DERIVATIVE AND OTHER FINANCIAL INSTRUMENTS

We use forward contracts and options, as well as contractual price escalators, to reduce the risks associated with our metal, natural gas and other supply requirements, as well as fuel costs and certain currency exposures. Generally, we enter into master netting arrangements with our counterparties and offset net derivative positions with the same counterparties against amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral under those arrangements in our Consolidated Balance Sheet. For classification purposes, we record the net fair value of each type of derivative position that is expected to settle in less than one year with each counterparty as a net current asset or liability and each type of long-term position as a net long-term asset or liability. No cash collateral was posted at March 31, 2018 or December 31, 2017. The amounts shown in the table below represent the gross amounts of recognized assets and liabilities, the amounts offset in the Consolidated Balance Sheet and the net amounts of assets and liabilities presented therein. As of March 31, 2018 and December 31, 2017, there were no amounts subject to an enforceable master netting arrangement or similar agreement that have not been offset in the Consolidated Balance Sheet.



	Fair Value of Derivatives as of
	March 31, 2018						December 31, 2017
Derivatives by Type	Asset			Liability			Asset			Liability
Metal	$	48.1		$	(18.5	)	$	33.5		$	(36.0	)
Energy	0.2			—			0.2			(0.1		)
Currency	3.4			—			1.6			(0.1		)
Total	51.7			(18.5		)	35.3			(36.2		)
Effect of counterparty netting	(18.1		)	18.1			(27.2		)	27.2
Net derivatives as classified in the balance sheet	$	33.6		$	(0.4	)	$	8.1		$	(9.0	)

The fair value of our derivative financial instruments at March 31, 2018 and December 31, 2017 are recorded in the Consolidated Balance Sheet as follows:



Asset Derivatives	Balance Sheet Location	March 31, 2018		December 31, 2017
Metal	Prepaid expenses and other current assets	$	28.5	$	2.2
	Other long-term assets	1.5		4.3
Energy	Prepaid expenses and other current assets	0.2		0.1
Currency	Prepaid expenses and other current assets	1.6		0.8
	Other long-term assets	1.8		0.7
Total		$	33.6	$	8.1


Liability Derivatives	Balance Sheet Location	March 31, 2018		December 31, 2017
Metal	Accrued liabilities	$	—	$	9.0
Metal	Other long-term liabilities	0.4		—
Total		$	0.4	$	9.0

Both realized and unrealized gains and losses on derivative financial instruments are included within “(Gains) losses on derivative financial instruments” in the Consolidated Statements of Comprehensive Income (Loss). Realized losses and (gains) on derivative financial instruments totaled the following:



	For the three months ended
	March 31, 2018			March 31, 2017
Metal	$	1.0		$	19.5
Energy	(0.2		)	0.4
Currency	(1.0		)	0.5

Metal Hedging

The selling prices of the majority of the orders for our products are established at the time of order entry or, for certain customers, under long-term contracts. As the related raw materials used to produce these orders can be purchased several months or years after the selling prices are fixed, margins are subject to the risk of changes in the purchase price of the raw materials used for these fixed price sales. In order to manage this transactional exposure, future, swaps or forward purchase contracts are purchased at the time the selling prices are fixed. As metal is purchased to fill these fixed price sales orders, future, swaps or forward contracts are then sold. We also maintain a significant amount of inventory on-hand to meet anticipated and unpriced future sales. In order to preserve the value of this inventory, future or forward contracts are sold at the time inventory is purchased. As sales orders are priced, future or forward contracts are purchased. These derivatives generally settle within three months. We can also use call option contracts, which function in a manner similar to the natural gas call option contracts discussed below, and put option contracts for managing metal price exposures. Option contracts require the payment of a premium which is recorded as a realized loss upon settlement or expiration of the option contract. Upon settlement of a put option contract, we receive cash and recognize a related gain if the closing price is less than the strike price of the put option. If the put option strike price is less than the closing price, no amount is paid and the option expires. As of March 31, 2018 we had 0.2 million metric tons and 0.2 million metric tons of metal buy and metal sell derivative contracts, respectively. As of December 31, 2017, we had 0.1 million metric tons and 0.2 million metric tons of metal buy and metal sell derivative contracts, respectively.

Energy Hedging

To manage our price exposure for natural gas purchases, we fix the future price of a portion of our natural gas requirements by entering into financial hedge agreements. Under these agreements, payments are made or received based on the differential between the monthly closing price on the New York Mercantile Exchange (“NYMEX”) and the contractual hedge price. We can also use a combination of call option contracts and put option contracts for managing the exposure to increasing natural gas prices while maintaining our ability to benefit from declining prices. Upon settlement of call option contracts, we receive cash and recognize a related gain if the NYMEX closing price exceeds the strike price of the call option. If the call option strike price exceeds the NYMEX closing price, no amount is received and the option expires unexercised. Upon settlement of a put option contract, we pay cash and recognize a related loss if the NYMEX closing price is lower than the strike price of the put option. If the put option strike price is less than the NYMEX closing price, no amount is paid and the option expires unexercised. Option contracts require the payment of a premium which is recorded as a realized loss upon settlement or expiration of the option contract. Natural gas cost can also be managed through the use of cost escalators included in some of our long-term supply contracts with customers, which limits exposure to natural gas price risk. As of March 31, 2018 and December 31, 2017, we had 3.5 trillion of British thermal unit forward buy contracts.

