Fair Value of Financial Instruments

9 Months Ended

Sep. 30, 2022

11.

Fair Value of Financial Instruments - MGE Energy and MGE.

Fair value is defined as the price that would be received to sell an asset or would be paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. The accounting standard clarifies that

fair value should be based on the assumptions market participants would use when pricing the asset or liability including assumptions about risk. The standard also establishes a three-level fair value hierarchy based upon the observability of the assumptions used and requires the use of observable market data when available. The levels are:

Level 1 - Pricing inputs are quoted prices within active markets for identical assets or liabilities.

Level 2 - Pricing inputs are quoted prices within active markets for similar assets or liabilities; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations that are correlated with or otherwise verifiable by observable market data.

Level 3 - Pricing inputs are unobservable and reflect management's best estimate of what market participants would use in pricing the asset or liability.

Fair Value of Financial Assets and Liabilities Recorded at the Carrying Amount.

The carrying amount of cash, cash equivalents, and outstanding commercial paper approximates fair market value due to the short maturity of those investments and obligations. The estimated fair market value of long-term debt is based on quoted market prices for similar financial instruments. Since long-term debt is not traded in an active market, it is classified as Level 2. The estimated fair market value of financial instruments are as follows:


	September 30, 2022				December 31, 2021
(In thousands)	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Long-term debt(a)	$	619,794	$	549,585	$	623,449	$	729,914

(a)

Includes long-term debt due within one year. Excludes debt issuance costs and unamortized discount of $3.9 million and $4.3 million as of September 30, 2022, and December 31, 2021, respectively.

Recurring Fair Value Measurements.

The following table presents the balances of assets and liabilities measured at fair value on a recurring basis.


	Fair Value as of September 30, 2022
(In thousands)	Total		Level 1		Level 2		Level 3
MGE Energy
Assets:
Derivatives, net(b)	$	9,827	$	5,446	$	—	$	4,381
Exchange-traded investments		1,504		1,504		—		—
Total Assets	$	11,331	$	6,950	$	—	$	4,381
Liabilities:
Derivatives, net(b)	$	4,614	$	4,087	$	—	$	527
Deferred compensation		3,782		—		3,782		—
Total Liabilities	$	8,396	$	4,087	$	3,782	$	527

MGE
Assets:
Derivatives, net(b)	$	9,827	$	5,446	$	—	$	4,381
Exchange-traded investments		99		99		—		—
Total Assets	$	9,926	$	5,545	$	—	$	4,381
Liabilities:
Derivatives, net(b)	$	4,614	$	4,087	$	—	$	527
Deferred compensation		3,782		—		3,782		—
Total Liabilities	$	8,396	$	4,087	$	3,782	$	527


	Fair Value as of December 31, 2021
(In thousands)	Total		Level 1		Level 2		Level 3
MGE Energy
Assets:
Derivatives, net(c)	$	3,606	$	1,170	$	—	$	2,436
Exchange-traded investments		1,296		1,296		—		—
Total Assets	$	4,902	$	2,466	$	—	$	2,436
Liabilities:
Derivatives, net	$	2,989	$	731	$	—	$	2,258
Deferred compensation		3,653		—		3,653		—
Total Liabilities	$	6,642	$	731	$	3,653	$	2,258

MGE
Assets:
Derivatives, net(c)	$	3,606	$	1,170	$	—	$	2,436
Exchange-traded investments		230		230		—		—
Total Assets	$	3,836	$	1,400	$	—	$	2,436
Liabilities:
Derivatives, net	$	2,989	$	731	$	—	$	2,258
Deferred compensation		3,653		—		3,653		—
Total Liabilities	$	6,642	$	731	$	3,653	$	2,258

(b)

No collateral was posted against derivative positions as of September 30, 2022.

(c)

As of December 31, 2021 MGE received collateral of $1.3 million from counterparties under a master netting agreement for outstanding exchange traded derivative positions. The fair value of the derivative asset disclosed in this table has not been reduced for the collateral received.

Investments include exchange-traded investment securities valued using quoted prices on active exchanges and are therefore classified as Level 1.

The deferred compensation plan allows participants to defer certain cash compensation into a notional investment account. These amounts are included within other deferred liabilities in the consolidated balance sheets. The notional investments earn interest based upon the semiannual rate of U.S. Treasury Bills having a 26-week maturity increased by 1% compounded monthly with a minimum annual rate of 7%, compounded monthly. The notional investments are based upon observable market data, however, since the deferred compensation obligations themselves are not exchanged in an active market, they are classified as Level 2.

Derivatives include exchange-traded derivative contracts, over-the-counter transactions, a purchased power agreement, and FTRs. Most exchange-traded derivative contracts are valued based on unadjusted quoted prices in active markets and are therefore classified as Level 1. A small number of exchange-traded derivative contracts are valued using quoted market pricing in markets with insufficient volumes and are therefore considered unobservable and classified as Level 3. Transactions done with an over-the-counter party are on inactive markets and are therefore classified as Level 3. These transactions are valued based on quoted prices from markets with similar exchange-traded transactions. FTRs are priced based upon monthly auction results for identical or similar instruments in a closed market with limited data available and are therefore classified as Level 3.

The purchased power agreement, with a term ended May 2022, (see Footnote 10) was valued using an internal pricing model and therefore was classified as Level 3. See the 2021 Annual Report on Form 10-K for details on the internal pricing model and significant unobservable inputs.

The following table summarizes the changes in Level 3 commodity derivative assets and liabilities measured at fair value on a recurring basis.


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(In thousands)	2022		2021		2022		2021
Beginning balance	$	8,959	$	(4,533)	$	178	$	(14,055)
Realized and unrealized gains (losses):
Included in regulatory liability		(5,105)		8,122		3,675		17,644
Included in other comprehensive income		—		—		—		—
Included in earnings		6,609		2,476		13,607		2,686
Included in current assets		(73)		—		45		175
Purchases		108		6,638		11,911		18,899
Sales		—		—		—		—
Issuances		—		—		—		—
Settlements		(6,644)		(9,114)		(25,562)		(21,760)
Balance as of September 30,	$	3,854	$	3,589	$	3,854	$	3,589
Total gains (losses) included in earnings attributed to the change in unrealized gains (losses) related to assets and liabilities held as of September 30,(d)	$	—	$	—	$	—	$	—

The following table presents total realized and unrealized gains (losses) included in income for Level 3 assets and liabilities measured at fair value on a recurring basis(d).


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(In thousands)	2022		2021		2022		2021
Purchased power expense	$	6,644	$	2,476	$	13,805	$	3,113
Cost of gas sold expense		(35)		—		(198)		(427)
Total	$	6,609	$	2,476	$	13,607	$	2,686

(d)

MGE's exchange-traded derivative contracts, over-the-counter party transactions, purchased power agreement, and FTRs are subject to regulatory deferral. These derivatives are therefore marked to fair value and are offset in the financial statements with a corresponding regulatory asset or liability.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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