6. Derivative Instruments

Objective and Strategy The Company uses derivative instruments to manage its exposure to cash-flow variability from commodity-price and interest-rate risks. Futures, swaps, and options are used to manage exposure to commodity-price risk inherent in the Company’s oil and natural-gas production and natural-gas processing operations (Oil and Natural-Gas Production/Processing Derivative Activities). Futures contracts and commodity-price swap agreements are used to fix the price of expected future oil and natural-gas sales at major industry trading locations such as Cushing, Oklahoma or Sullom Voe, Scotland for oil and Henry Hub, Louisiana for natural gas. Basis swaps are periodically used to fix or float the price differential between product prices at one market location versus another. Options are used to establish a floor price, a ceiling price, or a floor and a ceiling price (collar) for expected future oil and natural-gas sales. Derivative instruments are also used to manage commodity-price risk inherent in customer price requirements and to fix margins on the future sale of natural gas and NGLs from the Company’s leased storage facilities (Marketing and Trading Derivative Activities).

Interest-rate swaps are used to fix or float interest rates on existing or anticipated indebtedness. The purpose of these instruments is to manage the Company’s existing or anticipated exposure to interest-rate changes. The fair value of the Company’s current interest-rate swap portfolio is subject to changes in interest rates.

The Company does not apply hedge accounting to any of its derivative instruments. As a result, gains and losses associated with derivative instruments are recognized currently in earnings. Net derivative losses attributable to derivatives previously subject to hedge accounting reside in accumulated other comprehensive income (loss) and are reclassified to earnings as the transactions to which the derivatives relate are recognized in earnings. See Note 15—Accumulated Other Comprehensive Income (Loss).

6. Derivative Instruments (Continued)

Oil and Natural-Gas Production/Processing Derivative Activities The oil prices listed below are a combination of New York Mercantile Exchange (NYMEX) West Texas Intermediate and Intercontinental Exchange, Inc. (ICE) Brent Blend prices. The natural-gas prices listed below are NYMEX Henry Hub prices. The NGLs prices listed below are Oil Price Information Services prices. The following is a summary of the Company’s derivative instruments related to oil and natural-gas production/processing derivative activities at September 30, 2016:



	2016 Settlement		2017 Settlement		2018 Settlement
Oil
Three-Way Collars (MBbls/d)	83		—		—
Average price per barrel
Ceiling sold price (call)	$	63.82	$	—	$	—
Floor purchased price (put)	$	54.46	$	—	$	—
Floor sold price (put)	$	42.77	$	—	$	—
Natural Gas
Three-Way Collars (thousand MMBtu/d)	—		682		250
Average price per MMBtu
Ceiling sold price (call)	$	—	$	3.60	$	3.54
Floor purchased price (put)	$	—	$	2.75	$	2.75
Floor sold price (put)	$	—	$	2.00	$	2.00
Fixed-Price Contracts (thousand MMBtu/d)	—		37		—
Average price per MMBtu	$	—	$	3.14	$	—
NGLs
Fixed-Price Contracts (MBbls/d)	—		2		—
Average price per barrel	$	—	$	15.84	$	—

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MBbls/d—thousand barrels per day

MMBtu/d—million British thermal units per day

MMBtu—million British thermal units

A three-way collar is a combination of three options: a sold call, a purchased put, and a sold put. The sold call establishes the maximum price that the Company will receive for the contracted commodity volumes. The purchased put establishes the minimum price that the Company will receive for the contracted volumes unless the market price for the commodity falls below the sold put strike price, at which point the minimum price equals the reference price (e.g., NYMEX) plus the excess of the purchased put strike price over the sold put strike price.

Marketing and Trading Derivative Activities The Company had financial derivative transactions with notional volumes of natural gas totaling 5 billion cubic feet (Bcf) at September 30, 2016, and 8 Bcf at December 31, 2015, that were entered into to mitigate commodity-price risk related to fixed-price purchase and sales contracts and storage activity.

