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3. Financial Instruments
 6 Months Ended
Mar. 31, 2013
Financial Instruments [Abstract]  
3. Financial Instruments

3. Financial Instruments

 

We use financial instruments to mitigate commodity price risk and interest rate risk. The objectives and strategies for using financial instruments have been tailored to our regulated and nonregulated businesses. The accounting for these financial instruments is fully described in Note 2 to the consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended September 30, 2012. During the six months ended March 31, 2013 there were no changes in our objectives, strategies and accounting for these financial instruments. Currently, we utilize financial instruments in our natural gas distribution and nonregulated segments. We currently do not manage commodity price risk with financial instruments in our regulated transmission and storage segment.

 

Our financial instruments do not contain any credit-risk-related or other contingent features that could cause payments to be accelerated when our financial instruments are in net liability positions.

 

Regulated Commodity Risk Management Activities

 

Although our purchased gas cost adjustment mechanisms essentially insulate our natural gas distribution segment from commodity price risk, our customers are exposed to the effects of volatile natural gas prices. We manage this exposure through a combination of physical storage, fixed-price forward contracts and financial instruments, primarily over-the-counter swap and option contracts, in an effort to minimize the impact of natural gas price volatility on our customers during the winter heating season.

 

Our natural gas distribution gas supply department is responsible for executing this segment's commodity risk management activities in conformity with regulatory requirements. In jurisdictions where we are permitted to mitigate commodity price risk through financial instruments, the relevant regulatory authorities may establish the level of heating season gas purchases that can be hedged. Historically, if the regulatory authority does not establish this level, we seek to hedge between 25 and 50 percent of anticipated heating season gas purchases using financial instruments. For the 2012-2013 heating season (generally October through March), in the jurisdictions where we are permitted to utilize financial instruments, we hedged approximately 33 percent, or 22.8 Bcf of the winter flowing gas requirements. We have not designated these financial instruments as hedges for accounting purposes.

 

The costs associated with and the gains and losses arising from the use of financial instruments to mitigate commodity price risk are included in our purchased gas cost adjustment mechanisms in accordance with regulatory requirements. Therefore, changes in the fair value of these financial instruments are initially recorded as a component of deferred gas costs and recognized in the consolidated statement of income as a component of purchased gas cost when the related costs are recovered through our rates and recognized in revenue in accordance with applicable authoritative accounting guidance. Accordingly, there is no earnings impact on our natural gas distribution segment as a result of the use of financial instruments.

 

Nonregulated Commodity Risk Management Activities

 

Our nonregulated operations aggregate and purchase gas supply, arrange transportation and/or storage logistics and ultimately deliver gas to our customers at competitive prices. To provide these services, we utilize proprietary and customer-owned transportation and storage assets to provide the various services our customers request. In an effort to offset the demand fees paid to contract for storage capacity and to maximize the value of this capacity, AEH sells financial instruments to earn a gross profit margin through the arbitrage of pricing differences in various locations and by recognizing pricing differences that occur over time.

 

As a result of these activities, our nonregulated segment is exposed to risks associated with changes in the market price of natural gas. We manage our exposure to such risks through a combination of physical storage and financial instruments, including futures, over-the-counter and exchange traded options and swap contracts with counterparties. Future contracts provide the right, but not the obligation, to buy or sell the commodity at a fixed price. Option contracts provide the right, but not the requirement, to buy or sell the commodity at a fixed price. Swap contracts require receipt of payment for the commodity based on the difference between a fixed price and the market price on the settlement date.

 

We use financial instruments, designated as cash flow hedges of anticipated purchases and sales at index prices, to mitigate the commodity price risk in our nonregulated operations associated with deliveries under fixed-priced forward contracts to deliver gas to customers. These financial instruments have maturity dates ranging from one to 57 months. We use financial instruments, designated as fair value hedges, to hedge our natural gas inventory used in asset optimization activities in our nonregulated segment.

