(17) DISCONTINUED OPERATIONS

On March 21, 2013, Pepco Energy Services entered into an agreement whereby a third party assumed all the rights and obligations of the remaining natural gas supply customer contracts, and the associated supply obligations, inventory and derivative contracts. The transaction was completed on April 1, 2013. In addition, in the second quarter of 2013, Pepco Energy Services completed the wind-down of its retail electric supply business by terminating its remaining customer supply and wholesale purchase obligations beyond June 30, 2013. As a result, PHI has reported the results of operations of Pepco Energy Services’ retail electric and natural gas supply businesses as discontinued operations in all periods presented in the accompanying consolidated statements of income. Further, the assets and liabilities of Pepco Energy Services’ retail electric and natural gas supply businesses are reported as held for disposition as of each date presented in the accompanying consolidated balance sheets.

Operating Results

The operating results for the retail electric and natural gas supply businesses of Pepco Energy Services are as follows:


	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
	*(millions of dollars)*
Operating revenue	$	34	$	109	$	84	$	265

Income from operations of discontinued operations, net of income taxes (a)	$	1	$	9	$	3	$	17
Net gains associated with the accelerated disposition of retail electric and natural gas contracts, net of income taxes (b)		3		—		1		—

Income From Discontinued Operations, Net of Income Taxes	$	4	$	9	$	4	$	17

(a)	Includes income tax expense of zero and approximately $6 million for the three months ended June 30, 2013 and 2012, respectively, and approximately $1 million and $11 million for the six months ended June 30, 2013 and 2012, respectively.

(b)	Includes income tax expense of approximately $1 million and zero for the three months ended June 30, 2013 and 2012, respectively, and zero for each of the six months ended June 30, 2013 and 2012.

The net gains associated with the accelerated disposition of retail electric and natural gas contracts, net of income taxes for the three months ended June 30, 2013, reflects the pre-tax loss of $3 million ($2 million after-tax) associated with the terminations of the retail electric customer supply and wholesale purchase obligations beyond June 30, 2013, and the pre-tax gain of $8 million ($5 million after-tax) recognized regarding the assumption by a third party, on April 1, 2013, of all the rights and obligations of the derivative contracts associated with the retail natural gas supply business.

The net gains associated with the accelerated disposition of retail electric and natural gas contracts, net of income taxes for the six months ended June 30, 2013, reflects the pre-tax gain of $5 million ($3 million after-tax) described above, partially offset by unrealized derivative losses that were previously included in AOCL and were reclassified to income because PHI determined that the hedged forecasted purchases of supply for customers were probable not to occur. Accordingly, in the first quarter of 2013, PHI recognized $4 million of pre-tax unrealized derivative losses ($2 million after-tax) that previously were included in AOCL as cash flow hedges.

Balance Sheet Information

As of June 30, 2013 and December 31, 2012, the retail energy supply business of Pepco Energy Services had net accounts receivable of $12 million and $33 million, respectively, inventory assets of $2 million and $3 million, respectively, gross derivative assets of zero and $1 million, respectively, other current assets of zero and $1 million, respectively, accrued liabilities of $9 million and $20 million, respectively, gross derivative liabilities of zero and $21 million, respectively, exclusive of the collateral pledged by Pepco Energy Services against the derivative liabilities, and other current liabilities of $3 million and $1 million, respectively. The fair values of the derivative assets and liabilities were considered levels 1 and 2 within the fair value hierarchy.

Derivative Instruments and Hedging Activities

Derivatives were used by the retail electric and natural gas supply businesses of Pepco Energy Services to hedge commodity price risk.

The retail electric and natural gas supply businesses of Pepco Energy Services entered into energy commodity contracts in the form of 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 was 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 became available. There were no derivatives for Pepco Energy Services as of June 30, 2013.

Commodity contracts held by the retail electric and natural gas supply businesses of Pepco Energy Services that were not designated for hedge accounting, did not qualify for hedge accounting, or did not meet the requirements for normal purchase and normal sale accounting, were marked to market through current earnings. Forward contracts that met the requirements for normal purchase and normal sale accounting were recorded on an accrual basis.

The table below identifies the balance sheet location and fair values of the retail electric and natural gas supply businesses’ derivative instruments as of December 31, 2012:


	As of December 31, 2012
Balance Sheet Caption	Derivatives Designated as Hedging Instruments (a)			Other Derivative Instruments			Gross Derivative Instruments			Effects of Cash Collateral and Netting		Net Derivative Instruments
	*(millions of dollars)*

Assets held for disposition (current assets)	$	—		$	1		$	1		$	—	$	1

Total Derivative assets		—			1			1			—		1

Liabilities associated with assets held for disposition (current liabilities)		(10	)		(9	)		(19	)		16		(3	)
Liabilities associated with assets held for disposition (non-current liabilities)		(1	)		(1	)		(2	)		2		—

Total Derivative liabilities		(11	)		(10	)		(21	)		18		(3	)

Net Derivative (liability) asset	$	(11	)	$	(9	)	$	(20	)	$	18	$	(2	)

(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.

