Note 6. Derivative Instruments and Hedging

Our Networks, Renewables and Gas activities are exposed to certain risks, which are managed by using derivative instruments. All derivative instruments are recognized as either assets or liabilities at fair value on the condensed consolidated balance sheets in accordance with the accounting requirements concerning derivative instruments and hedging activities.

(a) Networks activities

NYSEG and RG&E have an electric commodity charge that passes through rates costs for the market price of electricity. They use electricity contracts, both physical and financial, to manage fluctuations in electricity commodity prices in order to provide price stability to customers. We include the cost or benefit of those contracts in the amount expensed for electricity purchased when the related electricity is sold. We record changes in the fair value of electric hedge contracts to derivative assets and / or liabilities with an offset to regulatory assets and / or regulatory liabilities, in accordance with the accounting requirements concerning regulated operations.

The amount recognized in regulatory assets for electricity derivatives was a loss of $20.1 million as of March 31, 2017, and $12.3 million as of December 31, 2016. The amount reclassified from regulatory assets and liabilities into income, which is included in electricity purchased, was a loss of $10.9 million and $34.8 million, for the three months ended March 31, 2017 and 2016, respectively.

NYSEG and RG&E have purchased gas adjustment clauses that allow them to recover through rates any changes in the market price of purchased natural gas, substantially eliminating their exposure to natural gas price risk. NYSEG and RG&E use natural gas futures and forwards to manage fluctuations in natural gas commodity prices to provide price stability to customers. We include the cost or benefit of natural gas futures and forwards in the commodity cost that is passed on to customers when the related sales commitments are fulfilled. We record changes in the fair value of natural gas hedge contracts to derivative assets and / or liabilities with an offset to regulatory assets and / or regulatory liabilities in accordance with the accounting requirements for regulated operations.

The amount recognized in regulatory liabilities for natural gas hedges was a gain of $0.5 million as of March 31, 2017, and $3.5 million as of December 31, 2016. The amount reclassified from regulatory assets and liabilities into income, which is included in natural gas purchased, was a gain of $0.6 million and a loss $3.4 million, for the three months ended March 31, 2017 and 2016, respectively.

Pursuant to PURA, UI and Connecticut’s other electric utility, The Connecticut Light and Power Company (CL&P), each executed two long-term CfDs with certain incremental capacity resources, each of which specifies a capacity quantity and a monthly settlement that reflects the difference between a forward market price and the contract price. The costs or benefits of each contract will be paid by or allocated to customers and will be subject to a cost-sharing agreement between UI and CL&P pursuant to which approximately 20% of the cost or benefit is borne by or allocated to UI customers and approximately 80% is borne by or allocated to CL&P customers.

PURA has determined that costs associated with these CfDs will be fully recoverable by UI and CL&P through electric rates, and UI has deferred recognition of costs (a regulatory asset) or obligations (a regulatory liability). For those CfDs signed by CL&P, UI records its approximate 20% portion pursuant to the cost-sharing agreement noted above. As of March 31, 2017, UI has recorded a gross derivative asset of $17 million ($0 of which is related to UI’s portion of the CfD signed by CL&P), a regulatory asset of $81 million, a gross derivative liability of $98 million ($76 million of which is related to UI’s portion of the CfD signed by CL&P) and a regulatory liability of $0. As of December 31, 2016, UI had recorded a gross derivative asset of $19 million ($0 of which is related to UI’s portion of the CfD signed by CL&P), a regulatory asset of $75 million, a gross derivative liability of $95 million ($70 million of which is related to UI’s portion of the CfD signed by CL&P) and a regulatory liability of $0.

