Annual report pursuant to Section 13 and 15(d)

DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

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DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
 12 Months Ended
Dec. 31, 2013
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
NOTE 3 - 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 Consolidated Financial Position as of December 31, 2013 and December 31, 2012:
 
(In Millions)
 
Derivative Assets
 
Derivative Liabilities
 
December 31, 2013
 
December 31, 2012
 
December 31, 2013
 
December 31, 2012
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:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-Rate Swaps
 
 
$
—

 
 
 
$
—

 
Other current liabilities
 
$
2.1

 
 
 
$
—

Foreign Exchange Contracts
Other current assets
 
0.3

 
Other current assets
 
16.2

 
Other current liabilities
 
25.8

 
Other current liabilities
 
1.9

Total derivatives designated as hedging instruments under ASC 815
 
 
$
0.3

 
 
 
$
16.2

 
 
 
$
27.9

 
 
 
$
1.9

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

 
 
 
$
—

 
Other current liabilities
 
$
1.1

 
 
 
$
—

Customer Supply Agreements
Other current assets
 
55.8

 
Other current assets
 
58.9

 
 
 
—

 
 
 
—

Provisional Pricing Arrangements
Other current assets
 
3.1

 
Other current assets
 
3.5

 
Other current liabilities
 
10.3

 
Other current liabilities
 
11.3

Total derivatives not designated as hedging instruments under ASC 815
 
 
$
58.9

 
 
 
$
62.4

 
 
 
$
11.4

 
 
 
$
11.3

Total derivatives
 
 
$
59.2

 
 
 
$
78.6

 
 
 
$
39.3

 
 
 
$
13.2


Derivatives Designated as Hedging Instruments
Cash Flow Hedges
Australian and Canadian 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. The functional currency of our Canadian operations is the U.S. dollar; however, the production costs for these operations primarily are incurred in the Canadian dollar.
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. For our Canadian operations, U.S. dollars are converted to Canadian dollars at the exchange rate in effect for the period the operating costs are incurred. The primary objective for the use of these instruments is to reduce exposure to changes in Australian and U.S. currency exchange rates and U.S. and Canadian currency exchange rates, respectively, 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.
As of December 31, 2013, we had outstanding Australian and Canadian foreign currency exchange contracts with notional amounts of $323.0 million and $285.9 million, respectively, in the form of forward contracts with varying maturity dates ranging from January 2014 to December 2014. This compares with outstanding Australian and Canadian foreign currency exchange contracts with a notional amount of $400.0 million and $630.4 million, respectively, as of December 31, 2012.
Changes in fair value of highly effective hedges are recorded as a component of Accumulated other comprehensive loss in the Statements of Consolidated Financial Position. Any ineffectiveness is recognized immediately in income. As of December 31, 2013 and 2012, there was no material ineffectiveness recorded for foreign exchange contracts that were classified as cash flow hedges. However, certain Canadian hedge contracts were deemed ineffective during the fourth quarter of 2013 and no longer qualified for hedge accounting treatment. 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 Australian hedge contracts and Canadian hedge contracts, we estimate that losses of $15.0 million and losses of $2.9 million (net of tax), respectively, will be reclassified into earnings within the next 12 months.
Interest Rate Risk Management
Interest rate risk is managed using a portfolio of variable-rate and fixed-rate debt composed of short-term and long-term instruments, such as U.S. treasury lock agreements and variable-to-fixed interest rate swaps. From time to time, these instruments, which are derivative instruments, are entered into to facilitate the maintenance of the desired ratio of variable-rate to fixed-rate debt.
In the second quarter of 2012, we entered into U.S. treasury lock agreements with a notional value of $200.0 million to hedge the exposure to the possible rise in the interest rate prior to the issuance of the five-year senior notes due 2018 discussed in NOTE 10 - DEBT AND CREDIT FACILITIES. These derivative instruments were designated and qualified as cash flow hedges. The U.S. treasury locks were settled in the fourth quarter of 2012 upon the issuance of $500.0 million principal amount of the senior notes due 2018 for a cumulative after-tax loss of $1.3 million, which was recorded in Accumulated other comprehensive loss and is being amortized to Changes in fair value of foreign currency contracts, net over the life of the senior notes due 2018. Approximately $0.1 million net of tax was recognized in earnings in 2013 and approximately $0.1 million net of tax is expected to be recognized in earnings in 2014.
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 Consolidated Operations for the years ended December 31, 2013, 2012 and 2011:
 
