Notes to Consolidated Financial Statements
Note 2 Derivative Financial Instruments
Netting of Cash Collateral and Derivative Assets and
Liabilities under Master Netting Arrangements
We maintain accounts with brokers to facilitate financial derivative
transactions in support of our energy marketing and risk
management activities. Based on the value of our positions in these
accounts and the associated margin requirements, we may be
required to deposit cash into these broker accounts.
The authoritative guidance related to derivatives and hedging
requires that we offset cash collateral held in our broker accounts on
our consolidated statements of financial position with the associated
fair value of the instruments in the accounts. Our cash collateral
amounts were $57 million as of December 31, 2009 and were
$124 million as of December 31, 2008.
Derivative Financial Instruments
Our risk management activities are monitored by our Risk
Management Committee, which consists of members of senior
management and is charged with reviewing and enforcing our risk
management activities and policies. Our use of derivative financial
instruments and physical transactions is limited to predefined risk
tolerances associated with pre-existing or anticipated physical
natural gas sales and purchases and system use and storage. We
use the following types of derivative financial instruments and
physical transactions to manage natural gas price, interest rate,
weather, automobile fuel price and foreign currency risks:
- forward contracts
- futures contracts
- options contracts
- financial swaps
- treasury locks
- weather derivative contracts
- storage and transportation capacity transactions
- foreign currency forward contracts
Our derivative financial instruments do not contain any material
credit-risk-related or other contingent features that could increase
the payments for collateral we post in the normal course of business
when our financial instruments are in net liability positions. For
information on our energy marketing receivables and payables,
which do have credit-risk-related or other contingent features, refer
to Note 1. Our derivative financial instrument activities are included
within operating cash flows as an adjustment to net income of
$11 million in 2009, $(129) million in 2008 and $74 million in 2007.
Natural Gas Derivative Financial Instruments
The fair value of natural gas derivative financial instruments we use
to manage exposures arising from changing natural gas prices
reflects the estimated amounts that we would receive or pay to
terminate or close the contracts at the reporting date, taking into
account the current unrealized gains or losses on open contracts.
We use external market quotes and indices to value substantially all
the derivative financial instruments we use.
Distribution Operations In accordance with a directive from the
New Jersey BPU, Elizabethtown Gas enters into derivative financial
instruments to hedge the impact of market fluctuations in natural
gas prices. Pursuant to the authoritative guidance related to
derivatives and hedging, such derivative transactions are accounted
for at fair value each reporting period in our consolidated statements
of financial position. In accordance with regulatory requirements
realized gains and losses related to these derivatives are reflected in
natural gas costs and ultimately included in billings to customers.
However, these derivative financial instruments are not designated
as hedges in accordance with the guidance. As of December 31,
2009, Elizabethtown Gas had entered into OTC swap contracts to
purchase approximately 18 Bcf of natural gas. Approximately 63%
of these contracts have durations of one year or less, and none of
these contracts extends beyond December 2011. The fair values of
these derivative instruments were reflected as a current and longterm
asset and liability of $11 million at December 31, 2009 and
$23 million at December 31, 2008. For more information on our
regulatory assets and liabilities see Note 1.
Retail Energy Operations We have designated a portion of
SouthStar’s derivative financial instruments, consisting of financial
swaps to manage the risk associated with forecasted natural gas
purchases and sales, as cash flow hedges under the authoritative
guidance related to derivatives and hedging. We record derivative
gains or losses arising from cash flow hedges in OCI and reclassify
them into earnings in the same period as the settlement of the
underlying hedged item.
SouthStar currently has minimal hedge ineffectiveness defined
as when the gains or losses on the hedging instrument do not offset
the losses or gains on the hedged item. This cash flow hedge
ineffectiveness is recorded in cost of gas in our consolidated
statements of income in the period in which it occurs. We have not
designated the remainder of SouthStar’s derivative financial
instruments as hedges under the authoritative guidance related to
derivatives and hedging and, accordingly, we record changes in their
fair value within cost of gas in our consolidated statements of income
in the period of change. For more information on SouthStar’s gains
and losses reported within comprehensive income that affect equity,
see our consolidated statements of comprehensive income (loss).
