Derivative Financial Instruments | 3 Months Ended |
Mar. 31, 2015 |
Derivative Financial Instruments | |
Derivative Financial Instruments | Note 5.Derivative Financial Instruments |
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The Partnership principally uses derivative instruments, which include regulated exchange-traded futures and options contracts (collectively, “exchange-traded derivatives”) and physical and financial forwards and over-the counter (“OTC”) swaps (collectively, “OTC derivatives”), to reduce its exposure to unfavorable changes in commodity market prices and interest rates. The Partnership uses these exchange-traded and OTC derivatives to hedge commodity price risk associated with its inventory and undelivered forward commodity purchases and sales (“physical forward contracts”) and uses interest rate swap instruments to reduce its exposure to fluctuations in interest rates associated with the Partnership’s credit facilities. The Partnership accounts for derivative transactions in accordance with ASC 815, “Derivatives and Hedging,” and recognizes derivatives instruments as either assets or liabilities in the consolidated balance sheet and measures those instruments at fair value. The changes in fair value of the derivative transactions are presented currently in earnings, unless specific hedge accounting criteria are met. |
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The fair value of exchange-traded derivative transactions reflects amounts that would be received from or paid to the Partnership’s brokers upon liquidation of these contracts. The fair value of these exchange-traded derivative transactions are presented on a net basis, offset by the cash balances on deposit with the Partnership’s brokers, presented as brokerage margin deposits in the consolidated balance sheets. The fair value of OTC derivative transactions reflects amounts that would be received from or paid to a third party upon liquidation of these contracts under current market conditions. The fair value of these OTC derivative transactions is presented on a gross basis as derivative assets or derivative liabilities in the consolidated balance sheets, unless a legal right of offset exists. The presentation of the change in fair value of the Partnership’s exchange-traded derivatives and OTC derivative transactions depends on the intended use of the derivative and the resulting designation. |
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The following table summarizes the notional values related to the Partnership’s derivative instruments outstanding at March 31, 2015: |
| | Units (1) | | | Unit of Measure | | | | | | | | | | |
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Exchange-Traded Derivatives | | | | | | | | | | | | | | | |
Long | | 46,736 | | | Thousands of barrels | | | | | | | | | | |
Short | | (50,292 | ) | | Thousands of barrels | | | | | | | | | | |
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OTC Derivatives (Petroleum/Ethanol) | | | | | | | | | | | | | | | |
Long | | 13,318 | | | Thousands of barrels | | | | | | | | | | |
Short | | (10,167 | ) | | Thousands of barrels | | | | | | | | | | |
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OTC Derivatives (Natural Gas) | | | | | | | | | | | | | | | |
Long | | 10,607 | | | Thousands of decatherms | | | | | | | | | | |
Short | | (10,661 | ) | | Thousands of decatherms | | | | | | | | | | |
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Interest Rate Swaps | $ | 200 | | | 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) | $ | 6 | | | Millions of Canadian dollars | | | | | | | | | | |
| $ | 4.7 | | | Millions of U.S. dollars | | | | | | | | | | |
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(1)Number of open positions and gross notional values do not measure the Partnership’s risk of loss, quantify risk or represent assets or liabilities of the Partnership, but rather indicate the relative size of the derivative instruments and are used in the calculation of the amounts to be exchanged between counterparties upon settlements. |
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(2)All-in forward rate Canadian dollars (“CAD”) $1.2662 to USD $1.00. |
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Derivatives Accounted for as Hedges |
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The Partnership utilizes fair value hedges and cash flow hedges to hedge commodity price risk and interest rate risk. |
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Fair Value Hedges |
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Derivatives designated as fair value hedges are used to hedge price risk in commodity inventories and principally include exchange-traded futures contracts that are entered into in the ordinary course of business. For a derivative instrument designated as a fair value hedge, the gain or loss is recognized in earnings in the period of change together with the offsetting change in fair value on the hedged item of the risk being hedged. Gains and losses related to fair value hedges 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 fair value hedges include exchange-traded futures contracts that are hedges against inventory with specific futures contracts matched to specific barrels. The change in fair value of these futures contracts and the change in fair value of the underlying inventory generally provide an offset to each other in the consolidated statement of income. |
