Derivative Instruments

3 Months Ended

Mar. 31, 2012

Derivative Instruments and Hedging Activities Disclosure [Abstract]

DERIVATIVE INSTRUMENTS

DERIVATIVE INSTRUMENTS

FirstEnergy is exposed to financial risks resulting from fluctuating interest rates and commodity prices, including prices for electricity, natural gas, coal and energy transmission. To manage the volatility relating to these exposures, FirstEnergy’s Risk Policy Committee, comprised of senior management, provides general management oversight for risk management activities throughout FirstEnergy. The Risk Policy Committee is responsible for promoting the effective design and implementation of sound risk management programs and oversees compliance with corporate risk management policies and established risk management practice. FirstEnergy also uses a variety of derivative instruments for risk management purposes including forward contracts, options, futures contracts and swaps.

FirstEnergy accounts for derivative instruments on its Consolidated Balance Sheets at fair value unless they meet the normal purchases and normal sales criteria. Derivatives that meet those criteria are accounted for under the accrual method of accounting, and their effects are included in earnings at the time of contract performance. Changes in the fair value of derivative instruments that qualified and were designated as cash flow hedge instruments are recorded in AOCI. Changes in the fair value of derivative instruments that are not designated as cash flow hedge instruments are recorded in net income on a mark-to-market basis. FirstEnergy has these contractual derivative agreements through December 2018.

Cash Flow Hedges

FirstEnergy has used cash flow hedges for risk management purposes to manage the volatility related to exposures associated with fluctuating interest rates and commodity prices. The effective portion of gains and losses on a derivative contract are reported as a component of AOCI with subsequent reclassification to earnings in the period during which the hedged forecasted transaction affects earnings.

In February 2011, FirstEnergy elected to dedesignate all outstanding cash flow hedge relationships, therefore, as of March 31, 2012 and December 31, 2011, there were no commodity derivative contracts designated in cash flow hedging relationships. Total net unamortized gains included in AOCI associated with dedesignated cash flow hedges totaled $14 million and $19 million as of March 31, 2012 and December 31, 2011, respectively. Since the forecasted transactions remain probable of occurring, these amounts will be amortized into earnings over the life of the hedging instruments. Reclassifications from AOCI into other operating expenses were $5 million of income and $5 million of loss during the three months ended March 31, 2012 and 2011, respectively. Approximately $7 million is expected to be amortized to income during the next twelve months.

FirstEnergy has used forward starting swap agreements to hedge a portion of the consolidated interest rate risk associated with anticipated issuances of fixed-rate, long-term debt securities of its subsidiaries. These derivatives were treated as cash flow hedges, protecting against the risk of changes in future interest payments resulting from changes in benchmark U.S. Treasury rates between the date of hedge inception and the date of the debt issuance. As of March 31, 2012, no forward starting swap agreements were outstanding. Total unamortized losses included in AOCI associated with prior interest rate cash flow hedges totaled $77 million as of March 31, 2012. Based on current estimates, approximately $9 million will be amortized to interest expense during the next twelve months. Reclassifications from AOCI into interest expense totaled $2 million and $3 million during the three months ended March 31, 2012 and 2011, respectively.

Fair Value Hedges

FirstEnergy has used fixed-for-floating interest rate swap agreements to hedge a portion of the consolidated interest rate risk associated with the debt portfolio of its subsidiaries. These derivative instruments were treated as fair value hedges of fixed-rate, long-term debt issues, protecting against the risk of changes in the fair value of fixed-rate debt instruments due to lower interest rates. As of March 31, 2012, no fixed-for-floating interest rate swap agreements were outstanding.

Unamortized gains included in long-term debt associated with prior fixed-for-floating interest rate swap agreements totaled $96 million as of March 31, 2012. Based on current estimates, approximately $23 million will be amortized to interest expense during the next twelve months. Reclassifications from long-term debt into interest expense totaled approximately $6 million and $5 million during the three months ended March 31, 2012 and 2011, respectively.

Commodity Derivatives

FirstEnergy uses both physically and financially settled derivatives to manage its exposure to volatility in commodity prices. Commodity derivatives are used for risk management purposes to hedge exposures when it makes economic sense to do so, including circumstances where the hedging relationship does not qualify for hedge accounting.

Electricity forwards are used to balance expected sales with expected generation and purchased power. Natural gas futures are entered into based on expected consumption of natural gas primarily for use in FirstEnergy’s peaking units. Heating oil futures are entered into based on expected consumption of oil and the financial risk in FirstEnergy’s coal transportation contracts.

As of March 31, 2012, FirstEnergy’s net asset position under commodity derivative contracts was $66 million, which related to FES and AE Supply positions. Under these commodity derivative contracts, FES posted $44 million and AE Supply posted $1 million of collateral. Certain commodity derivative contracts include credit risk related contingent features that would require FES to post $16 million and AE Supply to post $3 million of additional collateral if the credit rating for its debt were to fall below investment grade.

Based on commodity derivative contracts held as of March 31, 2012, an adverse 10% change in commodity prices would decrease net income by approximately $2 million during the next twelve months.

FTRs

FirstEnergy holds FTRs that generally represent an economic hedge of future congestion charges that will be incurred in connection with FirstEnergy’s load obligations. FirstEnergy acquires the majority of its FTRs in an annual auction through a self-scheduling process involving the use of ARRs allocated to members of an RTO that have load serving obligations and through the direct allocation of FTRs from the PJM RTO. The PJM RTO has a rule that allows directly allocated FTRs to be granted to LSEs in zones that have newly entered PJM. For the first two planning years, PJM permits the LSEs to request a direct allocation of FTRs in these new zones at no cost as opposed to receiving ARRs. The directly allocated FTRs differ from traditional FTRs in that the ownership of all or part of the FTRs may shift to another LSE if customers choose to shop with the other LSE.

