UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

FORM 10-Q

 

 

 

Commission file number 001-32593

 

Global Partners LP

(Exact name of registrant as specified in its charter)

 

 

P.O. Box 9161
800 South Street
Waltham, Massachusetts 02454-9161
(Address of principal executive offices, including zip code)

 

(781) 894-8800
(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.Yes ☒ No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.Yes ☒ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

 

The issuer had 33,995,563 common units outstanding as of May 5, 2016.

 

 

 

 

TABLE OF CONTENTS

 

 

 

 

 

Item 1.Financial Statements

 

GLOBAL PARTNERS LP

CONSOLIDATED BALANCE SHEETS

(In thousands, except unit data)

(Unaudited)

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

GLOBAL PARTNERS LP

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per unit data)

(Unaudited)

 

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

GLOBAL PARTNERS LP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

(In thousands)

(Unaudited)

 

 

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

GLOBAL PARTNERS LP

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

6

 

The accompanying notes are an integral part of these consolidated financial statements.

GLOBAL PARTNERS LP

CONSOLIDATED STATEMENTS OF PARTNERS’ EQUITY

(In thousands)

(Unaudited)

 

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

 

 

 

Note 1.    Organization and Basis of Presentation

 

Organization

 

Global Partners LP (the “Partnership”) is a midstream logistics and marketing master limited partnership formed in March 2005 engaged in the purchasing, selling, storing and logistics of transporting petroleum and related products, including domestic and Canadian crude oil, gasoline and gasoline blendstocks (such as ethanol), distillates (such as home heating oil, diesel and kerosene), residual oil, renewable fuels, natural gas and propane.  The Partnership also receives revenue from convenience store sales and gasoline station rental income.  The Partnership owns, controls or has access to one of the largest terminal networks of refined petroleum products and renewable fuels in Massachusetts, Maine, Connecticut, Vermont, New Hampshire, Rhode Island, New York, New Jersey and Pennsylvania (collectively, the “Northeast”).  The Partnership owns transload and storage terminals in North Dakota and Oregon that extend its origin-to-destination capabilities from the mid-continent region of the United States and Canada to the East and West Coasts.  The Partnership is one of the largest distributors of gasoline, distillates, residual oil and renewable fuels to wholesalers, retailers and commercial customers in the New England states and New York.  As of March 31, 2016, the Partnership had a portfolio of 1,498 owned, leased and/or supplied gasoline stations, including 274 directly operated convenience stores, in the Northeast, Maryland and Virginia.

 

Global GP LLC, the Partnership’s general partner (the “General Partner”), manages the Partnership’s operations and activities and employs its officers and substantially all of its personnel, except for most of its gasoline station and convenience store employees who are employed by GMG.

 

The General Partner, which holds a 0.67% general partner interest in the Partnership, is owned by affiliates of the Slifka family.  As of March 31, 2016, affiliates of the General Partner, including its directors and executive officers and their affiliates, owned 7,434,775 common units, representing a 21.9% limited partner interest.

 

Basis of Presentation

 

On January 7, 2015, the Partnership acquired, through one of its wholly owned subsidiaries, Global Montello Group Corp. (“GMG”), 100% of the equity interests in Warren Equities, Inc. (“Warren”) from The Warren Alpert Foundation.  On January 14, 2015, the Partnership acquired the Revere terminal (the “Revere Terminal”) located in Boston Harbor in Revere, Massachusetts from Global Petroleum Corp. (“GPC”) and related entities.  On June 1, 2015, the Partnership acquired, through one of its wholly owned subsidiaries, Alliance Energy LLC (“Alliance”), retail gasoline stations and dealer supply contracts from Capitol Petroleum Group (“Capitol”).  See Note 2.

 

The financial results of Warren and the Revere Terminal for the three months ended March 31, 2015 are included in the accompanying statement of operations for the three months ended March 31, 2015.  The accompanying consolidated financial statements as of March 31, 2016 and December 31, 2015 and for the three months ended March 31, 2016 and 2015 reflect the accounts of the Partnership.  Upon consolidation, all intercompany balances and transactions have been eliminated.