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The following table presents the gains and losses from the Partnership’s derivative instruments involved in fair value hedging relationships recognized in the consolidated statements of income for the three months ended March 31, 2015 and 2014 (in thousands): |
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| | Statement of Gain (Loss) | | Three Months Ended | | | | | | | |
| | Recognized in Income on | | March 31, | | | | | | | |
| | Derivatives | | 2015 | | 2014 | | | | | | | |
Derivatives in fair value hedging relationship | | | | | | | | | | | | | |
Exchange-traded futures contracts for petroleum commodity products | | Cost of sales | | $ | 26,176 | | $ | 16,373 | | | | | | | |
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Hedged items in fair value hedge relationship | | | | | | | | | | | | | |
Physical inventory | | Cost of sales | | $ | (23,621 | ) | $ | (16,209 | ) | | | | | | |
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Cash Flow Hedges |
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Derivatives designated as cash flow hedges are used to hedge interest rate risk from fluctuations in interest rates and may include various interest rate derivative instruments entered into with major financial institutions. For a derivative instrument being designated as a cash flow hedges, the effective portion of the derivative gain or loss is initially reported as a component of other comprehensive income (loss) and subsequently reclassified into the consolidated statement of income through interest expense in the same period that the hedged exposure affects earnings. The ineffective portion is recognized in the consolidated statement of income immediately. |
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The Partnership’s cash flow hedges currently include interest rate swaps and an interest rate cap that are hedges of variability in forecasted interest payments due to changes in the interest rate on LIBOR-based borrowings, a summary of which includes the following designations: |
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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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| · | | In September 2013, the Partnership executed an interest rate swap with a major financial institution. The swap, which became effective on October 2, 2013 and expires on October 2, 2018, is used to hedge the variability in cash flows in monthly 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 1.819%. | | | | | | | | | | | | |
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In the aggregate, these hedging instruments have historically been effective in hedging the variability in interest payments due to changes in the one-month LIBOR swap curve or rate with respect to $300.0 million of one-month LIBOR-based borrowings on the credit facility. |
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In June 2014 and as a result of the issuance of the Partnership’s $375.0 million aggregate principal amount of its 6.25% senior notes due 2022 (see Note 6), the Partnership determined that maintaining an excess of $300.0 million in principal of outstanding floating-rate debt was no longer probable. Therefore, the Partnership elected to de-designate its interest rate cap and discontinued the related hedge accounting for this instrument. Accordingly, at March 31, 2015, the Partnership had in place two interest rate swap agreements which are hedging $200.0 million of variable rate debt, both of which continue to be accounted for as cash flow hedges. The interest rate cap is not currently in a hedging relationship. Accordingly, all changes in fair value of this instrument subsequent to the date of de-designation are recorded in the consolidated statement of income through interest expense. |
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The following table presents the amount of gains and losses from the Partnership’s derivative instruments designated in cash flow hedging relationships recognized in the consolidated statements of income and partners’ equity for the three months ended March 31, 2015 and 2014 (in thousands): |
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| | Amount of Gain (Loss) | | Location of Gain (Loss) | | | |
| | Recognized in Other | | Reclassified from | | Amount of Gain (Loss) | |
| | Comprehensive Income on | | Accumulated Other | | Reclassified from Other | |
| | Derivatives | | Comprehensive Income into | | Comprehensive Income into | |
| | (Effective Portion) | | Income (Effective Portion) | | Income (Effective Portion) | |
Derivatives Designated | | Three Months Ended | | | | Three Months Ended | |
in Cash Flow Hedging | | March 31, | | | | March 31, | |
Relationship | | 2015 | | 2014 | | | | 2015 | | 2014 | |
Interest rate swaps | | $ | 47 | | $ | 677 | | Interest expense | | $ | — | | $ | — | |
Interest rate cap (1) | | — | | (18 | ) | Interest expense | | — | | — | |
Total | | $ | 47 | | $ | 659 | | | | $ | — | | $ | — | |
