Derivative Instruments and Hedging Activities

Commodity Price Risk Management

Our primary market risk is commodity price risk. We are exposed to market risks related to the volatility in crude oil and refined products, as well as volatility in the price of natural gas used in our refining operations. We periodically enter into derivative contracts in the form of commodity price swaps, forward purchase and sales and futures contracts to mitigate price exposure with respect to our inventory positions, natural gas purchases, sales prices of refined products and crude oil costs.

Foreign Currency Risk Management

We are exposed to market risk related to the volatility in foreign currency exchange rates. We periodically enter into derivative contracts in the form of foreign exchange forward and foreign exchange swap contracts to mitigate the exposure associated with fluctuations on intercompany notes with our foreign subsidiaries that are not denominated in the U.S. dollar.

Accounting Hedges

We have swap contracts serving as cash flow hedges against price risk on forecasted purchases of natural gas and to lock in basis spread differentials on forecasted purchases of crude oil. We also periodically have forward sales contracts that lock in the prices of future sales of crude oil and refined product and swap contracts serving as cash flow hedges against price risk on forecasted purchases of WTI crude oil and forecasted sales of refined product. These contracts have been designated as accounting hedges and are measured at fair value with offsetting adjustments (gains/losses) recorded directly to other comprehensive income. These fair value adjustments are later reclassified to earnings as the hedging instruments mature.

The following table presents the pre-tax effect on other comprehensive income (“OCI”) and earnings due to fair value adjustments and maturities of derivatives designated as hedging instruments under hedge accounting:



	Unrealized Gain (Loss) Recognized in OCI					Gain (Loss) Reclassified into Earnings
Derivatives Designated as Cash Flow Hedging Instruments	Three Months Ended September 30,					Income Statement Location	Three Months Ended September 30,
Derivatives Designated as Cash Flow Hedging Instruments	2018		2017			Income Statement Location	2018			2017
	(In thousands)
Commodity contracts	$	5,792	$	3,354		Sales and other revenues	$	(1,422	)	$	(488	)
						Operating expenses	(209		)	(4,961		)
Interest rate contracts ⁽¹⁾	—		(63		)	Interest expense	—			64
Total	$	5,792	$	3,291			$	(1,631	)	$	(5,385	)



	Unrealized Gain (Loss) Recognized in OCI					Gain (Loss) Reclassified into Earnings
Derivatives Designated as Cash Flow Hedging Instruments	Nine Months Ended September 30,					Income Statement Location	Nine Months Ended September 30,
Derivatives Designated as Cash Flow Hedging Instruments	2018		2017			Income Statement Location	2018			2017
	(In thousands)
Commodity contracts	$	1,742	$	8,658		Sales and other revenues	$	(5,093	)	$	7,937
						Cost of products sold	—			(299		)
						Operating expenses	(945		)	(13,676		)
Interest rate contracts ⁽¹⁾	—		(91		)	Interest expense	—			179
Total	$	1,742	$	8,567			$	(6,038	)	$	(5,859	)

(1) HEP used interest rate swap contracts to manage its exposure to interest rate risk, which matured in July 2017.

Economic Hedges

We have commodity contracts including forward purchase and sell contracts and swap contracts to lock in the crack spread of WTI and sub-octane gasoline and NYMEX futures contracts to lock in prices on forecasted purchases and sales of inventory that serve as economic hedges (derivatives used for risk management, but not designated as accounting hedges). We also have forward currency contracts to fix the rate of foreign currency. These contracts are measured at fair value with offsetting adjustments (gains/losses) recorded directly to income.

The following table presents the pre-tax effect on income due to maturities and fair value adjustments of our economic hedges:



	Gain (Loss) Recognized in Earnings
Derivatives Not Designated as Hedging Instruments	Income Statement Location	Three Months Ended September 30,						Nine Months Ended September 30,
Derivatives Not Designated as Hedging Instruments	Income Statement Location	2018			2017			2018			2017
		(In thousands)
Commodity contracts	Cost of products sold	$	(8,252	)	$	(10,632	)	$	(20,580	)	$	3,403
	Operating expenses	—			(629		)	—			(6,392		)
Foreign currency contracts	Gain on foreign currency transactions	(7,052		)	—			18,504			—
	Gain on foreign currency swap contracts ⁽¹⁾	—			—			—			24,545
	Total	$	(15,304	)	$	(11,261	)	$	(2,076	)	$	21,556

(1) Relates to Canadian currency swap contracts that settled on February 1, 2017 and effectively fixed the conversion rate on our PCLI purchase price.

