Derivative Instruments and Hedging Activities

3 Months Ended

Sep. 30, 2011

DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

5. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

Risk Management Objectives

The Company is exposed to market risks associated with its enterprise-wide business activities, namely the purchase and sale of fuel and electricity as well as foreign currency risk and interest rate risk. In order to manage the market risks associated with these business activities, we enter into contracts that incorporate derivatives and financial instruments, including forwards, futures, options, swaps or combinations thereof, as appropriate. The Company generally applies hedge accounting to contracts as long as they are eligible under the accounting standards for derivatives and hedging. While derivative transactions are not entered into for trading purposes, some contracts are not eligible for hedge accounting.

Interest Rate Risk

AES and its subsidiaries utilize variable rate debt financing for construction projects and operations, resulting in an exposure to interest rate risk. Interest rate swap, cap and floor agreements are entered into to manage interest rate risk by effectively fixing or limiting the interest rate exposure on the underlying financing. These interest rate contracts range in maturity through 2030, and are typically designated as cash flow hedges. The following table sets forth, by underlying type of interest rate index, the Company's current and maximum outstanding notional under its interest rate derivative instruments, the weighted average remaining term and the percentage of variable-rate debt hedged that is based on the related index as of September 30, 2011 regardless of whether the derivative instruments are in qualifying cash flow hedging relationships:

		September 30, 2011
		Current			Maximum(1)
			Derivative			Derivative		Weighted	% of Debt
			Notional			Notional		Average	Currently
		Derivative	Translated		Derivative	Translated		Remaining	Hedged
Interest Rate Derivatives		Notional	to USD		Notional	to USD		Term(1)	by Index(2)
		(in millions)						(in years)
Libor (U.S. Dollar)		3,511	$	3,511	3,585	$	3,585	9	75%
Euribor (Euro)		1,072		1,435	1,072		1,435	13	66%
Libor (British Pound Sterling)		63		98	72		112	12	87%
Securities Industry and Financial
	Markets Association Municipal
	Swap Index (U.S. Dollar)	40		40	40		40	11	N/A(3)

(1)       The Company's interest rate derivative instruments primarily include accreting and amortizing notionals. The maximum derivative notional represents the largest notional at any point between September 30, 2011 and the maturity of the derivative instrument, which includes forward starting derivative instruments. The weighted average remaining term represents the remaining tenor of our interest rate derivatives weighted by the corresponding maximum notional.

(2)       Excludes variable-rate debt tied to other indices where the Company has no interest rate derivatives.

(3)       The debt that was being hedged is no longer exposed to variable interest payments because it is now held on IPL's behalf and no longer bears interest.

Cross currency swaps are utilized in certain instances to manage the risk related to fluctuations in both interest rates and certain foreign currencies. These cross currency contracts range in maturity through 2028. The following table sets forth, by type of foreign currency denomination, the Company's outstanding notionalamount under its cross currency derivative instruments as of September 30, 2011, which are all in qualifying cash flow hedge relationships. These swaps are amortizing and therefore the notional amount represents the maximum outstanding notional amount as of September 30, 2011:

	September 30, 2011
				Weighted	% of Debt
		Notional		Average	Currently
		Translated		Remaining	Hedged
Cross Currency Swaps	Notional	to USD		Term(1)	by Index(2)
	(in millions)			(in years)
Chilean Unidad de Fomento (CLF)	6	$	237	14	83%

(1)        Represents the remaining tenor of our cross currency swaps weighted by the corresponding notional.

(2)       Represents the proportion of foreign currency denominated debt hedged by the same foreign currency denominated notional of the cross currency swap.

Foreign Currency Risk

We are exposed to foreign currency risk as a result of our investments in foreign subsidiaries and affiliates. AES operates businesses in many foreign countries and such operations may be impacted by significant fluctuations in foreign currency exchange rates. Foreign currency options and forwards are utilized, where deemed appropriate, to manage the risk related to fluctuations in certain foreign currencies. These foreign currency contracts range in maturity through 2015. The following tables set forth, by type of foreign currency denomination, the Company's outstanding notional amounts over the remaining terms of its foreign currency derivative instruments as of September 30, 2011 regardless of whether the derivative instruments are in qualifying hedging relationships:

	September 30, 2011
						Weighted
		Notional		Probability		Average
		Translated		Adjusted		Remaining
Foreign Currency Options	Notional	to USD(1)		Notional(2)		Term(3)
	(in millions)					(in years)
Brazilian Real (BRL)	173	$	105	$	96	<1
Euro (EUR)	67		96		82	<1
British Pound (GBP)	29		47		40	<1
Argentine Peso (ARS)	88		20		8	<1

(1)       Represents contractual notionals at inception of trade.

