Energy Transfer 2012 Annual Report Download - page 74

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In addition to transport fees, we generate revenue from purchasing natural gas and transporting it across our system. The
natural gas is then sold to electric utilities, independent power plants, local distribution companies, industrial end-users and
other marketing companies. The HPL System purchases natural gas at the wellhead for transport and selling. Other pipelines
with access to West Texas supply, such as Oasis and ET Fuel, may also purchase gas at the wellhead and other supply sources
for transport across our system to be sold at market on the east side of our system. This activity allows our intrastate
transportation and storage segment to capture the current basis differentials between delivery points on our system or to capture
basis differentials that were previously locked in through hedges. Firm capacity long-term contracts are typically not subject
to price differentials between shipping locations.
We also generate fee-based revenue from our natural gas storage facilities by contracting with third parties for their use of
our storage capacity. From time to time, we inject and hold natural gas in our Bammel storage facility to take advantage of
contango markets, a term used to describe a pricing environment when the price of natural gas is higher in the future than the
current spot price. We use financial derivatives to hedge the natural gas held in connection with these arbitrage opportunities.
Our earnings from natural gas storage we purchase, store and sell are subject to the current market prices (spot price in relation
to forward price) at the time the storage gas is hedged. At the inception of the hedge, we lock in a margin by purchasing gas
in the spot market and entering into a financial derivative to lock in the forward sale price. If we designate the related financial
derivative as a fair value hedge for accounting purposes, we value the hedged natural gas inventory at current spot market
prices whereas the financial derivative is valued using forward natural gas prices. As a result of fair value hedge accounting,
we have elected to exclude the spot forward premium from the measurement of effectiveness and changes in the spread
between forward natural gas prices and spot market prices result in unrealized gains or losses until the underlying physical
gas is withdrawn and the related financial derivatives are settled. Once the gas is withdrawn and the designated derivatives
are settled, the previously unrealized gains or losses associated with these positions are realized. If the spread narrows between
spot and forward prices, we will record unrealized gains or lower unrealized losses. If the spread widens prior to withdrawal
of the gas, we will record unrealized losses or lower unrealized gains.
As noted above, any excess retained fuel is sold at market prices. To mitigate commodity price exposure, we will use financial
derivatives to hedge prices on a portion of natural gas volumes retained. For certain contracts that qualify for hedge accounting,
we designate them as cash flow hedges of the forecasted sale of gas. The change in value, to the extent the contracts are
effective, remains in accumulated other comprehensive income until the forecasted transaction occurs. When the forecasted
transaction occurs, any gain or loss associated with the derivative is recorded in cost of products sold in the consolidated
statement of operations.
In addition, we use financial derivatives to lock in price differentials between market hubs connected to our assets on a portion
of our intrastate transportation system’s unreserved capacity. Gains and losses on these financial derivatives are dependent
on price differentials at market locations, primarily points in West Texas and East Texas. We account for these derivatives
using mark-to-market accounting, and the change in the value of these derivatives is recorded in earnings. During the fourth
quarter of 2011, we began using derivatives for trading purposes.
• Interstate natural gas transportation and storage – The majority of our interstate transportation and storage revenues are
generated through firm reservation charges that are based on the amount of firm capacity reserved for our firm shippers
regardless of usage. Tiger, Fayetteville Express Pipeline LLC (“FEP”) and Transwestern expansion shippers have made 10-
to 15-year commitments to pay reservation charges for the firm capacity reserved for their use. In addition to reservation
revenues, additional revenue sources include interruptible transportation charges as well as usage rates and overrun rates paid
by firm shippers based on their actual capacity usage.
• Midstream – Revenue is principally dependent upon the volumes of natural gas gathered, compressed, treated, processed,
purchased and sold through our pipelines as well as the level of natural gas and NGL prices.
In addition to fee-based contracts for gathering, treating and processing, we also have percent-of-proceeds and keep-whole
contracts, which are subject to market pricing. For percent-of-proceeds contracts, we retain a portion of the natural gas and
NGLs processed, or a portion of the proceeds of the sales of those commodities, as a fee. When natural gas and NGL prices
increase, the value of the portion we retain as a fee increases. Conversely, when prices of natural gas and NGLs decrease, so
does the value of the portion we retain as a fee. For wellhead (keep-whole) contracts, we retain the difference between the
price of NGLs and the cost of the gas to process the NGLs. In periods of high NGL prices relative to natural gas, our margins
increase. During periods of low NGL prices relative to natural gas, our margins decrease or could become negative. Our
processing contracts and wellhead purchases in rich natural gas areas provide that we earn and take title to specified volumes
of NGLs, which we also refer to as equity NGLs. Equity NGLs in our midstream segment are derived from performing a
service in a percent-of-proceeds contract or produced under a keep-whole arrangement.
In addition to NGL price risk, our processing activity is also subject to price risk from natural gas because, in order to process
the gas, in some cases we must purchase it. Therefore, lower gas prices generally result in higher processing margins.
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