Financial Instruments, Derivatives and Hedging Activities

3 Months Ended

Mar. 31, 2020

Financial Instruments, Derivatives and Hedging Activities

Financial Instruments, Derivatives and Hedging Activities

6. Financial Instruments, Derivatives and Hedging Activities

The Company is exposed to market risk stemming from changes in commodity prices (primarily 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 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-related futures, options and swap contracts, foreign currency-related forward contracts, interest rate swaps, and treasury locks (“T-Locks”).

Commodity price hedging: The Company’s principal use of derivative financial instruments is to manage commodity price risk relating to anticipated purchases of corn and natural gas to be used in the manufacturing process, generally over the next 12 to 24 months. The Company maintains a commodity-price risk management strategy that uses derivative instruments to minimize significant, unanticipated earnings fluctuations caused by commodity-price volatility. To manage price risk related to corn purchases primarily in North America, the Company uses corn futures and option contracts that trade on regulated commodity exchanges to lock-in corn costs associated with fixed-priced customer sales contracts. The Company also uses over-the-counter natural gas swaps in North America to hedge a portion of its natural gas usage. These derivative financial instruments limit the impact that volatility resulting from fluctuations in market prices will have on corn and natural gas purchases. The Company’s natural gas derivatives and the majority of its corn derivatives have been designated as cash flow hedging instruments.

The Company enters into certain corn derivative instruments that are not designated as hedging instruments as defined by ASC 815, Derivatives and Hedging. Therefore, the realized and unrealized gains and losses from these instruments are recognized in cost of sales during each accounting period. These derivative instruments also mitigate commodity price risk related to anticipated purchases of corn.

For commodity hedges designated as cash flow hedges, unrealized gains and losses associated with marking the commodity hedging contracts to market (fair value) 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 (“AOCI”). These amounts are subsequently reclassified into earnings in the same line item affected by the hedged transaction and in the same period or periods during which the hedged transaction affects earnings, 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. Gains and losses from cash flow hedging instruments reclassified from AOCI to earnings are reported as Cash provided by operating activities on the Condensed Consolidated Statements of Cash Flows.

As of March 31, 2020, the Company had outstanding futures and option contracts that hedged the forecasted purchase of approximately 85 million bushels of corn. The Company had outstanding swap and option contracts that hedged the forecasted purchase of approximately 31 million mmbtu’s of natural gas at March 31, 2020.

Foreign currency hedging: Due to the Company’s global operations, including operations in many emerging markets, the Company is exposed to fluctuations in foreign currency exchange rates. As a result, the Company has exposure to translational foreign-exchange risk when the results of its foreign operations are translated to U.S. dollars and to transactional foreign-exchange risk when transactions not denominated in the functional currency are revalued. The Company’s foreign-exchange risk management strategy uses derivative financial instruments such as foreign currency forward contracts, swaps and options to manage its transactional foreign exchange risk. The Company enters into foreign currency derivative instruments that are designated as both cash flow hedging instruments as well as instruments not designated as hedging instruments as defined by ASC 815, Derivatives and Hedging, in order to mitigate transactional foreign-exchange risk. Gains and losses from derivative financial instruments not designated as hedging instruments are marked to market in earnings during each accounting period.

The Company hedges certain assets using foreign currency derivatives not designated as hedging instruments, which had a notional value of $559 million and $621 million as of March 31, 2020 and December 31, 2019, respectively. The Company also hedges certain liabilities using foreign currency derivatives not designated as hedging instruments, which had a notional value of $226 million and $356 million as of March 31, 2020 and December 31, 2019, respectively.  

The Company hedges certain assets using foreign currency cash flow hedging instruments, which had a notional value of $300 million and $374 million as of March 31, 2020 and December 31, 2019, respectively. The Company also hedges certain liability positions using foreign currency cash flow hedging instruments, which had a notional value of $472 million and $541 million as of March 31, 2020 and December 31, 2019, respectively.

Interest rate hedging: The Company assesses its exposure to variability in interest rates by identifying and monitoring changes in interest rates that may adversely impact future cash flows and the fair value of existing debt instruments, and by evaluating hedging opportunities. The Company’s risk management strategy is to monitor interest rate risk attributable to both the Company’s outstanding and forecasted debt obligations as well as the Company’s offsetting hedge positions. Derivative financial instruments that have been used by the Company to manage its interest rate risk consist of interest rate swaps and T-Locks.

The Company has an interest rate swap agreement that converts the interest rates on $200 million of its $400 million of 4.625% senior notes due November 1, 2020, to variable rates. This swap agreement calls for the Company to receive interest at the fixed coupon rate of the respective notes and to pay interest at a variable rate based on the six-month U.S. dollar London Interbank Offered Rate (“LIBOR”) plus a spread. The Company has designated this interest rate swap agreement as a hedge of the changes in fair value of the underlying debt obligations attributable to changes in interest rates and accounts for it as a fair value hedging instrument. The change in fair value of an interest rate swap designated as a hedging instrument that effectively offsets the variability in the fair value of outstanding debt obligations is reported in earnings. This amount offsets the gain or loss (the change in fair value) of the hedged debt instrument that is attributable to changes in interest rates (the hedged risk), which is also recognized in earnings.

The Company periodically enters into T-Locks to hedge its exposure to interest rate changes. The T-Locks are designated as hedges of the variability in cash flows associated with future interest payments caused by market fluctuations in the benchmark interest rate until the fixed interest rate is established, and are accounted for as cash flow hedges. Accordingly, changes in the fair value of the T-Locks are recorded to AOCI until the consummation of the underlying debt offering, at which time any realized gain (loss) is amortized to earnings over the life of the debt. As of March 31, 2020, the Company had outstanding T-locks hedging a forecasted notes issuance. The Company did not have outstanding T-locks as of December 31, 2019.

