UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

FORM 10-Q

 

x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2016
 
OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from          to         

Commission file number 1-36175

 

MIDCOAST ENERGY PARTNERS, L.P.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware		61-1714064
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

1100 Louisiana Street,
Suite 3300
Houston, Texas 77002

(Address of Principal Executive Offices) (Zip Code)

(713) 821-2000
(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer o		Accelerated Filer                     x
Non-Accelerated Filer   o (Do not check if a smaller reporting company)		Smaller reporting company     o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes o No x

The registrant had 22,610,056 Class A common units outstanding as of May 2, 2016.

TABLE OF CONTENTS

MIDCOAST ENERGY PARTNERS, L.P.
 
TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Income for the three months ended March 31, 2016 and 2015			1
Consolidated Statements of Comprehensive Income for the three months ended March 31, 2016 and 2015			2
Consolidated Statements of Cash Flows for the three months ended March 31, 2016 and 2015			3
Consolidated Statements of Financial Position as of March 31, 2016 and December 31, 2015			4
Notes to the Consolidated Financial Statements			5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			29
Item 3. Quantitative and Qualitative Disclosures About Market Risk			41
Item 4. Controls and Procedures			44
PART II  —  OTHER INFORMATION
Item 1. Legal Proceedings			44
Item 1A. Risk Factors			44
Item 6. Exhibits			44
Signatures			45
Exhibits			46

In this report, unless the context otherwise requires, references to “Midcoast Energy Partners,” “the Partnership,” “MEP,” “we,” “our,” “us,” or like terms refer to Midcoast Energy Partners, L.P. and its subsidiaries. We refer to our general partner, Midcoast Holdings, L.L.C., as our “General Partner” and to Enbridge Energy Partners, L.P. and its subsidiaries, other than us, as “Enbridge Energy Partners,” or “EEP.” References to “Enbridge” refer collectively to Enbridge Inc. and its subsidiaries other than us, our subsidiaries, our General Partner, EEP, its subsidiaries and its general partner. References to “Enbridge Management” refer to Enbridge Energy Management, L.L.C., the delegate of EEP’s general partner that manages EEP’s business and affairs. References to “Midcoast Operating” refer to Midcoast Operating, L.P. and its subsidiaries. As of March 31, 2016, we owned a 51.6% controlling interest in Midcoast Operating, and EEP owned a 48.4% noncontrolling interest in Midcoast Operating. Unless otherwise specifically noted, financial results and operating data are shown on a 100% basis and are not adjusted to reflect EEP’s 48.4% noncontrolling interest in Midcoast Operating as of March 31, 2016.

This Quarterly Report on Form 10-Q includes forward-looking statements, which are statements that frequently use words such as “anticipate,” “believe,” “consider,” “continue,” “could,” “estimate,” “evaluate,” “expect,” “explore,” “forecast,” “intend,” “may,” “opportunity,” “plan,” “position,” “projection,” “should,” “strategy,” “target,” “will” and similar words. Although we believe that such forward-looking statements are reasonable based on currently available information, such statements involve risks, uncertainties and assumptions and are not guarantees of performance. Future actions, conditions or events and future results of operations may differ materially from those expressed in these forward-looking statements. Any forward-looking statement made by us in this Quarterly Report on Form 10-Q speaks only as of the date on which it is made, and we undertake no obligation to publicly update any forward-looking statement. Many of the factors that will determine these results are beyond our ability to control or predict. Specific factors that could cause actual results to differ from those in the forward-looking statements include: (1) changes in the demand for, the supply of, forecast data for, and price trends related to natural gas, natural gas liquids, or NGLs, and crude oil, and the response by natural gas and crude oil producers to changes in any of these factors; (2) our ability to successfully complete and finance expansion projects; (3) the effects of competition, in particular, by other pipeline and gathering systems, as well as other processing and treating plants; (4) shut-downs or cutbacks at our facilities or refineries, petrochemical plants, utilities or other businesses for which we transport products or to whom we sell products; (5) hazards and operating risks that may not be covered fully by insurance; (6) changes in or challenges to our rates; and (7) changes in laws or regulations to which we are subject, including compliance with environmental and operational safety regulations that may increase costs of system integrity testing and maintenance; and (8) cost overruns and delays on construction projects resulting from numerous factors.

For additional factors that may affect results, see “Item 1A. Risk Factors” included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015, which is available to the public over the Internet at the United States Securities and Exchange Commission’s, or the SEC’s, website (www.sec.gov) and at our website (www.midcoastpartners.com).

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

MIDCOAST ENERGY PARTNERS, L.P.
 
CONSOLIDATED STATEMENTS OF INCOME

		For the three months ended March 31,
		2016				2015
		(unaudited; in millions, except per unit amounts)
Operating revenues:
Commodity sales (Note 13)		$	377.8			$	800.9
Commodity sales – affiliate (Notes 11 and 13)			5.2				21.8
Transportation and other services			48.9				50.8
			431.9				873.5
Operating expenses:
Cost of natural gas and natural gas liquids (Notes 5 and 13)			335.4				761.2
Cost of natural gas and natural gas liquids – affiliate (Notes 11 and 13)			12.6				17.9
Operating and maintenance			32.3				38.2
Operating and maintenance – affiliate (Note 11)			24.9				25.2
General and administrative			2.5				1.9
General and administrative – affiliate (Note 11)			13.1				19.1
Depreciation and amortization			39.5				38.3
			460.3				901.8
Operating loss			(28.4	)			(28.3	)
Interest expense, net (Note 9)			(8.3	)			(6.7	)
Equity in earnings of joint ventures (Note 8)			7.1				5.7
Other income			0.2				—
Loss before income tax expense			(29.4	)			(29.3	)
Income tax expense (Note 14)			(0.9	)			(0.8	)
Net loss			(30.3	)			(30.1	)
Less: Net loss attributable to noncontrolling interest			(10.1	)			(10.1	)
Net loss attributable to general and limited partner ownership interest in Midcoast Energy Partners, L.P.		$	(20.2	)		$	(20.0	)
Net loss attributable to limited partner ownership interest		$	(19.8	)		$	(19.6	)
Net loss per limited partner unit (basic and diluted) (Note 2)		$	(0.44	)		$	(0.43	)
Weighted-average limited partner units outstanding			45.2				45.2

 
 
The accompanying notes are an integral part of these consolidated financial statements.

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MIDCOAST ENERGY PARTNERS, L.P.
 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

		For the three months ended March 31,
		2016				2015
		(unaudited; in millions)
Net loss		$	(30.3	)		$	(30.1	)
Other comprehensive loss, net of tax (Note 13)			—				(2.9	)
Comprehensive loss			(30.3	)			(33.0	)
Less:
Net loss attributable to noncontrolling interest			(10.1	)			(10.1	)
Other comprehensive loss attributed to noncontrolling interest			—				(1.4	)
Comprehensive loss attributable to general and limited partner ownership interests in Midcoast Energy Partners, L.P.		$	(20.2	)		$	(21.5	)

 
 
The accompanying notes are an integral part of these consolidated financial statements.

