form_10-q.htm
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 June 30, 2010
OR
___ 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   001-13643



ONEOK, Inc.
(Exact name of registrant as specified in its charter)


Oklahoma
73-1520922
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer Identification No.)
 
   
100 West Fifth Street, Tulsa, OK
74103
(Address of principal executive offices)
(Zip Code)


Registrant’s telephone number, including area code   (918) 588-7000


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 __  

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 __

Indicate by checkmark 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.
Large accelerated filer X             Accelerated filer __             Non-accelerated filer __             Smaller reporting company__

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes __ No X

On July 28, 2010, the Company had 106,418,886 shares of common stock outstanding.
 

ONEOK, Inc.
TABLE OF CONTENTS

Part I.
Financial Information
 
Page No.
Item 1.
Financial Statements (Unaudited)
 
 
 
Consolidated Statements of Income - Three and Six Months Ended June 30, 2010 and 2009
 
5
 
Consolidated Balance Sheets - June 30, 2010, and December 31, 2009
 
6-7
 
Consolidated Statements of Cash Flows - Six Months Ended June 30, 2010 and 2009
 
9
 
Consolidated Statement of Changes in Equity - Six Months Ended June 30, 2010
10-11
 
 
Consolidated Statements of Comprehensive Income - Three and Six Months Ended June 30, 2010 and 2009
 
12
 
Notes to Consolidated Financial Statements
 
13-34
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
35-56
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
56-57
Item 4.
Controls and Procedures
 
58
Part II.
Other Information
 
 
Item 1.
Legal Proceedings
 
58
Item 1A.
Risk Factors
 
58
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
59
Item 3.
Defaults Upon Senior Securities
 
59
Item 4.
(Removed and Reserved)
 
59
Item 5.
Other Information
 
59
Item 6.
Exhibits
 
59-60
Signature
  61

As used in this Quarterly Report, references to “we,” “our” or “us” refer to ONEOK, Inc., an Oklahoma corporation, and its predecessors and subsidiaries, unless the context indicates otherwise.

The statements in this Quarterly Report that are not historical information, including statements concerning plans and objectives of management for future operations, economic performance or related assumptions, are forward-looking statements.  Forward-looking statements may include words such as “anticipate,” “estimate,” “expect,” “project,” “intend,” “plan,” “believe,” “should,” “goal,” “forecast,” “guidance,” “could,” “may,” “continue,” “might,” “potential,” “scheduled” and other words and terms of similar meaning.  Although we believe that our expectations regarding future events are based on reasonable assumptions, we can give no assurance that such expectations and assumptions will be achieved.  Important factors that could cause actual results to differ materially from those in the forward-looking statements are described under Part I, Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, “Forward-Looking Statements” and Part II, Item 1A, “Risk Factors” in this Quarterly Report and under Part I, Item 1A, “Risk Factors,” in our Annual Report.

INFORMATION AVAILABLE ON OUR WEB SITE

We make available on our Web site copies of our Annual Report, Quarterly Reports, Current Reports on Form 8-K, amendments to those reports filed or furnished to the SEC pursuant to Section 13(a) or 15(d) of the Exchange Act and reports of holdings of our securities filed by our officers and directors under Section 16 of the Exchange Act as soon as reasonably practicable after filing such material electronically or otherwise furnishing it to the SEC.  Our Web site and any contents thereof are not incorporated by reference into this report.

We also make available on our Web site the Interactive Data Files required to be submitted and posted pursuant to Rule 405 of Regulation S-T.  In accordance with Rule 402 of Regulation S-T, the Interactive Data Files shall not be deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be incorporated by reference into any registration statement or other document filed under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.
2

GLOSSARY
The abbreviations, acronyms and industry terminology used in this Quarterly Report are defined as follows:

 
AFUDC.............................................................
Allowance for funds used during construction
 
Annual Report.................................................
Annual Report on Form 10-K for the year ended December 31, 2009
 
ASU...................................................................
Accounting Standards Update
 
Bbl.....................................................................
Barrels, one barrel is equivalent to 42 United States gallons
 
Bbl/d..................................................................
Barrels per day
 
BBtu/d...............................................................
Billion British thermal units per day
 
Bcf.....................................................................
Billion cubic feet
 
Bcf/d..................................................................
Billion cubic feet per day
 
Btu(s)................................................................
British thermal units, a measure of the amount of heat required to raise the
    temperature of one pound of water one degree Fahrenheit
 
Bushton Plant..................................................
Bushton Gas Processing Plant
 
Clean Air Act...................................................
Federal Clean Air Act, as amended
 
Clean Water Act..............................................
Federal Water Pollution Control Act Amendments of 1972, as amended
 
EBITDA............................................................
Earnings before interest, taxes, depreciation and amortization
 
EPA...................................................................
United States Environmental Protection Agency
 
Exchange Act...................................................
Securities Exchange Act of 1934, as amended
 
FASB.................................................................
Financial Accounting Standards Board
 
FERC.................................................................
Federal Energy Regulatory Commission
 
GAAP................................................................
Accounting principles generally accepted in the United States of America
 
KCC...................................................................
Kansas Corporation Commission
 
KDHE................................................................
Kansas Department of Health and Environment
 
LDCs.................................................................
Local distribution companies
 
LIBOR...............................................................
London Interbank Offered Rate
 
MBbl.................................................................
Thousand barrels
 
MBbl/d..............................................................
Thousand barrels per day
 
Mcf....................................................................
Thousand cubic feet
 
MMBbl.............................................................
Million barrels
 
MMBtu.............................................................
Million British thermal units
 
MMBtu/d.........................................................
Million British thermal units per day
 
MMcf................................................................
Million cubic feet
 
MMcf/d............................................................
Million cubic feet per day
 
Moody’s...........................................................
Moody’s Investors Service, Inc.
 
