Derivative Instruments and Hedging Activities

9 Months Ended

Sep. 30, 2013

Derivative Instruments and Hedging Activities

(12) DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

Derivatives are used by Power Delivery to hedge commodity price risk, as well as by PHI, from time to time, to hedge interest rate risk.

DPL uses derivative instruments in the form of swaps and over-the-counter options primarily to reduce natural gas commodity price volatility and to limit its customers’ exposure to increases in the market price of natural gas under a hedging program approved by the DPSC. DPL uses these derivatives to manage the commodity price risk associated with its physical natural gas purchase contracts. All premiums paid and other transaction costs incurred as part of DPL’s natural gas hedging activity, in addition to all gains and losses related to hedging activities, are deferred under FASB guidance on regulated operations (ASC 980) until recovered from its customers through a fuel adjustment clause approved by the DPSC. The natural gas purchase contracts qualify as normal purchases, which are not required to be recorded in the financial statements until settled.

ACE was ordered to enter into the SOCAs by the NJBPU, and under the SOCAs, ACE would receive payments from or make payments to electric generation facilities based on i) the difference between the fixed price in the SOCAs and the price for capacity that clears PJM and ii) ACE’s annual proportion of the total New Jersey load relative to the other EDCs in New Jersey, which is currently estimated to be approximately 15 percent. ACE began applying derivative accounting to two of its SOCAs as of June 30, 2012 because the generators cleared the 2015-2016 PJM capacity auction in May 2012. In May 2013, all three generation companies under the SOCAs bid into the PJM 2016-2017 capacity auction. Two of the generators cleared the capacity auction, while the third did not. On July 1, 2013, the SOCA with the third generation company was terminated as the generation company did not clear a PJM capacity auction by the commencement date required under the SOCA. The fair value of the derivatives embedded in the SOCAs are deferred as regulatory assets or regulatory liabilities because the NJBPU has allowed full recovery from ACE’s distribution customers for all payments made by ACE, and ACE’s distribution customers would be entitled to all payments received by ACE. As further discussed in Note (7), “Regulatory Matters,” in light of a Federal district court order issued on October 25, 2013, ACE expects to derecognize in the fourth quarter of 2013, the derivative asset of $4 million and the derivative liability of $14 million as of September 30, 2013 related to the SOCAs reflected in the table below, as well as the offsetting regulatory liability (asset).

PHI also uses derivative instruments from time to time to mitigate the effects of fluctuating interest rates on debt issued in connection with the operation of its businesses. In June 2002, PHI entered into several treasury rate lock transactions in anticipation of the issuance of several series of fixed-rate debt commencing in August 2002. Upon issuance of the fixed rate-debt in August 2002, the treasury rate locks were terminated at a loss. The loss has been deferred in Accumulated Other Comprehensive Loss (AOCL) and is being recognized in income over the life of the debt issued as interest payments are made.

The tables below identify the balance sheet location and fair values of derivative instruments as of September 30, 2013 and December 31, 2012:

	As of September 30, 2013
Balance Sheet Caption	Derivatives Designated as Hedging Instruments		Other Derivative Instruments			Gross Derivative Instruments			Effects of Cash Collateral and Netting		Net Derivative Instruments
	(millions of dollars)
Derivative assets (non-current assets)	$	—	$	4		$	4		$	—	$	4
Total Derivative assets		—		4			4			—		4
Derivative liabilities (current liabilities)		—		(1	)		(1	)		1		—
Derivative liabilities (non-current liabilities)		—		(14	)		(14	)		—		(14	)
Total Derivative liabilities		—		(15	)		(15	)		1		(14	)
Net Derivative (liability) asset	$	—	$	(11	)	$	(11	)	$	1	$	(10	)