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MIDCOAST ENERGY PARTNERS, L.P.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS

		For the three months ended March 31,
		2016				2015
		(unaudited; in millions)
Cash provided by operating activities:
Net loss		$	(30.3	)		$	(30.1	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization			39.5				38.3
Derivative fair value net losses (Note 13)			27.1				35.1
Inventory market price adjustments (Note 5)			—				4.6
Distributions from investment in joint ventures			7.1				5.7
Equity earnings from investment in joint ventures			(7.1	)			(5.7	)
Other			(3.1	)			0.7
Changes in operating assets and liabilities, net of acquisitions:
Receivables, trade and other			4.8				(11.6	)
Due from General Partner and affiliates			45.4				44.4
Accrued receivables			32.1				184.9
Inventory			18.2				48.2
Current and long-term other assets			(1.7	)			(12.1	)
Due to General Partner and affiliates			68.8				4.8
Accounts payable and other			(31.1	)			(9.3	)
Accrued purchases			(34.7	)			(115.9	)
Interest payable			(4.1	)			(4.1	)
Property and other taxes payable			(7.6	)			(9.7	)
Net cash provided by operating activities			123.3				168.2
Cash used in investing activities:
Additions to property, plant and equipment (Note 16)			(16.3	)			(56.1	)
Changes in restricted cash (Note 3)			3.0				(2.7	)
Acquisitions			—				(44.1	)
Investment in joint ventures			—				(1.9	)
Distributions from investment in joint ventures in excess of cumulative earnings			4.2				2.4
Other			(0.8	)			(0.6	)
Net cash used in investing activities			(9.9	)			(103.0	)
Cash used in financing activities:
Net repayments under credit facility (Note 9)			(50.0	)			(45.0	)
Distributions to partners (Note 10)			(16.5	)			(15.8	)
Contributions from General Partner (Note 11)			9.5				—
Contributions from noncontrolling interest			2.9				20.7
Distributions to noncontrolling interest (Note 10)			(25.9	)			(19.8	)
Net cash used in financing activities			(80.0	)			(59.9	)
Net increase in cash and cash equivalents			33.4				5.3
Cash and cash equivalents at beginning of year			18.0				—
Cash and cash equivalents at end of period		$	51.4			$	5.3

 
 
The accompanying notes are an integral part of these consolidated financial statements.

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MIDCOAST ENERGY PARTNERS, L.P.
 
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

		March 31, 2016				December 31, 2015
		(unaudited; in millions)
ASSETS
Current assets:
Cash and cash equivalents (Note 4)		$	51.4			$	18.0
Restricted cash (Note 4)			14.6				20.6
Receivables, trade and other, net of allowance for doubtful accounts of $2.6 million and $2.5 million, respectively, at March 31, 2016 and December 31, 2015			10.3				13.3
Due from General Partner and affiliates (Note 11)			4.3				47.0
Accrued receivables			24.0				56.1
Inventory (Note 5)			13.7				31.9
Other current assets (Note 13)			100.2				118.5
			218.5				305.4
Property, plant and equipment, net (Note 6)			4,207.5				4,226.3
Intangible assets, net			267.5				272.9
Equity investment in joint ventures (Note 8)			368.0				372.3
Other assets, net (Note 13)			81.1				95.2
Total assets		$	5,142.6			$	5,272.1
LIABILITIES AND PARTNERS’ CAPITAL
Current liabilities:
Due to General Partner and affiliates (Note 11)		$	108.2			$	45.7
Accounts payable and other (Notes 4 and 13)			57.2				92.6
Accrued purchases			109.1				143.8
Property and other taxes payable (Note 14)			10.8				18.4
Interest payable			1.1				5.2
			286.4				305.7
Long-term debt (Note 9)			838.3				888.2
Other long-term liabilities (Notes 13 and 14)			39.6				45.9
Total liabilities			1,164.3				1,239.8
Commitments and contingencies (Note 12)
Partners’ capital (Note 10):
Class A common units (22,610,056 authorized and issued at March 31, 2016 and December 31, 2015)			504.2				522.2
Subordinated units (22,610,056 authorized and issued at March 31, 2016 and December 31, 2015)			1,044.0				1,062.0
General Partner units (922,859 authorized and issued at March 31, 2016 and December 31, 2015)			52.1				43.3
Accumulated other comprehensive income (Note 13)			(0.9	)			(0.9	)
Total Midcoast Energy Partners, L.P. partners’ capital			1,599.4				1,626.6
Noncontrolling interest			2,378.9				2,405.7
Total partners’ capital			3,978.3				4,032.3
		$	5,142.6			$	5,272.1

Variable Interest Entities (VIEs) — see Note 7.

 
 
The accompanying notes are an integral part of these consolidated financial statements.

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MIDCOAST ENERGY PARTNERS, L.P.
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

1. ORGANIZATION AND NATURE OF OPERATIONS

Midcoast Energy Partners, L.P. is a publicly-traded Delaware limited partnership formed by Enbridge Energy Partners, L.P., or EEP, to serve as EEP’s primary vehicle for owning and growing its natural gas and natural gas liquids midstream business in the United States. Midcoast Energy Partners, L.P., together with its consolidated subsidiaries, are referred to in this report as “we,” “us,” “our,” “MEP” and the “Partnership.” We own and operate, through our 51.6% controlling interest in Midcoast Operating, L.P., or Midcoast Operating, a portfolio of assets engaged in the business of gathering, processing and treating natural gas, as well as the transportation of natural gas, natural gas liquids, or NGLs, crude oil and condensate. In addition, we also provide marketing services of natural gas and NGLs to wholesale customers. Our portfolio of natural gas and NGL pipelines, plants and related facilities are geographically concentrated in the Gulf Coast and Mid-Continent regions of the United States, primarily in Texas and Oklahoma. EEP owns a 48.4% noncontrolling interest in Midcoast Operating. EEP also has a significant interest in us through its ownership of our General Partner, which owns all of our General Partner units and all of our incentive distribution rights, or IDRs, as well as an approximate 52% limited partner interest in us. Our Class A common units trade on the New York Stock Exchange, or NYSE, under the ticker symbol “MEP.”

Basis of Presentation

We have prepared the accompanying unaudited interim consolidated financial statements in accordance with generally accepted accounting principles in the United States of America, or GAAP, for interim consolidated financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, the unaudited interim consolidated financial statements do not include all the information and footnotes required by GAAP for complete consolidated financial statements. In the opinion of management, they contain all adjustments, consisting only of normal recurring adjustments, which management considers necessary to present fairly our financial position as of March 31, 2016, our results of operations for the three months ended March 31, 2016 and 2015, and our cash flows for the three months ended March 31, 2016 and 2015. We derived our consolidated statement of financial position as of December 31, 2015 from the audited financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015. Our results of operations for the three months ended March 31, 2016 and 2015, should not be taken as indicative of the results to be expected for the full year due to seasonal fluctuations in the supply of and demand for natural gas, NGLs and crude oil, timing and completion of our construction projects, maintenance activities, the impact of forward commodity prices and differentials on derivative financial instruments that are accounted for at fair value. Our unaudited interim consolidated financial statements should be read in conjunction with our audited consolidated financial statements and notes thereto presented in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015.

2. NET INCOME PER LIMITED PARTNER AND GENERAL PARTNER INTEREST

We allocate our net income among our General Partner and limited partners using the two-class method. Under the two-class method, we allocate our net income, including any earnings in excess of distributions, to our limited partners, our General Partner and the holders of our IDRs in accordance with the terms of our partnership agreement. We allocate any distributions in excess of earnings for the period to our General Partner and our limited partners based on their respective proportionate ownership interests in us, after taking into account distributions to be paid with respect to the IDRs, as set forth in our partnership agreement.

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MIDCOAST ENERGY PARTNERS, L.P.
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

2. NET INCOME PER LIMITED PARTNER AND GENERAL PARTNER INTEREST  – (continued)

Distribution Targets		Portion of Quarterly Distribution Per Unit				Percentage Distributed to Limited Partners				Percentage Distributed to General Partner
Minimum Quarterly Distribution			Up to $0.3125				98%				2%
First Target Distribution			> $0.3125 to $0.359375				98%				2%
Second Target Distribution			> $0.359375 to $0.390625				85%				15%
Third Target Distribution			> $0.390625 to $0.468750				75%				25%
Over Third Target Distribution			In excess of $0.468750				50%				50%

We determined basic and diluted net loss per limited partner unit as follows:

		For the three months ended March 31,
		2016				2015
		(in millions, except per unit amounts)
Net loss		$	(30.3	)		$	(30.1	)
Less: Net loss attributable to noncontrolling interest			(10.1	)			(10.1	)
Net loss attributable to general and limited partner interests in Midcoast Energy Partners, L.P.			(20.2	)			(20.0	)
Less distributions:
Total distributed earnings to our General Partner			(0.3	)			(0.3	)
Total distributed earnings to our limited partners			(16.2	)			(15.7	)
Total distributed earnings			(16.5	)			(16.0	)
Overdistributed earnings		$	(36.7	)		$	(36.0	)
Weighted-average limited partner units outstanding			45.2				45.2
Basic and diluted earnings per unit:
Distributed earnings per limited partner unit(1)		$	0.36			$	0.35
Overdistributed earnings per limited partner unit(2)			(0.80	)			(0.78	)
Net loss per limited partner unit (basic and diluted)		$	(0.44	)		$	(0.43	)

3. ACQUISITIONS

Acquisitions

On February 27, 2015, we acquired a midstream business in Leon, Madison and Grimes counties, Texas. The acquisition consisted of a natural gas gathering system. We acquired the midstream business for $85.0 million in cash and a contingent future payment of up to $17.0 million.

