Derivative Instruments And Hedging Activities

9 Months Ended

Sep. 30, 2012

Derivative Instruments And Hedging Activities [Abstract]

Derivative Instruments And Hedging Activities

Derivative Instruments and Hedging Activities

Commodity Price Risk Management

Our primary market risk is commodity price risk. We are exposed to market risks related to the volatility in crude oil and refined products, as well as volatility in the price of natural gas used in our refining operations. We periodically enter into derivative contracts in the form of commodity price swaps and futures contracts to mitigate price exposure with respect to:

• our inventory positions;

• natural gas purchases;

• costs of crude oil and related grade differentials;

• prices of refined products; and

• our refining margins.

Accounting Hedges

We have swap contracts serving as cash flow hedges against price risk on forecasted purchases of WTI crude oil and forecasted sales of ultra-low sulfur diesel and conventional unleaded gasoline. These contracts have been designated as accounting hedges and are measured quarterly at fair value with offsetting adjustments (gains/losses) recorded directly to other comprehensive income. These fair value adjustments are later reclassified to earnings as the hedging instruments mature. Also on a quarterly basis, hedge ineffectiveness is measured by comparing the change in fair value of the swap contracts against the expected future cash inflows/outflows on the respective transaction being hedged. Any hedge ineffectiveness is also recognized in earnings.

The following table presents the pre-tax effect on other comprehensive income (“OCI”) and earnings due to fair value adjustments and maturities of commodity price swaps under hedge accounting:

	Unrealized Gain (Loss) Recognized in OCI			Gain (Loss) Recognized in Earnings Due to Settlements				Gain (Loss) Attributable to Hedge Ineffectiveness Recognized in Earnings
				Location	Amount			Location	Amount
				(In thousands)
Three Months Ended September 30, 2012
Commodity price swaps
Change in fair value	$	(144,635	)	Sales and other revenues	$	(44,936	)	Sales and other revenues	$	(3,531	)
Loss reclassified to earnings due to settlements	33,409			Cost of products sold	11,527			Cost of products sold	6,208
Total	$	(111,226	)		$	(33,409	)		$	2,677
Three Months Ended September 30, 2011
Commodity price swaps
Change in fair value	$	22,181		Cost of products sold	$	—		Cost of products sold	$	362
Nine Months Ended September 30, 2012
Commodity price swaps
Change in fair value	$	(257,711	)	Sales and other revenues	$	(99,228	)	Sales and other revenues	$	(1,876	)
Loss reclassified to earnings due to settlements	20,986			Cost of products sold	78,242			Cost of products sold	(109		)
Total	$	(236,725	)		$	(20,986	)		$	(1,985	)
Nine Months Ended September 30, 2011
Commodity price swaps
Change in fair value	$	22,053
Loss reclassified to earnings due to settlements	166			Operating expenses	$	(166	)	Cost of products sold	$	362
Total	$	22,219			$	(166	)		$	362

As of September 30, 2012, we have the following notional contract volumes (stated in barrels) related to outstanding swap contracts serving as cash flow hedges against price risk on forecasted purchases of crude oil and sales of refined products:

		Notional Contract Volumes by Year of Maturity
Commodity Price Swaps	Total Outstanding Notional	2012	2013
WTI crude oil - long	13,351,000	5,336,000	8,015,000
Ultra-low sulfur diesel - short	10,143,000	2,668,000	7,475,000
Conventional unleaded gasoline - short	3,208,000	2,668,000	540,000

Economic Hedges

We also have swap contracts that serve as economic hedges to fix our purchase price on forecasted crude oil, natural gas and butane purchases, and to lock in the spread between WCS and WTI crude oil on forecasted purchases. Also, we have NYMEX futures contracts to lock in prices on forecasted sales and purchases of inventory. These contracts are measured quarterly at fair value with offsetting adjustments (gains/losses) recorded directly to income.

The following table presents the pre-tax effect on income due to maturities and fair value adjustments of our economic hedges:

	Three Months Ended September 30,				Nine Months Ended September 30,
Location of Gain Recognized in Income	2012		2011		2012		2011
	(In thousands)
Cost of products sold	$	19,869	$	10,034	$	55,738	$	9,382
Operating expenses	604		—		446		—
Total	$	20,473	$	10,034	$	56,184	$	9,382

As of September 30, 2012, we have the following notional contract volumes related to our outstanding swap contracts serving as economic hedges:

		Notional Contract Volumes by Year of Maturity
Derivative Instrument	Total Outstanding Notional	2012	2013	Unit of Measure
Commodity price swap (natural gas) - long	3,312,000	3,312,000	—	MMBTU
Commodity price swap (WCS spread) - long	6,117,500	460,000	5,657,500	Barrels
Commodity price swap (WTI) - short	150,000	—	150,000	Barrels
Commodity price swap (gasoline) - short	630,000	150,000	480,000	Barrels
NYMEX futures (WTI) - long	234,000	—	234,000	Barrels
NYMEX futures (WTI)- short	2,206,000	1,856,000	350,000	Barrels

Interest Rate Risk Management

HEP uses interest rate swaps to manage its exposure to interest rate risk.

