Note 5 - Derivative Instruments and Hedging Activities

Questar and its subsidiaries may enter into derivative instruments to manage exposure to changes in current and future market interest rates. In order to mitigate its exposure to changes in the fair value of its fixed-rate corporate debt resulting from changes in benchmark interest rates, in the second quarter of 2011 Questar executed a fixed-to-floating interest rate swap transaction with a counterparty and converted $125.0 million of its 2.75% fixed rate long-term debt to floating rate debt. The 2.75% rate was swapped for a London Interbank Offered Rate (LIBOR)-based floating rate that is determined at the beginning of August and February each year until maturity of the notes in 2016. This swap is accounted for as a fair value hedge under the accounting standards for derivatives and hedging.

In the second and third quarters of 2011, Questar Pipeline entered into forward starting swaps totaling $150.0 million at a weighted average fixed interest rate of 3.91%. Under these swaps, Questar Pipeline paid fixed and received floating interest rates. These swaps fixed a portion of the cash flows related to interest payments on the $180.0 million of fixed-rate debt issued in December 2011 at market interest rates prevailing at the time the swaps were executed. These swaps terminated in October 2011, requiring a payment of $29.1 million from Questar Pipeline to the counterparties because interest rates declined. Questar Pipeline entered into a new forward starting swap in October 2011, of $150.0 million at a fixed interest rate of 3.00%. This swap terminated in December 2011 when the long-term debt was issued, requiring an additional payment of $8.2 million from Questar Pipeline to the counterparty because of further declines in interest rates. These swaps qualify as cash flow hedges under derivative and hedge accounting standards and the $37.3 million paid to settle the swaps will be amortized over the 30-year life of the debt.

All derivative instruments are required to be recorded on the balance sheet as either assets or liabilities measured at fair value. The designation of a derivative instrument as a hedge and its ability to meet hedge accounting criteria determines how the changes in fair value of the derivative instrument are reflected in the consolidated financial statements. A derivative instrument qualifies for fair value hedge accounting if, at inception and throughout its life, the derivative is expected to be highly effective in offsetting the changes in fair value of the hedged debt attributable to the hedged interest rate. Changes in the fair value of a derivative instrument qualifying and designated as a fair value hedge as well as the offsetting changes in the fair value of the hedged debt attributable to the hedged interest rate are recorded currently in the Consolidated Statements of Income. A derivative instrument qualifies for cash flow hedge accounting if, at inception and throughout its life, the derivative is expected to be highly effective in offsetting the changes in expected cash flows of the hedged interest payments. Changes in the effective portion of the fair value of a derivative instrument qualifying and designated as a cash flow hedge are initially recorded as a component of OCI in the period and remain in AOCI in the Consolidated Balance Sheets until they are reclassified into earnings as the Company records interest expense for the hedged interest payments. Ineffective portions of a qualifying and designated cash flow hedge are recorded currently in earnings.

Questar is not a party to any derivative instruments that do not qualify for hedge accounting designation or that require collateral to be posted by either party prior to settlement. Questar routinely monitors and manages its positions with, and the credit quality of the counterparties to its derivative instruments, all of which are large financial institutions. All derivative instruments are recorded in the Consolidated Balance Sheets at their fair values on a gross basis. Asset and liability derivative positions with the same counterparty are not netted.

Interest rate swaps and forward-starting interest rate swaps are settled in cash on periodic payment dates with one party paying the other for the net difference between the fixed and floating interest rate for the payment period as specified in the swap agreement, multiplied by the notional amount. Forward-starting interest rate swaps used as cash flow hedges of forecasted fixed-rate debt issuances are terminated and settled in cash when the forecasted debt is issued or as the swaps expire, with one party paying the other for the swap's net fair value at the time of settlement. Questar reports cash flows related to derivative instruments qualifying and designated as hedges in the Consolidated Statements of Cash Flows based upon the nature of the hedged items.

The following table presents the pre-tax effects of the derivative instruments designated as a fair value hedge (including the hedged item) and cash flow hedges on the Consolidated Statements of Income as well as the pre-tax effects of the derivative instruments designated as cash flow hedges on OCI:



	Financial Statement	Year Ended December 31,
Instrument and Activity	Location of Gain (Loss)	2011			2010		2009
		(in millions)
Fair Value Hedge
Questar Corporation
Interest rate derivative instrument
Realized and unrealized gain	Interest expense	$	9.8		$	—	$	—
2.75% Notes due 2016
Unrealized loss	Interest expense	(9.8		)	—		—

Cash Flow Hedges
Questar Pipeline
Interest rate derivative instruments
Deferrals of effective portions	OCI	(37.3		)	—		—
Losses reclassified from AOCI into earnings for effective portions	Interest expense	(0.1		)	—		—

There was no ineffectiveness recognized on the fair value hedge and ineffectiveness recognized on the cash flow hedges was de minimis in 2011. Reclassifications into earnings of amounts reported in AOCI will continue as interest expense is recorded for the hedged interest payments through maturity in 2041. Pre-tax net losses of $0.4 million are expected to be reclassified from AOCI to the Consolidated Statements of Income in the next 12 months. As of December 31, 2011, the Company is not hedging any exposure to variability in future cash flows of forecasted transactions.

The following table discloses the Level 2 fair value of the derivative instrument designated as a fair value hedge in the Consolidated Balance Sheets:



		December 31,
Instrument	Balance Sheet Location	2011		2010
		(in millions)
Assets
Questar Corporation
Interest rate derivative instrument	Prepaid expenses and other	$	1.1	$	—
Interest rate derivative instrument	Other noncurrent assets	7.8		—
Consolidated total - derivative assets		$	8.9	$	—

The following table provides additional information about the Company's derivative instrument as of December 31, 2011:



Instrument Type	Accounting Treatment	Maturity Date	Fixed Interest Rate⁽¹⁾		Notional Amount
					(in millions)
Questar Corporation
Interest rate swap - pay floating, receive fixed	Fair value hedge	2016	2.75	%	$	125.0

⁽¹⁾Floating rate is based on 6-month U.S. dollar LIBOR.