(2)       Represents the gross notional amounts times the probability of exercising the option, which is based on the relationship of changes in the option value with respect to changes in the price of the underlying currency.

(3)       Represents the remaining tenor of our foreign currency options weighted by the corresponding notional.

	September 30, 2011
		Notional		Weighted Average
Foreign Currency Forwards	Notional	Translated to USD		Remaining Term(1)
	(in millions)			(in years)
Chilean Peso (CLP)	98,944	$	201	<1
Euro (EUR)	123		169	2
Colombian Peso (COP)	80,376		44	<1
British Pound (GBP)	11		17	1
Argentine Peso (ARS)	61		13	1

(1)       Represents the remaining tenor of our foreign currency forwards weighted by the corresponding notional.

In addition, certain of our subsidiaries have entered into contracts which contain embedded derivatives that require separate valuation and accounting due to the fact that the item being purchased or sold is denominated in a currency other than the functional currency of that subsidiary or the currency of the item. These contracts range in maturity through 2025. The following table sets forth, by type of foreign currency denomination, the Company's outstanding notional over the remaining terms of its foreign currency embedded derivative instruments as of September 30, 2011:

	September 30, 2011
		Notional		Weighted Average
Embedded Foreign Currency Derivatives	Notional	Translated to USD		Remaining Term(1)
	(in millions)			(in years)
Philippine Peso (PHP)	15,973	$	363	2
Argentine Peso (ARS)	904		215	11
Kazakhstani Tenge (KZT)	30,606		207	9
Hungarian Forint (HUF)	10,114		46	<1
Euro (EUR)	20		27	2
Brazilian Real (BRL)	4		2	1

(1)        Represents the remaining tenor of our foreign currency embedded derivatives weighted by the corresponding notional.

Commodity Price Risk

We are exposed to the impact of market fluctuations in the price of electricity, fuel and environmental credits. Although we primarily consist of businesses with long-term contracts or retail sales concessions (which provide our distribution businesses with a franchise to serve a specific geographic region), a portion of our current and expected future revenues are derived from businesses without significant long-term purchase or sales contracts. These businesses subject our results of operations to the volatility of prices for electricity, fuel and environmental credits in competitive markets. We have used a hedging strategy, where appropriate, to hedge our financial performance against the effects of fluctuations in energy commodity prices. The implementation of this strategy can involve the use of PPAs, fuel supply agreements, commodity forward contracts, futures, swaps and options. Some of our businesses hedge certain aspects of their commodity risks using financial hedging instruments.

The PPAs and fuel supply agreements entered into by the Company are evaluated to determine if they meet the definition of a derivative or contain embedded derivatives, either of which requires separate valuation and accounting. To be a derivative under the accounting standards for derivatives and hedging, an agreement would need to have a notional and an underlying, require little or no initial net investment and could be net settled. Generally, these agreements do not meet the definition of a derivative, often due to the inability to be net settled. On a quarterly basis, we evaluate the markets for the commodities to be delivered under these agreements to determine if facts and circumstances have changed such that the agreements could then be net settled and meet the definition of a derivative.

