Quarterly report pursuant to Section 13 or 15(d)

DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

v2.4.1.9
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
 3 Months Ended
Mar. 31, 2015
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
NOTE 13 - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The following table presents the fair value of our derivative instruments and the classification of each in the Statements of Unaudited Condensed Consolidated Financial Position as of March 31, 2015 and December 31, 2014:
 
(In Millions)
 
Derivative Assets
 
Derivative Liabilities
 
March 31, 2015
 
December 31, 2014
 
March 31, 2015
 
December 31, 2014
Derivative Instrument
Balance Sheet Location
 
Fair
Value
 
Balance
Sheet
Location
 
Fair
Value
 
Balance Sheet
Location
 
Fair
Value
 
Balance Sheet
Location
 
Fair
Value
Derivatives designated as hedging instruments under ASC 815:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign Exchange Contracts
 
 
$
—

 
 
 
$
—

 
 
 
$
—

 
Other current liabilities
 
$
21.6

Total derivatives designated as hedging instruments under ASC 815
 
 
$
—

 
 
 
$
—

 
 
 
$
—

 
 
 
$
21.6

Derivatives not designated as hedging instruments under ASC 815:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign Exchange Contracts
 
 
$
—

 
 
 
$
—

 
Other current liabilities
 
$
8.7

 
Other current liabilities
 
$
9.9

Commodity Contracts
 
 
—

 
 
 
—

 
Other current liabilities
 
1.6

 
 
 
—

Customer Supply Agreement
Other current assets
 
34.5

 
Other current assets
 
63.2

 
 
 
—

 
 
 
—

Provisional Pricing Arrangements
 
 
—

 
 
 
—

 
Other current liabilities
 
16.2

 
Other current liabilities
 
9.5

Total derivatives not designated as hedging instruments under ASC 815
 
 
$
34.5

 
 
 
$
63.2

 
 
 
$
26.5

 
 
 
$
19.4

Total derivatives
 
 
$
34.5

 
 
 
$
63.2

 
 
 
$
26.5

 
 
 
$
41.0


Derivatives Designated as Hedging Instruments
Cash Flow Hedges
Australian Dollar Foreign Exchange Contracts
We are subject to changes in foreign currency exchange rates as a result of our operations in Australia and Canada. With respect to Australia, foreign exchange risk arises from our exposure to fluctuations in foreign currency exchange rates because the functional currency of our Asia Pacific operations is the Australian dollar. Our Asia Pacific operations receive funds in U.S. currency for their iron ore sales.
We use foreign currency exchange contracts to hedge our foreign currency exposure for a portion of our U.S. dollar sales receipts in our Australian functional currency entities and our entities with Canadian dollar operating costs. For our Australian operations, U.S. dollars are converted to Australian dollars at the currency exchange rate in effect during the period the transaction occurred. The primary objective for the use of these instruments is to reduce exposure to changes in currency exchange rates and to protect against undue adverse movement in these exchange rates. These instruments qualify for hedge accounting treatment and are tested for effectiveness at inception and at least once each reporting period. If and when any of our hedge contracts are determined not to be highly effective as hedges, the underlying hedged transaction is no longer likely to occur, or the derivative is terminated, hedge accounting is discontinued. Due to the uncertainty of 2015 hedge exposures, we have suspended entering into new foreign exchange rate contracts. As discussed in NOTE 1 - BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES, we have waived compliance with our current derivative financial instruments and hedging activities policy through December 31, 2015.
As of March 31, 2015, we had outstanding Australian foreign currency exchange contracts with notional amounts of $20.0 million in the form of forward contracts for which we elected hedge accounting. One outstanding Australian foreign exchange rate contract matures in May 2015 and the other matures in September 2015. This compares with outstanding Australian foreign currency exchange contracts with a notional amount of $220.0 million as of December 31, 2014.
Changes in fair value of highly effective hedges are recorded as a component of Accumulated other comprehensive loss in the Statements of Unaudited Condensed Consolidated Financial Position. Any ineffectiveness is recognized immediately in income. As of March 31, 2015 and 2014, there was no material ineffectiveness recorded for foreign exchange contracts that were classified as cash flow hedges. However, certain Australian hedge contracts were deemed ineffective during the first quarter of 2015 and no longer qualified for hedge accounting treatment. All of these de-designated hedges were settled and were no longer outstanding by March 31, 2015. The de-designated hedges are discussed within the Derivatives Not Designated as Hedging Instruments section of this footnote. Amounts recorded as a component of Accumulated other comprehensive loss are reclassified into earnings in the same period the forecasted transactions affect earnings. Of the amounts remaining in Accumulated other comprehensive loss related to the designated Australian hedge contracts, we estimate that losses of $2.2 million (net of tax), respectively, will be reclassified into earnings within the next 12 months.
The following summarizes the effect of our derivatives designated as cash flow hedging instruments, net of tax in Accumulated other comprehensive loss in the Statements of Unaudited Condensed Consolidated Operations for the three months ended March 31, 2015 and 2014:
 