NGL products..................................................
Marketable natural gas liquid purity products, such as ethane, ethane/propane mix,
    propane, iso-butane, normal butane and natural gasoline
 
NGL(s)...............................................................
Natural gas liquid(s)
 
Northern Border Pipeline...............................
Northern Border Pipeline Company
 
NYMEX............................................................
New York Mercantile Exchange
 
OBPI..................................................................
ONEOK Bushton Processing Inc.
 
OCC...................................................................
Oklahoma Corporation Commission
 
ONEOK.............................................................
ONEOK, Inc.
 
ONEOK Credit Agreement.............................
ONEOK’s $1.2 billion Amended and Restated Credit Agreement dated
    July 14, 2006
        
 
ONEOK Partners.............................................
ONEOK Partners, L.P.
 
ONEOK Partners Credit Agreement.............
ONEOK Partners’ $1.0 billion Amended and Restated Revolving Credit
    Agreement dated March 30, 2007
 
ONEOK Partners GP.......................................
ONEOK Partners GP, L.L.C., a wholly owned subsidiary of ONEOK and the sole
    general partner of ONEOK Partners
 
OPIS..................................................................
Oil Price Information Service
 
Overland Pass Pipeline Company.................
Overland Pass Pipeline Company LLC
 
Quarterly Report(s).........................................
Quarterly Report(s) on Form 10-Q
 
S&P...................................................................
Standard & Poor’s Rating Group
 
SEC....................................................................
Securities and Exchange Commission
 
Securities Act..................................................
Securities Act of 1933, as amended
 
Viking Gas Transmission...............................
Viking Gas Transmission Company
 
XBRL.................................................................
eXtensible Business Reporting Language
3


 











 
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4

 
PART I - FINANCIAL INFORMATION
                       
ITEM 1.  FINANCIAL STATEMENTS
                       
ONEOK, Inc. and Subsidiaries
                       
CONSOLIDATED  STATEMENTS OF INCOME
                       
             
   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(Unaudited)
 
2010
   
2009
   
2010
   
2009
 
   
(Thousands of dollars, except per share amounts)
 
                         
Revenues
  $ 2,807,131     $ 2,227,627     $ 6,731,098     $ 5,017,454  
Cost of sales and fuel
    2,349,054       1,795,201       5,653,701       4,033,617  
Net margin
    458,077       432,426       1,077,397       983,837  
Operating expenses
                               
Operations and maintenance
    178,478       184,874       358,750       346,593  
Depreciation and amortization
    75,510       71,249       153,367       143,375  
General taxes
    25,103       25,261       48,176       50,488  
Total operating expenses
    279,091       281,384       560,293       540,456  
Gain (loss) on sale of assets
    (273 )     3,762       (1,058 )     4,426  
Operating income
    178,713       154,804       516,046       447,807  
Equity earnings from investments (Note J)
    20,676       14,188       41,792       35,410  
Allowance for equity funds used during construction
    235       9,468       482       18,471  
Other income
    711       7,939       3,620       9,604  
Other expense
    (7,552 )     (1,399 )     (8,606 )     (5,343 )
Interest expense
    (75,361 )     (73,392 )     (151,881 )     (151,353 )
Income before income taxes
    117,422       111,608       401,453       354,596  
Income taxes
    (31,048 )     (30,258 )     (128,359 )     (109,697 )
Net income
    86,374       81,350       273,094       244,899  
Less: Net income attributable to noncontrolling interests
    44,650       39,671       76,831       80,935  
Net income attributable to ONEOK
  $ 41,724     $ 41,679     $ 196,263     $ 163,964  
                                 
Earnings per share of common stock (Note K)
                               
Net earnings per share, basic
  $ 0.39     $ 0.40     $ 1.85     $ 1.56  
Net earnings per share, diluted
  $ 0.39     $ 0.39     $ 1.82     $ 1.55  
                                 
Average shares of common stock (thousands)
                               
Basic
    106,356       105,335       106,244       105,249  
Diluted
    107,838       105,950       107,624       105,848  
                                 
Dividends declared per share of common stock
  $ 0.44     $ 0.40     $ 0.88     $ 0.80  
See accompanying Notes to Consolidated Financial Statements.
                         
 
5

 
ONEOK, Inc. and Subsidiaries
           
CONSOLIDATED BALANCE SHEETS
           
   
June 30,
   
December 31,
 
(Unaudited)
 
2010
   
2009
 
Assets
 
(Thousands of dollars)
 
Current assets
           
Cash and cash equivalents
  $ 103,251     $ 29,399  
Accounts receivable, net
    904,325       1,437,994  
Gas and natural gas liquids in storage
    572,941       583,127  
Commodity imbalances
    71,289       186,015  
Energy marketing and risk management assets (Notes B and C)
    88,183       113,039  
Other current assets
    138,266       238,890  
Total current assets
    1,878,255       2,588,464  
                 
Property, plant and equipment
               
Property, plant and equipment
    10,304,502       10,145,800  
Accumulated depreciation and amortization
    2,457,162       2,352,142  
Net property, plant and equipment
    7,847,340       7,793,658  
                 
Investments and other assets
               
Goodwill and intangible assets
    1,026,726       1,030,560  
Energy marketing and risk management assets (Notes B and C)
    19,686       23,125  
Investments in unconsolidated affiliates
    757,232       765,163  
Other assets
    590,672       626,713  
Total investments and other assets
    2,394,316       2,445,561  
Total assets
  $ 12,119,911     $ 12,827,683  
See accompanying Notes to Consolidated Financial Statements.
               

