v3.5.0.2
DERIVATIVES AND RISK MANAGEMENT ACTIVITIES
 6 Months Ended
Jun. 30, 2016
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
DERIVATIVES AND RISK MANAGEMENT ACTIVITIES
DERIVATIVES AND RISK MANAGEMENT ACTIVITIES

We utilize various derivative instruments to manage our exposure to interest rate risk and commodity price risk. 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 commodity volumes, grades, locations and delivery schedules, to help ensure that our hedging activities address our market risks.
Interest Rate Risk
We are a party to certain interest rate swap agreements to manage our exposure to changes in interest rates, which include forward-starting interest rate swap agreements related to forecasted debt issuances in 2018 and 2020. We entered into these 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. Under the terms of the swaps, we pay a fixed rate and receive a rate based on three-month USD LIBOR. These swaps qualified, and we designated them, as cash flow hedges. We record the effective portion of mark-to-market adjustments as a component of “Accumulated other comprehensive income (loss)” (AOCI), and the amount in AOCI will be recognized in “Interest expense, net” as the forecasted interest payments occur or if the interest payments are probable not to occur. As of June 30, 2016 and December 31, 2015, the aggregate notional amount of forward-starting interest rate swaps totaled $600.0 million.

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. 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. 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.

The volume of commodity contracts is based on open derivative positions and represents the combined volume of our long and short open positions on an absolute basis, which totaled 7.1 million barrels and 8.0 million barrels as of June 30, 2016 and December 31, 2015, respectively. As of June 30, 2016, we had $1.9 million of margin deposits; we had no margin deposits as of December 31, 2015. The fair values of our derivative instruments included in our consolidated balance sheets were as follows:
 
 
 
Asset Derivatives
 
Liability Derivatives
 
Balance Sheet Location
 
June 30,
2016
 
December 31,
2015
 
June 30,
2016
 
December 31,
2015
 
 
 
(Thousands of Dollars)
Derivatives Designated as
Hedging Instruments:
 
 
 
 
 
 
 
 
 
Commodity contracts
Other current assets
 
$
—

 
$
1,937

 
$
—

 
$
(23
)
Interest rate swaps
Other long-term assets, net
 
—

 
2,755

 
—

 
—

Commodity contracts
Accrued liabilities
 
333

 
—

 
(484
)
 
—

Interest rate swaps
Other long-term liabilities
 
—

 
—

 
(48,875
)
 
(1,452
)
Total
 
 
333

 
4,692

 
(49,359
)
 
(1,475
)
 
 
 
 
 
 
 
 
 
 
Derivatives Not Designated
as Hedging Instruments:
 
 
 
 
 
 
 
 
 
Commodity contracts
Other current assets
 
224

 
34,016

 
—

 
(24,528
)
Commodity contracts
Accrued liabilities
 
8,306

 
117

 
(13,253
)
 
(237
)
Total
 
 
8,530

 
34,133

 
(13,253
)
 
(24,765
)
 
 
 
 
 
 
 
 
 
 
Total Derivatives
 
 
$
8,863

 
$
38,825

 
$
(62,612
)
 
$
(26,240
)

 
Certain of our derivative instruments are eligible for offset in the consolidated balance sheets and subject to master netting arrangements. Under our master netting arrangements, there is a legally enforceable right to offset amounts, and we intend to settle such amounts on a net basis. The following are the net amounts presented on the consolidated balance sheets:
Commodity Contracts
 
June 30,
2016
 
December 31,
2015
 
 
(Thousands of Dollars)
Net amounts of assets presented in the consolidated balance sheets
 
$
224

 
$
11,402

Net amounts of liabilities presented in the consolidated balance sheets
 
$
(5,098
)
 
$
(120
)


We recognize the impact of our commodity contracts on earnings in “Cost of product sales” on the condensed consolidated statements of comprehensive income, and that impact was as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
 
(Thousands of Dollars)
Derivatives Designated as Fair Value Hedging Instruments:
 
 
 
 
 
 
 
Loss recognized in income on derivative
$
(5,792
)
 
$
(6,663
)
 
$
(6,804
)
 
$
(4,499
)
Gain recognized in income on hedged item
6,938

 
8,407

 
9,804

 
6,731

Gain recognized in income for ineffective portion
1,146

 
1,744

 
3,000

 
2,232

 
 
 
 
 
 
 
 
Derivatives Not Designated as Hedging Instruments:
 
 
 
 
 
 
 
Loss recognized in income on derivative
$
(724
)
 
$
(339
)
 
$
(4
)
 
$
(9
)

Our interest rate swaps had the following impact on earnings:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
 
(Thousands of Dollars)
Derivatives Designated as Cash Flow Hedging Instruments:
 
 
 
 
 
 
 
(Loss) gain recognized in other comprehensive income on derivative (effective portion)
$
(20,200
)
 
$
20,788

 
$
(50,178
)
 
$
18,753

Loss reclassified from AOCI into interest expense, net (effective portion)
$
(2,158
)
 
$
(2,506
)
 
$
(4,380
)
 
$
(5,044
)

As of June 30, 2016, we expect to reclassify a loss of $7.5 million to “Interest expense, net” within the next twelve months associated with unwound forward-starting interest rate swaps.