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Buckeye Partners 10-Q 2015

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2
BPL 06.30.2015 10-Q

 
 
 
 
 
 
 
 
 
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 
FORM 10-Q
 
 

(Mark One)
ý      Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2015
OR 
o         Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from             to             
 Commission file number 1-9356 
 
Buckeye Partners, L.P.
(Exact name of registrant as specified in its charter)
 
Delaware
 
23-2432497
(State or other jurisdiction of
 
(IRS Employer
incorporation or organization)
 
Identification number)
 
 
 
One Greenway Plaza
 
 
Suite 600
 
 
Houston, TX
 
77046
(Address of principal executive offices)
 
(Zip Code)
 Registrant’s telephone number, including area code: (832) 615-8600
 
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 ý  No o 
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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý  No o
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. (Check one):
Large accelerated filer
ý
 
Accelerated filer o
Non-accelerated filer
o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o  No ý
As of July 27, 2015, there were 128,032,477 limited partner units outstanding.
 
 
 
 
 



TABLE OF CONTENTS
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1.
 
 
 
2.
 
 
 
3.
 
 
 
4.
 
 
 
5.
 
 
 
6.

 
 
7.
 
 
 
8.
 
 
 
9.
 
 
 
10.
 
 
 
11.
 
 
 
12.
 
 
 
13.
 
 
 
14.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2


PART I.  FINANCIAL INFORMATION 
Item 1.  Financial Statements 
BUCKEYE PARTNERS, L.P.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per unit amounts)
(Unaudited) 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
Revenue:
 

 
 

 
 

 
 

Product sales
$
458,613

 
$
1,492,697

 
$
1,198,831

 
$
3,170,439

Transportation, storage and other services
338,170

 
316,254

 
686,052

 
630,341

Total revenue
796,783

 
1,808,951

 
1,884,883

 
3,800,780

 
 
 
 
 
 
 
 
Costs and expenses:
 

 
 

 
 

 
 

Cost of product sales
448,534

 
1,510,043

 
1,166,073

 
3,175,422

Operating expenses
141,339

 
133,018

 
283,704

 
257,847

Depreciation and amortization
55,598

 
43,394

 
109,374

 
86,385

General and administrative
20,293

 
20,330

 
42,911

 
37,687

Total costs and expenses
665,764

 
1,706,785

 
1,602,062

 
3,557,341

Operating income
131,019

 
102,166

 
282,821

 
243,439

 
 
 
 
 
 
 
 
Other income (expense):
 

 
 

 
 

 
 

Earnings from equity investments
2,446

 
2,170

 
4,580

 
3,436

Interest and debt expense
(41,975
)
 
(42,012
)
 
(83,684
)
 
(83,225
)
Other income (expense)
77

 
(232
)
 
110

 
(96
)
Total other expense, net
(39,452
)
 
(40,074
)
 
(78,994
)
 
(79,885
)
Income from continuing operations before taxes
91,567

 
62,092

 
203,827

 
163,554

Income tax expense
(241
)
 
(153
)
 
(480
)
 
(76
)
Income from continuing operations
91,326

 
61,939

 
203,347

 
163,478

Loss from discontinued operations

 
(38,186
)
 
(857
)
 
(48,228
)
Net income
91,326

 
23,753

 
202,490

 
115,250

Less: Net loss (income) attributable to noncontrolling interests
254

 
(733
)
 
701

 
(1,762
)
Net income attributable to Buckeye Partners, L.P.
$
91,580

 
$
23,020

 
$
203,191

 
$
113,488

 
 
 
 
 
 
 
 
Basic earnings (loss) per unit attributable to Buckeye Partners, L.P.:
 

 
 

 
 

 
 

Continuing operations
$
0.72

 
$
0.53

 
$
1.60

 
$
1.40

Discontinued operations

 
(0.33
)
 
(0.01
)
 
(0.42
)
Total
$
0.72

 
$
0.20

 
$
1.59

 
$
0.98

 
 
 
 
 
 
 
 
Diluted earnings (loss) per unit attributable to Buckeye Partners, L.P.:
 

 
 

 
 

 
 

Continuing operations
$
0.71

 
$
0.53

 
$
1.60

 
$
1.39

Discontinued operations

 
(0.33
)
 
(0.01
)
 
(0.41
)
Total
$
0.71

 
$
0.20

 
$
1.59

 
$
0.98

 
 
 
 
 
 
 
 
Weighted average units outstanding:
 

 
 

 
 

 
 

Basic
127,650

 
116,078

 
127,414

 
115,701

Diluted
128,198

 
116,652

 
127,904

 
116,226

 
See Notes to Unaudited Condensed Consolidated Financial Statements.

3


BUCKEYE PARTNERS, L.P.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
Net income
$
91,326

 
$
23,753

 
$
202,490

 
$
115,250

Other comprehensive income (loss):
 

 
 

 
 

 
 

Unrealized losses on derivative instruments
(3,857
)
 
(9,208
)
 
(3,857
)
 
(18,812
)
Reclassification of derivative losses to net income
3,039

 
1,778

 
6,076

 
3,557

Recognition of costs related to benefit plans to net income
259

 
394

 
520

 
787

Total other comprehensive (loss) income
(559
)
 
(7,036
)
 
2,739

 
(14,468
)
Comprehensive income
90,767

 
16,717

 
205,229

 
100,782

Less: Comprehensive loss (income) attributable to noncontrolling interests
254

 
(733
)
 
701

 
(1,762
)
Comprehensive income attributable to Buckeye Partners, L.P.
$
91,021

 
$
15,984

 
$
205,930

 
$
99,020

 
See Notes to Unaudited Condensed Consolidated Financial Statements.


