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 uses derivatives to manage the exposure that results from these activities. The use of derivatives is subject to the Company's overall risk management policies and procedures.
Derivatives and other instruments must be designated and be 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, after tax, and designated foreign currency denominated debt are offset against the exchange gains or losses 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. 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 likely to occur, related deferred gains or losses are recognized in income in the current period.
The recognition of gains and losses on the derivatives for the Canadian Mainline, Alberta System, Foothills and the BC System exposures is determined through the regulatory process. The gains and losses on derivatives accounted for as part of rate-regulated accounting that do not meet the criteria for hedge accounting are deferred.
The fair value of foreign exchange and interest rate derivatives has been calculated 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, 2006 and 2005, 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) | ||||||||||
| 2006 | 2005 | |||||||||
| December 31 (millions of dollars) | Accounting Treatment | Fair Value | Notional or Principal Amount | Fair Value | Notional or Principal Amount | |||||
| US dollar cross-currency swaps (maturing 2007 to 2013) | Hedge | 58 | U.S. 400 | 119 | U.S. 450 | |||||
| US dollar forward foreign exchange contracts (maturing 2007) | Hedge | (7) | U.S. 390 | 5 | U.S. 525 | |||||
| US dollar options (maturing 2007) | Hedge | (6) | U.S. 500 | — | U.S. 60 | |||||
| Reconciliation of Foreign Exchange Adjustment | ||||||
| December 31 (millions of dollars) | 2006 | 2005 | ||||
| Balance at January 1 (loss) | (90 | ) | (71 | ) | ||
| Translation gains/(losses) on foreign currency denominated net assets(1) |
8 | (21 | ) | |||
| (Losses)/Gains on derivatives | (9 | ) | 23 | |||
| Income taxes | 1 | (21 | ) | |||
| Balance at December 31 (loss) | (90 | ) | (90 | ) | ||
| (1) | The amount for 2006 includes gains of $6 million (2005 – $80 million) related to foreign currency denominated debt designated as a hedge. |
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) | |||||||||||
| 2006 | 2005 | ||||||||||
| December 31 (millions of dollars) | Accounting Treatment | Fair Value | Notional or Principal Amount | Fair Value | Notional or Principal Amount | ||||||
| Foreign Exchange | |||||||||||
| Cross-currency and interest-rate swaps | |||||||||||
| (maturing 2013) | Hedge | (32) | 136/U.S. 100 | — | |||||||
| (maturing 2010 to 2012) | Non-hedge | (52) | 227/U.S. 157 | (86) | 363/U.S. 257 | ||||||
| (84) | (86) | ||||||||||
| Interest Rate | |||||||||||
| Interest rate swaps | |||||||||||
| Canadian dollars | |||||||||||
| (maturing 2007 to 2008) | Hedge | 2 | 100 | 4 | 100 | ||||||
| (maturing 2007 to 2009) | Non-hedge | 5 | 300 | 7 | 374 | ||||||
| 7 | 11 | ||||||||||
| US dollars | |||||||||||
| (maturing 2007 to 2009) | Non-hedge | 4 | U.S. 100 | 5 | 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) | |||||||||||
| 2006 | 2005 | ||||||||||
| December 31 (millions of dollars) | Accounting Treatment | Fair Value | Notional or Principal Amount | Fair Value | Notional or Principal Amount | ||||||
| Foreign Exchange | |||||||||||
| Options (maturing 2007) | Non-hedge | — | U.S. 95 | 1 | U.S. 195 | ||||||
| Forward foreign exchange contracts | |||||||||||
| Hedge | — | — | 2 | U.S. 29 | |||||||
| (maturing 2007) | Non-hedge | (3) | U.S. 250 | 1 | U.S. 208 | ||||||
| (3) | 4 | ||||||||||
| Interest Rate | |||||||||||
| Options (maturing 2007) | Non-hedge | — | U.S. 50 | — | — | ||||||
| Interest rate swaps | |||||||||||
| Canadian dollar | |||||||||||
| (maturing 2007 to 2011) | Hedge | — | 150 | 1 | 100 | ||||||
| (maturing 2009 to 2011) | Non-hedge | — | 164 | 1 | 423 | ||||||
| — | 2 | ||||||||||
| US dollar | |||||||||||
| (maturing 2011 to 2017) | Hedge | (2 | ) | U.S. 350 | — | U.S. 50 | |||||
| (maturing 2007 to 2016) | Non-hedge | 9 | U.S. 450 | 18 | U.S. 550 | ||||||
| 7 | 18 | ||||||||||
For the year ended December 31, 2006, the Company had net losses of $1 million (2005 – net gains of $10 million; 2004 – net gains of $5 million) associated with interest rate swaps, which included a $6-million loss (2005 – $5-million loss; 2004 – $7-million gain) relating to a change in mark-to-market positions on non-hedges. The net losses are included in Financial Charges on the Consolidated Income Statement.
