Alcoa 2015 Annual Report Download - page 185

accompanying Consolidated Balance Sheet (see Note L). This deferred credit is recognized in Other expenses
(income), net on the accompanying Statement of Consolidated Operations as power is received over the life of the
contract. Alcoa had a similar power contract and related embedded derivative associated with another smelter and
rolling mill combined; however, the contract and related derivative instrument matured in July 2014.
Additionally, Alcoa has a natural gas supply contract, which has an LME-linked ceiling. This embedded derivative is
valued using probabilities of future LME aluminum prices and the price of Brent crude oil (priced on Platts), including
the interrelationships between the two commodities subject to the ceiling. Any change in the interrelationship would
result in a higher or lower fair value measurement. An LME ceiling was embedded into the contract price to protect
against an increase in the price of oil without a corresponding increase in the price of LME. An increase in oil prices
with no similar increase in the LME price would limit the increase of the price paid for natural gas. This embedded
derivative did not qualify for hedge accounting treatment. Unrealized gains and losses from the embedded derivative
were included in Other expenses (income), 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 gas purchases were made under the contract.
Furthermore, Alcoa has an embedded derivative in 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. Management uses market
prices, historical relationships, and forecast services to determine fair value. Significant increases or decreases in any
of these inputs would result in a lower or higher fair value measurement. A wider credit spread between Alcoa and the
counterparty would result in a higher cost of power and a corresponding increase in the derivative liability. This
embedded derivative did not qualify for hedge accounting treatment. Unrealized gains and losses were included in
Other expenses (income), 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 were made under the contract.
Finally, Alcoa has a derivative contract that will hedge the anticipated power requirements at one of its smelters once
the existing power contract expires in September 2016. Beyond the term where market information is available,
management has developed a forward curve, for valuation purposes, based on independent consultant market research.
Significant increases or decreases in the power market may result in a higher or lower fair value measurement. Lower
prices in the power market would cause a decrease in the derivative asset. The derivative contract has been designated
as a cash flow hedge of future purchases of electricity. Unrealized gains and losses on this contract were recorded in
Other comprehensive loss on the accompanying Consolidated Balance Sheet. Once the designated hedge period begins
in September 2016, realized gains and losses will be recorded in Cost of goods sold as electricity purchases are made
under the power contract. Alcoa had a similar contract related to another smelter once the prior existing contract
expired in 2014, but elected to terminate the new contract in early 2013. This election was available to Alcoa under the
terms of the contract and was made due to a projection that suggested the contract would be uneconomical. Prior to
termination, the new contract was accounted for in the same manner.
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