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DERIVATIVE INSTRUMENTS
9 Months Ended
Jun. 30, 2018
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
DERIVATIVE INSTRUMENTS
4. DERIVATIVE INSTRUMENTS

The Company is subject primarily to commodity price risk due to fluctuations in the market price of natural gas, SRECs and electricity. To manage this risk, the Company enters into a variety of derivative instruments including, but not limited to, futures contracts, physical forward contracts, financial options and swaps to economically hedge the commodity price risk associated with its existing and anticipated commitments to purchase and sell natural gas, SRECs and electricity. In addition, the Company is exposed to foreign currency and interest rate risk, The Company may utilize foreign currency derivatives to hedge Canadian dollar denominated gas purchases and/or sales and interest rate derivatives to reduce exposure to fluctuations in interest rates. All of these types of contracts are accounted for as derivatives. Accordingly, all of the financial and certain of the Company's physical derivative instruments are recorded at fair value on the Unaudited Condensed Consolidated Balance Sheets. For a more detailed discussion of the Company's fair value measurement policies and level disclosures associated with NJR's derivative instruments, see Note 5. Fair Value.

Energy Services

Energy Services chooses not to designate its financial commodity and physical forward commodity derivatives as accounting hedges or to elect NPNS. The changes in the fair value of these derivatives are recorded as a component of gas purchases or operating revenues, as appropriate for Energy Services, on the Unaudited Condensed Consolidated Statements of Operations as unrealized gains or losses. For Energy Services at settlement, realized gains and losses on all financial derivative instruments are recognized as a component of gas purchases and realized gains and losses on all physical derivatives follow the presentation of the related unrealized gains and losses as a component of either gas purchases or operating revenues.

Energy Services also enters into natural gas transactions in Canada and, consequently, is exposed to fluctuations in the value of Canadian currency relative to the U.S. dollar. Energy Services may utilize foreign currency derivatives to lock in the exchange rate associated with natural gas transactions denominated in Canadian currency. The derivatives may include currency forwards, futures, or swaps and are accounted for as derivatives. These derivatives are typically used to hedge demand fee payments on pipeline capacity, storage and gas purchase agreements.

As a result of Energy Services entering into transactions to borrow natural gas, commonly referred to as “park and loans,” an embedded derivative is recognized relating to differences between the fair value of the amount borrowed and the fair value of the amount that will ultimately be repaid, based on changes in the forward price for natural gas prices at the borrowed location over the contract term. This embedded derivative is accounted for as a forward sale in the month in which the repayment of the borrowed gas is expected to occur, and is considered a derivative transaction that is recorded at fair value on the Unaudited Condensed Consolidated Balance Sheets, with changes in value recognized in current period earnings.

Expected production of SRECs is hedged through the use of forward and futures contracts. All contracts require the Company to physically deliver SRECs through the transfer of certificates as per contractual settlement schedules. The Company applies NPNS accounting to SREC forward and futures contracts entered into on or before December 31, 2015. Effective for contracts executed on or after January 1, 2016, Energy Services no longer elects NPNS accounting treatment on all SREC forward sales contracts and recognizes changes in the fair value of these derivatives as a component of operating revenues. Upon settlement of the contract, the related revenue is recognized when the SREC is transferred to the counterparty. NPNS is a contract-by-contract election and, where appropriate, the Company can and may elect normal accounting for certain contracts.

Natural Gas Distribution

Changes in fair value of NJNG's financial commodity derivatives are recorded as a component of regulatory assets or liabilities on the Unaudited Condensed Consolidated Balance Sheets. The Company elects NPNS accounting treatment on all physical commodity contracts that NJNG entered into on or before December 31, 2015, and accounts for these contracts on an accrual basis. Accordingly, physical natural gas purchases are recognized in regulatory assets or liabilities on the Unaudited Condensed Consolidated Balance Sheets when the contract settles and the natural gas is delivered. The average cost of natural gas is charged to expense in the current period earnings based on the BGSS factor times the therm sales. Effective for contracts executed on or after January 1, 2016, NJNG no longer elects NPNS accounting treatment on all physical forward commodity contracts. However, since NPNS is a contract-by-contract election, where it makes sense to do so, NJNG can and may elect certain contracts to be normal. Because NJNG recovers these amounts through future BGSS rates as increases or decreases to the cost of natural gas in NJNG’s tariff for gas service, the changes in fair value of these contracts are deferred as a component of regulatory assets or liabilities on the Unaudited Condensed Consolidated Balance Sheets.