4


BUCKEYE PARTNERS, L.P.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except unit amounts)
(Unaudited)
 
 
June 30,
2015
 
December 31,
2014
Assets:
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
8,577

 
$
8,208

Accounts receivable, net
219,104

 
265,830

Construction and pipeline relocation receivables
12,595

 
20,542

Inventories
284,716

 
243,475

Derivative assets
12,408

 
69,189

Prepaid and other current assets
65,625

 
25,055

Total current assets
603,025

 
632,299

 
 
 
 
Property, plant and equipment, net
5,968,990

 
5,735,787

 
 
 
 
Equity investments
83,024

 
82,849

Goodwill
995,210

 
993,375

Intangible assets, net
521,812

 
553,924

Other non-current assets
79,881

 
87,854

Total assets
$
8,251,942

 
$
8,086,088

 
 
 
 
Liabilities and partners’ capital:
 

 
 

Current liabilities:
 

 
 

Line of credit
$
209,300

 
$
166,000

Accounts payable
95,851

 
159,129

Derivative liabilities
21,952

 
1,802

Accrued and other current liabilities
288,652

 
295,024

Total current liabilities
615,755

 
621,955

 
 
 
 
Long-term debt
3,574,555

 
3,388,986

Other non-current liabilities
125,082

 
134,551

Total liabilities
4,315,392

 
4,145,492

 
 
 
 
Commitments and contingencies (Note 3)

 

 
 
 
 
Partners’ capital:
 

 
 

Buckeye Partners, L.P. capital:
 

 
 

Limited Partners (128,030,831 and 127,043,317 units outstanding as of June 30, 2015 and December 31, 2014 respectively)
3,786,551

 
3,817,916

Accumulated other comprehensive loss
(112,549
)
 
(115,288
)
Total Buckeye Partners, L.P. capital
3,674,002

 
3,702,628

Noncontrolling interests
262,548

 
237,968

Total partners’ capital
3,936,550

 
3,940,596

Total liabilities and partners’ capital
$
8,251,942

 
$
8,086,088

 
See Notes to Unaudited Condensed Consolidated Financial Statements.


5


BUCKEYE PARTNERS, L.P.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited) 
 
Six Months Ended 
 June 30,
 
2015
 
2014
Cash flows from operating activities:
 

 
 

Net income
$
202,490

 
$
115,250

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 

 
 

Depreciation and amortization
109,374

 
86,385

Asset impairment expense

 
26,254

Litigation contingency accrual
13,500

 

Net changes in fair value of derivatives
73,238

 
(6,332
)
Non-cash deferred lease expense

 
1,819

Amortization of unfavorable storage contracts
(5,536
)
 
(5,536
)
Earnings from equity investments
(4,580
)
 
(3,436
)
Distributions from equity investments
4,258

 
125

Other non-cash items
22,761

 
12,037

Change in assets and liabilities, net of amounts related to acquisitions:
 

 
 

Accounts receivable
43,848

 
(65,718
)
Construction and pipeline relocation receivables
7,947

 
962

Inventories
(38,922
)
 
(131,774
)
Prepaid and other current assets
(43,226
)
 
19,244

Accounts payable
(69,211
)
 
(26,708
)
Accrued and other current liabilities
(21,898
)
 
12,264

Other non-current assets
2,244

 
(5,739
)
Other non-current liabilities
(4,685
)
 
(6,977
)
Net cash provided by operating activities
291,602

 
22,120

Cash flows from investing activities:
 

 
 

Capital expenditures
(298,414
)
 
(201,515
)
Acquisitions, net of working capital settlement
(2,921
)
 

Net proceeds from insurance settlement

 
549

Proceeds from disposal of property, plant and equipment
13

 
691

Net cash used in investing activities
(301,322
)
 
(200,275
)
Cash flows from financing activities:
 

 
 

Net proceeds from issuance of LP Units
62,414

 
74,517

Net proceeds from exercise of Unit options
173

 
615

Payment of tax withholding on issuance of LTIP awards
(6,539
)
 
(4,791
)
Debt issuance costs
(365
)
 

Borrowings under BPL Credit Facility
832,000

 
847,000

Repayments under BPL Credit Facility
(647,000
)
 
(631,000
)
Net borrowings under BMSC Credit Facility
43,300

 
174,000

Acquisition of additional interest in WesPac Memphis
(10,044
)
 
(9,510
)
Contributions from noncontrolling interests
30,000

 

Distributions paid to noncontrolling interests
(3,218
)
 
(3,549
)
Distributions paid to unitholders
(290,632
)
 
(252,171
)
Net cash provided by financing activities
10,089

 
195,111

Net increase in cash and cash equivalents
369

 
16,956

Cash and cash equivalents — Beginning of period
8,208

 
4,950

Cash and cash equivalents — End of period
$
8,577

 
$
21,906

 
See Notes to Unaudited Condensed Consolidated Financial Statements.

6


BUCKEYE PARTNERS, L.P.
CONDENSED CONSOLIDATED STATEMENTS OF PARTNERS’ CAPITAL
(In thousands)
(Unaudited)
 
 
 
 
Accumulated
 
 
 
 
 
 
 
Other
 
 
 
 
 
Limited
 
Comprehensive
 
Noncontrolling
 
 
 
Partners
 
Income (Loss)
 
Interests
 
Total
Partners’ capital - January 1, 2015
$
3,817,916

 
$
(115,288
)
 
$
237,968

 
$
3,940,596

Net income (loss)
203,191

 

 
(701
)
 
202,490

Acquisition of additional interest in WesPac Memphis
(8,276
)
 

 
(1,768
)
 
(10,044
)
Adjustment to value of noncontrolling equity interest in acquisition

 

 
(1,220
)
 
(1,220
)
Distributions paid to unitholders
(292,467
)
 

 
1,835

 
(290,632
)
Net proceeds from issuance of LP Units
62,414

 

 

 
62,414

Amortization of unit-based compensation awards
11,134

 

 

 
11,134

Net proceeds from exercise of Unit options
173

 

 

 
173

Payment of tax withholding on issuance of LTIP awards
(6,539
)
 

 

 
(6,539
)
Distributions paid to noncontrolling interests

 

 
(3,218
)
 
(3,218
)
Contributions from noncontrolling interests

 

 
30,000

 
30,000

Other comprehensive income

 
2,739

 

 
2,739

Noncash accrual for distribution equivalent rights
(1,361
)
 

 

 
(1,361
)
Other
366

 

 
(348
)
 
18

Partners' capital - June 30, 2015
$
3,786,551

 
$
(112,549
)
 
$
262,548

 
$
3,936,550

 
 
 
 
 
 
 
 
Partners’ capital - January 1, 2014
$
3,169,217

 
$
(103,552
)
 
$
15,171

 
$
3,080,836

Net income
113,488

 

 
1,762

 
115,250

Acquisition of additional interest in WesPac Memphis
(7,933
)
 

 
(1,577
)
 
(9,510
)
Distributions paid to unitholders
(253,849
)
 

 
1,678

 
(252,171
)
Net proceeds from issuance of LP Units
74,517

 

 

 
74,517

Amortization of unit-based compensation awards
8,190

 

 

 
8,190

Net proceeds from exercise of Unit options
615

 

 

 
615

Payment of tax withholding on issuance of LTIP awards
(4,791
)
 

 

 
(4,791
)
Distributions paid to noncontrolling interests

 

 
(3,549
)
 
(3,549
)
Other comprehensive loss

 
(14,468
)
 

 
(14,468
)
Noncash accrual for distribution equivalent rights
(666
)
 

 

 
(666
)
Other
20

 

 
(73
)
 
(53
)
Partners' capital - June 30, 2014
$
3,098,808

 
$
(118,020
)
 
$
13,412

 
$
2,994,200

 
See Notes to Unaudited Condensed Consolidated Financial Statements.