(In Millions)
Derivatives in Cash Flow Hedging Relationships
Amount of Gain (Loss)
Recognized in OCI on Derivatives
 
Location of Gain (Loss)
Reclassified
from Accumulated OCI into Earnings
 
Amount of Gain (Loss)
Reclassified
from Accumulated
OCI into Earnings
(Effective Portion)
 
(Effective Portion)
 
(Effective Portion)
 
Three Months Ended
March 31,
 
 
 
Three Months Ended
March 31,
 
2015
 
2014
 
 
 
2015
 
2014
Australian Dollar Foreign
Exchange Contracts
(hedge designation)
$
(2.6
)
 
$
5.5

 
Product revenues
 
$
(6.3
)
 
$
(9.1
)
Australian Dollar Foreign
Exchange Contracts
 (prior to de-designation)
(4.5
)
 
—

 
Product revenues
 
—

 
—

Canadian Dollar Foreign Exchange Contracts
    (hedge designation)
—

 
(7.8
)
 
Cost of goods sold and operating expenses
 
—

 
(3.4
)
Canadian Dollar Foreign Exchange Contracts
(prior to de-designation)
—

 
—

 
Cost of goods sold and operating expenses
 
—

 
(0.3
)
 
$
(7.1
)
 
$
(2.3
)
 
 
 
$
(6.3
)
 
$
(12.8
)

