Financial Instruments

9 Months Ended

Sep. 30, 2012

Fair Value Disclosures [Abstract]

FINANCIAL INSTRUMENTS

FINANCIAL INSTRUMENTS

Fair value of financial instruments

We record certain financial assets and liabilities at fair value at each balance sheet date. The tables below summarize the balances of these assets and liabilities at September 30, 2012 and December 31, 2011 (in thousands):

	September 30, 2012													December 31, 2011
	Level 1			Level 2		Level 3		Netting*			Total			Level 1			Level 2			Level 3		Netting*			Total
Assets:
Commodity derivatives	$	609		$	—	$	—	$	(15	)	$	594		$	393		$	—		$	—	$	(231	)	$	162
Total assets	609			—		—		(15		)	594			393			—			—		(231		)	162
Liabilities:
Commodity derivatives	$	15		$	—	$	—	$	(15	)	$	—		$	231		$	—		$	—	$	(231	)	$	—
Warrants	29,263			—		—		—			29,263			12,180			—			—		—			12,180
Interest rate swaps	—			—		—		—			—			—			358			—		—			358
Total liabilities	29,278			—		—		(15		)	29,263			12,411			358			—		(231		)	12,538
Net liabilities at fair value	$	(28,669	)	$	—	$	—	$	—		$	(28,669	)	$	(12,018	)	$	(358	)	$	—	$	—		$	(12,376	)

*Relates primarily to exchange traded futures. Gain and loss positions on multiple contracts are settled net on a daily basis with the exchange.

“Level 1” measurements use as inputs unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. These include commodity futures contracts that are traded on an exchange. These also include common stock warrants (Note 10), beginning in September 2011, when the warrants began to be traded on the New York Stock Exchange.

“Level 2” measurements use as inputs market observable and corroborated prices for similar commodity derivative contracts. Assets and liabilities classified as Level 2 include over-the-counter (“OTC”) traded forward contracts and swaps.

“Level 3” measurements use as inputs information from a pricing service and internal valuation models incorporating observable and unobservable market data. These include commodity derivatives, such as forwards and swaps for which there is not a highly liquid market, and therefore are not included in Level 2 above. Level 3 measurements also included common stock warrants until September 2011, when the warrants began to be traded on the New York Stock Exchange. Prior to that point, we used a Black-Scholes pricing model to estimate the fair value of the warrants.

Financial assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the measurement requires judgment, and may affect the valuation of assets and liabilities and their placement within the fair value levels.

There were no financial assets or liabilities classified as Level 3 during the three months and nine months ended September 30, 2012. The following table summarizes changes in the fair value of our net financial assets (liabilities) classified as Level 3 in the fair value hierarchy (in thousands):

	Three Months Ended September 30, 2012						Three Months Ended September 30, 2011
	Warrants		Commodity Derivatives		Total		Warrants			Commodity Derivatives			Total
Net liabilities—beginning balance	$	—	$	—	$	—	$	(13,618	)	$	(1,736	)	$	(15,354	)
Transfers out of Level 3(*)	—		—		—		8,934			6			8,940
Total gain (realized and unrealized) included in earnings(**)	—		—		—		4,684			3,156			7,840
Settlements	—		—		—		—			(1,884		)	(1,884		)
Net liabilities—ending balance	$	—	$	—	$	—	$	—		$	(458	)	$	(458	)
Amount of total gain included in earnings for the period attributable to the change in unrealized gain or loss relating to assets and liabilities still held at the reporting date	$	—	$	—	$	—	$	—		$	3,156		$	3,156

	Nine Months Ended September 30, 2012						Nine Months Ended September 30, 2011
	Warrants		Commodity Derivatives		Total		Warrants			Commodity Derivatives			Total
Net liabilities—beginning balance	$	—	$	—	$	—	$	(17,192	)	$	(547	)	$	(17,739	)
Transfers out of Level 3(*)	—		—		—		8,934			(419		)	8,515
Total gain (realized and unrealized) included in earnings(**)	—		—		—		8,258			2,783			11,041
Settlements	—		—		—		—			(2,275		)	(2,275		)
Net liabilities—ending balance	$	—	$	—	$	—	$	—		$	(458	)	$	(458	)
Amount of total gain included in earnings for the period attributable to the change in unrealized gain or loss relating to assets and liabilities still held at the reporting date	$	—	$	—	$	—	$	—		$	2,783		$	2,783

(*) In these tables, transfers in and transfers out are recognized as of the beginning of the reporting period for commodity derivatives and as of the transfer date for warrants.