7


BUCKEYE PARTNERS, L.P.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
1. ORGANIZATION AND BASIS OF PRESENTATION
 
Organization
 
Buckeye Partners, L.P. is a publicly traded Delaware master limited partnership and its limited partnership units representing limited partner interests (“LP Units”) are listed on the New York Stock Exchange (“NYSE”) under the ticker symbol “BPL.”  Buckeye GP LLC (“Buckeye GP”) is our general partner.  As used in these Notes to Unaudited Condensed Consolidated Financial Statements, “we,” “us,” “our” and “Buckeye” mean Buckeye Partners, L.P. and, where the context requires, includes our subsidiaries.
 
Buckeye owns and operates a diversified network of integrated assets providing midstream logistic solutions, primarily consisting of the transportation, storage and marketing of liquid petroleum products.  We are one of the largest independent liquid petroleum products pipeline operators in the United States in terms of volumes delivered, miles of pipeline and active products terminals across our portfolio of pipelines, inland terminals and marine terminals located primarily in the East Coast and Gulf Coast regions of the United States and in the Caribbean.  Our flagship marine terminal in The Bahamas, Bahamas Oil Refining Company International Limited (“BORCO”), is one of the largest marine crude oil and refined petroleum products storage facilities in the world and provides an array of logistics and blending services for petroleum products.  Our network of marine terminals enables us to facilitate global flows of crude oil, refined petroleum products, and other commodities, and to offer our customers connectivity to some of the world’s most important bulk storage and blending hubs.  In September 2014, we expanded our network of marine midstream assets by acquiring a controlling interest in a company with assets located in Corpus Christi and the Eagle Ford play in Texas.  We are also a wholesale distributor of refined petroleum products in certain areas served by our pipelines and terminals.  Finally, Buckeye operates and/or maintains third-party pipelines under agreements with major oil and gas, petrochemical and chemical companies, and performs certain engineering and construction management services for third parties.
 
On December 31, 2014, we completed the sale of our Natural Gas Storage disposal group and have reported the final working capital adjustments as discontinued operations in the first quarter of 2015. For additional information, see our Annual Report on Form 10-K for the year ended December 31, 2014.
 
Basis of Presentation and Principles of Consolidation
 
The unaudited condensed consolidated financial statements and the accompanying notes are prepared in accordance with U.S. generally accepted accounting principles and the rules of the U.S. Securities and Exchange Commission.  Accordingly, our financial statements reflect all normal and recurring adjustments that are, in the opinion of management, necessary for a fair presentation of our results of operations for the interim periods.  The unaudited condensed consolidated financial statements include the accounts of our subsidiaries controlled by us and variable interest entities (“VIE”) of which we are the primary beneficiary. We have eliminated all intercompany transactions in consolidation.
 
We believe that the disclosures in these unaudited condensed consolidated financial statements are adequate to make the information presented not misleading.  These interim financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2014.

Recent Accounting Developments

Revenue from Contracts with Customers. In July 2015, the Financial Accounting Standards Board (“FASB”) deferred the effective date of guidance that was originally issued in May 2014 to clarify principles used to recognize revenue for all entities. The guidance is now effective for annual and interim periods beginning after December 15, 2017, with early adoption permitted for annual and interim periods beginning after December 15, 2016. The standard’s core principle is that an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In doing so, entities will need to use more judgment and make more estimates than under current guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration included in the transaction price and/or allocating the transaction price to each separate performance obligation. We are currently evaluating the impact the adoption of this guidance will have on our consolidated financial statements.

8


 
Debt Issuance Costs. In April 2015, the FASB issued guidance to simplify the presentation of debt issuance costs. The amendments require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The guidance is effective for annual reporting periods beginning after December 15, 2015, and interim periods within those annual periods, with early adoption permitted. We are currently evaluating the impact the adoption of this guidance will have on our consolidated financial statements.

Consolidations. In February 2015, the FASB issued guidance changing the criteria for reporting entities that are required to evaluate whether they should consolidate certain legal entities. The amendments require additional testing to determine if a legal entity qualifies as a VIE and whether the entity should be consolidated. These provisions are effective prospectively for annual reporting periods beginning after December 15, 2015, and interim periods within those annual periods, with early adoption permitted. We are currently evaluating the impact the adoption of this guidance will have on our consolidated financial statements.

2. ACQUISITIONS
 
Business Combinations
 
2015 Transaction
 
In May 2015, we acquired a pipeline in Springfield, Massachusetts from ExxonMobil Oil Corporation ("ExxonMobil") for $5.8 million.  The operations of this asset are reported in the Pipelines & Terminals segment and complement the Springfield terminal also purchased from ExxonMobil for $2.0 million in the first quarter of 2015. We valued these acquisitions as a single portfolio of assets. The acquisition cost has been allocated on a preliminary basis to assets acquired based on estimated fair values at the acquisition date, with amounts exceeding the fair value recorded as goodwill, which represents both expected synergies from combining the acquired assets with our existing operations and the economic value attributable to optimizing, modernizing and commercializing the asset from this acquisition. Fair values have been developed using recognized business valuation techniques.  The estimates of fair value reflected as of June 30, 2015 are subject to change pending final valuation analysis.  The purchase price has been allocated to tangible and intangible assets acquired as follows (in thousands):

Property, plant and equipment
$
5,541

Goodwill
7,114

Asset retirement obligation
(4,200
)
Environmental liabilities
(653
)
  Allocated purchase price
$
7,802


Unaudited Pro forma Financial Results for the Springfield pipeline and terminal acquisition

Our consolidated statements of operations do not include earnings from the pipeline and terminal acquired from ExxonMobil prior to March 31, 2015 and May 5, 2015, the effective acquisition dates of the terminal and pipeline acquired from ExxonMobil, respectively. The preparation of unaudited pro forma financial information for the terminal and pipeline acquired from ExxonMobil is impracticable due to the fact that ExxonMobil historically operated the assets as part of its integrated distribution network and, therefore, meaningful historical revenue information is not available. The revenues and earnings impact of this acquisition was not significant to our financial results for the three and six months ended June 30, 2015.


