7. 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 risks.

Interest Rate Derivatives

We utilize forward-starting interest rate swaps to hedge the variability of the forecasted interest payments on anticipated debt issuances that may result from changes in the benchmark interest rate until the expected debt is issued. 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 entered into six forward-starting interest rate swaps with a total aggregate notional amount of $300.0 million, which we entered into in anticipation of the issuance of debt on or before July 15, 2013, and six forward-starting interest rate swaps with a total aggregate notional amount of $275.0 million, which we entered into in anticipation of the issuance of debt on or before October 15, 2014. We designated 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 underlying borrowings. In June 2013, we issued $500 million of the 4.150% Notes (see Note 6 for further discussion) and also settled the related six forward-starting interest rate swaps for approximately $62.0 million. As a result of the interest rate swap settlement, we recognized $0.9 million hedge ineffectiveness in interest and debt expense attributable to the timing difference between when the swaps were settled and when they were forecasted to settle. We expect to issue new fixed-rate debt on or before October 15, 2014 to repay the $275.0 million of 5.300% Notes that are due on October 15, 2014, although no assurances can be given that the issuance of fixed-rate debt will be possible on acceptable terms.

During the three months ended June 30, 2013 and 2012, unrealized gains of $23.9 million and unrealized losses of $40.1 million, respectively, were recorded in accumulated other comprehensive loss to reflect the change in the fair values of the forward-starting interest rate swaps. For the six months ended June 30, 2013 and 2012, unrealized gains of $32.5 million and unrealized losses of $23.1 million, respectively, were recorded in accumulated other comprehensive loss to that effect. Additionally, over the next twelve months, we expect to reclassify $7.1 million of net losses from accumulated other comprehensive loss to interest and debt expense. The loss consists of the following: i) the forward-starting interest rate swaps that were settled in 2008 and ii) the forward-starting interest rate swaps settled in June 2013 (as discussed above). These losses were partially offset by a gain attributable to the settlement of a treasury lock agreement settled in 2011.

Commodity Derivatives

Our Energy 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. The futures contracts used to hedge refined petroleum product inventories are designated as fair value hedges with changes in fair value of both the futures contracts and physical inventory reflected in earnings. Physical contracts and futures contracts that have not been designated in a hedge relationship are marked-to-market.

The following table summarizes our commodity derivative instruments outstanding at June 30, 2013 (amounts in thousands of gallons):

	Volume (1)		Accounting
Derivative Purpose	Current	Long-Term (2)	Treatment

Derivatives NOT designated as hedging instruments:

Physical fixed price derivative contracts	46,926	—	Mark-to-market
Physical index derivative contracts	40,337	—	Mark-to-market
Futures contracts for refined petroleum products	27,423	—	Mark-to-market

Derivatives designated as hedging instruments:

Futures contracts for refined petroleum products	46,284	—	Fair Value Hedge

(1) Volume represents absolute value of net notional volume position.

(2) There were no derivative contracts that extended beyond June 30, 2014.

The following table sets forth the fair value of each classification of derivative instruments and the locations of the derivative instruments on our condensed consolidated balance sheets at the dates indicated (in thousands):

	June 30, 2013
	Derivatives			Derivatives			Gross			Netting
	NOT Designated			Designated			Derivative			Balance
	as Hedging			as Hedging			Carrying			Sheet
	Instruments			Instruments			Value			Adjustment (1)			Net Total

Physical fixed price derivative contracts	$	4,396		$	—		$	4,396		$	(1,330	)	$	3,066
Physical index derivative contracts	594			—			594			(30		)	564
Futures contracts for refined products	60,898			386			61,284			(58,448		)	2,836
Total current derivative assets	65,888			386			66,274			(59,808		)	6,466

Physical fixed price derivative contracts	(3,687		)	—			(3,687		)	1,330			(2,357		)
Physical index derivative contracts	(204		)	—			(204		)	30			(174		)
Futures contracts for refined products	(57,003		)	(1,445		)	(58,448		)	58,448			—
Total current derivative liabilities	(60,894		)	(1,445		)	(62,339		)	59,808			(2,531		)

Interest rate derivatives	—			(35,237		)	(35,237		)	—			(35,237		)
Total non-current derivative liabilities	—			(35,237		)	(35,237		)	—			(35,237		)
Net derivative assets (liabilities)	$	4,994		$	(36,296	)	$	(31,302	)	$	—		$	(31,302	)

(1) Amounts represent the netting of physical fixed and index contracts’ assets and liabilities when a legal right of offset exists. Futures contracts are subject to settlement through margin requirements and are additionally presented on a net basis.

