Derivatives and Other Financial Instruments

3 Months Ended

Mar. 31, 2021

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:

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

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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.

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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):

	March 31. 2021				December 31, 2020
	Assets		Liabilities		Assets		Liabilities
Level 1 and 2 derivative instruments	$	15	$	24	$	21	$	7
Level 3 derivative instruments		—		1,080		—		838
Total	$	15	$	1,104	$	21	$	845
Less: Current		15		181		21		103
Noncurrent	$	—	$	923	$	—	$	742

	2021						2020
First quarter ended March 31,	Unrealized (loss) gain recognized in Other comprehensive (loss) income			Realized (loss) gain reclassed from Other comprehensive (loss) income to earnings			Unrealized gain (loss) recognized in Other comprehensive (loss) income			Realized (loss) gain reclassed from Other comprehensive (loss) income to earnings
Level 1 and 2 derivative instruments	$	(14	)	$	—		$	(29	)	$	(14	)
Level 3 derivative instruments		(300	)		(55	)		867			(8	)
Noncontrolling and equity interest		11			3			14			(3	)
Total	$	(303	)	$	(52	)	$	852		$	(25	)

For the quarter ended March 31, 2021, the realized gains and losses on Level 1 and Level 2 cash flow hedges were immaterial. For the quarter ended March 31, 2020, the realized loss of $14 on Level 1 and 2 cash flow hedges was comprised of a $7 loss recognized in Sales and a $7 loss recognized in Cost of goods sold.

Alcoa Corporation has a financial contract that hedges the anticipated power requirements at one of its smelters that expires in July 2021 (Financial contract, below). In March 2021, Alcoa entered into four new financial contracts (Financial contracts (undesignated), below) with three counterparties to hedge the anticipated power requirements at this smelter for the period from August 2021 through July 2026. Two of these financial contracts include LME-linked pricing components and do not qualify for hedge accounting treatment. Management elected not to apply hedge accounting treatment for the other two financial contracts as the value of these contracts is not significant. Significant increases or decreases in the power market or the LME may result in a higher or lower fair value measurement of the financial contracts. Lower prices in the power market would cause an increase in the derivative liability, while higher LME prices would cause an increase in the derivative liability. Unrealized and realized gains and losses on these financial contracts will be included in Other income, net on the accompanying Statement of Consolidated Operations.

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):

	March 31, 2021		Unobservable Input	Unobservable Input Range
Liability Derivatives
Power contract	$	248	MWh of energy needed	LME (per mt)	2021: $2,194
			to produce the forecasted		2027: $2,283
			mt of aluminum	Electricity	Rate of 4 million MWh per year
Power contracts		797	MWh of energy needed to produce the forecasted mt of aluminum	LME (per mt)	2021: $2,194 2029: $2,360 2036: $2,656
				Midwest premium (per pound)	2021: $0.2125 2029: $0.2125 2036: $0.2125
				Electricity	Rate of 17 million MWh per year
Power contract		2	MWh of energy needed to produce the forecasted mt of aluminum	LME (per mt)	2021: $2,194 2021: $2,209
				Midwest premium (per pound)	2021: $0.2125 2021: $0.2125
				Electricity	Rate of 2 million MWh per year
Power contract (undesignated)	18		Estimated spread between the 30-year debt yield of Alcoa and the counterparty	Credit spread	2.23%: 30-year debt yield spread 5.51%: Alcoa (estimated) 3.28%: counterparty
Financial contract		14	Interrelationship of	Electricity (per MWh)	2021: $25.26
			forward energy price and the Consumer Price Index		2021: $27.58
Financial contracts		1	Interrelationship of	Electricity (per MWh)	2021: $27.58
(undesignated)			forward energy price, LME		2021: $27.58
			forward price and the	LME (per mt)	2021: $2,220
			Consumer Price Index		2021: $2,224
Total Liability Derivatives	$	1,080

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

Liability Derivatives	March 31. 2021		December 31, 2020
Derivatives designated as hedging instruments:
Current—power contracts	$	145	$	94
Current—financial contract		14		1
Noncurrent—power contracts		902		720
Total derivatives designated as hedging instruments	$	1,061	$	815
Derivatives not designated as hedging instruments:
Current—embedded credit derivative	$	3	$	4
Current—financial contract		1		—
Noncurrent—embedded credit derivative		15		19
Total derivatives not designated as hedging instruments	$	19	$	23
Total Liability Derivatives	$	1,080	$	838

Assuming market rates remain constant with the rates at March 31, 2021, a realized loss of $145 related to power contracts and a realized loss of $14 related to the financial contract are expected to be recognized in Sales and Cost of goods sold, respectively, over the next 12 months.

At March 31, 2021 and December 31, 2020, the power contracts with embedded derivatives designated as cash flow hedges hedge forecasted aluminum sales of 2,074 kmt and 2,130 kmt, respectively. At March 31, 2021 and December 31, 2020, the financial contract hedges forecasted electricity purchases of 821,304 and 1,427,184 megawatt hours, respectively.

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

	Liabilities
First quarter ended March 31, 2021	Power contracts			Financial contract			Embedded credit derivative
January 1, 2021	$	814		$	1		$	23
Total gains or losses included in:
Sales (realized)		(40	)		—			—
Cost of goods sold (realized)		—			(15	)		—
Other income, net (unrealized/realized)		—			—			(6	)
Other comprehensive (loss) income (unrealized)		273			27			—
Other		—			2			1
March 31, 2021	$	1,047		$	15		$	18
Change in unrealized gains or losses included in earnings for derivative instruments held at March 31, 2021:
Other income, net	$	—		$	—		$	(5	)

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:

	March 31, 2021				December 31, 2020
	Carrying value		Fair value		Carrying value		Fair value
Cash and cash equivalents	$	2,544	$	2,544	$	1,607	$	1,607
Restricted cash		3		3		3		3
Short-term borrowings		77		77		77		77
Long-term debt due within one year		745		777		2		2
Long-term debt, less amount due within one year		2,214		2,386		2,463		2,692

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.

Short-term borrowings and Long-term debt, including amounts 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.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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