Derivatives and Fair Value Measurements

Risk Management — Non-Coal Trading Activities

The Company is exposed to various types of risk in the normal course of business, including price risk on commodities utilized in the Company's mining operations, interest rate risk on long-term debt and foreign currency exchange rate risk for non-U.S. dollar expenditures. In most cases, commodity price risk (excluding coal trading activities) related to the sale of coal is mitigated through the use of long-term, fixed-price contracts, with a small percentage mitigated through the use of financial instruments. In order to manage our exposure related to price risk on certain commodities used in production, as well as for interest rate and foreign currency exchange rate risk, the Company utilizes derivative financial instruments. These risks are actively monitored in an effort to ensure compliance with the risk management policies of the Company.

Foreign Currency Hedges. The Company is exposed to foreign currency exchange rate risk, primarily on Australian dollar expenditures made in its Australian Mining segment. This risk is managed through the use of forward contracts and options that the Company designates as cash flow hedges, with the objective of reducing the variability of cash flows associated with forecasted foreign currency expenditures.

Diesel Fuel and Explosives Hedges. The Company is exposed to commodity price risk associated with diesel fuel and explosives utilized in production in the U.S. and Australia. This risk is managed through the use of cost pass-through contracts and derivatives, primarily swaps. The Company generally designates the swap contracts as cash flow hedges, with the objective of reducing the variability of cash flows associated with forecasted diesel fuel and explosives purchases.

Interest Rate Swaps. The Company is exposed to interest rate risk on its fixed rate and variable rate long-term debt. From time to time, the Company manages the interest rate risk associated with the fair value of its fixed rate borrowings using fixed-to-floating interest rate swaps to effectively convert a portion of the underlying cash flows on the debt into variable rate cash flows. The Company designates these swaps as fair value hedges, with the objective of hedging against adverse changes in the fair value of the fixed rate debt that results from market interest rate changes. In addition, from time to time, interest rate risk associated with the Company’s variable rate borrowings is managed using floating-to-fixed interest rate swaps. The Company designates these swaps as cash flow hedges, with the objective of reducing the variability of cash flows associated with market interest rate changes. As of September 30, 2012, the Company had no interest rate swaps in place.

Notional Amounts and Fair Value. The following summarizes the Company’s foreign currency and commodity positions at September 30, 2012:



	Notional Amount by Year of Maturity
	Total		2012		2013		2014		2015
Foreign Currency
A$:US$ hedge contracts (A$ millions)	$	4,832.3	$	566.1	$	2,173.6	$	1,513.5	$	579.1
Commodity Contracts
Diesel fuel hedge contracts (million gallons)	215.4		27.0		102.1		63.6		22.7
U.S. explosives hedge contracts (million MMBtu)	4.6		0.8		2.6		1.2		—



	Account Classification by
	Cash Flow Hedge		Fair Value Hedge		Economic Hedge		Fair Value Asset (Liability)
							(Dollars in millions)
Foreign Currency
A$:US$ hedge contracts (A$ millions)	$	4,832.3	$	—	$	—	$	511.7
Commodity Contracts
Diesel fuel hedge contracts (million gallons)	215.4		—		—		30.9
U.S. explosives hedge contracts (million MMBtu)	4.6		—		—		(5.9		)

Hedge Ineffectiveness. The Company assesses, both at inception and at least quarterly thereafter, whether the derivatives used in hedging activities are highly effective at offsetting the changes in the anticipated cash flows of the hedged item. The effective portion of the change in the fair value is recorded in “Accumulated other comprehensive income (loss)” until the hedged transaction impacts reported earnings, at which time any gain or loss is reclassified to earnings. To the extent that periodic changes in the fair value of derivatives deemed highly effective exceeds such changes in the hedged item, the ineffective portion of the periodic non-cash changes are recorded in earnings in the period of the change. If the hedge ceases to qualify for hedge accounting, the Company prospectively recognizes changes in the fair value of the instrument in earnings in the period of the change.

A measure of ineffectiveness is inherent in hedging future diesel fuel purchases with derivative positions based on refined petroleum products as a result of location and product differences.

The Company’s derivative positions for the hedging of future explosives purchases are based on natural gas, which is the primary price component of explosives. However, a small measure of ineffectiveness exists as the contractual purchase price includes manufacturing fees that are subject to periodic adjustments. In addition, other fees, such as transportation surcharges, can result in ineffectiveness, but have historically changed infrequently and comprise a small portion of the total explosives cost.

