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Note 6 - Fair Value of Financial Instruments

12 Months Ended

Dec. 31, 2013

Fair Value Disclosures [Abstract]

Fair Value Disclosures [Text Block]

NOTE 6 — FAIR VALUE OF FINANCIAL INSTRUMENTS

The fair value measurement guidance clarifies that fair value is an exit price, representing the amount that would be received upon selling an asset or paid upon transferring a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. The guidance establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under the fair value measurement guidance are described below:

Level 1 — Unadjusted quoted prices in active markets that are accessible at the measurement date for identical assets or liabilities;

Level 2 — Quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability;

Level 3 — Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (supported by little or no market activity).

The following table sets forth certain fair value information at December 31, 2013 and 2012 for financial assets and liabilities measured at fair value by level within the fair value hierarchy, as well as cost or amortized cost. As required by the fair value measurement guidance, assets and liabilities are classified in their entirety based on the lowest level of inputs that is significant to the fair value measurement.

						December 31, 2013
						Fair Value
		Carrying Value at December 31, 2013				Total				Level 1				Level 2				Level 3
						(Dollars in thousands)
Assets
Current assets:
Cash equivalents (including restricted cash accounts)		$	40,015			$	40,015			$	40,015			$	-			$	-
Derivatives:
Currency forward contracts⁽⁴⁾			2,290				2,290				-				2,290				-
Liabilities
Current liabilities:
Derivatives:
Swap transaction on oil price⁽²⁾			(2,490	)			(2,490	)			-				(2,490	)			-
Swap transaction on natural gas price⁽³⁾			(341	)			(341	)			-				(341	)			-
		$	39,474			$	39,474			$	40,015			$	(541	)		$	-

						December 31, 2012
						Fair Value
		Carrying Value at December 31, 2012				Total				Level 1				Level 2				Level 3
						(Dollars in thousands)

Assets
Current assets:
Cash equivalents (including restricted cash accounts)		$	54,298			$	54,298			$	54,298			$	-			$	-
Derivatives:
Put options on oil price⁽¹⁾			1,842				1,842				-				1,842				-
Swap transaction on oil price⁽²⁾			336				336				-				336				-
Swap transaction on natural gas price⁽³⁾			2,804				2,804				-				2,804				-
Currency forward contracts⁽⁴⁾			1,675				1,675				-				1,675				-
		$	60,955			$	60,955			$	54,298			$	6,657			$	-

⁽¹⁾

This amount relates to derivatives which represent European put transactions on oil prices, valued primarily based on observable inputs, including forward and spot prices for related commodity indices, and are included within “prepaid expenses and other” in the consolidated balance sheet with the corresponding gain or loss being recognized within “electricity revenues” in the consolidated statement of operations and comprehensive income (loss).

⁽²⁾

This amount relates to derivatives which represent swap contract on oil prices, valued primarily based on observable inputs, including forward and spot prices for related commodity indices, and are included within “accounts payable and accrued expenses” and “prepaid expenses and other” on December 31, 2013 and 2012, respectively, in the consolidated balance sheets with the corresponding gain or loss being recognized within “electricity revenues” in the consolidated statement of operations and comprehensive income (loss).

⁽³⁾

This amount relates to derivatives which represent swap contract on natural gas prices, valued primarily based on observable inputs, including forward and spot prices for related commodity indices, and are included within “accounts payable and accrued expenses” and “prepaid expenses and other” on December 31, 2013 and 2012, respectively, in the consolidated balance sheets with the corresponding gain or loss being recognized within “electricity revenue” in the consolidated statement of operations and comprehensive income (loss).

⁽⁴⁾

These amounts relate to derivatives which represent currency forward contracts valued primarily based on observable inputs, including forward and spot prices for currencies, netted against contracted rates and then multiplied against notional amounts, and are included within “prepaid expenses and other” in the consolidated balance sheet with the corresponding gain or loss being recognized within “foreign currency translation and transaction gains (losses)” in the consolidated statement of operations and comprehensive income (loss).