6. Derivative Instruments (Continued)

Interest-Rate Derivatives Anadarko has outstanding interest-rate swap contracts to manage interest-rate risk associated with anticipated debt issuances. The Company has locked in a fixed interest rate in exchange for a floating interest rate indexed to the three-month London Interbank Offered Rate (LIBOR). In February 2016, in exchange for amended terms with certain counterparties, the Company modified the mandatory termination dates from 2021 to 2018 and, in some cases, the related fixed interest rates on interest-rate swaps with an aggregate notional principal amount of $500 million. Additionally, an interest-rate swap agreement was settled for a cash payment of $193 million in March 2016, and interest-rate swap agreements were settled for total cash payments of $73 million in September 2016. Anadarko does not expect additional net cash outlays in 2016 related to interest-rate derivative settlements.

At September 30, 2016, the Company had outstanding interest-rate swaps with a notional amount of $1.6 billion due prior to or at September 2021 that will manage interest-rate risk associated with the potential refinancing of the Company’s $900 million Senior Notes due 2019 and the Zero-Coupon Senior Notes due 2036 (Zero Coupons), should the Zero Coupons be put to the Company prior to the swap termination dates. None of the Zero Coupons (accreted value of $839 million) were put to the Company in October 2016. See Note 8—Debt and Interest Expense. Depending on market conditions, liability-management actions, or other factors, the Company may enter into offsetting interest-rate swap positions or settle or amend certain or all of the currently outstanding interest-rate swaps.

Derivative settlements and collateralization are classified as cash flows from operating activities unless the derivatives contain an other-than-insignificant financing element, in which case the settlements and collateralization are classified as cash flows from financing activities. As a result of prior extensions of reference-period start dates without settlement of the related interest-rate derivative obligations, the interest-rate derivatives in the Company’s portfolio contain an other-than-insignificant financing element, and therefore, any settlements or collateralization related to these extended interest-rate derivatives are classified as cash flows from financing activities.

The Company had the following outstanding interest-rate swaps at September 30, 2016:



millions except percentages			Mandatory	Weighted-Average
Notional Principal Amount		Reference Period	Termination Date	Interest Rate
$	500	September 2016 – 2046	September 2018	6.559%
$	300	September 2016 – 2046	September 2020	6.509%
$	450	September 2017 – 2047	September 2018	6.445%
$	100	September 2017 – 2047	September 2020	6.891%
$	250	September 2017 – 2047	September 2021	6.570%

6. Derivative Instruments (Continued)

Effect of Derivative Instruments—Balance Sheet The following summarizes the fair value of the Company’s derivative instruments:



	Gross Derivative Assets				Gross Derivative Liabilities
millions	September 30,		December 31,		September 30,			December 31,
Balance Sheet Classification	2016		2015		2016			2015
Commodity derivatives
Other current assets	$	65	$	462	$	(8	)	$	(177	)
Other assets	29		8		(2		)	—
Accrued expenses	2		—		(18		)	(3		)
Other liabilities	3		—		(22		)	—
	99		470		(50		)	(180		)
Interest-rate derivatives
Other current assets	4		2		—			—
Other assets	18		54		—			—
Accrued expenses	—		—		(48		)	(54		)
Other liabilities	—		—		(1,806		)	(1,488		)
	22		56		(1,854		)	(1,542		)
Total derivatives	$	121	$	526	$	(1,904	)	$	(1,722	)

Effect of Derivative Instruments—Statement of Income The following summarizes gains and losses related to derivative instruments:



millions	Three Months Ended September 30,						Nine Months Ended September 30,
Classification of (Gain) Loss Recognized	2016			2015			2016		2015
Commodity derivatives
Gathering, processing, and marketing sales ⁽¹⁾	$	(1	)	$	(1	)	$	5	$	—
(Gains) losses on derivatives, net	(59		)	(125		)	7		(177		)
Interest-rate derivatives
(Gains) losses on derivatives, net	84			407			622		300
Total (gains) losses on derivatives, net	$	24		$	281		$	634	$	123

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⁽¹⁾	Represents the effect of Marketing and Trading Derivative Activities.

6. Derivative Instruments (Continued)

Credit-Risk Considerations The financial integrity of exchange-traded contracts, which are subject to nominal credit risk, is assured by NYMEX or ICE through systems of financial safeguards and transaction guarantees. Over-the-counter traded swaps, options, and futures contracts expose the Company to counterparty credit risk. The Company monitors the creditworthiness of its counterparties, establishes credit limits according to the Company’s credit policies and guidelines, and assesses the impact on the fair value of its counterparties’ creditworthiness. The Company has the ability to require cash collateral or letters of credit to mitigate its credit-risk exposure.