SouthStar has hedged its exposures to natural gas price risk to
varying degrees in the markets in which it serves retail, commercial
and industrial customers. Approximately 97% of SouthStar’s
purchase instruments and 98% of its sales instruments are
scheduled to mature in 2010 and the remaining 3% and 2%,
respectively, from January 2011 through March 2012.
At December 31, 2009, the fair values of these derivatives were
reflected in our consolidated financial statements as a current asset
of $21 million with no current liability representing a net position of
15 Bcf. This includes a $2 million current asset associated with a
premium and related intrinsic value for weather derivatives. At
December 31, 2008, the fair values of these derivatives were
reflected in our consolidated financial statements as a current asset
of $11 million, a long-term asset of $5 million and a current liability
of $2 million representing a net position of 28 Bcf. This includes a
$4 million current asset associated with a premium and related
intrinsic value for weather derivatives and associated intrinsic value.
SouthStar also enters into both exchange and OTC derivative
financial instruments to hedge natural gas price risk. Credit risk is
mitigated for exchange transactions through the backing of the
NYMEX member firms. For OTC transactions, SouthStar utilizes
master netting arrangements to reduce overall credit risk. As of
December 31, 2009, SouthStar’s maximum exposure to any single
OTC counterparty was $7 million.
Wholesale Services We purchase natural gas for storage when
the difference in the current market price we pay to buy and
transport natural gas plus the cost to store the natural gas is less
than the market price we can receive in the future, resulting in a
positive net operating margin.We use NYMEX futures contracts and
other OTC derivatives to sell natural gas at that future price to
substantially lock in the operating margin we will ultimately realize
when the stored natural gas is actually sold. These futures contracts
meet the definition of derivatives under the authoritative guidance
related to derivatives and hedging and are accounted for at fair value
in our consolidated statements of financial position, with changes in
fair value recorded in our consolidated statements of income in the
period of change. However, these futures contracts are not
designated as hedges in accordance with the guidance.
The impact of changes in fair value of Sequent’s derivative
instruments utilized in its energy marketing and risk management
activities, contract settlements and new business contracts acquired
in 2009 increased the net fair value of its contracts outstanding by
$36 million during 2009, $25 million during 2008 and reduced net
fair value by $62 million during 2007.
At December 31, 2009, Sequent’s commodity-related derivative
financial instruments represented purchases (long) of 1,571 Bcf and
sales (short) of 1,494 Bcf with approximately 95% of purchase
instruments sales instruments are scheduled to mature in less than
2 years and the remaining 5%in 3 to 6 years. At December 31, 2009,
the fair values of these derivatives were reflected in our consolidated
financial statements as an asset of $208 million and a liability of
$51million. At December 31, 2008, the fair values of these derivatives
were reflected in our consolidated financial statements as an asset of
$206 million and a liability of $27 million.
The purchase, transportation, storage and sale of natural gas
are accounted for on a weighted average cost or accrual basis, as
appropriate, rather than on the fair value basis we utilize for the
derivatives used to mitigate the natural gas price risk associated
with our storage portfolio. This difference in accounting can result
in volatility in our reported earnings, even though the economic
margin is essentially unchanged from the date the transactions
were consummated.
Energy Investments Golden Triangle Storage uses derivative
financial instruments to reduce its exposure during the construction
of the storage caverns to the risk of changes in the price of natural
gas that will be purchased in future periods for pad gas. Pad gas
includes volumes of non-working natural gas used to maintain the
operational integrity of the caverns.
We have designated all of Golden Triangle Storage’s derivative
financial instruments, consisting of financial swaps as cash flow
hedges under the authoritative guidance related to derivatives and
hedging. The pad gas is considered to be a component of the
storage cavern’s construction costs; as a result, any derivative gains
or losses arising from the cash flow hedges will remain in OCI until
the pad gas is sold, which will not occur until the storage caverns are
decommissioned. The fair value of these derivative financial
instruments currently have minimal hedge ineffectiveness which is
recorded in cost of gas in our consolidated statements of income in
the period in which it occurs. Golden Triangle Storage began
entering into these derivative financial transactions during 2009.