9


2014 Transaction
 
In September 2014, we acquired an 80% interest in Buckeye Texas Partners LLC (“Buckeye Texas”), a newly-formed entity, for $816.1 million, net of cash acquired of $15.0 million and settlement of working capital and capital expenditure adjustments of $4.9 million required by the contribution agreement with Trafigura Corpus Christi Holdings Inc. (the “Buckeye Texas Partners Transaction”).  Buckeye Texas and its subsidiaries, which are owned jointly with Trafigura Trading LLC, formerly known as Trafigura AG (“Trafigura”), are constructing a vertically integrated system of midstream assets including a deep-water, high volume marine terminal located on the Corpus Christi Ship Channel, a condensate splitter and liquefied petroleum gas storage complex in Corpus Christi, Texas and three crude oil and condensate gathering facilities in the Eagle Ford play. The initial build-out of these facilities has been and continues to be funded through additional partnership contributions by us and Trafigura based on our respective ownership interests.  Concurrent with this acquisition, we entered into multi-year storage and throughput commitments with Trafigura that support substantially all the capacity and cash flows expected from these assets.  Buckeye Texas does not have sufficient resources to complete its initial build-out and activities without financial support of its joint owners. Accordingly, we concluded Buckeye Texas is a VIE of which we are the primary beneficiary.  In making this conclusion, we evaluated the activities that significantly impact the economics of the VIE, including our role to perform all services reasonably required to construct, operate and maintain the assets.  We consolidated Buckeye Texas due to our conclusion that Buckeye Texas is a VIE of which we are the primary beneficiary. The operations of these assets are reported in the Global Marine Terminals segment.
 
The acquisition cost has been allocated on a preliminary basis to assets acquired and liabilities assumed based on estimated fair values at the acquisition date, with amounts exceeding the fair value recorded as goodwill, which represents both expected synergies from combining the Buckeye Texas operations with our existing operations and the economic value attributable to future expansion projects resulting from this acquisition. Fair values have been developed using recognized business valuation techniques.  The estimates of fair value reflected as of June 30, 2015 are subject to change pending final valuation analysis.  The purchase price has been allocated to tangible and intangible assets acquired and liabilities assumed as follows (in thousands):
Current assets
$
23,087

Property, plant and equipment
527,390

Intangible assets
376,000

Goodwill
167,353

Current liabilities
(54,943
)
Noncontrolling interests
(207,778
)
Allocated purchase price
$
831,109

 
The pro forma impact of this acquisition was not significant to our financial results for the three and six months ended June 30, 2015 or 2014, as significant assets are still under construction.

Acquisition of Remaining Interest in WesPac Pipelines — Memphis LLC
 
In April 2015, our operating subsidiary, Buckeye Pipe Line Holdings, L.P. (“BPH”), purchased from Kealine LLC for $10.0 million the remaining 10% ownership interest in WesPac Pipelines — Memphis LLC (“WesPac Memphis”), which was accounted for as an equity transaction.  As a result of the acquisition, we now own 100% of WesPac Memphis.

3. COMMITMENTS AND CONTINGENCIES
 
Claims and Legal Proceedings
 
In the ordinary course of business, we are involved in various claims and legal proceedings, some of which are covered by insurance.  We are generally unable to predict the timing or outcome of these claims and proceedings.  Based upon our evaluation of existing claims and proceedings and the probability of losses relating to such contingencies, we have accrued certain amounts relating to such claims and proceedings, none of which are considered material.
 

10


Pennsauken Allisions.  Our terminal located in Pennsauken, New Jersey suffered two allisions in the second half of 2014.  The first occurred on August 5, 2014, when a vessel allided with our terminal’s ship dock.  Reconstruction of the dock has been completed and service has commenced. The aggregate cost to reconstruct the dock was approximately $8.0 million. Security for our claim has been provided by the vessel owner’s insurers, in the amount of $19.0 million, reserving all of their defenses.  We have commenced litigation against the vessel and its owner. They have stipulated to liability, so the only issue is the amount of Buckeye’s damages. The second incident occurred on October 5, 2014, when a tug and barge struck and damaged a second dock operated at the Pennsauken facility.  The tug and barge owners have commenced proceedings to limit their liability to $1.0 million and $5.0 million, respectively. We have filed claims in the limitation proceedings for the reconstruction of the second dock and response costs totaling approximately $7.0 million. We also are suffering loss-of-use damages as a result of the above allisions as the two incidents together have impacted the ability of vessels to call at the terminal. In order to mitigate these business losses, we have made modifications to two other berths at a cost of $1.3 million. Recovery for both the mitigation costs and business losses is being sought jointly from all of the respective responsible parties. Investigation of the incidents as well as our rights to recover our losses are ongoing.  We are insured for all property damage losses with respect to the allisions, subject to a $10.0 million deductible per occurrence. We also are insured for loss of use, subject to a 30 day deductible. The loss of use insurers are involved in the recovery efforts. As of June 30, 2015 we had $2.7 million included in “Other non-current assets” in our unaudited condensed consolidated balance sheet, representing expected reimbursement from third parties for mitigation costs and the loss of use.

BORCO Jetty.  On May 25, 2012, a ship, Cape Bari, allided with a jetty at our BORCO facility while berthing, causing damage to portions of the jetty.  Buckeye has insurance to cover this loss, subject to a $5.0 million deductible.  On May 26, 2012, we commenced legal proceedings in The Bahamas against the vessel’s owner and the vessel to obtain security for the cost of repairs and other losses incurred as a result of the incident.  Full security for our claim has been provided by the vessel owner’s insurers, reserving all of their defenses.  We also have notified the customer on whose behalf the vessel was at the BORCO facility that we intend to hold them responsible for all damages and losses resulting from the incident pursuant to the terms of an agreement between the parties.  Any disputes between us and our customer on this matter will be arbitrated in New York, New York.
 
The vessel owner has claimed that it is entitled to limit its liability to $17.0 million, but we are contesting the right of the vessel owner to such limitation.  The Bahamas court of first instance denied the vessel owner the right to limit its liability for the incident, leaving the vessel owner responsible for all provable damages.  The vessel owner appealed, and The Bahamas Court of Appeals reversed, holding that the vessel owner may limit its liability.  Our application for leave to appeal the Court of Appeals’ decision to the Privy Council was granted, and the appeal has been filed.  We can express no view on whether The Bahamas Court of Appeals decision ultimately will be affirmed or reversed.
 
We experienced no material interruption of service at the BORCO facility as a result of the incident, and the repairs and reconstruction of the damaged sections are complete.
 