In June 2015, NJNG entered into a treasury lock transaction to fix a benchmark treasury rate of 3.26 percent associated with a $125 million debt issuance that was finalized in May 2018. This debt issuance coincided with the maturity of NJNG's $125 million, 5.6 percent notes that came due May 15, 2018. This treasury lock was settled on March 13, 2018, which coincided with the pricing of the new debt being issued. Settlement of the treasury lock resulted in a $2.6 million loss, which is recorded as a component of regulatory assets on the Unaudited Condensed Consolidated Balance Sheets and will be amortized in earnings over the term of the $125 million, 4.01 percent notes that were issued on May 11, 2018.

Home Services and Other

On January 26, 2018, NJR entered into a variable-for-fixed interest rate swap on its existing $100 million variable rate term loan, which fixed the variable rate at 2.84 percent. The swap will terminate on August 16, 2019, which coincides with the maturity of the debt. The change in the fair value of the interest rate swap is recorded as interest expense on the Unaudited Condensed Consolidated Statements of Operations.

Fair Value of Derivatives

The following table reflects the fair value of NJR's derivative assets and liabilities recognized on the Unaudited Condensed Consolidated Balance Sheets as of:
 
 
 
Fair Value
 
 
June 30, 2018
 
September 30, 2017
(Thousands)
Balance Sheet Location
Asset
Derivatives
Liability
Derivatives
Asset
Derivatives
Liability
Derivatives
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
Natural Gas Distribution:
 
 
 
 
 
 
 
 
 
Physical commodity contracts
Derivatives - current
 
$
57

 
$
286

 
$
151

 
$
72

Financial commodity contracts
Derivatives - current
 
323

 
117

 

 
1,149

Interest rate contracts
Derivatives - current
 

 

 

 
8,467

Energy Services:
 
 
 
 
 
 
 
 
 
Physical commodity contracts
Derivatives - current
 
6,847

 
17,660

 
14,588

 
16,589

 
Derivatives - noncurrent
 
2,474

 
13,267

 
7,127

 
8,710

Financial commodity contracts
Derivatives - current
 
15,728

 
25,151

 
15,302

 
20,267

 
Derivatives - noncurrent
 
9,324

 
8,163

 
2,033

 
2,620

Foreign currency contracts
Derivatives - current
 

 
184

 
40

 

 
Derivatives - noncurrent
 

 
174

 
4

 

Home Services and Other:
 
 
 
 
 
 
 
 
 
Interest rate contracts
Derivatives - current
 
237

 

 

 

 
Derivatives - noncurrent
 
88

 

 

 

Total fair value of derivatives
 
 
$
35,078

 
$
65,002

 
$
39,245

 
$
57,874



Offsetting of Derivatives

The Company transacts under master netting arrangements or equivalent agreements that allow it to offset derivative assets and liabilities with the same counterparty. However, the Company’s policy is to present its derivative assets and liabilities on a gross basis at the contract level unit of account on the Unaudited Condensed Consolidated Balance Sheets.
The following table summarizes the reported gross amounts, the amounts that the Company has the right to offset but elects not to, financial collateral, as well as the net amounts the Company could present on the Unaudited Condensed Consolidated Balance Sheets but elects not to.
(Thousands)
Amounts Presented on Balance Sheets (1)
Offsetting Derivative Instruments (2)
Financial Collateral Received/Pledged (3)
Net Amounts (4)
As of June 30, 2018:
 
 
 
 
 
 
 
 
Derivative assets:
 
