Derivative Financial Instruments | 6 Months Ended |
Jun. 30, 2013 |
Derivative Financial Instruments | ' |
Derivative Financial Instruments | ' |
Note 6. Derivative Financial Instruments |
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Accounting and reporting guidance for derivative instruments and hedging activities requires that an entity recognize derivatives as either assets or liabilities on the balance sheet and measure the instruments at fair value. Changes in the fair value of the derivative are to be recognized currently in earnings, unless specific hedge accounting criteria are met. The Partnership principally uses derivative instruments to hedge the commodity risk associated with its inventory and product purchases and sales and to hedge variable interest rates associated with the Partnership’s credit facilities. |
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The following table presents the volume of activity related to the Partnership’s derivative financial instruments at June 30, 2013: |
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| | Units (1) | | Unit of Measure | | | | | | | | | | | | | | | | | | | | |
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Futures Contracts | | | | | | | | | | | | | | | | | | | | | | | | |
Long | | 10,673 | | Thousands of barrels | | | | | | | | | | | | | | | | | | | | |
Short | | (13,471 | ) | Thousands of barrels | | | | | | | | | | | | | | | | | | | | |
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Natural Gas Contracts | | | | | | | | | | | | | | | | | | | | | | | | |
Long | | 6,643 | | Thousands of decatherms | | | | | | | | | | | | | | | | | | | | |
Short | | (6,643 | ) | Thousands of decatherms | | | | | | | | | | | | | | | | | | | | |
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Interest Rate Collar | | $ | 100 | | Millions of U.S. dollars | | | | | | | | | | | | | | | | | | | | |
Interest Rate Swap | | $ | 100 | | Millions of U.S. dollars | | | | | | | | | | | | | | | | | | | | |
Interest Rate Cap | | $ | 100 | | Millions of U.S. dollars | | | | | | | | | | | | | | | | | | | | |
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Foreign Currency Derivatives | | | | | | | | | | | | | | | | | | | | | | | | |
Open Forward Exchange Contracts (2) | | $ | 20.2 | | Millions of Canadian dollars | | | | | | | | | | | | | | | | | | | | |
| | $ | 19.2 | | Millions of U.S. dollars | | | | | | | | | | | | | | | | | | | | |
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(1) Number of open positions and gross notional amounts do not quantify risk or represent assets or liabilities of the Partnership, but are used in the calculation of daily cash settlements under the contracts. |
(2) All-in forward rate Canadian dollars (“CAD”) $1.0521 to USD $1.00. |
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Fair Value Hedges |
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The Partnership enters into futures contracts in the normal course of business to reduce the risk of loss of inventory value, which could result from fluctuations in market prices. These futures contracts are designated as fair value hedges against the inventory with specific futures contracts matched to specific barrels of inventory. As a result of the Partnership’s hedge designation on these transactions, the futures contracts are recorded on the Partnership’s consolidated balance sheet and marked to market through the use of independent markets based on the prevailing market prices of such instruments at the date of valuation. Likewise, the underlying inventory being hedged is also marked to market. Changes in the fair value of the futures contracts, as well as the change in the fair value of the hedged inventory, are recognized in the consolidated statement of income through cost of sales. These futures contracts are settled on a daily basis by the Partnership through brokerage margin accounts. |
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The Partnership’s futures contracts are settled daily; therefore, there was no corresponding asset or liability on the Partnership’s consolidated balance sheet related to these contracts at June 30, 2013 and December 31, 2012. These contracts remain open until their contract end date. The daily settlement of these futures contracts is accomplished through the use of brokerage margin deposit accounts. |
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The following table presents the hedge ineffectiveness from derivatives involved in fair value hedging relationships recognized in the Partnership’s consolidated statements of operations for the three and six months ended June 30, 2013 and 2012 (in thousands): |
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| | | | Amount of Gain (Loss) Recognized in | | | | | | | | | | | |
| | | | Income on Derivatives | | | | | | | | | | | |
| | Location of Gain (Loss) | | Three Months Ended | | Six Months Ended | | | | | | | | | | | |
Derivatives in Fair Value | | Recognized in | | June 30, | | June 30, | | | | | | | | | | | |
Hedging Relationships | | Income on Derivative | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | |
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Futures contracts | | Cost of sales | | $ | 30,486 | | $ | 80,430 | | $ | 20,101 | | $ | (9,448 | ) | | | | | | | | | | |
