RISK MANAGEMENT AND HEDGING ACTIVITIES USING DERIVATIVES | 9 Months Ended |
Sep. 30, 2014 |
Derivative Instruments and Hedging Activities Disclosure [Abstract] | ' |
RISK MANAGEMENT AND HEDGING ACTIVITIES USING DERIVATIVES | ' |
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D. | RISK-MANAGEMENT AND HEDGING ACTIVITIES USING DERIVATIVES | | | | | | | | | | | | | | | |
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Risk-Management Activities - ONEOK Partners is sensitive to changes in natural gas, crude oil and NGL prices, principally as a result of contractual terms under which these commodities are processed, purchased and sold. ONEOK Partners uses physical-forward sales and financial derivatives to secure a certain price for a portion of its natural gas, condensate and NGL products. ONEOK Partners follows established policies and procedures to assess risk and approve, monitor and report its risk-management activities. ONEOK Partners has not used these instruments for trading purposes. We and ONEOK Partners are also subject to the risk of interest-rate fluctuation in the normal course of business. |
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Commodity-price risk - ONEOK Partners is exposed to the risk of loss in cash flows and future earnings arising from adverse changes in the price of natural gas, NGLs, crude oil and condensate. ONEOK Partners uses the following commodity derivatives instruments to mitigate the commodity-price risk associated with a portion of the forecasted sales of these commodities: |
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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 typically are nontransferable and only can be canceled with the consent of both parties; and | | | | | | | | | | | | | | | |
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• | Swaps - Exchange of one or more payments based on the value of one or more commodities. These instruments transfer 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. | | | | | | | | | | | | | | | |
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The Natural Gas Gathering and Processing segment is exposed to commodity-price risk as a result of receiving commodities in exchange for services associated with its POP contracts. ONEOK Partners is also exposed to basis risk between the various production and market locations where it receives and sells commodities. As part of its hedging strategy, ONEOK Partners uses the previously described commodity derivative financial instruments and physical-forward contracts to minimize the impact of price fluctuations related to natural gas, NGLs and condensate. |
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The Natural Gas Liquids segment is exposed to basis risk primarily as a result of the relative value of NGL purchases at one location and sales at another location. To a lesser extent, ONEOK Partners is exposed to commodity-price risk resulting from the relative values of the various NGL products to each other, NGLs in storage and the relative value of NGLs to natural gas. ONEOK Partners utilizes physical-forward contracts to reduce the impact of price fluctuations related to NGLs. At September 30, 2014, and December 31, 2013, there were no financial derivative instruments used in ONEOK Partners’ natural gas liquids operations. |
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The Natural Gas Pipelines segment is exposed to commodity-price risk because its intrastate and interstate natural gas pipelines retain natural gas from its customers for operations or as part of its fee for services provided. When the amount of natural gas consumed as fuel in operations by these pipelines differs from the amount provided by its customers, ONEOK Partners’ pipelines must buy or sell natural gas, or store or use natural gas from inventory, which can expose it to commodity-price risk depending on the regulatory treatment for this activity. To the extent that commodity-price risk in the Natural Gas Pipelines segment is not mitigated by fuel cost-recovery mechanisms, ONEOK Partners uses physical-forward sales or purchases to reduce the impact of price fluctuations related to natural gas. At September 30, 2014, and December 31, 2013, there were no financial derivative instruments used in ONEOK Partners’ natural gas pipeline operations. |
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Interest-rate risk - We and ONEOK Partners manage interest-rate risk through the use of fixed-rate debt, floating-rate debt and interest-rate swaps. Interest-rate swaps are agreements to exchange interest payments at some future point based on specified notional amounts. At September 30, 2014, ONEOK Partners had forward-starting interest-rate swaps with notional amounts totaling $900 million that have been 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, of which $400 million have settlement dates greater than 12 months. |
