Instruments	Income Statement Location	Amount of Gain (Loss) Recognized in Income
		(Thousands of Dollars)
Year ended December 31, 2011:
Commodity contracts	Revenues	$	235
Commodity contracts	Cost of product sales	(4,454		)
Commodity contracts	Operating expenses	46
Total		$	(4,173	)

Year ended December 31, 2010:
Commodity contracts	Cost of product sales	$	(3,050	)
Commodity contracts	Operating expenses	(52		)
Total		$	(3,102	)

Year ended December 31, 2009:
Commodity contracts	Cost of product sales	$	(13,594	)
Commodity contracts	Operating expenses	(3,589		)
Total		$	(17,183	)

For derivatives designated as cash flow hedging instruments, once a hedged transaction occurs, we reclassify the effective portion from AOCI to “Cost of product sales” or “Interest expense, net.” As of December 31, 2011, we expect to reclassify a gain of $1.9 million to “Cost of product sales” and a loss of $2.2 million to “Interest expense, net” within the next twelve months. The maximum length of time over which we are hedging our exposure to the variability in future cash flows is approximately four years for our commodity contracts and approximately two years for our forward-starting interest rate swaps.