Derivative Instruments And Hedging Activities

3 Months Ended

Mar. 31, 2012

Derivative Instruments And Hedging Activities

(13) DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

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

The retail energy supply business of Pepco Energy Services, which is in the process of being wound down, enters into energy commodity contracts in the form of electricity and natural gas futures, swaps, options and forward contracts to hedge commodity price risk in connection with the purchase of physical natural gas and electricity for distribution to customers. The primary risk management objective is to manage the spread between retail sales commitments and the cost of supply used to service those commitments to ensure stable cash flows and lock in favorable prices and margins when they become available.

Pepco Energy Services' commodity contracts that are not designated for hedge accounting, do not qualify for hedge accounting, or do not meet the requirements for normal purchase and normal sale accounting, are marked to market through current earnings. Forward contracts that meet the requirements for normal purchase and normal sale accounting are recorded on an accrual basis.

In Power Delivery, 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. The natural gas purchase contracts qualify as normal purchases, which are not required to be recorded in the financial statements until settled. DPL's capacity contracts are not classified as derivatives. 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.

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 their 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 March 31, 2012 and December 31, 2011:

	As of March 31, 2012
Balance Sheet Caption	Derivatives Designated as Hedging Instruments (a)			Other Derivative Instruments (b)			Gross Derivative Instruments			Effects of Cash Collateral and Netting			Net Derivative Instruments
	(millions of dollars)
Derivative assets (current assets)	$	9		$	8		$	17		$	(11	)	$	6
Derivative assets (non-current assets)		—			1			1			—			1
Total Derivative assets		9			9			18			(11	)		7
Derivative liabilities (current  liabilities)		(38	)		(50	)		(88	)		63			(25	)
Derivative liabilities (non-current liabilities)		(8	)		(6	)		(14	)		12			(2	)
Total Derivative liabilities		(46	)		(56	)		(102	)		75			(27	)
Net Derivative (liability) asset	$	(37	)	$	(47	)	$	(84	)	$	64		$	(20	)

(a) Amounts included in Derivatives Designated as Hedging Instruments primarily consist of derivatives that were designated as cash flow hedges prior to Pepco Energy Services' election to discontinue cash flow hedge accounting for these derivatives.

(b) Amounts included in Other Derivative Instruments include gains or losses on gas derivatives that are not accounted for as cash flow hedges subsequent to Pepco Energy Services' election to discontinue cash flow hedge accounting.

	As of December 31, 2011
Balance Sheet Caption	Derivatives Designated as Hedging Instruments (a)			Other Derivative Instruments (b)			Gross Derivative Instruments			Effects of Cash Collateral and Netting			Net Derivative Instruments
	(millions of dollars)
Derivative assets (current assets)	$	17		$	6		$	23		$	(18	)	$	5
Derivative assets (non-current assets)		—			1			1			(1	)		—
Total Derivative assets		17			7			24			(19	)		5
Derivative liabilities (current liabilities)		(55	)		(48	)		(103	)		77			(26	)
Derivative liabilities (non-current liabilities)		(11	)		(10	)		(21	)		15			(6	)
Total Derivative liabilities		(66	)		(58	)		(124	)		92			(32	)
Net Derivative (liability) asset	$	(49	)	$	(51	)	$	(100	)	$	73		$	(27	)

(a) Amounts included in Derivatives Designated as Hedging Instruments primarily consist of derivatives that were designated as cash flow hedges prior to Pepco Energy Services' election to discontinue cash flow hedge accounting for these derivatives.

(b) Amounts included in Other Derivative Instruments include gains or losses on gas derivatives that are not accounted for as cash flow hedges subsequent to Pepco Energy Services' election to discontinue cash flow hedge accounting.