The aggregate cost to repair and reconstruct the damaged portions of the jetty and pursue recovery in court has been $23.0 million.  We recorded a loss on disposal due to the assets destroyed in the incident and other related costs incurred; however, since we believe recovery of our losses is probable, we recorded a corresponding receivable.  As of June 30, 2015, we had a $6.3 million receivable included in “Other non-current assets” in our unaudited condensed consolidated balance sheet, representing reimbursement of the deductible and other third party expenses.  Additionally, we have received insurance reimbursements of $16.0 million, and to the extent the aggregate proceeds from the recovery of our losses is in excess of the carrying value of the destroyed assets or other costs incurred, we will recognize a gain when such proceeds are received and are not refundable.  Our insurers have paid most of the claim and are now parties in The Bahamas litigation.  As of June 30, 2015, no gain had been recognized; however, we recorded a $14.1 million deferred gain in “Accrued and other current liabilities” in our unaudited condensed consolidated balance sheet, representing excess proceeds received over the loss on disposal and other costs incurred.
 
On May 12, 2014, the vessel owner filed a third-party complaint against BORCO and a BORCO subsidiary, Borco Towing Company Limited, alleging negligence by the pilots and tugs that assisted the Cape Bari berth.  We have investigated these allegations and believe that we have defenses and intend to defend ourselves and pursue our claims against the vessel owner. BORCO and Borco Towing Company Limited are insured for the alleged liability, subject to an applicable deductible, and the liability insurers are participating in the defense.


11


 Federal Energy Regulatory Commission (“FERC”) Proceedings

FERC Docket No. OR12-28-000 Airlines Complaint against Buckeye Pipe Line Company, L.P. (“BPLC”) New York City Jet Fuel Rates.  On September 20, 2012, a complaint was filed with FERC by Delta Air Lines, JetBlue Airways, United/Continental Air Lines, and US Airways challenging BPLC’s rates for transportation of jet fuel from New Jersey to three New York City airports.  The complaint was not directed at BPLC’s rates for service to other destinations and does not involve pipeline systems and terminals owned by Buckeye’s other operating subsidiaries.  The complaint challenges these jet fuel transportation rates as generating revenues in excess of costs and thus being “unjust and unreasonable” under the Interstate Commerce Act.  On October 10, 2012, BPLC filed its answer to the complaint, contending that the airlines’ allegations are based on inappropriate adjustments to the pipeline’s costs and revenues, and that, in any event, any revenue recovery by BPLC in excess of costs would be irrelevant because BPLC’s rates are set under a FERC-approved program that ties rates to competitive levels.  BPLC also sought dismissal of the complaint to the extent it seeks to challenge the portion of BPLC’s rates that were deemed just and reasonable, or “grandfathered,” under Section 1803 of the Energy Policy Act of 1992.  BPLC further contested the airlines’ ability to seek relief as to past charges where the rates are lawful under BPLC’s FERC-approved rate program.  On October 25, 2012, the complainants filed their answer to BPLC’s motion to dismiss and answer.  On November 9, 2012, BPLC filed a response addressing newly raised arguments in the complainants’ October 25th answer.  On February 22, 2013, FERC issued an order setting the airline complaint in Docket (“Dkt.”) No. OR12-28-000 for hearing, but holding the hearing in abeyance and setting the dispute for settlement procedures before a settlement judge.  If FERC were to find these challenged rates to be in excess of costs and not otherwise protected by law, it could order BPLC to reduce these rates prospectively and could order repayment to the complaining airlines of any past charges found to be in excess of just and reasonable levels for up to two years prior to the filing date of the complaint.  BPLC intends to vigorously defend its rates. On March 8, 2013, an order was issued consolidating, for settlement purposes, this complaint proceeding with the proceeding regarding BPLC’s application for market-based rates in the New York City market in Dkt. No. OR13-3-000 (discussed below), and settlement discussions under the supervision of the FERC settlement judge continued until April 2014.  On April 1, 2014, the FERC settlement judge issued a status report stating that the parties had been unable to reach a settlement, and recommending that both Dkt. Nos. OR12-28-000 and OR13-3-000 be set for hearing.  The settlement judge further recommended that settlement procedures under the supervision of the settlement judge continue concurrently because the parties hope to continue settlement talks after the commencement of litigation.  On April 17, 2014, the FERC Chief Administrative Law Judge (the “ALJ”) ruled in favor of separate proceedings and of continuing the existing settlement procedures concurrently with litigation.  In May 2014, a procedural schedule was established for this matter, providing for a hearing in March 2015, which occurred, and an initial decision by August 2015.  The hearing was concluded on April 1, 2015. As a result of developments in ongoing settlement talks regarding Dkt. Nos. OR12-28-000, OR13-3-000 (discussed below) and OR 14-41-000 (discussed below), we recorded an accrual and a corresponding reduction in revenue in the amount of $40.0 million in the quarter ended December 31, 2014 in our Pipelines & Terminals segment.

On June 19, 2015, BPLC and the airlines submitted an Offer of Settlement at the FERC (the “Settlement”) that would, if approved, resolve the complaints set for hearing in Dkt. Nos. OR12-28-000, et al. and OR14-41-000, as well as BPLC’s application in Dkt. No. OR13-3-000. Under the terms of the Settlement, BPLC has agreed to reduce its jet fuel rates prospectively, to make settlement payments to the airlines, to install facilities to increase the flexibility and capacity of its system in shipping jet fuel to John F. Kennedy International Airport, and to resolve its application in Dkt. No. OR13-3-000 as described further below. The timing and outcome of FERC’s review of the Settlement cannot be predicted at this time. As a result of submission of the Settlement, we recorded an additional accrual and corresponding reduction in revenue in the amount of $13.5 million in the quarter ended June 30, 2015 in our Pipelines & Terminals segment, which, together with the previously recorded $40.0 million reduction in revenue, represents anticipated settlement payments and other expenses associated with the Settlement.
 
FERC Docket No. OR14-41-000 — American Airlines Complaint against BPLC New York City Jet Fuel Rates.  On September 17, 2014, a complaint was filed with FERC by American Airlines.  It is similar to the Dkt. No. OR12-28-000 complaint (see above) in that it challenges BPLC’s rates for transportation of jet fuel from New Jersey to the three New York City airports, is not directed at BPLC’s rates for service to other destinations, and does not involve pipeline systems and terminals owned by Buckeye’s other operating subsidiaries.  The complaint’s allegations are virtually identical to those in the other airline complaint proceeding.  On October 7, 2014, BPLC filed its answer to the complaint, contesting the airline’s allegations and presenting certain legal defenses to relief sought by the airline.  On December 18, 2014, FERC issued an order setting the complaint for hearing, but holding the hearing in abeyance and setting the dispute for settlement procedures before a settlement judge. As noted above, a proposed settlement to resolve this complaint is pending before the FERC.
 

