RISK MANAGEMENT AND HEDGING ACTIVITIES USING DERIVATIVES | 3 Months Ended |
Mar. 31, 2015 |
Derivative Instruments and Hedging Activities Disclosure [Abstract] | |
RISK MANAGEMENT AND HEDGING ACTIVITIES USING DERIVATIVES | | | | | | | | | | | | | | | | | |
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; to reduce its exposure to interest-rate fluctuations; and to achieve more predictable cash flows. 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 and condensate. ONEOK Partners uses the following commodity derivative instruments to mitigate the near-term 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 are typically nontransferable and can only 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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ONEOK Partners may also use other instruments including options or collars to mitigate commodity price risk. Options are 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. A collar is a combination of a purchased put option and a sold call option, which places a floor and a ceiling price for commodity sales being hedged. |
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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 also is exposed to basis risk between the various production and market locations where it receives and sells commodities. As part of ONEOK Partners’ hedging strategy, it uses the previously described commodity derivative financial instruments and physical-forward contracts to reduce the impact of price fluctuations related to natural gas, NGLs and condensate. |
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The Natural Gas Liquids segment is exposed to location price differential risk primarily as a result of the relative value of NGL purchases at one location and sales at another location. ONEOK Partners is also 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 March 31, 2015, and December 31, 2014, there were no financial derivative instruments with respect to 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 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 March 31, 2015, and December 31, 2014, there were no financial derivative instruments with respect to 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 December 31, 2014, ONEOK Partners had forward-starting interest-rate swaps with notional amounts totaling $900 million that were 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. Upon ONEOK Partners’ debt issuance in March 2015, it settled $500 million of its interest-rate swaps and realized a loss of $55.1 million, which is included in accumulated other comprehensive loss and will be amortized to interest expense over the term of the related debt. At March 31, 2015, ONEOK Partners’ remaining interest-rate swaps with notional amounts totaling $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 transactions that are expected to result in physical delivery. Commodity price and interest-rate volatility may have a significant impact on the fair value of derivative instruments as of a given date. 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 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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To reduce its exposure to fluctuations in natural gas, NGLs and condensate prices, ONEOK Partners periodically enters into futures, forward sales, options or swap transactions in order to hedge anticipated purchases and sales of natural gas, NGLs and condensate. Interest-rate swaps are used from time to time to manage interest-rate risk. Under certain conditions, we designate these derivative instruments as a hedge of exposure to changes in fair values or cash flows. We formally document all relationships between hedging instruments and hedged items, as well as risk-management objectives and strategies for undertaking various hedge transactions and methods for assessing and testing correlation and hedge ineffectiveness. We specifically identify the forecasted transaction that has been designated as the hedged item in a cash flow hedge relationship. We assess the effectiveness of hedging relationships quarterly by performing an effectiveness analysis on our 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 its normal purchases and normal sales transactions that are expected to result in physical delivery and that ONEOK Partners elects to exempt from derivative accounting treatment. |
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The realized revenues and purchase costs of our and ONEOK Partners’ derivative instruments 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. 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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For the three months ended March 31, 2014, income from discontinued operations in our Consolidated Statements of Income includes revenues from 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. See Note B for disclosures of our discontinued operations. |
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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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| March 31, 2015 | | December 31, 2014 | |
| Assets (a) | | (Liabilities) (a) | | Assets (a) | | (Liabilities) (a) | |
| (Thousands of dollars) | |
Derivatives designated as hedging instruments | | | | | | | | |
Commodity contracts | | | | | | | | |
Financial contracts | $ | 41,053 | | | $ | (3,565 | ) | | $ | 43,234 | | | $ | (1,137 | ) | |
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Physical contracts | 7,395 | | | — | | | 9,922 | | | — | | |
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Interest-rate contracts | — | | | (9,947 | ) | | 2,288 | | | (44,843 | ) | |
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Total derivatives designated as hedging instruments | 48,448 | | | (13,512 | ) | | 55,444 | | | (45,980 | ) | |
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Derivatives not designated as hedging instruments | | | | | | | | |
Commodity contracts | | | | | | | | |
Financial contracts | 575 | | | (204 | ) | | — | | | — | | |
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Physical contracts | — | | | — | | | — | | | (23 | ) | |
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Total derivatives not designated as hedging instruments | 575 | | | (204 | ) | | — | | | (23 | ) | |
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Total derivatives | $ | 49,023 | | | $ | (13,716 | ) | | $ | 55,444 | | | $ | (46,003 | ) | |
