Energy Transfer 2010 Annual Report Download - page 166

10. PRICE RISK MANAGEMENT ASSETS AND LIABILITIES:
Commodity Price Risk
We are exposed to market risks related to the volatility of natural gas, NGL and propane prices. To manage
the impact of volatility from these prices, we utilize various exchange-traded and OTC commodity financial
instrument contracts. These contracts consist primarily of futures, swaps and options and are recorded at fair
value in the consolidated balance sheets.
We inject and hold natural gas in our Bammel storage facility to take advantage of contango markets, 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. At the inception of the hedge,
we lock in a margin by purchasing gas in the spot market or off peak season and entering a financial
contract to lock in the sale price. If we designate the related financial contract as a fair value hedge for
accounting purposes, we value the hedged natural gas inventory at current spot market prices along with the
financial derivative we use to hedge it. Changes in the spread between the forward natural gas prices
designated as fair value hedges and the physical inventory spot price result in unrealized gains or losses
until the underlying physical gas is withdrawn and the related designated derivatives are settled.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gas is withdrawn and the designated derivatives are settled, the previously unrealized gains or losses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. Unrealized margins represent the unrealized gains or losses
from our derivative instruments using mark-to-market accounting, with changes in the fair value of our
derivatives being recorded directly in earnings. These margins fluctuate based upon changes in the spreads
between the physical spot price and forward natural gas prices. If the spread narrows between the physical
and financial prices, we will record unrealized gains or lower unrealized losses. If the spread widens, we
will record unrealized losses or lower unrealized gains. Typically, as we enter the winter months, the spread
converges so that we recognize in earnings the original locked-in spread through either mark-to-market
adjustments or the physical withdrawal of natural gas.
We are also exposed to market risk on natural gas we retain for fees in our intrastate transportation and
storage segment and operational gas sales on our interstate transportation segment. We use financial
derivatives to hedge the sales price of this gas, including futures, swaps and options. Certain contracts that
qualify for hedge accounting, are designated as cash flow hedges of the forecasted sale of natural gas. The
change in value, to the extent the contracts are effective, remains in AOCI 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.
Derivatives are utilized in our midstream segment in order to mitigate price volatility in our marketing
activities and manage fixed price exposure incurred from contractual obligations. We attempt to maintain
balanced positions in our marketing activities to protect ourselves from the volatility in the energy
commodities markets; however, net unbalanced positions can exist. Long-term physical contracts are tied to
index prices. System gas, which is also tied to index prices, is expected to provide most of the gas required
by our long-term physical contracts. When third-party gas is required to supply long-term contracts, a hedge
is put in place to protect the margin on the contract. Financial contracts, which are not tied to physical
delivery, are expected to be offset with financial contracts to balance our positions. To the extent open
commodity positions exist, fluctuating commodity prices can impact our financial position and results of
operations, either favorably or unfavorably.
Our propane segment permits customers to guarantee the propane delivery price for the next heating season.
As we execute fixed sales price contracts with our customers, we may enter into propane futures contracts to
fix the purchase price related to these sales contracts, thereby locking in a gross profit margin. Additionally,
we may use propane futures contracts to secure the purchase price of our propane inventory for a percentage
of our anticipated propane sales.
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