DERIVATIVE INSTRUMENTS

FirstEnergy is exposed to financial risks resulting from fluctuating interest rates and commodity prices, including prices for electricity, natural gas, coal and energy transmission. To manage the volatility relating to these exposures, FirstEnergy’s Risk Policy Committee, comprised of senior management, provides general management oversight for risk management activities throughout FirstEnergy. The Risk Policy Committee is responsible for promoting the effective design and implementation of sound risk management programs and oversees compliance with corporate risk management policies and established risk management practice. FirstEnergy also uses a variety of derivative instruments for risk management purposes including forward contracts, options, futures contracts and swaps.

FirstEnergy accounts for derivative instruments on its Consolidated Balance Sheets at fair value unless they meet the normal purchases and normal sales criteria. Derivatives that meet those criteria are accounted for under the accrual method of accounting, and their effects are included in earnings at the time of contract performance. Changes in the fair value of derivative instruments that qualified and were designated as cash flow hedge instruments are recorded in AOCI. Changes in the fair value of derivative instruments that are not designated as cash flow hedge instruments are recorded in net income on a mark-to-market basis. FirstEnergy has contractual derivative agreements through 2031.

Cash Flow Hedges

FirstEnergy has used cash flow hedges for risk management purposes to manage the volatility related to exposures associated with fluctuating commodity prices and interest rates. The effective portion of gains and losses on a derivative contract is reported as a component of AOCI with subsequent reclassification to earnings in the period during which the hedged forecasted transaction affects earnings.

Total net unamortized gains included in AOCI associated with instruments previously designated to be in a cash flow hedging relationship totaled $5 million and $10 million as of September 30, 2013 and December 31, 2012, respectively. Since the forecasted transactions remain probable of occurring, these amounts will be amortized into earnings over the life of the hedging instruments. Approximately $10 million is expected to be amortized to income during the next twelve months.

FirstEnergy has used forward starting swap agreements to hedge a portion of the consolidated interest rate risk associated with anticipated issuances of fixed-rate, long-term debt securities of its subsidiaries. These derivatives were treated as cash flow hedges, protecting against the risk of changes in future interest payments resulting from changes in benchmark U.S. Treasury rates between the date of hedge inception and the date of the debt issuance. No forward starting swap agreements accounted for as a cash flow hedge were outstanding as of September 30, 2013 or December 31, 2012. Total unamortized losses included in AOCI associated with prior interest rate cash flow hedges totaled $61 million and $70 million as of September 30, 2013 and December 31, 2012, respectively. Based on current estimates, approximately $9 million will be amortized to interest expense during the next twelve months.

Refer to Note 6, Accumulated Other Comprehensive Income, for reclassifications from AOCI during the three and nine months ended September 30, 2013 and 2012.

Fair Value Hedges

FirstEnergy has used fixed-for-floating interest rate swap agreements to hedge a portion of the consolidated interest rate risk associated with the debt portfolio of its subsidiaries. These derivative instruments were treated as fair value hedges of fixed-rate, long-term debt issues, protecting against the risk of changes in the fair value of fixed-rate debt instruments due to lower interest rates. As of September 30, 2013 and December 31, 2012, no fixed-for-floating interest rate swap agreements were outstanding.

Unamortized gains included in long-term debt associated with prior fixed-for-floating interest rate swap agreements totaled $48 million and $79 million as of September 30, 2013 and December 31, 2012, respectively. Based on current estimates, approximately $13 million will be amortized to interest expense during the next twelve months. Reclassifications from long-term debt into interest expense totaled approximately $4 million and $6 million during the three months ended September 30, 2013 and 2012, respectively and $15 million and $17 million during the nine months ended September 30, 2013 and 2012, respectively. In connection with the redemptions of senior notes by FES and taxable bonds by CEI and OE, unamortized gains associated with fixed for floating interest rate swap agreements of $9 million and $17 million were included in the Gain (loss) on debt redemptions in the Consolidated Statements of Income for the three and nine months ended September 30, 2013, respectively. Refer to Note 9, Fair Value Measurements - Long-Term Debt and Other Long-Term Obligations, for additional information regarding FirstEnergy's debt redemptions during the three and nine months ended September 30, 2013.

Commodity Derivatives

FirstEnergy uses both physically and financially settled derivatives to manage its exposure to volatility in commodity prices. Commodity derivatives are used for risk management purposes to hedge exposures when it makes economic sense to do so, including circumstances where the hedging relationship does not qualify for hedge accounting.