	As of December 31, 2012
Balance Sheet Caption	Derivatives Designated as Hedging Instruments		Other Derivative Instruments			Gross Derivative Instruments			Effects of Cash Collateral and Netting		Net Derivative Instruments
	(millions of dollars)
Derivative assets (non-current assets)	$	—	$	8		$	8		$	—	$	8
Total Derivative assets		—		8			8			—		8
Derivative liabilities (current liabilities)		—		(4	)		(4	)		—		(4	)
Derivative liabilities (non-current liabilities)		—		(11	)		(11	)		—		(11	)
Total Derivative liabilities		—		(15	)		(15	)		—		(15	)
Net Derivative (liability) asset	$	—	$	(7	)	$	(7	)	$	—	$	(7	)

Under FASB guidance on the offsetting of balance sheet accounts (ASC 210-20), PHI offsets the fair value amounts recognized for derivative assets and liabilities and the fair value amounts recognized for related collateral positions executed with the same counterparty under master netting agreements. All derivative assets and liabilities available to be offset under master netting arrangements were netted as of September 30, 2013 and December 31, 2012. The amount of cash collateral that was offset against these derivative positions is as follows:

	September 30, 2013		December 31, 2012
	(millions of dollars)
Cash collateral pledged to counterparties with the right to reclaim (a)	$	1	$	—

(a) Includes cash deposits on commodity brokerage accounts.

As of September 30, 2013 and December 31, 2012, all PHI cash collateral pledged related to derivative instruments accounted for at fair value was entitled to be offset under master netting agreements.

Derivatives Designated as Hedging Instruments

Cash Flow Hedges

Cash Flow Hedges Included in Accumulated Other Comprehensive Loss

The tables below provide details regarding effective cash flow hedges included in PHI’s consolidated balance sheets as of September 30, 2013 and 2012. Cash flow hedges are marked to market on the consolidated balance sheet with corresponding adjustments to AOCL for the effective portion of cash flow hedges. The data in the following tables indicate the cumulative net loss after-tax related to effective cash flow hedges by contract type included in AOCL, the portion of AOCL expected to be reclassified to income during the next 12 months, and the maximum hedge or deferral term:

Contracts	As of September 30, 2013				Maximum Term
	Accumulated Other Comprehensive Loss After-tax		Portion Expected to be Reclassified to Income during the Next 12 Months
	(millions of dollars)
Interest rate	$	9	$	1		227 months
Total	$	9	$	1
Contracts	As of September 30, 2012				Maximum Term
	Accumulated Other Comprehensive Loss After-tax		Portion Expected to be Reclassified to Income during the Next 12 Months
	(millions of dollars)
Interest rate	$	10	$	1		239 months
Total	$	10	$	1

Other Derivative Activity

DPL and ACE have certain derivatives that are not in hedge accounting relationships and are not designated as normal purchases or normal sales. These derivatives are recorded at fair value on the consolidated balance sheets with the gain or loss for changes in fair value recorded in income. In accordance with FASB guidance on regulated operations, offsetting regulatory liabilities or regulatory assets are recorded on the consolidated balance sheets and the recognition of the derivative gain or loss is deferred because of the DPSC-approved fuel adjustment clause for DPL’s derivatives and the NJBPU order pertaining to the SOCAs within which ACE’s capacity derivatives are embedded. The following table indicates the net unrealized derivative gains and losses arising during the period that were deferred as regulatory liabilities and regulatory assets, respectively, and the net realized losses recognized in the consolidated statements of income (through Fuel and Purchased Energy expense) that were also deferred as regulatory assets for the three and nine months ended September 30, 2013 and 2012 associated with these derivatives:

	Three Months Ended September 30,					Nine Months Ended September 30,
	2013		2012			2013			2012
	(millions of dollars)
Net unrealized gain (loss) arising during the period	$	—	$	2		$	(7	)	$	(3	)
Net realized losses recognized during the period		—		(2	)		(3	)		(13	)

As of September 30, 2013 and December 31, 2012, the quantities and positions of DPL’s net outstanding natural gas commodity forward contracts and ACE’s capacity derivatives associated with the SOCAs that did not qualify for hedge accounting were:

	September 30, 2013			December 31, 2012
Commodity	Quantity		Net Position	Quantity		Net Position
DPL – Natural gas (one Million British Thermal Units (MMBtu))		3,767,500	Long		3,838,000	Long
ACE – Capacity (MWs)		180	Long		180	Long

