DERIVATIVES AND RISK MANAGEMENT

The disclosures below in Note 6 apply only to Avista Corp. and Avista Utilities; AERC and its primary subsidiary AEL&P do not enter into derivative instruments.

Energy Commodity Derivatives

Avista Utilities is exposed to market risks relating to changes in electricity and natural gas commodity prices and certain other fuel prices. Market risk is, in general, the risk of fluctuation in the market price of the commodity being traded and is influenced primarily by supply and demand. Market risk includes the fluctuation in the market price of associated derivative commodity instruments. Avista Utilities utilizes derivative instruments, such as forwards, futures, swaps and options in order to manage the various risks relating to these commodity price exposures. The Company has an energy resources risk policy and control procedures to manage these risks. The Company’s Risk Management Committee establishes the Company’s energy resources risk policy and monitors compliance. The Risk Management Committee is comprised of certain Company officers and other members of management. The Audit Committee of the Company’s Board of Directors periodically reviews and discusses enterprise risk management processes, and it focuses on the Company’s material financial and accounting risk exposures and the steps management has undertaken to control them.

As part of the Company's resource procurement and management operations in the electric business, the Company engages in an ongoing process of resource optimization, which involves the economic selection from available energy resources to serve the Company's load obligations and the use of these resources to capture available economic value. The Company transacts in wholesale markets by selling and purchasing electric capacity and energy, fuel for electric generation, and derivative contracts related to capacity, energy and fuel. Such transactions are part of the process of matching resources with load obligations and hedging the related financial risks. These transactions range from terms of intra-hour up to multiple years.

Avista Utilities makes continuing projections of:


•	electric loads at various points in time (ranging from intra-hour to multiple years) based on, among other things, estimates of customer usage and weather, historical data and contract terms, and


•	resource availability at these points in time based on, among other things, fuel choices and fuel markets, estimates of streamflows, availability of generating units, historic and forward market information, contract terms, and experience.

On the basis of these projections, the Company makes purchases and sales of electric capacity and energy, fuel for electric generation, and related derivative instruments to match expected resources to expected electric load requirements and reduce exposure to electricity (or fuel) market price changes. Resource optimization involves generating plant dispatch and scheduling available resources and also includes transactions such as:


•	purchasing fuel for generation,


•	when economical, selling fuel and substituting wholesale electric purchases, and


•	other wholesale transactions to capture the value of generation and transmission resources and fuel delivery capacity contracts.

Avista Utilities’ optimization process includes entering into hedging transactions to manage risks. Transactions include both physical energy contracts and related derivative financial instruments.

As part of its resource procurement and management of its natural gas business, Avista Utilities makes continuing projections of its natural gas loads and assesses available natural gas resources including natural gas storage availability. Natural gas resource planning typically includes peak requirements, low and average monthly requirements and delivery constraints from natural gas supply locations to Avista Utilities’ distribution system. However, daily variations in natural gas demand can be significantly different than monthly demand projections. On the basis of these projections, Avista Utilities plans and executes a series of transactions to hedge a significant portion of its projected natural gas requirements through forward market transactions and derivative instruments. These transactions may extend as much as four natural gas operating years (November through October) into the future. Avista Utilities also leaves a significant portion of its natural gas supply requirements unhedged for purchase in short-term and spot markets.

Natural gas resource optimization activities include:


•	wholesale market sales of surplus natural gas supplies,


•	optimization of interstate pipeline transportation capacity not needed to serve daily load, and


•	purchases and sales of natural gas to optimize use of storage capacity.

The following table presents the underlying energy commodity derivative volumes as of December 31, 2014 that are expected to be settled in each respective year (in thousands of MWhs and mmBTUs):



	Purchases				Sales
	Electric Derivatives		Gas Derivatives		Electric Derivatives		Gas Derivatives
Year	Physical (1) MWH	Financial (1) MWH	Physical (1) mmBTUs	Financial (1) mmBTUs	Physical (1) MWH	Financial (1) MWH	Physical (1) mmBTUs	Financial (1) mmBTUs
2015	522	2,547	21,111	120,780	326	2,951	3,428	99,023
2016	397	1,071	2,505	70,480	287	1,634	910	56,520
2017	397	—	675	24,230	286	290	—	15,420
2018	397	—	—	3,020	286	—	—	—
2019	235	—	—	1,800	158	—	—	—
Thereafter	—	—	—	—	—	—	—	—


(1)	Physical transactions represent commodity transactions where Avista Utilities will take delivery of either electricity or natural gas and financial transactions represent derivative instruments with no physical delivery, such as futures, swaps or options.