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and reflect all adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial condition and operating results for the interim periods.  The interim financial information, which has been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”), should be read in conjunction with the consolidated financial statements for the year ended December 31, 2015 and notes thereto contained in the Partnership’s Annual Report on Form 10-K.  The significant accounting policies described in Note 2, “Summary of Significant

Accounting Policies,” of such Annual Report on Form 10-K are the same used in preparing the accompanying consolidated financial statements.

 

The results of operations for the three months ended March 31, 2016 are not necessarily indicative of the results of operations that will be realized for the entire year ending December 31, 2016.  The consolidated balance sheet at December 31, 2015 has been derived from the audited consolidated financial statements included in the Partnership’s Annual Report on Form 10-K for the year ended December 31, 2015.

 

Due to the nature of the Partnership’s business and its reliance, in part, on consumer travel and spending patterns, the Partnership may experience more demand for gasoline during the late spring and summer months than during the fall and winter.  Travel and recreational activities are typically higher in these months in the geographic areas in which the Partnership operates, increasing the demand for gasoline that the Partnership distributes.  Therefore, the Partnership’s volumes in gasoline are typically higher in the second and third quarters of the calendar year.  As demand for some of the Partnership’s refined petroleum products, specifically home heating oil and residual oil for space heating purposes, is generally greater during the winter months, heating oil and residual oil volumes are generally higher during the first and fourth quarters of the calendar year. These factors may result in fluctuations in the Partnership’s quarterly operating results.

 

Noncontrolling Interest

 

These financial statements reflect the application of ASC 810, “Consolidations” (“ASC 810”) which establishes accounting and reporting standards that require: (i) the ownership interest in subsidiaries held by parties other than the parent to be clearly identified and presented in the consolidated balance sheet within shareholder’s equity, but separate from the parent’s equity; (ii) the amount of consolidated net income attributable to the parent and the noncontrolling interest to be clearly identified and presented on the face of the consolidated statements of operations; and (iii) changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary to be accounted for consistently.

 

The Partnership acquired a 60% interest in Basin Transload, LLC (“Basin Transload”) on February 1, 2013.  After evaluating ASC 810, the Partnership concluded it is appropriate to consolidate the balance sheet and statements of operations of Basin Transload based on an evaluation of the outstanding voting interests.  Amounts pertaining to the noncontrolling ownership interest held by third parties in the financial position and operating results of the Partnership are reported as a noncontrolling interest in the accompanying consolidated balance sheets and statements of operations.

 

Concentration of Risk

 

The following table presents the Partnership’s product sales and other revenues as a percentage of the consolidated sales for the periods presented:

 

 

The following table presents the Partnership’s product margin by segment as a percentage of the consolidated product margin for the periods presented:

 

 

See Note 10, “Segment Reporting” for additional information on the Partnership’s operating segments.

 

None of the Partnership’s customers accounted for greater than 10% of total sales for the three months ended March 31, 2016 and 2015. 

 

Goodwill

Goodwill represents the future economic benefits arising from assets acquired in a business combination that are not individually identified and separately recognized.  The Partnership has concluded that its operating segments are also its reporting units.  At March 31, 2016 and December 31, 2015, goodwill recorded in the accompanying consolidated balance sheets aggregated $435.4 million, of which $121.7 million relates to the Wholesale segment and $313.7 million relates to the Gasoline Distribution and Station Operations (“GDSO”) segment.

 

Goodwill is tested for impairment annually as of October 1 or when events or changes in circumstances indicate that the carrying amount of goodwill may not be recoverable.  The process of testing goodwill for impairment involves numerous judgments, assumptions and estimates made by management which inherently reflect a high degree of uncertainty.  The impairment test first includes a qualitative assessment in order to conclude if it is more likely than not that the reporting unit’s fair value exceeds its carrying value.  Factors considered in the qualitative analysis include changes in the business and industry, as well as macro-economic conditions, that would influence the fair value of the reporting unit as well as changes in the carrying values of the reporting unit.  If necessary, the Partnership will then complete a two-step quantitative assessment.  In the quantitative assessment, the fair value of each reporting unit is determined and compared to the book value of the reporting unit.  If the fair value of the reporting unit is less than the book value, including goodwill, then the recorded goodwill is impaired to its implied fair value with a charge to operations.  The Partnership calculates the fair value of each reporting unit using a combination of discounted cash flows and market comparables.

