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DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
 9 Months Ended
Sep. 30, 2019
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES 12. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

We are exposed to financial market risks, including changes in interest rates and commodity prices, in the course of our normal business operations.  We use derivative instruments to manage such risks.
 
Interest Rate Derivatives

From time to time, we utilize forward-starting interest rate swaps to hedge the variability of the forecasted interest payments on anticipated or existing debt issuances that may result from changes in the benchmark interest rate until the expected debt is issued or during the period the debt is outstanding. When entering into interest rate swap transactions, we become exposed to both credit risk and market risk. We are subject to credit risk when the change in fair value of the swap instrument is positive and the counterparty may fail to perform under the terms of the contract. We are subject to market risk with respect to changes in the underlying benchmark interest rate that impacts the fair value of the swaps. We manage our credit risk by entering into swap transactions only with major financial institutions with investment-grade credit ratings. We manage our market risk by aligning the swap instrument with the existing underlying debt obligation or a specified expected debt issuance, generally associated with the maturity of an existing debt obligation. We designate the swap agreements as cash flow hedges at inception and expect the changes in values to be highly correlated with the changes in value of the anticipated interest payments associated with the hedged borrowings.

Refer to Note 11 - Long-Term Debt, for information regarding interest rate swap arrangements entered into in conjunction with the New Term Facility.

Commodity Derivatives

Our Merchant Services segment primarily uses exchange-traded refined petroleum product futures contracts to manage the risk of market price volatility on its refined petroleum product inventories and its physical derivative contracts, which we designated as fair value hedges, with changes in fair value of both the futures contracts and physical inventory reflected in earnings.  Our Merchant Services segment also uses exchange-traded refined petroleum contracts to hedge expected future transactions related to certain gasoline inventory, which are designated as cash flow hedges, with the effective portion of the hedge reported in other comprehensive income (“OCI”) and reclassified into earnings when the expected future transaction affects earnings. Any gains or losses incurred on the derivative instruments that are not effective in offsetting changes in fair value or cash flows of the hedged item are recognized immediately in earnings.

Additionally, our Merchant Services segment enters into exchange-traded refined petroleum product futures contracts on behalf of our Domestic Pipelines & Terminals segment to manage the risk of market price volatility on the gasoline-to-butane pricing spreads associated with our butane blending activities. These futures contracts are not designated in a hedge relationship for accounting purposes. Physical forward contracts and futures contracts that have not been designated in a hedge relationship are marked-to-market through earnings.
The following table summarizes the notional volumes of the net long (short) positions of our commodity derivative instruments outstanding at September 30, 2019 (amounts in thousands of gallons):
 
 
Volume
 
 
Derivative Purpose 
 
Current
 
Long-Term
 
 
Derivatives NOT designated as hedging instruments:
 
 

 
 

 
 
Physical fixed-price derivative contracts
 
(14,544
)
 
(879
)
 
 
Physical index derivative contracts
 
(677
)
 
—

 
 
Futures contracts for refined petroleum products
 
(26,622
)
 
1,638

 
 
 
 
 
 
 
 
Hedge Type
Derivatives designated as hedging instruments:
 
 

 
 

 
 
Cash flow hedge futures contracts
 
29,652

 
—

 
Cash Flow Hedge
Physical fixed price derivative contracts
 
(2,946
)
 
—

 
Cash Flow Hedge
Futures contracts for refined petroleum products
 
(50,568
)
 
—

 
Fair Value Hedge


Our futures contracts designated as fair value hedges relate to our inventory portfolio and extend to the second quarter of 2020. Our futures contracts related to forecasted purchases and sales of refined petroleum products, not designated in a hedging relationship, extend to the second quarter of 2020.

In accordance with the Chicago Mercantile Exchange rulebook, variation margin transfers are considered settlement payments, thereby reducing the corresponding derivative asset and liability balances for our exchange-settled derivative contracts. These settlement payments result in realized gains and losses on derivatives.

The following table sets forth the fair value of each classification of derivative instruments and the derivative instruments’ location on our unaudited condensed consolidated balance sheets at the dates indicated (in thousands):
    
September 30, 2019
 
Derivative
Carrying Value
 
Netting Balance Sheet Adjustment (1)
 
Net Total
Physical fixed-price derivative contracts
$
5,778

 
$
(230
)
 
$
5,548

Physical index derivative contracts
139

 
(36
)
 
103

Total current derivative assets
5,917

 
(266
)
 
5,651

Physical fixed-price derivative contracts
138

 
—

 
138

Total non-current derivative assets
138

 
—

 
138

Physical fixed-price derivative contracts
(1,166
)
 
230

 
(936
)
Physical index derivative contracts
(145
)
 
36

 
(109
)
Total current derivative liabilities
(1,311
)
 
266

 
(1,045
)
Net derivative assets
$
4,744

 
$
—

 
$
4,744

 
                                                      
(1) Amounts represent the netting of physical fixed price and index contracts’ assets and liabilities when a legal right of offset exists.
 
