Note 16. Derivative Financial Instruments and Risk Management
Derivative instruments
All derivative instruments are recognized in the accompanying Consolidated Balance Sheets at fair value. We do not net our derivative position by counterparty for purposes of balance sheet presentation and disclosure. The fair values of our derivative financial instruments are based on pricing models or formulas using current estimated cash flow and discount rate assumptions. We include an adjustment for non-performance risk in the recognized measure of fair value of derivative instruments. The adjustment is estimated based on the net exposure by counterparty. We use an estimate of the counterparty’s non-performance risk when we are in a net asset position and an estimate of our own non-performance risk when we are in a net liability position. As of December 31, 2013 and 2012, the adjustment for non-performance risk did not materially impact the fair value of derivative instruments.
The use of derivatives exposes us to the risk that a counterparty may default on a derivative contract. We establish exposure limits for each counterparty to minimize this risk and provide counterparty diversification. Substantially all of our derivative exposures are with counterparties that have long-term credit ratings of single–A or better. The aggregate fair value of derivative instruments in asset positions as of December 31, 2013 and 2012 was $133 million and $36 million, respectively, representing the maximum loss that we would recognize at that date if all counterparties failed to perform as contracted. We enter into master agreements with counterparties that generally allow for netting of certain exposures; therefore, the actual loss that we would recognize if all counterparties failed to perform as contracted could be significantly lower.
The terms of the agreements with our counterparties for foreign currency exchange and commodity hedge contracts require us to post collateral when derivative instruments are in a liability position, subject to posting thresholds. In addition, these agreements contain cross-default provisions that, if triggered, would permit the counterparty to declare a default and require settlement of the outstanding net asset or liability positions. These cross-default provisions could be triggered if there was a non-performance event under certain debt obligations. The fair value of the related gross liability positions as of December 31, 2013 and 2012, which represent our maximum potential exposure, were $29 million and $55 million, respectively. As of December 31, 2012, we posted $24 million as collateral for foreign exchange and commodity hedge contracts that were outstanding at year end. Per the terms of our agreements, no collateral was required to be posted as of December 31, 2013.
The following presents the gross and net amounts of our derivative assets and liabilities after giving consideration to the terms of the master netting arrangements with our counterparties as of December 31 (in millions of dollars):
| 2013 | 2012 | |||||||||||||||
| Derivative Assets |
Derivative Liabilities |
Derivative Assets |
Derivative Liabilities |
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Gross amounts recognized in the Consolidated Balance Sheets |
$ | 133 | $ | 29 | $ | 36 | $ | 55 | ||||||||
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Gross amounts not offset in the Consolidated Balance Sheets that are eligible for offsetting |
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Derivatives |
(24) | (24) | (24) | (24) | ||||||||||||
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Cash collateral pledged |
— | — | — | (24) | ||||||||||||
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Net Amount |
$ | 109 | $ | 5 | $ | 12 | $ | 7 | ||||||||
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The notional amounts of the derivative financial instruments do not necessarily represent amounts exchanged by the parties and, therefore, are not a direct measure of our exposure to the financial risks described above. The amounts exchanged are calculated by reference to the notional amounts and by other terms of the derivative instruments, such as foreign currency exchange rates or commodity volumes and prices.
Cash Flow Hedges
We use financial instruments designated as cash flow hedges to hedge exposure to foreign currency exchange risk associated with transactions in currencies other than the functional currency in which we operate. We also use financial instruments designated as cash flow hedges to hedge our exposure to commodity price risk associated with buying certain commodities used in the ordinary course of our operations.
Changes in the fair value of designated derivatives that are highly effective as cash flow hedges are recorded in AOCI, net of estimated income taxes. These changes in the fair value are then released into earnings contemporaneously with the earnings effects of the hedged items. Cash flows associated with cash flow hedges are reported in Net Cash Provided by Operating Activities in the accompanying Consolidated Statements of Cash Flows. The ineffective portions of the fair value changes are recognized in the results of operations immediately. The amount of ineffectiveness recorded for the years ended December 31, 2013 and 2012 was immaterial. Our cash flow hedges mature within 17 months.
We discontinue hedge accounting prospectively and hold amounts in AOCI with future changes in fair value recorded directly in earnings when (i) it is determined that a derivative is no longer highly effective in offsetting changes in cash flows of a hedged item; (ii) the derivative is discontinued as a hedge instrument because it is not probable that a forecasted transaction will occur or (iii) the derivative expires or is sold, terminated or exercised. Those amounts held in AOCI are subsequently reclassified into income over the same period or periods during which the forecasted transaction affects income. When hedge accounting is discontinued because it is determined that the forecasted transactions will not occur, the derivative continues to be carried on the balance sheet at fair value, and gains and losses that were recorded in AOCI are recognized immediately in earnings. The hedged item may be designated prospectively into a new hedging relationship with another derivative instrument.