The derivative instruments designated as cash flow hedges included in AOCI as of March 31, 2020 and December 31, 2019 are reflected below:

Derivatives in Cash Flow Hedging Relationships	Gains (Losses) included in AOCI
(in millions)	March 31, 2020		December 31, 2019
Commodity contracts, net of income tax effect of $13 and $5, respectively	$	(33)	$	(11)
Foreign currency contracts, net of income tax effect of $ — and $1, respectively		(2)		3
Interest rate contracts, net of income tax effect of $1 and $ — , respectively		(4)		(1)
Total	$	(39)	$	(9)

The fair value and balance sheet location of the Company’s derivative instruments, presented gross in the Condensed Consolidated Balance Sheets, are reflected below:

	Fair Value of Hedging Instruments as of March 31, 2020
	Designated Hedging Instruments (in millions)								Non-Designated Hedging Instruments (in millions)
Balance Sheet Location		Commodity Contracts		Foreign Currency Contracts		Interest Rate Contracts	Total			Commodity Contracts		Foreign Currency Contracts		Interest Rate Contracts	Total
Accounts receivable, net	$	1	$	10	$	—	$	11	$	—	$	13	$	—	$	13
Other assets		—		4		4		8		—		—		—		—
Assets		1		14		4		19		—		13		—		13
Accounts payable and accrued liabilities		37		12		4		53		9		10		—		19
Non-current liabilities		3		1		—		4		—		1		—		1
Liabilities		40		13		4		57		9		11		—		20
Net (Liabilities)/Assets	$	(39)	$	1	$	—	$	(38)	$	(9)	$	2	$	—	$	(7)

	Fair Value of Hedging Instruments as of December 31, 2019
	Designated Hedging Instruments (in millions)								Non-Designated Hedging Instruments (in millions)
Balance Sheet Location		Commodity Contracts		Foreign Currency Contracts		Interest Rate Contracts	Total			Commodity Contracts		Foreign Currency Contracts		Interest Rate Contracts	Total
Accounts receivable, net	$	5	$	7	$	—	$	12	$	2	$	4	$	—	$	6
Other assets		1		3		1		5		—		1		—		1
Assets		6		10		1		17		2		5		—		7
Accounts payable and accrued liabilities		13		4		—		17		1		8		—		9
Non-current liabilities		4		4		—		8		—		2		—		2
Liabilities		17		8		—		25		1		10		—		11
Net (Liabilities)/Assets	$	(11)	$	2	$	1	$	(8)	$	1	$	(5)	$	—	$	(4)

Additional information pertaining to the Company’s fair value hedges is presented below:

Line item in the statement of financial position in which the hedged item is included (in millions)	Carrying Amount of the Hedged Assets/(Liabilities)				Cumulative Amount of Fair Value Hedging Adjustment Included in the Carrying Amount of Hedged Assets/(Liabilities)
Balance sheet date as of	March 31, 2020		December 31, 2019		March 31, 2020		December 31, 2019
Interest Rate Contracts:
Long-Term Debt	$	(204)	$	(201)	$	(4)	$	(1)

Additional information relating to the Company’s derivative instruments is presented below:

Derivatives in Cash Flow	Gains (Losses) Recognized  in OCI on Derivatives				Income	Gains (Losses) Reclassified from AOCI into Income
Hedging Relationships	Three Months Ended March 31,				Statement	Three Months Ended March 31,
(in millions)	2020		2019		Location	2020		2019
Commodity contracts	$	(37)	$	(10)	Cost of sales	$	7	$	2
Foreign currency contracts		(5)		(2)	Net sales/Cost of sales		(1)		(3)
Interest rate contracts		(4)		—	Financing costs, net		—		(1)
Total	$	(46)	$	(12)		$	6	$	(2)

Derivatives in Fair Value Hedging	Income Statement Location of	Gains (Losses) Recognized in Income		Income Statement	Gains (Losses) Recognized in Income
Relationships	Derivatives Designated as	Three Months Ended March 31,		Location	Three Months Ended March 31,
(in millions)	Hedging Instruments	2020	2019	of Hedged Items	2020	2019

Interest rate contracts Financing costs, net $ 3 $ — Financing costs, net $ (3) $ —

As of March 31, 2020, AOCI included $36 million of net losses (net of income taxes of $10 million) on T-Locks, foreign currency hedges, and commodities-related derivative instruments designated as cash flow hedges that are expected to be reclassified into earnings during the next 12 months.

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

	As of March 31, 2020								As of December 31, 2019
(in millions)	Total		Level 1 (a)		Level 2 (b)		Level 3 (c)		Total		Level 1 (a)		Level 2 (b)		Level 3 (c)
Available for sale securities	$	11	$	11	$	—	$	—	$	13	$	13	$	—	$	—
Derivative assets		32		1		31		—		24		7		17		—
Derivative liabilities		77		34		43		—		36		5		31		—
Long-term debt		1,914		—		1,914		—		1,751		—		1,751		—

(a) Level 1 inputs consist of quoted prices (unadjusted) in active markets for identical assets or liabilities.

(b) 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 are based on 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.  

(c) Level 3 inputs are unobservable inputs for the asset or liability. Unobservable inputs are 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, short-term investments, accounts receivable, accounts payable and short-term borrowings approximate fair values. Commodity futures, options, and swap contracts are recognized at fair value. Foreign currency forward contracts, swaps and options are also 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. As of March 31, 2020, the carrying value and fair value of the Company’s Long-term debt was $1.9 billion.