Electricity forwards are used to balance expected sales with expected generation and purchased power. Natural gas futures are entered into based on expected consumption of natural gas primarily for use in FirstEnergy’s combustion turbine units. Heating oil futures are entered into based on expected consumption of oil and the financial risk in FirstEnergy’s coal transportation contracts. Derivative instruments are not used in quantities greater than forecasted needs.

As of September 30, 2013, FirstEnergy’s net asset position under commodity derivative contracts was $89 million, which related to FES positions. Under these commodity derivative contracts, FES posted $43 million of collateral. Certain commodity derivative contracts include credit risk related contingent features that would require FES to post $9 million of additional collateral if the credit rating for its debt were to fall below investment grade.

Based on commodity derivative contracts held as of September 30, 2013, an adverse change of 10% in commodity prices would decrease net income by approximately $27 million during the next twelve months.

Interest Rate Swaps

In 2013, in connection with certain debt redemptions, FirstEnergy recorded gains of approximately $17 million, including $9 million in the third quarter related to terminated interest rate swaps. In August 2012, FirstEnergy terminated all of the forward starting swap agreements that were executed in the second quarter of 2012, resulting in a net gain, recorded in the third quarter of 2012 as a reduction to interest expense, and cash proceeds of approximately $6 million.

NUGs

As of September 30, 2013, FirstEnergy's net liability position under NUG contracts was $210 million representing contracts held at JCP&L, ME and PN. NUG contracts represent purchased power agreements with third-party non-utility generators that are transacted to satisfy certain obligations under PURPA. Changes in the fair value of NUG contracts are subject to regulatory accounting treatment and do not impact earnings.

LCAPP

The LCAPP law was enacted in New Jersey during 2011 to promote the construction of qualified electric generation facilities. JCP&L maintains two LCAPP contracts, which are financially settled agreements that allow eligible generators to receive payments from, or make payments to, JCP&L pursuant to an annually calculated load-ratio share of the capacity produced by the generator based upon the annual forecasted peak demand as determined by PJM. JCP&L expects to recover from its customers payments made to the generators and give credit to customers for payments from the generators under these contracts. As a result, the projected future obligations for the LCAPP contracts are reflected on the Consolidated Balance Sheets as derivative liabilities with a corresponding regulatory asset. Since the LCAPP contracts are subject to regulatory accounting, changes in their fair value do not impact earnings. On October 11, 2013, the U.S. District Court for the District of New Jersey declared that the LCAPP is preempted by the FPA and unconstitutional. On October 22, 2013, the Superior Court of New Jersey Appellate Division dismissed two consolidated appeals which had been taken from the final order of the NJBPU which accepted and adopted the recommendation of the NJBPU's Agent regarding implementation of the LCAPP law. Dismissal of the consolidated appeals, along with pending matters currently on remand to the NJBPU, was without prejudice subject to the parties exercising their appellate rights in the federal courts. JCP&L continues to maintain a derivative liability with a corresponding regulatory asset on its Consolidated Balance Sheet until the the matter is finally resolved.

FTRs

As of September 30, 2013, FirstEnergy's and FES's net liability position under FTRs was $11 million and FES posted $6 million of collateral. FirstEnergy holds FTRs that generally represent an economic hedge of future congestion charges that will be incurred in connection with FirstEnergy’s load obligations. FirstEnergy acquires the majority of its FTRs in an annual auction through a self-scheduling process involving the use of ARRs allocated to members of an RTO that have load serving obligations and through the direct allocation of FTRs from the PJM RTO. The PJM RTO has a rule that allows directly allocated FTRs to be granted to LSEs in zones that have newly entered PJM. For the first two planning years, PJM permits the LSEs to request a direct allocation of FTRs in these new zones at no cost as opposed to receiving ARRs. The directly allocated FTRs differ from traditional FTRs in that the ownership of all or part of the FTRs may shift to another LSE if customers choose to shop with the other LSE.

The future obligations for the FTRs acquired at auction are reflected on the Consolidated Balance Sheets and have not been designated as cash flow hedge instruments. FirstEnergy initially records these FTRs at the auction price less the obligation due to the RTO, and subsequently adjusts the carrying value of remaining FTRs to their estimated fair value at the end of each accounting period prior to settlement. Changes in the fair value of FTRs held by FES and AE Supply are included in other operating expenses as unrealized gains or losses. Unrealized gains or losses on FTRs held by FirstEnergy’s utilities are recorded as regulatory assets or liabilities. Directly allocated FTRs are accounted for under the accrual method of accounting, and their effects are included in earnings at the time of contract performance.

