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Financial Risk Management Activities
 9 Months Ended
Sep. 30, 2012
Financial Risk Management Activities
Financial Risk Management Activities
The operations of PSEG, Power and PSE&G are exposed to market risks from changes in commodity prices, interest rates and equity prices that could affect their results of operations and financial condition. Exposure to these risks is managed through normal operating and financing activities and, when appropriate, through hedging transactions. Hedging transactions use derivative instruments to create a relationship in which changes to the value of the assets, liabilities or anticipated transactions exposed to market risks are expected to be offset by changes in the value of these derivative instruments.
Commodity Prices
The availability and price of energy commodities are subject to fluctuations due to weather, environmental policies, changes in supply and demand, state and federal regulatory policies, market conditions, transmission availability and other events. Power uses physical and financial transactions in the wholesale energy markets to mitigate the effects of adverse movements in fuel and electricity prices. Derivative contracts that do not qualify for hedge accounting or normal purchases/normal sales treatment are marked to market (MTM) with changes in fair value recorded in the income statement. The fair value for the majority of these contracts is obtained from quoted market sources. Modeling techniques using assumptions reflective of current market rates, yield curves and forward prices are used to interpolate certain prices when no quoted market exists.
Cash Flow Hedges
Power uses forward sale and purchase contracts, swaps and futures contracts to hedge
•
forecasted energy sales from its generation stations and the related load obligations,
•
the price of fuel to meet its fuel purchase requirements, and
•
certain forecasted natural gas sales and purchases made to support the BGSS contract with PSE&G.
These derivative transactions are designated and effective as cash flow hedges. During the second quarter of 2012, Power de-designated certain of its commodity derivative transactions that had previously qualified as cash flow hedges as they were deemed to no longer be highly effective as required by the relevant accounting guidance. As a result, subsequent to June 1, 2012, Power recognizes all gains and losses from changes in the fair value of these derivatives immediately in earnings rather than deferring any such amounts in Accumulated Other Comprehensive Income (Loss). The fair values of Power’s de-designated hedges were frozen in Accumulated Other Comprehensive Income (Loss) as the original forecasted transactions are still expected to occur and are reclassified into earnings as the original derivative transactions settle.
As of September 30, 2012 and December 31, 2011, the fair value and the impact on Accumulated Other Comprehensive Income (Loss) associated with accounting hedge activity was as follows:
 
 
 
 
 
 
 
 
As of
 
As of
 
 
 
September 30,
2012
 
December 31,
2011
 
 
 
Millions
 
 
Fair Value of Cash Flow Hedges
$
—

 
$
57

 
 
Impact on Accumulated Other Comprehensive Income (Loss) (after tax)
$
13

 
$
33

 
 
 
 
 
 
 


The expiration date of the longest-dated cash flow hedge at Power is in 2014. Power’s after-tax unrealized gains on these derivatives that are expected to be reclassified to earnings during the next 12 months are $10 million. There was no ineffectiveness associated with qualifying hedges as of September 30, 2012.
Trading Derivatives
The primary purpose of Power’s wholesale marketing operation is to optimize the value of the output of the generating facilities via various products and services available in the markets it serves. Historically, Power engaged in trading of electricity and energy-related products where such transactions were not associated with the output or fuel purchase requirements of its facilities. This trading consisted mostly of energy supply contracts where Power secured sales commitments with the intent to supply the energy services from purchases in the market rather than from its owned generation. Such trading activities were marked to market through the income statement and represented less than one percent of gross margin (revenues less energy costs) on an annual basis. Effective July 2011, Power anticipates that it will not enter into any more trading derivative contracts.
Other Derivatives
Power enters into additional contracts that are derivatives, but do not qualify for or are not designated as cash flow hedges. These transactions are intended to mitigate exposure to fluctuations in commodity prices and optimize the value of its expected generation. Trade types include financial options, futures, swaps, fuel purchases and forward purchases and sales of electricity. Changes in fair market value of these contracts are recorded in earnings.
PSE&G is a party to certain long-term natural gas sales contracts to optimize its pipeline capacity utilization.  In addition, as further described in Note 8. Commitments and Contingent Liabilities, PSE&G was directed to execute long-term SOCAs with certain generators to support the LCAPP Act. These contracts qualify as derivatives and are marked to fair value with the offset recorded to Regulatory Assets and Liabilities.
Interest Rates
PSEG, Power and PSE&G are subject to the risk of fluctuating interest rates in the normal course of business. Exposure to this risk is managed by targeting a balanced debt maturity profile which limits refinancing in any given period or interest rate environment. In addition, they have used a mix of fixed and floating rate debt, interest rate swaps and interest rate lock agreements.
Fair Value Hedges
PSEG enters into fair value hedges to convert fixed-rate debt into variable-rate debt. As of September 30, 2012, PSEG had eight interest rate swaps outstanding totaling $1.1 billion. These swaps convert Power’s $250 million of 5% Senior Notes due April 2014, Power’s $300 million of 5.5% Senior Notes due December 2015, $300 million of Power’s $303 million of 5.32% Senior Notes due September 2016 and Power’s $250 million of 2.75% Senior Notes due September 2016 into variable-rate debt. These interest rate swaps are designated and effective as fair value hedges. The fair value changes of the interest rate swaps are fully offset by the changes in the fair value of the underlying debt. As of September 30, 2012 and December 31, 2011, the fair value of all the underlying hedges was $70 million and $62 million, respectively.
Cash Flow Hedges
PSEG uses interest rate swaps and other derivatives, which are designated and effective as cash flow hedges, to manage its exposure to the variability of cash flows, primarily related to variable-rate debt instruments. The Accumulated Other Comprehensive Income (Loss) (after tax) related to interest rate derivatives designated as cash flow hedges was $(2) million as of September 30, 2012 and December 31, 2011.


Fair Values of Derivative Instruments
The following are the fair values of derivative instruments on the Condensed Consolidated Balance Sheets:

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As of September 30, 2012
 
 
 
Power
 
PSE&G
 
PSEG
 
Consolidated
 
 
 
Cash Flow
Hedges
 
Non
Hedges
 
 
 
 
 
Non
Hedges
 
Fair Value
Hedges
 
 
 
 
Balance Sheet Location
Energy-
Related
Contracts
 
Energy-
Related
Contracts
 
Netting
(A)
 
Total
Power
 
Energy-
Related
Contracts
 
Interest
Rate
Swaps
 
Total
Derivatives
 
 
 
Millions
 
 
Derivative Contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current Assets
$
3

 
$
354

 
$
(255
)
 
$
102

 
$
3

 
$
18

 
$
123

 
 
Noncurrent Assets
—

 
81

 
(59
)
 
22

 
70

 
52

 
144

 
 
Total Mark-to-Market Derivative Assets
$
3

 
$
435

 
$
(314
)
 
$
124

 
$
73

 
$
70

 
$
267

 
 
Derivative Contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current Liabilities
$
(3
)
 
$
(303
)
 
$
255

 
$
(51
)
 
$
—

 
$
—

 
$
(51
)
 
 
Noncurrent Liabilities
—

 
(63
)
 
57

 
(6
)
 
(106
)
 
—

 
(112
)
 
 
Total Mark-to-Market Derivative (Liabilities)
$
(3
)
 
$
(366
)
 
$
312

 
$
(57
)
 
$
(106
)
 
$
—

 
$
(163
)
 
 
Total Net Mark-to-Market Derivative Assets (Liabilities)
$
—

 
$
69

 
$
(2
)
 
$
67

 
$
(33
)
 
$
70

 
$
104

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As of December 31, 2011
 
 
 
Power
 
PSE&G
 
PSEG
 
Consolidated
 
 
 
Cash Flow
Hedges
 
Non
Hedges
 
 
 
 
 
Non
Hedges
 
Fair Value
Hedges
 
 
 
 
Balance Sheet Location
Energy-
Related
Contracts
 
Energy-
Related
Contracts
 
Netting
(A)
 
Total
Power
 
Energy-
Related
Contracts
 
Interest
Rate
Swaps
 
Total
Derivatives
 
 
 
