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Derivative Instruments
 3 Months Ended
Mar. 31, 2014
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
DERIVATIVE INSTRUMENTS
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 2020.

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 less than $1 million and $2 million as of March 31, 2014 and December 31, 2013, respectively. Since the forecasted transactions remain probable of occurring, these amounts will be amortized into earnings over the life of the hedging instruments. Approximately $9 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 March 31, 2014 or December 31, 2013. Total pre-tax unamortized losses included in AOCI associated with prior interest rate cash flow hedges totaled $57 million and $59 million as of March 31, 2014 and December 31, 2013, respectively. Based on current estimates, approximately $9 million will be amortized to interest expense during the next twelve months.

In connection with certain debt redemptions, FirstEnergy recorded interest expense related to deferred losses on terminated interest rate swaps of approximately $2 million for the three months ended March 31, 2013.

As of March 31, 2014 and December 31, 2013, no commodity or interest rate derivatives were designated as cash flow hedges.

Refer to Note 4, Accumulated Other Comprehensive Income, for reclassifications from AOCI during the three months ended March 31, 2014 and 2013.

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 March 31, 2014 and December 31, 2013, 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 $41 million and $44 million as of March 31, 2014 and December 31, 2013, respectively. Based on current estimates, approximately $11 million will be amortized to interest expense during the next twelve months. Reclassifications from long-term debt into interest expense totaled approximately $3 million and $6 million during the three months ended March 31, 2014 and 2013, respectively.

As of March 31, 2014 and December 31, 2013, no commodity or interest rate derivatives were designated as fair value hedges.

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 March 31, 2014, FirstEnergy’s net asset position under commodity derivative contracts was $117 million, which related to FES positions. Under these commodity derivative contracts, FES posted $85 million of collateral. Certain commodity derivative contracts include credit risk related contingent features that would require FES to post $11 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 March 31, 2014, an adverse change of 10% in commodity prices would decrease net income by approximately $40 million during the next twelve months.

NUGs

As of March 31, 2014, FirstEnergy's net liability position under NUG contracts was $185 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 maintained two LCAPP contracts, which were financially settled agreements that allowed 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 expected 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 were considered derivative liabilities with a corresponding regulatory asset. Since the LCAPP contracts were subject to regulatory accounting, changes in their fair value did not impact earnings. On October 11, 2013, the U.S. District Court for the District of New Jersey declared that the LCAPP was 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. The parties filed an appeal with the U.S. Court of Appeals for the Third Circuit and briefing by the parties was completed by March 5, 2014. Consistent with the provisions of the LCAPP contracts, the U.S. District Court's ruling was a termination event. During the fourth quarter of 2013, JCP&L issued termination notices to the counterparties and reversed the derivative liability and corresponding regulatory asset on its Consolidated Balance Sheet.

FTRs

As of March 31, 2014, FirstEnergy's and FES's net liability position under FTRs was $1 million and $3 million, respectively, and FES posted $4 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
 
March 31,
2014
 
December 31,
2013
 
 
March 31,
2014
 
December 31,
2013
 
(In millions)
 
 
(In millions)
Current Assets - Derivatives
 
 
 
 
Current Liabilities - Derivatives
 
 
 
Commodity Contracts
$
240

 
$
162

 
    Commodity Contracts
$
(154
)
 
$
(102
)
FTRs
7

 
4

 
FTRs
(5
)
 
(9
)
 
247

 
166

 
 
(159
)
 
(111
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Noncurrent Liabilities - Adverse Power Contract Liability
 
 
 
 
 
 
 
 
NUGs
(188
)
 
(222
)
Deferred Charges and Other Assets - Other
 
 
 
 
Noncurrent Liabilities - Other
 
 
 
Commodity Contracts
64

 
53

 
Commodity Contracts
(33
)
 
(11
)
NUGs
3

 
20

 
FTRs
(3
)
 
(3
)
 
67

 
73

 
 
(224
)
 
(236
)
Derivative Assets
$
314

 
$
239

 
Derivative Liabilities
$
(383
)
 
$
(347
)


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
 
 
March 31, 2014
 
Fair Value
 
Derivative Instruments
 
Cash Collateral (Received)/Pledged
 
Net Fair Value
 
 
(In millions)
Derivative Assets
 
 
 
 
 
 
 
 
Commodity contracts
 
$
304

 
$
(182
)
 
$
(4
)
 
$
118

FTRs
 
7

 
(7
)
 
—

 
—

NUG contracts
 
3

 
—

 
—

 
3

 
 
$
314

 
$
(189
)
 
$
(4
)
 
$
121

 
 
 
 
 
 
 
 
 
Derivative Liabilities 
 
 
 
 
 
 
 
 
Commodity contracts
 
$
(187
)
 
$
182

 
$
2

 
$
(3
)
FTRs
 
(8
)
 
7

 
1

 
—

NUG contracts
 
(188
)
 
—

 
—

 
(188
)
 
 
$
(383
)
 
$
189

 
$
3

 
$
(191
)
 
 
 
 
 
 
 
 
 


 
 
 
 
Amounts Not Offset in Consolidated Balance Sheet
 
 
December 31, 2013
 
Fair Value
 
Derivative Instruments
 
Cash Collateral (Received)/Pledged
 
Net Fair Value
 
 
(In millions)
Derivative Assets
 
 
 
 
 
 
 
 
Commodity contracts
 
$
215

 
$
(106
)
 
$
(9
)
 
