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Derivative and Hedging Instruments
 6 Months Ended
Jun. 30, 2012
Derivative and Hedging Instruments Disclosure [Abstract]  
Derivative and Hedging Instruments

9.       Derivative and Hedging Instruments - MGE Energy and MGE.

 

a.       Purpose.

 

As part of its regular operations, MGE enters into contracts, including options, swaps, futures, forwards, and other contractual commitments, to manage its exposure to commodity prices and gas revenues. To the extent that these contracts are derivatives, MGE assesses whether or not the normal purchases or normal sales exclusion applies. For contracts to which this exclusion cannot be applied, MGE Energy and MGE recognize such derivatives in the consolidated balance sheets at fair value. The majority of MGE's derivative activities are conducted in accordance with its electric and gas risk management program, which is approved by the PSCW and limits the volume MGE can hedge with specific risk management strategies. The maximum length of time over which cash flows related to energy commodities can be hedged is four years. If the derivative qualifies for regulatory deferral, the derivatives are marked to fair value and are offset with a corresponding regulatory asset or liability. The deferred gain or loss is recognized in earnings in the delivery month applicable to the instrument. Gains and losses related to hedges qualifying for regulatory treatment are recoverable in gas rates through the PGA or in electric rates as a component of the fuel rules mechanism.

b.       Notional Amounts.

 

The gross notional volume of open derivatives is as follows:

  June 30, 2012 December 31, 2011 
 Commodity derivative contracts460,825 MWh 482,545 MWh 
 Commodity derivative contracts3,550,000 Dth 4,030,000 Dth 
 FTRs5,587 MW 2,382 MW 

c.       Financial Statement Presentation.

 

MGE Energy and MGE offset fair value amounts recognized for the right to reclaim collateral (a receivable) or the obligation to return collateral (a payable) against fair value amounts recognized for derivative instruments executed with the same counterparty under a master netting agreement. At June 30, 2012 and December 31, 2011, MGE Energy and MGE had $0.7 million and $3.0 million, respectively, in collateral that was netted against the net derivative positions with counterparties.

 

MGE purchases and sells exchange-traded and over-the-counter options, swaps, and future contracts. These arrangements are primarily entered into to help stabilize the price risk associated with gas or power purchases. These transactions are employed by both MGE's gas and electric segments. Additionally, as a result of the firm transmission agreements that MGE holds on transmission paths in the MISO and PJM markets, MGE holds FTRs. An FTR is a financial instrument that entitles the holder to a stream of revenues or charges based on the differences in hourly day-ahead energy prices between two points on the transmission grid. The fair values of these instruments are reflected as a regulatory asset/liability depending on whether they are in a net loss/gain position. Depending on the nature of the instrument, the gain or loss associated with these transactions will be reflected as cost of gas sold, fuel for electric generation, or purchased power expense in the delivery month applicable to the instrument. At June 30, 2012, the fair value of exchange traded derivatives and FTRs exceeded their cost basis by $0.4 million. At December 31, 2011, the cost basis of exchange traded derivatives and FTRs exceeded their fair value by $2.8 million.

 

MGE has also entered into a ten-year purchased power agreement that provides MGE with firm capacity and energy during a base term from June 1, 2012, through May 31, 2022. The agreement also allows MGE an option to extend the contract after the base term. The agreement is accounted for as a derivative contract and is recognized at its fair value on the balance sheet. However, the derivative qualifies for regulatory deferral and is recognized with a corresponding regulatory asset or liability depending on whether the fair value is in a loss or gain position. The fair value of the contract at June 30, 2012 and December 31, 2011, reflects a loss position of $79.8 million and $39.5 million, respectively. The actual fuel cost will be recognized in purchased power expense in the month of purchase.

 

The following table summarizes the fair value of the derivative instruments on the balance sheet. All derivative instruments in this table are presented on a gross basis and are calculated prior to the netting of instruments with the same counterparty under a master netting agreement as well as the netting of collateral. For financial statement purposes, MGE Energy and MGE have netted instruments with the same counterparty under a master netting agreement as well as the netting of collateral.

