Derivative Instruments

3 Months Ended

Mar. 31, 2017

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 our 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 normal 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 their inventory or cash flow hedges of their future purchase commitments in order to mitigate the impact of wholesale price fluctuations. As of March 31, 2017, our natural gas and electric distribution operations did not have any outstanding derivative contracts.

Hedging Activities in 2017

PESCO enters into natural gas futures contracts associated with the purchase and sale of natural gas to other specific customers. These contracts have a two-year term, and we have accounted for them as cash flow hedges. There is no ineffective portion of these hedges. At March 31, 2017, PESCO had a total of 2.7 million Dts hedged under natural gas futures contracts, with an asset fair value of approximately $1.2 million. The change in fair value of the natural gas futures contracts is recorded as unrealized gain (loss) in other comprehensive income (loss).

The impact of financial instruments that have not been designated as hedges on our condensed consolidated financial statements for the quarter ended March 31, 2017 was $189,000, which was recorded as an increase in gas costs and is associated with 813,000 Dts of natural gas. This presentation does not reflect the expected gains or losses arising from the underlying physical transactions associated with these financial instruments.

Hedging Activities in 2016

In 2016, Sharp entered into swap agreements to mitigate the risk of fluctuations in wholesale propane index prices associated with 4.8 million gallons expected to be purchased through September 2017, of which 1.4 million gallons were outstanding at March 31, 2017. Under the swap agreements, Sharp will receive the difference between the index prices (Mont Belvieu prices in October 2016 through September 2017) and the swap prices of $0.5225 and $0.5650 per gallon, to the extent the index prices exceed the swap prices. If the index prices are lower than the swap price, Sharp will pay the difference. We accounted for these swap agreements as cash flow hedges, and there is no ineffective portion of these hedges. At March 31, 2017, the remaining swap agreements had a fair value of approximately $137,000. The change in the fair value of the swap agreements is recorded as unrealized gain (loss) in other comprehensive income (loss).

In December 2016, Sharp paid a total of $33,000 to purchase a put option to protect against a decline in propane prices and related potential inventory losses associated with 630,000 gallons for its propane price cap program in the 2016-2017 heating season. The put option expired without being exercised because the propane prices did not fall below the strike price of $0.5650 per gallon in December 2016, January 2017, or February 2017. We accounted for the put option as a fair value hedge, and there was no ineffective portion of this hedge.

In January 2016, PESCO entered into a SCO supplier agreement with Columbia Gas to provide natural gas supply for one of its local distribution customer pools. PESCO also assumed the obligation to store natural gas inventory to satisfy its obligations under the SCO supplier agreement, which terminated on March 31, 2017. In conjunction with the SCO supplier agreement, PESCO entered into natural gas futures contracts during the second quarter of 2016 in order to protect its natural gas inventory against market price fluctuations. We had previously accounted for these contracts as fair value hedges with any ineffective portion being reported directly in earnings and offset by any associated gain (loss) on the inventory value being hedged. During the third quarter of 2016, we discontinued hedge accounting as the hedges were no longer highly effective. As of March 31, 2017, these contracts have all expired and are no longer reported on the balance sheet.

Commodity Contracts for Trading Activities

During the first quarter of 2017, Xeron began winding down operations. Prior to March 31, 2017, Xeron engaged in trading activities using forward and futures contracts for propane and crude oil. These contracts were considered derivatives and were 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 were recognized as unrealized gains or losses in the statements of income for the period of change. As of March 31, 2017, Xeron had no outstanding contracts that were accounted for as derivatives.

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. The fair values of the derivative contracts recorded in the condensed consolidated balance sheets as of March 31, 2017 and December 31, 2016, are as follows:

	Asset Derivatives
		Fair Value As Of
(in thousands)	Balance Sheet Location	March 31, 2017		December 31, 2016
Derivatives not designated as hedging instruments
Propane swap agreements	Mark-to-market energy assets	$	4	$	8
Put options	Mark-to-market energy assets	—		9
Derivatives designated as cash flow hedges
Natural gas futures contracts	Mark-to-market energy assets	1,198		113
Propane swap agreements	Mark-to-market energy assets	137		693
Total asset derivatives		$	1,339	$	823

	Liability Derivatives
		Fair Value As Of
(in thousands)	Balance Sheet Location	March 31, 2017		December 31, 2016
Derivatives not designated as hedging instruments
Natural gas futures contracts	Mark-to-market energy liabilities	$	189	$	773
Total liability derivatives		$	189	$	773

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 March 31,
(in thousands)	(Loss) on Derivatives	2017			2016
Derivatives not designated as hedging instruments
Realized (loss) gain on forward contracts and options (1)	Revenue	$	112		$	187
Unrealized gain on forward contracts (1)	Revenue	—			1
Natural gas futures contracts	Cost of sales	124			—
Propane swap agreements	Cost of sales	(4		)	—
Derivatives designated as fair value hedges
Put /Call option (2)	Cost of sales	(9		)	73
Derivatives designated as cash flow hedges
Propane swap agreements	Cost of sales	388			(364		)
Propane swap agreements	Other Comprehensive Loss	(557		)	—
Natural gas futures contracts	Cost of sales	1,150			149
Natural gas futures contracts	Other Comprehensive Income (Loss)	1,087			(462		)
Total		$	2,291		$	(416	)

⁽¹⁾  All of the realized and unrealized gain (loss) on forward contracts represents the effect of trading activities on our condensed 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 put option effectively changed the value of propane inventory.