Contingent Credit Risk Features

The primary contracts used by the Power Delivery segment for derivative transactions are entered into under the International Swaps and Derivatives Association Master Agreement (ISDA) or similar agreements that closely mirror the principal credit provisions of the ISDA. The ISDAs include a Credit Support Annex (CSA) that governs the mutual posting and administration of collateral security. The failure of a party to comply with an obligation under the CSA, including an obligation to transfer collateral security when due or the failure to maintain any required credit support, constitutes an event of default under the ISDA for which the other party may declare an early termination and liquidation of all transactions entered into under the ISDA, including foreclosure against any collateral security. In addition, some of the ISDAs have cross default provisions under which a default by a party under another commodity or derivative contract, or the breach by a party of another borrowing obligation in excess of a specified threshold, is a breach under the ISDA.

Under the ISDA or similar agreements, the parties establish a dollar threshold of unsecured credit for each party in excess of which the party would be required to post collateral to secure its obligations to the other party. The amount of the unsecured credit threshold varies according to the senior, unsecured debt rating of the respective parties or that of a guarantor of the party’s obligations. The fair values of all transactions between the parties are netted under the master netting provisions. Transactions may include derivatives accounted for on-balance sheet as well as those designated as normal purchases and normal sales that are accounted for off-balance sheet. If the aggregate fair value of the transactions in a net loss position exceeds the unsecured credit threshold, then collateral is required to be posted in an amount equal to the amount by which the unsecured credit threshold is exceeded. The obligations of DPL are stand-alone obligations without the guaranty of PHI. If DPL’s debt rating were to fall below “investment grade,” the unsecured credit threshold would typically be set at zero and collateral would be required for the entire net loss position. Exchange-traded contracts are required to be fully collateralized without regard to the credit rating of the holder.

The gross fair values of DPL’s derivative liabilities with credit risk-related contingent features as of September 30, 2013 and December 31, 2012, were zero and $4 million, respectively, before giving effect to offsetting transactions or collateral under master netting agreements. As of September 30, 2013 and December 31, 2012, DPL had posted no cash collateral against its gross derivative liability, resulting in a net liability of zero and $4 million, respectively. If DPL’s debt ratings had been downgraded below investment grade as of September 30, 2013 and December 31, 2012, DPL’s net settlement amounts, including both the fair value of its derivative liabilities and its normal purchase and normal sale contracts would have been approximately zero and $2 million, respectively, and DPL would have been required to post collateral with the counterparties of approximately zero and $2 million, respectively, in addition to that which was posted as of September 30, 2013 and December 31, 2012. The net settlement and additional collateral amounts reflect the effect of offsetting transactions under master netting agreements.

DPL’s primary source for posting cash collateral or letters of credit is PHI’s credit facility. As of September 30, 2013 and December 31, 2012, the aggregate amount of cash plus borrowing capacity under the credit facility available to meet the future liquidity needs of PHI’s utility subsidiaries was $471 million and $477 million, respectively.

Delmarva Power & Light Co/De [Member]

Derivative Instruments and Hedging Activities

(11) DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

DPL uses derivative instruments in the form of swaps and over-the-counter options primarily to reduce natural gas commodity price volatility and limit its customers’ exposure to increases in the market price of natural gas under a hedging program approved by the DPSC. DPL uses these derivatives to manage the commodity price risk associated with its physical natural gas purchase contracts. The natural gas purchase contracts qualify as normal purchases, which are not required to be recorded in the financial statements until settled. All premiums paid and other transaction costs incurred as part of DPL’s natural gas hedging activity, in addition to all gains and losses related to hedging activities, are deferred under FASB guidance on regulated operations (ASC 980) until recovered from its customers through a fuel adjustment clause approved by the DPSC.