The electric and natural gas derivative contracts above will be included in either power supply costs or natural gas supply costs during the period they are settled and will be included in the various recovery mechanisms (ERM, PCA, and PGAs), or in the general rate case process, and are expected to be collected through retail rates from customers.

Foreign Currency Exchange Contracts

A significant portion of Avista Utilities’ natural gas supply (including fuel for power generation) is obtained from Canadian sources. Most of those transactions are executed in U.S. dollars, which avoids foreign currency risk. A portion of Avista Utilities’ short-term natural gas transactions and long-term Canadian transportation contracts are committed based on Canadian currency prices and settled within 60 days with U.S. dollars. Avista Utilities hedges a portion of the foreign currency risk by purchasing Canadian currency contracts when such commodity transactions are initiated. This risk has not had a material effect on the Company’s financial condition, results of operations or cash flows and these differences in cost related to currency fluctuations were included with natural gas supply costs for ratemaking. The following table summarizes the foreign currency hedges that the Company has entered into as of December 31 (dollars in thousands):



	2014		2013
Number of contracts	18		23
Notional amount (in United States dollars)	$	5,474	$	8,631
Notional amount (in Canadian dollars)	6,198		9,191

Interest Rate Swap Agreements

Avista Corp. is affected by fluctuating interest rates related to a portion of its existing debt, and future borrowing requirements. The Finance Committee of the Board of Directors periodically reviews and discusses interest rate risk management processes, and it focuses on the steps management has undertaken to manage it. The Risk Management Committee also reviews the interest risk management plan. Avista Corp. manages interest rate exposure by limiting the variable rate exposures to a percentage of total capitalization. Additionally, interest rate risk is managed by monitoring market conditions when timing the issuance of long-term debt and optional debt redemptions and through the use of fixed rate long-term debt with varying maturities. The Company also hedges a portion of its interest rate risk with financial derivative instruments, which may include interest rate swaps and U.S. Treasury lock agreements. These interest rate swaps and U.S. Treasury lock agreements are considered economic hedges against fluctuations in future cash flows associated with anticipated debt issuances.

The following table summarizes the interest rate swaps that the Company has outstanding as of the balance sheet date indicated below (dollars in thousands):



Balance Sheet Date	Number of Contracts	Notional Amount		Mandatory Cash Settlement Date
December 31, 2014	5	$	75,000	2015
	5	95,000		2016
	3	45,000		2017
	9	205,000		2018
December 31, 2013	2	50,000		2014
	2	45,000		2015
	2	40,000		2016
	1	15,000		2017
	4	95,000		2018

In October 2014, the Company cash settled two interest rate swap contracts (notional aggregate amount of $50.0 million) and received a total of $5.4 million. The interest rate swap contracts were settled in connection with the pricing of $60.0 million of Avista Corp. first mortgage bonds that were issued in December 2014 (see Note 14). Upon settlement of interest rate swaps, the regulatory asset or liability (included as part of long-term debt) is amortized as a component of interest expense over the term of the associated debt.

As of December 31, 2014, the fair value of the outstanding interest rate swaps decreased significantly compared to December 31, 2013 (see the table below). The fair value decrease was the result of a net increase in the notional amount of outstanding swap agreements and a decline in market interest rates below the rates that were fixed in the outstanding swaps. The Company enters into interest rate swaps to reduce uncertainty related to the net effective interest cost for future long-term debt. The Company would be required to make cash payments to settle the interest rate swaps if the fixed rates are higher than prevailing market rates at the date of settlement. Conversely, the Company receives cash to settle its interest rate swaps when prevailing market rates at the time of settlement exceed the fixed swap rates.

