RISK MANAGEMENT AND HEDGING ACTIVITIES USING DERIVATIVES | 9 Months Ended |
Sep. 30, 2013 |
Derivative Instruments and Hedging Activities Disclosure [Abstract] | ' |
RISK MANAGEMENT AND HEDGING ACTIVITIES USING DERIVATIVES | ' |
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E. | RISK-MANAGEMENT AND HEDGING ACTIVITIES USING DERIVATIVES | | | | | | | | | | | | | | | | |
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Our Energy Services and ONEOK Partners segments are exposed to various risks that we manage by periodically entering into derivative instruments. In June 2013, we announced we will exit the operations of our Energy Services segment. As a result, the use of derivative instruments will decrease significantly within our Energy Services segment. See Note B for additional information. These risks include the following: |
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• | Commodity-price risk - We are exposed to the risk of loss in cash flows and future earnings arising from adverse changes in the price of natural gas, NGLs and condensate. We use commodity derivative instruments such as futures, physical-forward contracts, swaps and options to mitigate the commodity-price risk associated with a portion of the forecasted purchases and sales of commodities and natural gas and natural gas liquids in storage. Commodity-price volatility may have a significant impact on the fair value of our derivative instruments as of a given date; | | | | | | | | | | | | | | | | |
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• | Basis risk - We are exposed to the risk of loss in cash flows and future earnings arising from adverse changes in the price differentials between pipeline receipt and delivery locations. Our firm transportation capacity allows us to purchase natural gas at a pipeline receipt point and sell natural gas at a pipeline delivery point. As market conditions permit, our Energy Services segment periodically enters into basis swaps between the transportation receipt and delivery points in order to protect the fair value of these location price differentials related to our firm commitments; and | | | | | | | | | | | | | | | | |
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• | Interest-rate risk - We are also subject to fluctuations in interest rates. We manage interest-rate risk through the use of fixed-rate debt, floating-rate debt and, at times, interest-rate swaps. | | | | | | | | | | | | | | | | |
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The following derivative instruments are used to manage our exposure to these risks: |
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• | Futures contracts - Standardized contracts to purchase or sell natural gas and crude oil for future delivery or settlement under the provisions of exchange regulations; | | | | | | | | | | | | | | | | |
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• | Forward contracts - Nonstandardized commitments between two parties to purchase or sell natural gas, crude oil or NGLs for future physical delivery. These contracts are typically nontransferable and can only be canceled with the consent of both parties; | | | | | | | | | | | | | | | | |
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• | Swaps - Exchange of one or more payments based on the value of one or more commodities. This transfers the financial risk associated with a future change in value between the counterparties of the transaction without also conveying ownership interest in the asset or liability; and | | | | | | | | | | | | | | | | |
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• | Options - Contractual agreements that give the holder the right, but not the obligation, to buy or sell a fixed quantity of a commodity, at a fixed price, within a specified period of time. Options may either be standardized and exchange traded or customized and nonexchange traded. | | | | | | | | | | | | | | | | |
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Our objectives for entering into such contracts include but are not limited to: |
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• | reducing the variability of cash flows by locking in the price for all or a portion of anticipated index-based physical purchases and sales, transportation fuel requirements, asset management transactions and customer-related business activities; | | | | | | | | | | | | | | | | |
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• | locking in a price differential to protect the fair value between transportation receipt and delivery points and to protect the fair value of natural gas or NGLs that are purchased in one month and sold in a later month; | | | | | | | | | | | | | | | | |
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• | reducing our exposure to fluctuations in interest rates; and | | | | | | | | | | | | | | | | |
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• | reducing variability in cash flows from changes in interest rates associated with forecasted debt issuances. | | | | | | | | | | | | | | | | |
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With respect to the net open positions that exist within our marketing operations, fluctuating commodity prices can impact our financial position and results of operations. The net open positions are managed actively, and the impact of the changing prices on our financial condition at a point in time is not necessarily indicative of the impact of price movements throughout the year. |
