Derivative Financial Instruments

9 Months Ended

Sep. 30, 2018

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Financial Instruments

Derivative Financial Instruments

Interest Rate Derivatives

We periodically enter into interest rate derivatives to hedge the fair value of debt or hedge against variability in interest rates. We record any ineffectiveness on interest rate derivatives designated as hedging instruments to interest expense and the change in fair value of interest rate derivatives that we do not designate as hedging instruments to other income or expense in our results of operations. For the effective portion of interest rate cash flow hedges, we record the noncurrent portion of unrealized gains or losses as an adjustment to other comprehensive income with the current portion recorded as an adjustment to interest expense. For the effective portion of fair value hedges on long-term debt, we record the noncurrent portion of gains or losses as an adjustment to long-term debt with the current portion recorded as an adjustment to interest expense. Adjustments resulting from discontinued hedges continue to be recognized in accordance with their historic hedging relationships.

During 2018, we entered into $200.0 million of treasury lock agreements to protect against the risk of variability of a portion of debt issuances we anticipate to occur in 2018 and 2019. The fair value of these interest rate derivative agreements at September 30, 2018 was recorded as a current asset of $5.2 million, with the offset recorded to other comprehensive income. We account for these agreements as cash flow hedges.

We entered into $100.0 million of interest rate swap agreements in 2016 to protect against the variability of future interest payments on a portion of debt we anticipated issuing in 2018. These agreements were accounted for as cash flow hedges. In September 2018, we terminated and settled these agreements for a gain of $20.9 million. The gain was recorded to other comprehensive income and will be recognized into earnings as an adjustment to our periodic interest accruals over the life of the expected debt issuance.

Commodity Derivatives

Our butane blending activities produce gasoline, and we can reasonably estimate the timing and quantities of sales of these products. We use a combination of exchange-traded commodities futures contracts and forward purchase and sale contracts to help manage commodity price changes and mitigate the risk of decline in the product margin realized from our butane blending activities. Further, certain of our other commercial operations generate petroleum products, and we also use futures contracts to hedge against price changes for some of these commodities.

Forward physical purchase and sale contracts that qualify for and are elected as normal purchases and sales are accounted for using traditional accrual accounting, whereby changes in the mark-to-market values of such contracts are not recognized in income; rather the revenues and expenses associated with such transactions are recognized during the period when commodities are physically delivered or received. Physical forward commodity contracts subject to this exception are evaluated for the probability of future delivery and are periodically tested once the forecasted period has passed to determine whether similar forward contracts are probable of physical delivery in the future.

We record the effective portion of the gains or losses for commodity-based contracts designated as fair value hedges as adjustments to the assets being hedged and the ineffective portions as well as amounts excluded from the assessment of hedge effectiveness as adjustments to other income or expense. We recognize the change in fair value of economic hedges that hedge against changes in the price of petroleum products that we expect to sell or purchase in the future currently in earnings as adjustments to product sales revenue, cost of product sales or operating expenses, as applicable.

Our open futures contracts at September 30, 2018 were as follows:

Type of Contract/Accounting Methodology	Product Represented by the Contract and Associated Barrels	Maturity Dates
Futures - Economic Hedges	5.4 million barrels of refined products and crude oil	Between October 2018 and April 2019
Futures - Economic Hedges	1.7 million barrels of butane and natural gasoline	Between October 2018 and April 2019

Energy Commodity Derivatives Contracts and Deposits Offsets

At December 31, 2017 and September 30, 2018, we had margin deposits of $36.7 million and $47.4 million, respectively, for our future contracts with our counterparties, which were recorded as current assets under energy commodity derivatives deposits on our consolidated balance sheets. We have the right to offset the combined fair values of our open futures contracts against our margin deposits under a master netting arrangement for each counterparty; however, we have elected to present the combined fair values of our open futures contracts separately from the related margin deposits on our consolidated balance sheets. Additionally, we have the right to offset the fair values of our futures contracts together for each counterparty, which we have elected to do, and we report the combined net balances on our consolidated balance sheets. A schedule of the derivative amounts we have offset and the deposit amounts we could offset under a master netting arrangement are provided below as of December 31, 2017 and September 30, 2018 (in thousands):

Description	Gross Amounts of Recognized Liabilities			Gross Amounts of Assets Offset in the Consolidated Balance Sheets		Net Amounts of Liabilities Presented in the Consolidated Balance Sheets(2)			Margin Deposit Amounts Not Offset in the Consolidated Balance Sheets		Net Asset Amount(1)
As of December 31, 2017	$	(38,936	)	$	12,851	$	(26,085	)	$	36,690	$	10,605
As of September 30, 2018	$	(55,087	)	$	22,843	$	(32,244	)	$	47,354	$	15,110

(1) Amount represents the maximum loss we would incur if all of our counterparties failed to perform on their derivative contracts.

(2) Net amount includes energy commodity derivative contracts classified as current liabilities of $25,694 and noncurrent liabilities of $391 at December 31, 2017. Net amount includes energy commodity derivative contracts classified as current liabilities of $32,244 at September 30, 2018.