Millions
 
 
Derivative Contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current Assets
$
55

 
$
532

 
$
(448
)
 
$
139

 
$
—

 
$
17

 
$
156

 
 
Noncurrent Assets
8

 
121

 
(74
)
 
55

 
4

 
47

 
106

 
 
Total Mark-to-Market Derivative Assets
$
63

 
$
653

 
$
(522
)
 
$
194

 
$
4

 
$
64

 
$
262

 
 
Derivative Contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current Liabilities
$
(5
)
 
$
(506
)
 
$
387

 
$
(124
)
 
$
(7
)
 
$
—

 
$
(131
)
 
 
Noncurrent Liabilities
(1
)
 
(76
)
 
53

 
(24
)
 
—

 
(2
)
 
(26
)
 
 
Total Mark-to-Market Derivative (Liabilities)
$
(6
)
 
$
(582
)
 
$
440

 
$
(148
)
 
$
(7
)
 
$
(2
)
 
$
(157
)
 
 
Total Net Mark-to-Market Derivative Assets (Liabilities)
$
57

 
$
71

 
$
(82
)
 
$
46

 
$
(3
)
 
$
62

 
$
105

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

(A)
Represents the netting of fair value balances with the same counterparty (where the right of offset exists) and the application of collateral. As of September 30, 2012 and December 31, 2011, net cash collateral received of $2 million and $82 million, respectively, was netted against the corresponding net derivative contract positions. Of the $2 million as of September 30, 2012, cash collateral of $(4) million and $(2) million were netted against current assets and noncurrent assets, respectively, and cash collateral of $4 million was netted against current liabilities. Of the $82 million as of December 31, 2011, cash collateral of $(77) million and $(23) million were netted against current assets and noncurrent assets, respectively, and cash collateral of $16 million and $2 million were netted against current liabilities and noncurrent liabilities, respectively.
Certain of Power’s derivative instruments contain provisions that require Power to post collateral. This collateral may be posted in the form of cash or credit support with thresholds contingent upon Power’s credit rating from each of the major credit rating agencies. The collateral and credit support requirements vary by contract and by counterparty. These credit risk-related contingent features stipulate that if Power were to be downgraded or lose its investment grade credit rating, it would be required to provide additional collateral. This incremental collateral requirement can offset collateral requirements related to other derivative instruments that are assets with the same counterparty, where the contractual right of offset exists under applicable master agreements. Power also enters into commodity transactions on the New York Mercantile Exchange (NYMEX) and Intercontinental Exchange (ICE). The NYMEX and ICE clearing houses act as counterparties to each trade. Transactions on NYMEX and ICE must adhere to comprehensive collateral and margining requirements.
The aggregate fair value of all derivative instruments with credit risk-related contingent features in a liability position that are not fully collateralized (excluding transactions on NYMEX and ICE that are fully collateralized) was $130 million and $285 million as of September 30, 2012 and December 31, 2011, respectively. As of September 30, 2012 and December 31, 2011, Power had the contractual right of offset of $88 million and $149 million, respectively, related to derivative instruments that are assets with the same counterparty under master agreements and net of margin posted. If Power had been downgraded or lost its investment grade rating, it would have had additional collateral obligations of $42 million and $136 million as of September 30, 2012 and December 31, 2011, respectively, related to its derivatives, net of the contractual right of offset under master agreements and the application of collateral. This potential additional collateral is included in the $610 million and $812 million as of September 30, 2012 and December 31, 2011, respectively, discussed in Note 8. Commitments and Contingent Liabilities.
The following shows the effect on the Condensed Consolidated Statements of Operations and on Accumulated Other Comprehensive Income (AOCI) of derivative instruments designated as cash flow hedges for the three months ended September 30, 2012 and 2011:

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives in
Cash Flow Hedging
Relationships
Amount of
Pre-Tax
Gain (Loss)
Recognized in
AOCI on
Derivatives
(Effective
Portion)
 
Location
of Pre-Tax Gain
(Loss)  Reclassified
from AOCI into
Income
 
Amount of
Pre-Tax
Gain (Loss)
Reclassified
from AOCI
into Income
(Effective
Portion)
 
Location of
Pre-Tax Gain
(Loss) Recognized in
Income on
Derivatives
(Ineffective Portion)
 
Amount of
Pre-Tax
Gain (Loss)
Recognized in
Income on
Derivatives
(Ineffective
Portion)
 
 
Three Months Ended
 
 
 
Three Months Ended
 
 
 
Three Months Ended
 
 
September 30,
 
 
 
September 30,
 
 
 
September 30,
 
 
2012
 
2011
 
 
 
2012
 
2011
 
 
 
2012
 
2011
 
 
 
Millions
 
 
PSEG and Power
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Energy-Related Contracts
$
(3
)
 
$
21

 
Operating Revenues
 
$
15

 
$
60

 
Operating Revenues
 
$
(1
)
 
$
—

 
 
Total PSEG and Power
$
(3
)
 
$
21

 
 
 
$
15

 
$
60

 
 
 
$
(1
)
 
$
—

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 








The following shows the effect on the Condensed Consolidated Statements of Operations and on Accumulated Other Comprehensive Income (AOCI) of derivative instruments designated as cash flow hedges for the nine months ended September 30, 2012 and 2011:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives in
Cash Flow Hedging
Relationships
Amount of
Pre-Tax
Gain (Loss)
Recognized in
AOCI on
Derivatives
(Effective
Portion)
 
Location
of Pre-Tax Gain
(Loss)  Reclassified
from AOCI into
Income
 
Amount of
Pre-Tax
Gain (Loss)
Reclassified
from AOCI
into Income
(Effective
Portion)
 
Location of
Pre-Tax Gain
(Loss) Recognized in
Income on
Derivatives
(Ineffective Portion)
 
Amount of
Pre-Tax
Gain (Loss)
Recognized in
Income on
Derivatives
(Ineffective
Portion)
 
 
Nine Months
Ended
 
 
 
Nine Months
Ended
 
 
 
Nine Months
Ended
 
 
September 30,
 
 
 
September 30,
 
 
 
September 30,
 
 
2012
 
2011
 
                              
 
2012
 
2011
 
 
 
2012
 
2011
 
 
 
Millions
 
 
PSEG (A)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Energy-Related Contracts
$
27

 
$
18

 
Operating Revenues
 
$
67

 
$
152

 
Operating Revenues
 
$
(1
)
 
$
1

 
 
Energy-Related Contracts
(4
)
 
1

 
Energy Costs
 
(9
)
 
2

 
 
 
—

 
—

 
 
Interest Rate Swaps
—

 
—

 
Interest Expense
 
(1
)
 
(1
)
 
 
 
—

 
—

 
 
Total PSEG
$
23

 
$
19

 
 
 
$
57

 
$
153

 
 
 
$
(1
)
 
$
1

 
 
Power
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Energy-Related Contracts
$
27

 
$
18

 
Operating Revenues
 
$
67

 
$
152

 
Operating Revenues
 
$
(1
)
 
$
1

 
 
Energy-Related Contracts
(4
)
 
1

 
Energy Costs
 
(9
)
 
2

 
 
 
—

 
—

 
 
Total Power
$
23

 
$
19

 
 
 
$
58

 
$
154

 
 
 
$
(1
)
 
$
1

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(A)
Includes amounts for PSEG parent.
The following reconciles the Accumulated Other Comprehensive Income for derivative activity included in the Accumulated Other Comprehensive Loss of PSEG on a pre-tax and after-tax basis:

 
 
 
 
 
 
 
Accumulated Other Comprehensive Income
Pre-Tax
 
After-Tax
 
 
 
Millions
 
 
Balance as of December 31, 2011
$
54

 
$
31

 
 
Gain Recognized in AOCI
26

 
15

 
 
Less: Gain Reclassified into Income
(42
)
 
(25
)
 
 
Balance as of June 30, 2012
$
38

 
$
21

 
 
Loss Recognized in AOCI
(3
)
 
(2
)
 
 
Less: Gain Reclassified into Income
(15
)
 