Of the $85.0 million purchase price, $20.0 million was placed into escrow, pending the resolution of a legal matter and completion of additional wells connecting to our system within one year of the acquisition date. We have classified $6.0 million of these escrow funds as “Other assets, net” in our consolidated statements of financial position as of March 31, 2016, pending the resolution of a legal matter. Since the acquisition date, we have released $11.0 million from escrow for additional wells connected to our system. During the first quarter of 2016, the remaining $3.0 million in escrow was returned to us as some of the additional wells were not connected to our system within one year of the acquisition date. For the three months ended March 31, 2016, we recognized a $3.0 million gain as a reduction to “Operating and maintenance” expense in our consolidated statements of income related to the return of these escrow funds.

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MIDCOAST ENERGY PARTNERS, L.P.
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

3. ACQUISITIONS  – (continued)

The purchase and sale agreement contained a provision whereby we would have been obligated to make future tiered payments of up to $17.0 million if volumes were delivered into the system at certain tiered volume levels over a five-year period. We determined at the time of the acquisition that the potential payment was contingent consideration. At the acquisition date, the fair value of this contingent consideration, using a probability-weighted discounted cash flow model was $2.3 million. The contingent consideration was re-measured on a fair value basis each quarter until December 31, 2015, which resulted in an addition to the liability of $0.3 million for accretion. During the three months ended March 31, 2016, we determined, based on current and forecasted volumes, that it is remote that we will be obligated to make any payments at the expiration of the five-year period. Consequently, we reversed the liability and recognized a $2.6 million gain as a reduction to “Operating and maintenance” expense in our consolidated statements of income for the three months ended March 31, 2016.

4. CASH AND CASH EQUIVALENTS

We extinguish liabilities when a creditor has relieved us of our obligation, which occurs when our financial institution honors a check that the creditor has presented for payment. Accordingly, obligations for which we have made payments that have not yet been presented to the financial institution, totaling approximately $3.0 million at March 31, 2016, and $4.2 million at December 31, 2015, are included in “Accounts payable and other” on our consolidated statements of financial position.

Restricted Cash

Restricted cash is comprised of the following:

		March 31, 2016				December 31, 2015
		(in millions)
Cash collateral on behalf of Enbridge subsidiary for accounts receivable sales and not remitted (see Note 11)		$	14.6			$	14.6
Cash held in escrow for acquisitions (see Note 3)			—				6.0
		$	14.6			$	20.6

5. INVENTORY

Our inventory is comprised of the following:

		March 31, 2016				December 31, 2015
		(in millions)
Materials and supplies		$	0.6			$	0.6
Natural gas and NGL inventory			13.1				31.3
		$	13.7			$	31.9

The “Cost of natural gas and natural gas liquids” on our consolidated statements of income includes charges totaling $4.6 million for the three months ended March 31, 2015, that we recorded to reduce the cost basis of our inventory of natural gas and NGLs, to reflect the current market value. For the three months ended March 31, 2016, we did not have any similar material charges related to our inventory of natural gas and NGLs.

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MIDCOAST ENERGY PARTNERS, L.P.
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

6. PROPERTY, PLANT AND EQUIPMENT

Our property, plant and equipment is comprised of the following:

		Depreciation Rates				March 31, 2016				December 31, 2015
						(in millions)
Land			—			$	14.5			$	14.2
Rights-of-way			2.08% – 7.14%				465.5				460.3
Pipelines			1.89% – 6.7%				1,869.1				1,864.4
Pumping equipment, buildings and tanks			1.48% – 6.67%				88.4				88.4
Compressors, meters and other operating equipment			1.8% – 20.0%				2,160.2				2,147.6
Vehicles, office furniture and equipment			2.19% – 33.33%				136.2				137.1
Processing and treating plants			2.21% – 4.0%				629.2				627.8
Construction in progress							47.3				57.1
Total property, plant and equipment							5,410.4				5,396.9
Accumulated depreciation							(1,202.9	)			(1,170.6	)
Property, plant and equipment, net						$	4,207.5			$	4,226.3

7. VARIABLE INTEREST ENTITIES

Principles of Consolidation

On January 1, 2016, we adopted Accounting Standards Update No. 2015-02, which amended consolidation guidance to, among other things, eliminate the specialized consolidation model and guidance for limited partnerships, including the presumption that the general partner should consolidate a limited partnership. As a result, we have determined that certain entities that we historically consolidated under this presumption are variable interest entities, or VIEs. Further, we determined that we are the primary beneficiary for these VIEs and will continue to consolidate these entities under the amended guidance. While the amended guidance did not impact our conclusion that such entities should be consolidated, because such entities are now considered VIEs, additional disclosures are necessary. We have applied this amended guidance retrospectively to our disclosures.

The consolidated financial statements include our accounts, and accounts of our subsidiaries and VIEs for which we are the primary beneficiary. Upon inception of a contractual agreement, we perform an assessment to determine whether the arrangement contains a variable interest in a legal entity and whether that legal entity is a VIE. Where we conclude we are the primary beneficiary of a VIE, we consolidate the accounts of that entity.

We assess all aspects of our interests in an entity and use judgment when determining if we are the primary beneficiary. The primary beneficiary has both the power to direct the activities of the VIE that most significantly impact the entity’s economic performance and the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Other qualitative factors that are considered include decision-making responsibilities, the VIE capital structure, risk and rewards sharing, contractual agreements with the VIE, voting rights and level of involvement of other parties. A reassessment of the primary beneficiary conclusion is conducted when there are changes in the facts and circumstances related to a VIE.

All significant intercompany accounts and transactions are eliminated upon consolidation. Ownership interests in subsidiaries represented by other parties that do not control the entity are presented in the consolidated financial statements as activities and balances attributable to noncontrolling interests. Investments and entities over which we exercise significant influence are accounted for using the equity method.

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MIDCOAST ENERGY PARTNERS, L.P.
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

7. VARIABLE INTEREST ENTITIES  – (continued)

Midcoast Operating

Midcoast Operating is a Texas limited partnership. As of March 31, 2016, we owned a 51.6% direct limited partner interest in Midcoast Operating. In addition, we own Midcoast Operating’s general partner, Midcoast OLP GP, L.L.C. EEP owns the remaining limited partner interests in Midcoast Operating. We are the primary beneficiary of Midcoast Operating because (1) through our ownership in Midcoast Operating’s general partner and our majority limited partner interest, we have the power to direct the activities that most significantly impact Midcoast Operating’s economic performance; and (2) we have the obligation to absorb losses and the right to receive residual returns that potentially could be significant to Midcoast Operating. In addition, we are the entity within the related party group that is most closely associated with Midcoast Operating.

As of March 31, 2016 and December 31, 2015, our consolidated statements of financial position include total assets of $5,079.0 million and $5,241.5 million, respectively, and total liabilities of $251.4 million and $323.7 million, respectively, related to Midcoast Operating. The assets of Midcoast Operating can only be used to settle their obligations, which include a cross-guarantee under MEP’s Credit Agreement and a guarantee of MEP’s Senior Notes. We do not have an obligation to provide financial support to Midcoast Operating other than by virtue of certain contractual obligations prescribed by the terms of certain indemnities and guarantees to pay certain liabilities of Midcoast Operating in the event of a default.

The following table includes assets to be used to settle liabilities of Midcoast Operating and liabilities of Midcoast Operating for which creditors do not have recourse to our general credit as the primary beneficiary. These assets and liabilities are included in our consolidated balance sheet.

