Derivative Instruments

3 Months Ended

Mar. 31, 2015

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Instruments

Derivative Instruments

We use derivative and non-derivative contracts to engage in trading activities and manage risks related to obtaining adequate supplies and the price fluctuations of natural gas, electricity and propane. Our natural gas, electric and propane distribution operations have entered into agreements with suppliers to purchase natural gas, electricity and propane for resale to their customers. Purchases under these contracts typically either do not meet the definition of derivatives or are considered “normal purchases and sales” and are accounted for on an accrual basis. Our propane distribution operation may also enter into fair value hedges of its inventory or cash flow hedges of its future purchase commitments in order to mitigate the impact of wholesale price fluctuations. As of March 31, 2015, our natural gas and electric distribution operations did not have any outstanding derivative contracts.

Hedging Activities in 2015

In March 2015, Sharp entered into a put option to protect against a decline in propane prices and related potential inventory losses associated with 630,000 gallons committed to be purchased for the propane price cap program in the upcoming heating season. The put option is exercised if propane prices fall below the strike price of $0.4950 per gallon in December 2015 through February 2016. We will receive the difference between the market price and the strike price during those months. We paid $43,000 to purchase the put option. We accounted for the put option as a fair value hedge, and there is no ineffective portion of this hedge. As of March 31, 2015, the put option had a fair value of $38,000. The change in fair value of the put option effectively reduced our propane inventory balance.

In March 2015, Sharp entered into a swap agreement to mitigate the risk of fluctuations in wholesale propane index prices associated with 630,000 gallons expected to be purchased for the upcoming heating season. Under the swap agreement, Sharp receives the difference between the index prices (Mont Belvieu prices in December 2015 through February 2016) and the swap price of $0.5950 per gallon, to the extent the index prices exceed the swap price. If the index prices are lower than the swap price, Sharp will pay the difference. The swap agreement essentially fixes the price of the 630,000 gallons that we expect to purchase for the upcoming heating season. We accounted for the swap agreement as a cash flow hedge, and there is no ineffective portion of this hedge. At March 31, 2015, the swap agreement had a liability fair value of $12,000. The change in the fair value of the swap agreement is recorded as unrealized gain/loss in other comprehensive income (loss).

Hedging Activities in 2014

In August and October 2014, Sharp entered into call options to protect against an increase in propane prices associated with 1.3 million gallons we expected to purchase at market-based prices to supply the demands of our propane price cap program customers. The retail price that we can charge to those customers during the heating season is capped at a pre-determined level. We would have exercised the call options if the propane prices had risen above the strike price of $1.0875 per gallon in December 2014 through February of 2015 and $1.0650 per gallon in January through March 2015. In that event, we would have received the difference between the market price and the strike price during those months. We paid $98,000 to purchase the call options, which expired without exercise as the market prices were below the strike prices. We accounted for the call options as cash flow hedges.

In May 2014, Sharp entered into swap agreements to mitigate the risk of fluctuations in wholesale propane index prices associated with 630,000 gallons we expected to purchase for the upcoming heating season. Under these swap agreements, Sharp would have received the difference between the index prices (Mont Belvieu prices in December 2014 through February 2015) and the swap prices of $1.1350, $1.0975 and $1.0475 per gallon for each swap agreement, to the extent the index prices exceeded the swap prices. If the index prices were lower than the swap prices, Sharp would pay the difference. These swap agreements essentially fixed the price of those 630,000 gallons purchased for the upcoming heating season. We had initially accounted for them as cash flow hedges as the swap agreements met all the requirements. We paid $1.1 million, representing the difference between the market prices and strike prices during those months for the swap agreements. At December 31, 2014, we elected to discontinue hedge accounting on the swap agreements and reclassified $735,000 of unrealized loss from other comprehensive loss to propane cost of sales. Subsequently, we accounted for them as derivative instruments on a mark-to-market basis with the change in the fair value reflected in current period earnings.