(**) Gains and losses related to commodity derivatives are reported in product revenue and gains and losses related to warrants are recorded in other expense (income) in the condensed consolidated statements of operations and comprehensive income (loss).

Commodity derivative contracts

Our consolidated results of operations and cash flows are impacted by changes in market prices for petroleum products. This exposure to commodity price risk is managed, in part, by entering into various commodity derivatives.

We seek to manage the price risk associated with our marketing operations by limiting our net open positions through (i) the concurrent purchase and sale of like quantities of crude oil to create back-to-back transactions that are intended to lock in positive margins based on the timing, location or quality of the crude oil purchased and delivered or (ii) derivative contracts. Our storage and transportation assets can also be used to mitigate location and time basis risk. All marketing activities are subject to our Comprehensive Risk Management Policy, which establishes limits in order to manage risk and mitigate financial exposure.

We contributed the primary operating assets of SemStream, L.P. (“SemStream) to NGL Energy on November 1, 2011, including all of SemStream’s commodity derivatives. Prior to November 1, 2011, SemStream managed commodity price risk by limiting its net open positions subject to outright price risk and basis risk resulting from grade, location or time differences. SemStream did so by selling and purchasing similar quantities of natural gas liquids with purchase and sale transactions for current or future delivery, by entering into future delivery and purchase obligations with futures contracts or other commodity derivatives and employing its storage and transportation assets. SemStream, at times, hedged its natural gas liquids commodity price exposure with derivatives on commodities other than natural gas liquids due to the limited size of the market for natural gas liquids derivatives. In addition, physical transaction sale and purchase strategies were intended to lock in positive margins for SemStream, e.g., the sales price was sufficient to cover purchase costs, any other fixed and variable costs and SemStream’s profit. All marketing activities were subject to our Comprehensive Risk Management Policy, which establishes limits to manage risk and mitigate financial exposure.

Our commodity derivatives were comprised of swaps, future contracts and forward contracts of crude oil and natural gas liquids. These are defined as follows:

Swaps – Over the counter transactions where a floating price, basis or index is exchanged for a fixed (or a different floating) price, basis or index at a preset schedule in the future, according to an agreed-upon formula.

Futures contracts – Exchange traded contracts to buy or sell a commodity. These contracts are standardized by the exchange in terms of quality, quantity, delivery period and location for each commodity.

Forward contracts – Over the counter contracts to buy or sell a commodity at an agreed upon future date. The buyer and seller agree on specific terms (price, quantity, delivery period and location) and conditions at the inception of the contract.

The following table sets forth the unaudited notional quantities for commodity derivative instruments entered into (in thousands of barrels):

	Three Months Ended September 30, 2012	Three Months Ended September 30, 2011	Nine Months Ended September 30, 2012	Nine Months Ended September 30, 2011
Sales	470	5,189	1,153	18,000
Purchases	380	4,344	1,066	17,716

We have not designated any of our commodity derivative instruments as accounting hedges. We record the fair value of our commodity derivative instruments on our condensed consolidated balance sheets in other current assets and other current liabilities in the following amounts (in thousands):

	September 30, 2012				December 31, 2011
	Assets		Liabilities		Assets		Liabilities
Commodity contracts	$	594	$	—	$	162	$	—

Realized and unrealized gains (losses) from our commodity derivatives were recorded to product revenue in the following amounts (in thousands):

Three Months Ended September 30, 2012			Three Months Ended September 30, 2011		Nine Months Ended September 30, 2012			Nine Months Ended September 30, 2011
$	(631	)	$	2,960	$	(342	)	$	62

Warrants

As described in Note 10, upon emergence from bankruptcy, we issued certain common stock warrants. These warrants are recorded at fair value in other noncurrent liabilities on the condensed consolidated balance sheets, with changes in the fair value recorded to other expense (income). Beginning in September 2011, the warrants began to be traded on the New York Stock Exchange.