DCP SOUTHEAST TEXAS HOLDINGS, GP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Years Ended December 31, 2011, 2010 and 2009
8. Risk Management and Hedging Activities
Our day to day operations expose us to a variety of risks including but not limited to changes in the prices
of commodities that we buy or sell and the creditworthiness of each of our counterparties. We manage certain
of these exposures with both physical and financial transactions. All of our derivative activities are conducted
under the governance of DCP Midstream’s internal Risk Management Committees that establish policies,
limiting exposure to market risk and requiring daily reporting to management of potential financial exposure.
These policies include statistical risk tolerance limits using historical price movements to calculate daily value
at risk. The following briefly describes each of the risks that we manage.
Commodity Price Risk
Our natural gas asset based trading and marketing activities engage in the business of trading energy
related products and services, including managing purchase and sales portfolios, storage contracts and facilities,
and transportation commitments for products. These energy trading operations are exposed to market variables
and commodity price risk with respect to these products and services, and we may enter into physical contracts
and financial instruments with the objective of realizing a positive margin from the purchase and sale of
commodity-based instruments. Through 2010, we managed commodity price risk related to owned natural gas
storage and pipeline assets by engaging in natural gas asset based trading and marketing. The commercial
activities related to our natural gas asset based trading and marketing primarily consist of time spreads and
basis spreads.
Prior to January 1, 2011, we were permitted to execute a time spread transaction when the difference
between the current price of natural gas (cash or futures) and the futures market price for natural gas exceeds
our cost of storing physical gas in our owned and/or leased storage facilities. The time spread transaction allows
us to lock in a margin when this market condition exists. A time spread transaction is executed by establishing a
long gas position at one point in time and establishing a corresponding short gas position at a different point in
time. We typically use swaps to execute these transactions, which are not designated as hedging instruments
and are recorded at fair value with changes in fair value recorded in the current period consolidated statements
of operations. While gas held in our storage location is recorded at the lower of average cost or market, the
derivative instruments that are used to manage our storage facility are recorded at fair value and any changes in
fair value are currently recorded in our consolidated statements of operations. Even though we may have
economically hedged our exposure and locked in a future margin the use of lower-of-cost-or-market accounting
for our physical inventory and the use of mark-to-market accounting for our derivative instruments may subject
our earnings to market volatility.
Prior to January 1, 2011, we were permitted to execute basis spread transactions when the market price
differential between locations on a pipeline asset exceeds our cost of transporting physical gas through our
owned and/or leased pipeline asset. When this market condition exists, we may execute derivative instruments
around this differential at the market price. This basis spread transaction allows us to lock in a margin on our
physical purchases and sales of gas. We typically use swaps to execute these transactions, which are not
designated as hedging instruments and are recorded at fair value with changes in fair value recorded in the
current period consolidated statements of operations. As discussed above, the accounting for physical gas
purchases and sales and the accounting for the derivative instruments used to manage such purchases and sales
differ, and may subject our earnings to market volatility, even though the transaction represents an economic
hedge in which we have locked in a future margin.
Additionally, in order for our storage facility to remain operational, we maintain a minimum level of base
gas in our storage cavern, which is capitalized on our consolidated balance sheets as a component of property,
plant and equipment, net. In the fourth quarter of 2008 we commenced a capacity expansion project for one of
our storage caverns, which required us to sell all of the base gas within the cavern. During 2009, the expansion
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