The unrealized gains and losses from fair value adjustments to these derivatives, which are recorded in regulatory assets or regulatory liabilities, for the three months ended March 31, 2017 and 2016, respectively, were as follows:

	Three Months Ended
	March 31,
	2017		2016
(Millions)
Regulatory Assets - Derivative liabilities	$	5	$	(3	)
Regulatory Liabilities - Derivative assets	$	1	$	(22	)

The net notional volumes of the outstanding derivative instruments associated with Networks activities as of March 31, 2017 and December 31, 2016, respectively, consisted of:

	March 31,		December 31,
As of	2017		2016
(Millions)
Wholesale electricity purchase contracts (MWh)		5.0	5.6
Natural gas purchase contracts (Dth)		6.0	5.8
Fleet fuel purchase contracts (Gallons)		2.3	2.3

The offsetting of derivatives, location in the condensed consolidated balance sheet and amounts of derivatives associated with Networks activities as of March 31, 2017 and December 31, 2016, respectively, consisted of:

As of March 31, 2017	Current Assets			Noncurrent Assets			Current Liabilities			Noncurrent Liabilities
(Millions)
Not designated as hedging instruments
Derivative assets	$	16		$	10		$	6		$	1
Derivative liabilities		(5	)		(1	)		(39	)		(86	)
		11			9			(33	)		(85	)
Designated as hedging instruments
Derivative assets		—			—			—			—
Derivative liabilities		—			—			(1	)		—
		—			—			(1	)		—
Total derivatives before offset of cash collateral		11			9			(34	)		(85	)
Cash collateral receivable		—			—			12			8
Total derivatives as presented in the balance sheet	$	11		$	9		$	(22	)	$	(77	)

As of December 31, 2016	Current Assets			Noncurrent Assets			Current Liabilities			Noncurrent Liabilities
(Millions)
Not designated as hedging instruments
Derivative assets	$	19		$	16		$	7		$	5
Derivative liabilities		(7	)		(5	)		(40	)		(79	)
		12			11			(33	)		(74	)
Designated as hedging instruments
Derivative assets		—			—			—			—
Derivative liabilities		—			—			—			—
		—			—			—			—
Total derivatives before offset of cash collateral		12			11			(33	)		(74	)
Cash collateral receivable		—			—			10			2
Total derivatives as presented in the balance sheet	$	12		$	11		$	(23	)	$	(72	)

The effect of derivatives in cash flow hedging relationships on Other Comprehensive Income (OCI) and income for the three months ended March 31, 2017 and 2016, respectively, consisted of:

Three Months Ended March 31,	(Loss) Recognized in OCI on Derivatives			Location of Loss Reclassified from Accumulated OCI into Income	Loss Reclassified from Accumulated OCI into Income
(Millions)	Effective Portion (a)			Effective Portion (a)
2017
Interest rate contracts	$	—		Interest expense	$	2
Commodity contracts		(1	)	Operating expenses		—
Total	$	(1	)		$	2
2016
Interest rate contracts	$	—		Interest expense	$	2
Commodity contracts		—		Operating expenses		1
Total	$	—			$	3

(a)Changes in OCI are reported on a pre-tax basis. The reclassified amounts of commodity contracts are included within “Purchase power, natural gas and fuel used” line item within operating expenses in the condensed consolidated statements of income.

The net loss in accumulated OCI related to previously settled forward starting swaps and accumulated amortization is $74.9 million and $76.7 million as of March 31, 2017 and December 31, 2016, respectively. We recorded $2.0 million and $2.0 million in net derivative losses related to discontinued cash flow hedges for the three months ended March 31, 2017 and 2016, respectively. We will amortize approximately $8.0 million of discontinued cash flow hedges in 2017. During the three months ended March 31, 2017 and 2016, there was no ineffective portion for cash flow hedges.

The unrealized loss of $0.8 million on hedge activities is reported in OCI because the forecasted transaction is considered to be probable as of March 31, 2017. We expect that $0.8 million of those losses will be reclassified into earnings within the next twelve months. The maximum length of time over which we are hedging our exposure to the variability in future cash flows for forecasted fleet fuel transactions is twelve months.

(b) Renewables and Gas activities

We sell fixed-price gas and power forwards to hedge our merchant wind assets from declining commodity prices for our Renewables business. We also purchase fixed-price gas and basis swaps and sell fixed-price power in the forward market to hedge the spark spread or heat rate of our merchant thermal assets. We also enter into tolling arrangements to sell the output of our thermal generation facilities.

Our gas business purchases and sells both fixed-price gas and basis swaps to hedge the value of contracted storage positions. The intent of entering into these swaps is to fix the margin of gas injected into storage for subsequent resale in future periods. We also enter into basis swaps to hedge the value of our contracted transport positions. The intent of buying and selling these basis swaps is to fix the location differential between the price of gas at the receipt and delivery point of the contracted transport in future periods.