		March 31, 2016				December 31, 2015
		(unaudited; in millions)
ASSETS
Cash and cash equivalents		$	3.6			$	3.4
Restricted cash		$	—			$	6.0
Receivables, trade and other, net		$	10.4			$	13.3
Due from General Partner and affiliates		$	4.1			$	46.9
Accrued receivables		$	24.0			$	56.1
Inventory		$	13.7			$	31.9
Other current assets		$	100.2			$	118.5
Property, plant and equipment, net		$	4,207.5			$	4,226.3
Intangible assets, net		$	267.5			$	272.9
Equity investment in joint ventures		$	368.0			$	372.3
Other assets, net		$	80.0			$	93.9
LIABILITIES
Due to General Partner and affiliates		$	38.4			$	28.5
Accounts payable and other		$	53.5			$	87.1
Accrued purchases		$	109.1			$	143.8
Property and other taxes payable		$	10.8			$	18.4
Other long-term liabilities		$	39.6			$	45.9

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MIDCOAST ENERGY PARTNERS, L.P.
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

8. EQUITY INVESTMENTS IN JOINT VENTURES

We have a 35% aggregate interest in the Texas Express NGL system, which is comprised of two joint ventures with third parties. The Texas Express NGL system consists of a 593-mile NGL intrastate transportation pipeline and a related NGL gathering system. Our investment in and earnings from the Texas Express NGL system are presented in “Equity investment in joint ventures” on our consolidated statements of financial position and “Equity in earnings of joint ventures” on our consolidated statements of income, respectively. The following table presents unaudited income statement information for the Texas Express NGL system on a combined, 100% basis for the periods presented:

		For the three months ended March 31,
		2016				2015
		(in millions)
Operating revenues		$	32.2			$	28.8
Operating expenses		$	12.0			$	11.0
Net income		$	20.1			$	17.7

9. DEBT

The following table presents the carrying amounts of our consolidated debt obligations.

		Interest Rate				March 31, 2016				December 31, 2015
						(in millions)
Credit Agreement due 2018			2.691%			$	440.0			$	490.0
Series A Senior Notes due September 2019			3.560%				75.0				75.0
Series B Senior Notes due September 2021			4.040%				175.0				175.0
Series C Senior Notes due September 2024			4.420%				150.0				150.0
Total principal amount of debt obligations							840.0				890.0
Unamortized debt issuance costs							(1.7	)			(1.8	)
Total						$	838.3			$	888.2

On January 1, 2016, we adopted Accounting Standards Update No. 2015-03, which requires us to present debt issuance costs in the balance sheet as a reduction to the carrying amount of the debt liability, rather than as an asset. We have retrospectively adopted this guidance for all periods presented. The adoption of this guidance did not have a material impact on our consolidated financial statements.

Our interest cost for the three months ended March 31, 2016, and 2015, is comprised of the following:

		For the three months ended March 31,
		2016				2015
		(in millions)
Interest cost incurred		$	8.4			$	7.6
Less: Interest capitalized			0.1				0.9
Interest expense, net		$	8.3			$	6.7

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MIDCOAST ENERGY PARTNERS, L.P.
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

9. DEBT  – (continued)

Debt Arrangements

Credit Agreement

We, Midcoast Operating, and our material domestic subsidiaries are parties to the Credit Agreement, which permits aggregate borrowings of up to $810.0 million at any one time outstanding. The original term of the Credit Agreement was three years, with an initial maturity date of November 13, 2016, subject to four one-year requests for extension. Our Credit Agreement’s current maturity date is September 30, 2018; however, $140.0 million of commitments expire on the initial maturity date of November 13, 2016 and an additional $25.0 million of commitments expire on September 30, 2017. During the three months ended March 31, 2016, we had net repayments of approximately $50.0 million, which includes gross borrowings of $1,585.0 million and gross repayments of $1,635.0 million.

Debt Covenants

At March 31, 2016, we were in compliance with the terms of our financial covenants under our debt agreements.

Available Credit

At March 31, 2016, we had approximately $370.0 million of unutilized commitments under the terms of our Credit Agreement, determined as follows:

		(in millions)
Total credit limit under Credit Agreement		$	810.0
Amounts outstanding under Credit Agreement			(440.0	)
Total amount available at March 31, 2016		$	370.0

Fair Value of Debt Obligations

The carrying amount of our outstanding borrowings under the Credit Agreement approximates the fair value at March 31, 2016 and December 31, 2015, respectively, due to the short-term nature and frequent repricing of the amounts outstanding under these obligations. The outstanding borrowings under the Credit Agreement are included with our long-term debt obligations since we have the ability and the intent to refinance the amounts outstanding on a long-term basis.

The approximate fair values of our fixed-rate debt obligations were $372.5 million at March 31, 2016. We determined the approximate fair values using a standard methodology that incorporates pricing points that are obtained from independent, third-party investment dealers who actively make markets in our debt securities. We use these pricing points to calculate the present value of the principal obligation to be repaid at maturity and all future interest payment obligations for any debt outstanding. The fair value of our long-term debt obligations is categorized as Level 2 within the fair value hierarchy.

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MIDCOAST ENERGY PARTNERS, L.P.
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

10. PARTNERS’ CAPITAL

Distribution to Partners

The following table sets forth our distributions, as approved by the board of directors of our General Partner, during the three months ended March 31, 2016.

Distribution Declaration Date		Record Date		Distribution Payment Date		Distribution per Unit		Cash Distributed
						(in millions, except per unit amounts)
January 28, 2016		February 5, 2016		February 12, 2016		$0.35750		$16.5

Cash distributed to partners is reflected in “Distributions to partners,” on our consolidated statements of cash flows. We paid cash distributions to EEP for its ownership interest in us totaling $8.9 million and $8.5 million for the three months ended March 31, 2016 and 2015, respectively.

Distributions to Noncontrolling Interests

Midcoast Operating paid cash distributions to EEP for its ownership interest in Midcoast Operating totaling $25.9 million and $19.8 million for the three months ended March 31, 2016 and 2015, respectively. These amounts are reflected in “Distributions to noncontrolling interest” in our consolidated statements of cash flows.

During any quarter until the quarter ending December 31, 2017, if our quarterly declared distribution exceeds our distributable cash, as that term is defined in Midcoast Operating’s limited partnership agreement, we receive an increased quarterly distribution from Midcoast Operating, and EEP receives a corresponding reduction to its quarterly distribution in the amount that our declared distribution exceeds our distributable cash. Midcoast Operating’s adjustment of EEP’s distribution will be limited by EEP’s pro rata share of the Midcoast Operating quarterly cash distribution and a maximum of $0.005 per unit quarterly distribution increase by us. There is no requirement for us to compensate EEP for these adjusted distributions, except for settling our capital accounts with Midcoast Operating in a liquidation scenario. For the three months ended March 31, 2016, EEP’s quarterly distribution from Midcoast Operating was reduced by $0.8 million.

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MIDCOAST ENERGY PARTNERS, L.P.
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

10. PARTNERS’ CAPITAL  – (continued)

Changes in Partners’ Capital

The following table presents significant changes in partners’ capital accounts attributable to our General Partner and limited partners as well as the noncontrolling interest in our consolidated subsidiary during the three months ended March 31, 2016 and 2015.

		For the three months ended March 31,
		2016				2015
		(in millions)
Class A common units:
Beginning balance		$	522.2			$	634.2
Net loss			(9.9	)			(9.8	)
Distributions			(8.1	)			(7.7	)
Ending balance		$	504.2			$	616.7
Subordinated units:
Beginning balance		$	1,062.0			$	1,174.0
Net loss			(9.9	)			(9.8	)
Distributions			(8.1	)			(7.7	)
Ending balance		$	1,044.0			$	1,156.5
General Partner units:
Beginning balance		$	43.3			$	47.8
Net loss			(0.4	)			(0.4	)
Contributions			9.5				—
Distributions			(0.3	)			(0.4	)
Ending balance		$	52.1			$	47.0
Accumulated other comprehensive income (loss)
Beginning balance		$	(0.9	)		$	11.6
Changes in fair value of derivative financial instruments reclassified to earnings			—				(4.3	)
Changes in fair value of derivative financial instruments recognized in other comprehensive income			—				2.8
Ending balance		$	(0.9	)		$	10.1
Noncontrolling interest
Beginning balance		$	2,405.7			$	2,529.0
Capital contributions			9.2				68.2
Comprehensive income:
Net loss			(10.1	)			(10.1	)
Other comprehensive loss, net of tax			—				(1.4	)
Distributions to noncontrolling interest			(25.9	)			(19.8	)
Ending balance		$	2,378.9			$	2,565.9
Total partners’ capital at end of period		$	3,978.3			$	4,396.2

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MIDCOAST ENERGY PARTNERS, L.P.
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

10. PARTNERS’ CAPITAL  – (continued)

Securities Authorized for Issuance under LTIP

In August 2014, we filed a registration statement on Form S-8 with the SEC registering the issuance of 3,750,000 Class A common units that are issuable pursuant to awards that may be granted under the LTIP. As of March 31, 2016, we had not granted any awards for, or that are convertible into, Class A common units under our LTIP.