FirstEnergy records the fair value of derivative instruments on a gross basis. The following table summarizes the fair value and classification of derivative instruments on FirstEnergy’s Consolidated Balance Sheets:



Derivative Assets					Derivative Liabilities
	Fair Value					Fair Value
	September 30, 2013		December 31, 2012			September 30, 2013			December 31, 2012
	(In millions)					(In millions)
Current Assets - Derivatives					Current Liabilities - Derivatives
Commodity Contracts	$	137	$	153	Commodity Contracts	$	(94	)	$	(119	)
FTRs	3		7		FTRs	(11		)	(7		)
	140		160			(105		)	(126		)

					Noncurrent Liabilities - Adverse Power Contract Liability
					NUGs	(233		)	(290		)
Deferred Charges and Other Assets - Other					LCAAP	(166		)	(144		)
Commodity Contracts	64		99		Noncurrent Liabilities - Other
FTRs	—		1		Commodity Contracts	(18		)	(36		)
NUGs	23		36		FTRs	(3		)	(2		)
	87		136			(420		)	(472		)
Derivative Assets	$	227	$	296	Derivative Liabilities	$	(525	)	$	(598	)

FirstEnergy enters into contracts with counterparties that allow for net settlement of derivative assets and derivative liabilities. Certain of these contracts contain margining provisions that require the use of collateral to mitigate credit exposure between FirstEnergy and these counterparties. In situations where collateral is pledged to mitigate exposures related to derivative and non-derivative instruments with the same counterparty, FirstEnergy allocates the collateral based on the percentage of the net fair value of derivative instruments to the total fair value of the combined derivative and non-derivative instruments. The following tables summarize the fair value of derivative instruments on FirstEnergy’s Consolidated Balance Sheets and the effect of netting arrangements and collateral on its financial position:



				Amounts Not Offset in Consolidated Balance Sheet
September 30, 2013	Fair Value			Derivative Instruments			Cash Collateral (Received)/Pledged			Net Fair Value
	(In millions)
Derivative Assets
Commodity contracts	$	201		$	(104	)	$	(11	)	$	86
FTRs	3			(3		)	—			—
NUG contracts	23			—			—			23
	$	227		$	(107	)	$	(11	)	$	109

Derivative Liabilities
Commodity contracts	$	(112	)	$	104		$	5		$	(3	)
FTRs	(14		)	3			6			(5		)
NUG contracts	(233		)	—			—			(233		)
LCAPP contracts	(166		)	—			—			(166		)
	$	(525	)	$	107		$	11		$	(407	)



				Amounts Not Offset in Consolidated Balance Sheet
December 31, 2012	Fair Value			Derivative Instruments			Cash Collateral (Received)/Pledged			Net Fair Value
	(In millions)
Derivative Assets
Commodity contracts	$	252		$	(142	)	$	(5	)	$	105
FTRs	8			(8		)	—			—
NUG contracts	36			—			—			36
	$	296		$	(150	)	$	(5	)	$	141

Derivative Liabilities
Commodity contracts	$	(155	)	$	142		$	12		$	(1	)
FTRs	(9		)	8			1			—
NUG contracts	(290		)	—			—			(290		)
LCAPP contracts	(144		)	—			—			(144		)
	$	(598	)	$	150		$	13		$	(435	)

The following table summarizes the volumes associated with FirstEnergy’s outstanding derivative transactions as of September 30, 2013:



	Purchases	Sales	Net		Units
	(In millions, except for LCAPP)
Power Contracts	32	37	(5	)	MWH
FTRs	59	—	59		MWH
NUGs	11	—	11		MWH
LCAPP	408	—	408		MW
Natural Gas	64	—	64		mmBTU

The effect of derivative instruments not in a hedging relationship on the Consolidated Statements of Income during the three months and nine months ended September 30, 2013 and 2012, are summarized in the following tables:



	Three Months Ended September 30
	Commodity Contracts			FTRs			Interest Rate Swaps		Total
	(In millions)
2013
Unrealized Gain (Loss) Recognized in:
Other Operating Expense	$	11		$	(8	)	$	—	$	3

Realized Gain (Loss) Reclassified to:
Revenues	$	14		$	6		$	—	$	20
Purchased Power Expense	(17		)	—			—		(17		)
Other Operating Expense	—			(10		)	—		(10		)
Fuel Expense	(2		)	—			—		(2		)

