Quarterly report pursuant to sections 13 or 15(d)

DERIVATIVE INSTRUMENTS

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DERIVATIVE INSTRUMENTS
 6 Months Ended
Jun. 30, 2012
DERIVATIVE INSTRUMENTS [Abstract]  
DERIVATIVE INSTRUMENTS
9. DERIVATIVE INSTRUMENTS

 
Commodity Financial Contracts

Hydrocarbon based manufacturers, such as the Company, are significantly impacted by changes in feedstock and natural gas prices. Not considering derivative transactions, feedstock and natural gas used for the six months ended June 30, 2012, and 2011, represented approximately 82.9% and 81.3% of our operating expenses, respectively.

The Company endeavors to acquire feedstock and natural gas at the lowest possible cost.  The primary feedstock (natural gasoline) is traded over the counter and not on organized futures exchanges.  Financially settled instruments (fixed price swaps) are the principal vehicle used to give some predictability to feed prices. The Company does not purchase or hold any derivative financial instruments for trading or speculative purposes and is limited by its risk management policy to hedging a maximum of 40% of monthly feedstock requirements.

The financial contracts currently in place are not designated as hedges.  As of June 30, 2012, South Hampton had committed to financial contracts with settlement dates through December 2012.

The following tables detail (in thousands) the impact the agreements had on the financial statements:

   
Three Months Ended
    
Six Months Ended
  
   
June 30,
    
June 30,
  
   
2012
    
2011
    
2012
    
2011
  
                         
Unrealized loss
   $ (2,815 )   $ (281 )   $ (2,283 )   $ (81 )
Realized gain
     213       321       504       365  
Net gain (loss)
   $ (2,602 )   $ 40     $ (1,779 )   $ 284  


   
June 30, 2012
    
December 31, 2011
  
             
Fair value of financial contracts - asset (liability)
   $ ( 1,890 )   $ 393  


The realized and unrealized gains/(losses) are recorded in Cost of Sales and Processing for the periods ended June 30, 2012, and 2011.  As a percentage of Cost of Sales and Processing, realized and unrealized gains/(losses) accounted for 4.9% and 0.1% for the three months and 1.7% and 0.4% for the six months ended June 30, 2012, and 2011, respectively.

With the drop in natural gasoline prices during the second quarter of 2012, margin calls were made on our outstanding financial contracts in the amount of $1.5 million.  These payments are reflected in prepaid derivative settlements at June 30, 2012.

 Interest Rate Swap

On March 21, 2008, we entered into a pay-fixed, receive-variable interest rate swap agreement with Bank of America related to $10.0 million of our $14 million term loan secured by plant, pipeline and equipment. The effective date of the interest rate swap agreement is August 15, 2008, and terminates on December 15, 2017.  The notional amount of the interest rate swap was $6,250,000 at June 30, 2012.  South Hampton receives credit for payments of variable interest made on the term loan's variable rates, which are based upon the London InterBank Offered Rate (LIBOR), and pays Bank of America an interest rate of 5.83% less the credit on the interest rate swap.  We have designated the transaction as a cash flow hedge.  Beginning on August 15, 2008, the derivative instrument was reported at fair value with any changes in fair value reported within other comprehensive income (loss) in the Company's Statement of Stockholders' Equity.  The Company entered into the interest rate swap to minimize the effect of changes in the LIBOR rate.  The following tables detail (in thousands) the impact the agreement had on the financial statements:


   
June 30,
  
   
2012
    
2011
  
Other Comprehensive Loss
            
  Cumulative loss
   $ (1,021 )   $ (1,057 )
  Deferred tax benefit
     347       359  
  Net cumulative loss
   $ (674 )   $ (698 )
                 
Interest expense reclassified from other comprehensive loss
   $ 94     $ 213  


   
June 30, 2012
    
December 31, 2011
  
             
Fair value of interest rate swap  - liability
   $ 1,021     $ 1,134  


The cumulative loss from the changes in the swap contract's fair value that is included in other comprehensive loss will be reclassified into income when interest is paid. The net amount of pre-tax loss in other comprehensive income (loss) as of June 30, 2012, predicted to be reclassified into earnings within the next 12 months is approximately $324,000. See further discussion of the fair value of the derivative instruments in Note 8.