Alcoa 2010 Annual Report Download - page 155

currencies other than the functional currency. These contracts cover periods consistent with known or expected
exposures through 2011. On March 31, 2009, Alcoa acquired foreign currency derivatives in the Elkem transaction
which cover anticipated foreign currency exposures through 2011.
Alcoa had the following outstanding forward contracts that were entered into to hedge forecasted transactions:
December 31, 2010 2009
Aluminum contracts (kmt) 1,285 1,917
Energy contracts:
Electricity (megawatt hours) 100,578,295 -
Natural gas (million British thermal units) - 13,560,000
Fuel oil (metric tons) - 307,143
Foreign exchange contracts $ 20 $ 158
Other
Alcoa has also entered into certain derivatives to minimize its price risk related to other customer sales and pricing
arrangements. Alcoa has not qualified these contracts for hedge accounting treatment and, therefore, the fair value
gains and losses on these contracts are recorded in earnings as follows:
Derivatives Not Designated as Hedging
Instruments
Location of Gain or (Loss)
Recognized in Earnings on Derivatives
Amount of Gain or (Loss)
Recognized in Earnings
on Derivatives
2010 2009 2008
Aluminum contracts Sales $ 5 $ (9) $ 10
Aluminum contracts Other income, net (18) (38) 66
Embedded credit derivative Other income, net (2) - (3)
Energy contract Other income, net (23) (30) -
Foreign exchange contracts Other income, net 6 6 (25)
Total $(32) $(71) $ 48
The embedded credit derivative relates to a power contract that indexes the difference between the long-term debt
ratings of Alcoa and the counterparty from any of the three major credit rating agencies. If Alcoa’s credit ratings were
downgraded at any time, an independent investment banker would be consulted to determine a hypothetical interest
rate for both parties. The two interest rates would be netted and the resulting difference would be multiplied by Alcoa’s
equivalent percentage of the outstanding principal of the counterparty’s debt obligation as of December 31st of the year
preceding the calculation date. This differential would be added to the cost of power in the period following the
calculation date.
In 2009, an existing power contract associated with a smelter in the U.S. no longer qualified for the normal purchase
normal sale exception under derivative accounting. The change in the classification of this contract was due to the fact
that Alcoa negotiated a new power contract that did not replace the existing contract, resulting in Alcoa receiving more
power than it requires for this smelter (the terms of the new power contract were favorable compared to the existing
power contract and management determined that is was beneficial to enter into the new contract now while fulfilling its
obligation under the existing contract as opposed to waiting closer to the end of the existing contract to negotiate a new
power contract). As a result, the existing contract was required to be accounted for as a derivative. Under the derivative
classification, this contract does not qualify as a fair value or cash flow hedge. As such, the existing power contract is
now marked to market through earnings. Alcoa’s obligation under the existing contract expires in mid-2011.
In 2009, Alcoa entered into a forward contract to purchase $58 (C$58) to mitigate the foreign currency risk related to a
Canadian-denominated loan due in 2014. All other foreign exchange contracts were entered into and settled within
each of the periods presented.
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