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| | | | Amount of Gain (Loss) Recognized in | | | | | | | | | | | |
| | | | Income on Hedged Items | | | | | | | | | | | |
| | Location of Gain (Loss) | | Three Months Ended | | Six Months Ended | | | | | | | | | | | |
Hedged Items in Fair Value | | Recognized in | | June 30, | | June 30, | | | | | | | | | | | |
Hedged Relationships | | Income on Hedged Items | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | |
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Inventories | | Cost of sales | | $ | (29,974 | ) | $ | (80,354 | ) | $ | (19,578 | ) | $ | 9,602 | | | | | | | | | | | |
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Cash Flow Hedges |
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The Partnership utilizes various interest rate derivative instruments to hedge variable interest rate on its debt. These derivative instruments are designated as cash flow hedges of the underlying debt. To the extent such hedges are effective, the changes in the fair value of the derivative instrument are reported as a component of other comprehensive income (loss) and reclassified into interest expense or interest income in the same period during which the hedged transaction affects earnings. |
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In September 2008, the Partnership executed a zero premium interest rate collar with a major financial institution. The collar, which became effective on October 2, 2008 and expires on October 2, 2013, is used to hedge the variability in cash flows in monthly interest payments made on $100.0 million of one-month LIBOR-based borrowings on the credit facility (and subsequent refinancings thereof) due to changes in the one-month LIBOR rate. |
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In October 2009, the Partnership executed an interest rate swap with a major financial institution. The swap, which became effective on May 16, 2011 and expires on May 16, 2016, is used to hedge the variability in interest payments due to changes in the one-month LIBOR swap curve with respect to $100.0 million of one-month LIBOR-based borrowings on the credit facility at a fixed rate of 3.93%. |
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In April 2011, the Partnership executed an interest rate cap with a major financial institution. The rate cap, which became effective on April 13, 2011 and expires on April 13, 2016, is used to hedge the variability in interest payments due to changes in the one-month LIBOR rate above 5.5% with respect to $100.0 million of one-month LIBOR-based borrowings on the credit facility. |
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The following table presents the fair value of the Partnership’s derivative instruments involved in cash flow hedging relationships and their location in the Partnership’s consolidated balance sheets at June 30, 2013 and December 31, 2012 (in thousands): |
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| | | | June 30, | | December 31, | | | | | | | | | | | | | | | | | |
Derivatives Designated as | | | | 2013 | | 2012 | | | | | | | | | | | | | | | | | |
Hedging Instruments | | Balance Sheet Location | | Fair Value | | Fair Value | | | | | | | | | | | | | | | | | |
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Asset derivatives | | | | | | | | | | | | | | | | | | | | | | | |
Interest rate cap | | Other assets | | $ | 92 | | $ | 35 | | | | | | | | | | | | | | | | | |
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Liability derivatives | | | | | | | | | | | | | | | | | | | | | | | |
Interest rate collar | | Other long-term liabilities | | $ | 642 | | $ | 1,868 | | | | | | | | | | | | | | | | | |
Interest rate swap | | Other long-term liabilities | | 9,295 | | 11,534 | | | | | | | | | | | | | | | | | |
Total liability derivatives | | | | $ | 9,937 | | $ | 13,402 | | | | | | | | | | | | | | | | | |
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The following table presents the amount of net gains and losses from derivatives involved in cash flow hedging relationships recognized in the Partnership’s consolidated statements of operations and partners’ equity for the three and six months ended June 30, 2013 and 2012 (in thousands): |
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| | | | Recognized in Income | | | | | | Recognized in Income | |
| | | | on Derivatives | | | | | | on Derivatives | |
| | Amount of Gain (Loss) | | (Ineffectiveness Portion | | Amount of Gain (Loss) | | (Ineffectiveness Portion | |
| | Recognized in Other | | and Amount Excluded | | Recognized in Other | | and Amount Excluded | |
| | Comprehensive Income | | from Effectiveness | | Comprehensive Income | | from Effectiveness | |
| | on Derivatives | | Testing) | | on Derivatives | | Testing) | |
Derivatives in | | Three Months Ended | | Three Months Ended | | Six Months Ended | | Six Months Ended | |
Cash Flow | | June 30, | | June 30, | | June 30, | | June 30, | | June 30, | | June 30, | | June 30, | | June 30, | |
Hedging Relationship | | 2013 | | 2012 | | 2013 | | 2012 | | 2013 | | 2012 | | 2013 | | 2012 | |
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Interest rate collar | | $ | 611 | | $ | 545 | | $ | — | | $ | — | | $ | 1,226 | | $ | 860 | | $ | — | | $ | — | |
