Cleveland-Cliffs Inc. Quarterly report pursuant to Section 13 or 15(d)

Quarterly report pursuant to Section 13 or 15(d)

DERIVATIVE INSTRUMENTS (Notes)

DERIVATIVE INSTRUMENTS (Notes)

6 Months Ended

Jun. 30, 2020

Derivative Instruments and Hedging Activities Disclosure [Abstract]

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:



	Derivatives designated as hedging instruments under Topic 815:						Derivatives not designated as hedging instruments under Topic 815:
Derivative Asset (Liability)	June 30, 2020			December 31, 2019			June 30, 2020			December 31, 2019
Other current assets:
Customer supply agreement	$	—		$	—		$	27.3		$	44.5
Provisional pricing arrangements	—			—			8.0			1.3
Commodity contracts	1.6			—			3.8			—
Other non-current assets:
Commodity contracts	0.6			—			0.1			—
Other current liabilities:
Provisional pricing arrangements	—			—			—			(1.1		)
Commodity contracts	(14.2		)	(3.2		)	(3.0		)	—
Foreign exchange contracts	(1.0		)	—			—			—
Other non-current liabilities:
Commodity contracts	(0.9		)	—			(0.2		)	—
Foreign exchange contracts	(0.4		)	—			—			—

Derivatives Designated as Hedging Instruments - Cash Flow Hedges

Exchange rate fluctuations affect a portion of revenues and operating costs that are denominated in foreign currencies, and we use forward currency and currency option contracts to reduce our exposure to certain of these currency price fluctuations. Contracts to purchase Canadian dollars are designated as cash flow hedges for accounting purposes, and we record the gains and losses for the derivatives and premiums paid for option contracts in Accumulated other comprehensive loss until we reclassify them into Cost of goods sold when we recognize the associated underlying operating costs.

We are exposed to fluctuations in market prices of raw materials and energy sources. We may use cash-settled commodity swaps and options to hedge the market risk associated with the purchase of certain of our raw materials and energy requirements. Our hedging strategy is to reduce the effect on earnings from the price volatility of these various commodity exposures, including timing differences between when we incur raw material commodity costs and when we receive sales surcharges from our customers based on those raw materials. Independent of any hedging activities, price changes in any of these commodity markets could negatively affect operating costs.

The following table presents our outstanding hedge contracts:



		(In Millions)
		June 30, 2020			December 31, 2019
	Unit of Measure	Maturity Dates	Notional Amount		Notional Amount
Commodity contracts:
Natural gas	MMBtu	July 2020 - December 2021	39.2		20.1
Diesel	Gallons	—	—		0.8
Zinc	Pounds	July 2020 - December 2021	18.2		—
Electricity	Megawatt hours	July 2020 - December 2021	1.5		—
Foreign exchange contracts:
Canadian dollars	CAD	July 2020 - December 2021	C$	48.7	C$	—

Estimated gains (losses) before tax expected to be reclassified into Cost of goods sold within the next 12 months for our existing derivatives that qualify as cash flow hedges are presented below:



	(In Millions)
Hedge:	Estimated Gains (Losses)
Natural gas	$	(4.6	)
Zinc	0.6
Electricity	(1.0		)

Derivatives Not Designated as Hedging Instruments

Customer Supply Agreement

A supply agreement with one customer provides for supplemental revenue or refunds to the customer based on the hot-rolled coil steel price at the time the iron ore product is consumed in the customer’s blast furnaces. The supplemental pricing is characterized as a freestanding derivative instrument and is required to be accounted for separately once control transfers to the customer. The derivative instrument, which is finalized based on a future price, is adjusted to fair value through Revenues each reporting period based upon current market data and forward-looking estimates provided by management until the pellets are consumed and the amounts are settled.

Provisional Pricing Arrangements

Certain of our supply agreements specify provisional price calculations, where the pricing mechanisms generally are based on market pricing, with the final revenue rate based on certain market inputs at a specified period in time in the future, per the terms of the supply agreements. Market inputs are tied to indexed price adjustment factors that are integral to the iron ore supply contracts and vary based on the agreement. The pricing mechanisms typically include adjustments based upon changes in the Platts 62% Price, Atlantic Basin pellet premiums and Platts international indexed freight rates. 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. The price adjustment factors have been evaluated to determine if they qualify as embedded derivatives. The price adjustment factors share the same economic characteristics and risks as the host sales contract and are integral to the host sales contract as inflation adjustments; accordingly, they have not been separately valued as derivative instruments.

Revenue is recognized generally upon delivery to our customers. Revenue is measured at the point that control transfers and represents the amount of consideration we expect to receive in exchange for transferring goods. Changes in the expected revenue rate from the date that control transfers through final settlement of contract terms is recorded in accordance with Topic 815 and is characterized as a derivative instrument and accounted for separately. Subsequently,

the derivative instruments are adjusted to fair value through Revenues each reporting period based upon current market data and forward-looking estimates provided by management until the final revenue rate is determined.

The following summarizes the effect of our derivatives that are not designated as hedging instruments in the Statements of Unaudited Condensed Consolidated Operations:



		(In Millions)
Derivatives Not Designated as Hedging Instruments	Location of Gain (Loss) Recognized in Income on Derivatives	Three Months Ended June 30,				Six Months Ended June 30,
		Three Months Ended June 30,				Six Months Ended June 30,
		2020		2019		2020			2019
Customer supply agreements	Revenues	$	31.2	$	57.5	$	5.6		$	74.6
Provisional pricing arrangements	Revenues	8.8		17.3		7.6			5.7
Foreign exchange contracts	Other non-operating income	0.1		—		—			—
Commodity contracts	Cost of goods sold	1.2		—		(4.7		)	—
Total		$	41.3	$	74.8	$	8.5		$	80.3

Refer to NOTE 8 - FAIR VALUE MEASUREMENTS for additional information.