Derivative Instruments and Hedging Activities

3 Months Ended

Mar. 31, 2015

Derivative Instruments and Hedging Activities [Abstract]

Derivative Instruments and Hedging Activities

Note 14 — Derivative Instruments and Hedging Activities

The Partnership’s Commodity Hedges

The primary purpose of the Partnership’s commodity risk management activities is to manage its exposure to commodity price risk and reduce volatility in its operating cash flow due to fluctuations in commodity prices. The Partnership has hedged the commodity prices associated with a portion of its expected (i) natural gas equity volumes in its Field Gathering and Processing segment and (ii) NGL and condensate equity volumes predominately in its Field Gathering and Processing segment and the LOU business unit in its Coastal Gathering and Processing segment that result from percent-of-proceeds processing arrangements. These hedge positions will move favorably in periods of falling commodity prices and unfavorably in periods of rising commodity prices. The Partnership has designated these derivative contracts as cash flow hedges for accounting purposes.

The hedges generally match the NGL product composition and the NGL delivery points of the Partnership’s physical equity volumes. The Partnership's natural gas hedges are a mixture of specific gas delivery points and Henry Hub. The NGL hedges may be transacted as specific NGL hedges or as baskets of ethane, propane, normal butane, isobutane and natural gasoline based upon the Partnership’s expected equity NGL composition. We believe this approach avoids uncorrelated risks resulting from employing hedges on crude oil or other petroleum products as “proxy” hedges of NGL prices. The Partnership’s natural gas and NGL hedges are settled using published index prices for delivery at various locations.

 The Partnership hedges a portion of its condensate equity volumes using crude oil hedges that are based on the New York Mercantile Exchange (“NYMEX”) futures contracts for West Texas Intermediate light, sweet crude, which approximates the prices received for condensate. This necessarily exposes the Partnership to a market differential risk if the NYMEX futures do not move in exact parity with the sales price of its underlying condensate equity volumes.

As part of the Atlas mergers, outstanding APL derivative contracts with a fair value of $102.1 million as of the acquisition date were novated to the Partnership, intended as cash flow hedges related to future TPL equity volumes. As the fair value of these APL derivative contracts settle, the Partnership will receive cash representing the future benefit of these contracts. For the quarter ended March 31, 2015, $7.8 million of the acquisition date fair value of the APL derivative contracts was received as a component of the derivative contract settlements.

The "off-market" nature of these acquired derivatives can introduce a degree of ineffectiveness for accounting purposes due to an embedded financing element representing the amount that would have to be paid or received as of the acquisition date to settle the derivative contract. The resulting ineffectiveness can either potentially disqualify the derivative contract in its entirety for hedge accounting or alternatively affect the amount of unrealized gains or losses on qualifying derivatives that can be deferred from inclusion in periodic net income. Certain novated APL crude options with a fair value of $7.7 million as of the acquisition date did not fall within the “highly effective” correlation range required to qualify as a hedging instrument for accounting purposes and resulted in $0.5 million of mark-to-market gains included in the Partnership’s first quarter 2015 earnings. These crude oil options expire during 2015. Additionally the first quarter included $1.0 million of ineffectiveness gains related to otherwise qualifying APL derivatives, primarily natural gas swaps.

At March 31, 2015, the notional volumes of the Partnership’s commodity hedges were:

Commodity	Instrument	Unit	2015		2016		2017
Natural Gas	Swaps	MMBtu/d		125,439		68,205		23,082
Natural Gas	Basis Swaps	MMBtu/d		23,782		-		-
NGL	Swaps	Bbl/d		5,928		2,254		658
NGL	Options	Bbl/d		899		790		790
Condensate	Swaps	Bbl/d		1,991		1,082		500
Condensate	Options	Bbl/d		1,198		380		380

The Partnership also enters into derivative instruments to help manage other short-term commodity-related business risks. The Partnership has not designated these derivatives as hedges and records changes in fair value and cash settlements to revenues.

The Partnership’s derivative contracts are subject to netting arrangements that allow net cash settlement of offsetting asset and liability positions with the same counterparty within the same Targa entity. We record derivative assets and liabilities on our Consolidated Balance Sheets on a gross basis, without considering the effect of master netting arrangements. The following schedules reflect the fair values of our derivative instruments and their location in our Consolidated Balance Sheets as well as pro forma reporting assuming that we reported derivatives subject to master netting agreements on a net basis:

		Fair Value as of March 31, 2015				Fair Value as of December 31, 2014
	Balance Sheet Location	Derivative Assets		Derivative Liabilities		Derivative Assets		Derivative Liabilities
Derivatives designated as hedging instruments
Commodity contracts	Current	$	117.8	$	0.4	$	44.4	$	-
	Long-term		51.2		1.8		15.8		-
Total derivatives designated as hedging instruments		$	169.0	$	2.2	$	60.2	$	-
Derivatives not designated as hedging instruments
Commodity contracts	Current	$	8.2	$	0.2	$	-	$	5.2
Total derivatives not designated as hedging instruments		$	8.2	$	0.2	$	-	$	5.2
Total current position		$	126.0	$	0.6	$	44.4	$	5.2
Total long-term position			51.2		1.8		15.8		-
Total derivatives		$	177.2	$	2.4	$	60.2	$	5.2

The pro forma impact of reporting derivatives in the Consolidated Balance Sheets on a net basis is as follows:

	Gross Presentation				Pro Forma Net Presentation
March 31, 2015	Asset Position		Liability Position		Asset Position		Liability Position
Current position
Counterparties with offsetting position	$	54.0	$	0.6	$	53.4	$	-
Counterparties without offsetting position - assets		72.0		-		72.0		-
Counterparties without offsetting position - liabilities		-		-		-		-
		126.0		0.6		125.4		-
Long-term position
Counterparties with offsetting position		19.4		1.8		17.6		-
Counterparties without offsetting position - assets		31.8		-		31.8		-
Counterparties without offsetting position - liabilities		-		-		-		-
		51.2		1.8		49.4		-
Total derivatives
Counterparties with offsetting position		73.4		2.4		71.0		-
Counterparties without offsetting position - assets		103.7		-		103.8		-
Counterparties without offsetting position - liabilities		-		-		-		-
	$	177.2	$	2.4	$	174.8	$	-
December 31, 2014
Current position
Counterparties with offsetting position	$	35.5	$	4.4	$	31.1	$	-
Counterparties without offsetting position - assets		8.9		-		8.9		-
Counterparties without offsetting position - liabilities		-		0.8		-		0.8
		44.4		5.2		40.0		0.8
Long-term position
Counterparties with offsetting position		-		-		-		-
Counterparties without offsetting position - assets		15.8		-		15.8		-
Counterparties without offsetting position - liabilities		-		-		-		-
		15.8		-		15.8		-
Total derivatives
Counterparties with offsetting position		35.5		4.4		31.1		-
Counterparties without offsetting position - assets		24.7		-		24.7		-
Counterparties without offsetting position - liabilities		-		0.8		-		0.8
	$	60.2	$	5.2	$	55.8	$	0.8

The Partnership’s payment obligations in connection with substantially all of these hedging transactions are secured by a first priority lien in the collateral securing its senior secured indebtedness that ranks equal in right of payment with liens granted in favor of its senior secured lenders.

The fair value of the Partnership’s derivative instruments, depending on the type of instrument, was determined by the use of present value methods or standard option valuation models with assumptions about commodity prices based on those observed in underlying markets. The estimated fair value of the Partnership’s derivative instruments was a net asset of $174.8 million as of March 31, 2015. The estimated fair value is net of an adjustment for credit risk based on the default probabilities by year as indicated by market quotes for the counterparties’ credit default swap rates. The credit risk adjustment was immaterial for all periods presented.

The following tables reflect amounts recorded in Other Comprehensive Income (“OCI”) and amounts reclassified from OCI to revenue and expense for the periods indicated:

	Gain (Loss) Recognized in OCI on Derivatives (Effective Portion)
Derivatives in Cash Flow	Three Months Ended March 31,
Hedging Relationships	2015		2014
Commodity contracts	$	25.2	$	(11.8	)
	Gain (Loss) Reclassified from OCI into Income (Effective Portion)
	Three Months Ended March 31,
Location of Gain (Loss)		2015		2014
Interest expense, net	$	-	$	(1.3	)
Revenues		8.1		(6.3	)
	$	8.1	$	(7.6	)

Our consolidated earnings are also affected by the Partnership’s use of the mark-to-market method of accounting for derivative instruments that do not qualify for hedge accounting or that have not been designated as hedges. The changes in fair value of these instruments are recorded on the balance sheet and through earnings rather than being deferred until the anticipated transaction settles. The use of mark-to-market accounting for financial instruments can cause non-cash earnings volatility due to changes in the underlying commodity price indices.

		Gain (Loss) Recognized in Income on Derivatives
Derivatives Not Designated as Hedging Instruments	Location of Gain Recognized in Income on Derivatives	March 31, 2015			March 31, 2014
Commodity contracts	Revenue		$	7.2		$	(0.2	)

The following table shows the deferred gains (losses) included in accumulated OCI, which will be reclassified into earnings before income taxes through the end of 2017 based on year-end valuations.

	March 31, 2015			December 31, 2014
Commodity hedges, before tax (1)		$	77.4		$	60.3

(1) Includes deferred net gains of $53.3 million as of March 31, 2015 related to contracts that will be settled and reclassified to revenue over the next 12 months.

See Note 15 for additional disclosures related to derivative instruments and hedging activities.