Derivative Instruments and Hedging Activities

Electric Utility

Commodity Price Risk

SCE is exposed to commodity price risk which represents the potential impact that can be caused by a change in the market value of a particular commodity. SCE's hedging program reduces customer exposure to variability in market prices related to SCE's power and gas activities. As part of this program, SCE enters into options, swaps, forwards, tolling arrangements and CRRs. These transactions are approved by the CPUC or executed in compliance with CPUC-approved procurement plans. SCE recovers its related hedging costs through the energy resource recovery account ("ERRA") balancing account, and as a result, exposure to commodity price risk is not expected to impact earnings, but may impact cash flows.

SCE's electricity price exposure arises from energy purchased from and sold to wholesale markets as a result of differences between SCE's load requirements and the amount of energy delivered from its generating facilities and power purchase agreements.

SCE's natural gas price exposure arises from natural gas purchased for the Mountainview power plant and peaker plants, QF contracts where pricing is based on a monthly natural gas index and power purchase agreements in which SCE has agreed to provide the natural gas needed for generation, referred to as tolling arrangements.

Notional Volumes of Derivative Instruments

The following table summarizes the notional volumes of derivatives used for hedging activities:



		Economic Hedges
Commodity	Unit of Measure	September 30, 2012	December 31, 2011
Electricity options, swaps and forwards	GWh	18,304	30,881
Natural gas options, swaps and forwards	Bcf	142	300
Congestion revenue rights	GWh	140,263	166,163
Tolling arrangements	GWh	102,123	104,154

Fair Value of Derivative Instruments

The following table summarizes the gross and net fair values of commodity derivative instruments at September 30, 2012:



	Derivative Assets									Derivative Liabilities¹
(in millions)	Short-Term			Long-Term			Subtotal			Short-Term			Long-Term			Subtotal			Net Liability
Non-trading activities
Economic hedges	$	55		$	80		$	135		$	177		$	1,002		$	1,179		$	1,044
Netting and collateral	(18		)	(6		)	(24		)	(49		)	(19		)	(68		)	(44		)
Total	$	37		$	74		$	111		$	128		$	983		$	1,111		$	1,000


¹	Includes the fair value of derivatives with SCE's consolidated affiliates; however, in Edison International’s consolidated financial statements, the fair value of such derivatives is eliminated.

The following table summarizes the gross and net fair values of commodity derivative instruments at December 31, 2011:



	Derivative Assets									Derivative Liabilities
(in millions)	Short-Term			Long-Term			Subtotal			Short-Term			Long-Term			Subtotal			Net Liability
Non-trading activities
Economic hedges	$	86		$	85		$	171		$	303		$	856		$	1,159		$	988
Netting and collateral	(21		)	(15		)	(36		)	(37		)	(51		)	(88		)	(52		)
Total	$	65		$	70		$	135		$	266		$	805		$	1,071		$	936

Income Statement Impact of Derivative Instruments

SCE recognizes realized gains and losses on derivative instruments as purchased power expense and expects that such gains or losses will be part of the purchase power costs recovered from customers. As a result, realized gains and losses do not affect earnings, but may temporarily affect cash flows. Due to expected future recovery from customers, unrealized gains and losses are recorded as regulatory assets and liabilities and therefore also do not affect earnings. The results of derivative activities and related regulatory offsets are recorded in cash flows from operating activities in the consolidated statements of cash flows.

The following table summarizes the components of economic hedging activity:



	Three months ended September 30,						Nine months ended September 30,
(in millions)	2012			2011			2012			2011
Realized gains (losses)	$	(77	)	$	(58	)	$	(199	)	$	(132	)
Unrealized gains (losses)	(91		)	(110		)	(29		)	(433		)

Contingent Features/Credit Related Exposure

Certain derivative instruments and power procurement contracts under SCE's power and natural gas hedging activities contain collateral requirements. SCE has provided collateral in the form of cash and/or letters of credit for the benefit of counterparties. These requirements can vary depending upon the level of unsecured credit extended by counterparties, changes in market prices relative to contractual commitments and other factors.

Certain of these power contracts contain a provision that requires SCE to maintain an investment grade credit rating from each of the major credit rating agencies, referred to as a credit-risk-related contingent feature. If SCE's credit rating were to fall below investment grade, SCE may be required to pay the derivative liability or post additional collateral. The aggregate fair value of all derivative liabilities with these credit-risk-related contingent features was $113 million and $216 million as of September 30, 2012 and December 31, 2011, respectively, for which SCE has posted no collateral to its counterparties for the respective periods. If the credit-risk-related contingent features underlying these agreements were triggered on September 30, 2012, SCE would be required to post $25 million of collateral.