Summary of Outstanding Derivative Instruments

Until May 2014, Avista Corp. had a master netting agreement that governed the transactions of multiple affiliated legal entities that were parties to this agreement. This master netting agreement allowed for cross-commodity netting (i.e. netting physical power, physical natural gas, and financial transactions) and cross-affiliate netting for the parties to the agreement. Avista Corp. performed cross-commodity netting for each legal entity that was a party to the master netting agreement for presentation in the Consolidated Balance Sheets; however, Avista Corp. did not perform cross-affiliate netting because the Company believed that cross-affiliate netting may not be enforceable. Therefore, the requirements for cross-affiliate netting under ASC 210-20-45 were not applicable to Avista Corp. As of December 31, 2013, all derivatives for each affiliated entity under this master netting agreement were in a net liability position; therefore, there was no additional netting which required disclosure for the year 2013. In May 2014, this master netting agreement was terminated and each affiliated legal entity is now under their own separate agreement. As of December 31, 2014, the Company no longer has any agreements that allow cross-affiliate netting. The Company has multiple agreements with a variety of entities that allow for cross-commodity netting under ASC 815-10-45. The amounts recorded on the Consolidated Balance Sheet as of December 31, 2014 and 2013 for these particular entities reflect the offsetting of derivative assets and liabilities where a legal right of offset exists.

The following table presents the fair values and locations of derivative instruments recorded on the Consolidated Balance Sheet as of December 31, 2014 (in thousands):



		Fair Value
Derivative	Balance Sheet Location	Gross Asset		Gross Liability			Collateral Netting		Net Asset (Liability) in Balance Sheet
Foreign currency contracts	Other current liabilities	$	1	$	(21	)	$	—	$	(20	)
Interest rate contracts	Other current assets	966		(506		)	—		460
Interest rate contracts	Other current liabilities	—		(7,325		)	—		(7,325		)
Interest rate contracts	Other non-current liabilities and deferred credits	—		(69,737		)	28,880		(40,857		)
Commodity contracts	Current utility energy commodity derivative assets	2,063		(538		)	—		1,525
Commodity contracts	Current utility energy commodity derivative liabilities	66,421		(97,586		)	13,120		(18,045		)
Commodity contracts	Other non-current liabilities and deferred credits	29,594		(54,077		)	2,390		(22,093		)
Total derivative instruments recorded on the balance sheet		$	99,045	$	(229,790	)	$	44,390	$	(86,355	)

The following table presents the fair values and locations of derivative instruments recorded on the Consolidated Balance Sheet as of December 31, 2013 (in thousands):



		Fair Value
Derivative	Balance Sheet Location	Gross Asset		Gross Liability			Collateral Netting		Net Asset (Liability) in Balance Sheet
Foreign currency contracts	Other current assets	$	7	$	(6	)	$	—	$	1
Interest rate contracts	Other current assets	13,968		—			—		13,968
Interest rate contracts	Other property and investments - net	19,575		—			—		19,575
Commodity contracts	Current utility energy commodity derivative assets	7,416		(4,394		)	—		3,022
Commodity contracts	Non-current utility energy commodity derivative assets	7,610		(6,756		)	—		854
Commodity contracts	Current utility energy commodity derivative liabilities	23,455		(37,306		)	2,976		(10,875		)
Commodity contracts	Other non-current liabilities and deferred credits	17,101		(41,213		)	5,756		(18,356		)
Total derivative instruments recorded on the balance sheet		$	89,132	$	(89,675	)	$	8,732	$	8,189