Weather Derivative Financial Instruments
In 2009 and 2008, SouthStar entered into weather derivative
contracts as economic hedges of operating margins in the event of
warmer-than-normal and colder-than-normal weather in the heating
season, primarily from November through March. SouthStar
accounts for these contracts using the intrinsic value method under
the authoritative guidance related to financial instruments. These
weather derivative financial instruments are not designated as
derivatives or hedges and SouthStar has recorded a current asset
of $2 million at December 31, 2009 and $4 million at December 31,
2008. SouthStar recognized losses on its weather derivative financial
instruments of $6 million for the year ended December 31, 2009,
$8 million for the year ended December 31, 2008 and gains of
$4 million for the year ended December 31, 2007 which was
reflected in cost of gas on our consolidated statements of income.
Derivative Financial Instruments –
Fair Value Hierarchy
The following table sets forth, by level within the fair value hierarchy,
our derivative financial assets and liabilities that were accounted for
at fair value on a recurring basis as of December 31, 2009. As
required by the authoritative guidance, derivative financial assets
and liabilities are classified in their entirety based on the lowest level
of input that is significant to the fair value measurement. Our
assessment of the significance of a particular input to the fair value
measurement requires judgment, and may affect the valuation of fair
value assets and liabilities and their placement within the fair value
hierarchy levels. For more information on a description of the fair
value hierarchy, see Note 1.
Recurring fair values
Natural gas derivative financial instruments |
||||
December 31, 2009 |
December 31, 2008 |
|||
| In millions | Assets (1) |
Liabilities |
Assets (1) |
Liabilities |
| Quoted prices in active markets (Level 1) | $ 36 |
$(37) |
$ 52 |
$(117) |
| Significant other observable inputs (Level 2) | 172 |
(52) |
154 |
(28) |
| Netting of cash collateral | 30 |
27 |
35 |
89 |
| Total carrying value(2) | $238 |
$(62) |
$241 |
$ (56) |
(1) $2 million premium at December 31, 2009 and $4 million at December 31, 2008 associated with weather derivatives have been excluded as they are based on intrinsic value, not fair value.
(2) There were no significant unobservable inputs (level 3) for any of the periods presented.
The determination of the fair values above incorporates various factors required under the guidance. These factors include not only the credit
standing of the counterparties involved and the impact of credit enhancements (such as cash deposits, letters of credit and priority interests),
but also the impact of our nonperformance risk on our liabilities.
Quantitative Disclosures Related to Derivative Financial Instruments
As of December 31, 2009, our derivative financial instruments were comprised of both long and short natural gas positions. A long position is
a contract to purchase natural gas, and a short position is a contract to sell natural gas. As of December 31, 2009, we had net long natural gas
contracts outstanding in the following quantities:
Natural gas contracts |
|
| Hedge designation | (in Bcf) |
| Cash flow | 5 |
| Not designated | 108 |
| Total | 113 |
Derivative Financial Instruments on the Consolidated Statements of Income
The following table presents the gain or (loss) on derivative financial instruments in our consolidated statements of income.
| In millions | For the twelve months ended December 31, 2009 |
| Designated as cash flow hedges under authoritative guidance related to derivatives and hedging | |
| Natural gas contracts – loss reclassified from OCI into cost of gas for settlement of hedged item | $(31) |
| Not designated as hedges under authoritative guidance related to derivatives and hedging | |
| Natural gas contracts – fair value adjustments recorded in operating revenues(1) | 21 |
| Natural gas contracts – net gain fair value adjustments recorded in cost of gas(2) | 1 |
| Total losses on derivative instruments | $ (9) |
(2) Excludes $6 million of losses recorded in cost of gas associated with weather derivatives for the year ended December 31, 2009.
The following amounts (pre-tax) represent the expected recognition in our consolidated statements of income of the deferred losses recorded in OCI associated with retail energy operations’ derivative instruments, based upon the fair values of these financial instruments:
| In millions | As of December 31, 2009 |
| Designated as hedges under authoritative guidance related to derivatives and hedging | |
| Natural gas contracts – expected net loss reclassified from OCI into cost of gas for settlement of hedged item over next twelve months |
$(8) |
Derivative Financial Instruments on the Consolidated Statements of Financial Position
In accordance with regulatory requirements, $38 million of realized losses on derivative financial instruments used at Elizabethtown Gas in
our distribution operations segment are reflected in deferred natural gas costs within our consolidated statements of financial position for the
year ended December 31, 2009. The following table presents the fair value and statements of financial position classification of our derivative
financial instruments.