The Company’s derivative positions for the hedging of forecasted foreign currency expenditures contain a small measure of ineffectiveness due to timing differences between the hedge settlement and the purchase transaction, which could differ by less than a day and up to a maximum of 30 days.

The tables below show the classification and amounts of pre-tax gains and losses related to the Company’s non-coal trading hedges during the three and nine months ended September 30, 2012 and 2011:



		Three Months Ended September 30, 2012
Financial Instrument	Income Statement Classification Gains (Losses) - Realized	Gain recognized in income on non-designated derivatives		Gain recognized in other comprehensive income on derivatives (effective portion)			Gain reclassified from other comprehensive income into income (effective portion)		Gain reclassified from other comprehensive income into income (ineffective portion)
		(Dollars in millions)
Commodity swap contracts	Operating costs and expenses	$	—	$	49.6		$	11.2	$	2.2
Foreign currency forward and option contracts	Operating costs and expenses	—		169.2			82.0		—
Total		$	—	$	218.8		$	93.2	$	2.2

		Three Months Ended September 30, 2011
Financial Instrument	Income Statement Classification Gains (Losses) - Realized	Gain recognized in income on non-designated derivatives		Loss recognized in other comprehensive income on derivatives (effective portion)			Gain reclassified from other comprehensive income into income (effective portion)		Loss reclassified from other comprehensive income into income (ineffective portion)
		(Dollars in millions)
Commodity swap contracts	Operating costs and expenses	$	—	$	(51.2	)	$	8.5	$	(1.2	)
Foreign currency forward and option contracts:
— Operating costs	Operating costs and expenses	—		(269.1		)	92.2		—
— Capital expenditures	Depreciation, depletion and amortization	—		(0.5		)	—		—
Total		$	—	$	(320.8	)	$	100.7	$	(1.2	)



		Nine Months Ended September 30, 2012
Financial Instrument	Income Statement Classification Gains (Losses) - Realized	Gain recognized in income on non-designated derivatives		Gain recognized in other comprehensive income on derivatives (effective portion)			Gain reclassified from other comprehensive income into income (effective portion)		Loss reclassified from other comprehensive income into income (ineffective portion)
		(Dollars in millions)
Commodity swap contracts	Operating costs and expenses	$	—	$	28.7		$	39.0	$	(2.3	)
Foreign currency forward and option contracts	Operating costs and expenses	—		297.5			276.6		—
Total		$	—	$	326.2		$	315.6	$	(2.3	)

		Nine Months Ended September 30, 2011
Financial Instrument	Income Statement Classification Gains (Losses) - Realized	Gain recognized in income on non-designated derivatives		Gain (loss) recognized in other comprehensive income on derivatives (effective portion)			Gain reclassified from other comprehensive income into income (effective portion)		Gain reclassified from other comprehensive income into income (ineffective portion)
		(Dollars in millions)
Commodity swap contracts	Operating costs and expenses	$	—	$	20.9		$	28.4	$	0.4
Foreign currency forward and option contracts:
— Operating costs	Operating costs and expenses	—		33.8			261.1		—
— Capital expenditures	Depreciation, depletion and amortization	—		(0.7		)	—		—
Total		$	—	$	54.0		$	289.5	$	0.4

Based on the net fair value of the Company’s non-coal trading positions held in “Accumulated other comprehensive income (loss)” at September 30, 2012, unrealized gains to be reclassified from comprehensive income to earnings over the next 12 months associated with the Company’s foreign currency and diesel fuel hedge programs are expected to be approximately $287 million and $30 million, respectively, while the unrealized losses to be realized under the explosives hedge program are expected to be approximately $4 million. As these unrealized gains are associated with derivative instruments that represent hedges of forecasted transactions, the amounts reclassified to earnings will partially offset the realized transactions, while the unrealized losses will add incremental expense to the unaudited condensed consolidated statements of income.

The classification and amount of derivatives presented on a gross basis as of September 30, 2012 and December 31, 2011 were as follows:



	Fair Value as of September 30, 2012
Financial Instrument	Current Assets		Noncurrent Assets		Current Liabilities		Noncurrent Liabilities
	(Dollars in millions)
Commodity swap contracts	$	32.8	$	5.2	$	6.1	$	6.9
Foreign currency forward and option contracts	286.7		225.0		—		—
Total	$	319.5	$	230.2	$	6.1	$	6.9



	Fair Value as of December 31, 2011
Financial Instrument	Current Assets		Noncurrent Assets		Current Liabilities		Noncurrent Liabilities
	(Dollars in millions)
Commodity swap contracts	$	43.4	$	11.7	$	7.1	$	15.0
Foreign currency forward and option contracts	270.4		229.0		4.3		4.5
Total	$	313.8	$	240.7	$	11.4	$	19.5

After netting by counterparty where permitted, the fair values of the respective derivatives are reflected in “Other current assets,” “Investments and other assets,” “Accounts payable and accrued expenses” and “Other noncurrent liabilities” in the condensed consolidated balance sheets.

