Item 3. Quantitative and Qualitative Disclosures About Market Risk
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK.
General
In the normal course of our business operations, we are exposed to certain risks, including changes in interest rates and commodity prices. In order to manage risks associated with assets, liabilities and certain anticipated future transactions, we use derivative instruments such as futures, forward contracts, swaps and other instruments with similar characteristics. Substantially all of our derivatives are used for non-trading activities.
We assess the risk associated with each of our derivative instrument portfolios using a sensitivity analysis model. This approach measures the change in fair value of the derivative instrument portfolio based on a hypothetical 10% change in the underlying interest rates or quoted market prices on a particular day. In addition to these variables, the fair value of each portfolio is influenced by changes in the notional amounts of the instruments outstanding and the discount rates used to determine the present values. The sensitivity analysis approach does not reflect the impact that the same hypothetical price movement would have on the hedged exposures to which they relate. Therefore, the impact on the fair value of a derivative instrument resulting from a change in interest rates or quoted market prices (as applicable) would normally be offset by a corresponding gain or loss on the hedged debt instrument, inventory value or forecasted transaction assuming:
•
the derivative instrument functions effectively as a hedge of the underlying risk;
•
the derivative instrument is not closed out in advance of its expected term; and
•
the hedged forecasted transaction occurs within the expected time period.
We routinely review the effectiveness of our derivative instrument portfolios in light of current market conditions. Accordingly, the nature and volume of our derivative instruments may change depending on the specific exposure being managed.
See Note 14 of the Notes to Unaudited Condensed Consolidated Financial Statements included under Part I, Item 1 of this quarterly report for additional information regarding our derivative instruments and hedging activities.
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Commodity Hedging Activities
The prices of natural gas, NGLs, crude oil, petrochemicals and refined products are subject to fluctuations in response to changes in supply and demand, market conditions and a variety of additional factors that are beyond our control. In order to manage such price risks, we enter into commodity derivative instruments such as physical forward contracts, futures contracts, fixed-for-float swaps and basis swaps.
The following table summarizes our portfolio of commodity derivative instruments outstanding at June 30, 2020 (volume measures as noted):
Volume (1)
Accounting
Derivative Purpose
Current (2)
Long-Term (2)
Treatment
Derivatives designated as hedging instruments:
Natural gas processing:
Forecasted natural gas purchases for plant thermal reduction (billion cubic feet (“Bcf”))
12.7
n/a
Cash flow hedge
Forecasted sales of NGLs (MMBbls)
0.1
n/a
Cash flow hedge
Octane enhancement:
Forecasted purchase of NGLs (MMBbls)
0.6
n/a
Cash flow hedge
Forecasted sales of octane enhancement products (MMBbls)
8.9
n/a
Cash flow hedge
Natural gas marketing:
Forecasted purchase of natural gas (Bcf)
1.8
n/a
Cash flow hedge
Natural gas storage inventory management activities (Bcf)
5.9
n/a
Fair value hedge
NGL marketing:
Forecasted purchases of NGLs and related hydrocarbon products (MMBbls)
157.9
4.6
Cash flow hedge
Forecasted sales of NGLs and related hydrocarbon products (MMBbls)
162.4
15.6
Cash flow hedge
NGLs inventory management activities (MMBbls)
1.8
n/a
Fair value hedge
Refined products marketing:
Forecasted purchases of refined products (MMBbls)
46.8
15.4
Cash flow hedge
Forecasted sales of refined products (MMBbls)
52.5
18.7
Cash flow hedge
Refined products inventory management activities (MMBbls)
3.9
n/a
Fair value hedge
Crude oil marketing:
Forecasted purchases of crude oil (MMBbls)
78.2
n/a
Cash flow hedge
Forecasted sales of crude oil (MMBbls)
88.7
n/a
Cash flow hedge
Petrochemical marketing:
Forecasted sales of petrochemical products (MMBbls)
1.2
n/a
Cash flow hedge
Commercial energy:
Forecasted purchases of power related to asset operations (terawatt hours (“TWh”))
0.3
n/a
Cash flow hedge
Derivatives not designated as hedging instruments:
Natural gas risk management activities (Bcf) (3,4)
44.2
2.1
Mark-to-market
NGL risk management activities (MMBbls) (4)
21.4
8.4
Mark-to-market
Refined products risk management activities (MMBbls) (4)
4.0
n/a
Mark-to-market
Crude oil risk management activities (MMBbls) (4)
28.8
7.7
Mark-to-market
Commercial energy risk management activities (TWh) (4)
0.1
n/a
Mark-to-market
(1)
Volume for derivatives designated as hedging instruments reflects the total amount of volumes hedged whereas volume for derivatives not designated as hedging instruments reflects the absolute value of derivative notional volumes.
(2)
The maximum term for derivatives designated as cash flow hedges, derivatives designated as fair value hedges and derivatives not designated as hedging instruments is December 2022, March 2021 and December 2022, respectively.
(3)
Current volumes include approximately 0.7 Bcf of physical derivatives instruments that are predominantly priced as index plus a premium or minus a discount.
(4)
Reflects the use of derivative instruments to manage risks associated with our transportation, processing, storage assets and end use power requirements.
At June 30, 2020, our predominant commodity hedging strategies consisted of (i) hedging anticipated future purchases and sales of commodity products associated with transportation, storage and blending activities, (ii) hedging the fair value of commodity products held in inventory and (iii) hedging natural gas processing margins.