Counterparty Default Risk Exposure

As part of SCE's procurement activities, SCE contracts with a number of utilities, energy companies, financial institutions and other companies, collectively referred to as counterparties. If a counterparty were to default on its contractual obligations, SCE could be exposed to potentially volatile spot markets for buying replacement power or selling excess power. In addition, SCE would be exposed to the risk of non-payment of accounts receivable, primarily related to sales of excess energy and realized gains on derivative instruments. Substantially all of the contracts that SCE has executed with counterparties are either entered into under SCE's procurement plan which has been pre-approved by the CPUC, or the contracts are approved by the CPUC before becoming effective. As a result of regulatory recovery mechanisms, losses from non-performance are not expected to affect earnings, but may temporarily affect cash flows.

To manage credit risk, SCE looks at the risk of a potential default by counterparties. Credit risk is measured by the loss that would be incurred if counterparties failed to perform pursuant to the terms of their contractual obligations. To mitigate credit risk from counterparties, master netting agreements are used whenever possible and counterparties may be required to pledge collateral when deemed necessary.

Competitive Power Generation

EMG's subsidiary, EME uses derivative instruments to reduce its exposure to market risks that arise from price fluctuations of electricity, capacity, fuel, emission allowances, transmission rights and interest rates. The derivative financial instruments vary in duration, ranging from a few days to several years, depending upon the instrument. To the extent that EME does not use derivative instruments to hedge these market risks, the unhedged portions will be subject to the risks and benefits of spot market price movements.

Risk management positions may be designated as cash flow hedges or economic hedges, which are derivatives that are not designated as cash flow hedges. Economic hedges are accounted for at fair value on the consolidated balance sheets as derivative assets or liabilities with offsetting changes recorded on the consolidated statements of operations. For derivative instruments that qualify for hedge accounting treatment, the fair value is recognized on the consolidated balance sheets as derivative assets or liabilities with offsetting changes in fair value, to the extent effective, recognized in accumulated other comprehensive loss until reclassified into earnings when the related forecasted transaction occurs. The portion of a cash flow hedge that does not offset the change in the fair value of the transaction being hedged, which is commonly referred to as the ineffective portion, is immediately recognized in earnings.

Derivative instruments that are utilized for trading purposes are measured at fair value and included on the consolidated balance sheets as derivative assets or liabilities, with offsetting changes recognized in operating revenues on the consolidated statements of operations.

The results of derivative activities are recorded in cash flows from operating activities on the consolidated statements of cash flows.

Where EME's derivative instruments are subject to a master netting agreement and the criteria of authoritative guidance are met, derivative assets and liabilities are presented on a net basis on the consolidated balance sheets.

Notional Volumes of Derivative Instruments

The following table summarizes the notional volumes of derivatives used for hedging and trading activities:



September 30, 2012
				Hedging Activities
Commodity	Instrument	Classification	Unit of Measure	Cash Flow Hedges	Economic Hedges		Trading Activities
Electricity	Forwards/Futures	Sales, net	GWh	5,644	58	2	—
Electricity	Forwards/Futures	Purchases, net	GWh	—	—		550
Electricity	Capacity	Purchases, net	GW-Day	—	—		97	1
Electricity	Congestion	Purchases, net	GWh	—	241	3	281,251	3
Natural gas	Forwards/Futures	Sales, net	bcf	—	—		0.4
Fuel oil	Forwards/Futures	Sales, net	barrels	—	—		100,000
Fuel oil	Forwards/Futures	Purchases, net	barrels	—	120,000		—

At September 30, 2012, EME had interest rate contracts with notional values totaling $727 million that converted floating rate LIBOR-based debt to fixed rates ranging from 0.79% to 4.29%. These contracts expire May 2013 through March 2026. In addition, at September 30, 2012, EME had forward starting interest rate contracts with notional values totaling $641 million that will convert floating rate LIBOR-based debt to fixed rates ranging from 0.7825% to 4.0025%. These contracts have effective dates beginning December 2012 through December 2021 and expire December 2013 through December 2029.



December 31, 2011
				Hedging Activities
Commodity	Instrument	Classification	Unit of Measure	Cash Flow Hedges		Economic Hedges		Trading Activities
Electricity	Forwards/Futures	Sales, net	GWh	8,320		335	2	—
Electricity	Forwards/Futures	Purchases, net	GWh	—		—		2,926
Electricity	Capacity	Sales, net	GW-Day	61	1	—		—
Electricity	Capacity	Purchases, net	GW-Day	—		—		184	1
Electricity	Congestion	Purchases, net	GWh	—		1,261	3	230,798	3
Natural gas	Forwards/Futures	Sales, net	bcf	—		—		0.2
Fuel oil	Forwards/Futures	Purchases, net	barrels	—		240,000		—


¹	EME's hedge transactions for capacity result from bilateral trades. Capacity sold in the PJM Interconnection, LLC Reliability Pricing Model (PJM RPM) auction is not accounted for as a derivative.


²	These positions adjust financial and physical positions, or day-ahead and real-time positions, to reduce costs or increase gross margin. The net sales positions of these categories are primarily related to hedge transactions that are not designated as cash flow hedges.


³	Congestion contracts include financial transmission rights, transmission congestion contracts or congestion revenue rights. These positions are similar to a swap, where the buyer is entitled to receive a stream of revenues (or charges) based on the hourly day-ahead price differences between two locations.