(8
)
 
 
Balance as of September 30, 2012
$
20

 
$
11

 
 
 
 
 
 
 


The following shows the effect on the Condensed Consolidated Statements of Operations of derivative instruments not designated as hedging instruments or as normal purchases and sales for the three months and nine months ended September 30, 2012 and 2011:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives Not Designated as Hedges
 
Location of Pre-Tax
Gain (Loss)
Recognized in Income
on Derivatives
 
Pre-tax Gain (Loss)
Recognized in Income
on Derivatives
 
 
 
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
 
 
 
 
September 30,
 
September 30,
 
 
 
 
 
 
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
Millions
 
 
PSEG and Power
 
 
 
 
 
 
 
 
 
 
 
 
Energy-Related Contracts
 
Operating Revenues
 
$
(90
)
 
$
24

 
$
145

 
$
(18
)
 
 
Energy-Related Contracts
 
Energy Costs
 
6

 
(11
)
 
(17
)
 
(10
)
 
 
Total PSEG and Power
 
 
 
$
(84
)
 
$
13

 
$
128

 
$
(28
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Power’s derivative contracts reflected in the preceding tables include contracts to hedge the purchase and sale of electricity and natural gas and the purchase of fuel. Not all of these contracts qualify for hedge accounting. Most of these contracts are marked to market. The tables above do not include contracts for which Power has elected the normal purchase/normal sales exemption, such as its BGS contracts and certain other energy supply contracts that it has with other utilities and companies with retail load. In addition, PSEG has interest rate swaps designated as fair value hedges. The effect of these hedges was to reduce interest expense by $6 million and $6 million for the three month periods and $17 million and $19 million for the nine month periods ended September 30, 2012 and 2011, respectively.
The following reflects the gross volume, on an absolute value basis, of derivatives as of September 30, 2012 and December 31, 2011: 
 
 
 
 
 
 
 
 
 
 
 
 
 
Type
Notional
 
Total
 
PSEG
 
Power
 
PSE&G
 
 
 
Millions
 
 
As of September 30, 2012
 
 
 
 
 
 
 
 
 
 
 
Natural Gas
Dth
 
588

 
—

 
385

 
203

 
 
Electricity
MWh
 
179

 
—

 
179

 
—

 
 
Capacity
MW days
 
4

 
—

 
—

 
4

 
 
FTRs
MWh
 
28

 
—

 
28

 
—

 
 
Interest Rate Swaps
US Dollars
 
1,100

 
1,100

 
—

 
—

 
 
Coal
Tons
 
1

 
—

 
1

 
—

 
 
As of December 31, 2011
 
 
 
 
 
 
 
 
 
 
 
Natural Gas
Dth
 
612

 
—

 
377

 
235

 
 
Electricity
MWh
 
137

 
—

 
137

 
—

 
 
FTRs
MWh
 
12

 
—

 
12

 
—

 
 
Interest Rate Swaps
US Dollars
 
1,100

 
1,100

 
—

 
—

 
 
Coal
Tons
 
1

 
—

 
1

 
—

 
 
 
 
 
 
 
 
 
 
 
 
 


Credit Risk
Credit risk relates to the risk of loss that we would incur as a result of non-performance by counterparties pursuant to the terms of their contractual obligations. We have established credit policies that we believe significantly minimize credit risk. These policies include an evaluation of potential counterparties’ financial condition (including credit rating), collateral requirements under certain circumstances and the use of standardized agreements, which allow for the netting of positive and negative exposures associated with a single counterparty. In the event of non-performance or non-payment by a major counterparty, there may be a material adverse impact on Power’s and PSEG’s financial condition, results of operations or net cash flows.
As of September 30, 2012, 99% of the credit for Power’s operations was with investment grade counterparties. Credit exposure is defined as any positive results of netting accounts receivable/accounts payable and the forward value of open positions (which includes all financial instruments including derivatives and non-derivatives and normal purchases/normal sales).
The following table provides information on Power’s credit risk from others, net of cash collateral, as of September 30, 2012. It further delineates that exposure by the credit rating of the counterparties and provides guidance on the concentration of credit risk to individual counterparties and an indication of the quality of Power’s credit risk by credit rating of the counterparties.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Rating
Current
Exposure
 
Securities
held as
Collateral
 
Net
Exposure
 
Number of
Counterparties
>10%
 
Net Exposure of
Counterparties
>10%
 
 
 
 
Millions
 
 
 
Millions
 
 
 
Investment Grade—External Rating
$
311

 
$
85

 
$
309

 
2

 
$
153

(A) 
 
 
Non-Investment Grade—External Rating
3

 
—

 
3

 
—

 
—

  
 
 
Investment Grade—No External Rating
9

 
—

 
9

 
—

 
—

  
 
 
Non-Investment Grade—No External Rating
—

 
—

 
—

 
—

 
—

  
 
 
Total
$
323

 
$
85

 
$
321

 
2

 
$
153

  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(A)
Includes net exposure of $108 million with PSE&G. The remaining net exposure of $45 million is with one nonaffiliated power purchaser which is a regulated investment grade counterparty.
The net exposure listed above, in some cases, will not be the difference between the current exposure and the collateral held. A counterparty may have posted more cash collateral than the outstanding exposure, in which case there would be no exposure. When letters of credit have been posted as collateral, the exposure amount is not reduced, but the exposure amount is transferred to the rating of the issuing bank. As of September 30, 2012, Power had 177 active counterparties.
Power [Member]
  
Financial Risk Management Activities
Financial Risk Management Activities
The operations of PSEG, Power and PSE&G are exposed to market risks from changes in commodity prices, interest rates and equity prices that could affect their results of operations and financial condition. Exposure to these risks is managed through normal operating and financing activities and, when appropriate, through hedging transactions. Hedging transactions use derivative instruments to create a relationship in which changes to the value of the assets, liabilities or anticipated transactions exposed to market risks are expected to be offset by changes in the value of these derivative instruments.
Commodity Prices
The availability and price of energy commodities are subject to fluctuations due to weather, environmental policies, changes in supply and demand, state and federal regulatory policies, market conditions, transmission availability and other events. Power uses physical and financial transactions in the wholesale energy markets to mitigate the effects of adverse movements in fuel and electricity prices. Derivative contracts that do not qualify for hedge accounting or normal purchases/normal sales treatment are marked to market (MTM) with changes in fair value recorded in the income statement. The fair value for the majority of these contracts is obtained from quoted market sources. Modeling techniques using assumptions reflective of current market rates, yield curves and forward prices are used to interpolate certain prices when no quoted market exists.
Cash Flow Hedges
Power uses forward sale and purchase contracts, swaps and futures contracts to hedge
•
forecasted energy sales from its generation stations and the related load obligations,
•
the price of fuel to meet its fuel purchase requirements, and
•
certain forecasted natural gas sales and purchases made to support the BGSS contract with PSE&G.
These derivative transactions are designated and effective as cash flow hedges. During the second quarter of 2012, Power de-designated certain of its commodity derivative transactions that had previously qualified as cash flow hedges as they were deemed to no longer be highly effective as required by the relevant accounting guidance. As a result, subsequent to June 1, 2012, Power recognizes all gains and losses from changes in the fair value of these derivatives immediately in earnings rather than deferring any such amounts in Accumulated Other Comprehensive Income (Loss). The fair values of Power’s de-designated hedges were frozen in Accumulated Other Comprehensive Income (Loss) as the original forecasted transactions are still expected to occur and are reclassified into earnings as the original derivative transactions settle.
As of September 30, 2012 and December 31, 2011, the fair value and the impact on Accumulated Other Comprehensive Income (Loss) associated with accounting hedge activity was as follows:
 
 
 
 
 
 
 
 
As of
 
As of
 
 
 
September 30,
2012
 
December 31,
2011
 
 
 
Millions
 
 
Fair Value of Cash Flow Hedges
$
—

 
$
57

 
 
Impact on Accumulated Other Comprehensive Income (Loss) (after tax)
$
13

 
$
33

 
 
 
 
 
 
 