 

Key assumptions included in the development of the discounted cash flow value for each reporting unit include:

 

Future commodity volumes and margins.  The discounted cash flows are based on a five-year forecast with an estimate of terminal value.  In general, the reporting units’ fair values are most sensitive to volume and gross margin assumptions.  In particular, the Wholesale segment’s cash flows are impacted by the crude oil market, given the Partnership’s 2013 investment in transloading terminals in North Dakota and Oregon.  The significant decline in the price of crude oil and tight crude oil differentials negatively impacted the Partnership’s fiscal 2015 results.  The Partnership expects low crude oil prices and tight differentials to continue for a period of time, which will negatively impact the Partnership’s 2016 performance with recovery expected in 2017.  As a result of these market conditions, there is increased uncertainty and sensitivity relating to the Partnership’s future cash flow projections within its crude oil business on which the Wholesale reporting unit’s goodwill impairment analysis relies.  If market conditions, and therefore the Partnership’s performance, are worse than its projections, the Partnership may record impairment charges in the future.  Actual results may not be consistent with these

judgments, assumptions and estimates, and goodwill impairment charges may be required in future periods.  This could have an adverse impact on the Partnership’s financial position and results of operations.

 

Discount rate commensurate with the risks involved.  The Partnership applies a discount rate to its expected cash flows based on a variety of factors, including market and economic conditions, operational risk, regulatory risk and political risk. A higher discount rate decreases the net present value of cash flows.

 

Future capital requirements.  The Partnership’s estimates of future capital requirements are based upon a combination of authorized spending and internal forecasts.

 

On October 1, 2015, the Partnership completed its quantitative assessments for both the Wholesale and GDSO reporting units, and no impairment indicator was identified for either reporting unit.  The declining crude oil prices, changes in certain market conditions, and decline in the Partnership’s common unit price, collectively caused the Partnership to reassess its goodwill for impairment as of December 31, 2015 for the Wholesale reporting unit.  Based on the results of this assessment, the Partnership concluded that step-two of the quantitative assessment was not necessary and no impairment was required. 

 

As of March 31, 2016, the Partnership considered whether there were any change of circumstances or events during the first quarter which would more likely than not reduce the fair value of the Wholesale segment’s reporting unit below its carrying amount.  The Partnership concluded that such events and circumstances have not occurred.

 

The fair values of the Partnership’s reporting units are based on underlying assumptions that represent the Partnership’s best estimates.  Many of the factors used in assessing fair value are outside of the control of management.  A further sustained decline in commodity prices may cause the Partnership to reassess its long-lived assets and goodwill for impairment, and could result in future non-cash impairment charges as a result of such impairment assessments.  If the Partnership is required to perform step-two in the future for the Wholesale reporting unit, up to $121.7 million of goodwill assigned to this reporting unit could be written off in the period of such impairment assessment.

 

Note 2.    Business Combinations

 

2015 Acquisitions

 

Warren Equities, Inc.—On January 7, 2015, the Partnership acquired, through GMG, 100% of the equity interests in Warren, one of the largest independent marketers of petroleum products in the Northeast, from The Warren Alpert Foundation.  The acquisition included 147 company-owned Xtra Mart convenience stores and related fuel operations, 53 commission agent locations and fuel supply rights for approximately 330 dealers.  The acquired properties are located in the Northeast, Maryland and Virginia.  The purchase price, inclusive of post-closing adjustments, was approximately $381.8 million, including working capital.  The acquisition was funded with borrowings under the Partnership’s credit facility and with proceeds from its December 2014 public offering of 3,565,000 common units.

 

The acquisition was accounted for using the purchase method of accounting in accordance with the Financial Accounting Standards Board’s (“FASB”) guidance regarding business combinations.  The Partnership’s financial statements include the results of operations of Warren subsequent to the acquisition date.

