FORM 10-K

86

MDU RESOURCES G ROUP, INC.

PART II

In the event a derivative instrument being accounted for as a cash flow hedge does not qualify for hedge accounting because it is no longer

highly effective in offsetting changes in cash flows of a hedged item; if the derivative instrument expires or is sold, terminated or exercised;

or if management determines that designation of the derivative instrument as a hedge instrument is no longer appropriate, hedge

accounting would be discontinued and the derivative instrument would continue to be carried at fair value with changes in its fair value

recognized in earnings. In these circumstances, the net gain or loss at the time of discontinuance of hedge accounting would remain in

accumulated other comprehensive income (loss) until the period or periods during which the hedged forecasted transaction affects

earnings, at which time the net gain or loss would be reclassified into earnings. In the event a cash flow hedge is discontinued because it is

unlikely that a forecasted transaction will occur, the derivative instrument would continue to be carried on the balance sheet at its fair value,

and gains and losses that had accumulated in other comprehensive income (loss) would be recognized immediately in earnings. In the event

of a sale, termination or extinguishment of a foreign currency derivative, the resulting gain or loss would be recognized immediately in

earnings. The Company's policy requires approval to terminate a derivative instrument prior to its original maturity. As of December 31,

2007, the Company had no outstanding foreign currency or interest rate hedges.

Cascade core

At December 31, 2007, Cascade held natural gas swap agreements which were not designated as hedges.

Cascade utilizes natural gas swap agreements to manage a portion of the market risk associated with fluctuations in the price of natural

gas on its forecasted purchases of natural gas for core customers in accordance with authority granted by the WUTC and OPUC. Core

customers consist of residential, commercial and smaller industrial customers. The fair value of the derivative instrument must be estimated

as of the end of each reporting period and is recorded on the Consolidated Balance Sheets as an asset or a liability. Cascade applies

SFAS No. 71 and records periodic changes in the fair market value of the derivative instruments on the Consolidated Balance Sheets as

a regulatory asset or a regulatory liability, and settlements of these arrangements are expected to be recovered through the purchased gas

cost adjustment mechanism. Under the terms of these arrangements, Cascade will either pay or receive settlement payments based on

the difference between the fixed strike price and the monthly index price applicable to each contract.

Fidelity and Cascade non-core

At December 31, 2007, Fidelity held natural gas and oil swap and collar derivative instruments designated as cash flow hedging instruments.

Cascade held natural gas swap derivative instruments designated as cash flow hedging instruments.

Fidelity utilizes natural gas and oil price swap and collar agreements to manage a portion of the market risk associated with fluctuations in

the price of natural gas and oil on its forecasted sales of natural gas and oil production. Cascade utilizes natural gas swap agreements to

manage a portion of the market risk associated with fluctuations in the price of natural gas on its forecasted purchases of natural gas for

non-core customers. Cascade's non-core customers, who are not covered by the purchased gas cost adjustment mechanism, are generally

large industrial, electric generation and institutional customers. Each of the price swap and collar agreements was designated as a cash

flow hedge of the forecasted sale of the related production or as a cash flow hedge of the forecasted purchase of the related commodity.

The fair value of the hedging instruments must be estimated as of the end of each reporting period and is recorded on the Consolidated

Balance Sheets as an asset or a liability. Changes in the fair value attributable to the effective portion of hedging instruments, net of tax, are

recorded in stockholders' equity as a component of accumulated other comprehensive income (loss). At the date the natural gas or oil

quantities are settled, the amounts accumulated in other comprehensive income (loss) are reported in the Consolidated Statements of

Income. To the extent that the hedges are not effective, the ineffective portion of the changes in fair market value is recorded directly in

earnings. The proceeds received for natural gas and oil production and the amount paid for natural gas purchases are also generally based

on market prices.

For the years ended December 31, 2007 and 2005, the amount of hedge ineffectiveness was immaterial. In the second quarter of 2006,

Fidelity's oil collar agreements became ineffective and no longer qualified for hedge accounting. The oil hedges became ineffective as the

physical price received no longer correlated to the hedge price due to the widening of regional basis differentials on the price of the physical

production received. The ineffectiveness related to these collar agreements resulted in a loss of approximately $138,000 (before tax) for the

year ended December 31, 2006, that was recorded in operation and maintenance expense. The ineffective collar agreements expired by

December 31, 2006. The amount of hedge ineffectiveness on Fidelity's remaining hedges was immaterial for the year ended December 31,

2006.

For the years ended December 31, 2007, 2006 and 2005, there were no components of the derivative instruments' gain or loss excluded

from the assessment of hedge effectiveness. Gains and losses must be reclassified into earnings as a result of the discontinuance of cash

flow hedges if it is probable that the original forecasted transactions will not occur. There were no such reclassifications into earnings as a

result of the discontinuance of hedges.

Gains and losses on derivative instruments that are reclassified from accumulated other comprehensive income (loss) to current-period

earnings are included in the line item in which the hedged item is recorded. As of December 31, 2007, the maximum term of the swap and

collar agreements, in which the exposure to the variability in future cash flows for forecasted transactions is being hedged, is 12 months.

The Company estimates that over the next 12 months, net gains of approximately $6.2 million (after tax) will be reclassified from

accumulated other comprehensive loss into earnings, subject to changes in natural gas and oil market prices, as the hedged transactions

affect earnings.