Entries for 'hedge accounting'

There have been several recent announcements from Delta Airlines related to jet fuel and oil trading.

According to Reuters, Delta Air Lines Inc. reported a second quarter loss because it took $561 million in charges for fuel hedges.  Part of the loss was taken for mark-to-market adjustments on open hedge contracts. 

It appears that Delta has chosen not to apply FAS commodity hedge accounting treatment.  Many of the news reports called these derivative purchases “bets” when in fact they are hedges that reduce risk. 

If Delta used hedge accounting it would match the loss of open fuel derivative contracts against future jet fuel purchases and not show the loss in the current period. Hedge accounting is extremely complex, and an advanced, auditable software system is required to support the adoption of these procedures.

Separately but related to managing fuel cost and risk, Delta announced that it completed its acquisition of the Trainer Refinery in Pennsylvania through its Monroe Energy subsidiary.  Delta will move jet fuel from the refinery to its hub airports in the Northeast.  Additional refined products such as gasoline and diesel fuels will be traded for jet fuel in other parts of the country. Delta spent about $12 billion on jet fuel in 2011 and expects to serve 80% of its domestic jet fuel needs from the Trainer refinery and related deals.

Delta is the first airline to own refining capacity. It will be interesting to observe if other airlines follow suit and move to vertically integrate their energy supply chains. 

Supplying a refinery with crude oil and trading products requires sophisticated energy trading and risk management (ETRM) software.  With volatility seemingly increasing daily in the commodity and crude oil markets, it seems prudent for Delta to invest in a hedge accounting and oil trading and risk management platform.

Four years ago Triple Point acquired INSSINC, the leading commodity hedge accounting software solution, and integrated it into its energy trading and risk management (ETRM) software solution.  At that time, Triple Point recognized the need for an integrated commodity management platform that seamlessly integrates all key risk areas.

The new volatility reality demands that all industries with exposure to commodities and energy review their current risk systems to ensure they are appropriately protected. 

Out of all the changes put forth in IFRS 9 with regard to Hedge Accounting, one that will likely be well received will be the ability to hedge the risk components of non-financial items.  This is big news to many companies out there, in particular the foods industry and airlines.  Under IAS 39 and current FASB rules, they are not allowed to isolate the risk associated with a component of the risk being hedged.  For instance a company that produces baked goods must hedge the overall cost of flour and cannot simply isolate the cost of the wheat component to qualify for hedge accounting. Likewise, an airline cannot hedge crude oil as a component of it forecasted jet fuel requirement.

The current standard requires that the entity compare the entire change in value of the hedged item with the change in the value of the hedging contract to prove effectiveness.  Due to changes in other variable costs, such as milling costs in the case of flour, or refining margin, in the case of jet fuel, derivative contracts may not always correlate well.

Certainly, the economic aspects are intact regardless of whether or not the hedge actually qualifies for hedge accounting under the accounting standards. The consequences would be undesirable income volatility, since the gains or losses of unqualified derivatives must be taken into income immediately and would not match up with the actual timing of the risk being hedged. 

An important precept in IFRS 9 regarding component risk is that there is no need for a component to be contractually specified in order to be eligible for hedge accounting.  This should not be interpreted as an anything goes clause.  IFRS 9 guidance states that the component risk, when not contractually specified, must be “separately identifiable and reliably measurable”.  This will certainly be easier for some markets than others.  When the component risk isn’t clearly spelled out in a contractual specification, it may be require a bit of effort in determining the influence of individual components to price of the end product. 

As was the case under IAS-39, proper documentation is essential to qualify for hedge accounting.  From a hedge documentation perspective, you will need to clearly identify your risk if you are electing to hedge a component.  You will need to also state your method of assessing hedge effectiveness as well as your anticipated level of effectiveness.  Since IFRS 9 now allows the rebalancing of hedges, it will be necessary to fully document any hedging relationship changes on an ongoing basis.

 For many companies, where the economics and value of hedging have always been apparent, adopting IFRS 9 may now allow them to finally achieve the accounting benefits.

Now if only we can get to the long awaited convergence of IFRS and US GAAP, wouldn't that be nice?

For more information about hedging the risk components of non-financial items, see Ernst & Young’s Hedge accounting under IFRS 9 Guide (pages 8-10).


NFR Energy has licensed Triple Point’s Commodity XL™ software for hedge accounting and fair value disclosure to ensure FAS 133, FAS 157, and FAS 161 compliance.

NFR Energy engages in the acquisition, exploration, development, and production of oil and natural gas and has invested $1 billion in business development to establish a focused asset base.

“Triple Point has a proven track record of providing risk management software to E&P companies,” said Ash Elias, controller, NFR Energy. “We’re confident Triple Point is the best choice to deliver a turnkey solution that manages our hedge accounting requirements, including mark-to-market analysis, effectiveness testing, and fair value disclosure reporting.”

US GAAP and international accounting standards are continually evolving. In a stringent and unforgiving regulatory environment, getting it wrong can put company reputation, earnings, and stock value at risk.

“Companies that rely on homegrown hedge accounting systems face a herculean task of keeping up with complex standards and ensuring modifications are reflected accurately in their systems,” said Michel Zadoroznyj, VP, treasury and regulatory compliance, Triple Point. “Triple Point stays on the forefront of regulatory change to ensure its treasury software remains compliant and to enable our customers to focus on growth.”

In addition to NFR Energy, notable companies that have recently selected Triple Point software for hedge accounting and fair value disclosure include World Fuel Services, Hunt Oil, Evonik, Alta Mesa, Magellan Midstream, Unilever, Xcel Energy, and Petra Foods.


Procemin 10th International Mineral Processing Conference

October 15-18, 2013 | Chile

XXV Brazilian National Meeting of Mineral Treatment and Extractive Metallurgy (ENTMME)

October 20-24, 2013 | Brazil

Opinions expressed on this blog are those of its individual contributors, and do not necessarily reflect the views of Triple Point Technology, Inc.