 

In connection with the acquisition of Warren, the Partnership recorded acquisition costs of approximately $4.4 million for the three months ended March 31, 2015 which are included in selling, general and administrative expenses in the accompanying consolidated statement of operations.  Additionally, in January 2015 and subsequent to the acquisition date, the Partnership recorded a restructuring charge of approximately $2.3 million, which is included in selling, general and administrative expenses in the accompanying consolidated statement of operations for the three

months ended March 31, 2015.  Approximately $0.5 million of the restructuring charge was paid during the three months ended March 31, 2015, and the remaining balance of $1.8 million was paid during the year ended December 31, 2015.

 

Revere Terminal—On January 14, 2015, through the Partnership’s wholly owned subsidiary, Global Companies LLC, the Partnership acquired the Revere Terminal located in Boston Harbor in Revere, Massachusetts from GPC, a privately held affiliate of the Partnership, and related entities for a purchase price of $23.7 million.  The acquisition includes contingent consideration which would be payable under specific circumstances involving a subsequent sale of the property during the eight years following the acquisition.  The contingent consideration was estimated to be $0 as of the acquisition date as the Partnership concluded that the sale of the terminal for non-petroleum use within the eight years following the acquisition is not probable.  The Partnership financed the transaction with borrowings under its revolving credit facility.  In connection with the Revere Terminal transaction, the pre-existing terminal storage rental and throughput agreement between the Partnership and GPC was terminated.

 

The acquisition was accounted for using the purchase method of accounting in accordance with the FASB’s guidance regarding business combinations.  As the acquisition transitioned the Revere Terminal from a formerly leased facility to an owned facility, the transaction did not have a material impact on the Partnership’s consolidated financial statements.

 

Capitol Petroleum Group—On June 1, 2015, the Partnership acquired 97 primarily Mobil and Exxon branded owned or leased retail gasoline stations and seven dealer supply contracts in New York City and Prince George’s County, Maryland, along with certain related supply and franchise agreements and third-party leases and other assets associated with the operations from Liberty Petroleum Realty, LLC, East River Petroleum Realty, LLC, Big Apple Petroleum Realty, LLC, White Oak Petroleum, LLC, Anacostia Realty, LLC, Mount Vernon Petroleum Realty, LLC and DAG Realty, LLC (collectively, “Capitol Petroleum Group”).  The purchase price was approximately $155.7 million.  The acquisition was financed with borrowings under the Partnership’s revolving credit facility.

 

The acquisition was accounted for using the purchase method of accounting in accordance with the FASB’s guidance regarding business combinations.  The Partnership’s financial statements include the results of operations of Capitol subsequent to the acquisition date.

 

No acquisition costs were recorded in connection with the acquisition of Capitol for the three months ended March 31, 2015.

 

Supplemental Pro Forma Information—Revenues and net income not included in the Partnership’s consolidated operating results for Warren from January 1, 2015 through January 7, 2015, the acquisition date, were immaterial.  Accordingly, the supplemental pro forma information for the three months ended March 31, 2015 is consistent with the amounts reported in the accompanying consolidated statement of operations for the three months ended March 31, 2015. 

 

The following unaudited pro forma information presents the consolidated results of operations of the Partnership as if the acquisition of Capitol occurred on January 1, 2015 (in thousands, except per unit data):

 

 

 

 

 

 

Note 3.    Net (Loss) Income Per Limited Partner Unit

 

Under the Partnership’s partnership agreement, for any quarterly period, the incentive distribution rights (“IDRs”) participate in net income only to the extent of the amount of cash distributions actually declared, thereby excluding the IDRs from participating in the Partnership’s undistributed net income or losses.  Accordingly, the Partnership’s undistributed net income or losses is assumed to be allocated to the common unitholders, or limited partners’ interest, and to the General Partner’s general partner interest.

 

Common units outstanding as reported in the accompanying consolidated financial statements at March 31, 2016 and December 31, 2015 excluded 478,060 and 488,719 common units, respectively, held on behalf of the Partnership pursuant to its repurchase program (see Note 13).  These units are not deemed outstanding for purposes of calculating net income per limited partner unit (basic and diluted).

