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. Aspire Energy has entered into contracts with producers to secure natural gas to meet its obligations. 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 and natural gas marketing operations 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 December 31, 2015, our natural gas and electric distribution operations did not have any outstanding derivative contracts.

Hedging Activities in 2015

In October 2015, PESCO entered into natural gas futures contracts associated with the purchase and sale of natural gas sales to specific customers. These contracts all expire within two years and we accounted for them as cash flow hedges. There is no ineffective portion of these hedges. At December 31, 2015, PESCO had a total of 1,410 Dts/d hedged under natural gas futures contracts, with a fair value of $109,000. The changes in fair value of the contracts are recognized as gains or losses in revenues on the consolidated statements of income in the period of change.

In March, May and June 2015, Sharp paid a total of $143,000 to purchase put options to protect against a decline in propane prices and related potential inventory losses associated with 2.5 million gallons for the propane price cap program in the 2015-2016 heating season. The put options are exercised if propane prices fall below the strike prices of $0.4950, $0.4888 and $0.4500 per gallon in December 2015 through February 2016 and $0.4200 per gallon in January through March 2016. If exercised, we will receive the difference between the market price and the strike price during those months. We accounted for the put options as fair value hedges, and there is no ineffective portion of these hedges. As of December 31, 2015, the put options had a fair value of $152,000. The change in fair value of the put options effectively reduced our propane inventory balance.

In March, May and June 2015, Sharp entered into swap agreements to mitigate the risk of fluctuations in wholesale propane index prices associated with 2.5 million gallons expected to be purchased for the 2015-2016 heating season. Under these swap agreements, Sharp receives the difference between the index prices (Mont Belvieu prices in December 2015 through March 2016) and the swap prices, which range from $0.5200 to $0.5950 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 the 2.5 million gallons that we expect to purchase for the upcoming heating season. We accounted for the swap agreements as cash flow hedges, and there is no ineffective portion of these hedges. At December 31, 2015, the swap agreements had a liability fair value of $323,000. The changes in fair value of the swap agreements are recognized as gains or losses in revenues on the consolidated statements of income in the period of change.

Hedging Activities in 2014

In August and October 2014, Sharp entered into call options to protect against an increase in propane prices associated with 1.3 million gallons purchased at market-based prices to supply the demands of our propane price cap program customers. The retail price that we charged those customers during the heating season was capped at a pre-determined level. We would have exercised the call options if the propane prices had risen above the strike price of $1.0875 per gallon in December 2014 through February of 2015, and $1.0650 per gallon in January through March 2015. We paid $98,000 to purchase the call options, which expired without exercise as the market prices were below the strike prices. We accounted for the call options as cash flow hedges.

In May 2014, Sharp entered into swap agreements to mitigate the risk of fluctuations in wholesale propane index prices associated with 630,000 gallons purchased in December 2014 through February 2015. Under these swap agreements, Sharp would have received 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 exceeded the swap prices. If the index prices were lower than the swap prices, Sharp would pay the difference. These swap agreements essentially fixed the price of the 630,000 gallons purchased during this period. We had initially accounted for them as cash flow hedges as the swap agreements met all the requirements. We paid $1.1 million, representing the difference between the market prices and strike prices during those months for the swap agreements. At December 31, 2014, we elected to discontinue hedge accounting on the swap agreements and reclassified $735,000 of unrealized loss from other comprehensive loss to propane cost of sales. Subsequently, we accounted for them as derivative instruments on a mark-to-market basis with the change in fair value reflected in current period earnings.

In May 2014, Sharp 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 December 2014 through February 2015. We exercised the put options because the propane prices fell below the strike prices of $1.0350, $0.9975 and $0.9475 per gallon, for each option agreement in December 2014 through February 2015, respectively. We paid $128,000 to purchase the put options and received $868,000 from the exercise of the options, representing the difference between the market prices and strike prices during those months. We accounted for them as fair value hedges.

Hedging Activities in 2013

In June 2013, Sharp entered into put options to protect against the decline in propane prices and related potential inventory losses associated with 1.3 million gallons purchased for the propane price cap program during the 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 at a pre-determined level that we could charge to those customers during the 2013-2014 heating season. 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.

Commodity Contracts for Trading Activities

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 the mark-to-market method of accounting, 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 consolidated statements of income in the period of change. As of December 31, 2015, we did not have outstanding trading contracts. As of December 31, 2014, we had the following outstanding trading contracts, which we accounted for as derivatives:



At December 31, 2014	Quantity in Gallons	Estimated Market Prices	Weighted Average Contract Prices
Forward Contracts
Sale	4,200,000	$0.5400 - $0.7900	$	0.6714
Purchase	4,201,000	$0.4700 - $1.3176	$	0.6416

Estimated market prices and weighted average contract prices are in dollars per gallon. All contracts expired during the first quarter of 2014.

Xeron 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 consolidated balance sheets. At December 31, 2015, Xeron had a right to offset $431,000 of accounts payable with these two counterparties. At December 31, 2015, Xeron did not have outstanding accounts receivable with these two counterparties. At December 31, 2014, Xeron had a right to offset $1.6 million and $1.2 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 consolidated balance sheets as of December 31, 2015 and 2014, are as follows:



	Asset Derivatives
		Fair Value As Of
(in thousands)	Balance Sheet Location	December 31, 2015		December 31, 2014
Derivatives not designated as hedging instruments
Forward contracts	Mark-to-market energy assets	$	1	$	407
Derivatives designated as fair value hedges
Put options	Mark-to-market energy assets	152		622
Derivatives designated as cash flow hedges
Call options	Mark-to-market energy assets	—		26
Total asset derivatives		$	153	$	1,055



	Liability Derivatives
		Fair Value As Of
(in thousands)	Balance Sheet Location	December 31, 2015		December 31, 2014
Derivatives not designated as hedging instruments
Forward contracts	Mark-to-market energy liabilities	$	1	$	283
Propane swap agreements	Mark-to-market energy liabilities	—		735
Derivatives designated as cash flow hedges
Propane swap agreements	Mark-to-market energy liabilities	323		—
Natural gas futures contracts	Mark-to-market energy liabilities	109		—
Total liability derivatives		$	433	$	1,018

The effects of gains and losses from derivative instruments are as follows:



	Amount of Gain (Loss) on Derivatives:
	Location of Gain (Loss) on Derivatives	For the Year Ended December 31,
(in thousands)	Location of Gain (Loss) on Derivatives	2015			2014			2013
Derivatives not designated as hedging instruments:
Realized gain on forward contracts and options ⁽¹⁾	Revenue	$	426		$	1,423		$	1,127
Unrealized gain (loss) on forward contracts ⁽¹⁾	Revenue	(126		)	57			217
Call options	Cost of Sales	—			—			97
Propane swap agreements	Cost of Sales	18			(735		)	—
Derivatives designated as fair value hedges:
Put/Call option	Cost of Sales	528			235			(28		)
Put/Call option ⁽²⁾	Propane Inventory	43			517			(100		)
Derivatives designated as cash flow hedges
Propane swap agreements	Cost of Sales	(120		)	(341		)	—
Propane swap agreements	Other Comprehensive Loss	(323		)	—			—
Call options	Cost of Sales	(81		)	(17		)	—
Call options	Other Comprehensive Loss	—			(55		)	—
Natural gas futures contracts	Other Comprehensive Income	109			—			—
Total		$	474		$	1,084		$	1,313


(1)	All of the realized and unrealized gain (loss) on forward contracts represents the effect of trading activities on our consolidated statements of income.

(2)

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.