December 31, 2018
 
Derivative
Carrying Value (1)
 
Netting Balance Sheet Adjustment (2)
 
Net Total
Physical fixed-price derivative contracts
$
17,934

 
$
(84
)
 
$
17,850

Physical index derivative contracts
286

 
(117
)
 
169

Total current derivative assets
18,220

 
(201
)
 
18,019

Physical fixed-price derivative contracts
1,003

 
—

 
1,003

Total non-current derivative assets
1,003

 
—

 
1,003

Physical fixed-price derivative contracts
(1,386
)
 
84

 
(1,302
)
Physical index derivative contracts
(135
)
 
117

 
(18
)
Total current derivative liabilities
(1,521
)
 
201

 
(1,320
)
Physical fixed-price derivative contracts
(3
)
 
—

 
(3
)
Total non-current derivative liabilities
(3
)
 
—

 
(3
)
Net derivative assets
$
17,699

 
$
—

 
$
17,699

                                                      
(1)
Other than our exchange-settled derivative contracts, as of December 31, 2018, none of our derivative instruments were designated as hedging instruments.
(2)
Amounts represent the netting of physical fixed price and index contracts’ assets and liabilities when a legal right of offset exists. 

At September 30, 2019, open refined petroleum product derivative contracts (represented by the physical fixed-price contracts and physical index contracts noted above) varied in duration in the overall portfolio, but did not extend beyond March 2021. In addition, at September 30, 2019, we had refined petroleum product inventories that we intend to use to satisfy a portion of the physical derivative contracts.
The gains and losses on our derivative instruments recognized in income were as follows for the periods indicated (in thousands):
 
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
Location
 
2019
 
2018
 
2019
 
2018
Derivatives NOT designated as hedging instruments:
 
 
 

 
 

 
 

 
 

Physical fixed price derivative contracts
Product sales
 
$
2,927

 
$
(3,887
)
 
$
(4,948
)
 
$
(4,192
)
Physical index derivative contracts
Product sales
 
63

 
123

 
171

 
283

Physical fixed price derivative contracts
Cost of product sales
 
(4,253
)
 
697

 
(5,884
)
 
644

Physical index derivative contracts
Cost of product sales
 
(127
)
 
53

 
(343
)
 
479

Futures contracts for refined products
Cost of product sales
 
2,403

 
2,493

 
4,251

 
(2,070
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
Location
 
2019
 
2018
 
2019
 
2018
Derivatives designated as fair value hedging instruments:
 
 
 
 
 

 
 

 
 

Futures contracts for refined products
Cost of product sales
 
$
1,886

 
$
(8,049
)
 
$
(25,738
)
 
$
(12,355
)
Physical inventory - hedged items
Cost of product sales
 
(1,041
)
 
7,214

 
27,524

 
10,754

 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
Location
 
2019
 
2018
 
2019
 
2018
Ineffectiveness excluding the time value component on fair value hedging instruments:
 
 
 
 
 

 
 

 
 

Fair value hedge ineffectiveness (excluding time value)
Cost of product sales
 
$
2,464

 
$
1,196

 
$
(245
)
 
$
1,000

Time value excluded from hedge assessment
Cost of product sales
 
(1,619
)
 
(2,031
)
 
2,031

 
(2,601
)
Net (loss) gain for ineffectiveness in income
 
 
$
845

 
$
(835
)
 
$
1,786

 
$
(1,601
)


The change in value recognized in OCI and the losses reclassified from accumulated other comprehensive income (“AOCI”) to income, attributable to our derivative instruments designated as cash flow hedges, were as follows for the periods indicated (in thousands):
 
Gain (Loss) Recognized in OCI on Derivatives for the
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2019
 
2018
 
2019
 
2018
Derivatives designated as cash flow hedging instruments:
 

 
 

 
 

 
 

Interest rate contracts
$
—

 
$
7,322

 
$
—

 
$
27,739

Commodity derivatives
2,033

 
(193
)
 
1,311

 
2,464

Total
$
2,033

 
$
7,129

 
$
1,311

 
$
30,203


 
 
 
Loss Reclassified from AOCI to Income (Effective Portion) for the
 
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
Location
 
2019
 
2018
 
2019
 
2018
Derivatives designated as cash flow hedging instruments:
 
 
 

 
 

 
 

 
 

Interest rate derivative contracts
Interest and debt expense
 
$
(2,296
)
 
$
(2,296
)
 
$
(6,888
)
 
$
(6,928
)
Total
 
 
$
(2,296
)
 
$
(2,296
)
 
$
(6,888
)
 
$
(6,928
)