 
 
 
 
 
 
 
Energy Services
 
 
 
 
 
 
 
 
Physical commodity contracts
 
$
9,321

 
$
(3,461
)
 
$
(200
)
 
$
5,660

Financial commodity contracts
 
25,052

 
(16,800
)
 
360

 
8,612

Total Energy Services
 
$
34,373

 
$
(20,261
)
 
$
160

 
$
14,272

Natural Gas Distribution
 
 
 
 
 
 
 
 
Physical commodity contracts
 
$
57

 
$
(6
)
 
$

 
$
51

Financial commodity contracts
 
323

 
(117
)
 

 
206

Total Natural Gas Distribution
 
$
380

 
$
(123
)
 
$

 
$
257

Home Services and Other
 
 
 
 
 
 
 
 
Interest rate contracts
 
$
325

 
$

 
$

 
$
325

Total Home Services and Other
 
$
325

 
$

 
$

 
$
325

Derivative liabilities:
 
 
 
 
 
 
 
 
Energy Services
 
 
 
 
 
 
 
 
Physical commodity contracts
 
$
30,927

 
$
(3,461
)
 
$

 
$
27,466

Financial commodity contracts
 
33,314

 
(16,800
)
 
(16,154
)
 
360

Foreign currency contracts
 
358

 

 

 
358

Total Energy Services
 
$
64,599

 
$
(20,261
)
 
$
(16,154
)
 
$
28,184

Natural Gas Distribution
 
 
 
 
 
 
 
 
Physical commodity contracts
 
$
286

 
$
(6
)
 
$

 
$
280

Financial commodity contracts
 
117

 
(117
)
 
206

 
206

Total Natural Gas Distribution
 
$
403

 
$
(123
)
 
$
206

 
$
486

As of September 30, 2017:
 
 
 
 
 
 
 
 
Derivative assets:
 
 
 
 
 
 
 
 
Energy Services
 
 
 
 
 
 
 
 
Physical commodity contracts
 
$
21,715

 
$
(2,173
)
 
$
(200
)
 
$
19,342

Financial commodity contracts
 
17,335

 
(14,121
)
 

 
3,214

Foreign currency contracts
 
44

 

 

 
44

Total Energy Services
 
$
39,094

 
$
(16,294
)
 
$
(200
)
 
$
22,600

Natural Gas Distribution
 
 
 
 
 
 
 
 
Physical commodity contracts
 
$
151

 
$
(20
)
 
$

 
$
131

Total Natural Gas Distribution
 
$
151

 
$
(20
)
 
$

 
$
131

Derivative liabilities:
 
 
 
 
 
 
 
 
Energy Services
 
 
 
 
 
 
 
 
Physical commodity contracts
 
$
25,299

 
$
(2,173
)
 
$

 
$
23,126

Financial commodity contracts
 
22,887

 
(14,121
)
 
(8,766
)
 

Total Energy Services
 
$
48,186

 
$
(16,294
)
 
$
(8,766
)
 
$
23,126

Natural Gas Distribution
 
 
 
 
 
 
 
 
Physical commodity contracts
 
$
72

 
$
(20
)
 
$

 
$
52

Financial commodity contracts
 
1,149

 

 
(1,149
)
 

Interest rate contracts
 
8,467

 

 

 
8,467

Total Natural Gas Distribution
 
$
9,688

 
$
(20
)
 
$
(1,149
)
 
$
8,519

(1)
Derivative assets and liabilities are presented on a gross basis on the balance sheet as the Company does not elect balance sheet offsetting under ASC 210-20.
(2)
Includes transactions with NAESB netting election, transactions held by FCMs with net margining and transactions with ISDA netting.
(3)
Financial collateral includes cash balances at FCMs as well as cash received from or pledged to other counterparties.
(4)
Net amounts represent presentation of derivative assets and liabilities if the Company were to elect balance sheet offsetting under ASC 210-20.

