Derivative Instruments

9 Months Ended

Sep. 30, 2014

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Instruments

Derivative Instruments

We use derivative and non-derivative contracts to engage in trading activities and manage risks related to obtaining adequate supplies and the price fluctuations of natural gas, electricity and propane. Our natural gas, electric and propane distribution operations have entered into agreements with suppliers to purchase natural gas, electricity and propane for resale to their customers. Purchases under these contracts typically either do not meet the definition of derivatives or are considered “normal purchases and sales” and are accounted for on an accrual basis. Our propane distribution operation may also enter into fair value hedges of its inventory or cash flow hedges of its future purchase commitments in order to mitigate the impact of wholesale price fluctuations. As of September 30, 2014, our natural gas and electric distribution operations did not have any outstanding derivative contracts.

In August 2014, Sharp entered into a call option to protect against an increase in propane prices associated with 630,000 gallons we expect to purchase at market-based prices to supply the demands of our propane price cap program customers. The retail price that we can charge to those customers during the upcoming heating season is capped at a pre-determined level. The call option is exercised if the propane prices rise above the strike price of $1.0875 per gallon in December 2014 through February of 2015. We will receive the difference between the market price and the strike price during those months. We paid $52,000 to purchase the call option, and we accounted for it as a cash flow hedge. As of September 30, 2014, the call option had a fair value of $35,000. The change in fair value of the call option is recorded as unrealized gain/loss in other comprehensive income (loss).

In May 2014, Sharp entered into swap agreements to mitigate the risk of fluctuations in wholesale propane index prices associated with 630,000 gallons expected to be purchased for the upcoming heating season. Under these swap agreements, Sharp receives the difference between the index prices (Mont Belvieu prices in December 2014 through February 2015) and the swap prices of $1.1350, $1.0975 and $1.0475 per gallon for each swap agreement, to the extent the index prices exceed the swap prices. If the index prices are lower than the swap prices, Sharp will pay the difference. These swap agreements essentially fix the price of those 630,000 gallons purchased for the upcoming heating season. We accounted for them as cash flow hedges, and there is no ineffective portion of these hedges. As of September 30, 2014, two swap agreements had a fair value of $60,000 of liability and one swap agreement had a fair value of $13,000 of asset. The change in fair value of the swap agreements is recorded as unrealized gain/loss in other comprehensive income (loss).

In May 2014, Sharp also entered into put options to protect against declines in propane prices and related potential inventory losses associated with 630,000 gallons purchased for the propane price cap program in the upcoming heating season. The put options are exercised if propane prices fall below the strike prices of $0.9475, $0.9975 and $1.0350 per gallon, for each option agreement in December 2014 through February 2015, respectively. We will receive the difference between the market price and the strike prices during those months. We paid $128,000 to purchase the put options. We accounted for them as fair value hedges and there is no ineffective portion of these hedges. As of September 30, 2014, the put options had a fair value of $56,000. The change in fair value of the put options effectively reduced our propane inventory balance.

In June 2013, Sharp entered into put options to protect against declines in propane prices and related potential inventory losses associated with 1.3 million gallons purchased for the propane price cap program in the upcoming heating season. If exercised, we would have received the difference between the market price and the strike price if propane prices had fallen below the strike prices of $0.830 per gallon in December 2013 through February of 2014, and $0.860 per gallon in January through March 2014. We accounted for those options as fair value hedges, and there was no ineffective portion of those hedges. We paid $120,000 to purchase the put options, which expired without exercise as the market prices exceeded the strike prices.

In May 2013, Sharp entered into a call option to protect against an increase in propane prices associated with 630,000 gallons we expected to purchase at market-based prices to supply the demands of our propane price cap program customers. The program capped the retail price that we could charge to those customers during the upcoming heating season at a pre-determined level. The call option was exercised because propane prices rose above the strike price of $0.975 per gallon in January through March of 2014. We accounted for this call option as a derivative instrument on a mark-to-market basis with any change in its fair value being reflected in current period earnings. We paid $72,000 to purchase the call option. In January through March of 2014, we received $209,000, representing the difference between the market price and the strike price during those months.

