Derivative Instruments and Hedging Activities

3 Months Ended

Sep. 30, 2012

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, 2012 regardless of whether the derivative instruments are in qualifying cash flow hedging relationships:

	September 30, 2012
	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)	3,614	$	3,614	4,561	$	4,561	10	70%
Euribor (Euro)	627		806	627		806	10	66%
Libor (British Pound)	58		94	70		113	16	88%

(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, 2012 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.

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, 2012, 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, 2012:

	September 30, 2012
				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	$	266	13	85%

(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, 2012 regardless of whether the derivative instruments are in qualifying hedging relationships:

	September 30, 2012
						Weighted
		Notional		Probability		Average
		Translated		Adjusted		Remaining
Foreign Currency Options	Notional	to USD(1)		Notional(2)		Term(3)
	(in millions)					(in years)
Euro (EUR)	68	$	87	$	38	<1
Brazilian Real (BRL)	94		46		26	<1
Philippine Peso (PHP)	1,174		28		6	<1
British Pound (GBP)	18		28		6	<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, 2012
		Notional		Weighted Average
Foreign Currency Forwards	Notional	Translated to USD		Remaining Term(1)
	(in millions)			(in years)
Chilean Peso (CLP)	86,476	$	176	<1
Euro (EUR)	115		161	1
Colombian Peso (COP)	172,643		94	<1
British Pound (GBP)	11		17	<1
Argentine Peso (ARS)	76		14	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 that is being purchased or sold is denominated in a currency other than the functional currency of the subsidiary or the currency of the item. These contracts range in maturity through 2026. 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, 2012:

	September 30, 2012
		Notional		Weighted Average
Embedded Foreign Currency Derivatives	Notional	Translated to USD		Remaining Term(1)
	(in millions)			(in years)
Philippine Peso (PHP)(2)	62,040	$	1,486	11
Argentine Peso (ARS)	857		183	12
Kazakhstani Tenge (KZT)	1,266		8	4
Euro (EUR)	2		3	8

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

(2)Notional also relates to an embedded derivative related to inflation.

Commodity Price Risk

We are exposed to the impact of market fluctuations in the price of electricity, fuel and environmental credits. Although our businesses primarily enter into 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 and fuel 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 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, 2012:

	September 30, 2012
		Weighted Average
Commodity Derivatives	Notional	Remaining Term(1)
	(in millions)	(in years)
Natural gas (MMBTU)	29	11
Aluminum (MWh)	14(2)	7
Petcoke (Metric tons)	12	12
Power (MWh)	4	2
Heating Oil (Gallons)	2	1
Coal (Metric tons)	1	1

(1)Represents the remaining tenor of our commodity and embedded derivatives weighted by the corresponding volume.

(2)The embedded derivative relates to fluctuations in the price of aluminum versus fluctuations in the price of electricity, where the notional is based on the amount of power we sell under the PPA.

Accounting and Reporting

Fair Value Hierarchy       

The following table sets forth the Company's derivative instruments as of September 30, 2012 and December 31, 2011 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 noncurrent derivative liabilities in other noncurrent liabilities.

				September 30, 2012								December 31, 2011
				Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
				(in millions)
Assets
Current assets:
	Foreign currency derivatives			$	-	$	6	$	5	$	11	$	-	$	24	$	4	$	28
	Commodity and other derivatives				-		14		5		19		2		16		3		21
		Total current assets			-		20		10		30		2		40		7		49
Noncurrent assets:
	Interest rate derivatives				-		2		-		2		-		-		-		-
	Cross currency derivatives				-		8		-		8		-		-		1		1
	Foreign currency derivatives				-		7		63		70		-		3		58		61
	Commodity and other derivatives				-		5		11		16		-		9		-		9
		Total noncurrent assets			-		22		74		96		-		12		59		71
			Total assets	$	-	$	42	$	84	$	126	$	2	$	52	$	66	$	120
Liabilities
Current liabilities:
	Interest rate derivatives			$	-	$	79	$	37	$	116	$	-	$	97	$	22	$	119
	Cross currency derivatives				-		4		-		4		-		-		5		5
	Foreign currency derivatives				-		8		1		9		-		5		1		6
	Commodity and other derivatives				-		18		7		25		-		17		6		23
		Total current liabilities			-		109		45		154		-		119		34		153
Noncurrent liabilities:
	Interest rate derivatives				-		263		260		523		-		334		106		440
	Cross currency derivatives				-		2		-		2		-		-		14		14
	Foreign currency derivatives				-		106		7		113		-		10		10		20
	Commodity and other derivatives				-		5		47		52		-		13		50		63
		Total noncurrent liabilities			-		376		314		690		-		357		180		537
			Total liabilities	$	-	$	485	$	359	$	844	$	-	$	476	$	214	$	690