Nonetheless, certain of the PPAs and fuel supply agreements entered into by certain of the Company's subsidiaries are derivatives or contain embedded derivatives requiring separate valuation and accounting. These contracts range in maturity through 2024. The following table sets forth, by type of commodity, the Company's outstanding notionals for the remaining term of its commodity derivatives and embedded derivative instruments as of September 30, 2011:

	September 30, 2011
		Weighted Average
Commodity Derivatives	Notional	Remaining Term(1)
	(in millions)	(in years)
Natural gas (MMBTU)	33	11
Aluminum (MWh)	16(2)	8
Petcoke (Metric tons)	13	13

• Represents the remaining tenor of our commodity and embedded derivatives weighted by the corresponding volume.
• Sonel's PPA with its primary offtaker, an aluminum smelter, contains an embedded derivative which reflects the linkage of our energy contract pricing, in part, to the price of aluminum as quoted on the London Metals Exchange, a global metals market maker (as required by contract).While the linkage between the contract price of power based on forecasted forward aluminum price curves and the Cameroon market price for power provides for economic alignment between Sonel's financial results under the PPA and the offtaker's financial performance, to the extent there are fluctuations in the price of aluminum as compared to the market price for power under our PPA, we may be exposed to significant swings in earnings through mark-to-market adjustments of the embedded derivative as the market price for aluminum has proven to be volatile.

Accounting and Reporting

The following table sets forth the Company's derivative instruments as of September 30, 2011 and December 31, 2010 by type of derivative and by level within the fair value hierarchy. Derivative assets and liabilities are recognized at their fair value. Derivative assets and liabilities are combined with other balances and included in the following captions in our condensed consolidated balance sheets: current derivative assets in other current assets, noncurrent derivative assets in other noncurrent assets, current derivative liabilities in accrued and other liabilities and long-term derivative liabilities in other long-term liabilities.

				September 30, 2011								December 31, 2010
				Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
				(in millions)								(in millions)
Assets
Current assets:
	Foreign currency derivatives			$	-	$	48	$	4	$	52	$	-	$	4	$	3	$	7
	Commodity and other derivatives				-		-		5		5		-		2		3		5
		Total current assets			-		48		9		57		-		6		6		12
Noncurrent assets:
	Interest rate derivatives				-		-		-		-		-		49		-		49
	Cross currency derivatives				-		-		1		1		-		-		12		12
	Foreign currency derivatives				-		5		49		54		-		4		27		31
	Commodity and other derivatives				-		4		1		5		-		4		16		20
		Total noncurrent assets			-		9		51		60		-		57		55		112
			Total assets	$	-	$	57	$	60	$	117	$	-	$	63	$	61	$	124
Liabilities
Current liabilities:
	Interest rate derivatives			$	-	$	102	$	29	$	131	$	-	$	137	$	-	$	137
	Cross currency derivatives				-		-		5		5		-		-		2		2
	Foreign currency derivatives				-		6		1		7		-		13		-		13
	Commodity and other derivatives				-		5		3		8		-		-		-		-
		Total current liabilities			-		113		38		151		-		150		2		152
Long-term liabilities:
	Interest rate derivatives				-		294		162		456		-		246		1		247
	Cross currency derivatives				-		-		17		17		-		-		-		-
	Foreign currency derivatives				-		11		11		22		-		15		8		23
	Commodity and other derivatives				-		1		41		42		-		-		1		1
		Total long-term liabilities			-		306		231		537		-		261		10		271
			Total liabilities	$	-	$	419	$	269	$	688	$	-	$	411	$	12	$	423

The following table sets forth the fair value and balance sheet classification of derivative instruments as of September 30, 2011 and December 31, 2010:

		September 30, 2011						December 31, 2010
				Not						Not
		Designated		Designated				Designated		Designated
		as Hedging		as Hedging				as Hedging		as Hedging
		Instruments		Instruments		Total		Instruments		Instruments		Total
		(in millions)						(in millions)
Assets
Current assets:
	Foreign currency derivatives	$	17	$	35	$	52	$	-	$	7	$	7
	Commodity and other derivatives		-		5		5		-		5		5
	Total current assets		17		40		57		-		12		12
Noncurrent assets:
	Interest rate derivatives		-		-		-		49		-		49
	Cross currency derivatives		1		-		1		12		-		12
	Foreign currency derivatives		2		52		54		-		31		31
	Commodity and other derivatives		-		5		5		-		20		20
	Total noncurrent assets		3		57		60		61		51		112
Total assets		$	20	$	97	$	117	$	61	$	63	$	124
Liabilities
Current liabilities:
	Interest rate derivatives	$	126	$	5	$	131	$	126	$	11	$	137
	Cross currency derivatives		5		-		5		2		-		2
	Foreign currency derivatives		1		6		7		8		5		13
	Commodity and other derivatives		-		8		8		-		-		-
	Total current liabilities		132		19		151		136		16		152
Long-term liabilities:
	Interest rate derivatives		437		19		456		232		15		247
	Cross currency derivatives		17		-		17		-		-		-
	Foreign currency derivatives		-		22		22		-		23		23
	Commodity and other derivatives		-		42		42		-		1		1
	Total long-term liabilities		454		83		537		232		39		271
Total liabilities		$	586	$	102	$	688	$	368	$	55	$	423