2012
Unrealized Gain (Loss) Recognized in:
Other Operating Expense	$	7		$	(5	)	$	—	$	2
Interest Expense	—			—			20		20

Realized Gain (Loss) Reclassified to:
Revenues	$	46		$	6		$	—	$	52
Purchased Power Expense	(27		)	—			—		(27		)
Other Operating Expense	—			(10		)	—		(10		)
Fuel Expense	3			—			—		3
Interest Expense	—			—			6		6



	Nine Months Ended September 30
	Commodity Contracts			FTRs			Interest Rate Swaps		Total
	(In millions)
2013
Unrealized Loss Recognized in:
Other Operating Expense	$	(5	)	$	(10	)	$	—	$	(15	)

Realized Gain (Loss) Reclassified to:
Revenues	$	29		$	19		$	—	$	48
Purchased Power Expense	(30		)	—			—		(30		)
Other Operating Expense	—			(28		)	—		(28		)

2012
Unrealized Gain Recognized in:
Other Operating Expense	$	72		$	12		$	—	$	84

Realized Gain (Loss) Reclassified to:
Revenues	$	260		$	18		$	—	$	278
Purchased Power Expense	(248		)	—			—		(248		)
Other Operating Expense	—			(51		)	—		(51		)
Fuel Expense	2			—			—		2
Interest Expense	—			—			6		6

The unrealized and realized gains (losses) on FirstEnergy’s derivative instruments subject to regulatory accounting during the three and nine months ended September 30, 2013 and 2012, are summarized in the following tables:



	Three Months Ended September 30
Derivatives Not in a Hedging Relationship with Regulatory Offset	NUGs			LCAPP			Regulated FTRs			Total
	(In millions)
2013
Unrealized Gain (Loss) on Derivative Instrument	$	7		$	(8	)	$	1		$	—
Realized Gain (Loss) on Derivative Instrument	14			—			(1		)	13

2012
Unrealized Gain (Loss) on Derivative Instrument	$	(50	)	$	3		$	—		$	(47	)
Realized Gain (Loss) on Derivative Instrument	61			—			(1		)	60



	Nine Months Ended September 30
Derivatives Not in a Hedging Relationship with Regulatory Offset	NUGs			LCAPP			Regulated FTRs			Total
	(In millions)
2013
Unrealized Gain (Loss) on Derivative Instrument	$	(13	)	$	(22	)	$	1		$	(34	)
Realized Gain (Loss) on Derivative Instrument	57			—			(1		)	56

2012
Unrealized Loss on Derivative Instrument	$	(183	)	$	(142	)	$	—		$	(325	)
Realized Gain on Derivative Instrument	194			—			7			201

The following tables provide a reconciliation of changes in the fair value of certain contracts that are deferred for future recovery from (or credit to) customers during the three months and nine months ended September 30, 2013 and 2012:



	Three Months Ended September 30
Derivatives Not in a Hedging Relationship with Regulatory Offset	NUGs			LCAPP			Regulated FTRs			Total
	(In millions)
Outstanding net liability as of July 1, 2013	$	(231	)	$	(158	)	$	—		$	(389	)
Additions/Change in value of existing contracts	7			(8		)	1			—
Settled contracts	14			—			(1		)	13
Outstanding net liability as of September 30, 2013	$	(210	)	$	(166	)	$	—		$	(376	)

Outstanding net liability as of July 1, 2012	$	(293	)	$	(145	)	$	—		$	(438	)
Additions/Change in value of existing contracts	(50		)	3			—			(47		)
Settled contracts	61			—			(1		)	60
Outstanding net liability as of September 30, 2012	$	(282	)	$	(142	)	$	(1	)	$	(425	)



	Nine Months Ended September 30
Derivatives Not in a Hedging Relationship with Regulatory Offset	NUGs			LCAPP			Regulated FTRs			Total
	(In millions)
Outstanding net liability as of January 1, 2013	$	(254	)	$	(144	)	$	—		$	(398	)
Additions/Change in value of existing contracts	(13		)	(22		)	1			(34		)
Settled contracts	57			—			(1		)	56
Outstanding net liability as of September 30, 2013	$	(210	)	$	(166	)	$	—		$	(376	)

Outstanding net liability as of January 1, 2012	$	(293	)	$	—		$	(8	)	$	(301	)
Additions/Change in value of existing contracts	(183		)	(142		)	—			(325		)
Settled contracts	194			—			7			201
Outstanding net liability as of September 30, 2012	$	(282	)	$	(142	)	$	(1	)	$	(425	)