6

 
ONEOK, Inc. and Subsidiaries
           
CONSOLIDATED BALANCE SHEETS
           
   
June 30,
   
December 31,
 
(Unaudited)
 
2010
   
2009
 
Liabilities and equity
 
(Thousands of dollars)
 
Current liabilities
           
Current maturities of long-term debt
  $ 643,225     $ 268,215  
Notes payable (Note E)
    680,000       881,870  
Accounts payable
    830,015       1,240,207  
Commodity imbalances
    205,967       394,971  
Energy marketing and risk management liabilities (Notes B and C)
    35,628       65,162  
Other current liabilities
    480,773       488,487  
Total current liabilities
    2,875,608       3,338,912  
                 
Long-term debt, excluding current maturities
    3,697,585       4,334,204  
                 
Deferred credits and other liabilities
               
Deferred income taxes
    1,053,931       1,037,665  
Energy marketing and risk management liabilities (Notes B and C)
    5,081       8,926  
Other deferred credits
    617,132       662,514  
Total deferred credits and other liabilities
    1,676,144       1,709,105  
                 
Commitments and contingencies (Note H)
               
                 
Equity (Note F)
               
ONEOK shareholders' equity:
               
Common stock, $0.01 par value:
               
authorized 300,000,000 shares; issued 122,676,368 shares and outstanding
               
106,415,009 shares at June 30, 2010; issued 122,394,015 shares and
               
outstanding 105,906,776 shares at December 31, 2009
    1,227       1,224  
Paid-in capital
    1,375,090       1,322,340  
Accumulated other comprehensive loss (Note D)
    (103,486 )     (118,613 )
Retained earnings
    1,788,501       1,685,710  
Treasury stock, at cost: 16,261,359 shares at June 30, 2010 and
               
16,487,239 shares at December 31, 2009
    (674,103 )     (683,467 )
Total ONEOK shareholders' equity
    2,387,229       2,207,194  
                 
Noncontrolling interests in consolidated subsidiaries
    1,483,345       1,238,268  
                 
Total equity
    3,870,574       3,445,462  
Total liabilities and equity
  $ 12,119,911     $ 12,827,683  
See accompanying Notes to Consolidated Financial Statements.
               

7


 













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8

 
ONEOK, Inc. and Subsidiaries
           
CONSOLIDATED STATEMENTS OF CASH FLOWS
           
 
Six Months Ended
 
 
June 30,
 
(Unaudited)
 
2010
   
2009
 
 
(Thousands of dollars)
 
Operating activities
           
Net income
  $ 273,094     $ 244,899  
Depreciation and amortization
    153,367       143,375  
Allowance for equity funds used during construction
    (482 )     (18,471 )
Loss (gain) on sale of assets
    1,058       (4,426 )
Equity earnings from investments
    (41,792 )     (35,410 )
Distributions received from unconsolidated affiliates
    39,034       38,233  
Deferred income taxes
    42,794       40,865  
Share-based compensation expense
    10,205       8,551  
Other
    3,416       (767 )
Changes in assets and liabilities:
               
Accounts receivable
    531,537       492,441  
Gas and natural gas liquids in storage
    1,618       285,271  
Accounts payable
    (407,513 )     (324,364 )
Commodity imbalances, net
    (74,278 )     (18,352 )
Unrecovered purchased gas costs
    89,026       42,766  
Energy marketing and risk management assets and liabilities
    64,050       35,373  
Fair value of firm commitments
    (68,968 )     179,582  
Other assets and liabilities
    (25,039 )     (33,714 )
Cash provided by operating activities
    591,127       1,075,852  
Investing activities
               
Changes in investments in unconsolidated affiliates
    9,448       17,393  
Capital expenditures (less allowance for equity funds used during construction)
    (179,704 )     (407,600 )
Proceeds from sale of assets
    371       10,029  
Cash used in investing activities
    (169,885 )     (380,178 )
Financing activities
               
Repayment of notes payable, net
    (201,870 )     (710,090 )
Repayment of notes payable with maturities over 90 days
    -       (870,000 )
Issuance of debt, net of discounts
    -       498,325  
Long-term debt financing costs
    -       (4,000 )
Repayment of debt
    (256,543 )     (107,970 )
Repurchase of common stock
    (5 )     (250 )
Issuance of common stock
    7,884       4,342  
Issuance of common units of ONEOK Partners, net of discounts
    322,704       220,458  
Dividends paid
    (93,472 )     (84,202 )
Distributions to noncontrolling interests
    (126,088 )     (105,307 )
Cash used in financing activities
    (347,390 )     (1,158,694 )
Change in cash and cash equivalents
    73,852       (463,020 )
Cash and cash equivalents at beginning of period
    29,399       510,058  
Cash and cash equivalents at end of period
  $ 103,251     $ 47,038  
See accompanying Notes to Consolidated Financial Statements.
 

9

 
ONEOK, Inc. and Subsidiaries
                       
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
                   
                         
                         
   
ONEOK Shareholders' Equity
 
                     
Accumulated
 
   
Common
               
Other
 
   
Stock
   
Common
   
Paid-in
   
Comprehensive
 
(Unaudited)
 
Issued
   
Stock
   
Capital
   
Income (Loss)
 
   
(Shares)
 
(Thousands of dollars)
 
                         
December 31, 2009
    122,394,015     $ 1,224     $ 1,322,340     $ (118,613 )
Net income
    -       -       -       -  
Other comprehensive income
    -       -       -       15,127  
Repurchase of common stock
    -       -       -       -  
Common stock issued
    282,353       3       2,019       -  
Common stock dividends -
                               
$0.88 per share
    -       -       -       -  
Issuance of common units of ONEOK Partners
    -       -       50,731       -  
Distributions to noncontrolling interests
    -       -       -       -  
June 30, 2010
    122,676,368     $ 1,227     $ 1,375,090     $ (103,486 )
See accompanying Notes to Consolidated Financial Statements.
                         