 

Our nonregulated operations also use storage swaps and futures to capture additional storage arbitrage opportunities that arise subsequent to the execution of the original fair value hedge associated with our physical natural gas inventory, basis swaps to insulate and protect the economic value of our fixed price and storage books and various over-the-counter and exchange-traded options. These financial instruments have not been designated as hedges for accounting purposes.

 

Interest Rate Risk Management Activities

 

We have periodically managed interest rate risk by entering into financial instruments to fix the Treasury yield component of the interest cost associated with anticipated financings. Prior to fiscal 2012, we used Treasury locks to mitigate interest rate risk; however, beginning in the fourth quarter of fiscal 2012 we started utilizing interest rate swaps and forward starting interest rate swaps to manage this risk.

 

In August 2011, we entered into three Treasury lock agreements to fix the Treasury yield component of the interest cost associated with $350 million out of a total $500 million of senior notes that were issued on January 11, 2013. This offering is discussed in Note 7. We designated these Treasury locks as cash flow hedges. The Treasury locks were settled on January 8, 2013 with a payment of $66.6 million to the counterparties due to a decrease in the 30-year Treasury lock rates between inception of the Treasury locks and settlement. Because the Treasury locks were effective, the $66.6 million unrealized loss was recorded as a component of accumulated other comprehensive income and is being recognized as a component of interest expense over the 30-year life of the senior notes.

 

In the fourth quarter of fiscal 2012, we entered into an interest rate swap to fix the LIBOR component of our $260 million short-term financing facility that terminated on December 27, 2012. We recorded an immaterial loss upon settlement of the swap, which was recorded as a component of interest expense as we did not designate the interest rate swap as a hedge.

 

In October 2012, we entered into forward starting interest rate swaps to fix the Treasury yield component associated with the anticipated issuance of $500 million and $250 million unsecured senior notes in fiscal 2015 and fiscal 2017, which we designated as cash flow hedges at the time the agreements were executed. Accordingly, unrealized gains and losses associated with the forward starting interest rate swaps are being recorded as a component of accumulated other comprehensive income (loss). When the forward starting interest rate swaps settle, the realized gain or loss will be recorded as a component of accumulated other comprehensive income (loss) and recognized as a component of interest expense over the life of the related financing arrangement. Hedge ineffectiveness to the extent incurred is reported as a component of interest expense.

 

In prior years, we entered into Treasury lock agreements to fix the Treasury yield component of the interest cost of financing various issuances of long-term debt and senior notes. The gains and losses realized upon settlement of these Treasury locks were recorded as a component of accumulated other comprehensive income (loss) when they were settled and are being recognized as a component of interest expense over the life of the associated notes from the date of settlement. As of March 31, 2013, the remaining amortization periods for the settled Treasury locks extend through fiscal 2043.

Quantitative Disclosures Related to Financial Instruments

 

The following tables present detailed information concerning the impact of financial instruments on our condensed consolidated balance sheet and income statements.

 

As of March 31, 2013, our financial instruments were comprised of both long and short commodity positions. A long position is a contract to purchase the commodity, while a short position is a contract to sell the commodity. As of March 31, 2013, we had net long/(short) commodity contracts outstanding in the following quantities:

 

 

    Natural  
  Hedge Gas  
Contract Type Designation Distribution Nonregulated
    Quantity (MMcf)
       
Commodity contracts Fair Value  -  (22,490)
  Cash Flow  -  23,768
  Not designated  5,890  55,387
     5,890  56,665

Financial Instruments on the Balance Sheet

 

The following tables present the fair value and balance sheet classification of our financial instruments by operating segment as of March 31, 2013 and September 30, 2012. As required by authoritative accounting literature, the fair value amounts below are presented on a gross basis and do not reflect the netting of asset and liability positions permitted under the terms of our master netting arrangements. Further, the amounts below do not include $12.0 million and $23.7 million of cash held on deposit in margin accounts as of March 31, 2013 and September 30, 2012 to collateralize certain financial instruments. Therefore, these gross balances are not indicative of either our actual credit exposure or net economic exposure. Additionally, the amounts below will not be equal to the amounts presented on our condensed consolidated balance sheet, nor will they be equal to the fair value information presented for our financial instruments in Note 5.

