Derivative Instruments and Hedging Activities

9 Months Ended

Sep. 30, 2014

Derivative Instruments and Hedging Activities

(13) 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 to limit its customers’ exposure to increases in the market price of natural gas under a hedging program approved by the DPSC. DPL uses these derivatives to manage the commodity price risk associated with its physical natural gas purchase contracts. All premiums paid and other transaction costs incurred as part of DPL’s natural gas hedging activity, in addition to all gains and losses related to hedging activities, are deferred under FASB guidance on regulated operations (ASC 980) until recovered from its customers through a fuel adjustment clause approved by the DPSC. The natural gas purchase contracts qualify as normal purchases, which are not required to be recorded in the financial statements until settled. In addition, included in derivative assets are PHI Preferred Stock derivatives which are further described in Note (12), “Preferred Stock.”

The tables below identify the balance sheet location and fair values of derivative instruments as of September 30, 2014 and December 31, 2013:

	As of September 30, 2014
Balance Sheet Caption	Derivatives Designated as Hedging Instruments		Other Derivative Instruments			Gross Derivative Instruments			Effects of Cash Collateral and Netting		Net Derivative Instruments
	(millions of dollars)
Derivative assets (current assets)	$	—	$	3		$	3		$	—	$	3
Total Derivative asset		—		3			3			—		3
Derivative liabilities (current liabilities)		—		(1	)		(1	)		1		—
Total Derivative liability		—		(1	)		(1	)		1		—
Net Derivative asset	$	—	$	2		$	2		$	1	$	3

	As of December 31, 2013
Balance Sheet Caption	Derivatives Designated as Hedging Instruments		Other Derivative Instruments		Gross Derivative Instruments		Effects of Cash Collateral and Netting			Net Derivative Instruments
	(millions of dollars)
Derivative assets (current assets)	$	—	$	1	$	1	$	(1	)	$	—
Total Derivative asset	$	—	$	1	$	1	$	(1	)	$	—

All derivative assets and liabilities available to be offset under master netting arrangements were netted as of September 30, 2014 and December 31, 2013. The amount of cash collateral that was offset against these derivative positions is as follows:

	September 30, 2014		December 31, 2013
	(millions of dollars)
Cash collateral pledged to counterparties with the right to reclaim (a)	$	1	$	—
Cash collateral received from counterparties with the obligation to return		—		(1	)

(a) Includes cash deposits on commodity brokerage accounts.

As of September 30, 2014 and December 31, 2013, all PHI cash collateral pledged related to derivative instruments accounted for at fair value was entitled to be offset under master netting agreements.

Derivatives Designated as Hedging Instruments

Cash Flow Hedges

Cash Flow Hedges Included in Accumulated Other Comprehensive Loss

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

The tables below provide details regarding terminated cash flow hedges included in PHI’s consolidated balance sheets as of September 30, 2014 and 2013. The data in the following tables indicate the cumulative net loss after-tax related to terminated 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 September 30, 2014				Maximum Term
Contracts	Accumulated Other Comprehensive Loss After-tax		Portion Expected to be  Reclassified to Income during the Next 12 Months
	(millions of dollars)
Interest rate	$	9	$	1	215 months
Total	$	9	$	1

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

Other Derivative Activity

PHI, DPL and ACE have certain derivatives that are not in hedge accounting relationships and are not designated as normal purchases or normal sales. These derivatives are recorded at fair value on the consolidated balance sheets with the gain or loss for changes in fair value recorded in income. In addition, in accordance with FASB guidance on regulated operations, regulatory liabilities or regulatory assets of the same amount are recorded on the consolidated balance sheets and the recognition of the derivative gain or loss is deferred because of the DPSC-approved fuel adjustment clause for DPL’s derivatives and the NJBPU order pertaining to the ACE SOCA derivatives. The following table shows the net unrealized and net realized derivative gains and losses arising during the period associated with these derivatives that were recognized in the consolidated statements of income (loss) (through Fuel and purchased energy expense) and that were also deferred as Regulatory liabilities and Regulatory assets, respectively, for the three and nine months ended September 30, 2014 and 2013:

	Three Months  Ended September 30,					Nine Months  Ended September 30,
	2014			2013		2014		2013
	(millions of dollars)
Net unrealized (losses) gains arising during the period	$	(1	)	$	—	$	1	$	(7	)
Net realized gains (losses) recognized during the period		—			—		3		(3	)

As of September 30, 2014 and December 31, 2013, the quantities and net positions of DPL’s net outstanding natural gas commodity forward contracts that did not qualify for hedge accounting were:

	September 30, 2014			December 31, 2013
Commodity	Quantity		Net Position	Quantity		Net Position
DPL – Natural gas (One Million British Thermal Units (MMBtu))		3,805,000	Long		3,977,500	Long

In addition, PHI recorded derivative assets for the embedded call and redemption features on the shares of Preferred Stock as further described in Note (12), “Preferred Stock.”