(In Millions)
Derivatives in Cash Flow
Amount of Gain (Loss)
Recognized in OCI on Derivative
 
Location of Gain (Loss)
Reclassified
from Accumulated OCI into Earnings
 
Amount of Gain (Loss)
Reclassified
from Accumulated
OCI into Earnings
Hedging Relationships
(Effective Portion)
 
(Effective Portion)
 
(Effective Portion)
 
Year Ended
December 31,
 
 
 
Year Ended
December 31,
 
2013
 
2012
 
2011
 
 
 
2013
 
2012
 
2011
Australian Dollar Foreign
Exchange Contracts
(hedge designation)
$
(34.7
)
 
$
20.2

 
$
1.8

 
Product revenues
 
$
(11.9
)
 
$
14.8

 
$
2.6

Canadian Dollar Foreign Exchange Contracts
    (hedge designation)
(12.9
)
 
6.7

 
—

 
Cost of goods sold and operating expenses
 
(8.2
)
 
3.3

 
—

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

 
—

 
—

 
Product revenues
 
—

 
—

 
0.7

Canadian Dollar Foreign
Exchange Contracts
(prior to de-designation)
(4.1
)
 
—

 
—

 
Cost of goods sold and operating expenses
 
(1.9
)
 
—

 
—

Treasury Locks
—

 
(1.3
)
 
—

 
Changes in fair value of foreign currency contracts, net
 
(0.1
)
 
—

 
—

Total
$
(51.7
)
 
$
25.6

 
$
1.8

 
 
 
$
(22.1
)
 