In May 2014, Sharp entered into put options to protect against declines in propane prices and related potential inventory losses associated with 630,000 gallons purchased for the propane price cap program in the upcoming heating season. We exercised the put options because the propane prices fell below the strike prices of $1.0350, $0.9975, and $0.9475 per gallon, for each option agreement in December 2014 through February 2015, respectively. We paid $128,000 to purchase the put options and we received $868,000, representing the difference between the market prices and strike prices during those months. We accounted for them as fair value hedges.

Commodity Contracts for Trading Activities

Xeron engages in trading activities using forward and futures contracts. These contracts are considered derivatives and have been accounted for using the mark-to-market method of accounting. Under this method, the trading contracts are recorded at fair value, and the changes in fair value of those contracts are recognized as unrealized gains or losses in the statement of income for the period of change. As of March 31, 2015, we had the following outstanding trading contracts, which we accounted for as derivatives:

	Quantity in	Estimated Market		Weighted Average
At March 31, 2015	Gallons	Prices		Contract Prices
Forward Contracts
Sale	420,000	$	0.4788	$	0.4788
Purchase	421,000	$	0.4775	$	0.4789

Estimated market prices and weighted average contract prices are in dollars per gallon. All contracts expire by the end of the second quarter of 2015.

Xeron has entered into master netting agreements with two counterparties to mitigate exposure to counterparty credit risk. The master netting agreements enable Xeron to net these two counterparties' outstanding accounts receivable and payable, which are presented on a gross basis in the accompanying condensed consolidated balance sheets. At March 31, 2015, Xeron had a right to offset $1.9 million and $2.3 million of accounts receivable and accounts payable, respectively, with these two counterparties. At December 31, 2014, Xeron had a right to offset $1.6 million and $1.2 million of accounts receivable and accounts payable, respectively, with these two counterparties.

The following tables present information about the fair value and related gains and losses of our derivative contracts. We did not have any derivative contracts with a credit-risk-related contingency.

The fair values of the derivative contracts recorded in the condensed consolidated balance sheets as of March 31, 2015 and December 31, 2014, are as follows:

	Asset Derivatives
		Fair Value As Of
(in thousands)	Balance Sheet Location	March 31, 2015		December 31, 2014
Derivatives not designated as hedging instruments
Forward contracts	Mark-to-market energy assets	$	8	$	407
Derivatives designated as fair value hedges
Put option(s)	Mark-to-market energy assets	38		622
Derivatives designated as cash flow hedges
Call option	Mark-to-market energy assets	—		26
Total asset derivatives		$	46	$	1,055

	Liability Derivatives
		Fair Value As Of
(in thousands)	Balance Sheet Location	March 31, 2015		December 31, 2014
Derivatives not designated as hedging instruments
Forward contracts	Mark-to-market energy liabilities	$	8	$	283
Propane swap agreements	Mark-to-market energy liabilities	—		735
Derivatives designated as cash flow hedges
Propane swap agreement	Mark-to-market energy liabilities	12		—
Total liability derivatives		$	20	$	1,018

The effects of gains and losses from derivative instruments on the condensed consolidated financial statements are as follows:

		Amount of Gain (Loss) on Derivatives:
	Location of Gain	For the Three Months Ended March 31,
(in thousands)	(Loss) on Derivatives	2015			2014
Derivatives not designated as hedging instruments
Realized gain on forward contracts (1)	Revenue	$	277		$	1,246
Unrealized loss on forward contracts	Revenue	(125		)	(68		)
Call option	Cost of sales	—			137
Propane swap agreements	Cost of sales	(717		)	—
Derivatives designated as fair value hedges
Put options	Cost of sales	506			(20		)
Put option (2)	Propane Inventory	(3		)	—
Derivatives designated as cash flow hedges
Propane swap agreement	Other Comprehensive loss	(12		)	—
Call options	Cost of sales	(81		)	—
Total		$	(155	)	$	1,295

⁽¹⁾  All of the realized and unrealized gain (loss) on forward contracts represents the effect of trading activities on our condensed consolidated statements of income.

⁽²⁾  As a fair value hedge with no ineffective portion, the unrealized gains and losses associated with this put option are recorded in cost of sales, offset by the corresponding change in the value of propane inventory (hedged item), which is also recorded in cost of sales. The amounts in cost of sales offset to zero, and the unrealized gains and losses of this put option effectively changed the value of propane inventory.