 

The following table provides a reconciliation of net (loss) income and the assumed allocation of net (loss) income to the limited partners’ interest for purposes of computing net (loss) income per limited partner unit for the three months ended March 31, 2016 and 2015 (in thousands, except per unit data):

 

 

During 2016, the board of directors of the General Partner declared the following quarterly cash distribution:

 

 

See Note 8, “Partners’ Equity and Cash Distributions” for further information.

 

Note 4.    Inventories

 

The Partnership hedges substantially all of its petroleum and ethanol inventory using a variety of instruments, primarily exchange-traded futures contracts.  These futures contracts are entered into when inventory is purchased and are either designated as fair value hedges against the inventory on a specific barrel basis for inventories qualifying for fair value hedge accounting or not designated and maintained as economic hedges against certain inventory of the Partnership on a specific barrel basis.  Changes in fair value of these futures contracts, as well as the offsetting change in fair value on the hedged inventory, is recognized in earnings as an increase or decrease in cost of sales.  All hedged inventory designated in a fair value hedge relationship is valued using the lower of cost, as determined by specific identification, or market, as determined at the product level.  All petroleum and ethanol inventory not designated in a fair value hedging relationship is carried at the lower of historical cost, on a first-in, first-out basis, or market.

 

Convenience store inventory and Renewable Identification Numbers (“RINs”) inventory are carried at the lower of historical cost or market. 

 

Inventories consisted of the following (in thousands):

 

 

 

In addition to its own inventory, the Partnership has exchange agreements for petroleum products and ethanol with unrelated third-party suppliers, whereby it may draw inventory from these other suppliers and suppliers may draw inventory from the Partnership.  Positive exchange balances are accounted for as accounts receivable and amounted to $9.3 million and $3.4 million at March 31, 2016 and December 31, 2015, respectively.  Negative exchange balances are accounted for as accounts payable and amounted to $4.1 million and $12.1 million at March 31, 2016 and December 31, 2015, respectively.  Exchange transactions are valued using current carrying costs.

 

Note 5.    Derivative Financial Instruments

 

The Partnership principally uses derivative instruments, which include regulated exchange-traded futures and options contracts (collectively, “exchange-traded derivatives”) and physical and financial forwards and over-the-counter (“OTC”) swaps (collectively, “OTC derivatives”), to reduce its exposure to unfavorable changes in commodity market prices and interest rates.  The Partnership uses these exchange-traded and OTC derivatives to hedge commodity price risk associated with its inventory and undelivered forward commodity purchases and sales (“physical forward contracts”) and uses interest rate swap instruments to reduce its exposure to fluctuations in interest rates associated with the Partnership’s credit facilities.  The Partnership accounts for derivative transactions in accordance with ASC 815, “Derivatives and Hedging,” and recognizes derivatives instruments as either assets or liabilities in the consolidated

balance sheet and measures those instruments at fair value.  The changes in fair value of the derivative transactions are presented currently in earnings, unless specific hedge accounting criteria are met.

 

The fair value of exchange-traded derivative transactions reflects amounts that would be received from or paid to the Partnership’s brokers upon liquidation of these contracts.  The fair value of these exchange-traded derivative transactions are presented on a net basis, offset by the cash balances on deposit with the Partnership’s brokers, presented as brokerage margin deposits in the consolidated balance sheets.  The fair value of OTC derivative transactions reflects amounts that would be received from or paid to a third party upon liquidation of these contracts under current market conditions.  The fair value of these OTC derivative transactions is presented on a gross basis as derivative assets or derivative liabilities in the consolidated balance sheets, unless a legal right of offset exists.  The presentation of the change in fair value of the Partnership’s exchange-traded derivatives and OTC derivative transactions depends on the intended use of the derivative and the resulting designation.

 

The following table summarizes the notional values related to the Partnership’s derivative instruments outstanding at March 31, 2016:

 

 

 

Derivatives Accounted for as Hedges

 

The Partnership utilizes fair value hedges and cash flow hedges to hedge commodity price risk and interest rate risk.