The Company has elected not to offset net derivative positions in the financial statements. Accordingly, the Company does not offset such derivative positions against the fair value of amounts (or amounts that approximate fair value) recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) under master netting arrangements. At September 30, 2011 and December 31, 2010, we held no cash collateral that we received from counterparties to our derivative positions. As we have not received collateral, our derivative assets are exposed to the credit risk of the respective counterparty and, due to this credit risk, the fair values of our derivative assets (as shown in the above two tables) have been reduced by a credit valuation adjustment. Also, at September 30, 2011 and December 31, 2010, we had no cash collateral posted with (held by) counterparties to our derivative positions.

The table below sets forth the pre-tax accumulated other comprehensive income (loss) expected to be recognized as an increase (decrease) to income from continuing operations before income taxes over the next twelve months as of September 30, 2011 for the following types of derivatives:

	Accumulated
	Other Comprehensive
	Income (Loss)
	(in millions)
Interest rate derivatives	$	(116)
Cross currency derivatives	$	(1)
Foreign currency derivatives	$	16

The balance in accumulated other comprehensive loss related to derivative transactions will be reclassified into earnings as interest expense is recognized for interest rate hedges and cross currency swaps, as depreciation is recognized for interest rate hedges during construction, and as foreign currency gains and losses are recognized for hedges of foreign currency exposure. These balances are included in the condensed consolidated statements of cash flows as operating and/or investing activities based on the nature of the underlying transaction.

The following tables set forth the gains (losses) recognized in accumulated other comprehensive loss (“AOCL”) and earnings related to the effective portion of derivative instruments in qualifying cash flow hedging relationships, as defined in the accounting standards for derivatives and hedging, for the three and nine months ended September 30, 2011 and 2010:

		Gains (Losses)						Gains (Losses) Reclassified
		Recognized in AOCL						from AOCL into Earnings(1)
		Three Months				Classification in		Three Months
		Ended September 30,				Condensed Consolidated		Ended September 30,
		2011		2010		Statements of Operations		2011		2010
		(in millions)						(in millions)
Interest rate derivatives		$	(297)	$	(138)	Interest expense		$	(35) (2)	$	(24) (2)
						Non-regulated cost of sales			(1) (2)		(3) (2)
						Net equity in earnings of
							affiliates		(1)		(1)
Cross currency derivatives			(37)		24	Interest expense			(3)		-
						Foreign currency transaction
							gains (losses)		(26)		30
Foreign currency derivatives			29		(12)	Foreign currency transaction
							gains (losses)		3		1
Commodity and other
	derivatives		-		(4)	Non-regulated cost of sales			(2)		-
Total		$	(305)	$	(130)			$	(65)	$	3

		Gains (Losses)						Gains (Losses) Reclassified
		Recognized in AOCL						from AOCL into Earnings(1)
		Nine Months				Classification in		Nine Months
		Ended September 30,				Condensed Consolidated		Ended September 30,
		2011		2010		Statements of Operations		2011		2010
		(in millions)						(in millions)
Interest rate derivatives		$	(389)	$	(388)	Interest expense		$	(88) (2)	$	(81) (2)
						Non-regulated cost of sales			(3) (2)		(3) (2)
						Net equity in earnings of
							affiliates		(3)		(3)
Cross currency derivatives			(34)		(5)	Interest expense			(7)		(1)
						Foreign currency transaction
							gains (losses)		(20)		16
Foreign currency derivatives			27		(5)	Foreign currency transaction
							gains (losses)		(1)		1
Commodity and other
	derivatives		-		(4)	Non-regulated cost of sales			(2)		-
Total		$	(396)	$	(402)			$	(124)	$	(71)

(1)        Excludes $0 million and $20million related to discontinued operations for the three months ended September 30, 2011 and 2010, respectively, and $0 million and $30 million related to discontinued operations for the nine months ended September 30, 2011 and 2010, respectively.