Foreign exchange gains included in Other Expenses/(Income) for the year ended December 31, 2006 are $4 million (2005 – $19 million; 2004 – $6 million).
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, 2006 and 2005 was nil.
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.
| Energy | ||||||||
| Asset/(Liability) | ||||||||
| 2006 | 2005 | |||||||
| December 31 (millions of dollars) | Accounting Treatment | Fair Value | Fair Value | |||||
| Power – swaps and contracts for differences | ||||||||
| (maturing 2007 to 2011) | Hedge | (179 | ) | (130 | ) | |||
| (maturing 2007 to 2010) | Non-hedge | (7 | ) | 13 | ||||
| Gas – swaps, futures and options | ||||||||
| (maturing 2007 to 2016) | Hedge | (66 | ) | 17 | ||||
| (maturing 2007 to 2008) | Non-hedge | 30 | (11 | ) | ||||
| Heat rate contracts | Non-hedge | — | — | |||||
| Notional Volumes | ||||||||||
| Power (GWh) | Gas (Bcf) | |||||||||
| December 31, 2006 | Accounting Treatment | Purchases | Sales | Purchases | Sales | |||||
| Power – swaps and contracts for differences | ||||||||||
| (maturing 2007 to 2011) | Hedge | 6,654 | 12,349 | — | — | |||||
| (maturing 2007 to 2010) | Non-hedge | 1,402 | 964 | — | — | |||||
| Gas – swaps, futures and options | ||||||||||
| (maturing 2007 to 2016) | Hedge | — | — | 77 | 59 | |||||
| (maturing 2007 to 2008) | Non-hedge | — | — | 11 | 15 | |||||
| Heat rate contracts | Non-hedge | — | 9 | — | — | |||||
| December 31, 2005 | ||||||||||
| Power – swaps and contracts for differences | Hedge | 2,566 | 7,780 | — | — | |||||
| Non-hedge | 1,332 | 456 | — | — | ||||||
| Gas – swaps, futures and options | Hedge | — | — | 91 | 69 | |||||
| Non-hedge | — | — | 15 | 18 | ||||||
| Heat rate contracts | Non-hedge | — | 35 | — | — | |||||
During 2006, the Company recorded net gains of $41 million (2005 – net losses of $12 million; 2004 – net losses of $1 million) as a result of the non-hedge gas swaps, futures and options. These net gains were partially offset by losses from the non-hedge power swaps and contracts of $19 million (2005 – net gains of $16 million; 2004 – net losses of $3 million). The net impact of gains and losses on non-hedge derivatives for power, gas, and heat rate contracts were net gains of $22 million (2005 – net gains of $4 million; 2004 – net losses of $4 million) for the year included in Revenue.
At December 31, 2006, the Company had unrealized net losses of $222 million (2005 – net losses of $111 million) as a result of its energy swaps, futures, options and contracts that had not settled by year end. There were unrealized losses from unsettled energy derivatives of $144 million (2005 – $107 million) included in Accounts Payable and $158 million (2005 – $105 million) included in Deferred Amounts. These losses were partially offset by unrealized gains of $39 million (2005 – $44 million) included in Other Assets and $41 million (2005 – $57 million) included in Other Current Assets.
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, 2006 was $55 million (2005 – $(38) million) and related to contracts which cover the period 2007 to 2010. The Company's proportionate share of the notional sales volumes associated with this exposure at December 31, 2006 was 4,500 GWh (2005 – 2,058 GWh).