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(a) - Included on a net basis in other current assets or deferred credits and other liabilities in 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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| | March 31, 2015 | | December 31, 2014 |
| 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 | — | | | (45.5 | ) | | — | | | (41.2 | ) |
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- Crude oil and NGLs (MMBbl) | Futures, forwards | — | | | (4.1 | ) | | — | | | (0.5 | ) |
and swaps |
Basis | | | | | | | | | | | | |
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- Natural gas (Bcf) | Futures and swaps | — | | | (45.5 | ) | | — | | | (41.2 | ) |
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Interest-rate contracts (Millions of dollars) | Forward-starting | $ | 400 | | | $ | — | | | $ | 900 | | | $ | — | |
swaps |
Derivatives not designated as hedging instruments: | | | | | | | |
Fixed price | | | | | | | | |
- Crude oil and NGLs (MMBbl) | Futures, forwards | 0.6 | | | (0.6 | ) | | — | | | — | |
and swaps |
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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 ONEOK Partners’ actual exposure to market or credit risk. |
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Cash Flow Hedges - ONEOK Partners uses 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 loss at March 31, 2015, includes gains of approximately $11.5 million, net of tax, related to these hedges that will be recognized within the next 21 months as the forecasted transactions affect earnings. If prices remain at current levels, we will recognize $11.3 million in net gains over the next 12 months and net gains of $0.2 million thereafter. The amount deferred in accumulated other comprehensive loss attributable to our and ONEOK Partners’ settled interest-rate swaps is a loss of $50.1 million, net of tax, which will be recognized over the life of the long-term, fixed-rate debt. We expect that losses of $5.8 million, net of tax, will be reclassified into earnings during the next 12 months as the hedged items affect earnings. The remaining amounts in accumulated other comprehensive 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 unrealized effect 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 | | | | | | | | | |
Hedging Relationships | March 31, | | | | | | | | | |
| 2015 | | 2014 | | | | | | | | | |
| (Thousands of dollars) | | | | | | | | | |
Continuing Operations | | | | | | | | | | | | |
Commodity contracts | $ | 10,019 | | | $ | (35,762 | ) | | | | | | | | | |
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Interest-rate contracts | (22,576 | ) | | (20,693 | ) | | | | | | | | | |
Total unrealized gain (loss) recognized in other comprehensive income (loss) on derivatives (effective portion) for continuing operations | (12,557 | ) | | (56,455 | ) | | | | | | | | | |
Discontinued Operations | | | | | | | | | | | | |
Total unrealized gain (loss) recognized in other comprehensive income (loss) on derivatives (effective portion) for discontinued operations - commodity contracts | — | | | (3,697 | ) | | | | | | | | | |
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Total unrealized gain (loss) recognized in other comprehensive income (loss) on derivatives (effective portion) | $ | (12,557 | ) | | $ | (60,152 | ) | | | | | | | | | |
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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 | | | | | | | | |
Hedging Relationships | Accumulated Other Comprehensive Income | March 31, | | | | | | | | |
| (Loss) into Net Income (Effective Portion) | 2015 | | 2014 | | | | | | | | |
| | (Thousands of dollars) | | | | | | | | |
Continuing Operations | | | | | | | | | | | | |
Commodity contracts | Commodity sales revenues | $ | 14,172 | | | $ | (26,419 | ) | | | | | | | | |
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Interest-rate contracts | Interest expense | (3,717 | ) | | (11,321 | ) | | | | | | | | |
Total gain (loss) reclassified from accumulated other comprehensive income (loss) into net income on derivatives (effective portion) | 10,455 | | | (37,740 | ) | | | | | | | | |
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Discontinued Operations | | | | | | | | | | | | |
Commodity contracts | Income (loss) from discontinued operations - | — | | | (12,803 | ) | | | | | | | | |
Commodity sales revenues | | | | | | | | |
Total gain (loss) reclassified from accumulated other comprehensive income (loss) into net income from discontinued operations on derivatives (effective portion) | — | | | (12,803 | ) | | | | | | | | |
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Total gain (loss) reclassified from accumulated other comprehensive income (loss) into net income on derivatives (effective portion) | $ | 10,455 | | | $ | (50,543 | ) | | | | | | | | |
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Ineffectiveness related to ONEOK Partners’ cash flow hedges was not material for the three months ended March 31, 2015 and 2014. Ineffectiveness related to our former energy services business’ cash flow hedges was not material for the three months ended March 31, 2014. In the event that it becomes probable that a forecasted transaction will not occur, we would discontinue cash flow hedge treatment, which would affect earnings. For the three months ended March 31, 2015, there were no gains or losses due to the discontinuance of cash flow hedge treatment. For the three months ended March 31, 2014, we reclassified losses of $4.6 million, net of taxes of $3.1 million, to interest expense from accumulated other comprehensive 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. |
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Credit Risk - 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 with regard to 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. 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 its 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 that were in a net liability position at March 31, 2015. |
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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, 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 March 31, 2015, the net credit exposure from ONEOK Partners’ derivative assets is primarily with investment-grade companies in the financial services sector. |