(2)       Includes amounts that were reclassified from AOCL related to derivative instruments that previously, but no longer, qualify for cash flow hedge accounting.

The following table sets forth the pre-tax gains (losses) recognized in earnings related to the ineffective portion of derivative instruments in qualifying cash flow hedging relationships, as defined in the accounting standards for derivatives and hedging, for the three and nine months ended September 30, 2011 and 2010:

			Gains (Losses)				Gains (Losses)
			Recognized in Earnings				Recognized in Earnings
	Classification in Condensed		Three Months Ended				Nine Months Ended
	Consolidated Statements		September 30,				September 30,
	of Operations		2011		2010		2011		2010
			(in millions)				(in millions)
Interest rate derivatives	Interest expense		$	1	$	(10)	$	(6)	$	(18)
	Net equity in earnings of
		affiliates		(1)		-(1)		(2)		(1)
Cross currency derivatives	Interest expense			(3)		-(1)		(5)		4
Foreign currency derivatives	Foreign currency transaction
		gains (losses)		- (1)		-(1)		- (1)		-(1)
Total			$	(3)	$	(10)	$	(13)	$	(15)

(1)       De minimis amount.

The following table sets forth the gains (losses) recognized in earnings related to derivative instruments not designated as hedging instruments under the accounting standards for derivatives and hedging, for the three and nine months ended September 30, 2011 and 2010:

				Gains (Losses)				Gains (Losses)
				Recognized in Earnings				Recognized in Earnings
		Classification		Three Months Ended				Nine Months Ended
		in Condensed Consolidated		September 30,				September 30,
		Statements of Operations		2011		2010		2011		2010
				(in millions)				(in millions)
Interest rate derivatives		Interest expense		$	(1)	$	(3)	$	(2)	$	(8)
Foreign exchange derivatives		Foreign currency transaction
			gains (losses)		27		(7)		54		(32)
		Net equity in earnings
			of affiliates		-		-		-		2
Commodity and other
	derivatives	Non-regulated revenue			(54)		1		(63)		5
		Non-regulated cost of sales			3		(3)		2		2
Total				$	(25)	$	(12)	$	(9)	$	(31)

In addition, IPL has two derivative instruments for which the gains and losses are accounted for in accordance with accounting standards for regulated operations, as regulatory assets or liabilities. Gains and losses on these derivatives due to changes in the fair value of these derivatives are probable of recovery through future rates and are initially recognized as an adjustment to the regulatory asset or liability and recognized through earnings when the related costs are recovered through IPL's rates. Therefore, these gains and losses are excluded from the above table. The following table sets forth the change in regulatory assets and liabilities resulting from the change in the fair value of these derivatives for the three and nine months ended September 30, 2011 and 2010:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2011		2010		2011		2010
	(in millions)
(Increase) decrease in regulatory assets	$	(4)	$	(3)	$	(6)	$	(6)
Increase (decrease) in regulatory liabilities	$	(3)	$	(2)	$	3	$	2

Credit Risk-Related Contingent Features

Gener, our business in Chile, has cross currency swap agreements with counterparties to swap Chilean inflation indexed bonds issued in December 2007 into U.S. Dollars. The derivative agreements contain credit contingent provisions which would permit the counterparties with which Gener is in a net liability position to require collateral credit support when the fair value of the derivatives exceeds the unsecured thresholds established in the agreement. These thresholds vary based on Gener's credit rating. If Gener's credit rating were to fall below the minimum threshold established in the swap agreements, the counterparties can demand immediate collateralization of the entire mark-to-market value of the swaps (excluding credit valuation adjustments) if Gener is in a net liability position, which was $21 million at September 30, 2011. The swaps were in a net asset position at December 31, 2010. As of September 30, 2011 and December 31, 2010, Gener had not posted collateral to support these swaps.