 

       Natural     
       Gas     
     Balance Sheet LocationDistribution Nonregulated Total
March 31, 2013   (In thousands)
               
Designated As Hedges:           
 Asset Financial Instruments           
  Current commodity contracts Other current assets$ - $ 10,447 $ 10,447
  Noncurrent commodity Deferred charges and        
   contracts  other assets  36,546   777   37,323
               
 Liability Financial Instruments           
  Current commodity contracts Other current liabilities  -   (17,622)   (17,622)
  Noncurrent commodity Deferred credits and        
   contracts  other liabilities  -   (2,229)   (2,229)
 Total      36,546   (8,627)   27,919
               
Not Designated As Hedges:           
 Asset Financial Instruments           
  Current commodity contracts Other current assets(1)  3,603   76,426   80,029
  Noncurrent commodity Deferred charges and        
   contracts  other assets  36   52,274   52,310
               
 Liability Financial Instruments           
  Current commodity contracts Other current liabilities  (59)   (77,518)   (77,577)
  Noncurrent commodity Deferred credits and        
   contracts  other liabilities  -   (46,574)   (46,574)
 Total      3,580   4,608   8,188
Total Financial Instruments   $ 40,126 $ (4,019) $ 36,107

(1) Other current assets not designated as hedges in our natural gas distribution segment include $0.2 million related to risk management assets that were classified as assets held for sale at March 31, 2013.

 

       Natural     
       Gas     
     Balance Sheet LocationDistribution Nonregulated Total
September 30, 2012   (In thousands)
               
Designated As Hedges:           
 Asset Financial Instruments           
  Current commodity contracts Other current assets$ - $ 19,301 $ 19,301
  Noncurrent commodity Deferred charges and        
   contracts  other assets  -   1,923   1,923
               
 Liability Financial Instruments           
  Current commodity contracts Other current liabilities  (85,040)   (23,787)   (108,827)
  Noncurrent commodity Deferred credits and        
   contracts  other liabilities  -   (4,999)   (4,999)
 Total      (85,040)   (7,562)   (92,602)
               
Not Designated As Hedges:           
 Asset Financial Instruments           
  Current commodity contracts Other current assets(1)  7,082   98,393   105,475
  Noncurrent commodity Deferred charges and        
   contracts  other assets  2,283   60,932   63,215
               
 Liability Financial Instruments           
  Current commodity contracts Other current liabilities(2)  (585)   (99,824)   (100,409)
  Noncurrent commodity Deferred credits and        
   contracts  other liabilities  -   (67,062)   (67,062)
 Total      8,780   (7,561)   1,219
Total Financial Instruments   $ (76,260) $ (15,123) $ (91,383)

  • Other current assets not designated as hedges in our natural gas distribution segment include $0.1 million related to risk management assets that were classified as assets held for sale at September 30, 2012.
  • Other current liabilities not designated as hedges in our natural gas distribution segment include $0.3 million related to risk management liabilities that were classified as liabilities held for sale at September 30, 2012.

 

 

Impact of Financial Instruments on the Income Statement

 

Hedge ineffectiveness for our nonregulated segment is recorded as a component of unrealized gross profit and primarily results from differences in the location and timing of the derivative instrument and the hedged item. Hedge ineffectiveness could materially affect our results of operations for the reported period. For the three months ended March 31, 2013 and 2012 we recognized a gain (loss) arising from fair value and cash flow hedge ineffectiveness of $ 1.7 million and $ (6.2) million. For the six months ended March 31, 2013 and 2012 we recognized gains arising from fair value and cash flow hedge ineffectiveness of $ 17.8 million and $ 2.2 million. Additional information regarding ineffectiveness recognized in the income statement is included in the tables below.