11. RELATED PARTY TRANSACTIONS

We do not directly employ any of the individuals responsible for managing or operating our business nor do we have any directors. Enbridge and its affiliates provide management, administrative, operational and workforce related services to us. Employees of Enbridge and its affiliates are assigned to work for one or more affiliates of Enbridge, including us. Where directly attributable, the costs of all compensation, benefits expenses and employer expenses for these employees are charged directly by Enbridge to the appropriate affiliate. Enbridge does not record any profit or margin for the administrative and operational services charged to us.

The affiliate amounts incurred by us through EEP for services received pursuant to the Intercorporate Services Agreement are reflected in “Operating and maintenance — affiliate” and “General and administrative — affiliate” on our consolidated statements of income. Under the Intercorporate Services Agreement, we reimburse EEP and its affiliates for the costs and expenses incurred in providing us with such services. However, EEP has agreed to reduce the amounts payable for general and administrative expenses that otherwise would have been allocable to Midcoast Operating by $25.0 million annually. As a result, for each of the three months ended March 31, 2016 and 2015, we recognized $6.3 million as a reduction to “Due to general partner and affiliates” with the offset recorded as a contribution to “Noncontrolling interest” in our consolidated statements of financial position.

Omnibus Agreement

We, Midcoast Holdings, EEP, and Enbridge are parties to the Omnibus Agreement under which EEP agreed to, among other things, indemnify us for certain matters, including environmental, right-of-way and permit matters. EEP’s obligation to indemnify us for these matters is subject to a $500,000 aggregate deductible before we are entitled to indemnification. Additionally, there is a $15.0 million aggregate cap on the amounts for which EEP will indemnify us for under the Omnibus Agreement. For the three months ended March 31, 2016, we received indemnification proceeds from EEP under the Omnibus Agreement of $12.2 million for the acquisition of title to right-of-way assets that were pending at the time of our initial public offering and associated legal fees. Of this amount, $9.5 million was classified as a contribution from our General Partner in our consolidated statements of cash flows, and $2.7 million was classified as a reduction of legal expenses reflected in “General and administrative — affiliate” expense in our consolidated statements of income.

Affiliate Revenues and Purchases

We sell natural gas, NGLs and crude oil at market prices on the date of sale to Enbridge and its affiliates. The sales to Enbridge and its affiliates are presented in “Operating revenue — affiliate” on our consolidated statements of income. We also purchase natural gas, NGLs and crude oil at market prices on the date of purchase from Enbridge and its affiliates for sale to third parties. The purchases of natural gas, NGLs and crude oil from Enbridge and its affiliates are presented in “Cost of natural gas and natural gas liquids — affiliate” on our consolidated statements of income.

Also included in “Cost of natural gas and natural gas liquids — affiliate,” are pipeline transportation and demand fees from the Texas Express NGL system of $5.4 million and $5.8 million for the three months ended March 31, 2016 and 2015, respectively. Our logistics and marketing business has made commitments to transport up to 120,000 barrels per day, or Bpd, of NGLs on the Texas Express NGL system through 2022. The current commitment level is 29,000 Bpd.

Routine purchases and sales with affiliates are settled monthly through our centralized treasury function at terms that are consistent with third-party transactions for the three months ended March 31, 2016 and 2015. Routine purchases and sales with affiliates that have not yet been settled are included in “Due from general partner and affiliates” and “Due to general partner and affiliates” on our consolidated statements of financial position.

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MIDCOAST ENERGY PARTNERS, L.P.
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

11. RELATED PARTY TRANSACTIONS  – (continued)

Sale of Accounts Receivable

For the three months ended March 31, 2016 and 2015, we sold and derecognized receivables of $435.3 million and $705.4 million, respectively, to an indirect, wholly-owned subsidiary of Enbridge. As a result, for the three months ended March 31, 2016 and 2015, we received cash proceeds of $435.1 million and $705.2 million, respectively. Consideration for the receivables sold is equivalent to the carrying value of the receivables less a discount for credit risk. The difference between the carrying value of the receivables sold and the cash proceeds received is recognized in “General and administrative — affiliate” expense in our consolidated statements of income. For each of the three months ended March 31, 2016 and 2015, the expense stemming from the discount on the receivables sold was $0.2 million.

As of March 31, 2016 and December 31, 2015, we had $14.6 million and $14.6 million, respectively, in “Restricted cash” on our consolidated statements of financial position for cash collections related to sold and derecognized receivables that have yet to be remitted to the Enbridge subsidiary. As of March 31, 2016 and December 31, 2015, outstanding receivables of $107.1 million and $147.1 million, respectively, which had been sold and derecognized, had not been collected on behalf of the Enbridge subsidiary.

Financial Support Agreement

At March 31, 2016, EEP provided $4.9 million of letters of credit outstanding and $23.3 million of guarantees to Midcoast Operating under a Financial Support Agreement with Midcoast Operating. At December 31, 2015, EEP provided $7.5 million of letters of credit outstanding and $21.7 million in guarantees to Midcoast Operating under this agreement. The annual costs that Midcoast Operating incurs under the Financial Support Agreement are based on the cumulative average amount of letters of credit and guarantees that EEP provides on behalf of Midcoast Operating and its wholly-owned subsidiaries, multiplied by a 2.5% annual fee. Midcoast Operating incurred $0.1 million and $0.2 million of these costs for the three months ended March 31, 2016 and 2015, respectively, which are included in “Operating and maintenance — affiliate” on our consolidated statements of income.

12. COMMITMENTS AND CONTINGENCIES

Environmental Liabilities

We are subject to federal and state laws and regulations relating to the protection of the environment. Environmental risk is inherent to our operating activities, and we are, at times, subject to environmental cleanup and enforcement actions. We manage this environmental risk through appropriate environmental policies and practices to minimize any impact our operations may have on the environment. To the extent that we are unable to recover payment for environmental liabilities from insurance or otherwise, we will be responsible for payment of liabilities arising from environmental incidents associated with our operating activities. We continue to voluntarily monitor past leak sites on our systems for the purpose of assessing whether any remediation is required in light of current regulations. As of March 31, 2016 and December 31, 2015, we did not have any material accrued environmental liabilities.

Legal and Regulatory Proceedings

We are a participant in a number of legal proceedings arising in the ordinary course of business. Some of these proceedings are covered, in whole or in part, by insurance. While the ultimate outcome and impact to us cannot be predicted with certainty, we believe the outcome of all these proceedings will not, individually or in the aggregate, have a material adverse effect on our financial position, results of operations or cash flows. In addition, we are not aware of any significant legal or governmental proceedings against us, or contemplated to be brought against us, under the various environmental protection statutes to which we are subject.

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MIDCOAST ENERGY PARTNERS, L.P.
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

13. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES

Our net income and cash flows are subject to volatility stemming from fluctuations in commodity prices of natural gas, NGLs, condensate, crude oil and fractionation margins. Fractionation margins represent the relative difference between the price we receive from NGL and condensate sales and the corresponding cost of natural gas we purchase for processing. Our exposure to commodity price risk exists within both of our segments. We use derivative financial instruments (i.e., futures, forwards, swaps, options, and other financial instruments with similar characteristics) to manage the risks associated with market fluctuations in commodity prices, as well as to reduce the volatility in our cash flows. Based on our risk management policies, all of our derivative financial instruments are employed in connection with an underlying asset, liability and/or forecasted transaction and are not entered into with the objective of speculating on commodity prices. We have hedged a portion of our exposure to the variability in future cash flows associated with commodity price risks in future periods in accordance with our risk management policies. Our derivative instruments that are designated for hedge accounting under authoritative guidance are classified as cash flow hedges.