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Our Natural Gas Distribution segment also uses derivative instruments to hedge the cost of a portion of anticipated natural gas purchases during the winter heating months to protect our customers from upward volatility in the market price of natural gas. The use of these derivative instruments and the associated recovery of these costs have been approved by the OCC, KCC and regulatory authorities in certain of our Texas jurisdictions. |
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ONEOK Partners has forward-starting interest-rate swaps designated as cash flow hedges of the variability of interest payments on a portion of forecasted debt issuances that may result from changes in the benchmark interest rate before the debt is issued. At September 30, 2013, and December 31, 2012, ONEOK Partners had forward-starting interest-rate swaps with notional amounts totaling $400 million. |
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Accounting Treatment - We record all derivative instruments at fair value, with the exception of normal purchases and normal sales that are expected to result in physical delivery. The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and, if so, the reason for holding it. |
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If certain conditions are met, we may elect to designate a derivative instrument as a hedge of exposure to changes in fair values, cash flows or foreign currency. Certain nontrading derivative transactions, which are economic hedges of our accrual transactions such as our storage and transportation contracts, do not qualify for hedge accounting treatment. |
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The table below summarizes the various ways in which we account for our derivative instruments and the impact on our consolidated financial statements: |
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| | Recognition and Measurement | | | | | | | | | | | | | |
Accounting Treatment | | Balance Sheet | | Income Statement | | | | | | | | | | | | | |
Normal purchases and normal | - | Fair value not recorded | - | Change in fair value not recognized in earnings | | | | | | | | | | | | | |
sales | | | | | | | | | | | | | |
Mark-to-market | - | Recorded at fair value | - | Change in fair value recognized in earnings | | | | | | | | | | | | | |
Cash flow hedge | - | Recorded at fair value | - | Ineffective portion of the gain or loss on the | | | | | | | | | | | | | |
derivative instrument is recognized in earnings | | | | | | | | | | | | | |
| - | Effective portion of the gain or loss on the | - | Effective portion of the gain or loss on the | | | | | | | | | | | | | |
derivative instrument is reported initially | derivative instrument is reclassified out of | | | | | | | | | | | | | |
as a component of accumulated other | accumulated other comprehensive income (loss) | | | | | | | | | | | | | |
comprehensive income (loss) | into earnings when the forecasted transaction | | | | | | | | | | | | | |
| affects earnings | | | | | | | | | | | | | |
Fair value hedge | - | Recorded at fair value | - | The gain or loss on the derivative instrument is | | | | | | | | | | | | | |
recognized in earnings | | | | | | | | | | | | | |
| - | Change in fair value of the hedged item is | - | Change in fair value of the hedged item is | | | | | | | | | | | | | |
recorded as an adjustment to book value | recognized in earnings | | | | | | | | | | | | | |
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Gains or losses associated with the fair value of derivative instruments entered into by our Natural Gas Distribution segment are included in, and recoverable through, the monthly purchased-gas cost mechanism. |
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We formally document all relationships between hedging instruments and hedged items, as well as risk-management objectives, strategies for undertaking various hedge transactions and methods for assessing and testing correlation and hedge ineffectiveness. We specifically identify the asset, liability, firm commitment or forecasted transaction that has been designated as the hedged item. We assess the effectiveness of hedging relationships quarterly by performing an effectiveness analysis on our cash flow and fair value hedging relationships to determine whether the hedge relationships are highly effective on a retrospective and prospective basis. We also document our normal purchases and normal sales transactions that we expect to result in physical delivery and that we elect to exempt from derivative accounting treatment. |
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The presentation of settled derivative instruments on either a gross or net basis in our Consolidated Statements of Income is dependent on the relevant facts and circumstances of our different types of activities rather than based solely on the terms of the individual contracts. All financially settled derivative instruments, as well as derivative instruments considered held for trading purposes that result in physical delivery, are reported on a net basis in revenues in our Consolidated Statements of Income. The realized revenues and purchase costs of derivative instruments that are not considered held for trading purposes and nonderivative contracts are reported on a gross basis. Derivatives that qualify as normal purchases or normal sales that are expected to result in physical delivery are also reported on a gross basis. |