 

Fair Value Hedges

 

Derivatives designated as fair value hedges are used to hedge price risk in commodity inventories and principally include exchange-traded futures contracts that are entered into in the ordinary course of business.  For a derivative instrument designated as a fair value hedge, the gain or loss is recognized in earnings in the period of change together

with the offsetting change in fair value on the hedged item of the risk being hedged.  Gains and losses related to fair value hedges are recognized in the consolidated statement of operations through cost of sales.  These futures contracts are settled on a daily basis by the Partnership through brokerage margin accounts.

 

The Partnership’s fair value hedges include exchange-traded futures contracts and OTC derivative contracts that are hedges against inventory with specific futures contracts matched to specific barrels.  The change in fair value of these futures contracts and the change in fair value of the underlying inventory generally provide an offset to each other in the consolidated statement of operations.

 

The following table presents the gains and losses from the Partnership’s derivative instruments involved in fair value hedging relationships recognized in the consolidated statements of operations for the three months ended March 31, 2016 and 2015 (in thousands):

 

 

 

Cash Flow Hedges

 

Derivatives designated as cash flow hedges are used to hedge interest rate risk from fluctuations in interest rates and may include various interest rate derivative instruments entered into with major financial institutions.  For a derivative instrument being designated as a cash flow hedge, the effective portion of the derivative gain or loss is initially reported as a component of other comprehensive income (loss) and subsequently reclassified into the consolidated statement of operations through interest expense in the same period that the hedged exposure affects earnings.  The ineffective portion is recognized in the consolidated statement of operations immediately.

 

The Partnership’s cash flow hedges currently include interest rate swaps and an interest rate cap that are hedges of variability in forecasted interest payments due to changes in the interest rate on LIBOR-based borrowings, a summary of which includes the following designations:

 

 

 

 

In the aggregate, these hedging instruments have historically been effective in hedging the variability in interest payments due to changes in the one month LIBOR swap curve or rate with respect to $300.0 million of one month LIBOR based borrowings on the credit facility.

 

In June 2014 and as a result of the issuance of the Partnership’s $375.0 million aggregate principal amount of its 6.25% senior notes due 2022 (see Note 6), the Partnership determined that maintaining an excess of $300.0 million in principal of outstanding floating-rate debt was no longer probable.  Therefore, the Partnership elected to de-designate its interest rate cap and discontinued the related hedge accounting for this instrument.  Accordingly, at March 31, 2016, the Partnership had in place two interest rate swap agreements which are hedging $200.0 million of variable rate debt, both of which continue to be accounted for as cash flow hedges.  The interest rate cap, which expired on April 13, 2016, was not in a hedging relationship for the three months ended March 31, 2016 and 2015.  Accordingly, all changes in fair value of this instrument subsequent to the date of de-designation were recorded in the consolidated statement of operations through interest expense.

 

The following table presents the amount of gains and losses from the Partnership’s derivative instruments designated in cash flow hedging relationships recognized in the consolidated statements of operations and partners’ equity for the three months ended March 31, 2016 and 2015 (in thousands):

 

 

 

 

The amount of gain (loss) recognized in income as ineffectiveness for derivatives designated in cash flow hedging relationships was $0 for the three months ended March 31, 2016 and 2015.

 

Derivatives Not Accounted for as Hedges

 

The Partnership utilizes petroleum and ethanol commodity contracts, natural gas commodity contracts and foreign currency derivatives to hedge price and currency risk in certain commodity inventories and physical forward contracts.

 

Petroleum and Ethanol Commodity Contracts

 

The Partnership uses exchange-traded derivative contracts to hedge price risk in certain commodity inventories which do not qualify for fair value hedge accounting or are not designated by the Partnership as fair value hedges.  Additionally, the Partnership uses exchange-traded derivative contracts, and occasionally financial forward and OTC swap agreements, to hedge commodity price exposure associated with its physical forward contracts which are not designated by the Partnership as cash flow hedges.  These physical forward contracts, to the extent they meet the definition of a derivative, are considered OTC physical forwards and are reflected as derivative assets or derivative liabilities in the consolidated balance sheet.  The related exchange-traded derivative contracts (and financial forward and OTC swaps, if applicable) are also reflected as brokerage margin deposits (and derivative assets or derivative liabilities, if applicable) in the consolidated balance sheet, thereby creating an economic hedge.  Changes in fair value of these derivative instruments are recognized in the consolidated statement of operations through cost of sales.  These exchange-traded derivatives are settled on a daily basis by the Partnership through brokerage margin accounts.