12


FERC Docket No. OR13-3-000 — BPLC’s Market-Based Rate Application.  On October 15, 2012, BPLC filed an application with FERC seeking authority to charge market-based rates for deliveries of liquid petroleum products to the New York City-area market (the “Application”).  In the Application, BPLC seeks to charge market-based rates from its three origin points in northeastern New Jersey to its five destinations on its Long Island System, including deliveries of jet fuel to the Newark, LaGuardia, and JFK airports.  The jet fuel rates were also the subject of the airlines’ Dkt. No. OR12-28-000 complaint discussed above.  On December 14, 2012, Delta Air Lines, JetBlue Airways, United/Continental Air Lines, and US Airways filed a joint intervention and protest challenging the Application and requesting its rejection.  On January 14, 2013, BPLC filed its answer to the protest and requested summary disposition as to those non-jet-fuel rates that were not challenged in the protest.  On January 29, 2013, the protestants responded to BPLC’s answer, and on February 13, 2013, BPLC filed a further answer to the protestants’ January 29, 2013 pleading.  On February 28, 2013, FERC issued an order setting the Application for hearing, holding the hearing in abeyance and setting the dispute for settlement procedures before a settlement judge.  As discussed above, the Application has been consolidated with the complaint proceeding in Dkt. No. OR12-28-000 for settlement purposes and the settlement judge has reported to the FERC and the Chief ALJ that the application should be set for hearing.  The settlement judge also recommended that settlement procedures under the supervision of the settlement judge continue concurrently because the parties hope to continue settlement talks after the commencement of litigation.  As noted above, the FERC Chief ALJ ruled that Dkt. No. OR13-3-000 would proceed separately from the Dkt. No. OR12-28-000 proceeding and that the existing settlement procedures would continue concurrently with litigation.  If FERC were to approve the Application, BPLC would be permitted prospectively to set these rates in response to competitive forces, and the basis for the airlines’ claim for relief in their Dkt. No. OR12-28-000 complaint as to BPLC’s future rates would be irrelevant prospectively. 

As noted above, BPLC and the airlines have submitted an Offer of Settlement to the FERC that would, if approved, resolve the Airlines’ objections to the Application. Under the terms of the Settlement, and in connection with the resolution of challenges to the jet fuel rates by the airlines in the complaint dockets discussed separately above, Buckeye would agree, inter alia, to withdraw the portions of the Application addressing transportation of jet fuel within the New York City market, including transportation of jet fuel to the three airports, while remaining free to pursue market-based rates for transportation of other refined petroleum products to other destinations within the New York City market. The timing and outcome of the FERC’s review of the Settlement cannot be predicted at this time.

Environmental Contingencies
 
We recorded operating expenses, net of insurance recoveries, of $1.3 million and $1.6 million during the three months ended June 30, 2015 and 2014, respectively, related to environmental remediation liabilities unrelated to claims and legal proceedings.  For the six months ended June 30, 2015 and 2014, we recorded operating expenses, net of recoveries, of $2.7 million and $2.2 million, respectively, related to environmental remediation liabilities unrelated to claims and legal proceedings.  As of June 30, 2015 and December 31, 2014, we recorded environmental remediation liabilities of $50.2 million and $52.3 million, respectively.  Costs incurred may be in excess of our estimate, which may have a material impact on our financial condition, results of operations or cash flows.  At June 30, 2015 and December 31, 2014, we had $14.4 million and $13.6 million, respectively, of receivables related to these environmental remediation liabilities covered by insurance or third party claims.
 
4. INVENTORIES
 
Our inventory amounts were as follows at the dates indicated (in thousands):
 
June 30,
2015
 
December 31,
2014
Liquid petroleum products (1)
$
268,093

 
$
226,898

Materials and supplies
16,623

 
16,577

Total inventories
$
284,716

 
$
243,475

                                                      
(1)
Ending inventory was 141.6 million and 140.3 million gallons of liquid petroleum products as of June 30, 2015 and December 31, 2014, respectively.
 

13


At June 30, 2015 and December 31, 2014, approximately 92% and 90% of our liquid petroleum products inventory volumes were designated in a fair value hedge relationship, respectively.  Because we generally designate inventory as a hedged item upon purchase, hedged inventory is valued at current market prices with the change in value of the inventory reflected in our unaudited condensed consolidated statements of operations.  Our inventory volumes that are not designated as the hedged item in a fair value hedge relationship are economically hedged to reduce our commodity price exposure.  Inventory not accounted for as a fair value hedge is accounted for at the lower of cost or market using the weighted average cost method.

5. PREPAID AND OTHER CURRENT ASSETS
 
Prepaid and other current assets consist of the following at the dates indicated (in thousands):
 
June 30,
2015
 
December 31,
2014
Prepaid insurance
$
12,792

 
$
9,918

Margin deposits
29,727

 

Unbilled revenue
3,385

 
3,556

Prepaid taxes
4,692

 
2,492

Vendor prepayments
150

 
136

Other
14,879

 
8,953

Total prepaid and other current assets
$
65,625

 
$
25,055


6. EQUITY INVESTMENTS
 
The following table presents earnings from equity investments for the periods indicated (in thousands): 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
West Shore Pipe Line Company
$
2,398

 
$
1,523

 
$
4,176

 
$
2,183

Muskegon Pipeline LLC
(671
)
 
322

 
(584
)
 
571

Transport4, LLC
305

 
186

 
273

 
253

South Portland Terminal LLC
414

 
139

 
715

 
429

Total earnings from equity investments
$
2,446

 
$
2,170

 
$
4,580

 
$
3,436

 
Summarized combined income statement data for our equity method investments are as follows for the periods indicated (amounts represent 100% of investee income statement data in thousands): 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
Revenue
$
22,874

 
$
21,771

 
$
44,346

 
$
41,465

Costs and expenses
(16,876
)
 
(13,223
)
 
(26,614
)
 
(24,645
)
Non-operating expenses
(3,361
)
 
(2,859
)
 
(7,657
)
 
(5,580
)
Net income
$
2,637

 
$
5,689

 
$
10,075

 
$
11,240

 

14


7. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
 
We are exposed to financial market risks, including changes in commodity prices, in the course of our normal business operations.  We use derivative instruments such as forwards, futures and other contracts to manage the risk of market price volatility associated with physical commodity inventory and expected future transactions. The majority of our futures contracts are used to hedge refined petroleum product inventories and are designated as fair value hedges with changes in fair value of both the futures contracts and physical inventory reflected in earnings. Other futures contracts are used to hedge certain expected future transactions and are designated as cash flow hedges with the effective portion of the hedge reported in other comprehensive income ("OCI") and reclassified into earnings when the expected future transaction affects earnings. In both cases, any gains or losses incurred on the derivative instrument that are not effective in offsetting changes in fair value or cash flows of the hedged item are recognized immediately in earnings. Physical forward contracts and futures contracts that have not been designated in a hedge relationship are marked-to-market.
 