The following summarizes the fair values of derivative instruments designated as cash flow hedges which were outstanding as of December 31 (in millions of dollars):
| 2013 | ||||||||||||
| Notional Amounts |
Derivative Assets (1) |
Derivative Liabilities (2) |
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Currency forwards and swaps |
$ | 2,494 | $ | 107 | $ | (12) | ||||||
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Commodity swaps |
212 | 9 | (3) | |||||||||
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Total |
$ | 2,706 | $ | 116 | $ | (15) | ||||||
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| 2012 | ||||||||||||
| Notional Amounts |
Derivative Assets (1) |
Derivative Liabilities (2) |
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Currency forwards and swaps |
$ | 3,369 | $ | 4 | $ | (43) | ||||||
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Commodity swaps |
223 | 13 | (8) | |||||||||
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Total |
$ | 3,592 | $ | 17 | $ | (51) | ||||||
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| (1) | The related derivative instruments are recognized in Prepaid Expenses and Other Assets and Advances to Related Parties and Other Financial Assets in the accompanying Consolidated Balance Sheets. |
| (2) | The related derivative instruments are recognized in Accrued Expenses and Other Liabilities in the accompanying Consolidated Balance Sheets. |
The following summarizes the pre-tax effect of gains (losses) recorded in other comprehensive income (loss) and reclassified from AOCI to income (in millions of dollars):
| Year Ended December 31, 2013 | ||||||||||||||||
| AOCI as of January 1, 2013 |
Gain (Loss) Recorded in OCI |
Gain (Loss) reclassified from AOCI to Income |
AOCI as of December 31, 2013 |
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Currency forwards and swaps |
$ | (40) | $ | 230 | $ | 84 | $ | 106 | ||||||||
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Commodity swaps |
4 | 7 | 3 | 8 | ||||||||||||
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Total |
$ | (36) | $ | 237 | $ | 87 | $ | 114 | ||||||||
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| Year Ended December 31, 2012 | ||||||||||||||||
| AOCI as of January 1, 2012 |
Gain (Loss) Recorded in OCI |
Gain (Loss) reclassified from AOCI to Income |
AOCI as of December 31, 2012 |
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Currency forwards and swaps |
$ | 57 | $ | (103) | $ | (6) | $ | (40) | ||||||||
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Commodity swaps |
(51) | 11 | (44) | 4 | ||||||||||||
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Total |
$ | 6 | $ | (92) | $ | (50) | $ | (36) | ||||||||
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| Year Ended December 31, 2011 | ||||||||||||||||
| AOCI as of January 1, 2011 |
Gain (Loss) Recorded in OCI |
Gain (Loss) reclassified from AOCI to Income |
AOCI as of December 31, 2011 |
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Currency forwards and swaps |
$ | (74) | $ | 35 | $ | (96) | $ | 57 | ||||||||
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Commodity swaps |
42 | (62) | 31 | (51) | ||||||||||||
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Total |
$ | (32) | $ | (27) | $ | (65) | $ | 6 | ||||||||
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We expect to reclassify existing pre-tax net gains of $112 million from AOCI to income within the next 12 months.
Derivatives Not Designated as Hedges
Some derivatives do not qualify for hedge accounting; for others, we elect not to apply hedge accounting. We use derivatives to economically hedge our financial and operational exposures. Unrealized and realized gains and losses related to derivatives that are not designated as accounting hedges are included in Revenues, Net or Cost of Sales in the accompanying Consolidated Statements of Income as appropriate depending on the nature of the risk being hedged. Cash flows associated with derivatives that are not designated as hedges are reported in Net Cash Provided by Operating Activities in the accompanying Consolidated Statements of Cash Flows.
The following summarizes the fair values of derivative instruments not designated as hedges as of December 31 (in millions of dollars):
| 2013 | ||||||||||||
| Notional Amounts |
Derivative Assets (1) |
Derivative Liabilities (2) |
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Currency forwards and swaps |
$ | 427 | $ | 12 | $ | (3) | ||||||
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Commodity swaps and options |
396 | 5 | (11) | |||||||||
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Total |
$ | 823 | $ | 17 | $ | (14) | ||||||
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| 2012 | ||||||||||||
| Notional Amounts |
Derivative Assets (1) |
Derivative Liabilities (2) |
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Currency forwards and swaps |
$ | 324 | $ | 2 | $ | (1) | ||||||
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Commodity swaps |
399 | 17 | (3) | |||||||||
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Total |
$ | 723 | $ | 19 | $ | (4) | ||||||
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| (1) | The related derivative instruments are recognized in Prepaid Expenses and Other Assets and Advances to Related Parties and Other Financial Assets in the accompanying Consolidated Balance Sheets. |
| (2) | The related derivative instruments are recognized in Accrued Expenses and Other Liabilities in the accompanying Consolidated Balance Sheets. |
The following summarizes the effect of derivative instruments not designated as hedges in the respective financial statement captions of the accompanying Consolidated Statements of Income (in millions of dollars):
| Years Ended December 31, | ||||||||||||||
| Financial Statement Caption |
2013 | 2012 | 2011 | |||||||||||
| Gain (Loss) | Gain (Loss) | Gain (Loss) | ||||||||||||
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Currency forwards and swaps |
Revenues, Net | $ | 43 | $ | (13) | $ | 4 | |||||||
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Commodity swaps and options |
Cost of Sales | (60) | 7 | (105) | ||||||||||
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Interest rate swaps |
Cost of Sales | — | — | 1 | ||||||||||
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Total |
$ | (17) | $ | (6) | $ | (100) | ||||||||
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