The expiration date of the longest-dated cash flow hedge at Power is in 2014. Power’s after-tax unrealized gains on these derivatives that are expected to be reclassified to earnings during the next 12 months are $10 million. There was no ineffectiveness associated with qualifying hedges as of September 30, 2012.
Trading Derivatives
The primary purpose of Power’s wholesale marketing operation is to optimize the value of the output of the generating facilities via various products and services available in the markets it serves. Historically, Power engaged in trading of electricity and energy-related products where such transactions were not associated with the output or fuel purchase requirements of its facilities. This trading consisted mostly of energy supply contracts where Power secured sales commitments with the intent to supply the energy services from purchases in the market rather than from its owned generation. Such trading activities were marked to market through the income statement and represented less than one percent of gross margin (revenues less energy costs) on an annual basis. Effective July 2011, Power anticipates that it will not enter into any more trading derivative contracts.
Other Derivatives
Power enters into additional contracts that are derivatives, but do not qualify for or are not designated as cash flow hedges. These transactions are intended to mitigate exposure to fluctuations in commodity prices and optimize the value of its expected generation. Trade types include financial options, futures, swaps, fuel purchases and forward purchases and sales of electricity. Changes in fair market value of these contracts are recorded in earnings.
PSE&G is a party to certain long-term natural gas sales contracts to optimize its pipeline capacity utilization.  In addition, as further described in Note 8. Commitments and Contingent Liabilities, PSE&G was directed to execute long-term SOCAs with certain generators to support the LCAPP Act. These contracts qualify as derivatives and are marked to fair value with the offset recorded to Regulatory Assets and Liabilities.
Interest Rates
PSEG, Power and PSE&G are subject to the risk of fluctuating interest rates in the normal course of business. Exposure to this risk is managed by targeting a balanced debt maturity profile which limits refinancing in any given period or interest rate environment. In addition, they have used a mix of fixed and floating rate debt, interest rate swaps and interest rate lock agreements.
Fair Value Hedges
PSEG enters into fair value hedges to convert fixed-rate debt into variable-rate debt. As of September 30, 2012, PSEG had eight interest rate swaps outstanding totaling $1.1 billion. These swaps convert Power’s $250 million of 5% Senior Notes due April 2014, Power’s $300 million of 5.5% Senior Notes due December 2015, $300 million of Power’s $303 million of 5.32% Senior Notes due September 2016 and Power’s $250 million of 2.75% Senior Notes due September 2016 into variable-rate debt. These interest rate swaps are designated and effective as fair value hedges. The fair value changes of the interest rate swaps are fully offset by the changes in the fair value of the underlying debt. As of September 30, 2012 and December 31, 2011, the fair value of all the underlying hedges was $70 million and $62 million, respectively.
Cash Flow Hedges
PSEG uses interest rate swaps and other derivatives, which are designated and effective as cash flow hedges, to manage its exposure to the variability of cash flows, primarily related to variable-rate debt instruments. The Accumulated Other Comprehensive Income (Loss) (after tax) related to interest rate derivatives designated as cash flow hedges was $(2) million as of September 30, 2012 and December 31, 2011.


Fair Values of Derivative Instruments
The following are the fair values of derivative instruments on the Condensed Consolidated Balance Sheets:

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As of September 30, 2012
 
 
 
Power
 
PSE&G
 
PSEG
 
Consolidated
 
 
 
Cash Flow
Hedges
 
Non
Hedges
 
 
 
 
 
Non
Hedges
 
Fair Value
Hedges
 
 
 
 
Balance Sheet Location
Energy-
Related
Contracts
 
Energy-
Related
Contracts
 
Netting
(A)
 
Total
Power
 
Energy-
Related
Contracts
 
Interest
Rate
Swaps
 
Total
Derivatives
 
 
 
Millions
 
 
Derivative Contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current Assets
$
3

 
$
354

 
$
(255
)
 
$
102

 
$
3

 
$
18

 
$
123

 
 
Noncurrent Assets
—

 
81

 
(59
)
 
22

 
70

 
52

 
144

 
 
Total Mark-to-Market Derivative Assets
$
3

 
$
435

 
$
(314
)
 
$
124

 
$
73

 
$
70

 
$
267

 
 
Derivative Contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current Liabilities
$
(3
)
 
$
(303
)
 
$
255

 
$
(51
)
 
$
—

 
$
—

 
$
(51
)
 
 
Noncurrent Liabilities
—

 
(63
)
 
57

 
(6
)
 
(106
)
 
—

 
(112
)
 
 
Total Mark-to-Market Derivative (Liabilities)
$
(3
)
 
$
(366
)
 
$
312

 
$
(57
)
 
$
(106
)
 
$
—

 
$
(163
)
 
 
Total Net Mark-to-Market Derivative Assets (Liabilities)
$
—

 
$
69

 
$
(2
)
 
$
67

 
$
(33
)
 
$
70

 
$
104

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As of December 31, 2011
 
 
 
Power
 
PSE&G
 
PSEG
 
Consolidated
 
 
 
Cash Flow
Hedges
 
Non
Hedges
 
 
 
 
 
Non
Hedges
 
Fair Value
Hedges
 
 
 
 
Balance Sheet Location
Energy-
Related
Contracts
 
Energy-
Related
Contracts
 
Netting
(A)
 
Total
Power
 
Energy-
Related
Contracts
 
Interest
Rate
Swaps
 
Total
Derivatives
 
 
 
Millions
 
 
Derivative Contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current Assets
$
55

 
$
532

 
$
(448
)
 
$
139

 
$
—

 
$
17

 
$
156

 
 
Noncurrent Assets
8

 
121

 
(74
)
 
55

 
4

 
47

 
106

 
 
Total Mark-to-Market Derivative Assets
$
63

 
$
653

 
$
(522
)
 
$
194

 
$
4

 
$
64

 
$
262

 
 
Derivative Contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current Liabilities
$
(5
)
 
$
(506
)
 
$
387

 
$
(124
)
 
$
(7
)
 
$
—

 
$
(131
)
 
 
Noncurrent Liabilities
(1
)
 
(76
)
 
53

 
(24
)
 
—

 
(2
)
 
(26
)
 
 
Total Mark-to-Market Derivative (Liabilities)
$
(6
)
 
$
(582
)
 
$
440

 
$
(148
)
 
$
(7
)
 
$
(2
)
 
$
(157
)
 
 
Total Net Mark-to-Market Derivative Assets (Liabilities)
$
57

 
$
71

 
$
(82
)
 
$
46

 
$
(3
)
 
$
62

 
$
105

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

(A)
Represents the netting of fair value balances with the same counterparty (where the right of offset exists) and the application of collateral. As of September 30, 2012 and December 31, 2011, net cash collateral received of $2 million and $82 million, respectively, was netted against the corresponding net derivative contract positions. Of the $2 million as of September 30, 2012, cash collateral of $(4) million and $(2) million were netted against current assets and noncurrent assets, respectively, and cash collateral of $4 million was netted against current liabilities. Of the $82 million as of December 31, 2011, cash collateral of $(77) million and $(23) million were netted against current assets and noncurrent assets, respectively, and cash collateral of $16 million and $2 million were netted against current liabilities and noncurrent liabilities, respectively.
Certain of Power’s derivative instruments contain provisions that require Power to post collateral. This collateral may be posted in the form of cash or credit support with thresholds contingent upon Power’s credit rating from each of the major credit rating agencies. The collateral and credit support requirements vary by contract and by counterparty. These credit risk-related contingent features stipulate that if Power were to be downgraded or lose its investment grade credit rating, it would be required to provide additional collateral. This incremental collateral requirement can offset collateral requirements related to other derivative instruments that are assets with the same counterparty, where the contractual right of offset exists under applicable master agreements. Power also enters into commodity transactions on the New York Mercantile Exchange (NYMEX) and Intercontinental Exchange (ICE). The NYMEX and ICE clearing houses act as counterparties to each trade. Transactions on NYMEX and ICE must adhere to comprehensive collateral and margining requirements.
The aggregate fair value of all derivative instruments with credit risk-related contingent features in a liability position that are not fully collateralized (excluding transactions on NYMEX and ICE that are fully collateralized) was $130 million and $285 million as of September 30, 2012 and December 31, 2011, respectively. As of September 30, 2012 and December 31, 2011, Power had the contractual right of offset of $88 million and $149 million, respectively, related to derivative instruments that are assets with the same counterparty under master agreements and net of margin posted. If Power had been downgraded or lost its investment grade rating, it would have had additional collateral obligations of $42 million and $136 million as of September 30, 2012 and December 31, 2011, respectively, related to its derivatives, net of the contractual right of offset under master agreements and the application of collateral. This potential additional collateral is included in the $610 million and $812 million as of September 30, 2012 and December 31, 2011, respectively, discussed in Note 8. Commitments and Contingent Liabilities.
The following shows the effect on the Condensed Consolidated Statements of Operations and on Accumulated Other Comprehensive Income (AOCI) of derivative instruments designated as cash flow hedges for the three months ended September 30, 2012 and 2011:

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives in
Cash Flow Hedging
Relationships
Amount of
Pre-Tax
Gain (Loss)
Recognized in
AOCI on
Derivatives
(Effective
Portion)
 
Location
of Pre-Tax Gain
(Loss)  Reclassified
from AOCI into
Income
 
Amount of
Pre-Tax
Gain (Loss)
Reclassified
from AOCI
into Income
(Effective
Portion)
 
Location of
Pre-Tax Gain
(Loss) Recognized in
Income on
Derivatives
(Ineffective Portion)
 
Amount of
Pre-Tax
Gain (Loss)
Recognized in
Income on
Derivatives
(Ineffective
Portion)
 
 
Three Months Ended
 
 
 
Three Months Ended
 
 
 
Three Months Ended
 
 
September 30,
 
 
 
September 30,
 
 
 
September 30,
 
 
2012
 
2011
 
 
 
2012
 
2011
 
 
 
2012
 
2011
 
 
 
Millions
 
 
PSEG and Power
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Energy-Related Contracts
$
(3
)
 
$
21

 
Operating Revenues
 
$
15

 
$
60

 
Operating Revenues
 
$
(1
)
 
$
—

 
 
Total PSEG and Power
$
(3
)
 
$
21

 
 
 
$
15

 
$
60

 
 
 
$
(1
)
 
$
—

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 








The following shows the effect on the Condensed Consolidated Statements of Operations and on Accumulated Other Comprehensive Income (AOCI) of derivative instruments designated as cash flow hedges for the nine months ended September 30, 2012 and 2011:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives in
Cash Flow Hedging
Relationships
Amount of
Pre-Tax
Gain (Loss)
Recognized in
AOCI on
Derivatives
(Effective
Portion)
 
Location
of Pre-Tax Gain
(Loss)  Reclassified
from AOCI into
Income
 
Amount of
Pre-Tax
Gain (Loss)
Reclassified
from AOCI
into Income
(Effective
Portion)
 
Location of
Pre-Tax Gain
(Loss) Recognized in
Income on
Derivatives
(Ineffective Portion)
 
Amount of
Pre-Tax
Gain (Loss)
Recognized in
Income on
Derivatives
(Ineffective
Portion)
 
 
Nine Months
Ended
 
 
 
Nine Months
Ended
 
 
 
Nine Months
Ended
 
 
September 30,
 
 
 
September 30,
 
 
 
September 30,
 
 
2012
 
2011
 
                              
 
2012
 
2011
 
 
 
2012
 
2011
 
 
 
Millions
 
 
PSEG (A)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Energy-Related Contracts
$
27

 
$
18

 
Operating Revenues
 
$
67

 
$
152

 
Operating Revenues
 
$
(1
)
 
$
1

 
 
Energy-Related Contracts
(4
)
 
1

 
Energy Costs
 
(9
)
 
2

 
 
 
—

 
—

 
 
Interest Rate Swaps
—

 
—

 
Interest Expense
 
(1
)
 
(1
)
 
 
 
—

 
—

 
 
Total PSEG
$
23

 
$
19

 
 
 
$
57

 
$
153

 
 
 
$
(1
)
 
$
1

 
 
Power
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Energy-Related Contracts
$
27

 
$
18

 
Operating Revenues
 
$
67

 
$
152

 
Operating Revenues
 
$
(1
)
 
$
1

 
 
Energy-Related Contracts
(4
)
 
1

 
Energy Costs
 
(9
)
 
2

 
 
 
—

 
—

 
 
Total Power
$
23

 
$
19

 
 
 
$
58

 
$
154

 
 
 
$
(1
)
 
$
1

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(A)
Includes amounts for PSEG parent.
The following reconciles the Accumulated Other Comprehensive Income for derivative activity included in the Accumulated Other Comprehensive Loss of PSEG on a pre-tax and after-tax basis:

 
 
 
 
 
 
 
Accumulated Other Comprehensive Income
Pre-Tax
 
After-Tax
 
 
 
Millions
 
 
Balance as of December 31, 2011
$
54

 
$
31

 
 
Gain Recognized in AOCI
26

 
15

 
 
Less: Gain Reclassified into Income
(42
)
 
(25
)
 
 
Balance as of June 30, 2012
$
38

 
$
21

 
 
Loss Recognized in AOCI
(3
)
 
(2
)
 
 
Less: Gain Reclassified into Income
(15
)
 
(8
)
 
 
Balance as of September 30, 2012
$
20

 
$
11

 
 
 
 
 
 
 


The following shows the effect on the Condensed Consolidated Statements of Operations of derivative instruments not designated as hedging instruments or as normal purchases and sales for the three months and nine months ended September 30, 2012 and 2011:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives Not Designated as Hedges
 
Location of Pre-Tax
Gain (Loss)
Recognized in Income
on Derivatives
 
Pre-tax Gain (Loss)
Recognized in Income
on Derivatives
 
 
 
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
 
 
 
 
September 30,
 
September 30,
 
 
 
 
 
 
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
Millions
 
 
PSEG and Power
 
 
 
 
 
 
 
 
 
 
 
 
Energy-Related Contracts
 
Operating Revenues
 
$
(90
)
 
$
24

 
$
145

 
$
(18
)
 
 
Energy-Related Contracts
 
Energy Costs
 
6

 
(11
)
 
(17
)
 
(10
)
 
 
Total PSEG and Power
 
 
 
$
(84
)
 
$
13

 
$
128

 
$
(28
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Power’s derivative contracts reflected in the preceding tables include contracts to hedge the purchase and sale of electricity and natural gas and the purchase of fuel. Not all of these contracts qualify for hedge accounting. Most of these contracts are marked to market. The tables above do not include contracts for which Power has elected the normal purchase/normal sales exemption, such as its BGS contracts and certain other energy supply contracts that it has with other utilities and companies with retail load. In addition, PSEG has interest rate swaps designated as fair value hedges. The effect of these hedges was to reduce interest expense by $6 million and $6 million for the three month periods and $17 million and $19 million for the nine month periods ended September 30, 2012 and 2011, respectively.
The following reflects the gross volume, on an absolute value basis, of derivatives as of September 30, 2012 and December 31, 2011: 
 
 
 
 
 
 
 
 
 
 
 
 
 
Type
Notional
 
Total
 
PSEG
 
Power
 
PSE&G
 
 
 
Millions
 
 
As of September 30, 2012
 
 
 
 
 
 
 
 
 
 
 
Natural Gas
Dth
 
588

 
—

 
385

 
203

 
 
Electricity
MWh
 
179

 
—

 
179

 
—

 
 
Capacity
MW days
 
4

 
—

 
—

 
4

 
 
FTRs
MWh
 
28

 
—

 
28

 
—

 
 
Interest Rate Swaps
US Dollars
 
1,100

 
1,100

 
—

 
—

 
 
Coal
Tons
 
1

 
—

 
1

 
—

 
 
As of December 31, 2011
 
 
 
 
 
 
 
 
 
 
 
Natural Gas
Dth
 
612

 
—

 
377

 
235

 
 