Derivative Positions

Our derivative financial instruments are included at their fair values in the consolidated statements of financial position as follows:

		March 31, 2016				December 31, 2015
		(in millions)
Other current assets		$	96.5			$	117.3
Other assets, net			26.2				39.2
Accounts payable and other(1)			(30.4	)			(45.7	)
Other long-term liabilities			(14.3	)			(18.3	)
		$	78.0			$	92.5

The changes in the assets and liabilities associated with our derivatives are primarily attributable to the effects of new derivative transactions we have entered at prevailing market prices, settlement of maturing derivatives and the change in forward market prices of our remaining hedges. Our portfolio of derivative financial instruments is largely comprised of natural gas, NGL and crude oil sales and purchase contracts.

The table below summarizes our derivative balances by counterparty credit quality (any negative amounts represent our net obligations to pay the counterparty).

		March 31, 2016				December 31, 2015
		(in millions)
Counterparty Credit Quality(1)
AAA		$	0.1			$	—
AA(2)			61.6				67.6
A			15.1				24.1
Lower than A			1.2				0.8
		$	78.0			$	92.5

As the net value of our derivative financial instruments has decreased as a result of the settlement of maturing derivatives, our outstanding financial exposure to third parties has also decreased. When credit thresholds are met pursuant to the terms of our International Swaps and Derivatives Association, Inc., or ISDA®, financial contracts, we have the right to require collateral from our counterparties. We include any cash collateral received in the balances listed above. At March 31, 2016, we did not have any cash collateral on our asset exposures. At

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MIDCOAST ENERGY PARTNERS, L.P.
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

13. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES  – (continued)

December 31, 2015, our short-term liabilities included $12.6 million relating to cash collateral on our asset exposures. Cash collateral is classified as “Restricted cash” in our consolidated statements of financial position. As of December 31, 2015, all of our cash collateral was held directly by EEP.

We provided letters of credit totaling $4.9 million and $7.5 million relating to our liability exposures pursuant to the margin thresholds in effect at March 31, 2016 and December 31, 2015, respectively, under our ISDA® agreements. The ISDA® agreements and associated credit support, which govern our financial derivative transactions, contain no credit rating downgrade triggers that would accelerate the maturity dates of our outstanding transactions. A change in ratings is not an event of default under these instruments, and the maintenance of a specific minimum credit rating is not a condition to transacting under the ISDA® agreements. In the event of a credit downgrade, additional collateral may be required to be posted under the agreement if we are in a liability position to our counterparty, but the agreement will not automatically terminate and require immediate settlement of all future amounts due.

The ISDA® agreements, in combination with our master netting agreements, and credit arrangements governing our commodity swaps require that collateral be posted per tiered contractual thresholds based on the credit rating of each counterparty. We generally provide letters of credit to satisfy such collateral requirements under our ISDA^® agreements. These agreements will require additional collateral postings of up to 100% on net liability positions in the event of a credit downgrade below investment grade. Automatic termination clauses which exist are related only to non-performance activities, such as the refusal to post collateral when contractually required to do so. When we are holding an asset position, our counterparties are likewise required to post collateral on their liability (our asset) exposures, also determined by tiered contractual collateral thresholds. Counterparty collateral may consist of cash or letters of credit, both of which must be fulfilled with immediately available funds.

In the event that our credit ratings were to decline below the lowest level of investment grade, as determined by Standard & Poor’s and Moody’s, we would be required to provide additional amounts under our existing letters of credit to meet the requirements of our ISDA® agreements. For example, if our credit ratings had been below the lowest level of investment grade at March 31, 2016, we would have been required to provide letters of credit in the amount of $10.5 million related to our open positions.

At March 31, 2016, and December 31, 2015, we had credit concentrations in the following industry sectors, as presented below:

		March 31, 2016				December 31, 2015
		(in millions)
United States financial institutions and investment banking entities(1)		$	68.2			$	80.8
Non-United States financial institutions			(12.5	)			(12.3	)
Integrated oil companies			(0.3	)			0.6
Other			22.6				23.4
		$	78.0			$	92.5

Gross derivative balances are presented below before the effects of collateral received or posted and without the effects of master netting arrangements. Both our assets and liabilities are adjusted for non-performance risk, which is statistically derived. This credit valuation adjustment model considers existing derivative asset and liability balances in conjunction with contractual netting and collateral arrangements, current market data such as credit default swap rates and bond spreads and probability of default assumptions to quantify an adjustment to fair value. For credit modeling purposes, collateral received is included in the calculation of our assets, while any collateral posted is excluded from the calculation of the credit adjustment. Our credit exposure for these over-the-counter, or OTC, derivatives is directly with our counterparty and continues until the maturity or termination of the contracts.

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MIDCOAST ENERGY PARTNERS, L.P.
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

13. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES  – (continued)

Effect of Derivative Instruments on the Consolidated Statements of Financial Position

						Asset Derivatives								Liability Derivatives
						Fair Value at								Fair Value at
		Financial Position Location				March 31, 2016				December 31, 2015				March 31, 2016				December 31, 2015
						(in millions)
Derivatives not designated as hedging instruments:
Commodity contracts			Other current assets				96.5				117.3				—				—
Commodity contracts			Other assets				26.2				39.2				—				—
Commodity contracts			Accounts payable and other(1)				—				—				(30.4	)			(33.1	)
Commodity contracts			Other long-term liabilities				—				—				(14.3	)			(18.3	)
							122.7				156.5				(44.7	)			(51.4	)
Total derivative instruments						$	122.7			$	156.5			$	(44.7	)		$	(51.4	)

Accumulated Other Comprehensive Income

We record the change in fair value of our highly effective cash flow hedges in AOCI until the derivative financial instruments are settled, at which time they are reclassified to earnings. As of March 31, 2016 and December 31, 2015, we included in AOCI unrecognized losses of approximately $0.4 million associated with derivative financial instruments that qualified for and were classified as cash flow hedges of forecasted transactions that were subsequently de-designated, settled, or terminated. These losses are reclassified to earnings over the periods during which the originally hedged forecasted transactions affect earnings.

During the three months ended March 31, 2015, unrealized commodity hedge gains of $0.6 million were de-designated as a result of the hedges no longer meeting hedge accounting criteria. At March 31, 2016, we had no designated commodity hedges. We estimate that approximately $0.1 million, representing unrealized net gains from our cash flow hedging activities based on pricing and positions at March 31, 2016, will be reclassified from AOCI to earnings during the next 12 months.

Effect of Derivative Instruments on the Consolidated Statements of Income and Accumulated Other Comprehensive Income

Derivatives in Cash Flow Hedging Relationships		Amount of Gain (Loss) Recognized in AOCI on Derivative (Effective Portion)				Location of Gain (Loss) Reclassified from AOCI to Earnings (Effective Portion)				Amount of Gain (Loss) Reclassified from AOCI to Earnings (Effective Portion)				Location of Gain (Loss) Recognized in Earnings on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)(1)				Amount of Gain (Loss) Recognized in Earnings on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)(1)
						(in millions)
For the three months ended March 31, 2016
Interest Rate contracts		$	—				Interest expense			$	(0.1	)			Interest expense			$	—
Commodity contracts			—				Cost of natural gas and   natural gas liquids				0.1				Cost of natural gas and   natural gas liquids				—
		$	—							$	—							$	—
For the three months ended March 31, 2015
Commodity contracts		$	(3.6	)			Cost of natural gas and   natural gas liquids			$	8.4				Cost of natural gas and   natural gas liquids			$	(4.0	)

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MIDCOAST ENERGY PARTNERS, L.P.
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

13. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES  – (continued)

Components of Accumulated Other Comprehensive Income/(Loss)