 Asset Derivatives Liability Derivatives
(In thousands)Balance Sheet Location Fair Value Balance Sheet Location Fair Value
June 30, 2012       
Commodity derivative contractsOther current assets$727Derivative liability (current)$1,151
Commodity derivative contractsOther deferred charges 65 Derivative liability (long-term) 239
FTRsOther current assets 986 Derivative liability (current) 0
Ten-year PPAN/A N/A Derivative liability (current) 10,180
Ten-year PPAN/A N/A Derivative liability (long-term) 69,570
        
December 31, 2011       
Commodity derivative contractsOther current assets$177 Derivative liability (current)$3,060
Commodity derivative contractsOther deferred charges 92 Derivative liability (long-term) 231
FTRsOther current assets 186 Derivative liability (current) 0
Ten-year PPAN/A N/A Derivative liability (current) 4,600
Ten-year PPAN/A N/A Derivative liability (long-term) 34,920

The following tables summarize the unrealized and realized gains (losses) related to the derivative instruments on the balance sheet at June 30, 2012 and 2011, and the income statement for the three and six months ended June 30, 2012 and 2011.

  2012  2011
(In thousands) Current and long-term regulatory asset Other current assets  Current and long-term regulatory asset Other current assets
Three Months Ended June 30:         
Balance at April 1,$71,514$672 $21,677$505
Change in unrealized loss 9,791 0  888 0
Realized loss reclassified to a deferred account (222) 222  (610) 610
Realized gain (loss) reclassified to income         
statement (1,721) (176)  649 (114)
Balance at June 30,$79,362$718 $22,604$1,001
          
Six Months Ended June 30:         
Balance at January 1,$42,356$1,604 $19,230$1,411
Change in unrealized loss 43,101 0  3,936 0
Realized loss reclassified to a deferred account (2,880) 2,880  (1,274) 1,274
Realized gain (loss) reclassified to income         
statement (3,215) (3,766)  712 (1,684)
Balance at June 30,$79,362$718 $22,604$1,001

   Realized losses (gains) 
     Fuel for electric    
   Regulated generation/ Cost of  
 (In thousands) gas revenues purchased power gas sold 
 Three Months Ended June 30, 2012:       
 Commodity derivative contracts$0$582$0 
 FTRs 0 96 0 
 Ten-year PPA 0 1,219 0 
         
 Three Months Ended June 30, 2011:       
 Commodity derivative contracts$0$90$0 
 FTRs 0 (625) 0 
 Ten-year PPA 0 0 0 
         
 Six Months Ended June 30, 2012:       
 Commodity derivative contracts$0$2,510$3,090 
 FTRs 0 162 0 
 Ten-year PPA 0 1,219 0 
         
 Six Months Ended June 30, 2011:       
 Commodity derivative contracts$0$28$1,315 
 FTRs 0 (371) 0 
 Ten-year PPA 0 0 0 

       MGE's commodity derivative contracts, FTRs, and ten-year PPA are subject to regulatory deferral. These derivatives are marked to fair value and are offset with a corresponding regulatory asset or liability. Realized gains and losses are deferred on the balance sheet and are recognized in earnings in the delivery month applicable to the instrument. As a result of the above described treatment, there are no unrealized gains or losses that flow through earnings.

 

The ten-year PPA has a provision that may require MGE to post collateral if MGE's debt rating falls below investment grade (i.e., below BBB-). The amount of collateral that it may be required to post varies from $20.0 million to $40.0 million, depending on MGE's nominated capacity amount. As of June 30, 2012, no collateral has been posted. Certain counterparties extend MGE a credit limit. If MGE exceeds these limits, the counterparties may require collateral to be posted. As of June 30, 2012 and December 31, 2011, no counterparties were in a net liability position.

 

Nonperformance of counterparties to the non-exchange traded derivatives could expose MGE to credit loss. However, MGE enters into transactions only with companies that meet or exceed strict credit guidelines, and it monitors these counterparties on an ongoing basis to mitigate nonperformance risk in its portfolio. As of June 30, 2012, no counterparties have defaulted.