Derivative Instruments

Derivative financial instruments are used to manage exposure to commodity price risk. These risks are managed in part by entering into forward commodity transactions, including options, swaps, and futures. To mitigate credit risk from counterparties in the event of nonperformance, master netting agreements are used whenever possible and counterparties may be required to pledge collateral depending on the creditworthiness of each counterparty and the risk associated with the transaction.

Commodity Price Risk

Commodity price risk represents the potential impact that can be caused by a change in the market value of a particular commodity. 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 PPAs. SCE's natural gas price exposure arises from natural gas purchased for the Mountainview power plant and peaker plants, qualifying facility contracts where pricing is based on a monthly natural gas index, and PPAs in which SCE has agreed to provide the natural gas needed for generation, referred to as tolling arrangements.

Credit and Default Risk

Credit and default risk represent the potential impact that can be caused if a counterparty were to default on its contractual obligations and SCE would be exposed to 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 the sales of excess power and realized gains on derivative instruments.

Certain power contracts contain master netting agreements or similar agreements, which generally allow counterparties subject to the agreement to offset amounts when certain criteria are met, such as in the event of default. The objective of netting is to reduce credit exposure. Additionally, to reduce SCE's risk exposures counterparties may be required to pledge collateral depending on the creditworthiness of each counterparty and the risk associated with the transaction.

Certain power contracts contain a provision that requires SCE to maintain an investment grade 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 post additional collateral to cover derivative liabilities and the related outstanding payables. The net fair value of all derivative liabilities with these credit-risk-related contingent features was $2 million and $12 million as of September 30, 2017 and December 31, 2016, respectively, for which SCE has posted $15 million and $12 million collateral at September 30, 2017 and December 31, 2016, respectively, to its counterparties for its derivative liabilities and related outstanding payables. If the credit-risk-related contingent features underlying these agreements were triggered on September 30, 2017, SCE would be required to post $15 million of additional collateral of which $13 million is related to outstanding payables that are net of collateral already posted.

Fair Value of Derivative Instruments

SCE presents its derivative assets and liabilities on a net basis on its consolidated balance sheets when subject to master netting agreements or similar agreements. Derivative positions are offset against margin and cash collateral deposits. In addition, SCE has provided collateral in the form of letters of credit. Collateral requirements can vary depending upon the level of unsecured credit extended by counterparties, changes in market prices relative to contractual commitments, and other factors. See Note 4 for a discussion of fair value of derivative instruments. The following table summarizes the gross and net fair values of SCE's commodity derivative instruments:



	September 30, 2017
	Derivative Assets								Derivative Liabilities								Net Asset
(in millions)	Short-Term			Long-Term		Subtotal			Short-Term			Long-Term		Subtotal²			Net Asset
Commodity derivative contracts
Gross amounts recognized	$	37		$	2	$	39		$	4		$	—	$	4		$	35
Gross amounts offset in the consolidated balance sheets	(1		)	—		(1		)	(1		)	—		(1		)	—
Cash collateral posted¹	—			—		—			—			—		—			—
Net amounts presented in the consolidated balance sheets	$	36		$	2	$	38		$	3		$	—	$	3		$	35



	December 31, 2016
	Derivative Assets								Derivative Liabilities								Net Liability
(in millions)	Short-Term			Long-Term		Subtotal			Short-Term			Long-Term		Subtotal			Net Liability
Commodity derivative contracts
Gross amounts recognized	$	74		$	1	$	75		$	217		$	941	$	1,158		$	1,083
Gross amounts offset in the consolidated balance sheets	(1		)	—		(1		)	(1		)	—		(1		)	—
Cash collateral posted¹	—			—		—			—			—		—			—
Net amounts presented in the consolidated balance sheets	$	73		$	1	$	74		$	216		$	941	$	1,157		$	1,083


¹	In addition, at September 30, 2017 and December 31, 2016, SCE had received $1 million and $2 million, respectively, of collateral that is not offset against derivative assets and is reflected in "Other current liabilities" on the consolidated balance sheets.


²	During the third quarter of 2017, SCE designated certain derivative contracts as normal purchase and normal sale contracts, which resulted in a reclassification of $914 million from derivative liabilities to other liabilities. These liabilities will be amortized over the remaining contract terms.

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 purchased 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 remaining effects 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 SCE's economic hedging activity:



	Three months ended September 30,						Nine months ended September 30,
(in millions)	2017			2016			2017			2016
Realized losses	$	(3	)	$	(1	)	$	(8	)	$	(53	)
Unrealized gains (losses)	116			(2		)	37			6

Notional Volumes of Derivative Instruments

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



		Economic Hedges
Commodity	Unit of Measure	September 30, 2017	December 31, 2016
Electricity options, swaps and forwards	GWh	874	1,816
Natural gas options, swaps and forwards	Bcf	137	36
Congestion revenue rights	GWh	74,849	93,319
Tolling arrangements	GWh	—	61,093