Under FASB guidance on the offsetting of balance sheet accounts (ASC 210-20), the retail electric and natural gas supply businesses of Pepco Energy Services offset 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. No derivative assets or liabilities were available to be offset under master netting arrangements as of December 31, 2012. The amount of cash collateral that was offset against these derivative positions is as follows:


	December 31, 2012
	*(millions of dollars)*
Cash collateral pledged to counterparties with the right to reclaim (a)	$	18

(a)	Includes cash deposits on commodity brokerage accounts.

As of December 31, 2012, all cash collateral pledged by the retail electric and natural gas supply businesses 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

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. The retail energy supply business of Pepco Energy Services had elected to no longer apply cash flow hedge accounting to its energy derivatives. Amounts included in AOCL for these cash flow hedges as of June 30, 2013 and 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 occurred 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 were recognized in income.

The cash flow hedge activity during the three and six months ended June 30, 2013 and 2012 is provided in the tables below:


	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
	*(millions of dollars)*
Amount of net pre-tax loss arising during the period included in Accumulated Other Comprehensive Loss	$	—	$	—	$	—	$	—

Amount of net pre-tax loss reclassified into income:
Effective portion:
Income from Discontinued operations, Net of Income Taxes		2		12		10		25

Total net pre-tax loss reclassified into Income from Discontinued operations, Net of Income Taxes		2		12		10		25

Net pre-tax gain on commodity derivatives included in Accumulated Other Comprehensive Loss	$	2	$	12	$	10	$	25

(a)

Included in the table above is a loss of $4 million for the six months ended June 30, 2013, which was reclassified from AOCL to Income from Discontinued operations, Net of Income Taxes because the forecasted hedged transactions were deemed probable not to occur. For the three months ended June 30, 2013, and for the three and six months ended June 30, 2012, no amounts were reclassified from AOCL to Income from Discontinued operations, Net of Income Taxes because the forecasted hedged transactions were deemed probable not to occur.

Cash Flow Hedges Included in Accumulated Other Comprehensive Loss

Cash flow hedges are marked to market on the balance sheet with corresponding adjustments to AOCL for effective cash flow hedges. As of June 30, 2013, all of the losses in AOCL that were associated with derivatives that the retail electric and natural gas supply businesses of Pepco Energy Services had previously designated as cash flow hedges have been reclassified to income. The table below provides details regarding effective cash flow hedges included in the retail electric and natural gas supply businesses of Pepco Energy Services’ balance sheets as of June 30, 2012. Although the retail electric and natural gas supply businesses of Pepco Energy Services elected to no longer apply cash flow hedge accounting to its derivatives prior to June 30, 2012, gains or losses previously deferred in AOCL prior to the decision to discontinue cash flow hedge accounting remained in AOCL until the hedged forecasted transaction occurred unless it was deemed probable that the hedged forecasted transaction would 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 June 30, 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)	$	15	$	13	23 months

Total	$	15	$	13

(a)

The unrealized derivative losses recorded in AOCL relate to forecasted physical natural gas and electricity purchases which are used to supply retail electric and natural gas supply contracts that are in gain positions and subject to accrual accounting. Under accrual accounting, no asset is recorded on Pepco Energy Services’ balance sheet and the purchase cost is not recognized until the period of distribution.

Other Derivative Activity

The retail electric and natural gas supply businesses of Pepco Energy Services held certain derivatives that were not in hedge accounting relationships and were not designated as normal purchases or normal sales. These derivatives were recorded at fair value on the balance sheet with the gain or loss for changes in fair value recorded through Income from Discontinued Operations, Net of Income Taxes.

For the three and six months ended June 30, 2013 and 2012, the amount of the derivative gain (loss) for the retail electric and natural gas supply businesses of Pepco Energy Services recognized in Income from Discontinued Operations, Net of Income Taxes is provided in the table below:


	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
	*(millions of dollars)*
Reclassification of mark-to-market to realized on settlement of contracts	$	5	$	7	$	10	$	17
Unrealized mark-to-market gain (loss)		—		5		—		(5	)

Total net (loss) gain	$	5	$	12	$	10	$	12

As of June 30, 2013, the retail electric and natural gas supply businesses of Pepco Energy Services had no outstanding commodity forward contracts or derivative positions.

As of December 31, 2012, the retail electric and natural gas supply businesses of Pepco Energy Services had the following net outstanding commodity forward contract quantities and net position on derivatives that did not qualify for hedge accounting:


	December 31, 2012
Commodity	Quantity		Net Position
Natural gas (MMBtu)		2,867,500	Long
Financial transmission rights (MWh)		181,008	Long
Electricity (MWh)		261,240	Long