Derivatives and Other Financial Instruments

6 Months Ended

Jun. 30, 2020

Fair Value Disclosures [Abstract]

Derivatives and Other Financial Instruments

M. Derivatives and Other Financial Instruments

Fair Value

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:

• 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.

Derivatives

Alcoa Corporation is exposed to certain risks relating to its ongoing business operations, including the risks of changing commodity prices, foreign currency exchange rates and interest rates. Alcoa Corporation’s commodity and derivative activities include aluminum, energy, foreign exchange, and interest rate 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. All of these contracts are designated as either fair value or cash flow hedging instruments. Alcoa Corporation also has several derivative instruments classified as Level 3 under the fair value hierarchy, which are either designated as cash flow hedges or undesignated.  

The following tables present the detail for Level 1, 2 and 3 derivatives (see additional Level 3 information in further tables below):

	June 30, 2020				December 31, 2019
	Assets		Liabilities		Assets		Liabilities
Level 1 and 2 derivative instruments	$	20	$	44	$	3	$	33
Level 3 derivative instruments		9		206		74		615
Total	$	29	$	250	$	77	$	648
Less: Current		24		47		59		67
Noncurrent	$	5	$	203	$	18	$	581

	Unrealized (loss) gain recognized in Other comprehensive (loss) income						Realized (loss) gain reclassed from Other comprehensive (loss) income to earnings
Second quarter ended June 30,	2020			2019			2020			2019
Level 1 and 2 derivative instruments	$	22		$	5		$	(1	)	$	(8	)
Level 3 derivative instruments		(536	)		80			(14	)		5
Noncontrolling and equity interest		1			(5	)		2			(7	)
Total	$	(513	)	$	80		$	(13	)	$	(10	)

For the quarter ended June 30, 2020, the realized loss of $1 on Level 1 and 2 cash flow hedges was recognized in Cost of goods sold. For the quarter ended June 30, 2019, the realized loss of $8 on Level 1 and 2 cash flow hedges was recognized in Sales.

	Unrealized gain (loss) recognized in Other comprehensive (loss) income						Realized (loss) gain reclassed from Other comprehensive (loss) income to earnings
Six months ended June 30,	2020			2019			2020			2019
Level 1 and 2 derivative instruments	$	(7	)	$	(3	)	$	(15	)	$	(12	)
Level 3 derivative instruments		331			(237	)		(22	)		36
Noncontrolling and equity interest		15			(32	)		(1	)		(25	)
Total	$	339		$	(272	)	$	(38	)	$	(1	)

For the six months ended June 30, 2020, the realized loss of $15 on Level 1 and 2 cash flow hedges was comprised of a $7 loss recognized in Sales and a $8 loss recognized in Cost of goods sold. For the six months ended June 30, 2019, the realized loss of $12 on Level 1 and 2 cash flow hedges was recognized in Sales.

Additional Level 3 Disclosures

The following table presents quantitative information related to the significant unobservable inputs described above for Level 3 derivative instruments (megawatt hours in MWh):

	June 30, 2020		Unobservable Input	Unobservable Input Range
Asset Derivatives
Financial contract	$	2	Interrelationship of	Electricity (per MWh)	2020: $32.29
			forward energy price and the Consumer Price Index		2021: $28.35
Total Asset Derivatives	$	2
Liability Derivatives
Power contract	$	147	MWh of energy needed	LME (per mt)	2020: $1,594
			to produce the forecasted		2027: $2,119
			mt of aluminum	Electricity	Rate of 4 million MWh per year
Power contracts		27	MWh of energy needed to produce the forecasted mt of aluminum	LME (per mt)	2020: $1,594 2029: $2,227 2036: $2,523
				Midwest premium (per pound)	2020: $0.0900 2029: $0.1500 2036: $0.1500
				Electricity	Rate of 11 million MWh per year
Power contract		1	MWh of energy needed to produce the forecasted mt of aluminum	LME (per mt)	2020: $1,594 2020: $1,616
				Midwest premium (per pound)	2020: $0.0900 2020: $0.1400
				Electricity	Rate of 2 million MWh per year
Power contract (undesignated)	24		Estimated spread between the 30-year debt yield of Alcoa and the counterparty	Credit spread	3.55%: 30-year debt yield spread 6.55%: Alcoa (estimated) 3.00%: counterparty
Total Liability Derivatives	$	199