Electricity
MWh
 
137

 
—

 
137

 
—

 
 
FTRs
MWh
 
12

 
—

 
12

 
—

 
 
Interest Rate Swaps
US Dollars
 
1,100

 
1,100

 
—

 
—

 
 
Coal
Tons
 
1

 
—

 
1

 
—

 
 
 
 
 
 
 
 
 
 
 
 
 


Credit Risk
Credit risk relates to the risk of loss that we would incur as a result of non-performance by counterparties pursuant to the terms of their contractual obligations. We have established credit policies that we believe significantly minimize credit risk. These policies include an evaluation of potential counterparties’ financial condition (including credit rating), collateral requirements under certain circumstances and the use of standardized agreements, which allow for the netting of positive and negative exposures associated with a single counterparty. In the event of non-performance or non-payment by a major counterparty, there may be a material adverse impact on Power’s and PSEG’s financial condition, results of operations or net cash flows.
As of September 30, 2012, 99% of the credit for Power’s operations was with investment grade counterparties. Credit exposure is defined as any positive results of netting accounts receivable/accounts payable and the forward value of open positions (which includes all financial instruments including derivatives and non-derivatives and normal purchases/normal sales).
The following table provides information on Power’s credit risk from others, net of cash collateral, as of September 30, 2012. It further delineates that exposure by the credit rating of the counterparties and provides guidance on the concentration of credit risk to individual counterparties and an indication of the quality of Power’s credit risk by credit rating of the counterparties.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Rating
Current
Exposure
 
Securities
held as
Collateral
 
Net
Exposure
 
Number of
Counterparties
>10%
 
Net Exposure of
Counterparties
>10%
 
 
 
 
Millions
 
 
 
Millions
 
 
 
Investment Grade—External Rating
$
311

 
$
85

 
$
309

 
2

 
$
153

(A) 
 
 
Non-Investment Grade—External Rating
3

 
—

 
3

 
—

 
—

  
 
 
Investment Grade—No External Rating
9

 
—

 
9

 
—

 
—

  
 
 
Non-Investment Grade—No External Rating
—

 
—

 
—

 
—

 
—

  
 
 
Total
$
323

 
$
85

 
$
321

 
2

 
$
153

  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(A)
Includes net exposure of $108 million with PSE&G. The remaining net exposure of $45 million is with one nonaffiliated power purchaser which is a regulated investment grade counterparty.
The net exposure listed above, in some cases, will not be the difference between the current exposure and the collateral held. A counterparty may have posted more cash collateral than the outstanding exposure, in which case there would be no exposure. When letters of credit have been posted as collateral, the exposure amount is not reduced, but the exposure amount is transferred to the rating of the issuing bank. As of September 30, 2012, Power had 177 active counterparties.
PSE And G [Member]
  
Financial Risk Management Activities
Financial Risk Management Activities
The operations of PSEG, Power and PSE&G are exposed to market risks from changes in commodity prices, interest rates and equity prices that could affect their results of operations and financial condition. Exposure to these risks is managed through normal operating and financing activities and, when appropriate, through hedging transactions. Hedging transactions use derivative instruments to create a relationship in which changes to the value of the assets, liabilities or anticipated transactions exposed to market risks are expected to be offset by changes in the value of these derivative instruments.
Commodity Prices
The availability and price of energy commodities are subject to fluctuations due to weather, environmental policies, changes in supply and demand, state and federal regulatory policies, market conditions, transmission availability and other events. Power uses physical and financial transactions in the wholesale energy markets to mitigate the effects of adverse movements in fuel and electricity prices. Derivative contracts that do not qualify for hedge accounting or normal purchases/normal sales treatment are marked to market (MTM) with changes in fair value recorded in the income statement. The fair value for the majority of these contracts is obtained from quoted market sources. Modeling techniques using assumptions reflective of current market rates, yield curves and forward prices are used to interpolate certain prices when no quoted market exists.
Cash Flow Hedges
Power uses forward sale and purchase contracts, swaps and futures contracts to hedge
•
forecasted energy sales from its generation stations and the related load obligations,
•
the price of fuel to meet its fuel purchase requirements, and
•
certain forecasted natural gas sales and purchases made to support the BGSS contract with PSE&G.
These derivative transactions are designated and effective as cash flow hedges. During the second quarter of 2012, Power de-designated certain of its commodity derivative transactions that had previously qualified as cash flow hedges as they were deemed to no longer be highly effective as required by the relevant accounting guidance. As a result, subsequent to June 1, 2012, Power recognizes all gains and losses from changes in the fair value of these derivatives immediately in earnings rather than deferring any such amounts in Accumulated Other Comprehensive Income (Loss). The fair values of Power’s de-designated hedges were frozen in Accumulated Other Comprehensive Income (Loss) as the original forecasted transactions are still expected to occur and are reclassified into earnings as the original derivative transactions settle.
As of September 30, 2012 and December 31, 2011, the fair value and the impact on Accumulated Other Comprehensive Income (Loss) associated with accounting hedge activity was as follows:
 
 
 
 
 
 
 
 
As of
 
As of
 
 
 
September 30,
2012
 
December 31,
2011
 
 
 
Millions
 
 
Fair Value of Cash Flow Hedges
$
—

 
$
57

 
 
Impact on Accumulated Other Comprehensive Income (Loss) (after tax)
$
13

 
$
33

 
 
 
 
 
 
 


The expiration date of the longest-dated cash flow hedge at Power is in 2014. Power’s after-tax unrealized gains on these derivatives that are expected to be reclassified to earnings during the next 12 months are $10 million. There was no ineffectiveness associated with qualifying hedges as of September 30, 2012.
Trading Derivatives
The primary purpose of Power’s wholesale marketing operation is to optimize the value of the output of the generating facilities via various products and services available in the markets it serves. Historically, Power engaged in trading of electricity and energy-related products where such transactions were not associated with the output or fuel purchase requirements of its facilities. This trading consisted mostly of energy supply contracts where Power secured sales commitments with the intent to supply the energy services from purchases in the market rather than from its owned generation. Such trading activities were marked to market through the income statement and represented less than one percent of gross margin (revenues less energy costs) on an annual basis. Effective July 2011, Power anticipates that it will not enter into any more trading derivative contracts.
Other Derivatives
Power enters into additional contracts that are derivatives, but do not qualify for or are not designated as cash flow hedges. These transactions are intended to mitigate exposure to fluctuations in commodity prices and optimize the value of its expected generation. Trade types include financial options, futures, swaps, fuel purchases and forward purchases and sales of electricity. Changes in fair market value of these contracts are recorded in earnings.
PSE&G is a party to certain long-term natural gas sales contracts to optimize its pipeline capacity utilization.  In addition, as further described in Note 8. Commitments and Contingent Liabilities, PSE&G was directed to execute long-term SOCAs with certain generators to support the LCAPP Act. These contracts qualify as derivatives and are marked to fair value with the offset recorded to Regulatory Assets and Liabilities.
Interest Rates
PSEG, Power and PSE&G are subject to the risk of fluctuating interest rates in the normal course of business. Exposure to this risk is managed by targeting a balanced debt maturity profile which limits refinancing in any given period or interest rate environment. In addition, they have used a mix of fixed and floating rate debt, interest rate swaps and interest rate lock agreements.
Fair Value Hedges
PSEG enters into fair value hedges to convert fixed-rate debt into variable-rate debt. As of September 30, 2012, PSEG had eight interest rate swaps outstanding totaling $1.1 billion. These swaps convert Power’s $250 million of 5% Senior Notes due April 2014, Power’s $300 million of 5.5% Senior Notes due December 2015, $300 million of Power’s $303 million of 5.32% Senior Notes due September 2016 and Power’s $250 million of 2.75% Senior Notes due September 2016 into variable-rate debt. These interest rate swaps are designated and effective as fair value hedges. The fair value changes of the interest rate swaps are fully offset by the changes in the fair value of the underlying debt. As of September 30, 2012 and December 31, 2011, the fair value of all the underlying hedges was $70 million and $62 million, respectively.
Cash Flow Hedges
PSEG uses interest rate swaps and other derivatives, which are designated and effective as cash flow hedges, to manage its exposure to the variability of cash flows, primarily related to variable-rate debt instruments. The Accumulated Other Comprehensive Income (Loss) (after tax) related to interest rate derivatives designated as cash flow hedges was $(2) million as of September 30, 2012 and December 31, 2011.