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Revenues in our Consolidated Statements of Income include financial trading margins, as well as certain physical natural gas transactions with our trading counterparties. Revenues and cost of sales and fuel from such physical transactions are reported on a net basis. |
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Cash flows from futures, forwards, options and swaps that are accounted for as hedges are included in the same category as the cash flows from the related hedged items in our Consolidated Statements of Cash Flows. |
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Fair Values of Derivative Instruments - The following table sets forth the fair values of our derivative instruments for our continuing and discontinued operations for the periods indicated: |
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| September 30, 2013 | | December 31, 2012 |
| Fair Values of Derivatives (a) | | Fair Values of Derivatives (a) |
| Assets | | | (Liabilities) | | Assets | | | (Liabilities) |
| (Thousands of dollars) |
Derivatives designated as hedging instruments | | | | | | | | | |
Commodity contracts | | | | | | | | | |
Financial contracts | $ | 33,216 | | (b) | | $ | (4,554 | ) | | $ | 47,516 | | (c) | | $ | (4,885 | ) |
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Physical contracts | 351 | | | | (2,711 | ) | | 56 | | | | (126 | ) |
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Interest-rate contracts | 43,614 | | | | — | | | 10,923 | | | | — | |
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Total derivatives designated as hedging instruments | 77,181 | | | | (7,265 | ) | | 58,495 | | | | (5,011 | ) |
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Derivatives not designated as hedging instruments | | | | | | | | | | | | | |
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Commodity contracts | | | | | | | | | | | | | |
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Nontrading instruments | | | | | | | | | | | | |
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Financial contracts | 12,260 | | | | (15,018 | ) | | 24,970 | | | | (25,009 | ) |
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Physical contracts | 3,976 | | | | (1,127 | ) | | 4,059 | | | | (153 | ) |
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Trading instruments | | | | | | | | | | | | | |
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Financial contracts | 15,986 | | | | (15,669 | ) | | 15,358 | | | | (14,192 | ) |
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Total derivatives not designated as hedging instruments | 32,222 | | | | (31,814 | ) | | 44,387 | | | | (39,354 | ) |
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Total derivatives | $ | 109,403 | | | | $ | (39,079 | ) | | $ | 102,882 | | | | $ | (44,365 | ) |
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(a) - Included on a net basis in energy marketing and risk-management assets and liabilities, other assets and other deferred credits on our Consolidated Balance Sheets. |
(b) - Includes $8.0 million of derivative assets associated with cash flow hedges of inventory that were adjusted to reflect the lower of cost or market value. The deferred gains associated with these assets have been reclassified from accumulated other comprehensive income (loss). |
(c) - Includes $16.9 million of derivative net assets and ineffectiveness associated with cash flow hedges of inventory related to certain financial contracts that were used to hedge forecasted purchases and sales of natural gas. The deferred gains associated with these assets have been reclassified from accumulated other comprehensive income (loss). |
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Notional Quantities for Derivative Instruments - The following table sets forth the notional quantities for derivative instruments held for periods indicated: |
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| | | September 30, 2013 | | December 31, 2012 |
| Contract | | Purchased/ | | Sold/ | | Purchased/ | | Sold/ |
Type | Payor | Receiver | Payor | Receiver |
Derivatives designated as hedging instruments: | | | | | | | | |
Cash flow hedges | | | | | | | | | |
Fixed price | | | | | | | | | |
- Natural gas (Bcf) | Futures, forwards and swaps | | — | | | (72.4 | ) | | — | | | (85.1 | ) |
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- Crude oil and NGLs (MMbbl) | Futures, forwards and swaps | | — | | | (2.3 | ) | | — | | | (1.1 | ) |
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Basis | | | | | | | | | | | | | |
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- Natural gas (Bcf) | Futures, forwards and swaps | | — | | | (58.0 | ) | | — | | | (56.3 | ) |
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Interest-rate contracts (Millions of dollars) | Forward-starting | | $ | 400 | | | $ | — | | | $ | 400 | | | $ | — | |
swaps |
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Fair value hedges | | | | | | | | | | | | | |
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Basis | | | | | | | | | | | | | |
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- Natural gas (Bcf) | Futures, forwards and swaps | | 5.8 | | | (5.8 | ) | | 59.1 | | | (59.1 | ) |
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Derivatives not designated as hedging instruments: | | | | | | | | | | | | |
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Fixed price | | | | | | | | | | | | | |
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- Natural gas (Bcf) | Futures, forwards and swaps | | 53 | | | (53.1 | ) | | 60.7 | | | (60.4 | ) |
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| Options | | — | | | — | | | 102.1 | | | (100.8 | ) |