Interest rate swap | | 1,376 | | (383 | ) | — | | — | | 2,239 | | 56 | | — | | — | |
Interest rate cap | | 62 | | (204 | ) | — | | — | | 57 | | (227 | ) | — | | — | |
Total | | $ | 2,049 | | $ | (42 | ) | $ | — | | $ | — | | $ | 3,522 | | $ | 689 | | $ | — | | $ | — | |
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Ineffectiveness related to the interest rate collar and the interest rate swap is recognized as interest expense and was immaterial for the three and six months ended June 30, 2013 and 2012. The effective portion related to the interest rate collar that was originally reported in other comprehensive income and reclassified to earnings was $0.7 million and $0.6 million for the three months ended June 30, 2013 and 2012, respectively, and $1.3 million and $1.2 million for the six months ended June 30, 2013 and 2012, respectively. None of the effective portion related to the interest rate cap that was originally reported in other comprehensive income was reclassified into earnings for the three and six months ended June 30, 2013 and 2012. |
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Other Derivative Activity |
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The Partnership uses futures contracts, and occasionally swap agreements, to hedge its commodity exposure under forward fixed price purchase and sale commitments on its products. These derivatives are not designated by the Partnership as either fair value hedges or cash flow hedges. Rather, the forward fixed price purchase and sales commitments, which meet the definition of a derivative, are reflected in the Partnership’s consolidated balance sheet. The related futures contracts (and swaps, if applicable) are also reflected in the Partnership’s consolidated balance sheet, thereby creating an economic hedge. Changes in the fair value of the futures contracts (and swaps, if applicable), as well as offsetting gains or losses due to the change in the fair value of forward fixed price purchase and sale commitments, are recognized in the consolidated statement of income through cost of sales. These futures contracts are settled on a daily basis by the Partnership through brokerage margin accounts. |
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While the Partnership seeks to maintain a position that is substantially balanced within its product purchase activities, it may experience net unbalanced positions for short periods of time as a result of variances in daily sales and transportation and delivery schedules as well as other logistical issues inherent in the business, such as weather conditions. In connection with managing these positions, maintaining a constant presence in the marketplace and managing the futures market outlook for future anticipated inventories, which are necessary for its business, the Partnership engages in a controlled trading program for up to an aggregate of 250,000 barrels of products at any one point in time. Any derivatives not involved in a direct hedging activity are marked to market and recognized in the consolidated statement of income through cost of sales. |
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The Partnership also markets and sells natural gas and propane by entering into forward purchase commitments for natural gas and propane when it enters into arrangements for the forward sale commitment of product for physical delivery to third-party users. The Partnership reflects the fair value of forward fixed purchase and sales commitments in its consolidated balance sheet. Changes in the fair value of the forward fixed price purchase and sale commitments are recognized in the consolidated statement of income through cost of sales. |
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During the three and six months ended June 30, 2013, the Partnership entered into forward currency contracts to hedge certain foreign denominated (Canadian) product purchases. These forward contracts are not designated and are reflected in the consolidated balance sheet. Changes in the fair values of these forward currency contracts are reflected in cost of sales. |
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Similar to the futures contracts used by the Partnership to hedge its inventory, the Partnership’s futures contracts are settled daily and, accordingly, there was no corresponding asset or liability in the Partnership’s consolidated balance sheets related to these contracts at June 30, 2013 and December 31, 2012. These contracts remain open until their contract end date. The daily settlement of these futures contracts is accomplished through the use of brokerage margin deposit accounts. |
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The following table summarizes the derivatives not designated by the Partnership as either fair value hedges or cash flow hedges and their respective fair values and location in the Partnership’s consolidated balance sheets at June 30, 2013 and December 31, 2012 (in thousands): |
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| | | | | | June 30, | | December 31, | | | | | | | | | | | | | | | |
| | | | Balance Sheet | | 2013 | | 2012 | | | | | | | | | | | | | | | |
Summary of Other Derivatives | | Item Pertains to | | Location | | Fair Value | | Fair Value | | | | | | | | | | | | | | | |