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Sensitivity Analysis
The following tables show the effect of hypothetical price movements on the estimated fair values of our principal commodity derivative instrument portfolios at the dates indicated (dollars in millions).
The fair value information presented in the sensitivity analysis tables excludes the impact of applying Chicago Mercantile Exchange (“CME”) Rule 814, which deems that financial instruments cleared by the CME are settled daily in connection with variation margin payments. As a result of this exchange rule, CME-related derivatives are considered to have no fair value at the balance sheet date for financial reporting purposes; however, the derivatives remain outstanding and subject to future commodity price fluctuations until they are settled in accordance with their contractual terms. Derivative transactions cleared on exchanges other than the CME (e.g., the Intercontinental Exchange or ICE) continue to be reported on a gross basis.
Natural gas marketing portfolio
Portfolio Fair Value at
Scenario
Resulting
Classification
December 31,
2019
June 30,
2020
July 15,
2020
Fair value assuming no change in underlying commodity prices
Asset (Liability)
$
1.1
$
22.0
$
23.0
Fair value assuming 10% increase in underlying commodity prices
Asset (Liability)
(4.3
)
19.6
20.7
Fair value assuming 10% decrease in underlying commodity prices
Asset (Liability)
6.6
24.4
25.2
NGL and refined products marketing, natural gas processing and octane enhancement portfolio
Portfolio Fair Value at
Scenario
Resulting
Classification
December 31,
2019
June 30,
2020
July 15,
2020
Fair value assuming no change in underlying commodity prices
Asset (Liability)
$
43.7
$
(138.3
)
$
(166.6
)
Fair value assuming 10% increase in underlying commodity prices
Asset (Liability)
(19.0
)
(237.3
)
(260.4
)
Fair value assuming 10% decrease in underlying commodity prices
Asset (Liability)
106.4
(39.3
)
(72.8
)
Crude oil marketing portfolio
Portfolio Fair Value at
Scenario
Resulting
Classification
December 31,
2019
June 30,
2020
July 15,
2020
Fair value assuming no change in underlying commodity prices
Asset (Liability)
$
(9.6
)
$
(77.7
)
$
(109.8
)
Fair value assuming 10% increase in underlying commodity prices
Asset (Liability)
(50.6
)
(136.0
)
(176.6
)
Fair value assuming 10% decrease in underlying commodity prices
Asset (Liability)
31.5
(19.4
)
(43.0
)
Interest Rate Hedging Activities
We may utilize interest rate swaps, forward-starting swaps, options to enter into forward-starting swaps (“swaptions”), and similar derivative instruments to manage our exposure to changes in interest rates charged on borrowings under certain consolidated debt agreements. This strategy may be used in controlling our overall cost of capital associated with such borrowings.
Sensitivity Analysis
At June 30, 2020, our interest rate hedging portfolio consisted of forward-starting swaps. Forward-starting swaps hedge the risk of an increase in underlying benchmark interest rates during the period of time between the inception date of the swap agreement and the future date of a debt issuance. Under the terms of the forward-starting swaps, we pay to the counterparties (at the expected settlement dates of the instruments) amounts based on a fixed interest rate applied to a notional amount and receive from the counterparties an amount equal to a variable interest rate (based on LIBOR or an equivalent index rate) on the same notional amount.
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With respect to the tabular data below, the portfolio’s estimated economic value at a given date is based on a number of factors, including the number and types of derivatives outstanding at that date, the notional value of the swaps and associated interest rates. The following table summarizes our portfolio of forward-starting swaps at June 30, 2020 (dollars in millions):
Hedged Transaction
Number and Type
of Derivatives
Outstanding
Notional
Amount
Expected
Settlement
Date
Weighted-Average
Fixed Rate
Locked
Accounting
Treatment
Future long-term debt offering
1 forward-starting swap
$75.0
4/2021
2.41%
Cash flow hedge
Future long-term debt offering
5 forward-starting swaps
$500.0
4/2021
2.13 %
Cash flow hedge
Future long-term debt offering
2 forward-starting swaps (1)
$150.0
2/2022
1.72%
Cash flow hedge
Future long-term debt offering
1 forward starting swap (1)
$100.0
4/2021
1.46%
Cash flow hedge
Future long-term debt offering
2 forward starting swaps (1)
$150.0
2/2022
1.48%
Cash flow hedge
Future long-term debt offering
2 forward starting swaps (1)
$100.0
2/2022
0.95%
Cash flow hedge
(1)
These swaps were entered into during the first quarter of 2020.
The following table shows the effect of hypothetical price movements (a sensitivity analysis) on the estimated economic value of our forward-starting swap portfolio at the dates indicated (dollars in millions):
Forward-Starting Swap
Portfolio Fair Value at
Scenario
Resulting
Classification
December 31,
2019
June 30,
2020
July 15,
2020
Fair value assuming no change in underlying interest rates
Asset (Liability)
$
(13.5
)
$
(250.5
)
$
(267.6
)
Fair value assuming 10% increase in underlying interest rates
Asset (Liability)
38.2
(221.4
)
(239.7
)
Fair value assuming 10% decrease in underlying interest rates
Asset (Liability)
(68.3
)
(280.5
)
(296.3
)
The $ 254.1 million decrease in the fair value of this portfolio from December 31, 2019 to July 15, 2020 was primarily due to declining interest rates relative to the fixed rates specified in the swap agreements. Upon settlement, we would expect that any loss on these swaps would be offset by lower interest rates on future debt issuances.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.