Commodity Derivatives

Our Merchant Services segment primarily uses exchange-traded refined petroleum product futures contracts to manage the risk of market price volatility on its refined petroleum product inventories and its physical derivative contracts which we designate as fair value hedges. In the second quarter of 2015, our Pipelines & Terminals segment designated exchange-traded refined petroleum product futures contracts as cash flow hedges. These hedges were executed to manage the risk of market price volatility on the narrowing gasoline-to-butane pricing spreads associated with our butane blending activities managed by a third party.
The following table summarizes our commodity derivative instruments outstanding at June 30, 2015 (amounts in thousands of gallons):
 
Volume (1)
 
Accounting
Derivative Purpose 
Current
 
Long-Term
 
Treatment
Derivatives NOT designated as hedging instruments:
 

 
 

 
 
Physical fixed price derivative contracts
21,517

 
728

 
Mark-to-market
Physical index derivative contracts
47,319

 

 
Mark-to-market
Futures contracts for refined petroleum products
33,171

 
1,428

 
Mark-to-market
 
 
 
 
 
 
Derivatives designated as hedging instruments:
 

 
 

 
 
Futures contracts for refined petroleum products
130,109

 

 
Fair Value Hedge
Futures contracts for refined petroleum products
33,600

 

 
Cash Flow Hedge
                                                      
 (1)         Volume represents absolute value of net notional volume position.



15


The following table sets forth the fair value of each classification of derivative instruments and the locations of the derivative instruments on our unaudited condensed consolidated balance sheets at the dates indicated (in thousands):
 
June 30, 2015
 
Derivatives
NOT Designated
as Hedging
Instruments
 
Derivatives
Designated
as Hedging
Instruments
 
Derivative
Carrying
Value
 
Netting
Balance
Sheet
Adjustment (1)
 
Net Total
Physical fixed price derivative contracts
$
12,574

 
$

 
$
12,574

 
$
(352
)
 
$
12,222

Physical index derivative contracts
237

 

 
237

 
(51
)
 
186

Futures contracts for refined products
24,565

 
6,489

 
31,054

 
(31,054
)
 

Total current derivative assets
37,376

 
6,489

 
43,865

 
(31,457
)
 
12,408

 
 
 
 
 
 
 
 
 
 
Physical fixed price derivative contracts
57

 

 
57

 
(1
)
 
56

Futures contracts for refined products
112

 

 
112

 
(10
)
 
102

Total non-current derivative assets
169

 

 
169

 
(11
)
 
158

 
 
 
 
 
 
 
 
 
 
Physical fixed price derivative contracts
(948
)
 

 
(948
)
 
352

 
(596
)
Physical index derivative contracts
(57
)
 

 
(57
)
 
51

 
(6
)
Futures contracts for refined products
(48,384
)
 
(4,020
)
 
(52,404
)
 
31,054

 
(21,350
)
Total current derivative liabilities
(49,389
)
 
(4,020
)
 
(53,409
)
 
31,457

 
(21,952
)
 
 
 
 
 
 
 
 
 
 
Physical fixed price derivative contracts
(24
)
 

 
(24
)
 
1

 
(23
)
Futures contracts for refined products
(10
)
 

 
(10
)
 
10

 

Total non-current derivative liabilities
(34
)
 

 
(34
)
 
11

 
(23
)
Net derivative assets (liabilities)
$
(11,878
)
 
$
2,469

 
$
(9,409
)
 
$

 
$
(9,409
)
                                                      
(1)  Amounts represent the netting of physical fixed and index contracts’ assets and liabilities when a legal right of offset exists.  Futures contracts are subject to settlement through margin requirements and are additionally presented on a net basis. 
 
December 31, 2014
 
Derivatives NOT Designated
as Hedging
Instruments
 
Derivatives Designated
as Hedging
Instruments
 
Derivative
Carrying
Value
 
Netting
Balance
Sheet
Adjustment (1)
 
Net Total
Physical fixed price derivative contracts
$
42,005

 
$

 
$
42,005

 
$
(12
)
 
$
41,993

Physical index derivative contracts
112

 

 
112

 
(59
)
 
53

Futures contracts for refined products
150,352

 
30,702

 
181,054

 
(153,911
)
 
27,143

Total current derivative assets
192,469

 
30,702

 
223,171

 
(153,982
)
 
69,189

 
 
 
 
 
 
 
 
 
 
Physical fixed price derivative contracts
2,919

 

 
2,919

 

 
2,919

Total non-current derivative assets
2,919

 

 
2,919

 

 
2,919

 
 
 
 
 
 
 
 
 
 
Physical fixed price derivative contracts
(1,502
)
 

 
(1,502
)
 
12

 
(1,490
)
Physical index derivative contracts
(371
)
 

 
(371
)
 
59

 
(312
)
Futures contracts for refined products
(153,911
)
 

 
(153,911
)
 
153,911

 

Total current derivative liabilities
(155,784
)
 

 
(155,784
)
 
153,982

 
(1,802
)
 
 
 
 
 
 
 
 
 
 
Physical fixed price derivative contracts
(5
)
 

 
(5
)
 

 
(5
)
Futures contracts for refined products
(2,615
)
 

 
(2,615
)
 

 
(2,615
)
Total non-current derivative liabilities
(2,620
)
 

 
(2,620
)
 

 
(2,620
)
Net derivative assets
$
36,984

 
$
30,702

 
$
67,686

 
$

 
$
67,686

                                                      
(1)  Amounts represent the netting of physical fixed and index contracts’ assets and liabilities when a legal right of offset exists.  Futures contracts are subject to settlement through margin requirements and are additionally presented on a net basis.

16


 
Our hedged inventory portfolio extends to the first quarter of 2016.  The unrealized gain at June 30, 2015 for inventory hedges represented by futures contracts of $6.5 million will be fully realized by the first quarter of 2016.  At June 30, 2015, open refined petroleum product derivative contracts (represented by the physical fixed-price contracts, physical index contracts, and futures contracts for fixed-price sales contracts noted above) varied in duration in the overall portfolio, but did not extend beyond December 2016.  In addition, at June 30, 2015, we had refined petroleum product inventories that we intend to use to satisfy a portion of the physical derivative contracts. The unrealized loss at June 30, 2015 for refined petroleum products designated as cash flow hedges of $4.0 million will be realized by the first quarter of 2016, at the end of the butane blending season.
 