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Basis | | | | | | | | | | | | | |
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- Natural gas (Bcf) | Futures, forwards and swaps | | 105.9 | | | (105.7 | ) | | 80.2 | | | (81.7 | ) |
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Index | | | | | | | | | | | | | |
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- Natural gas (Bcf) | Futures, forwards and swaps | | 8.2 | | | (4.8 | ) | | 20.3 | | | (22.3 | ) |
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These notional amounts are used to summarize the volume of financial instruments; however, they do not reflect the extent to which the positions offset one another and consequently do not reflect our actual exposure to market or credit risk. |
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Cash Flow Hedges - Our Energy Services and ONEOK Partners segments use derivative instruments to hedge the cash flows associated with anticipated purchases and sales of natural gas, NGLs and condensate and cost of fuel used in the transportation of natural gas. Accumulated other comprehensive income (loss) at September 30, 2013, includes gains of approximately $5.6 million, net of tax, related to these hedges that will be recognized within the next 27 months as the forecasted transactions affect earnings. If prices remain at current levels, we will recognize $3.6 million in net gains over the next 12 months and net gains of $2.0 million thereafter. The amount deferred in accumulated other comprehensive income (loss) attributable to our settled interest-rate swaps is a loss of $50.9 million, net of tax, which will be recognized over the life of the long-term, fixed-rate debt. We expect that losses of $5.3 million will be reclassified into earnings during the next 12 months as the hedged items affect earnings. The remaining amounts in accumulated other comprehensive income (loss) are attributable primarily to ONEOK Partners’ forward-starting interest-rate swaps with settlement dates greater than 12 months, which will be amortized to interest expense over the life of long-term, fixed-rate debt upon issuance of ONEOK Partners debt. |
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For the nine months ended September 30, 2013, cost of sales and fuel in our Consolidated Statements of Income includes $10.1 million reflecting an adjustment to natural gas inventory at the lower of cost or market value. We reclassified $8.0 million of deferred gains, before income taxes, on associated cash flow hedges from accumulated other comprehensive income (loss) into earnings. |
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For the nine months ended September 30, 2012, net margin in our Consolidated Statement of Income includes losses of $29.9 million related to certain financial contracts that were used to hedge forecasted purchases of natural gas. As a result of the continued decline in natural gas prices, the combination of the cost basis of the forecasted purchases of inventory and the financial contracts exceeded the amount expected to be recovered through sales of that inventory after considering related sales hedges, which required reclassification of the loss from accumulated other comprehensive loss to current period earnings. |
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The following table sets forth the effects of cash flow hedges recognized in other comprehensive income (loss) for the periods indicated: |
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Derivatives in Cash Flow | Three Months Ended | | Nine Months Ended | | |
Hedging Relationships | September 30, | | September 30, | | |
| 2013 | | 2012 | | 2013 | | 2012 | | |
| (Thousands of dollars) | | |
Commodity contracts | $ | (8,796 | ) | | $ | (41,452 | ) | | $ | 11,718 | | | $ | 39,461 | | | |
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Interest-rate contracts | 6,721 | | | (1,175 | ) | | 35,726 | | | (32,795 | ) | | |
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Total unrealized gain (loss) recognized in other comprehensive | $ | (2,075 | ) | | $ | (42,627 | ) | | $ | 47,444 | | | $ | 6,666 | | | |
income (loss) on derivatives (effective portion) | | |
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The following table sets forth the effect of cash flow hedges in our Consolidated Statements of Income for the periods indicated: |
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Derivatives in Cash Flow | Location of Gain (Loss) Reclassified from | Three Months Ended | | Nine Months Ended | |
Hedging Relationships | Accumulated Other Comprehensive Income | September 30, | | September 30, | |
| (Loss) into Net Income (Effective Portion) | 2013 | | 2012 | | 2013 | | 2012 | |
| | (Thousands of dollars) | |
Commodity contracts | Revenues | $ | 3,357 | | | $ | 31,447 | | | $ | 18,718 | | | $ | 127,477 | | |
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Commodity contracts | Cost of sales and fuel | (117 | ) | | (2,503 | ) | | (14,320 | ) | | (65,940 | ) | |
Interest-rate contracts | Interest expense | (3,696 | ) | | (1,828 | ) | | (10,840 | ) | | (3,908 | ) | |
Total gain (loss) reclassified from accumulated other comprehensive income | $ | (456 | ) | | $ | 27,116 | | | $ | (6,442 | ) | | $ | 57,629 | | |
(loss) into net income on derivatives (effective portion) | |