Xeron engages in trading activities using forward and futures contracts. These contracts are considered derivatives and have been accounted for using the mark-to-market method of accounting. Under this method, the trading contracts are recorded at fair value, and the changes in fair value of those contracts are recognized as unrealized gains or losses in the statement of income for the period of change. As of September 30, 2014, we had the following outstanding trading contracts, which we accounted for as derivatives:

	Quantity in	Estimated Market	Weighted Average
At September 30, 2014	Gallons	Prices	Contract Prices
Forward Contracts
Sale	1,260,000	$1.0838 - $1.1400	$	1.1118
Purchase	1,261,000	$1.0913 - $1.3176	$	1.1107

Estimated market prices and weighted average contract prices are in dollars per gallon. All contracts expire by the end of the fourth quarter of 2014.

Xeron has entered into master netting agreements with two counterparties to mitigate exposure to counterparty credit risk. The master netting agreements enable Xeron to net these two counterparties' outstanding accounts receivable and payable, which are presented on a gross basis in the accompanying condensed consolidated balance sheets. At September 30, 2014, Xeron had a right to offset $2.2 million and $1.6 million of accounts receivable and accounts payable, respectively, with these two counterparties. At December 31, 2013, Xeron had a right to offset $2.8 million and $3.2 million of accounts receivable and accounts payable, respectively, with these two counterparties.

The following tables present information about the fair value and related gains and losses of our derivative contracts. We did not have any derivative contracts with a credit-risk-related contingency.

Fair values of the derivative contracts recorded in the condensed consolidated balance sheets as of September 30, 2014 and December 31, 2013, are as follows:

	Asset Derivatives
		Fair Value As Of
(in thousands)	Balance Sheet Location	September 30, 2014		December 31, 2013
Derivatives not designated as hedging instruments
Forward contracts	Mark-to-market energy assets	$	83	$	196
Call Option (1)	Mark-to-market energy assets	—		169
Derivatives designated as fair value hedges
Put Options	Mark-to-market energy assets	56		20
Derivatives designated as cash flow hedges
Propane swap agreements	Mark-to-market energy assets	13		—
Call Option	Mark-to-market energy assets	35		—
Total asset derivatives		$	187	$	385

⁽¹⁾  We purchased a call option for the propane price cap program in May 2013. The call option was fully exercised during 2014. There was no outstanding call option at September 30, 2014.

	Liability Derivatives
		Fair Value As Of
(in thousands)	Balance Sheet Location	September 30, 2014		December 31, 2013
Derivatives not designated as hedging instruments
Forward contracts	Mark-to-market energy liabilities	$	81	$	127
Derivatives designated as cash flow hedges
Propane swap agreements	Mark-to-market energy liabilities	60		—
Total liability derivatives		$	141	$	127

The effects of gains and losses from derivative instruments on the condensed consolidated financial statements are as follows:

		Amount of Gain (Loss) on Derivatives:
	Location of Gain	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
(in thousands)	(Loss) on Derivatives	2014			2013			2014			2013
Derivatives not designated as hedging instruments
Unrealized gain (loss) on forward contracts	Revenue	$	(5	)	$	86		$	(67	)	$	239
Call Option	Cost of sales	—			38			137			29
Derivatives designated as fair value hedges
Put/Call Options	Cost of sales	(43		)	—			(92		)	(28		)
Put/Call Options (1)	Propane Inventory	—			(43		)	—			(57		)
Derivatives designated as cash flow hedges
Propane swap agreements	Other Comprehensive loss	(45		)	—			(46		)	—
Total		$	(93	)	$	81		$	(68	)	$	183

(1) As a fair value hedge with no ineffective portion, the unrealized gains and losses associated with this call option are recorded in cost of sales, offset by the corresponding change in the value of propane inventory (hedged item), which is also recorded in cost of sales. The amounts in cost of sales offset to zero and the unrealized gains and losses of this call option effectively changed the value of propane inventory.

The effects of trading activities on the condensed consolidated statements of income are the following:

	Location in the	For the Three Months Ended September 30,					For the Nine Months Ended September 30,
(in thousands)	Statements of Income	2014			2013		2014			2013
Realized gain on forward contracts	Revenue	$	54		$	321	$	1,384		$	506
Unrealized gain (loss) on forward contracts	Revenue	(5		)	86		(67		)	239
Total		$	49		$	407	$	1,317		$	745