The Company’s financial assets measured at fair value (including restricted cash accounts) at December 31, 2013 and 2012 include investments in debt instruments, money market funds (which are included in cash equivalents) and short-term bank deposits. Those securities and deposits are classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices in an active market.

The following table presents the amounts of gain (loss) recognized in the consolidated statements of operations and comprehensive income (loss) on derivative instruments not designated as hedges:

Derivatives not designated				Amount of recognized gain (loss)
as hedging instruments		Location of recognized gain (loss)		2013				2012				2011
				(Dollars in thousands)

Put options on oil price		Electricity revenues		$	(1,330	)		$	(807	)		$	-
Put options on natural gas price		Electricity revenues			-				(1,342	)			-
Swap transaction on oil price		Electricity revenues			(635	)			1,598				-
Swap transactions on natural gas price		Electricity revenues			(3,052	)			2,804				-
Currency forward contracts		Foreign currency translation and transaction gains			5,912				463				-
				$	895			$	2,716			$	-

On September 3, 2013, the Company entered into a NGI swap contract with a bank for notional volume of approximately 4.4 million MMbtus for settlement effective January 1, 2014 until December 31, 2014, in order to reduce its exposure to NGI below $4.035 per MMbtu under its PPAs with Southern California Edison. The contract did not have up-front costs. Under the terms of this contract, the Company will make floating rate payments to the bank and receive fixed rate payments from the bank on each settlement date. The swap contract has monthly settlement whereby the difference between the fixed price of $4.035 per MMbtu and the market price on the first commodity business day on which the relevant commodity reference price is published in the relevant calculation period (January 1, 2014 to December 1, 2014) will be settled on a cash basis. This contract will not be designated as hedge transaction and will be marked to market with the corresponding gains or losses recognized within “electricity revenues” in the consolidated statements of operations and comprehensive income (loss).

On October 16, 2013, the Company entered into a NGI swap contract with a bank for notional volume of approximately 4.2 million MMbtus for settlement effective January 1, 2014 until December 31, 2014, in order to reduce its exposure to NGI below $4.103 per MMbtu under its PPAs with Southern California Edison. The contract did not have any up-front costs. Under the terms of this contract, the Company will make floating rate payments to the bank and receive fixed rate payments from the bank on each settlement date. The swap contract has monthly settlements whereby the difference between the fixed price of $4.103 per MMbtu and the market price on the first commodity business day on which the relevant commodity reference price is published in the relevant calculation period (January 1, 2014 to December 1, 2014) will be settled on a cash basis. This contract will not be designated as a hedge transaction and will be marked to market with the corresponding gains or losses recognized within “electricity revenues” in the consolidated statements of operations and comprehensive income (loss).

On October 16, 2013, the Company entered into a New York Harbor ULSD swap contract with a bank for notional volume of 275,000 BBL effective from January 1, 2014 until December 31, 2014 to reduce the Company’s exposure to fluctuations in the energy rate caused by fluctuations in oil prices under the 25 MW PPA for the Puna complex. The Company entered into this contract because the swap had a high correlation with the avoided costs (which are incremental costs that the power purchaser avoids by not having to generate such electrical energy itself or purchase it from others) that HELCO uses to calculate the energy rate. The contract did not have any up-front costs. Under the terms of this contract, the Company will make floating rate payments to the bank and receive fixed rate payments from the bank on each settlement date ($125.15 per BBL). The swap contract has monthly settlements whereby the difference between the fixed price and the monthly average market price will be settled on a cash basis. This contract will not be designated as a hedge transaction and will be marked to market with the corresponding gains or losses recognized within “electricity revenues” in the consolidated statements of operations and comprehensive income (loss).

These transactions have not been designated as hedge transactions and are marked to market with the corresponding gains or losses recognized within “electricity revenues” in the consolidated statements of operations and comprehensive income (loss). The Company recognized a net loss from these transactions of $5.0 million in the year ended December 31, 2013, compared to net gain of $2.3 million in the year ended December 31, 2012.