Hedge Designation

The following table sets forth the fair value and balance sheet classification of derivative instruments as of September 30, 2012 and December 31, 2011:

		September 30, 2012						December 31, 2011
				Not						Not
		Designated		Designated				Designated		Designated
		as Hedging		as Hedging				as Hedging		as Hedging
		Instruments		Instruments		Total		Instruments		Instruments		Total
		(in millions)
Assets
Current assets:
	Foreign currency derivatives	$	4	$	7	$	11	$	10	$	18	$	28
	Commodity and other derivatives		1		18		19		2		19		21
	Total current assets		5		25		30		12		37		49
Noncurrent assets:
	Interest rate derivatives		-		2		2		-		-		-
	Cross currency derivatives		8		-		8		1		-		1
	Foreign currency derivatives		7		63		70		3		58		61
	Commodity and other derivatives		1		15		16		-		9		9
	Total noncurrent assets		16		80		96		4		67		71
Total assets		$	21	$	105	$	126	$	16	$	104	$	120
Liabilities
Current liabilities:
	Interest rate derivatives	$	106	$	10	$	116	$	110	$	9	$	119
	Cross currency derivatives		4		-		4		5		-		5
	Foreign currency derivatives		7		2		9		1		5		6
	Commodity and other derivatives		7		18		25		-		23		23
	Total current liabilities		124		30		154		116		37		153
Noncurrent liabilities:
	Interest rate derivatives		500		23		523		425		15		440
	Cross currency derivatives		2		-		2		14		-		14
	Foreign currency derivatives		-		113		113		-		20		20
	Commodity and other derivatives		3		49		52		3		60		63
	Total noncurrent liabilities		505		185		690		442		95		537
Total liabilities		$	629	$	215	$	844	$	558	$	132	$	690

The Company has elected not to offset derivative positions in the financial statements.Accordingly, we do 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, 2012 and December 31,2011, we held $1million and $3 million, respectively, of cash collateral that we received from counterparties to our derivative positions. Beyond the cash collateral held by us, our derivative assets are exposed to the credit risk of the respective counterparty and, due to this credit risk, the fair value of our derivative assets (as shown in the above two tables) have been reduced by a CVA. Also, at September 30, 2012 and December 31,2011,there was $13 million and $16 million, respectively, of 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 (in millions) over the next twelve months as of September 30, 2012 for the following types of derivative instruments:

Interest rate derivatives	$	(106)
Cross currency derivatives	$	6
Foreign currency derivatives	$	(5)
Commodity and other derivatives	$	(9)

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 (except for the amount reclassified to foreign currency transaction gains and losses to offset the remeasurement of the foreign currency-denominated debt being hedged by the cross currency swaps), as depreciation is recognized for interest rate hedges during construction, as foreign currency transaction gains and losses are recognized for hedges of foreign currency exposure, and as electricity sales and fuel purchases are recognized for hedges of forecasted electricity and fuel transactions. These balances are included in the consolidated statements of cash flows as operating and/or investing activities based on the nature of the underlying transaction.

For the three and nine months ended September 30, 2012 and 2011, pre-tax gains (losses) of $(11) million, and $0 million, respectively, net of noncontrolling interests were reclassified into earnings as a result of the discontinuance of a cash flow hedge because it was probable that the forecasted transaction would not occur by the end of the originally specified time period (as documented at the inception of the hedging relationship) or within an additional two-month time period thereafter.