Derivatives Not Designated as Hedging Instruments
Foreign Exchange Contracts
During the first quarter of 2015, in connection with our refinancing initiatives, we discontinued hedge accounting and early-settled certain of our Australian foreign currency exchange contracts associated with Asia Pacific Iron Ore operations. Subsequent to de-designation, no further foreign currency exchange rate contracts were entered into for the Asia Pacific Iron Ore operations. The amounts that were previously recorded as a component of Accumulated other comprehensive loss prior to de-designation and remaining in Accumulated other comprehensive loss as of March 31, 2015 will be reclassified to earnings and a corresponding realized gain or loss will be recognized when the forecasted cash flow occurs. The hedges were de-designated at the end of the first quarter of 2015. No forecasted cash flows have occurred related to the de-designated contracts between the de-designation date and March 31, 2015. For the three months ended March 31, 2015, prior to the de-designation of the Asia Pacific Iron Ore hedges, we reclassified losses of $6.3 million from Accumulated other comprehensive loss related to contracts that matured during the year, and recorded the amounts as Product revenues on the Statements of Unaudited Condensed Consolidated Operations. As of March 31, 2015, losses of $12.5 million (net of tax) remain in Accumulated other comprehensive loss related to the effective cash flow hedge contracts prior to de-designation and early-settlement. We estimate the remaining losses of $12.5 million (net of tax) will be reclassified to Product revenues during the remainder of 2015 upon the occurrence of the related forecasted cash flows.
During the fourth quarter of 2014, we discontinued hedge accounting for Canadian foreign currency exchange contracts for all outstanding contracts associated with Bloom Lake operations as projected future cash flows were no longer considered probable or reasonably possible, but we continued to hold these instruments as economic hedges to manage currency risk. Our parent company holds the Canadian foreign currency exchange contracts and the contracts were unaffected by Bloom Lake General Partner Limited and certain of its affiliates filing under the CCAA on January 27, 2015. Subsequent to de-designation, no further foreign currency exchange contracts were entered into for the Bloom Lake operations. As of March 31, 2015 and December 31, 2014, the de-designated outstanding foreign exchange rate contracts had notional amounts of $41.4 million and $183.0 million in the form of forward contracts, respectively. The outstanding contracts as of March 31, 2015 have varying maturity dates ranging from May 2015 to September 2015.
The amounts that were previously recorded as a component of Accumulated other comprehensive loss prior to de-designation and remaining in Accumulated other comprehensive loss as of December 31, 2014 were reclassified to earnings upon the de-designation of the hedges as the hedges would not be effective prospectively due to the projected future cash flows associated with the hedges no longer being considered probable or reasonably possible. We reclassified losses of $7.3 million from Accumulated other comprehensive loss related to contracts that had not matured during the year, and recorded the amounts as Cost of goods sold and operating expenses on the Statements of Unaudited Condensed Consolidated Operations. A corresponding realized gain or loss is recognized in each period until settlement of the related economic hedge during 2015.
We previously discontinued hedge accounting for Canadian foreign currency exchange contracts for all outstanding contracts associated with the Wabush operation and the Ferroalloys operating segment as projected future cash flows were no longer considered probable, but we continued to hold these instruments as economic hedges to manage currency risk. Subsequent to de-designation, no further foreign currency exchange contracts were entered into for the Wabush operation or the Ferroalloys operating segment. As of March 31, 2015 and December 31, 2014, there were no outstanding de-designated foreign currency exchange rate contracts as all remaining de-designated foreign exchange contracts matured during the second quarter of 2014.
Prior to the maturation of the contracts and as a result of discontinued hedge accounting, the instruments were prospectively adjusted to fair value each reporting period through Cost of goods sold and operating expenses on the Statements of Unaudited Condensed Consolidated Operations. For the three months ended March 31, 2014, the change in fair value of our de-designated foreign currency exchange contracts resulted in net losses of $0.9 million. The amounts that were previously recorded as a component of Accumulated other comprehensive loss prior to de-designation were reclassified to earnings and a corresponding realized gain or loss was recognized when the forecasted cash flow occurred. For the three months ended March 31, 2014, we reclassified losses of $0.3 million from Accumulated other comprehensive loss related to contracts that matured during the period, and recorded the amounts as Cost of goods sold and operating expenses on the Statements of Unaudited Condensed Consolidated Operations.
Fair Value Hedges
Interest Rate Hedges
Our fixed-to-variable interest rate swap derivative instruments, with a notional amount of $250.0 million, were de-designated and settled during August 2014. Prior to settlement, the derivatives were designated and qualified as fair value hedges. The objective of the hedges was to offset changes in the fair value of our debt instruments associated with fluctuations in the benchmark LIBOR interest rate as part of our risk management strategy.