There were no transfers of assets or liabilities between Level 1 and Level 2 during the year ended December 31, 2013.

The fair value of the Company’s long-term debt is as follows:

		Fair Value								Carrying Amount
		December 31,								December 31,
		2013				2012				2013				2012
		(Dollars in millions)								(Dollars in millions)
Olkaria III Loan - DEG		$	40.3			$	48.8			$	39.5			$	47.4
Olkaria III Loan - OPIC			279.6				220.0				299.9				220.0
Amatitlan Loan			34.8				38.9				31.5				34.3
Senior Secured Notes:
Ormat Funding LLC ("OFC")			83.5				105.0				90.8				114.1
OrCal Geothermal LLC ("OrCal")			65.8				77.3				66.2				76.5
OFC 2 LLC ("OFC 2")			119.0				131.2				144.4				150.5
Senior Unsecured Bonds			270.6				273.2				250.6				250.9
Loan from institutional investors		20.1					27.7				19.5				27.0

The fair value of OFC Senior Secured Notes is determined using observable market prices as these securities are traded. The fair value of the other long-term debt is determined by a valuation model, which is based on a conventional discounted cash flow methodology and utilizes assumptions of current borrowing rates.The fair value of revolving lines of credit is determined using a comparison of market-based price sources that are reflective of similar credit ratings to those of the Company.

The carrying value of other financial instruments, such as revolving lines of credit, deposits, and other long-term debt approximates fair value.

The following table presents the fair value of financial instruments as of December 31, 2013:

		Level 1				Level 2				Level 3				Total
		(Dollars in millions)
Olkaria III - DEG		$	—			$	—			$	40.3			$	40.3
Olkaria III - OPIC			—				—				279.6				279.6
Amatitlan loan			—				—				34.8				34.8
Senior Secured Notes:
OFC			—				83.5				—				83.5
OrCal			—				—				65.8				65.8
OFC 2			—				—				119.0				119.0
Senior unsecured bonds			—				—				270.6				270.6
Loan from institutional investors			—				—				20.1				20.1
Other long-term debt			—				23.3				—				23.3
Revolving credit lines with banks			—				112.0				—				112.0
Deposits			21.3				—				—				21.3

The following table presents the fair value of financial instruments as of December 31, 2012:

		Level 1				Level 2				Level 3				Total
		(Dollars in millions)
Olkaria III Loan - DEG		$	—			$	—			$	48.8			$	48.8
Olkaria III Loan - OPIC			—				—				220.0				220.0
Amatitlan Loan			—				—				38.9				38.9
Senior Secured Notes:
OFC			—				105.0				—				105.0
OrCal			—				—				77.3				77.3
OFC 2			—				—				131.2				131.2
Senior unsecured bonds			—				—				273.2				273.2
Loan from institutional investors			—				—				27.7				27.7
Other long-term debt			—				36.7				—				36.7
Revolving lines of credit			—				73.6				—				73.6
Deposits			21.7				—				—				21.7

Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis

The North Brawley geothermal power plant was tested for impairment as of December 31, 2012 due to the low output and higher than expected operating costs. The plant was placed in service under its PPA with Southern California Edison in 2010. However, management found that the North Brawley geothermal field was significantly more difficult to operate than other fields of the Company and the power plant was unable to reach its design capacity of 50 MW and instead, operated at capacities between 20 MW and 33 MW. This generation level was achieved only after significant additional capital expenditures and higher than anticipated operating costs.

In order to improve the economics of the plant, the Company approached Southern California Edison to discuss various contractual alternatives to the PPA and, in early 2012 it reached a written understanding to engage in discussions with third parties about purchasing the power at better rates. However, in a letter dated January 14, 2013, Southern California Edison informed the Company that it is no longer interested in pursuing alternatives to the current PPA, thus retracting its permission to the Company to explore a replacement PPA with higher electricity prices.

