Fair Value of Financial Instruments and Fair Value Measurements

3 Months Ended

Mar. 31, 2020

Fair Value Disclosures [Abstract]

Fair Value of Financial Instruments and Fair Value Measurements

Fair Value of Financial Instruments and Fair Value Measurements

We determine the fair value of our derivative assets and liabilities and non-current equity investments associated with Networks’ activities utilizing market approach valuation techniques:

• Our equity and other investments consist of Rabbi Trusts for deferred compensation plans and a supplemental retirement benefit life insurance trust. The Rabbi Trusts primarily include equity securities and money market funds. We measure the fair value of our Rabbi Trust portfolio using observable, unadjusted quoted market prices in active markets for identical assets and include the measurements in Level 1. We measure the fair value of the supplemental retirement benefit life insurance trust based on quoted prices in the active markets for the various funds within which the assets are held and include the measurement in Level 2.

• NYSEG and RG&E enter into electric energy derivative contracts to hedge the forecasted purchases required to serve their electric load obligations. They hedge their electric load obligations using derivative contracts that are settled based upon Locational Based Marginal Pricing published by the NYISO. NYSEG and RG&E hedge approximately 70% of their electric load obligations using contracts for a NYISO location where an active market exists. The forward market prices used to value the companies’ open electric energy derivative contracts are based on quoted prices in active markets for identical assets or liabilities with no adjustment required and therefore we include the fair value measurements in Level 1.

• NYSEG and RG&E enter into natural gas derivative contracts to hedge their forecasted purchases required to serve their natural gas load obligations. The forward market prices used to value open natural gas derivative contracts are exchange-based prices for the identical derivative contracts traded actively on the New York Mercantile Exchange (NYMEX). Because we use prices quoted in an active market we include the fair value measurements in Level 1.

• NYSEG, RG&E and CMP enter into fuel derivative contracts to hedge their unleaded and diesel fuel requirements for their fleet vehicles. Exchange-based forward market prices are used, but because an unobservable basis adjustment is added to the forward prices, we include the fair value measurement for these contracts in Level 3.

• UI enters into CfDs, which are marked-to-market based on a probability-based expected cash flow analysis that is discounted at risk-free interest rates and an adjustment for non-performance risk using credit default swap rates. We include the fair value measurement for these contracts in Level 3 (See Note 7 for further discussion of CfDs).

We determine the fair value of our derivative assets and liabilities associated with Renewables activities utilizing market approach valuation techniques. Exchange-traded transactions, such as NYMEX futures contracts, that are based on quoted market prices in active markets for identical products with no adjustment are included in fair value Level 1. Contracts with delivery periods of two years or less which are traded in active markets and are valued with or derived from observable market data for identical or similar products such as over-the-counter NYMEX, foreign exchange swaps, and fixed price physical and basis and index trades are included in fair value Level 2. Contracts with delivery periods exceeding two years or that have unobservable inputs or inputs that cannot be corroborated with market data for identical or similar products are included in fair value Level 3. The unobservable inputs include historical volatilities and correlations for tolling arrangements and extrapolated values for certain power swaps. The valuation for this category is based on our judgments about the assumptions market participants would use in pricing the asset or liability since limited market data exists.

We determine the fair value of our interest rate swap derivative instruments based on a model whose inputs are observable, such as the London Interbank Offered Rate (LIBOR) forward interest rate curves. We include the fair value measurement for these contracts in Level 2 (See Note 7 for further discussion of interest rate swaps).

We determine the fair value of our foreign currency exchange derivative instruments based on current exchange rates compared to the rates at inception of the hedge. We include the fair value measurement for these contracts in Level 2.

The carrying amounts for cash and cash equivalents, restricted cash, accounts receivable, accounts payable, notes payable, lease obligations and interest accrued approximate their estimated fair values and are considered Level 1.

Restricted cash was $6 million as of both March 31, 2020 and December 31, 2019, and is included in "Other Assets" on our condensed consolidated balance sheets.

The financial instruments measured at fair value as of March 31, 2020 and December 31, 2019, respectively, consisted of:

As of March 31, 2020	Level 1			Level 2			Level 3			Netting			Total
(Millions)
Equity investments with readily determinable fair values	$	37		$	11		$	—		$	—		$	48
Derivative assets
Derivative financial instruments - power	2			42			125			(63		)	106
Derivative financial instruments - gas	1			33			32			(65		)	1
Contracts for differences	—			—			2			—			2
Total	3			75			159			(128		)	109
Derivative liabilities
Derivative financial instruments - power	(37		)	(28		)	(39		)	98			(6		)
Derivative financial instruments - gas	—			(22		)	(6		)	28			—
Contracts for differences	—			—			(97		)	—			(97		)
Derivative financial instruments – other	—			(39		)	(2		)	—			(41		)
Total	$	(37	)	$	(89	)	$	(144	)	$	126		$	(144	)

As of December 31, 2019	Level 1			Level 2			Level 3			Netting			Total
(Millions)
Equity investments with readily determinable fair values	$	38		$	13		$	—		$	—		$	51
Derivative assets
Derivative financial instruments - power	4			23			120			(54		)	93
Derivative financial instruments - gas	—			40			31			(71		)	—
Contracts for differences	—			—			2			—			2
Total	4			63			153			(125		)	95
Derivative liabilities
Derivative financial instruments - power	(28		)	(43		)	(29		)	92			(8		)
Derivative financial instruments - gas	(4		)	(26		)	(5		)	33			(2		)
Contracts for differences	—			—			(94		)	—			(94		)
Derivative financial instruments - other	—			(1		)	—			—			(1		)
Total	$	(32	)	$	(70	)	$	(128	)	$	125		$	(105	)

