Quarterly report pursuant to Section 13 or 15(d)

Fair Value Measurements and Derivatives

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Fair Value Measurements and Derivatives
9 Months Ended
Sep. 30, 2015
Derivative Instruments And Hedging Activities Disclosure [Abstract]  
Fair Value Measurements and Derivatives
8. Fair Value Measurements and Derivatives

 

Fair value is defined as the price at which an orderly transaction to sell an asset or to transfer a liability would take place between market participants at the measurement date under current market conditions (that is, an exit price at the measurement date from the perspective of a market participant that holds the asset or owes the liability).

 

Fair Value Hierarchy

 

The following hierarchy for inputs used in measuring fair value should maximize the use of observable inputs and minimize the use of unobservable inputs by requiring that the most observable inputs be used when available:

 

Level 1 Quoted prices in active markets for identical assets or liabilities that are accessible at the measurement dates.
   
Level 2 Significant other observable inputs that are used by market participants in pricing the asset or liability based on market data obtained from independent sources.
   
Level 3 Significant unobservable inputs we believe market participants would use in pricing the asset or liability based on the best information available.

 

Derivatives

 

We are exposed to market risk attributable to changes in interest rates, foreign currency exchange rates and fuel prices. We attempt to minimize these risks through a combination of our normal operating and financing activities and through the use of derivatives. We assess whether derivatives used in hedging transactions are “highly effective” in offsetting changes in the cash flow of our hedged forecasted transactions. We use regression analysis for this hedge relationship and high effectiveness is achieved when a statistically valid relationship reflects a high degree of offset and correlation between the fair values of the derivative and the hedged forecasted transaction. Cash flows from the derivatives are classified in the same category as the cash flows from the underlying hedged transaction. The determination of ineffectiveness is based on the amount of dollar offset between the cumulative change in fair value of the derivative and the cumulative change in fair value of the hedged transaction at the end of the reporting period. If it is determined that a derivative is not highly effective as a hedge, or if the hedged forecasted transaction is no longer probable of occurring, then the amount recognized in accumulated other comprehensive income (loss) is released to earnings. In addition, the ineffective portion of our highly effective hedges is recognized in earnings immediately and reported in other income (expense) in our consolidated statements of operations. There are no amounts excluded from the assessment of hedge effectiveness and there are no credit-risk-related contingent features in our derivative agreements.

 

We monitor concentrations of credit risk associated with financial and other institutions with which we conduct significant business. Credit risk, including but not limited to counterparty non-performance under derivatives and our Revolving Loan Facility, is not considered significant, as we primarily conduct business with large, well-established financial institutions that we have established relationships with and that have credit risks acceptable to us or the credit risk is spread out among a large number of creditors. We do not anticipate non-performance by any of our significant counterparties.

 

The following table sets forth our derivatives measured at fair value and discloses the balance sheet location (in thousands):

 

    Asset     Liability  
  Balance Sheet location   September 30,
2015
    December 31,
2014
    September 30,
2015
    December 31,
2014
 
Fuel swaps designated as hedging instruments                                    
    Accrued expenses and other liabilities   $ 2,610     $     $ 101,328     $ 111,304  
    Other long-term liabilities     4,953       190       88,516       77,250  
Fuel swaps not designated as hedging instruments                                    
    Accrued expenses and other liabilities                 10,215        
Foreign currency forward contracts designated as hedging instruments                                    
    Prepaid expenses and other assets     988                    
    Other long-term assets     1,538                    
    Accrued expenses and other liabilities                 84,316       29,498  
    Other long-term liabilities                 11,933       118  
Foreign currency collar not designated as a hedging instrument                                    
    Accrued expenses and other liabilities                 35,392       16,744  
Interest rate swaps designated as hedging instruments                                    
    Accrued expenses and other liabilities                 5,626       5,736  
    Other long-term liabilities                 5,397       3,104  
Interest rate swap not designated as a hedging instrument                                    
    Accrued expenses and other liabilities                       3,823  

 

The fair values of swap and forward contracts are determined based on inputs that are readily available in public markets or can be derived from information available in publicly quoted markets. The Company determines the value of options and collars utilizing an option pricing model based on inputs that are either readily available in public markets or can be derived from information available in publicly quoted markets. The option pricing model used by the Company is an industry standard model for valuing options and is used by the broker/dealer community. The inputs to this option pricing model are the option strike price, underlying price, risk free rate of interest, time to expiration, and volatility. The fair value of option contracts considers both the intrinsic value and any remaining time value associated with those derivatives that have not yet settled. The Company also considers counterparty credit risk and its own credit risk in its determination of all estimated fair values. Our derivatives and financial instruments were categorized as Level 2 in the fair value hierarchy, and we had no derivatives or financial instruments categorized as Level 1 or Level 3 as of September 30, 2015 and December 31, 2014.