As a result of Southern California Edison’s notification and the rates under the existing PPA, coupled with a further understanding of the cost and probability of success of additional well field work which has been accumulated in recent months, the Company has concluded that it will not be economical to continue to invest the substantial capital required to increase the generating capacity of the power plant. Accordingly, the Company decided to operate the plant at the current capacity level of approximately 27 MW and refrain from additional capital investment to expand the capacity.

Based on these indicators, the power plant was tested for recoverability by estimating its future cash flows taking into consideration rates to be received under the PPA with Southern California Edison through the end of its term and expected market rates thereafter, possible penalties for underperformance during periods when the plant is expected to operate below the stated capacity in the PPA, projected capital expenditures and projected operating expenses over the life of the plant.

As a result, the North Brawley power plant was written down to its fair value of $32.0 million. The impairment loss of $229.1 million is presented in the consolidated statement of operations and comprehensive income (loss) under “Impairment Charges”.

In estimating the fair value for the power plant, the Company primarily relied on the “Income Approach”, using assumptions that the Company believes market participants would utilize in making such valuation. The “Income Approach” is based on the principle that the value of an asset is equal to the present value of the cash flows that the asset is expected to generate. To estimate the fair value of the power plant, a discounted cash flow (“DCF”) analysis was utilized whereby the cash flows expected to be generated by the power plant were discounted to their present value equivalent using the rate of return that reflects the relative risk of each asset, as well as the time value of money. This return, known as the weighted average cost of capital (“WACC”), an overall rate based upon the individual rates of return for invested capital (equity and interest-bearing debt), was calculated by weighting the acquired return on interest-bearing debt and common equity capital in proportion to their estimated percentage in the expected capital structure. The estimate for the WACC of 8% developed in the valuation is for independent power producers and geothermal power producers.

In addition to the WACC rate of 8%, other significant inputs of the future net cash flow estimates included in the valuation are generation output, average realized price, and operating costs. These future net cash flow estimates are classified as Level 3 within the fair value hierarchy. Below are the significant unobservable inputs for each year included in the valuation as of the year ended December 31, 2012.

(Dollars in thousands, except realized price)

		Valuation Technique			Amount or Range					Weighted Average
Generation output (MWh)		DCF				224,836				224,836
Average realized price ($/MWh)		DCF			$84.50	—	$111.25			$92.31
Operating costs		DCF			$12,687	—	$20,430			$16,163

OREG 4, a recovered energy generation power plant, was also tested for impairment in the third quarter of 2012 due to continued low run time of the compressor station that serves as it heat source, which resulted in low power generation and revenues. Based on these indicators, the power plant was tested for recoverability by estimating its future cash flows over the life of the plant.

As a result, the OREG 4 power plant was written down to its fair value of $3.6 million. The impairment loss of $7.3 million is presented in the consolidated statement of operations and comprehensive income (loss) under “Impairment Charges”.

In estimating the fair value for the power plant, the Company primarily relied on the “Income Approach”, using assumptions that the Company believes market participants would utilize in making such valuation. The “Income Approach” is based on the principle that the value of an asset is equal to the present value of the cash flows that the asset is expected to generate. To estimate the fair value of the power plant, a DCF analysis was utilized and the estimate for the WACC of 8% developed in the valuation is for independent power producers and geothermal power producers.

In addition to the WACC rate of 8%, other significant inputs of the future net cash flow estimates included in the valuation are generation output, average realized price, and operating costs. These future net cash flow estimates are classified as Level 3 within the fair value hierarchy. Below are the significant unobservable inputs for each year included in the valuation as of the quarter ended September 30, 2012.

(Dollars in thousands, except realized price)

		Valuation Technique			Amount or Range					Weighted Average
Generation output (MWh)		DCF			11,916	—	15,456			15,097
Average realized price ($/MWh)		DCF			$49.00	—	$71.50			$60.36
Operating costs		DCF			$86	—	$595			$400

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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