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, QF 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 $3 million and $1 million as of June 30, 2018 and December 31, 2017, respectively, for which SCE has posted no collateral and less than $1 million collateral at June 30, 2018 and December 31, 2017, 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 June 30, 2018, SCE would be required to post $5 million of additional collateral of which $1 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 also 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:



	June 30, 2018
	Derivative Assets								Derivative Liabilities								Net Assets
(in millions)	Short-Term			Long-Term		Subtotal			Short-Term			Long-Term		Subtotal			Net Assets
Commodity derivative contracts
Gross amounts recognized	$	89		$	3	$	92		$	10		$	—	$	10		$	82
Gross amounts offset in the consolidated balance sheets	(4		)	—		(4		)	(4		)	—		(4		)	—
Cash collateral posted	—			—		—			(2		)	—		(2		)	2
Net amounts presented in the consolidated balance sheets	$	85		$	3	$	88		$	4		$	—	$	4		$	84



	December 31, 2017
	Derivative Assets								Derivative Liabilities								Net Assets
(in millions)	Short-Term			Long-Term		Subtotal			Short-Term			Long-Term		Subtotal			Net Assets
Commodity derivative contracts
Gross amounts recognized	$	106		$	5	$	111		$	3		$	—	$	3		$	108
Gross amounts offset in the consolidated balance sheets	(1		)	—		(1		)	(1		)	—		(1		)	—
Cash collateral posted	—			—		—			(1		)	—		(1		)	1
Net amounts presented in the consolidated balance sheets	$	105		$	5	$	110		$	1		$	—	$	1		$	109

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 reported 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 June 30,						Six months ended June 30,
(in millions)	2018			2017			2018			2017
Realized losses	$	(8	)	$	(3	)	$	(20	)	$	(5	)
Unrealized (losses) gains	(12		)	6			(26		)	(80		)

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	June 30, 2018	December 31, 2017
Electricity options, swaps and forwards	GWh	2,015	475
Natural gas options, swaps and forwards	Bcf	141	143
Congestion revenue rights	GWh	48,673	78,765