Derivative Financial Instruments and Related Hedging Programs

6 Months Ended

Jun. 30, 2011

Derivative Financial Instruments and Related Hedging Programs [Abstract]

Derivative Financial Instruments and Related Hedging Programs

11. Derivative Financial Instruments and Related Hedging Programs

     Overview. In conducting its business, the Company, from time to time, enters into derivative transactions, including forward contracts and options, to limit its economic (i.e., cash) exposure resulting from (i) metal price risk related to its sale of fabricated aluminum products and the purchase of metal used as raw material for its fabrication operations, (ii) energy price risk relating to fluctuating prices of natural gas and electricity used in its production processes, and (iii) foreign currency requirements with respect to its foreign subsidiaries, investment and cash commitments for equipment purchases. Additionally, in connection with the issuance of the Notes, the Company purchased cash-settled Call Options relating to the Company’s common stock to limit its exposure to the cash conversion feature of the Notes (see Note 3). The Company may modify the terms of its derivative contracts based on operational needs or financing objectives. As the Company’s operational hedging activities are generally designed to lock in a specified price or range of prices, realized gains or losses on the derivative contracts utilized in the hedging activities generally offset at least a portion of any losses or gains, respectively, on the transactions being hedged at the time the transactions occur. However, due to mark-to-market accounting, during the term of the derivative contracts, significant unrealized, non-cash gains and losses may be recorded in the income statement.

     Hedges of Operational Risks. The Company’s pricing of fabricated aluminum products is generally intended to lock in a conversion margin (representing the value added from the fabrication process(es)) and to pass metal price risk to its customers. However, in certain instances the Company enters into firm price arrangements with its customers and incurs price risk on its anticipated aluminum purchases in respect of such customer orders. The Hedging business unit uses third-party hedging instruments to limit exposure to metal-price risks related to firm price customer sales contracts (see Note 12 for additional information regarding the Company’s material derivative positions relating to hedges of operational risks, and their respective fair values).

     During the six month periods ended June 30, 2011 and June 30, 2010, total fabricated products shipments that contained fixed price terms were (in millions of pounds) 61.1 and 47.8, respectively. At June 30, 2011, the Fabricated Products segment held contracts for the delivery of fabricated aluminum products that have the effect of creating price risk on anticipated purchases of aluminum for the remainder of 2011, 2012 and 2013 and thereafter, totaling approximately (in millions of pounds) 81.1, 15.3 and 0.4, respectively.

     A majority of the Company’s derivative contracts relating to hedges of operational risks contain credit-risk related contingencies, which the Company tries to minimize or offset through the management of counterparty credit lines, the utilization of options as part of the hedging activities, or both. The Company regularly reviews the creditworthiness of its derivative counterparties and does not expect to incur a significant loss from the failure of any counterparties to perform under any agreements.

     Hedges Relating to the Notes. As described in Note 3, the Company issued Notes in the aggregate principal amount of $175.0 in March 2010. The conversion feature of the Notes can only be settled in cash and is required to be bifurcated from the Notes and treated as a separate derivative instrument. In order to offset the cash flow risk associated with the Bifurcated Conversion Feature, the Company purchased Call Options, which are accounted for as derivative instruments. The Company expects that the realized gain or loss from the Call Options will substantially offset the realized loss or gain of the Bifurcated Conversion Feature upon maturity of the Notes. However, because valuation assumptions for the Bifurcated Conversion Feature and the Call Option are not identical, over time the Company expects to record net unrealized gains and losses due to mark to market adjustments to the fair values of the two derivatives. (see Note 12 for additional information regarding the fair values of the Bifurcated Conversion Feature and the Call Options).

     The following table summarizes the Company’s material derivative positions at June 30, 2011:

		Notional
		Amount of
		Contracts
Commodity	Maturity Period	(mmlbs)
Aluminum —
Call option purchase contracts	7/11 through 12/11		24.5
Call option sales contracts	7/11 through 12/11		24.5
Put option purchase contracts	7/11 through 12/11		50.8
Put option sales contracts	7/11 through 12/11		24.5
Fixed priced purchase contracts	7/11 through 11/13		93.1
Fixed priced sales contracts	7/11 through 1/12		11.2
Midwest premium swap contracts1	7/11 through 12/12		49.6

		Notional
		Amount
		of Contracts
Energy	Maturity Period	(mmbtu)
Natural gas —2
Call option purchase contracts	7/11 through 12/13		5,430,000
Call option sales contracts	7/11 through 12/11		1,380,000
Put option purchase contracts	7/11 through 12/11		1,380,000
Put option sales contracts	7/11 through 12/13		5,430,000
Fixed priced purchase contracts	7/11 through 12/13		2,110,000

		Notional
		Amount
		of Contracts
Electricity	Maturity Period	(Mwh)
Fixed priced purchase contracts	1/12 through 12/12		175,680

			Notional
			Amount
			of Contracts
Foreign Currency	Maturity Period		(mm)
Euro-
Fixed priced purchase contracts		7/11	€	0.2

		Notional
		Amount
		of Contracts
Hedges Relating to the Notes	Contract Period	(Common Shares)
Bifurcated Conversion Feature3	3/10 through 3/15		3,621,608
Call Options3	3/10 through 3/15		3,621,608

1	Regional premiums represent the premium over the London Metal Exchange price for primary aluminum which is incurred on the Company’s purchases of primary aluminum.
2	As of June 30, 2011, the Company’s exposure to fluctuations in natural gas prices had been substantially reduced for approximately 93%, 74% and 32% of the expected natural gas purchases for the remainder of 2011, 2012 and 2013, respectively.
3	The Bifurcated Conversion Feature represents the cash conversion feature of the Notes. To hedge against the potential cash outflows associated with the Bifurcated Conversion Feature, the Company purchased cash-settled Call Options. The Call Options have an exercise price equal to the conversion price of the Notes, subject to anti-dilution adjustments substantially similar to the anti-dilution adjustments for the Notes. The Call Options will expire upon the maturity of the Notes. Although the fair value of the Call Options is derived from a notional number of shares of the Company’s common stock, the Call Options may only be settled in cash.

The Company reflects the fair value of its derivative contracts on a gross basis in the Consolidated Balance Sheets (see Note 2).

Realized and Unrealized Gain and Losses. Realized and unrealized gains (losses) associated with all derivative contracts consisted of the following, for each period presented:

	Quarter Ended						Six Months Ended
	June 30,						June 30,
	2011			2010			2011			2010
Realized gains (losses):
Aluminum	$	5.8		$	(1.0	)	$	10.3		$	(1.7	)
Natural Gas		(1.0	)		(0.2	)		(2.4	)		(0.3	)
Total realized gains (losses):	$	4.8		$	(1.2	)	$	7.9		$	(2.0	)
Unrealized (losses) gains:
Aluminum	$	(9.7	)	$	(19.4	)	$	(6.6	)	$	(16.0	)
Natural Gas		0.3			0.4			1.5			(2.8	)
Electricity		(0.1	)		—			(0.1	)		—
Call Options relating to the Notes		8.4			(5.6	)		6.4			(5.6	)
Cash conversion feature of the Notes		(12.0	)		6.5			(8.3	)		6.5
Total unrealized losses	$	(13.1	)	$	(18.1	)	$	(7.1	)	$	(17.9	)