Under FASB guidance on the offsetting of balance sheet accounts (ASC 210-20), PHI offsets the fair value amounts recognized for derivative instruments and the fair value amounts recognized for related collateral positions executed with the same counterparty under master netting agreements. The amount of cash collateral that was offset against these derivative positions is as follows:

	March 31, 2012		December 31, 2011
	(millions of dollars)
Cash collateral pledged to counterparties with the right to reclaim (a)	$	64	$	73

(a) Includes cash deposits on commodity brokerage accounts

As of March 31, 2012 and December 31, 2011, all PHI cash collateral pledged related to derivative instruments accounted for at fair value was entitled to offset under master netting agreements.

Derivatives Designated as Hedging Instruments

Cash Flow Hedges

Pepco Energy Services

For energy commodity contracts that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative is reported as a component of AOCL and is reclassified into income in the same period or periods during which the hedged transactions affect income. Gains and losses on the derivative that are related to hedge ineffectiveness or the forecasted hedged transaction being probable not to occur, are recognized in income. Pepco Energy Services has elected to no longer apply cash flow hedge accounting to certain of its electricity derivatives and all of its natural gas derivatives. Amounts included in AOCL for these cash flow hedges as of March 31, 2012 represent net losses on derivatives prior to the election to discontinue cash flow hedge accounting less amounts reclassified into income as the hedged transactions occur or because the hedged transactions were deemed probable not to occur. Gains or losses on these derivatives after the election to discontinue cash flow hedge accounting are recognized directly in income.

The cash flow hedge activity during the three months ended March 31, 2012 and 2011 is provided in the tables below:

	Three Months Ended March  31,
	2012		2011
	(millions of dollars)
Amount of net pre-tax loss arising during the period included in accumulated other comprehensive loss	$	—	$	(1	)
Amount of net pre-tax loss reclassified into income:
Effective portion:
Fuel and purchased energy		13		27
Ineffective portion: (a)
Revenue		—		—
Total net pre-tax loss reclassified into income		13		27
Net pre-tax gain on commodity derivatives included in accumulated other comprehensive loss	$	13	$	26

(a) For the three months ended March 31, 2012 and 2011, no amounts were reclassified from AOCL to income because it was deemed probable that the forecasted hedged transactions would not occur.

As of March 31, 2012 and December 31, 2011, Pepco Energy Services had the following types and quantities of outstanding energy commodity contracts employed as cash flow hedges of forecasted purchases and forecasted sales.

	Quantities
Commodity	March 31, 2012		December 31, 2011
Forecasted Purchases Hedges
Natural gas (One Million British Thermal Units (MMBtu))		—		—
Electricity (Megawatt hours (MWh))		246,680		614,560
Electricity capacity (MW-Days)		—		—
Forecasted Sales Hedges
Electricity (MWh)		246,680		614,560

Power Delivery

All premiums paid and other transaction costs incurred as part of DPL's natural gas hedging activity, in addition to all of DPL's gains and losses related to hedging activities, are deferred under FASB guidance on regulated operations until recovered from customers based on the fuel adjustment clause approved by the DPSC. The following table indicates the amount of the net unrealized derivative losses arising during the period included in Regulatory assets and the realized losses recognized in the consolidated statements of income for the three months ended March 31, 2012 and 2011 associated with cash flow hedges:

	Three Months Ended March  31,
	2012		2011
	(millions of dollars)
Net unrealized (loss) gain arising during the period included in Regulatory assets	$	—	$	—
Net realized loss recognized in Fuel and purchased energy expense		—		(2	)

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 March 31, 2012 and 2011. Cash flow hedges are marked to market on the consolidated balance sheets with corresponding adjustments to AOCL for effective cash flow hedges. As of March 31, 2012, $33 million of the losses in AOCL were associated with derivatives that Pepco Energy Services previously designated as cash flow hedges. Although Pepco Energy Services no longer designates these derivatives as cash flow hedges, gains or losses previously deferred in AOCL prior to the decision to discontinue cash flow hedge accounting will remain in AOCL until the hedged forecasted transaction occurs unless it is deemed probable that the hedged forecasted transaction will not occur. 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:

	As of March 31, 2012
Contracts	Accumulated Other Comprehensive Loss After-tax		Portion Expected to be Reclassified to Income during the Next 12 Months		Maximum Term
	(millions of dollars)
Energy commodity (a)	$	21	$	17		26 months
Interest rate		10		1		245 months
Total	$	31	$	18

(a) The unrealized derivative losses recorded in AOCL relate to forecasted physical natural gas and electricity purchases which are used to supply retail natural gas and electricity contracts that are in gain positions and subject to accrual accounting. Under accrual accounting, no asset is recorded on PHI's consolidated balance sheet and the purchase cost is not recognized until the period of distribution.

