The company issues short-term and long-term debt, purchases and sells energy commodities including amounts in foreign currencies, and invests in foreign operations. These activities result in exposures to interest rates, energy commodity prices and foreign currency exchange rates. The company utilizes derivatives to manage the risk that results from these activities.
Derivatives and other instruments must be designated and effective to qualify for hedge accounting. Derivatives are recorded at their fair value at each balance sheet date. For cash flow and fair value hedges, gains or losses relating to derivatives are deferred and recognized in the same period and in the same financial statement category as the corresponding hedged transactions. For hedges of net investments in self-sustaining foreign operations, exchange gains or losses on derivatives, net of tax, and designated foreign currency denominated debt are offset against the exchange losses or gains arising on the translation of the financial statements of the foreign operations included in the foreign exchange adjustment account in Shareholders' Equity. In the event that a derivative does not meet the designation or effectiveness criteria, realized and unrealized gains or losses are recognized in income each period in the same financial statement category as the underlying transaction giving rise to the exposure being economically hedged. Premiums paid or received with respect to derivatives that are hedges are deferred and amortized to income over the term of the hedge.
If a derivative that previously qualified as a hedge is settled, de-designated or ceases to be effective, the gain or loss at that date is deferred and recognized in the same period and in the same financial statement category as the corresponding hedged transactions. If a hedged anticipated transaction is no longer probable to occur, related deferred gains or losses are recognized in income in the current period.
The recognition of gains and losses on derivatives for Canadian Mainline, Alberta System, the Foothills System and the BC System exposures is determined through the regulatory process.
The fair value of foreign exchange and interest rate derivatives has been estimated using year-end market rates. The fair value of power, natural gas and heat rate derivatives has been calculated using estimated forward prices for the relevant period.
Net Investment in Foreign Operations
At December 31, 2005 and 2004, the company had net investments in self sustaining foreign operations with a U.S. dollar functional currency which created an exposure to changes in exchange rates. The company uses U.S. dollar denominated debt and derivatives to hedge this exposure on an after-tax basis. The fair value for derivatives used to manage the exposure is shown in the table below.
| Asset/(Liability) | |||||||||
| 2005 | 2004 | ||||||||
| December 31 (millions of dollars) | Accounting Treatment | Fair Value | Notional or Notional Principal Amount | Fair Value | Notional or Notional Principal Amount | ||||
| U.S. dollar cross-currency swaps (maturing 2006 to 2012) | Hedge | 119 | U.S. 450 | 95 | U.S. 400 | ||||
| U.S. dollar forward foreign exchange contracts (maturing 2006) | Hedge | 5 | U.S. 525 | (1 | ) | U.S. 305 | |||
| U.S. dollar options (maturing 2006) | Hedge | - | U.S. 60 | 1 | U.S. 100 | ||||
| Reconciliation of Foreign Exchange Adjustment (Losses)/Gains | ||||||
| December 31 (millions of dollars) | 2005 | 2004 | ||||
| Balance at January 1 | (71 | ) | (40 | ) | ||
| Translation losses on foreign currency denominated net assets(1) | (21 | ) | (39 | ) | ||
| Gains on derivatives | 23 | 52 | ||||
| Income taxes | (21 | ) | (44 | ) | ||
| Balance at December 31 | (90 | ) | (71 | ) | ||
| (1) | In 2005, includes gains of $80 million (2004 - $101 million) related to foreign currency denominated debt designated as a hedge. |
Foreign Exchange Gains/(Losses)
Foreign exchange gains included in Other Expenses/(Income) for the year ended December 31, 2005 are $19 million (2004 – $6 million; 2003 – nil).
Foreign Exchange and Interest Rate Management Activity
The company manages the foreign exchange and interest rate risks related to its U.S. dollar denominated debt, and transactions and interest rate exposures of the Canadian Mainline, the Alberta System and the BC System through the use of foreign currency and interest rate derivatives. Certain of the realized gains and losses on these derivatives are shared with shippers on predetermined terms. The details of the foreign exchange and interest rate derivatives are shown in the table below.
| Asset/(Liability) | ||||||||||
| 2005 | 2004 | |||||||||
| December 31 (millions of dollars) | Accounting Treatment | Fair Value | Notional or Notional Principal Amount | Fair Value | Notional or Notional Principal Amount | |||||
| Foreign Exchange | ||||||||||
| Cross-currency swaps (maturing 2010 to 2013) | Non-hedge | (86 | ) | 363/U.S. 257 | (69 | ) | 363/U.S. 257 | |||
| Interest Rate | ||||||||||
| Interest rate swaps | ||||||||||
| Canadian dollars | ||||||||||
| (maturing 2007 to 2008) | Hedge | 4 | 100 | 7 | 145 | |||||
| (maturing 2006 to 2009) | Non-hedge | 7 | 374 | 9 | 374 | |||||
| 11 | 16 | |||||||||
| U.S. dollars | ||||||||||
| (maturing 2007 to 2009) | Non-hedge | 5 | U.S. 100 | 7 | U.S. 100 | |||||
The company manages the foreign exchange and interest rate exposures of its other businesses through the use of foreign currency and interest rate derivatives. The details of these foreign currency and interest rate derivatives are shown in the table below.