10

 
ONEOK, Inc. and Subsidiaries
                       
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
                   
(Continued)
                       
                         
 
ONEOK Shareholders' Equity
 
               
Noncontrolling
       
               
Interests in
       
   
Retained
   
Treasury
   
Consolidated
   
Total
 
(Unaudited)
 
Earnings
   
Stock
   
Subsidiaries
   
Equity
 
 
(Thousands of dollars)
 
                         
December 31, 2009
  $ 1,685,710     $ (683,467 )   $ 1,238,268     $ 3,445,462  
Net income
    196,263       -       76,831       273,094  
Other comprehensive income
    -       -       22,361       37,488  
Repurchase of common stock
    -       (5 )     -       (5 )
Common stock issued
    -       9,369       -       11,391  
Common stock dividends -
                               
$0.88 per share
    (93,472 )     -       -       (93,472 )
Issuance of common units of ONEOK Partners
    -       -       271,973       322,704  
Distributions to noncontrolling interests
    -       -       (126,088 )     (126,088 )
June 30, 2010
  $ 1,788,501     $ (674,103 )   $ 1,483,345     $ 3,870,574  

11

 
ONEOK, Inc. and Subsidiaries
                       
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
                   
             
   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
(Unaudited)
 
2010
   
2009
   
2010
   
2009
 
   
(Thousands of dollars)
 
                         
Net income
  $ 86,374     $ 81,350     $ 273,094     $ 244,899  
Other comprehensive income (loss), net of tax
                               
Unrealized gains (losses) on energy marketing and risk management
                               
assets/liabilities, net of tax of $(4,689), $9,743, $(23,526) and
                               
$(28,340), respectively
    14,036       (22,177 )     57,527       38,469  
Realized gains in net income, net of tax of $748, $5,176, $8,769
                               
and $32,853, respectively
    (1,717 )     (16,793 )     (11,776 )     (70,713 )
Unrealized holding gains (losses) on available-for-sale securities,
                               
net of tax of $107, $(200), $168 and $(319), respectively
    (169 )     318       (267 )     505  
Change in pension and postretirement benefit plan liability, net of tax
                               
of $2,533, $2,057, $5,066 and $3,655, respectively
    (4,016 )     (3,260 )     (8,032 )     (5,795 )
Other, net of tax of $(11), $(11), $(22) and $(62), respectively
    18       18       36       208  
Total other comprehensive income (loss), net of tax
    8,152       (41,894 )     37,488       (37,326 )
Comprehensive income
    94,526       39,456       310,582       207,573  
Less: Comprehensive income attributable to noncontrolling interests
    50,723       24,731       99,192       55,953  
Comprehensive income attributable to ONEOK
  $ 43,803     $ 14,725     $ 211,390     $ 151,620  
See accompanying Notes to Consolidated Financial Statements.
                               

12

ONEOK, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

A.           SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Our accompanying unaudited consolidated financial statements have been prepared in accordance with GAAP and reflect all adjustments that, in our opinion, are necessary for a fair presentation of the results for the interim periods presented.  All such adjustments are of a normal recurring nature.  The 2009 year-end consolidated balance sheet data was derived from audited financial statements but does not include all disclosures required by GAAP.  These unaudited consolidated financial statements should be read in conjunction with our audited consolidated financial statements in our Annual Report.  Due to the seasonal nature of our business, the results of operations for the three and six months ended June 30, 2010, are not necessarily indicative of the results that may be expected for a 12-month period.

Our significant accounting policies are consistent with those disclosed in Note A of the Notes to Consolidated Financial Statements in our Annual Report.

Recently Issued Accounting Standards Update

The following recently issued accounting standards update affects our consolidated financial statements and related disclosures:

Fair Value Measurements and Disclosures - In January 2010, the FASB issued ASU 2010-06, “Improving Disclosures about Fair Value Measurements,” which established new disclosure requirements and clarified existing requirements for disclosures of fair value measurements.  ASU 2010-06 required us to add two new disclosures, when applicable: (i) transfers in and out of Level 1 and 2 fair value measurements including the reasons for the transfers, and (ii) a gross presentation of activity within the reconciliation of Level 3 fair value measurements.  Except for separate disclosure of purchases, sales, issuances and settlements in the reconciliation of our Level 3 fair value measurements, we applied this guidance to our disclosures beginning with our March 31, 2010, Quarterly Report.  The separate disclosure of purchases, sales, issuances and settlements in the reconciliation of our Level 3 fair value measurements will be required beginning with our March 31, 2011, Quarterly Report, and we do not expect the impact to be material.  ASU 2010-06 requires prospective application in the period of adoption, and we have not recast our prior-year disclosures.  See Note B for more discussion of our fair value measurements.

Our policy for calculating transfers between levels of the fair value hierarchy recognizes the transfer as of the end of each reporting period.  Prior to January 1, 2010, our policy of calculating transfers recognized transfers in at the end of the reporting period and transfers out at the beginning of the reporting period.  Therefore, transfers into and out of Level 3 and included in earnings may not be comparable with prior periods.

