Financial Instruments, Derivatives and Hedging Activities

6 Months Ended

Jun. 30, 2012

Financial Instruments, Derivatives and Hedging Activities

Financial Instruments, Derivatives and Hedging Activities

5.Financial Instruments, Derivatives and Hedging Activities

The Company has manufacturing operations in North America, South America, Asia Pacific and EMEA.  The Company’s products are made primarily from corn.

The Company is exposed to market risk stemming from changes in commodity prices (corn and natural gas), foreign currency exchange rates and interest rates.  In the normal course of business, the Company actively manages its exposure to these market risks by entering into various hedging transactions, authorized under established policies that place clear controls on these activities.  These transactions utilize exchange-traded derivatives or over-the-counter derivatives with investment grade counterparties.  Derivative financial instruments currently used by the Company consist of commodity futures, options and swap contracts, forward currency contracts and options, and interest rate swaps.

Commodity price hedging:  The Company’s principal use of derivative financial instruments is to manage commodity price risk in North America relating to anticipated purchases of corn and natural gas to be used in the manufacturing process, generally over the next twelve to eighteen months.  To manage price risk related to corn purchases in North America, the Company uses corn futures and options contracts that trade on regulated commodity exchanges to lock in its corn costs associated with firm-priced customer sales contracts.  The Company uses over-the-counter gas swaps to hedge a portion of its natural gas usage in North America.  These derivative financial instruments limit the impact that volatility resulting from fluctuations in market prices will have on corn and natural gas purchases and have been designated as cash flow hedges.  Unrealized gains and losses associated with marking the commodity hedging contracts to market are recorded as a component of other comprehensive income (“OCI”) and included in the equity section of the Condensed Consolidated Balance Sheets as part of accumulated other comprehensive income/loss (“AOCI”).  These amounts are subsequently reclassified into earnings in the month in which the related corn or natural gas is used or in the month a hedge is determined to be ineffective.  The Company assesses the effectiveness of a commodity hedge contract based on changes in the contract’s fair value.  The changes in the market value of such contracts have historically been, and are expected to continue to be, highly effective at offsetting changes in the price of the hedged items.  The amounts representing the ineffectiveness of these cash flow hedges are not significant.

At June 30, 2012, the Company’s AOCI account included $6 million of losses, net of tax of $3 million, related to its commodity-hedging derivative instruments.

Interest rate hedging:  Derivative financial instruments that have been used by the Company to manage its interest rate risk consist of Treasury Lock agreements (“T-Locks”) and interest rate swaps.  The Company did not have any Treasury Lock agreements outstanding at June 30, 2012.

On March 25, 2011, the Company entered into interest rate swap agreements that effectively convert the interest rate on the Company’s 3.2 percent $350 million senior notes due November 1, 2015 to a variable rate.  These swap agreements call for the Company to receive interest at a fixed rate (3.2 percent) and to pay interest at a variable rate based on the six-month US dollar LIBOR rate plus a spread.  The Company has designated these interest rate swap agreements as hedges of the changes in fair value of the underlying debt obligation attributable to changes in interest rates and accounts for them as fair value hedges.  Changes in the fair value of interest rate swaps designated as hedging instruments that effectively offset the variability in the fair value of outstanding debt obligations are reported in earnings.  These amounts offset the gain or loss (that is, the change in fair value) of the hedged debt instrument that is attributable to changes in interest rates (that is, the hedged risk) which is also recognized currently in earnings.  The fair value of these interest rate swap agreements approximated $21 million at June 30, 2012 and is reflected in the Condensed Consolidated Balance Sheet within non-current assets, with an offsetting amount recorded in long-term debt to adjust the carrying amount of the hedged debt obligation.

At June 30, 2012, the Company’s AOCI account included $11 million of losses (net of tax of $7 million) related to settled Treasury Lock agreements.  These deferred losses are being amortized to financing costs over the terms of the senior notes with which they are associated.

Foreign currency hedging:  Due to the Company’s global operations, it is exposed to fluctuations in foreign currency exchange rates.  As a result, the Company has exposure to translational foreign exchange risk when its foreign operation results are translated to US dollars (USD) and to transactional foreign exchange risk when transactions not denominated in the functional currency of the operating unit are revalued.  The Company primarily uses derivative financial instruments such as foreign currency forward contracts, swaps and options to manage its transactional foreign exchange risk.  These derivative financial instruments are primarily accounted for as fair value hedges.  As of June 30, 2012, the Company had $134 million of net notional foreign currency forward contracts that hedged net asset transactional exposures.  The fair value of these derivative instruments was approximately $2 million at June 30, 2012.