Exposure to Demands for Collateral

The Company's derivative contracts often require collateral (in the form of cash or letters of credit) or other credit enhancements, or reductions or terminations of a portion of the contract through cash settlement, in the event of a downgrade in the Company's credit ratings or changes in market prices. In periods of price volatility, the level of exposure can change significantly. As a result, sudden and significant demands may be made against the Company's credit facilities and cash. The Company actively monitors the exposure to possible collateral calls and takes steps to mitigate capital requirements. As of December 31, 2014, the Company had cash deposited as collateral of $20.6 million and letters of credit of $14.5 million outstanding related to its energy derivative contracts. The Company also had deposited cash in the amount of $28.9 million and letters of credit of $10.9 million as collateral for its interest rate swap derivative contracts. The Consolidated Balance Sheet at December 31, 2014 reflects the offsetting of $44.4 million of cash collateral against net derivative positions where a legal right of offset exists. As of December 31, 2013, the Company had cash deposited as collateral of $26.1 million and letters of credit of $20.3 million outstanding related to its energy derivative contracts. The Consolidated Balance Sheet at December 31, 2013 reflects the offsetting of $8.7 million of cash collateral against net derivative positions where a legal right of offset exists. As of December 31, 2014 and December 31, 2013, the Company did not hold any cash as collateral from counterparties under energy derivative contracts.

Certain of the Company’s derivative instruments contain provisions that require the Company to maintain an "investment grade" credit rating from the major credit rating agencies. If the Company’s credit ratings were to fall below “investment grade,” it would be in violation of these provisions, and the counterparties to the derivative instruments could request immediate payment or demand immediate and ongoing collateralization on derivative instruments in net liability positions. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a liability position as of December 31, 2014 was $12.9 million. If the credit-risk-related contingent features underlying these agreements were triggered on December 31, 2014, the Company could be required to post $16.2 million of additional collateral to its counterparties. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a liability position as of December 31, 2013 was $13.3 million. If the credit-risk-related contingent features underlying these agreements had been triggered on December 31, 2013, the Company could have been required to post $12.6 million of additional collateral to its counterparties.

Credit Risk

Credit risk relates to the potential losses that the Company would incur as a result of non-performance by counterparties of their contractual obligations to deliver energy or make financial settlements. The Company often extends credit to counterparties and customers and is exposed to the risk that it may not be able to collect amounts owed to the Company. Credit risk includes potential counterparty default due to circumstances:


•	relating directly to it,


•	caused by market price changes, and


•	relating to other market participants that have a direct or indirect relationship with such counterparty.

Changes in market prices may dramatically alter the size of credit risk with counterparties, even when conservative credit limits are established. Should a counterparty fail to perform, the Company may be required to honor the underlying commitment or to replace existing contracts with contracts at then-current market prices.

The Company enters into bilateral transactions with various counterparties. The Company also trades energy and related derivative instruments through clearinghouse exchanges.

The Company seeks to mitigate bilateral credit risk by:


•	entering into bilateral contracts that specify credit terms and protections against default,


•	applying credit limits and duration criteria to existing and prospective counterparties,


•	actively monitoring current credit exposures,


•	asserting our collateral rights with counterparties,


•	carrying out transaction settlements timely and effectively, and


•	conducting transactions on exchanges with fully collateralized clearing arrangements that significantly reduce counterparty default risk.

The Company's credit policy includes an evaluation of the financial condition of counterparties. Credit risk management includes collateral requirements or other credit enhancements, such as letters of credit or parent company guarantees. The Company enters into various agreements that address credit risks including standardized agreements that allow for the netting or offsetting of positive and negative exposures.

The Company has concentrations of suppliers and customers in the electric and natural gas industries including:


•	electric and natural gas utilities,


•	electric generators and transmission providers,


•	natural gas producers and pipelines,


•	financial institutions including commodity clearing exchanges and related parties, and


•	energy marketing and trading companies.

In addition, the Company has concentrations of credit risk related to geographic location as it operates in the western United States and western Canada. These concentrations of counterparties and concentrations of geographic location may impact the Company’s overall exposure to credit risk because the counterparties may be similarly affected by changes in conditions.

The Company maintains credit support agreements with certain counterparties and margin calls are periodically made and/or received. Margin calls are triggered when exposures exceed contractual limits or when there are changes in a counterparty’s creditworthiness. Price movements in electricity and natural gas can generate exposure levels in excess of these contractual limits. Negotiating for collateral in the form of cash, letters of credit, or performance guarantees is common industry practice.