As of September 30, 2012, HEP had three interest rate swap contracts that hedge its exposure to the cash flow risk caused by the effects of LIBOR changes on $305.0 million in credit agreement advances. The first interest rate swap effectively converts $155.0 million of LIBOR based debt to fixed rate debt having an interest rate of 0.99% plus an applicable margin of 2.00% as of September 30, 2012, which equaled an effective interest rate of 2.99%. This swap matures in February 2016. In August 2012, HEP entered into two similar interest rate swaps with identical terms which convert $150.0 million of LIBOR based debt to fixed rate debt having an interest rate of 0.74% plus an applicable margin of 2.00% as of September 30, 2012, which equaled an effective interest rate of 2.74%. Both of these swap contracts mature in July 2017. All of these swap contracts have been designated as cash flow hedges. To date, there has been no ineffectiveness on these cash flow hedges.

At September 30, 2012, HEP had a pre-tax unrealized loss recorded in accumulated other comprehensive income of $5.9 million that relates to its current and previous cash flow hedging instruments. Of this amount, $2.1 million relates to a cash flow hedge terminated in December 2011 and represents the application of hedge accounting prior to termination. This amount will be amortized as a charge to interest expense through February 2013, the remaining term of the terminated swap contract.

The following table presents the pre-tax effect on other comprehensive income and earnings due to fair value adjustments and maturities of HEP's interest rate swaps under cash flow hedge accounting:

	Unrealized Gain (Loss) Recognized in OCI			Loss Recognized in Earnings Due to Settlements
				Location	Amount
				(In thousands)
Three Months Ended September 30, 2012
Interest rate swaps
Change in fair value	$	(1,802	)
Loss reclassified to earnings due to settlements	1,695			Interest expense	$	(1,695	)
Total	$	(107	)		$	(1,695	)
Three Months Ended September 30, 2011
Interest rate swaps
Change in fair value	$	(310	)
Loss reclassified to earnings due to settlements	1,403			Interest expense	$	(1,403	)
Total	$	1,093			$	(1,403	)
Nine Months Ended September 30, 2012
Interest rate swaps
Change in fair value	$	(4,240	)
Loss reclassified to earnings due to settlements	4,818			Interest expense	$	(4,818	)
Total	$	578			$	(4,818	)
Nine Months Ended September 30, 2011
Interest rate swaps
Change in fair value	$	(1,485	)
Loss reclassified to earnings due to settlements	4,132			Interest expense	$	(4,132	)
Total	$	2,647			$	(4,132	)

The following table presents balance sheet locations and related fair values of outstanding derivative instruments. These amounts are presented on a gross basis in accordance with GAAP disclosure requirements and do not reflect the netting of asset or liability positions permitted under the terms of master netting arrangements. Therefore, they are not equal to amounts presented in our consolidated balance sheets.

	Asset Derivatives			Liability Derivatives
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
	(In thousands)
September 30, 2012
Derivatives designated as cash flow hedging instruments:
Commodity price swap contracts	Accrued liabilities	$	22,018	Accrued liabilities	$	86,945
Variable-to-fixed interest rate swap contracts				Other long-term liabilities	3,764
Total		$	22,018		$	90,709
Derivatives not designated as hedging instruments:
Commodity price swap contracts	Prepayments and other current assets	$	4,126
	Accrued liabilities	20,986		Accrued liabilities	$	13,516
Total		$	25,112		$	13,516
December 31, 2011
Derivatives designated as cash flow hedging instruments:
Commodity price swap contracts	Prepayments and other current assets	$	173,784
Variable-to-fixed interest rate swap contracts				Other long-term liabilities	$	520
Total		$	173,784		$	520
Derivatives not designated as hedging instruments:
Commodity price swap contracts	Prepayments and other current assets	$	1,870	Accrued liabilities	$	1,252

At September 30, 2012, we had a pre-tax net unrealized loss of $68.7 million classified in accumulated other comprehensive income that relates to all accounting hedges. Assuming commodity prices and interest rates remain unchanged, an unrealized loss of approximately $66.0 million will be effectively transferred from accumulated other comprehensive income into the statement of income as the hedging instruments mature over the next twelve-month period.