See Note 8 for information related to the Company’s coal trading activities.

Fair Value Measurements

The Company uses a three-level fair value hierarchy that categorizes assets and liabilities measured at fair value based on the observability of the inputs utilized in the valuation. These levels include: Level 1 - inputs are quoted prices in active markets for the identical assets or liabilities; Level 2 - inputs are other than quoted prices included in Level 1 that are directly or indirectly observable through market-corroborated inputs; and Level 3 - inputs are unobservable, or observable but cannot be market-corroborated, requiring the Company to make assumptions about pricing by market participants.

Financial Instruments Measured on a Recurring Basis. The following tables set forth the hierarchy of the Company’s net financial asset positions for which fair value is measured on a recurring basis:



	September 30, 2012
	Level 1		Level 2		Level 3		Total
	(Dollars in millions)
Investments in debt and equity securities	$	67.3	$	—	$	—	$	67.3
Commodity swap contracts	—		25.0		—		25.0
Foreign currency forward and option contracts	—		511.7		—		511.7
Total net financial assets	$	67.3	$	536.7	$	—	$	604.0



	December 31, 2011
	Level 1		Level 2		Level 3		Total
	(Dollars in millions)
Investments in debt and equity securities	$	83.5	$	—	$	—	$	83.5
Commodity swap contracts	—		33.0		—		33.0
Foreign currency forward and option contracts	—		490.6		—		490.6
Total net financial assets	$	83.5	$	523.6	$	—	$	607.1

For Level 1 and 2 financial assets and liabilities, the Company utilizes both direct and indirect observable price quotes, including interest rate yield curves, exchange indices, broker quotes, published indices and other market quotes. Below is a summary of the Company’s valuation techniques for Level 1 and 2 financial assets and liabilities:


•	Investments in debt and equity securities: valued based on quoted prices in active markets (Level 1).


•	Commodity swap contracts — diesel fuel and explosives: valued based on a valuation that is corroborated by the use of market-based pricing (Level 2).


•	Foreign currency forward and option contracts: valued utilizing inputs obtained in quoted public markets (Level 2).

The Company did not have any transfers between levels during the three or nine months ended September 30, 2012 or 2011 for its non-coal trading positions. The Company’s policy is to value transfers between levels using the beginning of period valuation.

Other Financial Instruments. The following methods and assumptions were used by the Company in estimating fair values for other financial instruments as of September 30, 2012 and December 31, 2011:


•	Cash and cash equivalents, accounts receivable, including those within the Company’s accounts receivable securitization program, and accounts payable and accrued expenses have carrying values which approximate fair value due to the short maturity or the liquid nature of these instruments.

•

The Company’s investment in debt securities related to its pro-rata share of funding in NCIG were included in “Investments and other assets” in the condensed consolidated balance sheets as of December 31, 2011, at which time the debt securities were recorded at cost, which approximated fair value. The Company disposed of its remaining investment in debt securities related to NCIG during the nine months ended September 30, 2012.

•

Long-term debt fair value estimates are based on observed prices for securities with an active trading market when available (Level 2), and otherwise on estimated borrowing rates to discount the cash flows to their present value (Level 3). The carrying amounts of the 7.875% Senior Notes due December 2026 and the Convertible Junior Subordinated Debentures due 2066 (the Debentures) are net of the respective unamortized note discounts.

The carrying amounts and estimated fair values of the Company’s debt are summarized as follows:



	September 30, 2012				December 31, 2011
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
	(Dollars in millions)
Long-term debt	$	6,363.1	$	6,393.0	$	6,657.5	$	6,922.7

Nonperformance and Credit Risk

The fair value of the Company’s non-coal trading derivative assets and liabilities reflects adjustments for nonperformance and credit risk. The Company manages its counterparty risk through established credit standards, diversification of counterparties, utilization of investment grade commercial banks and continuous monitoring of counterparty creditworthiness. To reduce its credit exposure for these hedging activities, the Company seeks to enter into netting agreements with counterparties that permit the Company to offset asset and liability positions with such counterparties in the event of defaul