At December 31, 2011, EME had interest rate contracts with notional values totaling $644 million that converted floating rate LIBOR-based debt to fixed rates ranging from 0.79% to 4.29%. These contracts expire May 2013 through March 2026. In addition, EME had forward starting interest rate contracts with notional values totaling $506 million that will convert floating rate LIBOR-based debt to fixed rates of 3.5429%, 3.57% and 4.0025%. These contracts have effective dates of June 2013 and December 2021 and expire May 2023 and December 2029.

Fair Value of Derivative Instruments

The following table summarizes the fair value of derivative instruments reflected on EME's consolidated balance sheets:



September 30, 2012
	Derivative Assets									Derivative Liabilities
(in millions)	Short-term			Long-term			Subtotal			Short-term			Long-term			Subtotal			Net Assets (Liabilities)
Non-trading activities
Cash flow hedges
Commodity contracts	$	14		$	2		$	16		$	9		$	1		$	10		$	6
Interest rate contracts	—			—			—			—			125			125			(125		)
Economic hedges	25			1			26			23			1			24			2
Trading activities	321			145			466			265			98			363			103
	360			148			508			297			225			522			(14		)
Netting and collateral received¹	(321		)	(105		)	(426		)	(296		)	(100		)	(396		)	(30		)
Total	$	39		$	43		$	82		$	1		$	125		$	126		$	(44	)



December 31, 2011
	Derivative Assets									Derivative Liabilities
(in millions)	Short-term			Long-term			Subtotal			Short-term			Long-term			Subtotal			Net Assets (Liabilities)
Non-trading activities
Cash flow hedges
Commodity contracts	$	40		$	1		$	41		$	2		$	—		$	2		$	39
Interest rate contracts	—			—			—			—			90			90			(90		)
Economic hedges	24			—			24			20			—			20			4
Trading activities	277			142			419			232			79			311			108
	341			143			484			254			169			423			61
Netting and collateral received¹	(301		)	(81		)	(382		)	(253		)	(79		)	(332		)	(50		)
Total	$	40		$	62		$	102		$	1		$	90		$	91		$	11


¹	Netting of derivative receivables and derivative payables and the related cash collateral received and paid is permitted when a legally enforceable master netting agreement exists with a derivative counterparty.

Income Statement Impact of Derivative Instruments

The following table provides the cash flow hedge activity as part of accumulated other comprehensive loss:



	Cash Flow Hedge Activity¹
	Nine months ended September 30,
	2012						2011
(in millions)	Commodity Contracts			Interest Rate Contracts			Commodity Contracts			Interest Rate Contracts			Income Statement Location
Beginning of period derivative gains (losses)	$	35		$	(90	)	$	43		$	(16	)
Effective portion of changes in fair value	3			(35		)	2			(64		)
Reclassification to earnings	(31		)	—			(29		)	—			Competitive power generation revenue
End of period derivative gains (losses)	$	7		$	(125	)	$	16		$	(80	)


¹	Unrealized derivative gains (losses) are before income taxes. The after-tax amounts recorded in accumulated other comprehensive loss at September 30, 2012 and 2011 for commodity and interest rate contracts were $7 million and $(79) million, and $10 million and $(49) million, respectively.

For additional information, see Note 11.

EME recorded gains (losses) of $(2) million and $2 million during the three months ended September 30, 2012 and 2011, respectively, and gains of none and $2 million during the nine months ended September 30, 2012 and 2011, respectively, in operating revenues on the consolidated statements of income representing the amount of cash flow hedge ineffectiveness.

The effect of realized and unrealized gains (losses) from derivative instruments used for economic hedging and trading purposes on the consolidated statements of operations is presented below:



		Three months ended September 30,					Nine months ended September 30,
(in millions)	Income Statement Location	2012		2011			2012		2011
Economic hedges	Competitive power generation revenues	$	8	$	(3	)	$	25	$	5
	Fuel	3		(3		)	2		1
Trading activities	Competitive power generation revenues	22		11			72		68

Contingent Features

Certain derivative instruments contain margin and collateral deposit requirements. Since EME's and its subsidiaries' credit ratings are below investment grade, EME and its subsidiaries have provided collateral in the form of cash and letters of credit for the benefit of derivative counterparties.

Margin and Collateral Deposits

Margin and collateral deposits include cash deposited with counterparties and brokers, and cash received from counterparties and brokers as credit support under energy contracts. The amount of margin and collateral deposits generally varies based on changes in the fair value of the related positions. Edison International nets counterparty receivables and payables where balances exist under master netting agreements. Edison International presents the portion of its margin and collateral deposits netted with its derivative positions on its consolidated balance sheets. The following table summarizes margin and collateral deposits provided to and received from counterparties:



(in millions)	September 30, 2012		December 31, 2011
Collateral provided to counterparties:
Offset against derivative liabilities	$	54	$	53
Reflected in margin and collateral deposits	88		58
Collateral received from counterparties:
Offset against derivative assets	39		53