DERIVATIVES AND RISK MANAGEMENT

The below disclosures in Note 5 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 March 31, 2015 that are expected to be delivered 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	203	1,839	10,357	97,928	253	2,730	2,079	83,313
2016	397	1,287	2,505	81,730	287	1,826	910	63,000
2017	397	—	675	31,930	286	483	—	15,420
2018	397	—	—	6,795	286	—	—	—
2019	235	—	—	4,050	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 delivered 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 March 31, 2015 and December 31, 2014 (dollars in thousands):



	March 31,		December 31,
	2015		2014
Number of contracts	25		18
Notional amount (in United States dollars)	$	4,357	$	5,474
Notional amount (in Canadian dollars)	5,498		6,198

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 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 entered into as of March 31, 2015 and December 31, 2014 (dollars in thousands):



Balance Sheet Date	Number of Contracts	Notional Amount	Mandatory Cash Settlement Date
March 31, 2015	5	75,000	2015
	6	115,000	2016
	3	45,000	2017
	11	245,000	2018
	1	20,000	2019
December 31, 2014	5	75,000	2015
	5	95,000	2016
	3	45,000	2017
	9	205,000	2018

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 March 31, 2015, the fair value of the outstanding interest rate swaps decreased significantly compared to December 31, 2014 (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 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

As of March 31, 2015, the Company has multiple master netting agreements with a variety of entities that allow for cross-commodity netting under ASC 815-10-45. The Company does not have any agreements which allow for cross-affiliate netting among multiple affiliated legal entities. The amounts recorded on the Condensed Consolidated Balance Sheet as of March 31, 2015 and December 31, 2014 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 Condensed Consolidated Balance Sheet as of March 31, 2015 (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	$	14	$	(24	)	$	—	$	(10	)
Interest rate contracts	Other current liabilities	—		(12,819		)	677		(12,142		)
Interest rate contracts	Other non-current liabilities and deferred credits	—		(100,016		)	49,813		(50,203		)
Commodity contracts	Current utility energy commodity derivative assets	41,898		(40,319		)	—		1,579
Commodity contracts	Current utility energy commodity derivative liabilities	22,658		(40,298		)	3,462		(14,178		)
Commodity contracts	Other non-current liabilities and deferred credits	33,370		(57,515		)	3,982		(20,163		)
Total derivative instruments recorded on the balance sheet		$	97,940	$	(250,991	)	$	57,934	$	(95,117	)

The following table presents the fair values and locations of derivative instruments recorded on the Condensed 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	)

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.

The following table presents the Company's collateral outstanding related to its derivative instruments as of March 31, 2015 and December 31, 2014 (in thousands):



	March 31, 2015		December 31, 2014
Energy commodity derivatives
Cash collateral posted	$	17,471	$	20,565
Letters of credit outstanding	7,500		14,500
Balance sheet offsetting (cash collateral against net derivative positions)	7,444		15,510

Interest rate swaps
Cash collateral posted	50,490		28,880
Letters of credit outstanding	17,900		10,900
Balance sheet offsetting (cash collateral against net derivative positions)	50,490		28,880

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 following table presents the aggregate fair value of all derivative instruments with credit-risk-related contingent features that are in a liability position and the amount of additional collateral the Company could be required to post as of March 31, 2015 and December 31, 2014 (in thousands):



	March 31, 2015		December 31, 2014
Liabilities with credit-risk-related contingent features	$	6,640	$	12,911
Additional collateral to post	6,638		16,227

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.