The Total Asset Derivatives and Total Liability Derivatives in the table above are lower by $7 compared with the respective amount reflected in the Level 3 tables presented below. This is due to the fact that the financial contract and two of the power contracts are in an asset position for the current portion and are in a liability position for the noncurrent portion and are reflected as such on the accompanying Consolidated Balance Sheet. However, the financial contract is reflected as a net asset and the two power contracts are reflected as a net liability in the above table for purposes of presenting the assumptions utilized to measure the fair value of the derivative instruments in their entirety.

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

Asset Derivatives	June 30, 2020		December 31, 2019
Derivatives designated as hedging instruments:
Current—power contracts	$	4	$	—
Current—financial contract		4		57
Noncurrent—power contracts		1		—
Noncurrent—financial contract		—		17
Total derivatives designated as hedging instruments	$	9	$	74
Total Asset Derivatives	$	9	$	74
Liability Derivatives
Derivatives designated as hedging instruments:
Current—power contracts	$	15	$	47
Noncurrent—power contracts		165		551
Noncurrent—financial contract		2		—
Total derivatives designated as hedging instruments	$	182	$	598
Derivatives not designated as hedging instruments:
Current—power contracts	$	4	$	3
Noncurrent—power contracts		20		14
Total derivatives not designated as hedging instruments	$	24	$	17
Total Liability Derivatives	$	206	$	615

Assuming market rates remain constant with the rates at June 30, 2020, a realized loss of $11 related to power contracts and a gain of $4 related to the financial contract are expected to be recognized in Sales and Cost of goods sold, respectively, over the next 12 months.

At June 30, 2020 and December 31, 2019, the power contracts with embedded derivatives designated as cash flow hedges hedge forecasted aluminum sales of 2,244 kmt and 2,347 kmt, respectively. At June 30, 2020 and December 31, 2019, the financial contract hedges forecasted electricity purchases of 2,265,872 and 3,891,096 megawatt hours, respectively.

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

	Assets						Liabilities
Second quarter ended June 30, 2020	Power contracts			Financial contract			Power contracts			Financial contract		Embedded credit derivative
April 1, 2020	$	461		$	6		$	113		$	2	$	28
Total gains or losses included in:
Sales (realized)		6			—			(1	)		—		—
Cost of goods sold (realized)		—			7			—			—		—
Other expenses (income), net (unrealized/realized)		—			—			—			—		(2	)
Other comprehensive (loss) income (unrealized)		(462	)		(7	)		67			—		—
Other		—			(2	)		1			—		(2	)
June 30, 2020	$	5		$	4		$	180		$	2	$	24
Change in unrealized gains or losses included in earnings    for derivative instruments held at June 30, 2020:
Other expenses (income), net	$	—		$	—		$	—		$	—	$	—

	Assets					Liabilities
Six months ended June 30, 2020	Power contracts		Financial contract			Power contracts			Financial contract		Embedded credit derivative
January 1, 2020	$	—	$	74		$	598		$	—	$	17
Total gains or losses included in:
Sales (realized)		5		—			(15	)		—		—
Cost of goods sold (realized)		—		2			—			—		—
Other expenses (income), net (unrealized/realized)		—		—			—			—		9
Other comprehensive (loss) income (unrealized)		—		(68	)		(401	)		2		—
Other		—		(4	)		(2	)		—		(2	)
June 30, 2020	$	5	$	4		$	180		$	2	$	24
Change in unrealized gains or losses included in earnings    for derivative instruments held at June 30, 2020:
Other expenses (income), net	$	—	$	—		$	—		$	—	$	11

There were no purchases, sales or settlements of Level 3 derivative instruments in the periods presented.

Other Financial Instruments

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

	June 30, 2020				December 31, 2019
	Carrying value		Fair value		Carrying value		Fair value
Cash and cash equivalents	$	965	$	965	$	879	$	879
Restricted cash		3		3		4		4
Long-term debt due within one year		1		1		1		1
Long-term debt, less amount due within one year		1,800		1,896		1,799		1,961

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.