B.           FAIR VALUE MEASUREMENTS

Determining Fair Value - We define fair value as the price that would be received from the sale of an asset or the transfer of a liability in an orderly transaction between market participants at the measurement date.  We use the market and income approaches to determine the fair value of our assets and liabilities and consider the markets in which the transactions are executed.  While many of the contracts in our portfolio are executed in liquid markets where price transparency exists, some contracts are executed in markets for which market prices may exist, but the market may be relatively inactive.  This results in limited price transparency that requires management’s judgment and assumptions to estimate fair values.  Inputs into our fair value estimates include commodity exchange prices, over-the-counter quotes, volatility, historical correlations of pricing data and LIBOR, and other liquid money market instrument rates.  We also utilize internally developed basis curves that incorporate observable and unobservable market data.  We validate our valuation inputs with third-party information and settlement prices from other sources, where available.  In addition, as prescribed by the income approach, we compute the fair value of our derivative portfolio by discounting the projected future cash flows from our derivative assets and liabilities to present value using interest rate yields to calculate present-value discount factors derived from LIBOR, Eurodollar futures and U.S. Treasury swaps.  We also take into consideration the potential impact on market prices of liquidating positions in an orderly manner over a reasonable period of time under current market conditions.  We consider current market data in evaluating counterparties’, as well as our own, nonperformance risk, net of collateral, by using specific and sector bond yields and also monitoring the credit default swap markets.  Although we use our best estimates to determine the fair value of
 
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the derivative contracts we have executed, the ultimate market prices realized could differ from our estimates, and the differences could be material.

Recurring Fair Value Measurements - The following tables set forth our recurring fair value measurements for the periods indicated:

   
June 30, 2010
 
   
Level 1
   
Level 2
   
Level 3
   
Netting
   
Total
 
   
(Thousands of dollars)
 
Assets
                             
Derivatives (a)
                             
Commodity contracts
                             
Financial contracts
  $ 104,965     $ 8,173     $ 340,770     $ -     $ 453,908  
Physical contracts
    -       21,841       23,245       -       45,086  
Netting
    -       -       -       (391,142 )     (391,142 )
Foreign Exchange contracts
    17       -       -       -       17  
Total derivatives
    104,982       30,014       364,015       (391,142 )     107,869  
Trading securities (b)
    6,643       -       -       -       6,643  
Available-for-sale investment securities (c)
    2,252       -       -       -       2,252  
    Total assets   $ 113,877     $ 30,014     $ 364,015     $ (391,142   $ 116,764  
                                         
Liabilities
                                       
Derivatives (a)
                                       
Commodity contracts
                                       
Financial contracts
  $ (74,431 )   $ (2,291 )   $ (262,402 )   $ -     $ (339,124 )
Physical contracts
    -       (4,419 )     (12,501 )     -       (16,920 )
Netting
    -       -       -       315,348       315,348  
Foreign Exchange contracts
    (13 )     -       -       -       (13 )
Total derivatives
    (74,444 )     (6,710 )     (274,903 )     315,348       (40,709 )
Fair value of firm commitments (d)
    -       -       (65,653 )     -       (65,653 )
    Total liabilities   $ (74,444   $ (6,710   $ (340,556   $ 315,348     $ (106,362
(a) - Our derivative assets and liabilities are presented in our Consolidated Balance Sheets as energy marketing and risk management assets and liabilities on a net basis. We net derivative assets and liabilities, including cash collateral, when a legally enforceable master-netting arrangement exists between the counterparty to a derivative contract and us. At June 30, 2010, we held $78.9 million of cash collateral and had posted $3.1 million of cash collateral with various counterparties.
 
(b) - Our trading securities are presented in our Consolidated Balance Sheets as other current assets.
 
(c) - Our available-for-sale investment securities are presented in our Consolidated Balance Sheets as other assets.
 
(d) - Our fair value of firm commitments are presented in our Consolidated Balance Sheets as other current liabilities and other deferred credits.
 
 
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December 31, 2009
 
   
Level 1
 
Level 2
 
Level 3
 
Netting
 
Total
 
   
(Thousands of dollars)
 
Assets
                             
Derivatives (a)
  $ 149,034     $ 4,898     $ 672,631     $ (690,399 )   $ 136,164  
Trading securities (b)
    7,927       -       -       -       7,927  
Available-for-sale investment securities (c)
    2,688       -       -       -       2,688  
    Total assets
  $ 159,649     $ 4,898     $ 672,631     $ (690,399 )   $ 146,779  
                                         
Liabilities
                                       
Derivatives (a)
  $ (109,713 )   $ (8,481 )   $ (535,937 )   $ 580,043     $ (74,088 )
Fair value of firm commitments (d)
    -       -       (134,620 )     -       (134,620 )
    Total liabilities
  $ (109,713 )   $ (8,481 )   $ (670,557 )   $ 580,043     $ (208,708 )
(a) - Our derivative assets and liabilities are presented in our Consolidated Balance Sheets as energy marketing and risk management assets and liabilities on a net basis. We net derivative assets and liabilities, including cash collateral, when a legally enforceable master-netting arrangement exists between the counterparty to a derivative contract and us. At December 31, 2009, we held $136.5 million of cash collateral and had posted $26.1 million of cash collateral with various counterparties.
 
(b) - Our trading securities are presented in our Consolidated Balance Sheets as other current assets.
 
(c) - Our available-for-sale investment securities are presented in our Consolidated Balance Sheets as other assets.
 
(d) - Our fair value of firm commitments are presented in our Consolidated Balance Sheets as other current liabilities and other deferred credits.
 
                                         
We categorize derivatives for which fair value is determined using multiple inputs within a single level, based on the lowest level input that is significant to the fair value measurement in its entirety.
 
Our Level 1 fair value measurements are based on NYMEX-settled prices, actively quoted prices for equity securities and foreign currency forward-exchange rates.  These balances are predominantly comprised of exchange-traded derivative contracts, including futures and certain options for natural gas and crude oil, which are valued based on unadjusted quoted prices in active markets.  Also included in Level 1 are equity securities and foreign currency forwards.

Our Level 2 fair value inputs are based on NYMEX-settled prices for natural gas and crude oil that are utilized to determine the fair value of certain non-exchange traded financial instruments, including natural gas and crude oil swaps, as well as physical forwards.

For the six months ended June 30, 2010, there were no transfers between levels 1 and 2.