The tables below identify the balance sheet location and fair values of derivative instruments as of September 30, 2013 and December 31, 2012:

	As of September 30, 2013
Balance Sheet Caption	Derivatives Designated as Hedging Instruments		Other Derivative Instruments			Gross Derivative Instruments			Effects of Cash Collateral and Netting		Net Derivative Instruments
	(millions of dollars)
Derivative liabilities (current liabilities)	$	—	$	(1	)	$	(1	)	$	1	$	—
Net Derivative liability	$	—	$	(1	)	$	(1	)	$	1	$	—

	As of December 31, 2012
Balance Sheet Caption	Derivatives Designated as Hedging Instruments		Other Derivative Instruments			Gross Derivative Instruments			Effects of Cash Collateral and Netting		Net Derivative Instruments
	(millions of dollars)
Derivative liabilities (current liabilities)	$	—	$	(4	)	$	(4	)	$	—	$	(4	)
Net Derivative liability	$	—	$	(4	)	$	(4	)	$	—	$	(4	)

Under FASB guidance on the offsetting of balance sheet accounts (ASC 210-20), DPL offsets the fair value amounts recognized for derivative instruments and fair value amounts recognized for related collateral positions executed with the same counterparty under master netting agreements. All derivative assets and liabilities available to be offset under master netting arrangements were netted as of September 30, 2013 and December 31, 2012. The amount of cash collateral that was offset against these derivative positions is as follows:

	September 30, 2013		December 31, 2012
	(millions of dollars)
Cash collateral pledged to counterparties with the right to reclaim (a)	$	1	$	—

(a) Includes cash deposits on commodity brokerage accounts.

As of September 30, 2013 and December 31, 2012, all DPL cash collateral pledged related to derivative instruments accounted for at fair value was entitled to be offset under master netting agreements.

Other Derivative Activity

DPL holds certain derivatives that are not in hedge accounting relationships and are not designated as normal purchases or normal sales. These derivatives are recorded at fair value on the balance sheets with the gain or loss for changes in the fair value recorded in income. In accordance with FASB guidance on regulated operations, offsetting regulatory liabilities or regulatory assets are recorded on the balance sheets and the recognition of the derivative gain or loss is deferred because of the DPSC-approved fuel adjustment clause. For the three and nine months ended September 30, 2013 and 2012, the net unrealized derivative gains and losses arising during the period that were deferred as regulatory liabilities and regulatory assets and the net realized losses recognized in the statements of income (through Purchased Energy and Gas Purchased expense) that were also deferred as regulatory assets are provided in the table below:

	Three Months Ended September 30,					Nine Months Ended September 30,
	2013		2012			2013			2012
	(millions of dollars)
Net unrealized gain (loss) arising during the period	$	—	$	2		$	—		$	(2	)
Net realized losses recognized during the period		—		(2	)		(3	)		(13	)

As of September 30, 2013 and December 31, 2012, DPL had the following net outstanding natural gas commodity forward contracts that did not qualify for hedge accounting:

	September 30, 2013			December 31, 2012
Commodity	Quantity		Net Position	Quantity		Net Position
Natural gas (one Million British Thermal Units)		3,767,500	Long		3,838,000	Long

Contingent Credit Risk Features

The primary contracts used by DPL for derivative transactions are entered into under the International Swaps and Derivatives Association Master Agreement (ISDA) or similar agreements that closely mirror the principal credit provisions of the ISDA. The ISDAs include a Credit Support Annex (CSA) that governs the mutual posting and administration of collateral security. The failure of a party to comply with an obligation under the CSA, including an obligation to transfer collateral security when due or the failure to maintain any required credit support, constitutes an event of default under the ISDA for which the other party may declare an early termination and liquidation of all transactions entered into under the ISDA, including foreclosure against any collateral security. In addition, some of the ISDAs have cross default provisions under which a default by a party under another commodity or derivative contract, or the breach by a party of another borrowing obligation in excess of a specified threshold, is a breach under the ISDA.