Fair Values of Derivative Instruments
The following are the fair values of derivative instruments on the Condensed Consolidated Balance Sheets:

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As of September 30, 2012
 
 
 
Power
 
PSE&G
 
PSEG
 
Consolidated
 
 
 
Cash Flow
Hedges
 
Non
Hedges
 
 
 
 
 
Non
Hedges
 
Fair Value
Hedges
 
 
 
 
Balance Sheet Location
Energy-
Related
Contracts
 
Energy-
Related
Contracts
 
Netting
(A)
 
Total
Power
 
Energy-
Related
Contracts
 
Interest
Rate
Swaps
 
Total
Derivatives
 
 
 
Millions
 
 
Derivative Contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current Assets
$
3

 
$
354

 
$
(255
)
 
$
102

 
$
3

 
$
18

 
$
123

 
 
Noncurrent Assets
—

 
81

 
(59
)
 
22

 
70

 
52

 
144

 
 
Total Mark-to-Market Derivative Assets
$
3

 
$
435

 
$
(314
)
 
$
124

 
$
73

 
$
70

 
$
267

 
 
Derivative Contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current Liabilities
$
(3
)
 
$
(303
)
 
$
255

 
$
(51
)
 
$
—

 
$
—

 
$
(51
)
 
 
Noncurrent Liabilities
—

 
(63
)
 
57

 
(6
)
 
(106
)
 
—

 
(112
)
 
 
Total Mark-to-Market Derivative (Liabilities)
$
(3
)
 
$
(366
)
 
$
312

 
$
(57
)
 
$
(106
)
 
$
—

 
$
(163
)
 
 
Total Net Mark-to-Market Derivative Assets (Liabilities)
$
—

 
$
69

 
$
(2
)
 
$
67

 
$
(33
)
 
$
70

 
$
104

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As of December 31, 2011
 
 
 
Power
 
PSE&G
 
PSEG
 
Consolidated
 
 
 
Cash Flow
Hedges
 
Non
Hedges
 
 
 
 
 
Non
Hedges
 
Fair Value
Hedges
 
 
 
 
Balance Sheet Location
Energy-
Related
Contracts
 
Energy-
Related
Contracts
 
Netting
(A)
 
Total
Power
 
Energy-
Related
Contracts
 
Interest
Rate
Swaps
 
Total
Derivatives
 
 
 
Millions
 
 
Derivative Contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current Assets
$
55

 
$
532

 
$
(448
)
 
$
139

 
$
—

 
$
17

 
$
156

 
 
Noncurrent Assets
8

 
121

 
(74
)
 
55

 
4

 
47

 
106

 
 
Total Mark-to-Market Derivative Assets
$
63

 
$
653

 
$
(522
)
 
$
194

 
$
4

 
$
64

 
$
262

 
 
Derivative Contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current Liabilities
$
(5
)
 
$
(506
)
 
$
387

 
$
(124
)
 
$
(7
)
 
$
—

 
$
(131
)
 
 
Noncurrent Liabilities
(1
)
 
(76
)
 
53

 
(24
)
 
—

 
(2
)
 
(26
)
 
 
Total Mark-to-Market Derivative (Liabilities)
$
(6
)
 
$
(582
)
 
$
440

 
$
(148
)
 
$
(7
)
 
$
(2
)
 
$
(157
)
 
 
Total Net Mark-to-Market Derivative Assets (Liabilities)
$
57

 
$
71

 
$
(82
)
 
$
46

 
$
(3
)
 
$
62

 
$
105

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

(A)
Represents the netting of fair value balances with the same counterparty (where the right of offset exists) and the application of collateral. As of September 30, 2012 and December 31, 2011, net cash collateral received of $2 million and $82 million, respectively, was netted against the corresponding net derivative contract positions. Of the $2 million as of September 30, 2012, cash collateral of $(4) million and $(2) million were netted against current assets and noncurrent assets, respectively, and cash collateral of $4 million was netted against current liabilities. Of the $82 million as of December 31, 2011, cash collateral of $(77) million and $(23) million were netted against current assets and noncurrent assets, respectively, and cash collateral of $16 million and $2 million were netted against current liabilities and noncurrent liabilities, respectively.
Certain of Power’s derivative instruments contain provisions that require Power to post collateral. This collateral may be posted in the form of cash or credit support with thresholds contingent upon Power’s credit rating from each of the major credit rating agencies. The collateral and credit support requirements vary by contract and by counterparty. These credit risk-related contingent features stipulate that if Power were to be downgraded or lose its investment grade credit rating, it would be required to provide additional collateral. This incremental collateral requirement can offset collateral requirements related to other derivative instruments that are assets with the same counterparty, where the contractual right of offset exists under applicable master agreements. Power also enters into commodity transactions on the New York Mercantile Exchange (NYMEX) and Intercontinental Exchange (ICE). The NYMEX and ICE clearing houses act as counterparties to each trade. Transactions on NYMEX and ICE must adhere to comprehensive collateral and margining requirements.
The aggregate fair value of all derivative instruments with credit risk-related contingent features in a liability position that are not fully collateralized (excluding transactions on NYMEX and ICE that are fully collateralized) was $130 million and $285 million as of September 30, 2012 and December 31, 2011, respectively. As of September 30, 2012 and December 31, 2011, Power had the contractual right of offset of $88 million and $149 million, respectively, related to derivative instruments that are assets with the same counterparty under master agreements and net of margin posted. If Power had been downgraded or lost its investment grade rating, it would have had additional collateral obligations of $42 million and $136 million as of September 30, 2012 and December 31, 2011, respectively, related to its derivatives, net of the contractual right of offset under master agreements and the application of collateral. This potential additional collateral is included in the $610 million and $812 million as of September 30, 2012 and December 31, 2011, respectively, discussed in Note 8. Commitments and Contingent Liabilities.
The following shows the effect on the Condensed Consolidated Statements of Operations and on Accumulated Other Comprehensive Income (AOCI) of derivative instruments designated as cash flow hedges for the three months ended September 30, 2012 and 2011:

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives in
Cash Flow Hedging
Relationships
Amount of
Pre-Tax
Gain (Loss)
Recognized in
AOCI on
Derivatives
(Effective
Portion)
 
Location
of Pre-Tax Gain
(Loss)  Reclassified
from AOCI into
Income
 
Amount of
Pre-Tax
Gain (Loss)
Reclassified
from AOCI
into Income
(Effective
Portion)
 
Location of
Pre-Tax Gain
(Loss) Recognized in
Income on
Derivatives
(Ineffective Portion)
 
Amount of
Pre-Tax
Gain (Loss)
Recognized in
Income on
Derivatives
(Ineffective
Portion)
 
 
Three Months Ended
 
 
 
Three Months Ended
 
 
 
Three Months Ended
 
 
September 30,
 
 
 
September 30,
 
 
 
September 30,
 
 
2012
 
2011
 
 
 
2012
 
2011
 
 
 
2012
 
2011
 
 
 
Millions
 
 
PSEG and Power
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Energy-Related Contracts
$
(3
)
 
$
21

 
Operating Revenues
 
$
15

 
$
60

 
Operating Revenues
 
$
(1
)
 
$
—

 
 
Total PSEG and Power
$
(3
)
 
$
21

 
 
 
$
15

 
$
60

 
 
 
$
(1
)
 
$
—

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 








The following shows the effect on the Condensed Consolidated Statements of Operations and on Accumulated Other Comprehensive Income (AOCI) of derivative instruments designated as cash flow hedges for the nine months ended September 30, 2012 and 2011:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives in
Cash Flow Hedging
Relationships
Amount of
Pre-Tax
Gain (Loss)
Recognized in
AOCI on
Derivatives
(Effective
Portion)
 