As of September 30, 2018, we have the following notional contract volumes related to outstanding derivative instruments:



			Notional Contract Volumes by Year of Maturity
	Total Outstanding Notional		2018		2019		2020	2021	Unit of Measure
Derivatives Designated as Hedging Instruments
Natural gas price swaps - long	5,850,000		450,000		1,800,000		1,800,000	1,800,000	MMBTU
Crude oil price swaps (basis spread) - long	4,388,000		—		1,460,000		2,928,000	—	Barrels

Derivatives Not Designated as Hedging Instruments
NYMEX futures (WTI) - short	2,303,000		2,102,000		201,000		—	—	Barrels
WTI and sub-octane gasoline crack spread swaps - short	400,000		400,000		—		—	—	Barrels
Forward gasoline contracts - long	25,000		25,000		—		—	—	Barrels
Foreign currency forward contracts	$	446,361,369	$	113,632,223	$	332,729,146	—	—	U.S. Dollar

The following table presents the fair value and balance sheet locations of our outstanding derivative instruments. These amounts are presented on a gross basis with offsetting balances that reconcile to a net asset or liability position in our consolidated balance sheets. We present on a net basis to reflect the net settlement of these positions in accordance with provisions of our master netting arrangements.



	Derivatives in Net Asset Position						Derivatives in Net Liability Position
	Gross Assets		Gross Liabilities Offset in Balance Sheet		Net Assets Recognized in Balance Sheet		Gross Liabilities		Gross Assets Offset in Balance Sheet			Net Liabilities Recognized in Balance Sheet
			(In thousands)
September 30, 2018
Derivatives designated as cash flow hedging instruments:
Commodity price swap contracts	$	1,565	$	—	$	1,565	$	3,243	$	(2,114	)	$	1,129
	$	1,565	$	—	$	1,565	$	3,243	$	(2,114	)	$	1,129

Derivatives not designated as cash flow hedging instruments:
Foreign exchange forward contracts	$	9,137	$	—	$	9,137	$	—	$	—		$	—
NYMEX futures contracts	—		—		—		8,854		—			8,854
Commodity price swap contracts	—		—		—		1,288		(802		)	486
Commodity forward contracts	25		—		25		4		—			4
	$	9,162	$	—	$	9,162	$	10,146	$	(802	)	$	9,344

Total net balance					$	10,727						$	10,473

Balance sheet classification:	Prepayment and other				$	9,162	Accrued liabilities					$	10,332
	Intangibles and other				1,565		Other long-term liabilities					141
					$	10,727						$	10,473



	Derivatives in Net Asset Position						Derivatives in Net Liability Position
	Gross Assets		Gross Liabilities Offset in Balance Sheet		Net Assets Recognized in Balance Sheet		Gross Liabilities		Gross Assets Offset in Balance Sheet		Net Liabilities Recognized in Balance Sheet
			(In thousands)
December 31, 2017
Derivatives designated as cash flow hedging instruments:
Commodity price swap contracts	$	—	$	—	$	—	$	2,424	$	—	$	2,424
Commodity forward contracts	3,067		—		3,067		418		—		418
	$	3,067	$	—	$	3,067	$	2,842	$	—	$	2,842

Derivatives not designated as cash flow hedging instruments:
NYMEX futures contracts	$	—	$	—	$	—	$	3,360	$	—	$	3,360
Commodity forward contracts	773		—		773		602		—		602
	$	773	$	—	$	773	$	3,962	$	—	$	3,962

Total net balance					$	3,840					$	6,804

Balance sheet classification:							Accrued liabilities				$	5,365
							Other long-term liabilities				1,439
	Prepayment and other				$	3,840					$	6,804

At September 30, 2018, we had a pre-tax net unrealized gain of $0.4 million classified in accumulated other comprehensive income that relates to all accounting hedges having contractual maturities through 2021. Assuming commodity prices remain unchanged, an unrealized loss of $1.0 million will be effectively transferred from accumulated other comprehensive income into the statement of income as the hedging instruments contractually mature over the next twelve-month period.