Our Level 3 inputs include internally developed basis curves incorporating observable and unobservable market data, NGL price curves from a pricing service, historical correlations of NGL product prices to published NYMEX crude oil prices, market volatilities derived from the most recent NYMEX close spot prices and forward LIBOR curves, and adjustments for the credit risk of our counterparties.  We corroborate the data on which our fair value estimates are based using our market knowledge of recent transactions, analysis of historical correlations and validation with independent broker quotes or a pricing service.  The derivatives categorized as Level 3 include natural gas basis swaps, swing swaps, options, NGL swaps, commodity or natural gas and NGL physical forward contracts and interest-rate swaps.  Also included in Level 3 are the fair values of firm commitments.  We do not believe that our Level 3 fair value estimates have a material impact on our results of operations, as the majority of our derivatives are accounted for as hedges for which ineffectiveness is not material.

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The following tables set forth the reconciliation of our Level 3 fair value measurements for the periods indicated:
 
   
Derivative
Assets
(Liabilities)
   
Fair Value of
Firm
 Commitments
     
Total
 
   
(Thousands of dollars)
 
April 1, 2010
  $ 147,573     $ (111,597 )     $ 35,976  
   Total realized/unrealized gains (losses):
                         
       Included in earnings
    (52,606 )
 (a)
  45,944  
 (a)
    (6,662 )
       Included in other comprehensive income (loss)
    8,484       -         8,484  
   Transfers into Level 3
    431       -         431  
   Transfers out of Level 3
    (14,770 )     -         (14,770 )
June 30, 2010
  $ 89,112     $ (65,653 )     $ 23,459  
                           
Total gains (losses) for the period included in
   earnings attributable to the change in unrealized
   gains (losses) relating to assets and liabilities
   still held as of June 30, 2010 (a)
  $ (24,529 )   $ 13,481       $ (11,048 )
(a) - Reported in revenues and cost of sales and fuel in our Consolidated Statements of Income.
       
 
   
Derivative
Assets
 (Liabilities)
   
Fair Value of
Firm Commitments
     
Total
 
   
(Thousands of dollars)
 
April 1, 2009
  $ 170,238     $ (111,212 )     $ 59,026  
   Total realized/unrealized gains (losses):
                         
       Included in earnings
    34,202  
 (a)
  (26,191 )
 (a)
    8,011  
       Included in other comprehensive income (loss)
    (52,330 )     -         (52,330 )
   Transfers in and/or out of Level 3
    18,304       -         18,304  
June 30, 2009
  $ 170,414     $ (137,403 )     $ 33,011  
                           
Total gains (losses) for the period included in
   earnings attributable to the change in unrealized
   gains (losses) relating to assets and liabilities
   still held as of June 30, 2009 (a)
  $ 57,041     $ (44,189 )     $ 12,852  
(a) - Reported in revenues and cost of sales and fuel in our Consolidated Statements of Income.
       
 
   
Derivative
Assets (Liabilities)
   
Fair Value of
Firm Commitments
   
Total
 
   
(Thousands of dollars)
 
January 1, 2010
  $ 136,694     $ (134,620 )   $ 2,074  
   Total realized/unrealized gains (losses):
                       
       Included in earnings (a)
    (56,032 )     68,967       12,935  
       Included in other comprehensive income (loss)
    21,705       -       21,705  
   Transfers into Level 3
    1,423       -       1,423  
   Transfers out of Level 3
    (14,678 )     -       (14,678 )
June 30, 2010
  $ 89,112     $ (65,653 )   $ 23,459  
                         
Total gains (losses) for the period included in
   earnings attributable to the change in unrealized
   gains (losses) relating to assets and liabilities
   still held as of June 30, 2010 (a)
  $ (5,761 )   $ 8,532     $ 2,771  
(a) - Reported in revenues and cost of sales and fuel in our Consolidated Statements of Income.
         
 
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Derivative
Assets
 (Liabilities)
   
Fair Value of
Firm
Commitments
   
Long-Term
Debt
     
Total
 
 
(Thousands of dollars)
 
January 1, 2009
$ 42,355     $ 42,179     $ (171,455 )     $ (86,921 )
   Total realized/unrealized gains (losses):
                               
       Included in earnings
  188,038  
(a)
  (179,582 )
(a)
  1,455  
(b)
    9,911  
       Included in other comprehensive income (loss)
  (60,060 )     -       -         (60,060 )
   Maturities
  -       -       100,000         100,000  
   Terminations prior to maturity
  -       -       70,000         70,000  
   Transfers in and/or out of Level 3
  81       -       -         81  
June 30, 2009
$ 170,414     $ (137,403 )   $ -       $ 33,011  
                                 
Total gains (losses) for the period included in
   earnings attributable to the change in unrealized
   gains (losses) relating to assets and liabilities
   still held as of June 30, 2009 (a)
$ 189,866     $ (162,734 )   $ -       $ 27,132  
(a) - Reported in revenues and cost of sales and fuel in our Consolidated Statements of Income.
               
(b) - Reported in interest expense in our Consolidated Statements of Income.
                   
 
Realized/unrealized gains (losses) include the realization of our derivative contracts through maturity and changes in fair value of our hedged firm commitments and fixed-rate debt swapped to a floating rate.  Maturities represent the long-term debt associated with an interest-rate swap that matured during the period.  Terminations prior to maturity represent the long-term debt associated with an interest-rate swap that was terminated during the period.  Transfers into Level 3 represent existing assets or liabilities that were previously categorized at a higher level for which the unobservable inputs became a more significant portion of the fair value estimates.  Transfers out of Level 3 represent existing assets and liabilities that were previously classified as Level 3 for which the observable inputs became a more significant portion of the fair value estimates.

Other Financial Instruments - The approximate fair value of cash and cash equivalents, accounts receivable and accounts payable is equal to book value, due to the short-term nature of these items.  The fair value of notes payable approximates the carrying value since the interest rates, prescribed by each borrowing’s respective credit agreement, are periodically adjusted to reflect current market conditions.