Under the ISDA or similar agreements, the parties establish a dollar threshold of unsecured credit for each party in excess of which the party would be required to post collateral to secure its obligations to the other party. The amount of the unsecured credit threshold varies according to the senior, unsecured debt rating of the respective parties or that of a guarantor of the party’s obligations. The fair values of all transactions between the parties are netted under the master netting provisions. Transactions may include derivatives accounted for on-balance sheet as well as normal purchases and normal sales that are accounted for off-balance sheet. If the aggregate fair value of the transactions in a net loss position exceeds the unsecured credit threshold, then collateral is required to be posted in an amount equal to the amount by which the unsecured credit threshold is exceeded. The obligations of DPL are stand-alone obligations without the guaranty of PHI. If DPL’s debt rating were to fall below “investment grade,” the unsecured credit threshold would typically be set at zero and collateral would be required for the entire net loss position. Exchange-traded contracts are required to be fully collateralized without regard to the credit rating of the holder.

The gross fair values of DPL’s derivative liabilities with credit-risk-related contingent features as of September 30, 2013 and December 31, 2012, were zero and $4 million, respectively. As of those dates, DPL had posted no cash collateral in the normal course of business against its gross derivative liabilities, resulting in net liabilities of zero and $4 million, respectively. If DPL’s debt ratings had been downgraded below investment grade as of September 30, 2013 and December 31, 2012, DPL’s net settlement amounts would have been approximately zero and $2 million, respectively, and DPL would have been required to post collateral with the counterparties of approximately zero and $2 million, respectively. The net settlement and additional collateral amounts reflect the effect of offsetting transactions under master netting agreements.

DPL’s primary source for posting cash collateral or letters of credit is PHI’s credit facility. As of September 30, 2013 and December 31, 2012, the aggregate amount of cash plus borrowing capacity under the credit facility available to meet the liquidity needs of PHI’s utility subsidiaries was $471 million and $477 million, respectively.

Atlantic City Electric Co [Member]

Derivative Instruments and Hedging Activities

(10) DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

ACE was ordered to enter into the SOCAs by the NJBPU, and under the SOCAs, ACE would receive payments from or make payments to electric generation facilities based on (i) the difference between the fixed price in the SOCAs and the price for capacity that clears PJM and (ii) ACE’s annual proportion of the total New Jersey load relative to the other EDCs in New Jersey, which is currently estimated to be 15 percent. ACE began applying derivative accounting to two of its SOCAs as of June 30, 2012 because the generators cleared the 2015-2016 PJM capacity auction in May 2012. In May 2013, all three generation companies under the SOCAs bid into the PJM 2016-2017 capacity auction. Two of the generators cleared the capacity auction, while the third did not. On July 1, 2013, the SOCA with the third generation company was terminated as the generation company did not clear a PJM capacity auction by the commencement date required under the SOCA. The fair value of the derivatives embedded in the SOCAs are deferred as Regulatory Assets or Regulatory Liabilities because the NJBPU has allowed full recovery from ACE’s distribution customers for all payments made by ACE, and ACE’s distribution customers would be entitled to all payments received by ACE.

As of September 30, 2013 and December 31, 2012, ACE had non-current Derivative Assets of $4 million and $8 million, respectively, and non-current Derivative Liabilities of $14 million and $11 million, respectively, associated with the two SOCAs and an offsetting Regulatory Liability and Regulatory Asset, respectively, of the same amounts. As of September 30, 2013 and December 31, 2012, ACE had 180 MWs of capacity in a long position, with no collateral or netting applicable to the capacity. Unrealized gains and losses associated with these capacity derivatives, which netted to unrealized losses of zero and $1 million for the three months ended September 30, 2013 and 2012, respectively, and unrealized losses of $7 million and $1 million for the nine months ended September 30, 2013 and 2012, respectively, have been deferred as regulatory liabilities and regulatory assets.

As further discussed in Note (7), “Regulatory Matters,” in light of a Federal district court order issued on October 25, 2013, ACE expects to derecognize in the fourth quarter of 2013, the derivative asset of $4 million and the derivative liability of $14 million as of September 30, 2013 related to the SOCAs, as well as the offsetting regulatory liability (asset).