$
100

FTRs
 
4

 
(4
)
 
—

 
—

NUG contracts
 
20

 
—

 
—

 
20

 
 
$
239

 
$
(110
)
 
$
(9
)
 
$
120

 
 
 
 
 
 
 
 
 
Derivative Liabilities
 
 
 
 
 
 
 
 
Commodity contracts
 
$
(113
)
 
$
106

 
$
7

 
$
—

FTRs
 
(12
)
 
4

 
5

 
(3
)
NUG contracts
 
(222
)
 
—

 
—

 
(222
)
 
 
$
(347
)
 
$
110

 
$
12

 
$
(225
)


The following table summarizes the volumes associated with FirstEnergy’s outstanding derivative transactions as of March 31, 2014:

 
Purchases
 
Sales
 
Net
 
Units
 
(In millions)
Power Contracts
41

 
38

 
3

 
MWH
FTRs
26

 
—

 
26

 
MWH
NUGs
7

 
—

 
7

 
MWH
Natural Gas
65

 
8

 
57

 
mmBTU

The effect of derivative instruments not in a hedging relationship on the Consolidated Statements of Income during the three months ended March 31, 2014 and 2013, are summarized in the following tables:
 
Three Months Ended March 31
 
Commodity Contracts
 
FTRs
 
Total
 
(In millions)
2014
 

 
 

 
 

Unrealized Gain Recognized in:
 

 
 

 
 

Other Operating Expense (1)

$12

 

$5

 

$17

 
 
 
 
 
 
Realized Gain (Loss) Reclassified to:
 

 
 

 
 

Revenues (2)

($13
)
 

$52

 

$39

Purchased Power Expense (3)
436

 
—

 
436

Other Operating Expense (4)
—

 
(7
)
 
(7
)
Fuel Expense
9

 
—

 
9

 
 
 
 
 
 
(1) Includes $12 million for commodity contracts and $5 million for FTRs associated with FES.
(2) Represents losses on structured financial contracts. Includes ($13) million for commodity contracts and $51 million for FTRs associated with FES.
(3) Realized losses on financially settled wholesale sales contracts of $321 million resulting from higher market prices were netted in purchased power. Includes $436 million for commodity contracts associated with FES.
(4) Includes ($7) million for FTRs associated with FES.
 
 
 
 
 
 
2013
 

 
 

 
 

Unrealized Loss Recognized in:
 

 
 

 
 

Other Operating Expense (5)

($5
)
 

($2
)
 

($7
)
 
 
 
 
 
 
Realized Gain (Loss) Reclassified to:
 

 
 

 
 

Revenues (6)

$10

 

$7

 

$17

Purchased Power Expense (7)
(11
)
 
—

 
(11
)
Other Operating Expense (8)
—

 
(9
)
 
(9
)
Fuel Expense
(1
)
 
—

 
(1
)
 
 
 
 
 
 
(5) Includes ($5) million for commodity contracts and ($1) million for FTRs associated with FES.
(6) Includes $10 million for commodity contracts and $6 million for FTRs associated with FES.
(7) Includes ($11) million for commodity contracts associated with FES.
(8) Includes ($8) million for FTRs associated with FES.


The unrealized and realized gains (losses) on FirstEnergy’s derivative instruments subject to regulatory accounting during the three months ended March 31, 2014 and 2013, are summarized in the following tables:

 
 
Three Months Ended March 31
Derivatives Not in a Hedging Relationship with Regulatory Offset
 
NUGs
 
LCAPP(1)
 
Regulated FTRs
 
Total
 
 
(In millions)
2014
 
 
 
 
 
 
 
 
Unrealized Gain on Derivative Instrument
 
$
27

 
$
—

 
$
4

 
$
31

Realized Loss on Derivative Instrument
 
(10
)
 
—

 
(1
)
 
(11
)
 
 
 
 
 
 
 
 
 
2013
 
 
 
 
 
 
 
 
Unrealized Gain (Loss) on Derivative Instrument
 
$
18

 
$
(2
)
 
$
—

 
$
16

Realized Gain (Loss) on Derivative Instrument
 
23

 
—

 
(1
)
 
22



(1) 
During the fourth quarter of 2013, all LCAPP contracts were terminated as discussed above.

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 ended March 31, 2014 and 2013:

 
 
Three Months Ended March 31
Derivatives Not in a Hedging Relationship with Regulatory Offset
 
NUGs
 
LCAPP(1)
 
Regulated FTRs
 
Total
 
 
(In millions)
Outstanding net liability as of January 1, 2014
 
$
(202
)
 
$
—

 
$
—

 
$
(202
)
Additions/Change in value of existing contracts
 
27

 
—

 
4

 
31

Settled contracts
 
(10
)
 
—

 
(1
)
 
(11
)
Outstanding net liability as of March 31, 2014
 
$
(185
)
 
$
—

 
$
3

 
$
(182
)
 
 
 
 
 
 
 
 
 
Outstanding net liability as of January 1, 2013
 
$
(254
)
 
$
(144
)
 
$
—

 
$
(398
)
Additions/Change in value of existing contracts
 
18

 
(2
)
 
—

 
16

Settled contracts
 
23

 
—

 
(1
)
 
22

Outstanding net liability as of March 31, 2013
 
$
(213
)
 
$
(146
)
 
$
(1
)
 
$
(360
)


(1) 
During the fourth quarter of 2013, all LCAPP contracts were terminated as discussed above.