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| -1 | | The interest rate cap was de-designated as a cash flow hedge in June 2014. Prepaid interest rate caplet amounts recognized in accumulated other comprehensive income up until the date of de-designation have been frozen in partner’s equity as of the de-designation date and are being amortized to income through the tenor of the interest rate cap instrument. The change in the fair value of the interest rate cap following de-designation is reflected in earnings and was immaterial for the three months ended March 31, 2015. As of March 31, 2015, the remaining unamortized prepaid interest rate caplets were $0.9 million and will be amortized over the remaining life for the interest rate cap which expires in April 2016. | | | | | | | | | | | | |
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The amount of gain (loss) recognized in income as ineffectiveness for derivatives designated in cash flow hedging relationships was $0 for the three months ended March 31, 2015 and 2014. |
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Derivatives NOT Accounted for as Hedges |
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The Partnership utilizes petroleum and ethanol commodity contracts, natural gas commodity contracts and foreign currency derivatives to hedge price and currency risk in certain commodity inventories and physical forward contracts. |
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Petroleum and Ethanol Commodity Contracts |
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The Partnership uses exchange-traded derivative contracts to hedge price risk in certain commodity inventories which do not qualify for fair value hedge accounting or are not designated by the Partnership as fair value hedges. Additionally, the Partnership uses exchange-traded derivative contracts, and occasionally financial forward and OTC swap agreements, to hedge commodity exposure associated with its physical forward contracts which are not designated by the Partnership as cash flow hedges. These physical forward contracts, to the extent they meet the definition of a derivative, are considered OTC physical forwards and are reflected as derivative assets or derivative liabilities in the consolidated balance sheet. The related exchange-traded derivative contracts (and financial forward and OTC swaps, if applicable) are also reflected as brokerage margin deposits (and derivative assets or derivative liabilities, if applicable) in the consolidated balance sheet, thereby creating an economic hedge. Changes in fair value of these derivative instruments 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 commodity product purchase and sale activities, it may experience net unbalanced positions for short periods of time as a result of variances in daily purchases and 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, the Partnership is aided by maintaining a constant presence in the marketplace. The Partnership also engages in a controlled trading program for up to an aggregate of 250,000 barrels of commodity products at any one point in time. Changes in fair value of these derivative instruments are recognized in the consolidated statement of income through cost of sales. |
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Natural Gas Commodity Contracts |
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The Partnership uses physical forward purchase contracts to hedge price risk associated with the marketing and selling of natural gas to third-party users. These physical forward purchase commitments for natural gas are typically executed when the Partnership enters into physical forward sale commitments of product for physical delivery. These physical forward contracts, to the extent they meet the definition of a derivative, are reflected as derivative assets and derivative liabilities in the consolidated balance sheet. Changes in 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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Foreign Currency Contracts |
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The Partnership uses forward foreign currency contracts to hedge certain foreign denominated (Canadian) commodity product purchases. These forward foreign currency contracts are not designated by the Partnership as hedges and are reflected as prepaid expenses and other current assets or accrued expenses and other current liabilities in the consolidated balance sheets. Changes in fair values of these forward foreign currency contracts are reflected in cost of sales. |
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The following table presents the gains and losses from the Partnership’s derivative instruments not involved in hedging relationships recognized in the consolidated statements of income for the three months ended March 31, 2015 and 2014 (in thousands): |
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| | Statement of Gain (Loss) | | Three Months Ended | | | | | | | |
| | Recognized in Income on | | March 31, | | | | | | | |
| | Derivatives | | 2015 | | 2014 | | | | | | | |
Derivatives NOT designated as hedging instruments | | | | | | | | | | | | | |
Commodity contracts | | Cost of sales | | $ | 3,651 | | $ | 15,543 | | | | | | | |
Forward foreign currency contracts | | Cost of sales | | 18 | | (57 | ) | | | | | | |
