Quarterly report pursuant to sections 13 or 15(d)

DERIVATIVE INSTRUMENTS

 v2.3.0.11
DERIVATIVE INSTRUMENTS
 6 Months Ended
Jun. 30, 2011
DERIVATIVE INSTRUMENTS [Abstract]  
DERIVATIVE INSTRUMENTS
9. DERIVATIVE INSTRUMENTS

Commodity Financial Instruments

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, 2011, and 2010, represented approximately 81.3% and 81.4% of our operating expenses, respectively.

On February 26, 2009, the Board of Directors adopted a new resolution regarding derivative transactions.  The 2009 resolution allows the Company to establish a commodity futures account for the purpose of maximizing Company resources and reducing the Company's risk as pertaining to its purchases of natural gas and feedstock for operational purposes by employing a four step process. This process, in summary, includes: (1) education of Company employees who are responsible for carrying out the policy, (2) adoption of a derivatives policy by the Board explaining the objectives for use of derivatives including accepted risk limits, (3) implementation of a comprehensive derivative strategy designed to clarify the specific circumstances under which the Company will use derivatives, and (4) establishment and maintenance of a set of internal controls to ensure that all of the derivatives transactions taking place are authorized and in accord with the policies and strategies that have been enacted.  On August 31, 2009, the Company adopted a formal risk management policy which incorporates the above process and establishes a “hedge committee” for derivative oversight.  On January 28, 2010, we appointed members to the hedge committee to oversee transactions.

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.

The derivative agreements currently in place are not designated as hedges per ASC Topic 815, Derivatives and Hedging.  As of June 30, 2011, South Hampton had committed to derivative contracts with settlement dates through September 2011.

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,
  
   
2011
    
2010
    
2011
    
2010
  
                         
Unrealized (loss)
   $ (281 )   $ (1,155 )   $ (81 )   $ (524 )
Realized gain
     321       314       365       260  
Net gain (loss)
   $ 40     $ (841 )   $ 284     $ (264 )

   
June 30, 2011
    
December 31, 2010
  
             
Fair value of derivative asset
   $ 96     $ 177  

The realized and unrealized gains/ (losses) are recorded in Cost of Petrochemical Product Sales and Processing for the periods ended June 30, 2011, and 2010.

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 $7,150,000 at June 30, 2011.  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 according to ASC Topic 815, Derivatives and Hedging.  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,
  
   
2011
    
2010
  
Other Comprehensive Loss
            
  Cumulative loss
   $ (1,057 )   $ (1,193 )
  Deferred tax benefit
     359       406  
  Net cumulative loss
   $ (698 )   $ (787 )
                 
Interest expense reclassified from other comprehensive loss
   $ 213     $ 241  

   
June 30, 2011
    
December 31, 2010
  
             
Fair value of derivative liability
   $ 1,057     $ 1,116  

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, 2011, predicted to be reclassified into earnings within the next 12 months is approximately $376,000. See further discussion of the fair value of the derivative instruments in Note 8.