Hedges and Derivative Financial Instruments

12 Months Ended

Dec. 31, 2019

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Hedges and Derivative Financial Instruments

HEDGES AND DERIVATIVE FINANCIAL INSTRUMENTS

Derivative instruments are accounted for at fair value based on market rates. Derivatives where we elect hedge accounting are designated as either cash flow, fair value or net investment hedges. Derivatives that are not accounted for based on hedge accounting are marked to market through earnings. If the designated cash flow hedges are highly effective, the gains and losses are recorded in other comprehensive income (loss) and subsequently reclassified to earnings to offset the impact of the hedged items when they occur. In the event it becomes probable the forecasted transaction to which a cash flow hedge relates will not occur, the derivative would be terminated and the amount in accumulated other comprehensive income (loss) would be recognized in earnings. The fair value of the hedge asset or liability is present in either other current assets/liabilities or other noncurrent assets/liabilities on the Consolidated Balance Sheets and in other within cash provided by (used in) operating activities in the Consolidated Statements of Cash Flows.

Using derivative instruments means assuming counterparty credit risk. Counterparty credit risk relates to the loss we could incur if a counterparty were to default on a derivative contract. We generally deal with investment grade counterparties and monitor the overall credit risk and exposure to individual counterparties. We do not anticipate nonperformance by any counterparties. The amount of counterparty credit exposure is limited to the unrealized gains, if any, on such derivative contracts. We do not require nor do we post collateral on such contracts.

Hedging Strategy

In the normal course of business, we manage risks relating to our ongoing business operations including those arising from changes in commodity prices, foreign exchange rates and interest rates. Fluctuations in these rates and prices can affect our operating results and financial condition. We use a variety of strategies, including the use of derivative instruments, to manage these risks. We do not enter into derivative financial instruments for trading or speculative purposes.

Commodity Price Risk

We enter into commodity derivative contracts on various commodities to manage the price risk associated with forecasted purchases of materials used in our manufacturing process. The objective of these hedges is to reduce the variability of cash flows associated with the forecasted purchase of commodities.

Foreign Currency and Interest Rate Risk

We incur expenses associated with the procurement and production of products in a limited number of countries, while we sell in the local currencies of a large number of countries. Our primary foreign currency exchange exposures result from cross-currency sales of products. As a result, we enter into foreign exchange contracts to hedge certain firm commitments and forecasted transactions to acquire products and services that are denominated in foreign currencies. We enter into certain undesignated non-functional currency asset and liability hedges that relate primarily to short-term payables, receivables, intercompany loans and dividends. When we hedge a foreign currency denominated payable or receivable with a derivative, the effect of changes in the foreign exchange rates are reflected currently in interest and sundry (income) expense for both the payable/receivable and the derivative. Therefore, as a result of the economic hedge, we do not elect hedge accounting.

We also enter into hedges to mitigate currency risk primarily related to forecasted foreign currency denominated expenditures, intercompany financing agreements and royalty agreements and designate them as cash flow hedges. Gains and losses on derivatives designated as cash flow hedges, to the extent they are included in the assessment of effectiveness, are recorded in other comprehensive income (loss) and subsequently reclassified to earnings to offset the impact of the hedged items when they occur.

We may enter into cross-currency interest rate swaps to manage our exposure relating to cross-currency debt. At December 31, 2019 there was a notional amount of $1,275 million of outstanding cross-currency interest rate swap agreements. At December 31, 2018 there were no outstanding cross-currency interest rate swap agreements.

We may enter into interest rate swap agreements to manage interest rate risk exposure. Our interest rate swap agreements, if any, effectively modify our exposure to interest rate risk, primarily through converting certain floating rate debt to a fixed rate basis, and certain fixed rate debt to a floating rate basis. These agreements involve either the receipt or payment of floating rate amounts in exchange for fixed rate interest payments or receipts, respectively, over the life of the agreements without an exchange of the underlying principal amounts. We may enter into swap rate lock agreements to effectively reduce our exposure to interest rate risk by locking in interest rates on probable long-term debt issuances. At December 31, 2019 there was a notional amount of $300 million of outstanding interest rate swap agreements. At December 31, 2018 there were no outstanding swap agreements.