Total | | | | $ | 3,669 | | $ | 15,486 | | | | | | | |
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Margin Deposits |
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All of Partnership’s exchange-traded derivative contracts (designated and not designated) are transacted through clearing brokers. The Partnership deposits initial margin with the clearing brokers, along with variation margin, which is paid or received on a daily basis, based upon the changes in fair value of open futures contracts and settlement of closed futures contracts. Cash balances on deposit with clearing brokers and open equity are presented on a net basis within brokerage margin deposits in the consolidated balance sheets. |
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Commodity Contracts and Other Derivative Activity |
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The Partnership’s commodity contract derivatives and other derivative activity include: (i) exchange-traded derivative contracts that are hedges against inventory and either do not quality for hedge accounting or are not designated in a hedge accounting relationship, (ii) exchange-traded derivative contracts used to economically hedge physical forward contracts, (iii) financial forward and swap agreements used to economically hedge physical forward contracts, and (iv) the derivative instruments under the Partnership’s controlled trading program. The Partnership does not take the normal purchase and sale exemption available under ASC 815. |
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The following table presents the fair value of each classification of the Partnership’s derivative instruments and its location in the consolidated balance sheets at March 31, 2015 and December 31, 2014 (in thousands): |
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| | | | March 31, 2015 | | | | |
| | | | Derivatives | | Derivatives Not | | | | | | |
| | | | Designated as | | Designated as | | | | | | |
| | | | Hedging | | Hedging | | | | | | |
| | Balance Sheet Location | | Instruments | | Instruments | | Total | | | | |
Asset Derivatives | | | | | | | | | | | | |
Exchange-traded derivative contracts | | Broker margin deposits | | $ | 17,895 | | $ | 60,354 | | $ | 78,249 | | | | |
Forward derivative contracts (1) | | Derivative assets | | — | | 57,470 | | 57,470 | | | | |
Forward foreign currency contracts | | Other Assets | | — | | 27 | | 27 | | | | |
Interest rate cap contract | | Other assets | | — | | 17 | | 17 | | | | |
Total asset derivatives | | | | $ | 17,895 | | $ | 117,868 | | $ | 135,763 | | | | |
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Liability Derivatives | | | | | | | | | | | | |
Forward derivative contracts (1) | | Derivative liabilities | | $ | — | | $ | 48,272 | | $ | 48,272 | | | | |
Interest rate swap contracts | | Other long-term liabilities | | — | | 6,649 | | 6,649 | | | | |
Total liability derivatives | | | | $ | — | | $ | 54,921 | | $ | 54,921 | | | | |
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| | | | December 31, 2014 | | | | |
| | | | Derivatives | | Derivatives Not | | | | | | |
| | | | Designated as | | Designated as | | | | | | |
| | | | Hedging | | Hedging | | | | | | |
| | Balance Sheet Location | | Instruments | | Instruments | | Total | | | | |
Asset Derivatives | | | | | | | | | | | | |
Exchange-traded derivative contracts | | Broker margin deposits | | $ | 30,600 | | $ | 90,890 | | $ | 121,490 | | | | |
Forward derivative contracts (1) | | Derivative assets | | — | | 83,826 | | 83,826 | | | | |
Forward foreign currency contracts | | Other Assets | | — | | 9 | | 9 | | | | |
Interest rate cap contract | | Other assets | | — | | 17 | | 17 | | | | |
Total asset derivatives | | | | $ | 30,600 | | $ | 174,742 | | $ | 205,342 | | | | |
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Liability Derivatives | | | | | | | | | | | | |
Forward derivative contracts (1) | | Derivative liabilities | | $ | — | | $ | 58,507 | | $ | 58,507 | | | | |
Interest rate swap contracts | | Other long-term liabilities | | — | | 6,696 | | 6,696 | | | | |
Total liability derivatives | | | | $ | — | | $ | 65,203 | | $ | 65,203 | | | | |
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| -1 | | Forward derivative contracts include the Partnership’s petroleum and ethanol physical and financial forwards and OTC swaps. | | | | | | | | | | | | |
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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 to the Partnership’s exchange-traded and OTC derivative contracts, but the Partnership has no current reason to expect any material nonperformance by any of these counterparties. Exchange-traded derivative 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”), Chicago Mercantile Exchange (“CME”) and IntercontinentalExchange (“ICE”) derivative transactions and the right of offset exists with these financial institutions under master netting agreements. Accordingly, the fair value of the Partnership’s exchange-traded derivative instruments is presented on a net basis in the consolidated balance sheets. Exposure on OTC derivatives is limited to the amount of the recorded fair value as of the balance sheet dates. |
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