 

Fair Value Hedges

 

The impact of our nonregulated commodity contracts designated as fair value hedges and the related hedged item on our condensed consolidated income statement for the three and six months ended March 31, 2013 and 2012 is presented below.

 

   Three Months Ended March 31
   2013 2012
   (In thousands)
        
Commodity contracts $ (17,846) $ 29,090
Fair value adjustment for natural gas      
 inventory designated as the hedged item   19,586   (35,087)
Total (increase) decrease in purchased gas       
 cost$ 1,740 $ (5,997)
        
The (increase) decrease in purchased gas       
cost is comprised of the following:      
 Basis ineffectiveness $ 1,458 $ (739)
 Timing ineffectiveness   282   (5,258)
   $ 1,740 $ (5,997)
        
        
   Six Months Ended March 31
   2013 2012
    (In thousands)
        
Commodity contracts $ (10,532) $ 53,153
Fair value adjustment for natural gas      
 inventory designated as the hedged item   28,405   (50,335)
Total decrease in purchased gas cost $ 17,873 $ 2,818
        
The decrease in purchased gas cost is       
comprised of the following:      
 Basis ineffectiveness $ 1,218 $ 102
 Timing ineffectiveness   16,655   2,716
   $ 17,873 $ 2,818

Basis ineffectiveness arises from natural gas market price differences between the locations of the hedged inventory and the delivery location specified in the hedge instruments. Timing ineffectiveness arises due to changes in the difference between the spot price and the futures price, as well as the difference between the timing of the settlement of the futures and the valuation of the underlying physical commodity. As the commodity contract nears the settlement date, spot-to-forward price differences should converge, which should reduce or eliminate the impact of this ineffectiveness on purchased gas cost.

 

To the extent that the Company's natural gas inventory does not qualify as a hedged item in a fair-value hedge, or has not been designated as such, the natural gas inventory is valued at the lower of cost or market. We did not record a writedown for nonqualifying natural gas inventory for the six months ended March 31, 2013. During the six months ended March 31, 2012, we recorded a $1.7 million charge to write down nonqualifying natural gas inventory to market.

 

Cash Flow Hedges

 

The impact of cash flow hedges on our condensed consolidated income statements for the three and six months ended March 31, 2013 and 2012 is presented below. Note that this presentation does not reflect the financial impact arising from the hedged physical transaction. Therefore, this presentation is not indicative of the economic gross profit we realized when the underlying physical and financial transactions were settled.

 

   Three Months Ended March 31, 2013
   Natural    
   Gas    
   Distribution Nonregulated Consolidated
   (In thousands)
           
Loss reclassified from AOCI for effective          
 portion of commodity contracts $ - $ (5,199) $ (5,199)
Loss arising from ineffective portion of          
 commodity contracts    -   (83)   (83)
Total impact on purchased gas costs   -   (5,282)   (5,282)
Loss on settled interest rate agreements         
 reclassified from AOCI into interest expense   (873)   -   (873)
Total Impact from Cash Flow Hedges $ (873) $ (5,282) $ (6,155)
           
   Three Months Ended March 31, 2012
   Natural    
   Gas    
   Distribution Nonregulated Consolidated
   (In thousands)
           
Loss reclassified from AOCI for effective         
  portion of commodity contracts $ - $ (21,181) $ (21,181)
Loss arising from ineffective portion of          
 commodity contracts    -   (238)   (238)
Total impact on purchased gas costs   -   (21,419)   (21,419)
Loss on settled interest rate agreements         
 reclassified from AOCI into interest expense   (502)   -   (502)
Total Impact from Cash Flow Hedges $ (502) $ (21,419) $ (21,921)
           
   Six Months Ended March 31, 2013
   Natural    
   Gas    
   Distribution Nonregulated Consolidated
   (In thousands)
           