Energy Services utilizes financial derivatives to economically hedge the gross margin associated with the purchase of physical gas to be used for storage injection and its subsequent sale at a later date. The gains or (losses) on the financial transactions that are economic hedges of the cost of the purchased gas are recognized prior to the gains or (losses) on the physical transaction, which are recognized in earnings when the natural gas is delivered. Therefore, mismatches between the timing of the recognition of realized gains or (losses) on the financial derivative instruments and gains or (losses) associated with the actual sale of the natural gas that is being economically hedged along with fair value changes in derivative instruments creates volatility in the results of Energy Services, although the Company's intended economic results relating to the entire transaction are unaffected.

The following table reflects the effect of derivative instruments on the Unaudited Condensed Consolidated Statements of Operations as of:
(Thousands)
Location of gain (loss) recognized in income on derivatives
Amount of gain (loss) recognized
in income on derivatives
 
 
Three Months Ended
Nine Months Ended
 
 
June 30,
June 30,
Derivatives not designated as hedging instruments:
2018
 
2017
2018
 
2017
Energy Services:
 
 
 
 
 
 
 
Physical commodity contracts
Operating revenues
$
3,046

 
$
1,364

$
(7,696
)
 
$
8,089

Physical commodity contracts
Gas purchases
1,008

 
(1,131
)
(66,335
)
 
(13,912
)
Financial commodity contracts
Gas purchases
(6,777
)
 
22,004

(19,007
)
 
29,514

Foreign currency contracts
Gas purchases
(194
)
 
9

(457
)
 
(24
)
Home Services and Other:
 
 
 
 
 
 
 
Interest rate contracts
Interest expense
165

 

286

 

Total unrealized and realized gains (losses)
$
(2,752
)
 
$
22,246

$
(93,209
)
 
$
23,667



NJNG’s derivative contracts are part of the Company's risk management activities that relate to its natural gas purchases, BGSS incentive programs and debt financing. These transactions are entered into pursuant to regulatory approval. At settlement, the resulting gains and/or losses are payable to or recoverable from utility customers and are deferred in regulatory assets or liabilities resulting in no impact to earnings. The following table reflects the (losses) gains associated with NJNG's derivative instruments as of:
 
Three Months Ended
Nine Months Ended
 
June 30,
June 30,
(Thousands)
2018
 
2017
2018
 
2017
Natural Gas Distribution:
 
 
 
 
 
 
Physical commodity contracts
$
(178
)
 
$
(301
)
$
(16,033
)
 
$
(3,031
)
Financial commodity contracts
3,306

 
(4,232
)
1,730

 
6,528

Interest rate contracts

 
(4,203
)
8,467

 
14,478

Total unrealized and realized (losses) gains
$
3,128

 
$
(8,736
)
$
(5,836
)
 
$
17,975



NJNG and Energy Services had the following outstanding long (short) derivatives as of:
 
 
 
Volume (Bcf)
 
 
 
June 30,
2018
 
September 30,
2017
Natural Gas Distribution
Futures
 
25.8

 
18.2

 
Physical
 
31.6

 
32.1

Energy Services
Futures
 
(30.2
)
 
(16.4
)
 
Physical
 
19.9

 
(13.1
)


Not included in the previous table are Energy Services' gross notional amount of foreign currency transactions of approximately $7.9 million, NJNG’s treasury lock agreement and NJR's interest rate swap as previously discussed and 702,000 SRECs at Energy Services that are open as of June 30, 2018.
Broker Margin

Futures exchanges have contract specific margin requirements that require the posting of cash or cash equivalents relating to traded contracts. Margin requirements consist of initial margin that is posted upon the initiation of a position, maintenance margin that is usually expressed as a percent of initial margin, and variation margin that fluctuates based on the daily marked-to-market relative to maintenance margin requirements. The Company maintains separate broker margin accounts for the Natural Gas Distribution and Energy Services segments. The balances are as follows:
(Thousands)
Balance Sheet Location
June 30,
2018
September 30,
2017
Natural Gas Distribution
Broker margin - Current assets
$
1,845

$
2,661

Energy Services
Broker margin - Current assets
$
51,296

$
23,166



Wholesale Credit Risk

NJNG, Energy Services and Clean Energy Ventures are exposed to credit risk as a result of their sales/wholesale marketing activities. As a result of the inherent volatility in the prices of natural gas commodities, derivatives, SRECs, electricity and RECs, the market value of contractual positions with individual counterparties could exceed established credit limits or collateral provided by those counterparties. If a counterparty fails to perform the obligations under its contract (e.g., failed to deliver or pay for natural gas, SRECs, electricity or RECs), then the Company could sustain a loss.