		Cash Flow Hedges
		2016				2015
		(in millions)
Balance at January 1		$	(0.9	)		$	11.6
Other comprehensive income (loss) before reclassifications(1)			—				2.8
Amounts reclassified from AOCI(2)(3)			—				(4.3	)
Net other comprehensive income (loss)		$	—			$	(1.5	)
Balance at March 31		$	(0.9	)		$	10.1

Reclassifications from Accumulated Other Comprehensive Income

		For the three months ended March 31,
		2016				2015
		(in millions)
Losses (gains) on cash flow hedges:
Commodity Contracts(1)(2)		$	—			$	(4.3	)
Total Reclassifications from AOCI		$	—			$	(4.3	)

Effect of Derivative Instruments on Consolidated Statements of Income

						For the three months ended March 31,
						2016				2015
Derivatives Not Designated as Hedging Instruments		Location of Gain or (Loss) Recognized in Earnings				Amount of Gain or (Loss) Recognized in Earnings(1)(2)
						(in millions)
Commodity contracts			Operating revenue			$	(2.4	)		$	(17.3	)
Commodity contracts			Operating revenue – affiliate				—				(0.2	)
Commodity contracts			Cost of natural gas and natural gas liquids(3)				1.8				12.1
Total						$	(0.6	)		$	(5.4	)

We record the fair market value of our derivative financial and physical instruments in the consolidated statements of financial position as current and long-term assets or liabilities on a gross basis. However, the terms of the ISDA®, which govern our financial contracts and our other master netting agreements, allow the parties to elect in respect of all transactions under the agreement, in the event of a default and upon notice to the defaulting party, for the non-defaulting party to set-off all settlement payments, collateral held and any other obligations (whether or not then due), which the non-defaulting party owes to the defaulting party. The effect of the rights of set-off are outlined below.

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MIDCOAST ENERGY PARTNERS, L.P.
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

13. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES  – (continued)

Offsetting of Financial Assets and Derivative Assets

		As of March 31, 2016
		Gross Amount of Recognized Assets				Gross Amount Offset in the Statement of Financial Position				Net Amount of Assets Presented in the Statement of Financial Position				Gross Amount Not Offset in the Statement of Financial Position				Net Amount
		(in millions)
Description:
Derivatives		$	122.7			$	—			$	122.7			$	(23.2	)		$	99.5

		As of December 31, 2015
		Gross Amount of Recognized Assets				Gross Amount Offset in the Statement of Financial Position				Net Amount of Assets Presented in the Statement of Financial Position				Gross Amount Not Offset in the Statement of Financial Position(1)				Net Amount
		(in millions)
Description:
Derivatives		$	156.5			$	—			$	156.5			$	(41.5	)		$	115.0

Offsetting of Financial Liabilities and Derivative Liabilities

		As of March 31, 2016
		Gross Amount of Recognized Liabilities				Gross Amount Offset in the Statement of Financial Position				Net Amount of Liabilities Presented in the Statement of Financial Position				Gross Amount Not Offset in the Statement of Financial Position				Net Amount
		(in millions)
Description:
Derivatives		$	(44.7	)		$	—			$	(44.7	)		$	23.2			$	(21.5	)

		As of December 31, 2015
		Gross Amount of Recognized Liabilities(1)				Gross Amount Offset in the Statement of Financial Position				Net Amount of Liabilities Presented in the Statement of Financial Position				Gross Amount Not Offset in the Statement of Financial Position(1)				Net Amount
		(in millions)
Description:
Derivatives		$	(64.0	)		$	—			$	(64.0	)		$	41.5			$	(22.5	)

TABLE OF CONTENTS

MIDCOAST ENERGY PARTNERS, L.P.
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

13. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES  – (continued)

Inputs to Fair Value Derivative Instruments

The following table sets forth by level within the fair value hierarchy our net financial assets and liabilities that were accounted for at fair value on a recurring basis as of March 31, 2016, and December 31, 2015. We classify financial assets and liabilities in their entirety based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment and may affect our valuation of the financial assets and liabilities and their placement within the fair value hierarchy.

		March 31, 2016																December 31, 2015
		Level 1				Level 2				Level 3				Total				Level 1				Level 2				Level 3				Total
		(in millions)
Commodity contracts:
Financial		$	—			$	0.6			$	5.5			$	6.1			$	—			$	1.3			$	8.9			$	10.2
Physical			—				—				0.9				0.9				—				—				0.6				0.6
Commodity options			—				—				71.0				71.0				—				—				94.3				94.3
		$	—			$	0.6			$	77.4			$	78.0			$	—			$	1.3			$	103.8			$	105.1
Cash collateral															—																(12.6	)
Total														$	78.0															$	92.5

Qualitative Information about Level 2 Fair Value Measurements

We categorize, as Level 2, the fair value of assets and liabilities that we measure with either directly or indirectly observable inputs as of the measurement date, where pricing inputs are other than quoted prices in active markets for the identical instrument. This category includes both OTC transactions valued using exchange traded pricing information in addition to assets and liabilities that we value using either models or other valuation methodologies derived from observable market data. These models are primarily industry-standard models that consider various inputs including: (1) quoted prices for assets and liabilities; (2) time value; and (3) current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Substantially all of these inputs are observable in the marketplace throughout the full term of the assets and liabilities, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace.

Qualitative Information about Level 3 Fair Value Measurements

Data from pricing services and published indices are used to measure the fair value of our Level 3 derivative instruments on a recurring basis. We may also use these inputs with internally developed methodologies that result in our best estimate of fair value. The inputs listed in the table below would have a direct impact on the fair values of the listed instruments. The significant unobservable inputs used in the fair value measurement of the commodity derivatives (natural gas, NGLs, crude and power) are forward commodity prices. The significant unobservable inputs used in determining the fair value measurement of options are price and volatility. Forward commodity price in isolation has a direct relationship to the fair value of a commodity contract in a long position and an inverse relationship to a commodity contract in a short position. Volatility has a direct relationship to the fair value of an option contract. Generally, a change in the estimate of forward commodity prices is unrelated to a change in the estimate of volatility of prices. A change to the credit valuation has an inverse relationship to the fair value of our derivative contracts.

TABLE OF CONTENTS

MIDCOAST ENERGY PARTNERS, L.P.
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

13. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES  – (continued)

Quantitative Information About Level 3 Fair Value Measurements

Contract Type		Fair Value at March 31, 2016(2)				Valuation Technique				Unobservable Input				Range(1)												Units
														Lowest				Highest				Weighted Average
		(in millions)
Commodity Contracts – Financial
Natural Gas		$	0.6				Market Approach				Forward Gas Price				1.80				3.27				2.69				MMBtu
NGLs			4.9				Market Approach				Forward NGL Price				0.17				0.92				0.42				Gal
Commodity Contracts – Physical
Natural Gas			(1.8	)			Market Approach				Forward Gas Price				1.53				3.27				2.01				MMBtu
Crude Oil			0.3				Market Approach				Forward Crude Price				28.29				40.90				38.91				Bbl
NGLs			2.4				Market Approach				Forward NGL Price				0.17				0.92				0.41				Gal
Commodity Options
Natural Gas, Crude and NGLs			71.0				Option Model				Option Volatility				8	%			100	%			37	%
Total Fair Value		$	77.4

Quantitative Information About Level 3 Fair Value Measurements

Contract Type		Fair Value at December 31, 2015(2)				Valuation Technique				Unobservable Input				Range(1)												Units
														Lowest				Highest				Weighted Average
		(in millions)
Commodity Contracts – Financial
Natural Gas		$	0.3				Market Approach				Forward Natural Gas Price				2.27				3.07				2.64				MMBtu
NGLs			8.6				Market Approach				Forward NGL Price				0.16				0.93				0.41				Gal
Commodity Contracts – Physical
Natural Gas			(2.5	)			Market Approach				Forward Natural Gas Price				2.08				3.44				2.33				MMBtu
Crude Oil			—				Market Approach				Forward Crude Oil Price				26.50				38.41				37.29				Bbl
NGLs			3.1				Market Approach				Forward NGL Price				0.16				1.20				0.40				Gal
Commodity Options
Natural Gas, Crude and NGLs			94.3				Option Model				Option Volatility				13	%			74	%			36	%
Total Fair Value		$	103.8

TABLE OF CONTENTS

MIDCOAST ENERGY PARTNERS, L.P.
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

13. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES  – (continued)

Level 3 Fair Value Reconciliation

The table below provides a reconciliation of changes in the fair value of our Level 3 financial assets and liabilities measured on a recurring basis from January 1, 2016 to March 31, 2016. No transfers of assets between any of the Levels occurred during the period.

