NOTE 13 FAIR VALUE MEASUREMENTS

(a) Fair Value Hierarchy

Under Accounting Standards Codification (ASC) 820, Fair Value Measurements and Disclosures, fair value measurements are characterized in one of three levels based upon the inputs used to arrive at the measurement. The three levels of the fair value hierarchy are as follows:

Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access at the measurement date.

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.

Level 3 inputs are unobservable inputs for the asset or liability.

When appropriate, valuations are adjusted for various factors including credit considerations. Such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate is used.

(b) Fair Value of Financial Instruments

The carrying value of cash and cash equivalents, accounts receivable and other, accounts payable and accrued liabilities, accounts payable to affiliates and accrued interest approximate their fair values because of the short maturity or duration of these instruments, or because the instruments bear a variable rate of interest or a rate that approximates current rates. The fair value of the Partnership’s debt is estimated by discounting the future cash flows of each instrument at estimated current borrowing rates. The fair value of interest rate derivatives is calculated using the income approach, which uses period-end market rates and applies a discounted cash flow valuation model.

Long-term debt is recorded at amortized cost and classified as Level 2 of the fair value hierarchy for fair value disclosure purposes. Interest rate derivative assets and liabilities are classified as Level 2 for all periods presented where the fair value is determined by using valuation techniques that refer to observable market data or estimated market prices. The estimated fair value of the Partnership’s debt as at June 30, 2018 and December 31, 2017 was $2,311 million and $2,475 million, respectively.

Market risk is the risk that changes in market interest rates may result in fluctuations in the fair values or cash flows of financial instruments. The Partnership’s floating rate debt is subject to LIBOR benchmark interest rate risk. The Partnership uses interest rate derivatives to manage its exposure to interest rate risk. We regularly assess the impact of interest rate fluctuations on future cash flows and evaluate hedging opportunities to mitigate our interest rate risk.

The Partnership’s interest rate swaps are structured such that the cash flows of the derivative instruments match those of the variable rate of interest on the 2013 Term Loan Facility. The Partnership hedged interest payments on the variable-rate 2013 Term Loan Facility with interest rate swaps maturing July 1, 2018, at a weighted average fixed interest rate of 2.31 percent. At June 30, 2018, the fair value of the interest rate swaps accounted for as cash flow hedges was an asset of $15 million (both on a gross and net basis). At December 31, 2017, the fair value of the interest rate swaps accounted for as cash flow hedges was an asset of $5 million (on both gross and net basis). The change in fair value of interest rate derivative instruments recognized in other comprehensive income was a loss of $1 million and a gain of $6 million for the three and six months ended June 30, 2018, respectively (2017 — nil and gain of $1 million). During the three and six months ended June 30, 2018, gain of $3 million was reclassified from other comprehensive income to net income (2017 — loss of $1 million). For the three and six months ended June 30, 2018, the net realized gain related to the interest rate swaps was $1 million and $2 million, respectively, and was included in financial charges and other (2017 - nil) (Refer to Note 15).

The Partnership’s $500 million 2013 Term Loan is hedged using fixed interest rate swaps until July 1, 2018 at an average rate of 2.31 percent. During the fourth quarter of 2017, the Partnership implemented an interest rate hedging strategy that hedged the $500 million 2013 Term Loan until its October 2, 2022 maturity using forward starting swaps at an average rate of 3.26 percent.

The Partnership has no master netting agreements; however, it has derivative contracts containing provisions with rights of offset. The Partnership has elected to present the fair value of derivative instruments with the right to offset on a gross basis in the balance sheet. Had the Partnership elected to present these instruments on a net basis, there would be no effect on the consolidated balance sheet as of June 30, 2018 (net asset of $5 million as of December 31, 2017).

In anticipation of a debt refinancing in 2003, PNGTS entered into forward interest rate swap agreements to hedge the interest rate on its Senior Secured Notes due in 2018. These interest rate swaps were used to manage the impact of interest rate fluctuations and qualified as derivative financial instruments in accordance with Accounting Standards Codification (ASC) 815, Derivatives and Hedging. PNGTS settled its position with a payment of $20.9 million to counterparties at the time of the refinancing and recorded the realized loss in accumulated other comprehensive income as of the termination date. The previously recorded loss was amortized against earnings over the life of the PNGTS Senior Secured Notes. On May 10, 2018, PNGTS paid the remaining principal balance of its 2003 Senior Secured Notes using its available cash and, as a result, our 61.71 percent proportionate share of the net unamortized loss on PNGTS included in other comprehensive income was all amortized against earnings (December 31, 2017 - $1 million). For the three and six months ended June 30, 2018, our 61.71 percent proportionate share of the amortization of realized loss on derivative instruments was $1 million (2017 - $1 million).