Contingent Credit Risk Features

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

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

The gross fair values of DPL’s derivative liabilities with credit risk-related contingent features as of September 30, 2014 and December 31, 2013 were zero.

DPL’s primary source for posting cash collateral or letters of credit is PHI’s credit facility. As of September 30, 2014 and December 31, 2013, the aggregate amount of cash plus borrowing capacity under the credit facility available to meet the future liquidity needs of PHI’s utility subsidiaries was $885 million and $332 million, respectively.

Delmarva Power & Light Co/De [Member]

Derivative Instruments and Hedging Activities

(11) DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

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

The tables below identify the balance sheet location and fair values of derivative instruments as of September 30, 2014 and December 31, 2013:

	As of September 30, 2014
Balance Sheet Caption	Derivatives Designated as Hedging Instruments		Other Derivative Instruments			Gross Derivative Instruments			Effects of Cash Collateral and Netting		Net Derivative Instruments
	(millions of dollars)
Derivative liabilities (current liabilities)	$	—	$	(1	)	$	(1	)	$	1	$	—
Total Derivative liability	$	—	$	(1	)	$	(1	)	$	1	$	—

	As of December 31, 2013
Balance Sheet Caption	Derivatives Designated as Hedging Instruments		Other Derivative Instruments		Gross Derivative Instruments		Effects of Cash Collateral and Netting			Net Derivative Instruments
	(millions of dollars)
Derivative assets (current assets)	$	—	$	1	$	1	$	(1	)	$	—
Total Derivative asset	$	—	$	1	$	1	$	(1	)	$	—

All derivative assets and liabilities available to be offset under master netting arrangements were netted as of September 30, 2014 and December 31, 2013. The amount of cash collateral that was offset against these derivative positions is as follows:

	September 30, 2014		December 31, 2013
	(millions of dollars)
Cash collateral pledged to counterparties with the right to reclaim (a)	$	1	$	—
Cash collateral received from counterparties with the obligation to return		—		(1	)

(a) Includes cash deposits on commodity brokerage accounts

As of September 30, 2014 and December 31, 2013, all DPL cash collateral pledged related to derivative instruments accounted for at fair value was entitled to be offset under master netting agreements.

Other Derivative Activity

DPL has certain derivatives that are not in hedge accounting relationships and are not designated as normal purchases or normal sales. These derivatives are recorded at fair value on the balance sheets with the gain or loss for changes in the fair value recorded in income. In addition, in accordance with FASB guidance on regulated operations, regulatory liabilities or regulatory assets of the same amount 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. The following table shows the net unrealized and net realized derivative gains and losses arising during the period associated with these derivatives that were recognized in the statements of income (through Purchased energy and Gas purchased expense) and that were also deferred as Regulatory liabilities and Regulatory assets, respectively, for the three and nine months ended September 30, 2014 and 2013:

	Three Months  Ended September 30,					Nine Months  Ended September 30,
	2014			2013		2014		2013
	(millions of dollars)
Net unrealized (losses) gains arising during the period	$	(1	)	$	—	$	1	$	—
Net realized gains (losses) recognized during the period		—			—		3		(3	)

As of September 30, 2014 and December 31, 2013, the quantities and net positions of DPL’s net outstanding natural gas commodity forward contracts that did not qualify for hedge accounting were:

	September 30, 2014			December 31, 2013
Commodity	Quantity		Net Position	Quantity		Net Position
Natural gas (One Million British Thermal Units (MMBtu))		3,805,000	Long		3,977,500	Long

Contingent Credit Risk Features

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

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

The gross fair values of DPL’s derivative liabilities with credit-risk-related contingent features as of September 30, 2014 and December 31, 2013 were zero.

DPL’s primary source for posting cash collateral or letters of credit is PHI’s credit facility under which DPL is a borrower. As of September 30, 2014 and December 31, 2013, the aggregate amount of cash plus borrowing capacity under the credit facility available to meet the liquidity needs of PHI’s utility subsidiaries was $885 million and $332 million, respectively.