 

Our derivative contracts include rights of offset with our counterparties. We have elected to net certain assets and liabilities within counterparties. We are not required to post cash collateral related to our derivative instruments. The following table discloses the amounts recognized within the consolidated balance sheets (in thousands):

 

September 30, 2015   Gross Amounts     Gross
Amounts
Offset
    Total Net
Amounts
    Gross
Amounts Not
Offset
    Net Amounts  
Assets   $ 2,526     $     $ 2,526     $ (2,526 )   $  
Liabilities     342,723       (7,563 )     335,160       (142,664 )     192,496  

 

December 31, 2014   Gross Amounts     Gross
Amounts
Offset
    Total Net
Amounts
    Gross
Amounts Not
Offset
    Net Amounts  
Liabilities   $ 247,577     $ (190 )   $ 247,387     $ (59,023 )   $ 188,364  

 

Fuel Swaps

 

As of September 30, 2015, we had fuel swaps maturing through December 31, 2019 which are used to mitigate the financial impact of volatility in fuel prices pertaining to approximately 1.4 million metric tons of our projected fuel purchases.

 

The effects on the consolidated financial statements of the fuel swaps which were designated as cash flow hedges were as follows (in thousands):

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2015     2014     2015     2014  
Loss recognized in other comprehensive income (loss) – effective portion   $ (101,056 )   $ (27,777 )   $ (69,724 )   $ (25,938 )
Loss recognized in other income (expense) – ineffective portion     (1,580 )     (51 )     (10,825 )     (16 )
Amount reclassified from accumulated other comprehensive income (loss) into fuel expense     11,670       578       47,503       (1,345 )

 

As of September 30, 2015, we had bought fuel swaps pertaining to approximately 40,000 metric tons offset by sold fuel swaps which were not designated as cash flow hedges. The bought fuel swaps were previously designated as cash flow hedges and were dedesignated due to a change in our expected future fuel purchases mix.

 

The effects on the consolidated financial statements of the fuel swaps which were dedesignated and recognized into earnings were as follows (in thousands):

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2015     2014     2015     2014  
Amount reclassified from accumulated other comprehensive income (loss) into other income (expense)   $     $     $ 10,000     $  
Loss recognized in other income (expense)     (4,716 )           (4,716 )      

 

Fuel Collars and Options

 

We had fuel collars and fuel options maturing through December 2014, which were used to mitigate the financial impact of volatility in fuel prices of our fuel purchases.

 

The effects on the consolidated financial statements of the fuel collars which were designated as cash flow hedges were as follows (in thousands):

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2015     2014     2015     2014  
Loss recognized in other comprehensive income (loss) – effective portion   $     $ (127 )   $     $ (436 )
Gain recognized in other income (expense) – ineffective portion           4             111  
Amount reclassified from accumulated other comprehensive income (loss) into fuel expense           370       248       1,111  

 

The effects on the consolidated financial statements of the fuel options which were not designated as hedging instruments were as follows (in thousands):

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2015     2014     2015     2014  
Gain (loss) recognized in other income (expense)   $     $ (59 )   $     $ 127  

 

Foreign Currency Options

 

We had foreign currency options that matured through January 2014, which consisted of call options with deferred premiums. These options were used to mitigate the financial impact of volatility in foreign currency exchange rates related to our ship construction contracts denominated in euros. If the spot rate at the date the ships were delivered was less than the strike price under these option contracts, we would have paid the deferred premium and would not exercise the foreign currency options.