Effective Portion of Cash Flow Hedges

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 andnine months ended September 30, 2012 and 2011:

		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,
Type of Derivative		2012		2011		Statements of Operations		2012		2011
		(in millions)						(in millions)
Interest rate derivatives		$	(62)	$	(295)	Interest expense		$	(40)	$	(35)
						Non-regulated cost of sales			(1)		(1)
						Net equity in earnings of
							affiliates		(2)		(1)
						Asset impairment expense			(5)		-
Cross currency derivatives			4		(37)	Interest expense			(3)		(3)
						Foreign currency transaction
							gains (losses)		15		(26)
Foreign currency derivatives			-		29	Foreign currency transaction
							gains (losses)		4		3
Commodity and other
	derivatives		(4)		-	Non-regulated revenue			-		(2)
Total		$	(62)	$	(303)			$	(32)	$	(65)

		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,
Type of Derivative		2012		2011		Statements of Operations		2012		2011
		(in millions)						(in millions)
Interest rate derivatives		$	(204)	$	(391)	Interest expense		$	(102)	$	(91)
						Non-regulated cost of sales			(4)		(3)
						Net equity in earnings of
							affiliates		(4)		(3)
						Asset impairment expense			(5)		-
						Gain on sale of investments			(96)		-
Cross currency derivatives			9		(34)	Interest expense			(9)		(7)
						Foreign currency transaction
							gains (losses)		27		(20)
Foreign currency derivatives			12		27	Foreign currency transaction
							gains (losses)		4		(1)
Commodity and other
	derivatives		(11)		-	Non-regulated revenue			(2)		(2)
Total		$	(194)	$	(398)			$	(191)	$	(127)

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

Ineffective Portion of Cash Flow Hedges

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, 2012 and 2011:

		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,
Type of Derivative	of Operations	2012		2011		2012		2011
		(in millions)
Interest rate derivatives	Interest expense	$	(2)	$	1	$	(1)	$	(6)
	Net equity in earnings of affiliates		-		(1)		(1)		(2)
Cross currency derivatives	Interest expense		(1)		(3)		(1)		(5)
Total		$	(3)	$	(3)	$	(3)	$	(13)

Not Designated for Hedge Accounting

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 thethree and nine months ended September 30, 2012 and 2011:

		Gains (Losses)				Gains (Losses)
		Recognized in Earnings				Recognized in Earnings
	Classification	Three Months Ended				Nine Months Ended
	in Condensed Consolidated	September 30,				September 30,
Type of Derivative	Statements of Operations	2012		2011		2012		2011
		(in millions)
Interest rate derivatives	Interest expense	$	(2)	$	(1)	$	(5)	$	(2)
Foreign currency derivatives	Foreign currency transaction gains (losses)		(11)		27		(87)		54
Commodity and other derivatives	Non-regulated revenue		14		(54)		15		(63)
	Regulated revenue		(3)		-		(2)		-
	Non-regulated cost of sales		1		3		4		2
	Regulated cost of sales		(3)		-		(20)		-
Total		$	(4)	$	(25)	$	(95)	$	(9)

Regulatory Assets and Liabilities

In addition, DPL and IPL, our utilities in North America, have 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 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 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, 2012 and 2011:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2012		2011		2012		2011
	(in millions)
(Increase) decrease in regulatory assets	$	4	$	(4)	$	(1)	$	(6)
Increase (decrease) in regulatory liabilities	$	-	$	(3)	$	(1)	$	3

Credit Risk-Related Contingent Features

Gener, our generation 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 agreements. 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 loss of the swaps (excluding credit valuation adjustments), which was $2 million at September 30, 2012. The mark-to-market value of the swaps was $18 million at December 31, 2011. As of September 30, 2012 and December 31, 2011, Gener had not posted collateral to support these swaps.

DPL has certain over-the-counter commodity derivative contracts under master netting agreements that contain provisions that require its debt to maintain an investment-grade credit rating from credit rating agencies. If its debt were to fall below investment grade, the business would be in violation of these provisions, and the counterparties to the derivative contracts could request immediate payment or demand immediate and ongoing full overnight collateralization of the mark-to-market loss (excluding credit valuation adjustments), which was $22 million as of September 30, 2012. As of September 30, 2012, DPL had posted $13 million of cash collateral directly with third parties and in a broker margin account and held $1 million of cash collateral that it received from counterparties to its derivative instruments that were in an asset position.As of December 31, 2011, DPL had posted $16 million of cash collateral directly with third parties and in a broker margin account and held $3 million of cash collateral that it received from counterparties to its derivative instruments that were in an asset position.