Impact of Derivatives on Our Financial Statements

Comprehensive Income

The changes in derivative activity included in AOCL for the three and nine months ended September 30, 2017 and 2018 were as follows (in thousands):

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
Derivative Losses Included in AOCL	2017			2018			2017			2018
Beginning balance	$	(34,804	)	$	(25,165	)	$	(34,776	)	$	(33,755	)
Net gain (loss) on cash flow hedges	(228		)	6,852			(1,735		)	13,963
Reclassification of net loss on cash flow hedges to income	740			740			2,219			2,219
Ending balance	$	(34,292	)	$	(17,573	)	$	(34,292	)	$	(17,573	)

The following is a summary of the effect on our consolidated statements of income for the three and nine months ended September 30, 2017 and 2018 of derivatives that were designated as cash flow hedges (in thousands):

	Interest Rate Contracts
	Amount of Gain (Loss) Recognized in AOCL on Derivative			Location of Loss Reclassified from AOCL into  Income	Amount of Loss Reclassified from AOCL into Income
Three Months Ended September 30, 2017	$	(228	)	Interest expense	$	(740	)

Three Months Ended September 30, 2018 $ 6,852 Interest expense $ (740 )

Nine Months Ended September 30, 2017 $ (1,735 ) Interest expense $ (2,219 )

Nine Months Ended September 30, 2018 $ 13,963 Interest expense $ (2,219 )

As of September 30, 2018, the net loss estimated to be classified to interest expense over the next twelve months from AOCL is approximately $2.3 million. This amount relates to the amortization of losses on interest rate contracts over the life of the related debt instruments.

We used futures contracts designated as fair value hedges to hedge against changes in the fair value of crude oil that was contractually reserved as tank bottoms and included with other noncurrent assets on our consolidated balance sheets. During September 2017, as a result of contract renegotiations, we sold a portion of the tank bottoms, settled the related hedges and transferred the permanent portion of the tank bottoms from noncurrent assets to PP&E. The effective portions of the fair value gains or losses on these futures contracts were offset by fair value gains or losses on the crude oil, and there was no ineffectiveness recognized. The cash flows from settled contracts were recorded in operating activities in our consolidated statements of cash flows. The gains (losses) on these futures contracts and the underlying crude oil were as follows (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2017			2018			2017			2018
Gain (loss) recognized in other income/expense on derivatives (futures contracts)	$	(1,661	)	$	122		$	5,107		(427	)
Gain (loss) recognized in other income/expense on hedged item (crude oil)	$	1,661		$	(122	)	$	(5,107	)	427

The differential between the current spot price and forward price was excluded from the assessment of hedge effectiveness for these fair value hedges. For the three and nine months ended September 30, 2017, we recognized a gain of $0.7 million and $2.4 million, respectively, for the amounts we excluded from the assessment of effectiveness of these fair value hedges, which we reported as other (income) expense on our consolidated statements of income.

The following table provides a summary of the effect on our consolidated statements of income for the three and nine months ended September 30, 2017 and 2018 of derivatives accounted for as economic hedges (in thousands):

		Amount of Gain (Loss) Recognized on Derivatives
		Three Months Ended						Nine Months Ended
	Location of Gain (Loss) Recognized on Derivatives	September 30,						September 30,
Derivative Instrument		2017			2018			2017			2018
Futures contracts	Product sales revenue	$	(47,336	)	$	(24,354	)	$	(4,442	)	$	(70,140	)
Futures contracts	Operating expenses	663			—			663			—
Futures contracts	Cost of product sales	19,660			11,665			19,713			16,058
	Total	$	(27,013	)	$	(12,689	)	$	15,934		$	(54,082	)

The impact of the derivatives in the above table was reflected as cash from operations on our consolidated statements of cash flows.

Balance Sheets

The following tables provide a summary of the fair value of derivatives, which are presented on a net basis in our consolidated balance sheets, that were designated as hedging instruments as of December 31, 2017 and September 30, 2018 (in thousands):

	December 31, 2017
	Asset Derivatives			Liability Derivatives
Derivative Instrument	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Futures contracts	Energy commodity derivatives contracts, net	$	—	Energy commodity derivatives contracts, net	$	173
Interest rate contracts	Other current assets	12,177		Other current liabilities	—
	Total	$	12,177	Total	$	173

	September 30, 2018
	Asset Derivatives			Liability Derivatives
Derivative Instrument	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Futures contracts	Energy commodity derivatives contracts, net	$	—	Energy commodity derivatives contracts, net	$	189
Interest rate contracts	Other current assets	5,215		Other current liabilities	—
	Total	$	5,215	Total	$	189

The following tables provide a summary of the fair value of derivatives, which are presented on a net basis in our consolidated balance sheets, that were not designated as hedging instruments as of December 31, 2017 and September 30, 2018 (in thousands):

	December 31, 2017
	Asset Derivatives			Liability Derivatives
Derivative Instrument	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Futures contracts	Energy commodity derivatives contracts, net	$	12,605	Energy commodity derivatives contracts, net	$	38,126
Futures contracts	Other noncurrent assets	246		Other noncurrent liabilities	637
	Total	$	12,851	Total	$	38,763
	September 30, 2018
	Asset Derivatives			Liability Derivatives
Derivative Instrument	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Futures contracts	Energy commodity derivatives contracts, net	$	22,843	Energy commodity derivatives contracts, net	$	54,898