 

The effects on the consolidated financial statements of the foreign currency options which were designated as cash flow hedges were as follows (in thousands):

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2015     2014     2015     2014  
Loss recognized in other comprehensive income (loss) – effective portion   $     $     $     $ (1,157 )
Loss recognized in other income (expense) – ineffective portion                       (241 )
Amount reclassified from accumulated other comprehensive income (loss) into depreciation and amortization expense     330       330       990       938  

 

Foreign Currency Forward Contracts

 

As of September 30, 2015, we had foreign currency forward contracts which were used to mitigate the financial impact of volatility in foreign currency exchange rates related to our ship construction contracts and forecasted Dry-dock payments denominated in euros. The notional amount of our foreign currency forward contracts was €0.9 billion, or $1.0 billion based on the euro/U.S. dollar exchange rate as of September 30, 2015.

 

The effects on the consolidated financial statements of the foreign currency forward contracts which were designated as cash flow hedges were as follows (in thousands):

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2015     2014     2015     2014  
Loss recognized in other comprehensive income (loss) – effective portion   $ (1,519 )   $ (11,199 )   $ (61,966 )   $ (12,187 )
Loss recognized in other income (expense) – ineffective portion     (3 )           (10 )     (1 )
Amount reclassified from accumulated other comprehensive income (loss) into depreciation and amortization expense     (64 )     (63 )     (191 )     (180 )

 

We had a foreign currency forward contract related to a foreign currency financial instrument denominated in Norwegian kroner that matured in July 2015.

 

The effects on the consolidated financial statements of the foreign currency forward contract which was not designated as a cash flow hedge was as follows (in thousands):

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2015     2014     2015     2014  
Gain recognized in other income (expense)   $ 585     $     $ 684     $  

 

Foreign Currency Collar

 

We had a foreign currency collar that matured in January 2014, which was used to mitigate the volatility of foreign currency exchange rates related to our ship construction contracts denominated in euros.

 

The effects on the consolidated financial statements of the foreign currency collar which was designated as a cash flow hedge was as follows (in thousands):

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2015     2014     2015     2014  
Loss recognized in other comprehensive income (loss) – effective portion   $     $     $     $ (1,588 )
Amount reclassified from accumulated other comprehensive income (loss) into depreciation and amortization expense     (91 )     (91 )     (273 )     (242 )

 

As of September 30, 2015, we had a foreign currency collar which was used to mitigate the financial impact of volatility in foreign currency exchange rates related to a ship construction contract. The notional amount of our foreign currency collar was €274.4 million, or $306.7 million based on the euro/U.S. dollar exchange rate as of September 30, 2015.

 

The effect on the consolidated financial statements of the foreign currency collar contract which was not designated as a cash flow hedge was as follows (in thousands):

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2015     2014     2015     2014  
Gain (loss) recognized in other income (expense)   $ 955     $     $ (18,648 )   $  

 

Interest Rate Swaps

 

As of September 30, 2015, we had interest rate swap agreements to mitigate our exposure to interest rate movements and to manage our interest expense. The notional amount of outstanding debt associated with the interest rate swap agreements was $1.1 billion.

 

The effects on the consolidated financial statements of the interest rates swaps which were designated as cash flow hedges were as follows (in thousands):

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2015     2014     2015     2014  
Gain (loss) recognized in other comprehensive income (loss) – effective portion   $ (2,652 )   $ 1,302     $ (6,811 )   $ (3,054 )
Loss recognized in other income (expense) – ineffective portion     (9 )           (21 )      
Amount reclassified from accumulated other comprehensive income (loss) into interest expense, net     1,287       695       3,305       1,543  

 

We had an interest rate swap that matured in January 2015, which was used to mitigate our exposure to interest rate movements and to manage our interest expense.

 

The effect on the consolidated financial statements of the interest rate swap which was not designated as a cash flow hedge was as follows (in thousands):

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2015     2014     2015     2014  
Loss recognized in other income (expense)   $     $     $ (2 )   $  

 

Long-Term Debt

 

As of September 30, 2015 and December 31, 2014, the fair value of our long-term debt, including the current portion, was $5,765.7 million and $6,229.1 million, which was $82.6 million and $45.0 million higher, respectively, than the carrying values. The difference between the fair value and carrying value of our long-term debt is due to our fixed and variable rate debt obligations carrying interest rates that are above or below market rates at the measurement dates. The fair value of our long-term debt was calculated based on estimated rates for the same or similar instruments with similar terms and remaining maturities. The calculation of the fair value of our long-term debt is considered a Level 2 input.

 

Other

 

The carrying amounts reported in the consolidated balance sheets of all financial assets and liabilities other than our long-term debt approximate fair value.