The gains and losses on our derivative instruments recognized in income were as follows for the periods indicated (in thousands):
 
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
Location
 
2015
 
2014
 
2015
 
2014
Derivatives NOT designated as hedging instruments:
 
 
 

 
 

 
 

 
 

Physical fixed price derivative contracts
Product sales
 
$
(3,126
)
 
$
(7,280
)
 
$
3,929

 
$
(10,652
)
Physical index derivative contracts
Product sales
 
(5
)
 
(79
)
 
(10
)
 
(73
)
Physical fixed price derivative contracts
Cost of product sales
 
3,952

 
7,210

 
6,591

 
8,621

Physical index derivative contracts
Cost of product sales
 
220

 
(521
)
 
64

 
(713
)
Futures contracts for refined products
Cost of product sales
 
4,878

 
(6,301
)
 
13,583

 
187

 
 
 
 
 
 
 
 
 
 
Derivatives designated as fair value hedging instruments:
 
 
 

 
 

 
 

 
 

Futures contracts for refined products
Cost of product sales
 
$
(14,708
)
 
$
(13,732
)
 
$
(32,555
)
 
$
(12,453
)
Physical inventory - hedged items
Cost of product sales
 
11,152

 
7,954

 
20,576

 
1,729

 
 
 
 
 
 
 
 
 
 
Ineffectiveness excluding the time value component on fair value hedging instruments:
 
 
 

 
 

 
 

 
 

Fair value hedge ineffectiveness (excluding time value)
Cost of product sales
 
$
(1,216
)
 
$
(1,122
)
 
$
(150
)
 
$
3,610

Time value excluded from hedge assessment
Cost of product sales
 
(2,340
)
 
(4,656
)
 
(11,829
)
 
(14,334
)
Net loss in income
 
 
$
(3,556
)
 
$
(5,778
)
 
$
(11,979
)
 
$
(10,724
)


17


The change in value recognized in OCI and the losses reclassified from accumulated other comprehensive income (“AOCI”) to income attributable to our derivative instruments designated as cash flow hedges were as follows for the periods indicated (in thousands):
 
Loss Recognized in OCI on Derivatives for the
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
Derivatives designated as cash flow hedging instruments:
 

 
 

 
 

 
 

Interest rate contracts
$

 
$
(9,208
)
 
$

 
$
(18,812
)
Commodity derivatives
(3,857
)
 

 
(3,857
)
 

Total
$
(3,857
)
 
$
(9,208
)
 
$
(3,857
)
 
$
(18,812
)

 
 
 
Loss Reclassified from AOCI to Income (Effective Portion) for the
 
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
Location
 
2015
 
2014
 
2015
 
2014
Derivatives designated as cash flow hedging instruments:
 
 
 

 
 

 
 

 
 

Interest rate contracts
Interest and debt expense
 
$
(3,039
)
 
$
(1,778
)
 
$
(6,076
)
 
$
(3,557
)
Total
 
 
$
(3,039
)
 
$
(1,778
)
 
$
(6,076
)
 
$
(3,557
)

The ineffective portion of the change in fair value of cash flow hedges was not material for the three and six months ended June 30, 2015. Over the next twelve months, we expect to reclassify $3.9 million of net losses attributable to commodity derivative instruments from AOCI to products sales. Likewise, we expect to reclassify $12.2 million of net losses attributable to interest rate derivative instruments from AOCI to earnings as an increase to interest and debt expense. For additional information on the net losses attributable to interest rate derivative instruments, see our Annual Report on Form 10-K for the year ended December 31, 2014.

8. FAIR VALUE MEASUREMENTS
 
We categorize our financial assets and liabilities using the three-tier hierarchy as follows:
 
Recurring
 
The following table sets forth financial assets and liabilities measured at fair value on a recurring basis, as of the measurement dates indicated, and the basis for that measurement, by level within the fair value hierarchy (in thousands):
 
June 30, 2015
 
December 31, 2014
 
Level 1
 
Level 2
 
Level 1
 
Level 2
Financial assets:
 

 
 

 
 

 
 

Physical fixed price derivative contracts
$

 
$
12,278

 
$

 
$
44,912

Physical index derivative contracts

 
186

 

 
53

Futures contracts for refined products

 
102

 
27,143

 

 
 
 
 
 
 
 
 
Financial liabilities:
 

 
 

 
 

 
 

Physical fixed price derivative contracts

 
(619
)
 

 
(1,495
)
Physical index derivative contracts

 
(6
)
 

 
(312
)
Futures contracts for refined products
(21,350
)
 

 
(2,615
)
 

Fair value
$
(21,350
)
 
$
11,941

 
$
24,528

 
$
43,158

 
The values of the Level 1 derivative assets and liabilities were based on quoted market prices obtained from the New York Mercantile Exchange.
 

18


The values of the Level 2 commodity derivative contracts were calculated using market approaches based on observable market data inputs, including published commodity pricing data, which is verified against other available market data, and market interest rate and volatility data.  Level 2 fixed price derivative assets are net of credit value adjustments (“CVAs”) determined using an expected cash flow model, which incorporates assumptions about the credit risk of the derivative contracts based on the historical and expected payment history of each customer, the amount of product contracted for under the agreement and the customer’s historical and expected purchase performance under each contract.  The Merchant Services segment determined CVAs are appropriate because few of the Merchant Services segment’s customers entering into these derivative contracts are large organizations with nationally recognized credit ratings.  The Level 2 fixed price derivative assets of $44.9 million as of December 31, 2014 are net of CVAs of ($0.1) million.  As of June 30, 2015, the Merchant Services segment did not hold any net liability derivative position containing credit contingent features.
 
Financial instruments included in current assets and current liabilities are reported in the unaudited condensed consolidated balance sheets at amounts which approximate fair value due to the relatively short period to maturity of these financial instruments.  The fair values of our fixed-rate debt were estimated by observing market trading prices and by comparing the historic market prices of our publicly issued debt with the market prices of the publicly issued debt of other master limited partnerships with similar credit ratings and terms.  The fair values of our variable-rate debt are their carrying amounts, as the carrying amount reasonably approximates fair value due to the variability of the interest rates.  The carrying value and fair value, using Level 2 input values, of our debt were as follows at the dates indicated (in thousands):
 
June 30, 2015
 
December 31, 2014
 
Carrying
Amount
 
Fair Value
 
Carrying
Amount
 
Fair Value
Fixed-rate debt
$
3,389,555

 
$
3,425,992