Item 7A. Quantitative and Qualitative Disclosures About Market Risk
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Changes in commodity prices (mainly crude oil and unleaded gasoline) and interest rates are our primary sources of market risk. When we make the decision to manage our market exposure, our objective is generally to avoid losses from adverse price changes, realizing we will not obtain the gains of beneficial price changes.
Impact of Changing Prices
Our revenues and cash flows, as well as estimates of future cash flows, are sensitive to changes in energy prices. Major shifts in the cost of crude oil, the prices of refined products and the cost of ethanol can generate large changes in the operating margin in each of our segments.
We maintain, at both company-owned and third-party facilities, inventories of crude oil, feedstocks and refined petroleum products, the values of which are subject to wide fluctuations in market prices driven by world economic conditions, regional and global inventory levels and seasonal conditions. At December 31, 2021 and 2020, we held approximately 5.0 million and 3.8 million barrels, respectively, of crude and product inventories associated with the Tyler refinery valued under the last-in, first-out ("LIFO") valuation method, with an average cost of $65.56 and $52.50 per barrel, respectively. At December 31, 2021 and 2020, the excess of replacement cost over the carrying value of refinery inventories was $68.4 million and $3.4 million, respectively. At December 31, 2021 and 2020, we held approximately 8.7 million and 9.1 million barrels, respectively, of crude and product inventories associated with the El Dorado, Big Spring and Krotz Springs refineries valued under the first-in, first-out ("FIFO") valuation method, with an average cost of $81.04 and $49.31 per barrel, respectively. In periods of declining crude oil and refined product pricing, market prices may decline to a level below the average cost of our inventories. At December 31, 2021, we recorded a pre-tax inventory valuation reserve of $8.8 million, none of which related to LIFO inventory. At December 31, 2020, we recorded a pre-tax
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Management's Discussion and Analysis
inventory valuation reserve of $31.1 million, of which $30.3 million related to LIFO inventory, which is subject to reversal in subsequent periods, not to exceed LIFO cost, when those physical inventory quantities are sold. For the years ended December 31, 2021, 2020 and 2019, we recognized net inventory valuation (losses) gains of $(8.8) million, $(31.1) million and $37.6 million, respectively, which were recorded as a component of cost of materials and other in the consolidated statements of income.
From time to time, we also may enter into forward purchase or sale derivative contracts for trading purposes (primarily in our Canadian business) and, as a result, may have trading investment commodities on hand related to the purchased inventory. Such derivative contracts and related investment commodities are recorded at fair value and subject to pricing risk each period with changes in fair value reflected in other operating income, net in the profit and loss section of our consolidated financial statements. For the years ended December 31, 2021, 2020 and 2019, all of our forward purchase and sales contracts that were accounted for as derivative instruments consisted of contracts related to our Canadian trading activities.
Price Risk Management Activities
At times, we enter into the following instruments/transactions in order to manage our market-indexed pricing risk: commodity derivative contracts which we use to manage our price exposure to our inventory positions, future purchases of crude oil and ethanol, future sales of refined products or to fix margins on future production; and future commitments to purchase or sell RINs at fixed prices and quantities, which are used to manage the costs associated with our RINs obligations and meet the definition of derivative instruments under Accounting Standards Codification ("ASC") 815, Derivatives and Hedging ("ASC 815"). In accordance with ASC 815, all of these commodity contracts and future purchase commitments are recorded at fair value, and any change in fair value between periods has historically been recorded in the profit and loss section of our consolidated financial statements. Occasionally, at inception, the Company will elect to designate the commodity derivative contracts as cash flow hedges under ASC 815. Gains or losses on commodity derivative contracts accounted for as cash flow hedges are recognized in other comprehensive income on the consolidated balance sheets and, ultimately, when the forecasted transactions are completed in net revenues or cost of materials and other in the consolidated statements of income.
The following table sets forth information relating to our open commodity derivative contracts, excluding our trading derivative contracts (which are presented separately below), as of December 31, 2021 ($ in millions):
Total Outstanding Notional Contract Volume by Year of Maturity
Contract Description Fair Value Notional Contract Volume 2022 2023 2024 2025 2026
Contracts not designated as hedging instruments:
Crude oil price swaps - long (1)
$ 21.0 22,529,000 25,929,000 — — — —
Crude oil price swaps - short (1)
(27.2) 16,488,000 20,038,000 — — — —
Inventory, refined product and crack spread swaps - long (1)
51.6 67,591,000 52,791,000 14,800,000 — — —
Inventory, refined product and crack spread swaps - short (1)
(50.2) 69,393,000 54,593,000 14,800,000 — — —
Natural gas swaps - short (3)
— 1,320,000 1,320,000 — — — —
RINs commitment contracts - long (2)
1.4 13,325,000 — — — — —
RINs commitment contracts - short (2)
(0.5) 3,000,000 — — — — —
Total $ (3.9) 193,646,000 154,671,000 29,600,000 — — —
(1) Volume in barrels (2) Volume in RINs (3) Volume in MMBTU
Interest Rate Risk
We have market exposure to changes in interest rates relating to our outstanding floating rate borrowings, which totaled approximately $1,547.2 million as of December 31, 2021. The annualized impact of a hypothetical one percent change in interest rates on our floating rate debt outstanding as of December 31, 2021 would be to change interest expense by approximately $15.5 million.
LIBOR Transition
LIBOR is a commonly used indicative measure of the average interest rate at which major global banks could borrow from one another. The United Kingdom’s Financial Conduct Authority, which regulates LIBOR discontinued the reporting of certain LIBOR rates on December 31, 2021, and has publically announced that it intends to discontinue all USD LIBOR rates after June 2023. Certain of our agreements use LIBOR as a “benchmark” or “reference rate” for various terms. Some agreements contain an existing LIBOR alternative. Where there is not an alternative, we expect to replace the LIBOR benchmark with an alternative reference rate. While we do not expect the transition to an alternative rate to have a significant impact on our business or operations, it is possible that the move away from LIBOR could materially impact our borrowing costs on our variable rate indebtedness.
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Management's Discussion and Analysis
Commodity Derivatives Trading Activities
We enter into active trading positions in a variety of commodity derivatives, which include forward physical contracts, swap contracts, and futures contracts. These trading activities are undertaken by using a range of contract types in combination to create incremental gains by capitalizing on crude oil supply and pricing seasonality. These contracts are classified as held for trading and are recognized at fair value with changes in fair value recognized in the income statement.
The following table sets forth information relating to trading commodity derivative contracts as of December 31, 2021 ($ in millions):
Total Outstanding Notional Contract Volume by Year of Maturity
Contract Description Fair Value Notional Contract Volume 2022 2023 2024 2025 2026
Crude oil price swaps - long (1)
$ 21.9 3,400,000 3,400,000 — — — —
Crude oil price swaps - short (1)
(2.2) 3,550,000 3,550,000 — — — —
Crude forward contracts- long (1)
152.6 2,406,412 2,406,412 — — — —
Crude forward contracts- short (1)
(157.3) 2,468,481 2,468,481 — — — —
Total $ 15.0 11,824,893 11,824,893 — — — —
(1) Volume in barrels.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by Item 8 is incorporated by reference to the section beginning on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.