The estimated fair value of long-term debt, including current maturities, was $4.6 billion at June 30, 2010, and $4.8 billion at December 31, 2009.  The book value of long-term debt, including current maturities, was $4.3 billion at June 30, 2010, and $4.6 billion at December 31, 2009.  The estimated fair value of long-term debt has been determined using quoted market prices of the same or similar issues with similar terms and maturities.

C.           RISK MANAGEMENT AND HEDGING ACTIVITIES USING DERIVATIVES

Our Energy Services and ONEOK Partners segments are exposed to various risks that we manage by periodically entering into derivative instruments.  These risks include the following:
·  
Commodity price risk - We are exposed to the risk of loss in cash flows and future earnings arising from adverse changes in the price of natural gas, NGLs and crude oil.  We use commodity derivative instruments such as futures, physical forward contracts, swaps and options to mitigate the commodity price risk associated with a portion of the forecasted purchases and sales of commodities and natural gas and natural gas liquids in storage;
·  
Basis risk - We are exposed to the risk of loss in cash flows and future earnings arising from adverse changes in the price differentials between pipeline receipt and delivery locations.  Our firm transportation capacity allows us to purchase gas at a pipeline receipt point and sell gas at a pipeline delivery point.  Our Energy Services segment periodically enters into basis swaps between the transportation receipt and delivery points in order to protect the fair value of these location price differentials related to our firm commitments; and
·  
Currency exchange rate risk - As a result of our Energy Services segment’s activities in Canada, we are exposed to the risk of loss in cash flows and future earnings from adverse changes in currency exchange rates on our commodity purchases and sales primarily related to our firm transportation and storage contracts that are transacted in a currency other than our functional currency, the U.S. dollar.  To reduce our exposure to exchange-rate fluctuations, we use physical forward transactions, which result in an actual two-way flow of currency on the settlement date in which we exchange U.S. dollars for Canadian dollars with another party.
 
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The following derivative instruments are used to manage our exposure to these risks:
·  
Futures contracts - Standardized exchange-traded contracts to purchase or sell natural gas or crude oil at a specified price, requiring delivery on or settlement through the sale or purchase of an offsetting contract by a specified future date under the provisions of exchange regulations;
·  
Forward contracts - Commitments to purchase or sell natural gas, crude oil or NGLs for delivery at some specified time in the future.  We also use currency forward contracts to manage our currency exchange rate risk. Forward contracts are different from futures in that forwards are customized and non-exchange traded;
·  
Swaps - Financial trades involving the exchange of payments based on two different pricing structures for a commodity.  In a typical commodity swap, parties exchange payments based on changes in the price of a commodity or a market index, while fixing the price they effectively pay or receive for the physical commodity.  As a result, one party assumes the risks and benefits of movements in market prices, while the other party assumes the risks and benefits of a fixed price for the commodity; and
·  
Options - Contractual agreements that give the holder the right, but not the obligation, to buy or sell a fixed quantity of a commodity, at a fixed price, within a specified period of time.  Options may either be standardized and exchange traded or customized and non-exchange traded.

Our objectives for entering into such contracts include but are not limited to:
·  
reducing the variability of cash flows by locking in the price for all or a portion of anticipated index-based physical purchases and sales, transportation fuel requirements, asset management transactions and customer-related business activities;
·  
locking in a price differential to protect the fair value between transportation receipt and delivery points and to protect the fair value of natural gas or NGLs that are purchased in one month and sold in a later month; and
·  
reducing our exposure to fluctuations in foreign currency exchange rates.

Our Energy Services segment also enters into derivative contracts for financial trading purposes primarily to capitalize on opportunities created by market volatility, weather-related events, supply-demand imbalances and market liquidity inefficiency, which allows us to capture additional margin.  Financial trading activities are executed generally using financially settled derivatives and are normally short term in nature.

With respect to the net open positions that exist within our marketing and financial trading operations, fluctuating commodity prices can impact our financial position and results of operations.  The net open positions are actively managed, and the impact of the changing prices on our financial condition at a point in time is not necessarily indicative of the impact of price movements throughout the year.

Our Distribution segment also uses derivative instruments to hedge the cost of anticipated natural gas purchases during the winter heating months to protect our customers from upward volatility in the market price of natural gas.  The use of these derivative instruments and the associated recovery of these costs have been approved by the OCC, KCC and regulatory authorities in most of our Texas jurisdictions.

We are also subject to fluctuation in interest rates.  We manage interest-rate risk through the use of fixed-rate debt, floating-rate debt and interest-rate swaps.  Interest-rate swaps are agreements to exchange an interest payment at some future point based on the differential between two interest rates.

Accounting Treatment

We record derivative instruments at fair value, with the exception of normal purchases and normal sales that are expected to result in physical delivery.  The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and, if so, the reason for holding it.

If certain conditions are met, we may elect to designate a derivative instrument as a hedge of exposure to changes in fair values, cash flows or foreign currency.  Certain non-trading derivative transactions, which are economic hedges of our accrual transactions such as our storage and transportation contracts, do not qualify for hedge accounting treatment.