	As of March 31, 2011
Contracts	Accumulated Other Comprehensive Loss After-tax		Portion Expected to be Reclassified to Income during the Next 12 Months		Maximum Term
	(millions of dollars)
Energy commodity (a)	$	62	$	38		38 months
Interest rate		11		1		257 months
Total	$	73	$	39

(a) The unrealized derivative losses recorded in AOCL relate to forecasted physical natural gas and electricity purchases which are used to supply retail natural gas and electricity contracts that are in gain positions and subject to accrual accounting. Under accrual accounting, no asset is recorded on PHI's consolidated balance sheet and the purchase cost is not recognized until the period of distribution.

Other Derivative Activity

Pepco Energy Services

Pepco Energy Services 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 sheet with changes in fair value recorded through income.

For the three months ended March 31, 2012 and 2011, the amount of the derivative gain (loss) for Pepco Energy Services recognized in income is provided in the table below:

	Three Months Ended March 31,
	2012			2011
	(millions of dollars)
Reclassification to realized on settlement of contracts	$	10		$	(4	)
Unrealized mark-to-market loss		(10	)		—
Total net loss	$	—		$	(4	)

As of March 31, 2012 and December 31, 2011, Pepco Energy Services had the following net outstanding commodity forward contract quantities and net position on derivatives that did not qualify for hedge accounting:

	March 31, 2012				December 31, 2011
Commodity	Quantity		Net Position		Quantity		Net Position
Financial transmission rights (MWh)		79,607		Long		267,480		Long
Electric capacity (MW–Days)		5,185		Long		12,920		Long
Electric (MWh)		657,240		Long		788,280		Long
Natural gas (MMBtu)		15,037,300		Long		24,550,257		Long

Power Delivery

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 consolidated balance sheets with the gain or loss for the change 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 the three months ended March 31, 2012 and 2011, the net unrealized derivative losses arising during the period included in Regulatory assets and the net realized losses recognized in the consolidated statements of income are provided in the table below:

	Three Months Ended March  31,
	2012			2011
Net unrealized gain (loss) arising during the period included in Regulatory assets	$	(4	)	$	(1	)
Net realized loss recognized in Fuel and purchased energy expense		(7	)		(7	)

As of March 31, 2012 and December 31, 2011, DPL had the following net outstanding natural gas commodity forward contracts that did not qualify for hedge accounting:

	March 31, 2012				December 31, 2011
Commodity	Quantity		Net Position		Quantity		Net Position
Natural gas (MMBtu)		4,109,100		Long		6,161,200		Long

Contingent Credit Risk Features

The primary contracts used by Pepco Energy Services and Power Delivery 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 Pepco Energy Services are usually guaranteed by PHI. The obligations of DPL are stand-alone obligations without the guaranty of PHI. If PHI's or 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 debt rating of the holder.

The gross fair values of PHI's derivative liabilities with credit risk-related contingent features as of March 31, 2012 and December 31, 2011, were $40 million and $54 million, respectively, before giving effect to offsetting transactions or collateral under master netting agreements. As of March 31, 2012, PHI had posted no cash collateral against its gross derivative liability, resulting in a net liability of $40 million. As of December 31, 2011, PHI had posted cash collateral of $1 million against its gross derivative liability, resulting in a net liability of $53 million. If PHI's and DPL's debt ratings had been downgraded below investment grade as of March 31, 2012 and December 31, 2011, PHI's net settlement amounts, including both the fair value of its derivative liabilities and its normal purchase and normal sale contracts in loss positions, would have been approximately $111 million and $124 million, respectively, and PHI would have been required to post additional collateral with the counterparties of approximately $111 million and $123 million, respectively. The net settlement and additional collateral amounts reflect the effect of offsetting transactions under master netting agreements.

