Alcoa 2012 Annual Report Download - page 162

Assets Liabilities
2011
Aluminum
contracts
Energy
contracts
Aluminum
contracts
Embedded
credit
derivative
Energy
contracts
Opening balance—January 1, 2011 $ - $ 9 $702 $24 $ 62
Total gains or losses (realized and unrealized)
included in:
Sales - - (63) - -
Cost of goods sold - - - (1) (14)
Other income, net - - - 5 (48)
Other comprehensive loss 5 (7) (37) - -
Purchases, sales, issuances, and settlements** 5 - - - -
Transfers into and (or) out of Level 3** - - - - -
Foreign currency translation - - - - -
Closing balance—December 31, 2011 $10 $ 2 $602 $28 $ -
Change in unrealized gains or losses included in
earnings for derivative contracts held at
December 31, 2011:
Sales $ - $ - $ - $ - $ -
Cost of goods sold - - - - -
Other income, net - - - 5 -
**In 2011, there was an issuance of a Level 3 financial instrument related to a natural gas supply contract (see below).
There were no purchases, sales, or settlements of Level 3 financial instruments. Additionally, there were no transfers
of financial instruments into or out of Level 3.
As reflected in the table above, the net unrealized loss on derivative contracts using Level 3 valuation techniques was
$88 and $618 as of December 31, 2012 and 2011, respectively. These losses were mainly attributed to embedded
derivatives in power contracts that index the price of power to the LME price of aluminum. These embedded
derivatives are primarily valued using observable market prices; however, due to the length of the contracts, the
valuation model also requires management to estimate the long-term price of aluminum based upon an extrapolation of
the 10-year LME forward curve. Significant increases or decreases in the actual LME price beyond 10 years would
result in a higher or lower fair value measurement. An increase of actual LME price over the inputs used in the
valuation model will result in a higher cost of power and a corresponding increase to the liability. The embedded
derivatives have been designated as hedges of forward sales of aluminum and related realized gains and losses were
included in Sales on the accompanying Statement of Consolidated Operations.
In July 2012, as provided for in the arrangements, management elected to modify the pricing for two existing power
contracts, which end in 2014 and 2016 (see directly below), for Alcoa’s two smelters in Australia and the Point Henry
rolling mill in Australia. These contracts contain an LME-linked embedded derivative, which previously was not
recorded as an asset in Alcoa’s Consolidated Balance Sheet. Beginning on January 1, 2001, all derivative contracts
were required to be measured and recorded at fair value on an entity’s balance sheet under GAAP; however, an
exception existed for embedded derivatives upon meeting certain criteria. The LME-linked embedded derivative in
these two contracts met such criteria at that time. Management’s election to modify the pricing of these contracts
qualifies as a significant change to the contracts thereby requiring that the contracts now be evaluated under derivative
accounting as if they were new contracts. As a result, Alcoa recorded a derivative asset in the amount of $596 (reflects
the finalization of the valuation model) with an offsetting liability (deferred credit) recorded in Other current and non-
current liabilities. Unrealized gains and losses from the embedded derivative were included in Other (income)
expenses, net on the accompanying Statement of Consolidated Operations, while realized gains and losses were
included in Cost of goods sold on the accompanying Statement of Consolidated Operations as electricity purchases are
made under the contracts. The deferred credit is recognized in Other (income) expenses, net on the accompanying
Statement of Consolidated Operations as power is received over the life of the contracts. The embedded derivative is
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