Both Renewables and Gas have proprietary trading operations that enter into fixed-price power and gas forwards in addition to basis swaps. The intent is to speculate on fixed-price commodity and basis volatility in the U.S. commodity markets.

Renewables will periodically designate derivative contracts as cash flow hedges for both its thermal and wind portfolios. To the extent that the derivative contracts are effective in offsetting the variability of cash flows associated with future power sales and gas purchases, the fair value changes are recorded in OCI. Any hedge ineffectiveness is recorded in current period earnings. For thermal operations, Renewables will periodically designate both fixed price NYMEX gas contracts and AECO basis swaps that hedge the fuel requirements of its Klamath Plant in Klamath, Oregon. Renewables will also designate fixed price power swaps at various locations in the U.S. market to hedge future power sales from its Klamath facility and various wind farms.

Gas also periodically designates NYMEX fixed price derivative contracts as cash flow hedges related to its firm storage trading activities. To the extent that the derivative contracts are effective in offsetting the variability of cash flows associated with future gas sales and purchases, the fair value changes are recorded in OCI. Any hedge ineffectiveness is recorded in current period earnings. Derivative contracts entered into to hedge the gas transport trading activities are not designated as cash flow hedges, with all changes in fair value of such derivative contracts recorded in current period earnings.

The net notional volumes of outstanding derivative instruments associated with Renewables and Gas activities as of March 31, 2017 and December 31, 2016, respectively, consisted of:

	March 31,		December 31,
As of	2017		2016
(MWh/Dth in millions)
Wholesale electricity purchase contracts		2		3
Wholesale electricity sales contracts		7		7
Natural gas and other fuel purchase contracts		314		329
Financial power contracts		8		8
Basis swaps – purchases		60		49
Basis swaps – sales		76		45

The fair values of derivative contracts associated with Renewables and Gas activities as of March 31, 2017 and December 31, 2016, respectively, consisted of:

	March 31,			December 31,
As of	2017			2016
(Millions)
Wholesale electricity purchase contracts	$	(10	)	$	(2	)
Wholesale electricity sales contracts		25			6
Natural gas and other fuel purchase contracts		6			30
Financial power contracts		64			56
Basis swaps – purchases		(8	)		3
Basis swaps – sales		5			(2	)
Total	$	82		$	91

The effect of trading derivatives associated with Renewables and Gas activities for the three months ended March 31, 2017 and 2016, consisted of:

	Three Months Ended
	March 31,
	2017			2016
(Millions)
Wholesale electricity purchase contracts	$	(3	)	$	—
Wholesale electricity sales contracts		7			(1	)
Financial power contracts		(3	)		1
Financial and natural gas contracts		4			(30	)
Total Gain (Loss)	$	5		$	(30	)

The effect of non-trading derivatives associated with Renewables and Gas activities for the three months ended March 31, 2017 and 2016, consisted of:

	Three Months Ended
	March 31,
	2017			2016
(Millions)
Wholesale electricity purchase contracts	$	(6	)	$	(3	)
Wholesale electricity sales contracts		11			6
Financial power contracts		16			1
Financial and natural gas contracts		(4	)		(9	)
Total Gain (Loss)	$	17		$	(5	)

Such gains and losses are included in “Operating revenues” and in “Purchased power, natural gas and fuel used” operating expenses in the condensed consolidated statements of income, depending upon the nature of the transaction.

The offsetting of derivatives, location in the condensed consolidated balance sheet and amounts of derivatives associated with Renewables and Gas activities as of March 31, 2017 and December 31, 2016, respectively, consisted of:

As of March 31, 2017	Current Assets			Noncurrent Assets			Current Liabilities			Noncurrent Liabilities
(Millions)
Not designated as hedging instruments
Derivative assets	$	79		$	117		$	100		$	6
Derivative liabilities		(30	)		(7	)		(115	)		(10	)
		49			110			(15	)		(4	)
Designated as hedging instruments
Derivative assets		16			8			—			1
Derivative liabilities		—			(2	)		(15	)		(1	)
		16			6			(15	)		—
Total derivatives before offset of cash collateral		65			116			(30	)		(4	)
Cash collateral receivable (payable)		(19	)		(49	)		2			1
Total derivatives as presented in the balance sheet	$	46		$	67		$	(28	)	$	(3	)