Loss reclassified from AOCI for effective          
 portion of commodity contracts $ - $ (10,359) $ (10,359)
Loss arising from ineffective portion of          
 commodity contracts    -   (102)   (102)
Total impact on purchased gas costs   -   (10,461)   (10,461)
Loss on settled interest rate agreements         
 reclassified from AOCI into interest expense   (1,375)   -   (1,375)
Total Impact from Cash Flow Hedges $ (1,375) $ (10,461) $ (11,836)
           
   Six Months Ended March 31, 2012
   Natural    
   Gas    
   Distribution Nonregulated Consolidated
   (In thousands)
           
Loss reclassified from AOCI for effective          
 portion of commodity contracts $ - $ (32,823) $ (32,823)
Loss arising from ineffective portion of          
 commodity contracts    -   (668)   (668)
Total impact on purchased gas costs   -   (33,491)   (33,491)
Loss on settled interest rate agreements         
 reclassified from AOCI into interest expense   (1,004)   -   (1,004)
Total Impact from Cash Flow Hedges $ (1,004) $ (33,491) $ (34,495)

The following table summarizes the gains and losses arising from hedging transactions that were recognized as a component of other comprehensive income (loss), net of taxes, for the three and six months ended March 31, 2013 and 2012. The amounts included in the table below exclude gains and losses arising from ineffectiveness because those amounts are immediately recognized in the income statement as incurred.

 

  Three Months Ended Six Months Ended
  March 31 March 31
  2013 2012 2013 2012
  (In thousands)
             
Increase (decrease) in fair value:           
 Interest rate agreements$ 22,955 $ 15,079 $ 34,900 $ 13,676
 Forward commodity contracts  5,666   (18,234)   2,153   (41,912)
Recognition of losses in earnings due to            
 settlements:           
 Interest rate agreements  554   317   873   633
 Forward commodity contracts  3,172   12,919   6,320   20,022
Total other comprehensive income (loss) from           
 hedging, net of tax(1)$ 32,347 $ 10,081 $ 44,246 $ (7,581)

(1)        Utilizing an income tax rate ranging from 37 percent to 39 percent based on the effective rates in each taxing jurisdiction.

 

Deferred gains (losses) recorded in accumulated other comprehensive income (AOCI) associated with our treasury lock agreements are recognized in earnings as they are amortized over the terms of the underlying debt instruments, while deferred losses associated with commodity contracts are recognized in earnings upon settlement. The following amounts, net of deferred taxes, represent the expected recognition in earnings of the deferred gains (losses) recorded in AOCI associated with our financial instruments, based upon the fair values of these financial instruments as of March 31, 2013. However, the table below does not include the expected recognition in earnings of our outstanding interest rate agreements as those instruments have not yet settled.

  Interest    
  Rate Commodity  
  Agreements Contracts Total
  (In thousands)
          
Next twelve months $ (2,686) $ 317 $ (2,369)
Thereafter   (29,021)   (839)   (29,860)
Total(1) $ (31,707) $ (522) $ (32,229)

(1) Utilizing an income tax rate ranging from 37 percent to 39 percent based on the effective rates in each taxing jurisdiction.

 

Financial Instruments Not Designated as Hedges

 

The impact of financial instruments that have not been designated as hedges on our condensed consolidated income statements for the three months ended March 31, 2013 and 2012 was an increase (decrease) in gross profit of $6.8 million and $(12.8) million. For the six months ended March 31, 2013 and 2012 gross profit increased (decreased) $6.7 million and $(15.0) million. Note that this presentation does not reflect the expected gains or losses arising from the underlying physical transactions associated with these financial instruments. Therefore, this presentation is not indicative of the economic gross profit we realized when the underlying physical and financial transactions were settled.

 

As discussed above, financial instruments used in our natural gas distribution segment are not designated as hedges. However, there is no earnings impact on our natural gas distribution segment as a result of the use of these financial instruments because the gains and losses arising from the use of these financial instruments are recognized in the consolidated statement of income as a component of purchased gas cost when the related costs are recovered through our rates and recognized in revenue. Accordingly, the impact of these financial instruments is excluded from this presentation.