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Accounting Treatment - We and ONEOK Partners 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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The table below summarizes the various ways in which we and ONEOK Partners account for 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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Under certain conditions, we and ONEOK Partners designate derivative instruments as a hedge of exposure to changes in fair values or cash flows. We and ONEOK Partners 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 and ONEOK Partners specifically identify the forecasted transaction that has been designated as the hedged item in a cash flow hedge relationship. We and ONEOK Partners assess the effectiveness of hedging relationships quarterly by performing an effectiveness analysis on fair value and cash flow hedging relationships to determine whether the hedge relationships are highly effective on a retrospective and prospective basis. ONEOK Partners also documents normal purchases and normal sales transactions expected to result in physical delivery and that are exempted from derivative accounting treatment. |
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The realized revenues and purchase costs of derivative instruments that are not considered held for trading purposes and derivatives that qualify as normal purchases or normal sales that are expected to result in physical delivery are reported on a gross basis. |
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Cash flows from futures, forwards 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 - See Note C for a discussion of the inputs associated with our fair value measurements. The following table sets forth the fair values of derivative instruments for our continuing operations for the periods indicated: |
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| September 30, 2014 | | December 31, 2013 | |
| Assets (a) | | (Liabilities) (a) | | Assets (a) | | (Liabilities) (a) | |
| (Thousands of dollars) | |
Derivatives designated as hedging instruments | | | | | | | | |
Commodity contracts | | | | | | | | |
Financial contracts | $ | 9,532 | | | $ | (3,004 | ) | | $ | 6,469 | | | $ | (5,107 | ) | |
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Physical contracts | 2,554 | | | (608 | ) | | 1,064 | | | (3,463 | ) | |
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Interest-rate contracts | 20,962 | | | (23,308 | ) | | 54,503 | | | — | | |
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Total derivatives designated as hedging instruments | 33,048 | | | (26,920 | ) | | 62,036 | | | (8,570 | ) | |
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Derivatives not designated as hedging instruments | | | | | | | | |
Commodity contracts | | | | | | | | |
Physical contracts | 346 | | | (75 | ) | | 959 | | | — | | |
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Total derivatives not designated as hedging instruments | 346 | | | (75 | ) | | 959 | | | — | | |
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Total derivatives | $ | 33,394 | | | $ | (26,995 | ) | | $ | 62,995 | | | $ | (8,570 | ) | |
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(a) - Included on a net basis in other current assets, other assets or other current liabilities on our Consolidated Balance Sheets. |
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Notional Quantities for Derivative Instruments - The following table sets forth the notional quantities for derivative instruments for our continuing operations for the periods indicated: |
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| | September 30, 2014 | | December 31, 2013 |
| Contract | Purchased/ | | Sold/ | | Purchased/ | | Sold/ |
Type | Payor | Receiver | Payor | Receiver |
Derivatives designated as hedging instruments: | | | | | | | |
Cash flow hedges | | | | | | | | |
Fixed price | | | | | | | | |
- Natural gas (Bcf) | Futures and swaps | — | | | (31.2 | ) | | — | | | (48.1 | ) |
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- Crude oil and NGLs (MMbbl) | Futures, forwards | — | | | (1.7 | ) | | — | | | (4.0 | ) |
and swaps |
Basis | | | | | | | | | | | | |
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- Natural gas (Bcf) | Futures and swaps | — | | | (31.2 | ) | | — | | | (48.1 | ) |
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Interest-rate contracts (Millions of dollars) | Forward-starting | $ | 900 | | | $ | — | | | $ | 400 | | | $ | — | |
swaps |
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These notional quantities 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 ONEOK Partners’ actual exposure to market or credit risk. |