PHI's primary sources for posting cash collateral or letters of credit are its credit facility. At March 31, 2012 and December 31, 2011, the aggregate amount of cash plus borrowing capacity under the credit facility available to meet the future liquidity needs of PHI and its subsidiaries totaled $679 million and $1 billion, respectively, of which $227 million and $283 million, respectively, was available to Pepco Energy Services.

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. DPL's capacity contracts are not classified as derivatives. 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 March 31, 2012 and December 31, 2011:

	As of March 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)	$	—	$	(14	)	$	(14	)	$	2	$	(12	)
Derivative liabilities (non-current liabilities)		—		—			—			—		—
Total Derivative liabilities		—		(14	)		(14	)		2		(12	)
Net Derivative (liability) asset	$	—	$	(14	)	$	(14	)	$	2	$	(12	)

	As of December 31, 2011
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)	$	—	$	(14	)	$	(14	)	$	2	$	(12	)
Derivative liabilities (non-current liabilities)		—		(3	)		(3	)		—		(3	)
Total Derivative liabilities		—		(17	)		(17	)		2		(15	)
Net Derivative (liability) asset	$	—	$	(17	)	$	(17	)	$	2	$	(15	)

Under FASB guidance on the offsetting of balance sheet accounts (ASC 210), 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. The amount of cash collateral that was offset against these derivative positions is as follows:

	March 31, 2012		December 31, 2011
	(millions of dollars)
Cash collateral pledged to counterparties with the right to reclaim	$	2	$	2

As of March 31, 2012 and December 31, 2011, all DPL 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

All premiums paid and other transaction costs incurred as part of DPL's natural gas hedging activity, in addition to all of DPL's gains and losses related to hedging activities, are deferred under FASB guidance on regulated operations until recovered from customers based on the fuel adjustment clause approved by the DPSC. The following table indicates the net unrealized derivative losses arising during the period included in Regulatory assets and the realized losses recognized in the statements of income for the three months ended March 31, 2012 and 2011 associated with cash flow hedges:

	Three Months Ended March  31,
	2012		2011
	(millions of dollars)
Net unrealized (loss) gain arising during the period included in Regulatory assets	$	—	$	—
Net realized losses recognized in Purchased energy or Gas Purchased		—		(2	)

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 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 months ended March 31, 2012 and 2011, the net unrealized derivative losses arising during the period included in Regulatory Assets and the net realized losses recognized in the statements of income are provided in the table below:

	Three Months Ended March  31,
	2012			2011
	(millions of dollars)
Net unrealized (loss) gain arising during the period included in Regulatory assets	$	(4	)	$	(1	)
Net realized loss recognized in Purchased energy or Gas purchased		(7	)		(7	)

As of March 31, 2012 and December 31, 2011, DPL had the following net outstanding natural gas commodity forward contracts that did not qualify for hedge accounting:

	March 31, 2012				December 31, 2011
Commodity	Quantity		Net Position		Quantity		Net Position
Natural gas (MMBtu)		4,109,100		Long		6,161,200		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 collateral requirements of 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 debt rating of the holder.

The gross fair values of DPL's derivative liabilities with credit-risk-related contingent features as of March 31, 2012 and December 31, 2011, were $12 million and $15 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 $12 million and $15 million, respectively. If DPL's debt ratings had been downgraded below investment grade as of March 31, 2012 and December 31, 2011, DPL's net settlement amounts would have been approximately $12 million and $15 million, respectively, and DPL would have been required to post additional collateral with the counterparties of approximately $12 million and $15 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. At March 31, 2012 and December 31, 2011, the aggregate amount of cash plus borrowing capacity under the credit facility available to meet the liquidity needs of PHI's utility subsidiaries was $452 million and $711 million, respectively.