The Company also uses derivative instruments that are designated as cash flow hedges relating to certain US dollar obligations of a foreign subsidiary.  At June 30, 2012, the Company’s AOCI account included gains of $1 million, net of tax, related to its currency-hedging derivative instruments.

The fair value and balance sheet location of the Company’s derivative instruments accounted for as cash flow hedges are presented below:

	Fair Value of Derivative Instruments
		Fair Value					Fair Value
Derivatives designated as hedging instruments: (in millions)	Balance Sheet Location	AtJune 30, 2012		AtDecember 31, 2011		Balance Sheet Location	AtJune 30, 2012		AtDecember 31, 2011
Commodity and foreign currency contracts	Accounts receivable-net	$	35	$	14	Accounts payable and accrued liabilities	$	16	$	34
Commodity contracts	Other non-current assets	2		—		Non-current liabilities	9		11
Total		$	37	$	14		$	25	$	45

At June 30, 2012, the Company had outstanding futures and option contracts that hedge approximately 101 million bushels of forecasted corn and soy bean oil purchases.  Also at June 30, 2012, the Company had outstanding swap and option contracts that hedge approximately 18 million mmbtu’s of forecasted natural gas purchases.

Additional information relating to the Company’s derivative instruments is presented below (in millions):

Derivatives in	Amount of Gains Recognized in OCI on Derivatives				Location of Gains (Losses)	Amount of Gains (Losses) Reclassified from AOCI  into Income
Cash Flow  Hedging Relationships	Three Months Ended June 30, 2012		Three Months Ended June 30, 2011		Reclassified from AOCI into Income	Three Months Ended June 30, 2012			Three Months Ended June 30, 2011
Commodity and foreign currency contracts	$	53	$	18	Cost of sales	$	(14	)	$	46
Interest rate contracts	—		—		Financing costs, net	(1		)	(1		)
Total	$	53	$	18		$	(15	)	$	45

Derivatives in	Amount of Gains Recognized in OCI on Derivatives				Location of Gains (Losses)	Amount of Gains (Losses) Reclassified from AOCI  into Income
Cash Flow Hedging Relationships	Six Months Ended June 30, 2012		Six Months Ended June 30, 2011		Reclassified from AOCI into Income	Six Months Ended June 30, 2012			Six Months Ended June 30, 2011
Commodity and foreign currency contracts	$	8	$	82	Cost of sales	$	(20	)	$	79
Interest rate contracts	—		—		Financing costs, net	(2		)	(2		)
Total	$	8	$	82		$	(22	)	$	77

At June 30, 2012, the Company’s AOCI account included approximately $1 million of losses on commodity hedging contracts, net of income taxes, which are expected to be reclassified into earnings during the next twelve months.  The Company expects the losses to be offset by changes in the underlying commodities cost.  Additionally at June 30, 2012, the Company’s AOCI account included approximately $2 million of losses on Treasury Lock agreements (net of income taxes) and an after-tax gain of $1 million related to currency hedges, which are expected to be reclassified into earnings during the next twelve months.

Presented below are the fair values of the Company’s financial instruments and derivatives for the periods presented:

	As of June 30, 2012								As of December 31, 2011
(in millions)	Total		Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3
Available for sale securities	$	3	$	3	$	—	$	—	$	2	$	2	$	—	$	—
Derivative assets	60		35		25		—		33		14		19		—
Derivative liabilities	25		1		24		—		46		16		30		—
Long-term debt	1,935		—		1,935		—		1,921		—		1,921		—

Level 1 inputs consist of quoted prices (unadjusted) in active markets for identical assets or liabilities.  Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly for substantially the full term of the financial instrument.  Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability or can be derived principally from or corroborated by observable market data.  Level 3 inputs are unobservable inputs for the asset or liability.  Unobservable inputs shall be used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date.

The carrying values of cash equivalents, accounts receivable, accounts payable and short-term borrowings approximate fair values.  Commodity futures, options and swap contracts, which are designated as hedges of specific volumes of commodities are recognized at fair value.  Foreign currency forward contracts, swaps and options hedge transactional foreign exchange risk related to assets and liabilities denominated in currencies other than the functional currency and are recognized at fair value.  The fair value of the Company’s long-term debt is estimated based on quotations of major securities dealers who are market makers in the securities.  At June 30, 2012, the carrying value and fair value of the Company’s long-term debt was $1.78 billion and $1.94 billion, respectively.