	December 31, 2012
	Derivatives			Derivatives			Gross			Netting
	NOT Designated			Designated			Derivative			Balance
	as Hedging			as Hedging			Carrying			Sheet
	Instruments			Instruments			Value			Adjustment (1)			Net Total

Physical fixed price derivative contracts	$	1,489		$	—		$	1,489		$	(335	)	$	1,154
Physical index derivative contracts	724			—			724			(159		)	565
Futures contracts for refined products	10,359			435			10,794			(10,794		)	—
Total current derivative assets	12,572			435			13,007			(11,288		)	1,719

Physical fixed price derivative contracts	(2,377		)	—			(2,377		)	335			(2,042		)
Physical index derivative contracts	(705		)	—			(705		)	159			(546		)
Futures contracts for refined products	(15,268		)	(3,096		)	(18,364		)	10,794			(7,570		)
Interest rate derivatives	—			(72,831		)	(72,831		)	—			(72,831		)
Total current derivative liabilities	(18,350		)	(75,927		)	(94,277		)	11,288			(82,989		)

Interest rate derivatives	—			(57,805		)	(57,805		)	—			(57,805		)
Total non-current derivative liabilities	—			(57,805		)	(57,805		)	—			(57,805		)
Net derivative assets (liabilities)	$	(5,778	)	$	(133,297	)	$	(139,075	)	$	—		$	(139,075	)

Our hedged inventory portfolio extends to the fourth quarter of 2013. The majority of the unrealized loss at June 30, 2013 for inventory hedges represented by futures contracts of $1.1 million will be realized by the fourth quarter of 2013 as the related inventory is sold. At June 30, 2013, open refined petroleum product derivative contracts (represented by the physical fixed-price contracts, physical index contracts, and futures contracts for fixed-price sales contracts noted above) varied in duration in the overall portfolio, but did not extend beyond May 2014. In addition, at June 30, 2013, 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						Six Months Ended
		June 30,						June 30,
	Location	2013			2012			2013			2012

Derivatives NOT designated as hedging instruments:
Physical fixed price derivative contracts	Product sales	$	2,795		$	3,791		$	3,376		$	2,898
Physical index derivative contracts	Product sales	700			258			1,109			360
Physical fixed price derivative contracts	Cost of product sales and natural gas storage services	(359		)	784			(445		)	(603		)
Physical index derivative contracts	Cost of product sales and natural gas storage services	(541		)	4			(544		)	(39		)
Futures contracts for refined products	Cost of product sales and natural gas storage services	1,457			1,960			5,797			5,331

Derivatives designated as fair value hedging instruments:
Futures contracts for refined products	Cost of product sales and natural gas storage services	8,159			14,536			8,935			(14,635		)
Physical inventory - hedged items	Cost of product sales and natural gas storage services	(8,959		)	(17,301		)	(9,440		)	11,157

Ineffectiveness excluding the time value component on fair value hedging instruments:
Fair value hedge ineffectiveness (excluding time value)	Cost of product sales and natural gas storage services	(5,212		)	172			(3,627		)	(560		)
Time value excluded from hedge assessment	Cost of product sales and natural gas storage services	4,412			(2,937		)	3,122			(2,917		)
Net loss in income		$	(800	)	$	(2,765	)	$	(505	)	$	(3,477	)

The losses reclassified from AOCI to income and the change in value recognized in OCI on our derivatives were as follows for the periods indicated (in thousands):

		Loss Reclassified from AOCI to Income for the
		Three Months Ended						Six Months Ended
		June 30,						June 30,
	Location	2013			2012			2013			2012

Derivatives designated as cash flow hedging instruments:
Interest rate contracts	Interest and debt expense	$	(1,093	)	$	(229	)	$	(1,321	)	$	(459	)

		Gain (Loss) Recognized in OCI on Derivatives for the
		Three Months Ended						Six Months Ended
		June 30,						June 30,
		2013			2012			2013			2012

Derivatives designated as cash flow hedging instruments:
Interest rate contracts		$	23,907		$	(40,136	)	$	32,526		$	(23,075	)