Derivatives

9 Months Ended

Sep. 30, 2014

Derivatives

NOTE 7: DERIVATIVES

The Utility uses both derivative and non-derivative contracts in managing its customers' exposure to commodity-related price risk, including forward contracts, swap agreements, futures contracts, and option contracts.

These instruments are not held for speculative purposes and are subject to certain regulatory requirements.  Customer rates are designed to recover the Utility's reasonable costs of providing services, including the costs related to price risk management activities.

Price risk management activities that meet the definition of derivatives are recorded at fair value on the Condensed Consolidated Balance Sheets.  The Utility expects to fully recover in rates all costs related to derivatives as long as the current ratemaking mechanism remains in place and the Utility's price risk management activities are carried out in accordance with CPUC directives.  Therefore, all unrealized gains and losses associated with the change in fair value of these derivatives are deferred and recorded within the Utility's regulatory assets and liabilities.  (See Note 3 above.)  Net realized gains or losses on commodity derivatives are recorded in the cost of electricity or the cost of natural gas with corresponding increases or decreases to regulatory balancing accounts for recovery from or refund to customers.

The Utility offsets cash collateral paid or cash collateral received against the fair value amounts recognized for derivative instruments executed with the same counterparty under a master netting arrangement where the right of offset and the intention to offset exist.

The Utility elects the normal purchase and sale exception for eligible derivatives.  Derivatives that require physical delivery in quantities that are expected to be used by the Utility over a reasonable period in the normal course of business, and do not contain pricing provisions unrelated to the commodity delivered, are eligible for the normal purchase and sale exception.  The fair value of derivatives that are eligible for the normal purchase and sales exception are not reflected in the Condensed Consolidated Balance Sheets at fair value, but are accounted for under the accrual method of accounting.  Therefore, expenses are recognized as incurred.

Volume of Derivative Activity

At September 30, 2014, the volumes of the Utility's outstanding derivatives were as follows:

		Contract Volume (1)
			1 Year or	3 Years or
			Greater but	Greater but
		Less Than 1	Less Than 3	Less Than 5	5 Years or
Underlying Product	Instruments	Year	Years	Years	Greater (2)
Natural Gas (3)	Forwards and
(MMBtus (4))	Swaps	218,107,731	70,621,174	3,530,000	-
	Options	116,213,741	62,844,400	-	-
Electricity	Forwards and
(Megawatt-hours)	Swaps	1,364,184	1,956,498	1,574,588	969,478
	Congestion
	Revenue Rights	55,886,532	87,533,830	41,126,312	22,755,431

⁽¹⁾ Amounts shown reflect the total gross derivative volumes by commodity type that are expected to settle in each period.

      ⁽²⁾ Derivatives in this category expire between 2019 and 2023.

      ⁽³⁾ Amounts shown are for the combined positions of the electric fuels and core gas portfolios.

⁽⁴⁾ Million British Thermal Units.

                  At December 31, 2013, the volumes of the Utility's outstanding derivatives were as follows:

		Contract Volume (1)
			1 Year or	3 Years or
			Greater but	Greater but
		Less Than 1	Less Than 3	Less Than 5	5 Years or
Underlying Product	Instruments	Year	Years	Years	Greater (2)
Natural Gas (3)	Forwards and
(MMBtus (4))	Swaps	243,213,288	79,735,000	8,892,500	-
	Options	169,123,208	87,689,708	3,450,000	-
Electricity	Forwards and
(Megawatt-hours)	Swaps	2,537,023	2,009,505	2,008,046	1,534,695
	Congestion
	Revenue Rights	73,510,440	83,747,782	63,718,517	29,945,852

 ⁽¹⁾ Amounts shown reflect the total gross derivative volumes by commodity type that are expected to settle in each period.

⁽²⁾ Derivatives in this category expire between 2019 and 2022.

⁽³⁾ Amounts shown are for the combined positions of the electric fuels and core gas portfolios.

⁽⁴⁾ Million British Thermal Units.

Presentation of Derivative Instruments in the Financial Statements

Derivatives that are subject to a master netting agreement where the right and the intent to offset assets and liabilities exists, are presented on a net basis in the Condensed Consolidated Balance Sheets. The net balances include outstanding cash collateral associated with derivative positions.

At September 30, 2014, the Utility's outstanding derivative balances were as follows:

	Commodity Risk
	Gross Derivative								Total Derivative
(in millions)	Balance			Netting			Cash Collateral		Balance
Current assets - other	$	51		$	(6	)	$	15	$	60
Other noncurrent assets - other		81			(4	)		-		77
Current liabilities - other		(57	)		6			6		(45	)
Noncurrent liabilities - other		(87	)		4			-		(83	)
Net commodity risk	$	(12)		$	-		$	21	$	9

At December 31, 2013, the Utility's outstanding derivative balances were as follows:

	Commodity Risk
	Gross Derivative								Total Derivative
(in millions)	Balance			Netting			Cash Collateral		Balance
Current assets - other	$	42		$	(10	)	$	16	$	48
Other noncurrent assets - other		99			(4	)		-		95
Current liabilities - other		(122	)		10			69		(43	)
Noncurrent liabilities - other		(110	)		4			2		(104	)
Net commodity risk	$	(91)		$	-		$	87	$	(4)

Gains and losses associated with price risk management activities were recorded as follows:

	Commodity Risk
	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(in millions)	2014			2013			2014			2013
Unrealized gain (loss) - regulatory assets and liabilities (1)	$	(6	)	$	40		$	79		$	115
Realized loss - cost of electricity (2)		(22	)		(57	)		(48	)		(136	)
Realized loss - cost of natural gas (2)		(4	)		(2	)		(7	)		(14	)
Net commodity risk	$	(32)		$	(19)		$	24		$	(35)

⁽¹⁾ Unrealized gains and losses on commodity risk-related derivative instruments are recorded to regulatory liabilities or assets, respectively, rather than being recorded to the Condensed Consolidated Statements of Income.  These amounts exclude the impact of cash collateral postings.

⁽²⁾ These amounts are fully passed through to customers in rates.  Accordingly, net income was not impacted by realized amounts on these instruments.

The majority of the Utility's derivatives contain collateral posting provisions tied to the Utility's credit rating from each of the major credit rating agencies. At September 30, 2014, the Utility's credit rating was investment grade.  

 If the Utility's credit rating were to fall below investment grade, the Utility would be required to post additional cash immediately to fully collateralize some of its net liability derivative positions.  

The additional cash collateral that the Utility would be required to post if the credit risk-related contingency features were triggered was as follows:

	Balance at
	September 30,			December 31,
(in millions)	2014			2013
Derivatives in a liability position with credit risk-related
contingencies that are not fully collateralized	$	(22	)	$	(79	)
Related derivatives in an asset position		1			4
Collateral posting in the normal course of business related to
these derivatives		8			65
Net position of derivative contracts/additional collateral
posting requirements (1)	$	(13)		$	(10)

 ⁽¹⁾ This calculation excludes the impact of closed but unpaid positions, as their settlement is not impacted by any of the Utility's credit risk-related contingencies.