Net Investment Hedging

The following table summarizes our foreign currency denominated debt and foreign exchange forwards/options designated as net investment hedges at December 31, 2019 and 2018:



	Notional (local)				Notional (USD)				Current Maturity
Instrument	2019		2018		2019		2018
Senior note - 0.625%	€	500	€	500	$	561	$	573	March 2020
Foreign exchange forwards/options	MXN 7,200		MXN 7,200		$	382	$	366	August 2022

For instruments that are designated and qualify as a net investment hedge, the effective portion of the instruments' gain or loss is reported as a component of other comprehensive income (loss) and recorded in accumulated other comprehensive loss. The gain or loss will be subsequently reclassified into net earnings when the hedged net investment is either sold or substantially liquidated. The remaining change in fair value of the hedge instruments represents the ineffective portion, which is immediately recognized in interest and sundry (income) expense on our Consolidated Statements of Income. As of December 31, 2019, there was no ineffectiveness on hedges designated as net investment hedges.

The following table summarizes our outstanding derivative contracts and their effects on our Consolidated Balance Sheets at December 31, 2019 and 2018:



					Fair Value of								Type of Hedge ⁽¹⁾
	Notional Amount				Hedge Assets				Hedge Liabilities					Maximum Term (Months)
Millions of dollars	2019		2018		2019		2018		2019		2018			2019	2018
Derivatives accounted for as hedges
Commodity swaps/options	$	174	$	216	$	4	$	1	$	10	$	27	(CF)	21	30
Foreign exchange forwards/options	3,177		3,126		94		49		84		48		(CF/NI)	32	44
Cross-currency swaps	1,275		—		25		—		23		—		(CF)	110	0
Interest rate derivatives	300		—		6		—		—		—		(CF)	65	0
Total derivatives accounted for as hedges					$	129	$	50	$	117	$	75
Derivatives not accounted for as hedges
Commodity swaps/options	$	1	$	3	$	—	$	—	$	—	$	—	N/A	7	0
Foreign exchange forwards/options	3,182		4,382		15		27		22		69		N/A	12	21
Total derivatives not accounted for as hedges					$	15	$	27	$	22	$	69
Total derivatives					$	144	$	77	$	139	$	144

Current					$	55	$	60	$	61	$	95
Noncurrent					89		17		78		49
Total derivatives					$	144	$	77	$	139	$	144

⁽¹⁾ Derivatives accounted for as hedges are considered either cash flow (CF) or net investment (NI) hedges.

The following tables summarize the effects of derivative instruments on our Consolidated Statements of Income (Loss) and Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2019 and 2018:



		Gain (Loss) Recognized in OCI (Effective Portion) ⁽²⁾
Cash Flow Hedges - Millions of dollars		2019			2018
Commodity swaps/options		$	(4	)	$	(51	)
Foreign exchange forwards/options		60			131
Cross-currency swaps		9			—
Interest rate derivatives		6			(3		)
Net Investment Hedges
Foreign currency		5			23
		$	76		$	100

	Location of Gain (Loss) Reclassified from OCI into Earnings (Effective Portion)	Gain (Loss) Reclassified from OCI into Earnings (Effective Portion)
Cash Flow Hedges - Millions of dollars		2019			2018
Commodity swaps/options ⁽³⁾	Cost of products sold	$	(22	)	$	22
Foreign exchange forwards/options	Net sales	(4		)	(3		)
Foreign exchange forwards/options	Cost of products sold	16			(5		)
Foreign exchange forwards/options	Interest and sundry (income) expense	73			94
Cross-currency swaps	Interest and sundry (income) expense	26			—
Interest rate derivatives	Interest expense	(1		)	(1		)
		$	88		$	107

	Location of Gain (Loss) Recognized on Derivatives not Accounted for as Hedges	Gain (Loss) Recognized on Derivatives not Accounted for as Hedges ⁽³⁾
Derivatives not Accounted for as Hedges - Millions of dollars		2019			2018
Foreign exchange forwards/options	Interest and sundry (income) expense	$	30		$	19

⁽²⁾The tax impact of the cash flow hedges was $4 million and $7 million in 2019 and 2018, respectively. The tax impact of the net investment hedges was $2 million and $(15) million in 2019 and 2018, respectively.

⁽³⁾Cost for commodity swaps/options are recognized in cost of sales as products are sold.

For cash flow hedges, the amount of ineffectiveness recognized in interest and sundry (income) expense was nominal during 2019 and 2018. There were no hedges designated as fair value in 2019 and 2018. The net amount of unrealized gain or loss on derivative instruments included in accumulated other comprehensive income (loss) related to contracts maturing and expected to be realized during the next twelve months is nominal at December 31, 2019.