| Asset/(Liability) | ||||||||||
| 2005 | 2004 | |||||||||
| December 31 (millions of dollars) | Accounting Treatment | Fair Value | Notional or Notional Principal Amount | Fair Value | Notional or Notional Principal Amount | |||||
| Foreign Exchange | ||||||||||
| Options (maturing 2006) | Non-hedge | 1 | U.S. 195 | 2 | U.S. 255 | |||||
| Forward foreign exchange contracts | ||||||||||
| (maturing 2006) | Hedge | 2 | U.S. 29 | - | - | |||||
| (maturing 2006) | Non-hedge | 1 | U.S. 208 | 1 | U.S. 129 | |||||
| Interest Rate | ||||||||||
| Options | Non-hedge | - | - | - | U.S. 50 | |||||
| Interest rate swaps | ||||||||||
| Canadian dollars | ||||||||||
| (maturing 2007 to 2009) | Hedge | 1 | 100 | 4 | 100 | |||||
| (maturing 2006 to 2011) | Non-hedge | 1 | 423 | 5 | 485 | |||||
| 2 | 9 | |||||||||
| U.S. dollars | ||||||||||
| (maturing 2013) | Hedge | - | U.S. 50 | 3 | U.S. 375 | |||||
| (maturing 2006 to 2010) | Non-hedge | 18 | U.S. 550 | 22 | U.S. 500 | |||||
| 18 | 25 | |||||||||
Certain of the company's joint ventures use interest rate derivatives to manage interest rate exposures. The company's proportionate share of the fair value of the outstanding derivatives at December 31, 2005 was nil (2004 – $1 million).
Energy Price Risk Management
The company executes power, natural gas and heat rate derivatives for overall management of its asset portfolio. Heat rate contracts are contracts for the sale or purchase of power that are priced based on a natural gas index. The fair value and notional volumes of contracts for differences and the swap, future, option and heat rate contracts are shown in the tables below.
| Power | ||||||||
| Asset/(Liability) | ||||||||
| 2005 | 2004 | |||||||
| December 31 (millions of dollars) | Accounting Treatment | Fair Value | Fair Value | |||||
| Power - swaps and contracts for differences | ||||||||
| (maturing 2006 to 2011) | Hedge | (130 | ) | 7 | ||||
| (maturing 2006 to 2010) | Non-hedge | 13 | (2 | ) | ||||
| Gas - swaps, futures and options | ||||||||
| (maturing 2006 to 2016) | Hedge | 17 | (39 | ) | ||||
| (maturing 2006 to 2008) | Non-hedge | (11 | ) | (2 | ) | |||
| Heat rate contracts | ||||||||
| (maturing 2006) | Non-hedge | - | (1 | ) | ||||
| Notional Volumes | ||||||||||
| Power (GWh) | Gas (Bcf) | |||||||||
| December 31, 2005 | Accounting Treatment | Purchases | Sales | Purchases | Sales | |||||
| Power - swaps and contracts for differences | ||||||||||
| (maturing 2006 to 2011) | Hedge | 2,566 | 7,780 | - | - | |||||
| (maturing 2006 to 2010) | Non-hedge | 1,332 | 456 | - | - | |||||
| Gas - swaps, futures and options | ||||||||||
| (maturing 2006 to 2016) | Hedge | - | - | 91 | 69 | |||||
| (maturing 2006 to 2008) | Non-hedge | - | - | 15 | 18 | |||||
| Heat rate contracts | ||||||||||
| (maturing 2006) | Non-hedge | - | 35 | - | - | |||||
| December 31, 2004 | ||||||||||
| Power - swaps and contracts for differences | Hedge | 3,314 | 7,029 | - | - | |||||
| Non-hedge | 438 | - | - | - | ||||||
| Gas - swaps, futures and options | Hedge | - | - | 80 | 84 | |||||
| Non-hedge | - | - | 5 | 8 | ||||||
| Heat rate contracts | Non-hedge | - | 229 | 2 | - | |||||
Certain of the company's joint ventures use power derivatives to manage energy price risk exposures. The company's proportionate share of the fair value of these outstanding power sales derivatives at December 31, 2005 was $(38) million (2004 – nil) and relates to contracts which cover the period 2006 to 2008. The company's proportionate share of the notional sales volumes associated with this exposure at December 31, 2005 was 2,058 GWh (2004 – nil).