 

While the Partnership seeks to maintain a position that is substantially balanced within its commodity product purchase and sale activities, it may experience net unbalanced positions for short periods of time as a result of variances in daily purchases and sales and transportation and delivery schedules as well as other logistical issues inherent in the business, such as weather conditions.  In connection with managing these positions, the Partnership is aided by maintaining a constant presence in the marketplace.  The Partnership also engages in a controlled trading program for up to an aggregate of 250,000 barrels of commodity products at any one point in time.  Changes in fair value of these derivative instruments are recognized in the consolidated statement of operations through cost of sales.

 

Natural Gas Commodity Contracts

 

The Partnership uses physical forward purchase contracts to hedge price risk associated with the marketing and selling of natural gas to third-party users.  These physical forward purchase commitments for natural gas are typically executed when the Partnership enters into physical forward sale commitments of product for physical delivery.  These physical forward contracts, to the extent they meet the definition of a derivative, are reflected as derivative assets and derivative liabilities in the consolidated balance sheet.  Changes in fair value of the forward purchase and sale commitments are recognized in the consolidated statement of operations through cost of sales.

 

Foreign Currency Contracts

 

The Partnership uses forward foreign currency contracts to hedge certain foreign denominated (Canadian) commodity product purchases.  These forward foreign currency contracts are not designated by the Partnership as hedges and are reflected as prepaid expenses and other current assets or accrued expenses and other current liabilities in the consolidated balance sheets.  Changes in fair values of these forward foreign currency contracts are reflected in cost of sales.

 

The following table presents the gains and losses from the Partnership’s derivative instruments not involved in a hedging relationship recognized in the consolidated statements of operations for the three months ended March 31, 2016 and 2015 (in thousands):

 

 

 

Margin Deposits

 

All of the Partnership’s exchange-traded derivative contracts (designated and not designated) are transacted through clearing brokers.  The Partnership deposits initial margin with the clearing brokers, along with variation margin, which is paid or received on a daily basis, based upon the changes in fair value of open futures contracts and settlement of closed futures contracts.  Cash balances on deposit with clearing brokers and open equity are presented on a net basis within brokerage margin deposits in the consolidated balance sheets.

 

Commodity Contracts and Other Derivative Activity

 

The Partnership’s commodity contract derivatives and other derivative activity include: (i) exchange-traded derivative contracts that are hedges against inventory and either do not qualify for hedge accounting or are not designated in a hedge accounting relationship, (ii) exchange-traded derivative contracts used to economically hedge physical forward contracts, (iii) financial forward and OTC swap agreements used to economically hedge physical forward contracts and (iv) the derivative instruments under the Partnership’s controlled trading program.  The

Partnership does not take the normal purchase and sale exemption available under ASC 815 for its physical forward contracts.

 

The following table presents the fair value of each classification of the Partnership’s derivative instruments and its location in the consolidated balance sheets at March 31, 2016 and December 31, 2015 (in thousands):

 

 

 

 

 

Credit Risk

 

The Partnership’s derivative financial instruments do not contain credit risk related to other contingent features that could cause accelerated payments when these financial instruments are in net liability positions.

 

The Partnership is exposed to credit loss in the event of nonperformance by counterparties to the Partnership’s exchange-traded and OTC derivative contracts, but the Partnership has no current reason to expect any material nonperformance by any of these counterparties.  Exchange-traded derivative contracts, the primary derivative instrument utilized by the Partnership, are traded on regulated exchanges, greatly reducing potential credit risks.  The Partnership utilizes primarily three clearing brokers, all major financial institutions, for all New York Mercantile Exchange (“NYMEX”), Chicago Mercantile Exchange (“CME”) and Intercontinental Exchange (“ICE”) derivative transactions and the right of offset exists with these financial institutions under master netting agreements.  Accordingly, the fair