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Cash Flow Hedges - Accumulated other comprehensive income (loss) at September 30, 2014, includes gains of approximately $1.5 million, net of tax, related to ONEOK Partners’ commodity derivative instruments that will be recognized within the next 15 months as the forecasted transactions affect earnings. If prices remain at current levels, we will recognize $1.3 million in net gains over the next 12 months and net gains of $0.2 million thereafter. The amount deferred in accumulated other comprehensive income (loss) attributable to our and ONEOK Partners’ settled interest-rate swaps is a loss of $38.6 million, net of tax, which will be recognized over the life of the long-term, fixed-rate debt. We expect that losses of $4.8 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 future settlement dates, 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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The following table sets forth the effects of cash flow hedges recognized in other comprehensive income (loss) for our continuing operations for the periods indicated: |
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Derivatives in Cash Flow | Three Months Ended | | Nine Months Ended | |
Hedging Relationships | September 30, | | September 30, | |
| 2014 | | 2013 | | 2014 | | 2013 | |
| (Thousands of dollars) | |
Commodity contracts | $ | 17,133 | | | $ | (10,317 | ) | | $ | (24,743 | ) | | $ | 3,060 | | |
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Interest-rate contracts | (9,755 | ) | | 6,721 | | | (56,849 | ) | | 35,726 | | |
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Total unrealized gain (loss) recognized in other comprehensive | $ | 7,378 | | | $ | (3,596 | ) | | $ | (81,592 | ) | | $ | 38,786 | | |
income (loss) on derivatives(effective portion) | |
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The following table sets forth the effect of cash flow hedges on our Consolidated Statements of Income for our continuing operations 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) | 2014 | | 2013 | | 2014 | | 2013 |
| | (Thousands of dollars) |
Commodity contracts | Commodity sales revenues | $ | (355 | ) | | $ | 361 | | | $ | (31,961 | ) | | $ | 4,172 | |
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Interest-rate contracts | Interest expense | (3,525 | ) | | (3,696 | ) | | (18,372 | ) | | (10,840 | ) |
Total gain (loss) reclassified from accumulated other comprehensive | $ | (3,880 | ) | | $ | (3,335 | ) | | $ | (50,333 | ) | | $ | (6,668 | ) |
income (loss) into net income on derivatives (effective portion) |
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Ineffectiveness related to our and ONEOK Partners’ cash flow hedges was not material for the three and nine months ended September 30, 2014 and 2013. In the event that it becomes probable that a forecasted transaction will not occur, ONEOK Partners will discontinue cash flow hedge treatment, which will affect earnings. |
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For the nine months ended September 30, 2014, we reclassified losses of $4.6 million, net of taxes of $3.1 million, to interest expense from accumulated other comprehensive income (loss) due to the discontinuance of cash flow hedge treatment from the de-designation of interest-rate swaps related to the early retirement of long-term debt. See Note F for additional information. There were no gains or losses due to the discontinuance of cash flow hedge treatment during the three months ended September 30, 2014, and the three and nine months ended September 30, 2013. |
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Credit Risk - In the first quarter 2014, outstanding commodity derivative positions with third parties entered into by our energy services business on ONEOK Partners’ behalf were transferred to ONEOK Partners. Beginning in the second quarter 2014, ONEOK Partners enters into all commodity derivative financial contracts directly with unaffiliated third parties. |
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We and ONEOK Partners monitor the creditworthiness of counterparties and compliance with policies and limits established by our Risk Oversight and Strategy Committee. We and ONEOK Partners maintain credit policies on counterparties that we and ONEOK Partners 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. ONEOK Partners has counterparties whose credit is not rated, and for those customers it uses internally developed credit ratings. |
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Some of ONEOK Partners’ financial derivative instruments contain provisions that require it to maintain an investment-grade credit rating from S&P and/or Moody’s. If ONEOK Partners’ 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. There were no financial derivative instruments with contingent features related to credit risk in a net liability position at September 30, 2014. |
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The counterparties to ONEOK Partners’ derivative contracts consist primarily of major energy companies, financial institutions and commercial and industrial end users. This concentration of counterparties may affect ONEOK Partners’ overall exposure to credit risk, either positively or negatively, in that the counterparties may be affected similarly by changes in economic, regulatory or other conditions. Based on ONEOK Partners’ policies, exposures, credit and other reserves, it does not anticipate a material adverse effect on its financial position or results of operations as a result of counterparty nonperformance. |