| In millions | Statement of financial position location (1) | As of December 31, 2009 (2) |
| Designated as cash flow hedges under authoritative guidance related to derivatives and hedging | ||
| Asset Financial Instruments | ||
Current natural gas contracts |
Derivative financial instruments assets and liabilities – current portion | $ 6 |
| Liability Financial Instruments | ||
Current natural gas contracts |
Derivative financial instruments assets and liabilities – current portion | (5) |
Total |
1 | |
| Not designated as cash flow hedges under authoritative guidance related to derivatives and hedging | ||
| Asset Financial Instruments | ||
Current natural gas contracts |
Derivative financial instruments assets and liabilities – current portion | 590 |
Noncurrent natural gas contracts |
Derivative financial instruments assets and liabilities | 118 |
| Liability Financial Instruments | ||
Current natural gas contracts |
Derivative financial instruments assets and liabilities – current portion | (510) |
Noncurrent natural gas contracts |
Derivative financial instruments assets and liabilities | (78) |
Total |
120 | |
Total derivative financial instruments |
$121 | |
(1) These amounts are netted within our consolidated statements of financial position. Some of our derivative financial instruments have asset positions which are presented as a liability in our consolidated
statements of financial position, and we have derivative instruments that have liability positions which are presented as an asset in our consolidated statements of financial position.
(2) As required by the authoritative guidance related to derivatives and hedging, the fair value amounts above are presented on a gross basis. As a result, the amounts above do not include $57 million of cash
collateral held on deposit in broker margin accounts as of December 31, 2009. Accordingly, the amounts above will differ from the amounts presented on our consolidated statements of financial position,
and the fair value information presented for our derivative financial instruments in the recurring values table of this note.
Concentration of Credit Risk
Atlanta Gas Light Concentration of credit risk occurs at Atlanta
Gas Light for amounts billed for services and other costs to its
customers, which consist of nine Marketers in Georgia. The credit
risk exposure to Marketers varies seasonally, with the lowest
exposure in the nonpeak summer months and the highest
exposure in the peak winter months. Marketers are responsible for
the retail sale of natural gas to end-use customers in Georgia.
These retail functions include customer service, billing, collections,
and the purchase and sale of natural gas. Atlanta Gas Light’s tariff
allows it to obtain security support in an amount equal to no less
than two times a Marketer’s highest month’s estimated bill from
Atlanta Gas Light.
Wholesale Services Sequent has a concentration of credit risk for
services it provides to marketers and to utility and industrial
counterparties. This credit risk is measured by 30-day receivable
exposure plus forward exposure, which is generally concentrated in
20 of its counterparties. Sequent evaluates the credit risk of its
counterparties using a S&P equivalent credit rating, which is
determined by a process of converting the lower of the S&P or
Moody’s rating to an internal rating ranging from 9.00 to 1.00, with
9.00 being equivalent to AAA/Aaa by S&P and Moody’s and 1.00
being equivalent to D or Default by S&P andMoody’s. For a customer
without an external rating, Sequent assigns an internal rating based
on Sequent’s analysis of the strength of its financial ratios. At
December 31, 2009, Sequent’s top 20 counterparties represented
approximately 58% of the total credit exposure of $534 million,
derived by adding together the top 20 counterparties’ exposures and
dividing by the total of Sequent’s counterparties’ exposures.
Sequent’s counterparties or the counterparties’ guarantors had a
weighted average S&P equivalent rating of A- at December 31, 2009.
The weighted average credit rating is obtained by multiplying
each customer’s assigned internal rating by its credit exposure and
then adding the individual results for all counterparties. That total is
divided by the aggregate total exposure. This numeric value is
converted to an S&P equivalent.
Sequent has established credit policies to determine and
monitor the creditworthiness of counterparties, including
requirements for posting of collateral or other credit security, as well
as the quality of pledged collateral. Collateral or credit security is
most often in the form of cash or letters of credit from an investmentgrade
financial institution, but may also include cash or U.S.
Government Securities held by a trustee.When Sequent is engaged
in more than one outstanding derivative transaction with the same
counterparty and it also has a legally enforceable netting agreement
with that counterparty, the “net” mark-to-market exposure
represents the netting of the positive and negative exposures with
that counterparty and a reasonable measure of Sequent’s credit risk.
Sequent also uses other netting agreements with certain
counterparties with which it conducts significant transactions.