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Asset Derivatives | | | | | | | | | | | | | | | | | | | | | | | |
Forward purchase commitments | | Gasoline and Gasoline Blendstocks | | -1 | | $ | 636 | | $ | 131 | | | | | | | | | | | | | | | |
| | Crude Oil | | -1 | | — | | 15,127 | | | | | | | | | | | | | | | |
| | Residual Oil | | -1 | | — | | 285 | | | | | | | | | | | | | | | |
Total forward purchase commitments | | | | | | 636 | | 15,543 | | | | | | | | | | | | | | | |
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Forward sales commitments | | Gasoline and Gasoline Blendstocks | | -1 | | 407 | | 30,928 | | | | | | | | | | | | | | | |
| | Distillates | | -1 | | 847 | | — | | | | | | | | | | | | | | | |
| | Natural Gas | | -1 | | 50 | | 1,591 | | | | | | | | | | | | | | | |
| | Propane | | -1 | | 82 | | — | | | | | | | | | | | | | | | |
Total forward sales commitments | | | | | | 1,386 | | 32,519 | | | | | | | | | | | | | | | |
Total forward fixed price contracts | | | | | | 2,022 | | 48,062 | | | | | | | | | | | | | | | |
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Foreign currency forward contract | | Foreign Denominated Sales | | -2 | | 380 | | 145 | | | | | | | | | | | | | | | |
Total asset derivatives | | | | | | $ | 2,402 | | $ | 48,207 | | | | | | | | | | | | | | | |
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Liability Derivatives | | | | | | | | | | | | | | | | | | | | | | | |
Forward purchase commitments | | Gasoline and Gasoline Blendstocks | | -3 | | $ | 116 | | $ | 27,604 | | | | | | | | | | | | | | | |
| | Crude Oil | | -3 | | 8,990 | | — | | | | | | | | | | | | | | | |
| | Residual Oil | | -3 | | 277 | | — | | | | | | | | | | | | | | | |
| | Distillates | | -3 | | 516 | | 2,171 | | | | | | | | | | | | | | | |
| | Natural Gas | | -3 | | 49 | | 1,576 | | | | | | | | | | | | | | | |
| | Propane | | -3 | | 97 | | — | | | | | | | | | | | | | | | |
Total forward purchase commitments | | | | | | 10,045 | | 31,351 | | | | | | | | | | | | | | | |
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Forward sales commitments | | Gasoline and Gasoline Blendstocks | | -3 | | — | | 173 | | | | | | | | | | | | | | | |
| | Distillates | | -3 | | — | | 2,950 | | | | | | | | | | | | | | | |
Total forward sales commitments | | | | | | — | | 3,123 | | | | | | | | | | | | | | | |
Total obligations on forward fixed price contracts | | | | | | $ | 10,045 | | $ | 34,474 | | | | | | | | | | | | | | | |
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(1) Fair value of forward fixed price contracts |
(2) Prepaid expenses and other current assets |
(3) Obligations on forward fixed price contracts |
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The following table presents the amount of gains and losses from derivatives not involved in a hedging relationship recognized in the Partnership’s consolidated statements of operations for the three and six months ended June 30, 2013 and 2012 (in thousands): |
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| | | | Amount of Gain (Loss) | | Amount of Gain (Loss) | | | | | | | | | | | |
| | Location of | | Recognized in Income | | Recognized in Income | | | | | | | | | | | |
| | Gain (Loss) | | on Derivatives | | on Derivatives | | | | | | | | | | | |
| | Recognized in | | Three Months Ended | | Six Months Ended | | | | | | | | | | | |
Derivatives Not Designated as | | Income on | | June 30, | | June 30, | | June 30, | | June 30, | | | | | | | | | | | |
Hedging Instruments | | Derivatives | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | |
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Product contracts | | Cost of sales | | $ | 2,981 | | $ | 2,872 | | $ | 3,647 | | $ | 4,604 | | | | | | | | | | | |
Foreign currency contracts | | Cost of sales | | 555 | | (39 | ) | 234 | | (39 | ) | | | | | | | | | | |
Total | | | | $ | 3,536 | | $ | 2,833 | | $ | 3,881 | | $ | 4,565 | | | | | | | | | | | |
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Credit Risk |
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The Partnership’s derivative financial instruments do not contain credit risk related to other contingent features that could cause accelerated payments when these financial instruments are in net liability positions. |
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The Partnership is exposed to credit loss in the event of nonperformance by counterparties of forward purchase and sale commitments, futures contracts and swap agreements, but the Partnership has no current reason to expect any material nonperformance by any of these counterparties. Futures contracts, the primary derivative instrument utilized by the Partnership, are traded on regulated exchanges, greatly reducing potential credit risks. The Partnership utilizes primarily three clearing brokers, all major financial institutions, for all New York Mercantile Exchange (“NYMEX”) and Chicago Mercantile Exchange (“CME”) derivative transactions and the right of offset exists. Accordingly, the fair value of derivative instruments is presented on a net basis in the consolidated balance sheets. Exposure on forward purchase and sale commitments and swap agreements is limited to the amount of the recorded fair value as of the balance sheet dates. |