Fair Value of Financial Instruments

9 Months Ended

Sep. 30, 2012

Fair Value of Financial Instruments Disclosure [Abstract]

Fair Value of Financial Instruments

11.       Fair Value of Financial Instruments - MGE Energy and MGE.

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

At September 30,2012 and December 31, 2011, the carrying amount of cash and cash equivalents approximates fair market value due to the short maturity of those investments and obligations. The estimated fair market value of MGE Energy's and MGE's long-term debt is based on quoted market prices for similar financial instruments at September 30,2012 and December 31, 2011. Since the long-term debt is not traded in an active market, it is classified as Level 2 (see discussion regarding the fair value level hierarchy below in section b).The estimated fair market value, of MGE Energy's and MGE's financial instruments are as follows:

		September 30, 2012				December 31, 2011
		Carrying		Fair		Carrying		Fair
(In thousands)		Amount		Value		Amount		Value
MGE Energy
Assets:
Cash and cash equivalents	$	59,203	$	59,203	$	41,169	$	41,169
Liabilities:
Long-term debt*		362,473		436,747		364,473		432,515
MGE
Assets:
Cash and cash equivalents		29,536		29,536		13,898		13,898
Liabilities:
Long-term debt*		362,473		436,747		364,473		432,515
*Includes long-term debt due within one year.

b.       Recurring Fair Value Measurements.

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 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.

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

	Fair Value as of September 30, 2012
(In thousands)		Total		Level 1		Level 2		Level 3
MGE Energy
Assets:
Exchange-traded investments	$	409	$	409	$	0	$	0
Total Assets	$	409	$	409	$	0	$	0
Liabilities:
Derivatives, net	$	75,257	$	(858)	$	0	$	76,115
Deferred compensation		1,922		0		1,922		0
Total Liabilities	$	77,179	$	(858)	$	1,922	$	76,115
MGE
Assets:
Exchange-traded investments	$	138	$	138	$	0	$	0
Total Assets	$	138	$	138	$	0	$	0
Liabilities:
Derivatives, net	$	75,257	$	(858)	$	0	$	76,115
Deferred compensation		1,922		0		1,922		0
Total Liabilities	$	77,179	$	(858)	$	1,922	$	76,115
No transfers were made in or out of Level 1 or Level 2 for the nine months ended September 30, 2012.
	Fair Value as of December 31, 2011
(In thousands)		Total		Level 1		Level 2		Level 3
MGE Energy
Assets:
Exchange-traded investments	$	350	$	350	$	0	$	0
Total Assets	$	350	$	350	$	0	$	0
Liabilities:
Derivatives, net(a)	$	42,356	$	1,695	$	0	$	40,661
Deferred compensation(b)		1,725		0		1,725		0
Total Liabilities	$	44,081	$	1,695	$	1,725	$	40,661
MGE
Assets:
Exchange-traded investments	$	188	$	188	$	0	$	0
Total Assets	$	188	$	188	$	0	$	0
Liabilities:
Derivatives, net(a)	$	42,356	$	1,695	$	0	$	40,661
Deferred compensation(b)		1,725		0		1,725		0
Total Liabilities	$	44,081	$	1,695	$	1,725	$	40,661
(a)     These amounts are shown gross and exclude $3.0 million of collateral that was posted
against derivative positions with counterparties.
(b)     The deferred compensation liability at December 31, 2011, was transferred from Level 1
to Level 2.

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

Derivatives include exchange-traded derivative contracts, over-the-counter party transactions, a ten-year 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 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 with 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 ten-year purchased power agreement (see Footnote 9) was valued using an internally-developed pricing model and therefore is classified as Level 3. The model projects future market energy prices and compares those prices to the projected power costs to be incurred under the contract. Inputs to the model require significant management judgment and estimation. Future energy prices are based on a forward power pricing curve using exchange-traded contracts in the electric futures market, where such exchange-traded contracts exist, and upon calculations based on forward gas prices, where such exchange-traded contracts do not exist. A basis adjustment is applied to the market energy price to reflect the price differential between the market price delivery point and the counterparty delivery point. The historical relationship between the delivery points is reviewed and a discount (below 100%) or premium (above 100%) is derived. This comparison is done for both peak times when demand is high and off peak times when demand is low. If the basis adjustment is lowered, the fair value measurement will decrease and if the basis adjustment is increased, the fair value measurement will increase.

The projected power costs anticipated to be incurred under the purchased power agreement are determined using many factors, including historical generating costs, future prices, and expected fuel mix of the counterparty. An increase in the projected fuel costs would result in a decrease in the fair value measurement of the purchased power agreement. A significant input that MGE estimates is the counterparty's fuel mix in determining the projected power cost. MGE also considers the assumptions that market participants would use in valuing the asset or liability. This consideration includes assumptions about market risk such as liquidity, volatility and contract duration. The fair value model uses a discount rate that incorporates discounting, credit, and model risks.

This model is prepared by members of the Energy Supply group. It is reviewed on a quarterly basis by management in Energy Supply and Finance to review the assumptions, inputs and fair value measurements.

The following table presents the significant unobservable inputs used in the pricing model.

Significant Unobservable Inputs	Model Input
Basis adjustment
On peak	96.8%
Off peak	94.8%
Counterparty fuel mix:
Internal generation	49 % - 65 %
Purchased power	51 % - 35 %

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 balance sheets of MGE Energy and MGE. 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.

The following table summarizes the changes in Level 3 assets and liabilities measured at fair value on a recurring basis for both MGE Energy and MGE.

		Three Months Ended				Nine Months Ended
(In thousands)		September 30,				September 30,
		2012		2011		2012		2011
Beginning balance,	$	(79,580)	$	(22,983)	$	(40,661)	$	(19,216)
Realized and unrealized gains (losses):
Included in regulatory liabilities (assets)		3,465		(2,927)		(35,455)		(6,694)
Included in other comprehensive income		0		0		0		0
Included in earnings		(3,422)		182		(6,659)		815
Included in current assets		0		(7)		(77)		(66)
Purchases		5,864		178		7,764		342
Sales		45		0		77		0
Issuances		0		0		0		0
Settlements		(2,487)		(353)		(1,104)		(1,091)
Transfers in and/or out of Level 3		0		0		0		0
Balance as of September 30,	$	(76,115)	$	(25,910)	$	(76,115)	$	(25,910)
Total gains (losses) included in earnings attributed to
the change in unrealized gains (losses) related to
assets and liabilities held at September 30,(d)	$	0	$	0	$	0	$	0

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 for both MGE Energy and MGE(d).

		Three Months Ended				Nine Months Ended
(In thousands)		September 30,				September 30,
		2012		2011		2012		2011
Purchased Power Expense	$	(3,422)	$	182	$	(6,659)	$	815
Cost of Gas Sold Expense		0		0		0		0
Regulated Gas Revenues		0		0		0		0
Total	$	(3,422)	$	182	$	(6,659)	$	815

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