The reconciliation of changes in the fair value of financial instruments based on Level 3 inputs for the three months ended March 31, 2020 and 2019, respectively, is as follows:

	Three Months Ended March 31,
(Millions)	2020			2019
Fair Value Beginning of Period,	$	25		$	(15	)
Gains recognized in operating revenues	13			25
(Losses) recognized in operating revenues	(10		)	(13		)
Total gains recognized in operating revenues	3			12
Gains recognized in OCI	1			1
(Losses) recognized in OCI	(5		)	(15		)
Total gains recognized in OCI	(4		)	(14		)
Net change recognized in regulatory assets and liabilities	(3		)	(2		)
Purchases	—			—
Settlements	(6		)	(3		)
Fair Value as of March 31,	$	15		$	(22	)
Gains for the period included in operating revenues attributable to the change in unrealized gains relating to financial instruments still held at the reporting date	$	3		$	12

For assets and liabilities that are recognized in the condensed consolidated financial statements at fair value on a recurring basis, we determine whether transfers have occurred between levels in the hierarchy by re-assessing categorization based on the lowest level of input that is significant to the fair value measurement as a whole at the end of each reporting period. There have been no transfers between Level 1 and Level 2 during the periods reported.

Level 3 Fair Value Measurement

The table below illustrates the significant sources of unobservable inputs used in the fair value measurement of our Level 3 derivatives and the variability in prices for those transactions classified as Level 3 derivatives.

As of March 31, 2020
Instruments	Instrument Description	Valuation Technique	Valuation Inputs	Index	Avg.		Max.		Min.
Fixed price power and gas swaps with delivery period > two years	Transactions with delivery periods exceeding two years	Transactions are valued against forward market prices on a discounted basis	Observable and extrapolated forward gas and power prices not all of which can be corroborated by market data for identical or similar products	NYMEX ($/MMBtu)	$	2.84	$	4.90	$	1.60
				Indiana hub ($/MWh)	$	30.15	$	61.12	$	16.79
				Mid C ($/MWh)	$	24.68	$	105.00	$	(0.50	)
				Minn hub ($/MWh)	$	24.72	$	52.17	$	12.48
				NoIL hub ($/MWh)	$	26.93	$	55.39	$	12.98
				Ercot S hub ($/MWh)	$	31.20	$	248.39	$	11.41

Our Level 3 valuations primarily consist of NYMEX gas and fixed price power swaps with delivery periods extending through 2024 and 2032, respectively. The gas swaps are used to hedge merchant wind positions. The power swaps are used to hedge merchant wind production in the West and Midwest.

We performed a sensitivity analysis around the Level 3 gas and power positions to changes in the valuation inputs. Given the nature of the transactions in Level 3, the only material input to the valuation is the market price of gas or power for transactions with delivery periods exceeding two years. The fixed price power swaps are economic hedges of future power generation, with decreases in power prices resulting in unrealized gains and increases in power prices resulting in unrealized losses. The gas swaps are economic hedges of merchant generation, with decreases in gas prices resulting in unrealized gains and increases in gas prices resulting in unrealized losses. As all transactions are economic hedges of the underlying position, any changes in the fair value of these transactions will be offset by changes in the anticipated purchase/sales price of the underlying commodity.

Two elements of the analytical infrastructure employed in valuing transactions are the price curves used in the calculation of market value and the models themselves. We maintain and document authorized trading points and associated forward price curves, and we develop and document models used in valuation of the various products.

Transactions are valued in part on the basis of forward price, correlation and volatility curves. We maintain and document descriptions of these curves and their derivations. Forward price curves used in valuing the transactions are applied to the full duration of the transaction.

The determination of fair value of the CfDs (see Note 7 for further details on CfDs) was based on a probability-based expected cash flow analysis that was discounted at risk-free interest rates, as applicable, and an adjustment for non-performance risk using credit default swap rates. Certain management assumptions were required, including development of pricing that extends over the term of the contracts. We believe this methodology provides the most reasonable estimates of the amount of future discounted cash flows associated with the CfDs. Additionally, on a quarterly basis, we perform analytics to ensure that the fair value of the derivatives is consistent with changes, if any, in the various fair value model inputs. Significant isolated changes in the risk of non-performance, the discount rate or the contract term pricing would result in an inverse change in the fair value of the CfDs. Additional quantitative information about Level 3 fair value measurements of the CfDs is as follows:

	Range at
Unobservable Input	March 31, 2020
Risk of non-performance	1.13% - 1.68%
Discount rate	0.37% - 0.55%
Forward pricing ($ per KW-month)	$2.00 - $7.03

Fair Value of Debt

As of March 31, 2020 and December 31, 2019, debt consisted of first mortgage bonds, unsecured pollution control notes and other various non-current debt securities. The estimated fair value of debt amounted to $7,963 million and $8,168 million as of March 31, 2020 and December 31, 2019, respectively. The estimated fair value was determined, in most cases, by discounting the future cash flows at market interest rates. The interest rates used to make these calculations take into account the credit ratings of the borrowers in each case. All debt is considered Level 2 within the fair value hierarchy.