$
18.1

 
$
3.3


Fair Value Hedges
Interest Rate Hedges
Our fixed-to-variable interest rate swap derivative instruments, with a notional amount of $250.0 million, are designated and qualify as fair value hedges as of December 31, 2013. The objective of the hedges are to hedge changes in the debt's fair value associated with fluctuations in the benchmark LIBOR interest rate as part of our risk management strategy.
For derivative instruments that are designated and qualify 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 are recognized in current net income. We include 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 year ended December 31, 2013 was $0.1 million. There were no derivative instruments that were designated and qualifying as fair-value hedges for the year ended December 31, 2012.
Derivatives Not Designated as Hedging Instruments
Foreign Exchange Contracts
During the fourth quarter of 2013, we discontinued hedge accounting for Canadian foreign currency exchange contracts for all outstanding contracts associated with Wabush and Ferroalloys operations as projected future cash flows were no longer considered probable, but we continue 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 Wabush or Ferroalloys operations. As of December 31, 2013, the de-designated outstanding foreign currency exchange rate contracts had a notional amount of $74.8 million in the form of forward contracts with varying maturity dates ranging from January 2014 to June 2014.
As a result of discontinued hedge accounting, the instruments are prospectively marked to fair value each reporting period through Cost of goods sold and operating expenses on the Statements of Consolidated Operations. For the year ended December 31, 2013, the change in fair value of our de-designated foreign currency exchange contracts resulted in net losses of $0.6 million. The amounts that were previously recorded as a component of Accumulated other comprehensive loss prior to de-designation are reclassified to earnings and a corresponding realized gain or loss will be recognized when the forecasted cash flow occurs. For the year ended December 31, 2013, we reclassified losses of $1.9 million from Accumulated other comprehensive loss related to contracts that matured during the year, and recorded the amounts as Cost of goods sold and operating expenses on the Statements of Consolidated Operations. As of December 31, 2013, approximately $0.5 million of losses remains in Accumulated other comprehensive loss related to the effective cash flow hedge contracts prior to de-designation. We estimate the remaining $0.5 million of losses will be reclassified to Cost of goods sold and operating expenses in the next 12 months upon the maturity of the related contracts.
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, some of which are subject to annual price collars in order to limit the percentage increase or decrease in prices for our iron ore pellets during any given year. The base price is the primary component of the purchase price for each contract. The inflation-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 market rate and/or international pellet prices and changes in specified Producers Price Indices, including those for all commodities, 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 supply agreements with one U.S. Iron Ore customer provide 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 $149.2 million, $171.4 million and $178.0 million as Product revenues in the Statements of Consolidated Operations for the years ended December 31, 2013, 2012 and 2011, respectively, related to the supplemental payments. Other current assets, representing the fair value of the pricing factors, were $55.8 million and $58.9 million in the December 31, 2013 and December 31, 2012 Statements of Consolidated Financial Position, respectively.
Provisional Pricing Arrangements
Certain of our U.S. Iron Ore, Eastern Canadian 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 point 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 December 31, 2013 and December 31, 2012, we recorded $3.1 million and $3.5 million, respectively, as Other current assets and $10.3 million and $11.3 million, respectively, as Other current liabilities in the Statements of Consolidated Financial Position related to our estimate of final revenue rate with our U.S. Iron Ore, Eastern Canadian Iron Ore and Asia Pacific Iron Ore customers at December 31, 2013 and related to our U.S. Iron Ore and Eastern Canadian Iron Ore customers at December 31, 2012. 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 $7.2 million decrease in Product revenues in the Statements of Consolidated Operations for the year ended December 31, 2013 related to these arrangements. This compares with a net $7.8 million decrease in Product revenues for the comparable period in 2012. At December 31, 2011, we did not have any derivative assets or liabilities recorded due to these arrangements.
In instances when we were still working to revise components of the pricing calculations referenced within our supply agreements to incorporate new market inputs to the pricing mechanisms, we recorded certain shipments made to customers based on an agreed-upon provisional price. The shipments were recorded based on the provisional price until settlement of the market inputs to the pricing mechanisms are finalized. The lack of agreed-upon market inputs results in these provisional prices being characterized as derivatives. The derivative instrument, which is settled and billed or credited once the determinations of the market inputs to the pricing mechanisms are finalized, is adjusted to fair value through Product revenues each reporting period based upon current market data and forward-looking estimates determined by management. During 2013 and 2012, we reached final pricing settlements on the customer supply agreements in which components of the pricing calculation were still being revised, prior to each year end. As such, at December 31, 2013 and December 31, 2012, no shipments were recorded based upon contracts where the market inputs to the pricing mechanisms were still being finalized, as all outstanding were settled during the corresponding year. We recognized $809.1 million as an increase in Product revenues in the Statements of Consolidated Operations for the year ended December 31, 2011 under the pricing provisions for certain shipments to U.S. Iron Ore and Eastern Canadian Iron Ore customers as we were still in the process of revising the terms of the related customer supply agreements. For the year ended December 31, 2011, $309.4 million of the revenues were realized due to the pricing settlements that primarily occurred with our U.S. Iron Ore customers during 2011.
At December 31, 2011, we recorded $1.2 million Other current assets, $19.5 million Other current liabilities and $83.8 million Accounts receivable, net in the Statements of Consolidated Financial Position related to these types of provisional pricing arrangements with various U.S. Iron Ore and Eastern Canadian Iron Ore customers.
The following summarizes the effect of our derivatives that are not designated as hedging instruments in the Statements of Consolidated Operations for the years ended December 31, 2013, 2012 and 2011:
(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
 
 
Year Ended
December 31,
 
 
2013
 
2012
 
2011
Foreign Exchange Contracts
Product revenues
$
—

 
$
—

 
$
1.0

Foreign Exchange Contracts
Cost of goods sold and operating expenses
(0.6
)
 
—

 
—

Foreign Exchange Contracts
Other income (expense)
—

 
0.3

 
101.9

Foreign Exchange Contracts
Income and Gain on Sale from Discontinued Operations, net of tax
—

 
(0.3
)
 
—

Treasury Locks
Changes in fair value of foreign currency contracts, net
—

 
(0.4
)
 
—

Customer Supply Agreements
Product revenues
149.2

 
171.4

 
178.0

Provisional Pricing Arrangements
Product revenues
(7.2
)
 
(7.8
)
 
809.1

Total
 
$
141.4

 
$
163.2

 
$
1,090.0


Refer to NOTE 9 - FAIR VALUE OF FINANCIAL INSTRUMENTS for additional information.