		Commodity Financial Contracts				Commodity Physical Contracts				Commodity Options				Total
		(in millions)
Beginning balance as of January 1, 2016		$	8.9			$	0.6			$	94.3			$	103.8
Transfer out of Level 3(1)			—				—				—				—
Gains or losses included in earnings:
Reported in Operating revenue			—				(6.7	)			—				(6.7	)
Reported in Cost of natural gas and natural gas liquids			0.4				8.5				(1.5	)			7.4
Gains or losses included in other comprehensive income:
Purchases, issuances, sales and settlements:
Purchases			—				—				—				—
Sales			—				—				—				—
Settlements(2)			(3.8	)			(1.5	)			(21.8	)			(27.1	)
Ending balance as of March 31, 2016		$	5.5			$	0.9			$	71.0			$	77.4
Amounts reported in Operating revenue		$	—			$	(2.4	)		$	—			$	(2.4	)
Amount of changes in net assets attributable to the change in unrealized gains or losses related to assets and liabilities still held at the reporting date:
Reported in Operating revenue		$	—			$	(2.7	)		$	—			$	(2.7	)
Reported in Cost of natural gas and natural gas liquids		$	0.4			$	4.8			$	(2.5	)		$	2.7

TABLE OF CONTENTS

MIDCOAST ENERGY PARTNERS, L.P.
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

13. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES  – (continued)

Fair Value Measurements of Commodity Derivatives

The following table provides summarized information about the fair values of expected cash flows of our outstanding commodity based swaps and physical contracts at March 31, 2016 and December 31, 2015.

		At March 31, 2016																								At December 31, 2015
										Wtd. Average Price(2)								Fair Value(3)								Fair Value(3)
		Commodity				Notional(1)				Receive				Pay				Asset				Liability				Asset				Liability
																		(in millions)
Portion of contracts maturing in 2016
Swaps
Receive variable/pay fixed			Natural Gas				16,287			$	2.43			$	3.48			$	—			$	—			$	—			$	—
			NGL				1,570,750			$	23.30			$	25.39			$	1.8			$	(5.1	)		$	0.2			$	(8.4	)
			Crude Oil				464,000			$	40.65			$	65.19			$	0.1			$	(11.5	)		$	—			$	(17.5	)
Receive fixed/pay variable			NGL				1,894,000			$	27.74			$	22.68			$	11.0			$	(1.4	)		$	18.3			$	(0.2	)
			Crude Oil				494,000			$	64.02			$	40.51			$	12.2			$	(0.6	)		$	18.2			$	—
Receive variable/pay variable			Natural Gas				7,355,000			$	2.47			$	2.47			$	0.2			$	(0.2	)		$	0.1			$	(0.1	)
Physical Contracts
Receive variable/pay fixed			NGL				890,000			$	17.94			$	16.02			$	1.8			$	(0.1	)		$	—			$	(0.2	)
			Crude Oil				—			$	—			$	—			$	—			$	—			$	—			$	(0.2	)
Receive fixed/pay variable			NGL				869,166			$	22.46			$	24.95			$	0.1			$	(2.3	)		$	1.9			$	(0.2	)
Receive variable/pay variable			Natural Gas				118,233,634			$	1.94			$	1.96			$	—			$	(2.1	)		$	—			$	(2.8	)
			NGL				8,400,616			$	16.85			$	16.51			$	3.7			$	(0.8	)		$	4.0			$	(2.4	)
			Crude Oil				681,040			$	38.84			$	38.38			$	0.7			$	(0.4	)		$	0.7			$	(0.5	)
Portion of contracts maturing in 2017
Swaps
Receive variable/pay fixed			Natural Gas				76,530			$	2.49			$	2.97			$	—			$	—			$	—			$	—
			NGL				757,500			$	16.63			$	21.05			$	0.1			$	(3.5	)		$	—			$	(4.5	)
			Crude Oil				547,500			$	44.92			$	66.72			$	—			$	(11.8	)		$	—			$	(10.9	)
Receive fixed/pay variable			NGL				757,500			$	19.19			$	16.63			$	2.2			$	(0.3	)		$	3.3			$	(0.1	)
			Crude Oil				638,750			$	63.63			$	44.92			$	11.9			$	—			$	10.9			$	—
Receive variable/pay variable			Natural Gas				12,550,000			$	2.75			$	2.70			$	0.8			$	(0.2	)		$	0.5			$	(0.2	)
Physical Contracts
Receive fixed/pay variable			NGL				595			$	22.37			$	21.17			$	—			$	—			$	—			$	—
Receive variable/pay variable			Natural Gas				3,987,810			$	2.78			$	2.75			$	0.1			$	—			$	0.1			$	—
			NGL				186,500			$	23.33			$	23.40			$	—			$	—			$	—			$	—
Portion of contracts maturing in 2018
Physical Contracts
Receive variable/pay variable			Natural Gas				2,187,810			$	2.92			$	2.89			$	0.1			$	—			$	0.1			$	—
Portion of contracts maturing in 2019
Physical Contracts
Receive variable/pay variable			Natural Gas				2,187,810			$	3.00			$	2.97			$	0.1			$	—			$	0.1			$	—
Portion of contracts maturing in 2020
Physical Contracts
Receive variable/pay variable			Natural Gas				359,640			$	3.29			$	3.26			$	—			$	—			$	—			$	—

TABLE OF CONTENTS

MIDCOAST ENERGY PARTNERS, L.P.
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

13. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES  – (continued)

The following table provides summarized information about the fair value of expected cash flows of our outstanding commodity options at March 31, 2016 and December 31, 2015.

		At March 31, 2016																								At December 31, 2015
		Commodity				Notional(1)				Strike Price(2)				Market Price(2)				Fair Value(3)								Fair Value(3)
																		Asset				Liability				Asset				Liability
																		(in millions)
Portion of option contracts maturing in 2016
Puts (purchased)			Natural Gas				1,237,500			$	3.75			$	2.22			$	1.9			$	—			$	2.1			$	—
			NGL				2,227,500			$	39.29			$	22.66			$	37.6			$	—			$	54.4			$	—
			Crude Oil				605,000			$	75.91			$	41.68			$	20.7			$	—			$	27.7			$	—
Calls (written)			Natural Gas				1,237,500			$	4.98			$	2.22			$	—			$	—			$	—			$	—
			NGL				2,227,500			$	45.09			$	22.66			$	—			$	(0.4	)		$	—			$	(0.3	)
			Crude Oil				605,000			$	86.68			$	41.68			$	—			$	—			$	—			$	—
Puts (written)			Natural Gas				1,237,500			$	3.75			$	2.22			$	—			$	(1.9	)		$	—			$	(2.1	)
			NGL				68,750			$	39.06			$	23.25			$	—			$	(1.1	)		$	—			$	(1.5	)
Calls (purchased)			Natural Gas				1,237,500			$	4.98			$	2.22			$	—			$	—			$	—			$	—
			NGL				68,750			$	46.41			$	23.25			$	—			$	—			$	—			$	—
Portion of option contracts maturing in 2017
Puts (purchased)			NGL				1,277,500			$	25.26			$	23.44			$	5.1			$	—			$	5.8			$	—
			Crude Oil				638,750			$	59.86			$	44.92			$	11.1			$	—			$	10.0			$	—
Calls (written)			NGL				1,277,500			$	29.46			$	23.44			$	—			$	(0.8	)		$	—			$	(0.8	)
			Crude Oil				638,750			$	68.19			$	44.92			$	—			$	(0.9	)		$	—			$	(0.6	)
Portion of option contracts maturing in 2018
Puts (purchased)			Crude Oil				91,250			$	42.00			$	47.03			$	0.5			$	—			$	—			$	—
Calls (written)			Crude Oil				91,250			$	51.75			$	47.03			$	—			$	(0.5	)		$	—			$	—