The Company has netting agreements with financial institutions that permit net settlement of gross commodity derivative assets against gross commodity derivative liabilities, and routinely exercises its contractual right to offset gains and losses when settling with derivative counterparties. In addition, the Company has setoff agreements with certain financial institutions that may be exercised in the event of default and provide for contract termination and net settlement across derivative types. At September 30, 2016, $52 million of the Company’s $1.904 billion gross derivative liability balance, and at December 31, 2015, $347 million of the Company’s $1.722 billion gross derivative liability balance, would have been eligible for setoff against the Company’s gross derivative asset balance in the event of default. Other than in the event of default, the Company does not net settle across derivative types.

The Company’s derivative instruments are subject to individually negotiated credit provisions that may require collateral of cash or letters of credit depending on the derivative’s portfolio valuation versus negotiated credit thresholds. These credit thresholds may also require full or partial collateralization or immediate settlement of the Company’s obligations if certain credit-risk-related provisions are triggered, such as if the Company’s credit rating from major credit rating agencies declines to a level that is below investment grade. In February 2016, Moody’s Investors Service (Moody’s) downgraded the Company’s long-term debt credit rating from “Baa2” to “Ba1,” which is below investment grade. The downgrade triggered credit-risk-related features with certain derivative counterparties and required the Company to post collateral under its derivative instruments. During the third quarter of 2016, Anadarko paid a fee in connection with the negotiated increase of a credit threshold for an interest-rate derivative with an other-than-insignificant financing element. As a result of the increased credit threshold, $200 million of collateral was returned to the Company. No counterparties have requested termination or full settlement of derivative positions. The aggregate fair value of derivative instruments with credit-risk-related contingent features for which a net liability position existed was $1.4 billion (net of $422 million of collateral) at September 30, 2016, and $1.3 billion (net of $58 million of collateral) at December 31, 2015.

6. Derivative Instruments (Continued)

Fair Value Fair value of futures contracts is based on unadjusted quoted prices in active markets for identical assets or liabilities, which represent Level 1 inputs. Valuations of physical-delivery purchase and sale agreements, over-the-counter financial swaps, and commodity option collars are based on similar transactions observable in active markets and industry-standard models that primarily rely on market-observable inputs. Inputs used to estimate fair value in industry-standard models are categorized as Level 2 inputs because substantially all assumptions and inputs are observable in active markets throughout the full term of the instruments. Inputs used to estimate the fair value of swaps and options include market-price curves; contract terms and prices; credit-risk adjustments; and, for Black-Scholes option valuations, discount factors and implied market volatility.

The following summarizes the fair value of the Company’s derivative assets and liabilities by input level within the fair-value hierarchy:



millions
September 30, 2016	Level 1			Level 2			Level 3		Netting ⁽¹⁾			Collateral			Total
Assets
Commodity derivatives	$	—		$	99		$	—	$	(14	)	$	—		$	85
Interest-rate derivatives	—			22			—		—			—			22
Total derivative assets	$	—		$	121		$	—	$	(14	)	$	—		$	107
Liabilities
Commodity derivatives	$	(1	)	$	(49	)	$	—	$	14		$	2		$	(34	)
Interest-rate derivatives	—			(1,854		)	—		—			422			(1,432		)
Total derivative liabilities	$	(1	)	$	(1,903	)	$	—	$	14		$	424		$	(1,466	)

December 31, 2015
Assets
Commodity derivatives	$	10		$	460		$	—	$	(178	)	$	(8	)	$	284
Interest-rate derivatives	—			56			—		—			—			56
Total derivative assets	$	10		$	516		$	—	$	(178	)	$	(8	)	$	340
Liabilities
Commodity derivatives	$	(1	)	$	(179	)	$	—	$	178		$	—		$	(2	)
Interest-rate derivatives	—			(1,542		)	—		—			58			(1,484		)
Total derivative liabilities	$	(1	)	$	(1,721	)	$	—	$	178		$	58		$	(1,486	)

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⁽¹⁾	Represents the impact of netting commodity derivative assets and liabilities with counterparties where the Company has the contractual right and intends to net settle.