NJR monitors and manages the credit risk of its wholesale operations through credit policies and procedures that management believes reduce overall credit risk. These policies include a review and evaluation of current and prospective counterparties' financial statements and/or credit ratings, daily monitoring of counterparties' credit limits and exposure, daily communication with traders regarding credit status and the use of credit mitigation measures, such as collateral requirements and netting agreements. Examples of collateral include letters of credit and cash received for either prepayment or margin deposit. Collateral may be requested due to NJR's election not to extend credit or because exposure exceeds defined thresholds. Most of NJR's wholesale marketing contracts contain standard netting provisions. These contracts include those governed by ISDA and the NAESB. The netting provisions refer to payment netting, whereby receivables and payables with the same counterparty are offset and the resulting net amount is paid to the party to which it is due.

Internally-rated exposure applies to counterparties that are not rated by S&P or Moody's. In these cases, the counterparty's or guarantor's financial statements are reviewed, and similar methodologies and ratios used by S&P and/or Moody's are applied to arrive at a substitute rating. Gross credit exposure is defined as the unrealized fair value of physical and financial derivative commodity contracts, plus any outstanding wholesale receivable for the value of natural gas delivered and/or financial derivative commodity contract that has settled for which payment has not yet been received.

The following is a summary of gross credit exposures grouped by investment and noninvestment grade counterparties, as of June 30, 2018. The amounts presented below have not been reduced by any collateral received or netting and exclude accounts receivable for NJNG retail natural gas sales and services and Clean Energy Ventures residential solar installations.
(Thousands)
Gross Credit Exposure
Investment grade
 
$
150,226

 
Noninvestment grade
 
31,860

 
Internally rated investment grade
 
26,536

 
Internally rated noninvestment grade
 
13,965

 
Total
 
$
222,587

 


Conversely, certain of NJNG's and Energy Services' derivative instruments are linked to agreements containing provisions that would require cash collateral payments from the Company if certain events occur. These provisions vary based upon the terms in individual counterparty agreements and can result in cash payments if NJNG's credit rating were to fall below its current level. NJNG's credit rating, with respect to S&P, reflects the overall corporate credit profile of NJR. Specifically, most, but not all, of these additional payments will be triggered if NJNG's debt is downgraded by the major credit agencies, regardless of investment grade status. In addition, some of these agreements include threshold amounts that would result in additional collateral payments if the values of derivative liabilities were to exceed the maximum values provided for in relevant counterparty agreements. Other provisions include payment features that are not specifically linked to ratings, but are based on certain financial metrics.

Collateral amounts associated with any of these conditions are determined based on a sliding scale and are contingent upon the degree to which the Company's credit rating and/or financial metrics deteriorate, and the extent to which liability amounts exceed applicable threshold limits. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a liability position on June 30, 2018 and September 30, 2017, was $687,000 and $8.7 million, respectively, for which the Company had not posted collateral. If all thresholds related to the credit-risk-related contingent features underlying these agreements had been invoked on June 30, 2018 and September 30, 2017, the Company would have been required to post an additional $171,000 and $8.6 million, respectively, to its counterparties. These amounts differ from the respective net derivative liabilities reflected on the Unaudited Condensed Consolidated Balance Sheets because the agreements also include clauses, commonly known as “Rights of Offset,” that would permit the Company to offset its derivative assets against its derivative liabilities for determining additional collateral to be posted, as previously discussed.