As of December 31, 2016	Current Assets			Noncurrent Assets			Current Liabilities			Noncurrent Liabilities
(Millions)
Not designated as hedging instruments
Derivative assets	$	198		$	108		$	78		$	7
Derivative liabilities		(118	)		(4	)		(132	)		(16	)
		80			104			(54	)		(9	)
Designated as hedging instruments
Derivative assets		25			4			—			—
Derivative liabilities		(1	)		—			(39	)		(21	)
		24			4			(39	)		(21	)
Total derivatives before offset of cash collateral		104			108			(93	)		(30	)
Cash collateral receivable (payable)		(17	)		(46	)		41			24
Total derivatives as presented in the balance sheet	$	87		$	62		$	(52	)	$	(6	)

The effect of derivatives in cash flow hedging relationships on OCI and income for the three months ended March 31, 2017 and 2016, respectively, consisted of:

Three Months Ended March 31,	Gain Recognized in OCI on Derivatives		Location of Gain Reclassified from Accumulated OCI into Income	Loss (Gain) Reclassified from Accumulated OCI into Income
(Millions)	Effective Portion (a)		Effective Portion (a)
2017
Commodity contracts	$	4	Revenues	$	33
Total	$	4		$	33
2016
Commodity contracts	$	3	Revenues	$	(46	)
Total	$	3		$	(46	)

(a)

Changes in OCI are reported on a pre-tax basis.

Amounts are reclassified from accumulated OCI into income in the period during which the transaction being hedged affects earnings or when it becomes probable that a forecasted transaction being hedged would not occur. Notwithstanding future changes in prices, approximately $0.5 million of gain included in accumulated OCI at March 31, 2017, is expected to be reclassified into earnings within the next 12 months. During the three months ended March 31, 2017 and 2016, we recorded a net loss of $0.3 million and $4.4 million, respectively, in earnings as a result of ineffectiveness from cash flow hedges. The net loss in accumulated OCI related to a discontinued cash flow hedge is $0.5 million as of March 31, 2017. This amount will be amortized in 2018.

NYSEG and RG&E face risks related to counterparty performance on hedging contracts due to counterparty credit default. We have developed a matrix of unsecured credit thresholds that are dependent on the counterparty’s or the counterparty’s guarantor’s applicable credit rating, normally Moody’s or Standard & Poor’s. When our exposure to risk for a counterparty exceeds the unsecured credit threshold, the counterparty is required to post additional collateral or we will no longer transact with the counterparty until the exposure drops below the unsecured credit threshold.

The wholesale power supply agreements of UI contain default provisions that include required performance assurance, including certain collateral obligations, in the event that UI’s credit rating on senior debt were to fall below investment grade. If such an event had occurred as of March 31, 2017, UI would have had to post an aggregate of approximately $11 million in collateral.

We have various master netting arrangements in the form of multiple contracts with various single counterparties that are subject to contractual agreements that provide for the net settlement of all contracts through a single payment. Those arrangements reduce our exposure to a counterparty in the event of default on or termination of any single contract. For financial statement presentation purposes, we offset fair value amounts recognized for derivative instruments and fair value amounts recognized for the right to reclaim or the obligation to return cash collateral arising from derivative instruments executed with the same counterparty under a master netting arrangement. The amounts of cash collateral under master netting arrangements that have not been offset against net derivative positions were $23 million and $20 million as of March 31, 2017 and December 31, 2016, respectively. Derivative instruments settlements and collateral payments are included in “Other assets/liabilities” of operating activities in the condensed consolidated statements of cash flows.

Certain of our derivative instruments contain provisions that require us to maintain an investment grade credit rating on our debt from each of the major credit rating agencies. If our debt were to fall below investment grade, we would be in violation of those provisions and the counterparties to the derivative instruments could request immediate payment or demand immediate and ongoing full overnight collateralization on derivative instruments in net liability positions. The aggregate fair value of all derivative instruments with credit risk related contingent features that are in a liability position as of March 31, 2017 is $20.1 million, for which we have posted collateral.