We use independent freight carriers to deliver our products. As part of the total freight charge, these carriers include a per mile diesel surcharge based on the Department of Energy, Energy Information Administration’s (“DOE”) Weekly Retail Automotive Diesel National Average Price. From time to time we may enter into over-the-counter DOE diesel fuel swaps with financial counterparties to mitigate the impact of the volatility of diesel fuel prices on our freight costs. Under these swap agreements, we pay a fixed price per gallon of diesel fuel determined at the time the agreements were executed and receive a floating rate payment that is determined on a monthly basis based on the average price of the DOE Diesel Fuel Index during the applicable month. The swaps are designed to offset increases or decreases in fuel surcharges that we pay to our carriers. All swaps are financially settled. There is no possibility of physical settlement. As of March 31, 2018 and December 31, 2017, we had 3.5 million gallons and 1.5 million gallons of diesel swap contracts, respectively.

Currency Hedging

Our aerospace and heat exchanger businesses expose the U.S. dollar operating results of our European operations to fluctuations in the euro as the sales contracts are generally in U.S. dollars while the costs of production are in euros. In order to mitigate the risk that fluctuations in the euro may have on our business, we have entered into forward currency contracts. As of March 31, 2018 and December 31, 2017, we had euro forward contracts covering a notional amount of €82.6 million and €100.8 million, respectively.

Credit Risk

We are exposed to losses in the event of non-performance by the counterparties to the derivative financial instruments discussed above; however, we do not anticipate any non-performance by the counterparties. The counterparties are evaluated for creditworthiness and risk assessment prior to initiating trading activities with the brokers and periodically throughout each year while actively trading.

Recurring Fair Value Measurements

Derivative contracts are recorded at fair value using quoted market prices and significant other observable inputs. Fair value is defined by FASB Accounting Standards Codification 820, “Fair Value Measurements and Disclosures,” as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below:

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

Level 2—Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, including quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates); and inputs that are derived principally from or corroborated by observable market data by correlation or other means.

Level 3—Inputs that are both significant to the fair value measurement and unobservable.

We endeavor to use the best available information in measuring fair value. Where appropriate, valuations are adjusted for various factors such as liquidity, bid/offer spreads, and credit considerations. Such adjustments are generally based on available market evidence and unobservable inputs. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. As of March 31, 2018 and December 31, 2017, all of our derivative assets and liabilities represent Level 2 fair value measurements.

Other Financial Instruments

The carrying amount, fair values and level in the fair value hierarchy of our other financial instruments at March 31, 2018 and December 31, 2017 are as follows:



	March 31, 2018					December 31, 2017
	Carrying Amount		Fair Value		Level in the Fair Value Hierarchy	Carrying Amount		Fair Value		Level in the Fair Value Hierarchy
Cash and cash equivalents	$	79.1	$	79.1	Level 1	$	102.4	$	102.4	Level 1
Restricted cash	5.7		5.7		Level 1	5.6		5.6		Level 1
ABL Facility	365.9		365.9		Level 2	319.3		319.3		Level 2
7 ⁷/₈% Senior Notes	437.0		432.6		Level 1	436.7		438.1		Level 1
9 ½ % Senior Secured Notes	800.7		834.0		Level 1	800.8		847.3		Level 1
Exchangeable Notes	44.5		45.4		Level 3	44.5		45.4		Level 3
Zhenjiang Term Loans	172.1		172.6		Level 3	169.8		170.3		Level 3

The principal amount of the ABL Facility approximates fair value because the interest rate paid is variable and there have been no significant changes in the credit risk of Aleris International subsequent to the borrowings. The fair values of the 7⁷/8% Senior Notes due 2020 (the “7⁷/8% Senior Notes”) and 9½% Senior Secured Notes due 2021 (the “9½% Senior Secured Notes”) were estimated using market quotations. The fair value of Aleris International’s Exchangeable Notes was estimated using a binomial lattice pricing model based on the fair value of our common stock, a risk-free interest rate of 2.3% and 1.9% as of March 31, 2018 and December 31, 2017, respectively and expected equity volatility of 60% as of March 31, 2018 and December 31, 2017. Expected equity volatility was determined based on historical stock prices and implied and stated volatilities of our peer companies. The principal amount of the Zhenjiang Term Loans approximates fair value because the interest rate paid is variable, is set for periods of six months or less and there have been no significant changes in the credit risk of Aleris Zhenjiang subsequent to the inception of the Zhenjiang Term Loans.