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The table below summarizes the various ways in which we account for our derivative instruments and the impact on our consolidated financial statements:
 
       
Recognition and Measurement
Accounting Treatment
     
Balance Sheet
   
Income Statement
Normal purchases and
normal sales
    -  
Fair value not recorded
-  
Change in fair value not recognized in earnings
Mark-to-market
    -  
Recorded at fair value
-  
Change in fair value recognized in earnings
Cash flow hedge
    -  
Recorded at fair value
-  
Ineffective portion of the gain or loss on the derivative instrument is recognized in earnings
      -  
Effective portion of the gain or loss on the derivative instrument is reported initially as a component of accumulated other comprehensive income (loss)
-  
Effective portion of the gain or loss on the derivative instrument is reclassified out of accumulated other comprehensive income (loss) into earnings when the forecasted transaction affects earnings
Fair value hedge
    -  
Recorded at fair value
-  
The gain or loss on the derivative instrument is recognized in earnings
      -  
Change in fair value of the hedged item is recorded as an adjustment to book value
-  
Change in fair value of the hedged item is recognized in earnings

Gains or losses associated with the fair value of derivative instruments entered into by our Distribution segment are included in, and recoverable through, the monthly purchased-gas cost mechanism.

We formally document all relationships between hedging instruments and hedged items, as well as risk management objectives, strategies for undertaking various hedge transactions and methods for assessing and testing correlation and hedge ineffectiveness.  We specifically identify the asset, liability, firm commitment or forecasted transaction that has been designated as the hedged item.  We assess the effectiveness of hedging relationships quarterly by performing a regression analysis on our cash flow and fair value hedging relationships to determine whether the hedge relationships are highly effective on a retrospective and prospective basis.  We also document our normal purchases and normal sales transactions that we expect to result in physical delivery and which we elect to exempt from derivative accounting treatment.

The presentation of settled derivative instruments on either a gross or net basis in our Consolidated Statements of Income is dependent on the relevant facts and circumstances of our different types of activities rather than based solely on the terms of the individual contracts.  All financially settled derivative instruments, as well as derivative instruments considered held for trading purposes that result in physical delivery, are reported on a net basis in revenues in our Consolidated Statements of Income.  The realized revenues and purchase costs of derivative instruments that are not considered held for trading purposes and non-derivative contracts are reported on a gross basis.  Derivatives that qualify as normal purchases or normal sales that are expected to result in physical delivery are also reported on a gross basis.

Revenues in our Consolidated Statements of Income include financial trading margins, as well as certain physical natural gas transactions with our trading counterparties.  Revenues and cost of sales and fuel from such physical transactions are reported on a net basis.

Cash flows from futures, forwards, options and swaps that are accounted for as hedges are included in the same Consolidated Statements of Cash Flows category as the cash flows from the related hedged items.

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Fair Values of Derivative Instruments

See Note B for a discussion of the inputs associated with our fair value measurements.

The following table sets forth the fair values of our derivative instruments for the periods indicated:
 
 
June 30, 2010
 
December 31, 2009
 
 
Fair Values of Derivatives (a)
 
Fair Values of Derivatives (a)
 
 
Assets
   
(Liabilities)
 
Assets
   
(Liabilities)
 
 
(Thousands of dollars)
 
Derivatives designated as hedging instruments
                   
Commodity contracts
                   
Financial contracts
$ 187,813
 (b)
  $ (49,132 ) $ 311,009
 (c)
  $ (130,831 )
Physical contracts
  756       (176 )   1,702       (937 )
Total derivatives designated as hedging instruments
  188,569       (49,308 )   312,711       (131,768 )
Derivatives not designated as hedging instruments
                           
Commodity contracts
                           
Non-trading instruments
                           
Financial contracts
  226,532       (252,735 )   407,475       (447,714 )
Physical contracts
  44,330       (16,744 )   46,598       (16,234 )
Trading instruments
                           
Financial contracts
  39,563       (37,257 )   59,751       (58,334 )
Total commodity contracts
  310,425       (306,736 )   513,824       (522,282 )
Foreign exchange contracts
  17       (13 )   28       (81 )
Total derivatives not designated as hedging instruments
  310,442       (306,749 )   513,852       (522,363 )
Total derivatives
$ 499,011     $ (356,057 ) $ 826,563     $ (654,131 )
(a) - Included on a net basis in energy marketing and risk management assets and liabilities on our Consolidated Balance Sheets.
 
(b) - Includes $11.3 million of derivative assets associated with cash flow hedges of inventory that were adjusted to reflect the lower of cost or market value. The deferred gains associated with these assets have been reclassified from accumulated other comprehensive loss.
 
(c) - Includes $37.7 million of derivative assets associated with cash flow hedges of inventory that were adjusted to reflect the lower of cost or market value. The deferred gains associated with these assets have been reclassified from accumulated other comprehensive loss.
 
                             
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Notional Quantities for Derivative Instruments

The following table sets forth the notional quantities for derivative instruments held for the periods indicated:
 
     
June 30, 2010
   
December 31, 2009
 
 
Contract
Type
 
Purchased/
Payor
   
Sold/
Receiver
   
Purchased/
Payor
   
Sold/
Receiver
 
Derivatives designated as hedging instruments:
                       
 Cash flow hedges
                         
  Fixed price
                         
    - Natural gas (Bcf)
Exchange futures
    5.4       (12.5 )     6.4       (20.7 )
 
Swaps
    3.2       (65.3 )     18.1       (80.7 )
    - Crude oil and NGLs (MMBbl)
Swaps
    -       (1.8 )     -       (2.4 )
  Basis
                                 
    - Natural gas (Bcf)
Forwards and swaps
    8.9       (71.7 )     23.7       (99.6 )
 Fair value hedges
                                 
  Basis
                                 
    - Natural gas (Bcf)
Forwards and swaps
    187.3       (187.3 )     210.4       (210.4 )
                                   
Derivatives not designated as hedging instruments:
                               
  Fixed price
                                 
    - Natural gas (Bcf)
Exchange futures
    23.9       (15.0 )     38.8       (22.7 )
 
Forwards and swaps
    83.3       (104.0 )     100.6       (117.4 )
 
Options
    115.4       (75.1 )     102.6       (80.6 )
    - Crude and NGLs (MBbl)
Forwards and swaps
    1.1       (1.6 )