The future obligations for the FTRs acquired at auction are reflected on the Consolidated Balance Sheets and have not been designated as cash flow hedge instruments. FirstEnergy initially records these FTRs at the auction price less the obligation due to the RTO, and subsequently adjusts the carrying value of remaining FTRs to their estimated fair value at the end of each accounting period prior to settlement. Changes in the fair value of FTRs held by FirstEnergy’s unregulated subsidiaries are included in other operating expenses as unrealized gains or losses. Unrealized gains or losses on FTRs held by FirstEnergy’s regulated subsidiaries are recorded as regulatory assets or liabilities. Directly allocated FTRs are accounted for under the accrual method of accounting, and their effects are included in earnings at the time of contract performance.

The following tables summarize the fair value of derivative instruments on FirstEnergy’s Consolidated Balance Sheets:

Derivatives not designated as hedging instruments:
Derivative Assets					Derivative Liabilities
	Fair Value					Fair Value
	March 31, 2012		December 31, 2011			March 31, 2012			December 31, 2011
	(In millions)					(In millions)
Power Contracts					Power Contracts
Current Assets	$	300	$	185	Current Liabilities	$	(282	)	$	(196	)
Noncurrent Assets	115		79		Noncurrent Liabilities	(66		)	(51		)
FTRs					FTRs
Current Assets	1		1		Current Liabilities	(15		)	(22		)
Noncurrent Assets	—		—		Noncurrent Liabilities	—			(1		)
NUGs	42		56		NUGs	(342		)	(349		)
Other					Other
Current Assets	1		—		Current Liabilities	(2		)	—
Noncurrent Assets	—		—		Noncurrent Liabilities	—			—
Total Derivatives Assets	$	459	$	321	Total Derivatives Liabilities	$	(707	)	$	(619	)

The following table summarizes the volumes associated with FirstEnergy’s outstanding derivative transactions as of March 31, 2012:

	Purchases	Sales	Net		Units
	(In millions)
Power Contracts	33	47	(14	)	MWH
FTRs	17	—	17		MWH
NUGs	23	—	23		MWH
Natural Gas Futures	11	—	11		Million British Thermal Units

The effect of derivative instruments on the Consolidated Statements of Income during the three months ended March 31, 2012 and 2011, are summarized in the following tables:

	Three Months Ended March 31
	Power Contracts			FTRs			Other			Total
	(In millions)
Derivatives in a Hedging Relationship
2012
Gain (Loss) Recognized in AOCI (Effective Portion)	$	(5	)	$	—		$	—		$	(5	)
2011
Gain (Loss) Recognized in AOCI (Effective Portion)	$	(9	)	$	—		$	—		$	(9	)
Effective Gain (Loss) Reclassified to:
Purchased Power Expense	16			—			—			16
Revenues	(12		)	—			—			(12		)
Fuel Expense	—			—			—			—
Derivatives Not in a Hedging Relationship
2012
Unrealized Gain (Loss) Recognized in:
Purchased Power Expense	$	—		$	—		$	—		$	—
Other Operating Expense	55			5			(2		)	58
Realized Gain (Loss) Reclassified to:
Purchased Power Expense	(117		)	—			—			(117		)
Revenues	112			6			—			118
Other Operating Expense	—			(24		)	—			(24		)
2011
Unrealized Gain (Loss) Recognized in:
Purchased Power Expense	$	29		$	—		$	—		$	29
Other Operating Expense	(20		)	1			1			(18		)
Realized Gain (Loss) Reclassified to:
Purchased Power Expense	(37		)	—			—			(37		)
Revenue	10			3			(1		)	12
Other Operating Expense	—			(15		)	—			(15		)

The unrealized and realized gains (losses) on FirstEnergy’s NUG contracts and regulated FTRs not in a hedging relationship for the three months ended March 31, 2012 were ($7) million and $3 million, respectively. The unrealized and realized gains (losses) on FirstEnergy’s NUG contracts and other derivative contracts not in a hedging relationship for the three months ended March 31, 2011 were ($17) million and ($10) million, respectively. These unrealized and realized gains (losses) on NUG contracts and regulated FTRs are subject to regulatory accounting and do not impact earnings.

The following table provides a reconciliation of changes in the fair value of certain contracts that are deferred for future recovery from (or credit to) customers during the three months ended March 31, 2012 and 2011:

	Three Months Ended March 31
Derivatives Not in a Hedging Relationship with Regulatory Offset(1)	NUGs			Other			Total
	(In millions)
Outstanding net asset (liability) as of January 1, 2012	$	(293	)	$	(8	)	$	(301	)
Additions/Change in value of existing contracts	(79		)	(1		)	(80		)
Settled contracts	72			4			76
Outstanding net asset (liability) as of March 31, 2012	$	(300	)	$	(5	)	$	(305	)
Outstanding net asset (liability) as of January 1, 2011	$	(345	)	$	10		$	(335	)
Additions/Change in value of existing contracts	(89		)	—			(89		)
Settled contracts	72			(10		)	62
Outstanding net asset (liability) as of March 31, 2011	$	(362	)	$	—		$	(362	)

⁽¹⁾  Changes in the fair value of certain contracts are deferred for future recovery from (or credited to) customers.