Fair value is defined 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 (i) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (ii) 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:

Alcoa Corporation is exposed to certain risks relating to its ongoing business operations, including the risks of changing commodity prices and foreign currency exchange rates. Alcoa Corporation’s commodity and derivative activities include aluminum, energy, and foreign exchange contracts which are held for purposes other than trading. They are used primarily to mitigate uncertainty and volatility, and to cover underlying exposures. Alcoa Corporation is not involved in trading activities for energy, weather derivatives, or other nonexchange commodity trading activities.

Several of Alcoa Corporation’s aluminum, energy, and foreign exchange contracts are classified as Level 1 or Level 2 under the fair value hierarchy. The total fair value of these derivative contracts recorded as assets and liabilities was $2 and $49, respectively, at March 31, 2019 and $2 and $54, respectively, at December 31, 2018. Certain of these contracts are designated as either fair value or cash flow hedging instruments. For the contracts designated as cash flow hedges, Alcoa Corporation recognized an unrealized loss of $8 in the first quarter of 2019 and an unrealized gain of $68 in the first quarter of 2018 in Other comprehensive (loss) income. Additionally, Alcoa Corporation reclassified a realized loss of $4 and $1 in 2019 and 2018, respectively, from Accumulated other comprehensive (loss) income to Sales.

In addition to the Level 1 and 2 derivative instruments described above, Alcoa Corporation has several derivative instruments classified as Level 3 under the fair value hierarchy. These instruments are composed of (i) embedded aluminum derivatives and an embedded credit derivative related to energy supply contracts and (ii) freestanding financial contracts related to energy purchases made in the spot market, all of which are associated with nine smelters and three refineries. Certain of the embedded aluminum derivatives and financial contracts are designated as cash flow hedging instruments.

Alcoa Corporation had a power contract at one of its facilities which expired in March 2019 that indexed the price of power to the London Metal Exchange (LME) price of aluminum plus the Midwest premium. Prior to its expiration, this embedded derivative was valued using the interrelationship of future metal prices (LME base plus Midwest premium) and the amount of megawatt hours of energy needed to produce the forecasted metric tons of aluminum at the smelter. Management elected not to qualify the embedded derivative for hedge accounting treatment.

In March 2019, Alcoa and the counterparty to the power contract described above entered into a new power contract which also contains an embedded derivative that indexes the price of power to the LME price of aluminum plus the Midwest premium. The embedded aluminum derivative is valued using the interrelationship of future metal prices (LME base plus Midwest premium) and the amount of megawatt hours of energy needed to produce the forecasted metric tons of aluminum at the smelter. An overall increase in actual LME price and the Midwest premium will result in a higher cost of power and a corresponding decrease to the derivative asset or increase to the derivative liability. The embedded derivative has been designated as a cash flow hedge of forward sales of aluminum. Unrealized gains and losses will be included in Other comprehensive (loss) income on the accompanying Consolidated Balance Sheet while realized gains and losses will be included in Sales on the accompanying Statement of Consolidated Operations.

The following table presents quantitative information related to the significant unobservable inputs for Level 3 derivative instruments:


	Fair value at March 31, 2019		Unobservable input	Range ($ in full amounts)
Assets:

Financial contract		137	Interrelationship of forward energy price and the Consumer Price Index and price of electricity beyond forward curve	Electricity: $73.13 per megawatt hour in 2019 to $55.02 per megawatt hour in 2021

Liabilities:

Embedded aluminum derivative		267	Interrelationship of LME price to the amount of megawatt hours of energy needed to produce the forecasted metric tons of aluminum	Aluminum: $1,900 per metric ton in 2019 to $2,445 per metric ton in 2027 Electricity: rate of 4 million megawatt hours per year

Embedded aluminum derivatives		320	Price of aluminum beyond forward curve	Aluminum: $2,533 per metric ton in July 2029 to $2,553 per metric ton in December 2029 (two contracts) and $2,850 per metric ton in 2036 (one contract) Midwest premium: $0.1900 per pound in 2019 to $0.1850 per pound in 2029 (two contracts) and 2036 (one contract)

Embedded aluminum derivative		-	Interrelationship of LME price to the amount of megawatt hours of energy needed to produce the forecasted metric tons of aluminum	Aluminum: $1,900 per metric ton in April 2019 to $1,911 per metric ton in June 2019 Midwest premium: $0.1900 per pound in April 2019 and June 2019 Electricity: rate of 2 million megawatt hours per year

Embedded aluminum derivative		7	Interrelationship of LME price to overall energy price	Aluminum: $1,857 per metric ton in April 2019 to $1,954 per metric ton in December 2019

Embedded credit derivative		21	Estimated spread between the respective 30-year debt yield of Alcoa Corporation and the counterparty	3.25% (30-year debt yields: Alcoa Corporation – 7.21% (estimated) and counterparty – 3.96%)

The fair values of Level 3 derivative instruments recorded as assets and liabilities in the accompanying Consolidated Balance Sheet were as follows:

	March 31, 2019		December 31, 2018
Asset Derivatives
Derivatives designated as hedging instruments:
Fair value of derivative instruments – current:
Financial contract	$	69	$	70
Fair value of derivative instruments – noncurrent:
Embedded aluminum derivatives		—		41
Financial contract		68		42
Total derivatives designated as hedging instruments		137		153
Total Asset Derivatives	$	137	$	153
Liability Derivatives
Derivatives designated as hedging instruments:
Fair value of derivative instruments – current:
Embedded aluminum derivatives	$	59	$	46
Fair value of derivative instruments – noncurrent:
Embedded aluminum derivatives		535		218
Total derivatives designated as hedging instruments		594		264
Derivatives not designated as hedging instruments:
Fair value of derivative instruments – current:
Embedded aluminum derivative		—		5
Embedded credit derivative		4		4
Fair value of derivative instruments – noncurrent:
Embedded credit derivative		17		16
Total derivatives not designated as hedging instruments		21		25
Total Liability Derivatives	$	615	$	289

The following tables present a reconciliation of activity for Level 3 derivative instruments:

	Assets						Liabilities
First quarter ended March 31, 2019	Embedded aluminum derivatives			Financial contracts			Embedded aluminum derivatives			Embedded credit derivative
Balance at January 1, 2019	$	41		$	112		$	269		$	20
Total gains or losses (realized and unrealized) included in:
Sales		—			—			(13	)		—
Cost of goods sold		—			(42	)		—			—
Other expenses, net		—			—			(2	)		1
Other comprehensive (loss) income		(41	)		68			344			—
Other					(1	)		(4	)		—
Balance at March 31, 2019	$	—		$	137		$	594		$	21
Change in unrealized gains or losses included in earnings for derivative instruments held at March 31, 2019:
Other expenses, net	$	—		$	—		$	(2	)	$	1

In the first quarter of 2019, there was an expiration of an existing and an issuance of a new embedded aluminum derivative (see above). There were no purchases, sales or settlements of Level 3 derivative instruments. Additionally, there were no transfers of derivative instruments into or out of Level 3.

Alcoa Corporation has six Level 3 embedded aluminum derivatives and one Level 3 financial contract that have been designated as cash flow hedges.

At March 31, 2019 and December 31, 2018, these embedded aluminum derivatives hedge forecasted aluminum sales of 2,496 kmt and 2,508 kmt, respectively. Assuming market rates remain constant with the rates at March 31, 2019, a realized loss of $59 is expected to be recognized in Sales over the next 12 months. There was no ineffectiveness related to these six derivative instruments in the first quarter of 2019 and 2018.

At March 31, 2019 and December 31, 2018, the financial contract hedges forecasted electricity purchases of 5,742,396 and 6,348,276 megawatt hours, respectively. Assuming market rates remain consistent with the rates at March 31, 2019, a realized gain of $69 is expected to be recognized in Cost of goods sold over the next 12 months. There was no ineffectiveness related to this derivative instrument in the first quarter of 2019. The amount of hedge ineffectiveness related to this derivative instrument was not material in the first quarter of 2018.

The disclosures with respect to commodity prices and foreign currency exchange risk do not consider the underlying commitments or anticipated transactions. If the underlying items were included in the analysis, the gains or losses on the futures contracts may be offset. Actual results will be determined by several factors that are not under Alcoa Corporation’s control and could vary significantly from those factors disclosed.

Alcoa Corporation is exposed to credit loss in the event of nonperformance by counterparties on the above instruments, as well as credit or performance risk with respect to its hedged customers’ commitments. Alcoa Corporation does not anticipate nonperformance by any of these parties. Contracts are with creditworthy counterparties and are further supported by cash, treasury bills, or irrevocable letters of credit issued by carefully chosen banks. In addition, various master netting arrangements are in place with counterparties to facilitate settlement of gains and losses on these contracts.

The carrying values and fair values of Alcoa Corporation’s other financial instruments were as follows:

	March 31, 2019				December 31, 2018
	Carrying value		Fair value		Carrying value		Fair value
Cash and cash equivalents	$	1,017	$	1,017	$	1,113	$	1,113
Restricted cash		3		3		3		3
Long-term debt due within one year		1		1		1		1
Long-term debt, less amount due within one year		1,802		1,939		1,801		1,863

The following methods were used to estimate the fair values of other financial instruments:

Cash and cash equivalents and Restricted cash. The carrying amounts approximate fair value because of the short maturity of the instruments. The fair value amounts for Cash and cash equivalents and Restricted cash were classified in Level 1 of the fair value hierarchy.

Long-term debt due within one year and Long-term debt, less amount due within one year. The fair value was based on quoted market prices for public debt and on interest rates that are currently available to Alcoa Corporation for issuance of debt with similar terms and maturities for non-public debt. The fair value amounts for all Long-term debt were classified in Level 2 of the fair value hierarchy.