Prior to de-designation and settlement, when the interest rate swap derivative instruments were designated and qualified as fair-value hedges, the gain or loss on the hedge instrument as well as the offsetting loss or gain on the hedged item attributable to the hedged risk were recognized in net income. We included the gain or loss on the derivative instrument and the offsetting loss or gain on the hedged item in Other non-operating income (expense). The net gain recognized in Other non-operating income (expense) for the three months ended March 31, 2014 was $0.2 million.
Customer Supply Agreements
Most of our U.S. Iron Ore long-term supply agreements are comprised of a base price with annual price adjustment factors. The base price is the primary component of the purchase price for each contract. The indexed price adjustment factors are integral to the iron ore supply contracts and vary based on the agreement, but typically include adjustments based upon changes in the Platts 62 percent Fe fines spot price and/or international pellet prices and changes in specified Producer Price Indices, including those for industrial commodities, energy and steel. The pricing adjustments generally operate in the same manner, with each factor typically comprising a portion of the price adjustment, although the weighting of each factor varies based upon the specific terms of each agreement. In most cases, these adjustment factors have not been finalized at the time our product is sold. In these cases, we historically have estimated the adjustment factors at each reporting period based upon the best third-party information available. The estimates are then adjusted to actual when the information has been finalized. The price adjustment factors have been evaluated to determine if they contain embedded derivatives. The price adjustment factors share the same economic characteristics and risks as the host contract and are integral to the host contract as inflation adjustments; accordingly, they have not been separately valued as derivative instruments. Certain of our term supply agreements contain price collars, which typically limit the percentage increase or decrease in prices for our products during any given year.
A certain supply agreement with one U.S. Iron Ore customer provides for supplemental revenue or refunds to the customer based on the customer’s average annual steel pricing at the time the product is consumed in the customer’s blast furnace. The supplemental pricing is characterized as a freestanding derivative and is required to be accounted for separately once the product is shipped. The derivative instrument, which is finalized based on a future price, is adjusted to fair value as a revenue adjustment each reporting period until the pellets are consumed and the amounts are settled.
We recognized $10.1 million as Product revenues in the Statements of Unaudited Condensed Consolidated Operations for the three months ended March 31, 2015 related to the supplemental payments. This compares with Product revenues of $27.7 million for the comparable period in 2014. Derivative assets, representing the fair value of the pricing factors, were $34.5 million and $63.2 million in the March 31, 2015 and December 31, 2014 Statements of Unaudited Condensed Consolidated Financial Position, respectively.
Provisional Pricing Arrangements
Certain of our U.S. Iron Ore and Asia Pacific Iron Ore customer supply agreements specify provisional price calculations, where the pricing mechanisms generally are based on market pricing, with the final revenue rate to be based on market inputs at a specified period in time in the future, per the terms of the supply agreements. The difference between the provisionally agreed-upon price and the estimated final revenue rate is characterized as a freestanding derivative and is required to be accounted for separately once the provisional revenue has been recognized. The derivative instrument is adjusted to fair value through Product revenues each reporting period based upon current market data and forward-looking estimates provided by management until the final revenue rate is determined. At March 31, 2015 and December 31, 2014, we recorded no Other current assets related to our estimate of the final revenue rate with any of our customers. At March 31, 2015 and December 31, 2014, we recorded $16.2 million and $9.5 million, respectively, as Other current liabilities in the Statements of Unaudited Condensed Consolidated Financial Position related to our estimate of the final revenue rate with our U.S. Iron Ore and Asia Pacific Iron Ore customers. These amounts represent the difference between the provisional price agreed upon with our customers based on the supply agreement terms and our estimate of the final revenue rate based on the price calculations established in the supply agreements. As a result, we recognized a net $16.2 million decrease in Product revenues in the Statements of Unaudited Condensed Consolidated Operations for the three months ended March 31, 2015 related to these arrangements. This compares with a net $2.7 million decrease in Product revenues for the comparable period in 2014.
The following summarizes the effect of our derivatives that are not designated as hedging instruments in the Statements of Unaudited Condensed Consolidated Operations for the three months ended March 31, 2015 and 2014:
(In Millions)
Derivatives Not Designated as Hedging Instruments
Location of Gain (Loss) Recognized in
Income on Derivative
Amount of Gain (Loss) Recognized in Income on Derivative
 
 
Three Months Ended
March 31,
 
 
2015
 
2014
Foreign Exchange Contracts
Other non-operating income (expense) (1)
$
(5.9
)
 
$
(0.9
)
Commodity Contracts
Cost of goods sold and operating expenses
(3.6
)
 
—

Customer Supply Agreement
Product revenues
10.1

 
27.7

Provisional Pricing Arrangements
Product revenues
(16.2
)
 
(2.7
)
 
 
$
(15.6
)
 
$
24.1


                                                                     
(1)  
At March 31, 2014, the location of the Gain (Loss) Recognized in Income on Derivative for Foreign Exchange Contracts was Cost of goods sold and operating expenses.
Refer to NOTE 6 - FAIR VALUE MEASUREMENTS for additional information.