Location
of Pre-Tax Gain
(Loss)  Reclassified
from AOCI into
Income
 
Amount of
Pre-Tax
Gain (Loss)
Reclassified
from AOCI
into Income
(Effective
Portion)
 
Location of
Pre-Tax Gain
(Loss) Recognized in
Income on
Derivatives
(Ineffective Portion)
 
Amount of
Pre-Tax
Gain (Loss)
Recognized in
Income on
Derivatives
(Ineffective
Portion)
 
 
Nine Months
Ended
 
 
 
Nine Months
Ended
 
 
 
Nine Months
Ended
 
 
September 30,
 
 
 
September 30,
 
 
 
September 30,
 
 
2012
 
2011
 
                              
 
2012
 
2011
 
 
 
2012
 
2011
 
 
 
Millions
 
 
PSEG (A)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Energy-Related Contracts
$
27

 
$
18

 
Operating Revenues
 
$
67

 
$
152

 
Operating Revenues
 
$
(1
)
 
$
1

 
 
Energy-Related Contracts
(4
)
 
1

 
Energy Costs
 
(9
)
 
2

 
 
 
—

 
—

 
 
Interest Rate Swaps
—

 
—

 
Interest Expense
 
(1
)
 
(1
)
 
 
 
—

 
—

 
 
Total PSEG
$
23

 
$
19

 
 
 
$
57

 
$
153

 
 
 
$
(1
)
 
$
1

 
 
Power
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Energy-Related Contracts
$
27

 
$
18

 
Operating Revenues
 
$
67

 
$
152

 
Operating Revenues
 
$
(1
)
 
$
1

 
 
Energy-Related Contracts
(4
)
 
1

 
Energy Costs
 
(9
)
 
2

 
 
 
—

 
—

 
 
Total Power
$
23

 
$
19

 
 
 
$
58

 
$
154

 
 
 
$
(1
)
 
$
1

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(A)
Includes amounts for PSEG parent.
The following reconciles the Accumulated Other Comprehensive Income for derivative activity included in the Accumulated Other Comprehensive Loss of PSEG on a pre-tax and after-tax basis:

 
 
 
 
 
 
 
Accumulated Other Comprehensive Income
Pre-Tax
 
After-Tax
 
 
 
Millions
 
 
Balance as of December 31, 2011
$
54

 
$
31

 
 
Gain Recognized in AOCI
26

 
15

 
 
Less: Gain Reclassified into Income
(42
)
 
(25
)
 
 
Balance as of June 30, 2012
$
38

 
$
21

 
 
Loss Recognized in AOCI
(3
)
 
(2
)
 
 
Less: Gain Reclassified into Income
(15
)
 
(8
)
 
 
Balance as of September 30, 2012
$
20

 
$
11

 
 
 
 
 
 
 


The following shows the effect on the Condensed Consolidated Statements of Operations of derivative instruments not designated as hedging instruments or as normal purchases and sales for the three months and nine months ended September 30, 2012 and 2011:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives Not Designated as Hedges
 
Location of Pre-Tax
Gain (Loss)
Recognized in Income
on Derivatives
 
Pre-tax Gain (Loss)
Recognized in Income
on Derivatives
 
 
 
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
 
 
 
 
September 30,
 
September 30,
 
 
 
 
 
 
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
Millions
 
 
PSEG and Power
 
 
 
 
 
 
 
 
 
 
 
 
Energy-Related Contracts
 
Operating Revenues
 
$
(90
)
 
$
24

 
$
145

 
$
(18
)
 
 
Energy-Related Contracts
 
Energy Costs
 
6

 
(11
)
 
(17
)
 
(10
)
 
 
Total PSEG and Power
 
 
 
$
(84
)
 
$
13

 
$
128

 
$
(28
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Power’s derivative contracts reflected in the preceding tables include contracts to hedge the purchase and sale of electricity and natural gas and the purchase of fuel. Not all of these contracts qualify for hedge accounting. Most of these contracts are marked to market. The tables above do not include contracts for which Power has elected the normal purchase/normal sales exemption, such as its BGS contracts and certain other energy supply contracts that it has with other utilities and companies with retail load. In addition, PSEG has interest rate swaps designated as fair value hedges. The effect of these hedges was to reduce interest expense by $6 million and $6 million for the three month periods and $17 million and $19 million for the nine month periods ended September 30, 2012 and 2011, respectively.
The following reflects the gross volume, on an absolute value basis, of derivatives as of September 30, 2012 and December 31, 2011: 
 
 
 
 
 
 
 
 
 
 
 
 
 
Type
Notional
 
Total
 
PSEG
 
Power
 
PSE&G
 
 
 
Millions
 
 
As of September 30, 2012
 
 
 
 
 
 
 
 
 
 
 
Natural Gas
Dth
 
588

 
—

 
385

 
203

 
 
Electricity
MWh
 
179

 
—

 
179

 
—

 
 
Capacity
MW days
 
4

 
—

 
—

 
4

 
 
FTRs
MWh
 
28

 
—

 
28

 
—

 
 
Interest Rate Swaps
US Dollars
 
1,100

 
1,100

 
—

 
—

 
 
Coal
Tons
 
1

 
—

 
1

 
—

 
 
As of December 31, 2011
 
 
 
 
 
 
 
 
 
 
 
Natural Gas
Dth
 
612

 
—

 
377

 
235

 
 
Electricity
MWh
 
137

 
—

 
137

 
—

 
 
FTRs
MWh
 
12

 
—

 
12

 
—

 
 
Interest Rate Swaps
US Dollars
 
1,100

 
1,100

 
—

 
—

 
 
Coal
Tons
 
1

 
—

 
1

 
—

 
 
 
 
 
 
 
 
 
 
 
 
 


Credit Risk
Credit risk relates to the risk of loss that we would incur as a result of non-performance by counterparties pursuant to the terms of their contractual obligations. We have established credit policies that we believe significantly minimize credit risk. These policies include an evaluation of potential counterparties’ financial condition (including credit rating), collateral requirements under certain circumstances and the use of standardized agreements, which allow for the netting of positive and negative exposures associated with a single counterparty. In the event of non-performance or non-payment by a major counterparty, there may be a material adverse impact on Power’s and PSEG’s financial condition, results of operations or net cash flows.
As of September 30, 2012, 99% of the credit for Power’s operations was with investment grade counterparties. Credit exposure is defined as any positive results of netting accounts receivable/accounts payable and the forward value of open positions (which includes all financial instruments including derivatives and non-derivatives and normal purchases/normal sales).
The following table provides information on Power’s credit risk from others, net of cash collateral, as of September 30, 2012. It further delineates that exposure by the credit rating of the counterparties and provides guidance on the concentration of credit risk to individual counterparties and an indication of the quality of Power’s credit risk by credit rating of the counterparties.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Rating
Current
Exposure
 
Securities
held as
Collateral
 
Net
Exposure
 
Number of
Counterparties
>10%
 
Net Exposure of
Counterparties
>10%
 
 
 
 
Millions
 
 
 
Millions
 
 
 
Investment Grade—External Rating
$
311

 
$
85

 
$
309

 
2

 
$
153

(A) 
 
 
Non-Investment Grade—External Rating
3

 
—

 
3

 
—

 
—

  
 
 
Investment Grade—No External Rating
9

 
—

 
9

 
—

 
—

  
 
 
Non-Investment Grade—No External Rating
—

 
—

 
—

 
—

 
—

  
 
 
Total
$
323

 
$
85

 
$
321

 
2

 
$
153

  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(A)
Includes net exposure of $108 million with PSE&G. The remaining net exposure of $45 million is with one nonaffiliated power purchaser which is a regulated investment grade counterparty.
The net exposure listed above, in some cases, will not be the difference between the current exposure and the collateral held. A counterparty may have posted more cash collateral than the outstanding exposure, in which case there would be no exposure. When letters of credit have been posted as collateral, the exposure amount is not reduced, but the exposure amount is transferred to the rating of the issuing bank. As of September 30, 2012, Power had 177 active counterparties.