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Ineffectiveness related to our cash flow hedges was not material for the three and nine months ended September 30, 2013 and 2012. In the event that it becomes probable that a forecasted transaction will not occur, we will discontinue cash flow hedge treatment, which will affect earnings. For the three and nine months ended September 30, 2013, we recorded immaterial gains due to the discontinuance of cash flow hedge treatment as a result of the underlying transactions being no longer probable. For the three and nine months ended September 30, 2012, there were no gains or losses due to the discontinuance of cash flow hedge treatment as a result of the underlying transactions being no longer probable. |
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Other Derivative Instruments - The following table sets forth the effect of our derivative instruments that are not part of a hedging relationship in our Consolidated Statements of Income for our continuing and discontinued operations for the periods indicated: |
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Derivatives Not Designated as | Location of Gain (Loss) | Three Months Ended | | Nine Months Ended | |
Hedging Instruments | September 30, | | September 30, | |
| 2013 | | 2012 | | 2013 | | 2012 | |
| | (Thousands of dollars) | |
Commodity contracts - trading | Revenues | $ | 4 | | | $ | 867 | | | $ | (2,054 | ) | | $ | 1,673 | | |
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Commodity contracts - nontrading (a) | Cost of sales and fuel | (534 | ) | (b) | 601 | | | (2,959 | ) | (b) | 4,924 | | |
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Total gain (loss) recognized in income on derivatives | $ | (530 | ) | | $ | 1,468 | | | $ | (5,013 | ) | | $ | 6,597 | | |
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(a) - Amounts are presented net of deferred gains (losses) associated with derivatives entered into by our Natural Gas Distribution segment. |
(b) - Includes losses of $0.4 million and $2.2 million for the three and nine months ended September 30, 2013, respectively, on certain derivatives derecognized that were designated previously as fair value hedges of firm transportation commitments that no longer meet the definition of a firm commitment. |
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Our Natural Gas Distribution segment held natural gas call options with fair values of $4.8 million and $1.8 million at September 30, 2013, and December 31, 2012, respectively. The premiums are recorded in other current assets as these contracts are included in, and recoverable through, the monthly purchased-gas cost mechanism. For the three and nine months ended September 30, 2013, we recorded losses of $2.3 million and $7.4 million, respectively, which are deferred as part of our unrecovered purchased-gas costs. For the three and nine months ended September 30, 2012, we recorded gains of $2.8 million and $3.8 million, respectively, which are deferred as part of our unrecovered purchased-gas costs. |
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Fair Value Hedges - Our Energy Services segment uses basis swaps to hedge the fair value of location price differentials related to certain firm transportation commitments. The change in fair value of derivatives designated as fair value hedges and the related hedged firm commitments and the ineffectiveness related to these hedges were not material for the three and nine months ended September 30, 2013 and 2012. |
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Credit Risk - We monitor the creditworthiness of our counterparties and compliance with policies and limits established by our Risk Oversight and Strategy Committee. We maintain credit policies with regard to our counterparties that we believe minimize overall credit risk. These policies include an evaluation of potential counterparties’ financial condition (including credit ratings, bond yields and credit default swap rates), collateral requirements under certain circumstances and the use of standardized master-netting agreements that allow us to net the positive and negative exposures associated with a single counterparty. We have counterparties whose credit is not rated, and for those customers we use internally developed credit ratings. |
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Some of our derivative instruments contain provisions that require us to maintain an investment-grade credit rating from S&P and/or Moody’s. If our credit ratings on senior unsecured long-term debt were to decline below investment grade, the counterparties to the derivative instruments could request collateralization on derivative instruments in net liability positions. The aggregate fair value of all financial derivative instruments with contingent features related to credit risk that were in a net liability position at September 30, 2013, was $2.5 million. |
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The counterparties to our derivative contracts consist primarily of major energy companies, LDCs, electric utilities, financial institutions and commercial and industrial end-users. This concentration of counterparties may impact our overall exposure to credit risk, either positively or negatively, in that the counterparties may be similarly affected by changes in economic, regulatory or other conditions. Based on our policies, exposures, credit and other reserves, we do not anticipate a material adverse effect on our financial position or results of operations as a result of counterparty nonperformance. |
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At September 30, 2013, the net credit exposure from our derivative assets is primarily with investment-grade companies in the financial services sector. |