Assets and Liabilities with Recurring Fair Value Measurements

3 Months Ended

Mar. 31, 2013

Fair Value Measurements [Abstract]

Assets and Liabilities with Recurring Fair Value Measurements

Assets and Liabilities with Recurring Fair Value Measurements

Cash Equivalents — Highly liquid investments which meet the definition of cash equivalents, primarily investments in money market accounts, are included in both our cash and cash equivalents and our restricted cash on our Consolidated Condensed Balance Sheets. Certain of our money market accounts invest in U.S. Treasury securities or other obligations issued or guaranteed by the U.S. Government, its agencies or instrumentalities. Our cash equivalents are classified within level 1 of the fair value hierarchy.

Margin Deposits and Margin Deposits Posted with Us by Our Counterparties — Margin deposits and margin deposits posted with us by our counterparties represent cash collateral paid between our counterparties and us to support our commodity contracts. Our margin deposits and margin deposits posted with us by our counterparties are generally cash and cash equivalents and are classified within level 1 of the fair value hierarchy.

Derivatives — The primary factors affecting the fair value of our derivative instruments at any point in time are the volume of open derivative positions (MMBtu, MWh and $ notional amounts); changing commodity market prices, primarily for power and natural gas; our credit standing and that of our counterparties for energy commodity derivatives; and prevailing interest rates for our interest rate swaps. Prices for power and natural gas and interest rates are volatile, which can result in material changes in the fair value measurements reported in our financial statements in the future.

We utilize market data, such as pricing services and broker quotes, and assumptions that we believe market participants would use in pricing our assets or liabilities including assumptions about the risks inherent to the inputs in the valuation technique. These inputs can be either readily observable, market corroborated or generally unobservable. The market data obtained from broker pricing services is evaluated to determine the nature of the quotes obtained and, where accepted as a reliable quote, used to validate our assessment of fair value. We use other qualitative assessments to determine the level of activity in any given market. We primarily apply the market approach and income approach for recurring fair value measurements and utilize what we believe to be the best available information. We utilize valuation techniques that seek to maximize the use of observable inputs and minimize the use of unobservable inputs. We classify fair value balances based on the observability of those inputs.

The fair value of our derivatives includes consideration of our credit standing, the credit standing of our counterparties and the impact of credit enhancements, if any. We have also recorded credit reserves in the determination of fair value based on our expectation of how market participants would determine fair value. Such valuation adjustments are generally based on market evidence, if available, or our best estimate.

Our level 1 fair value derivative instruments primarily consist of power and natural gas swaps, futures and options traded on the NYMEX or Intercontinental Exchange.

Our level 2 fair value derivative instruments primarily consist of interest rate swaps and OTC power and natural gas forwards for which market-based pricing inputs are observable. Generally, we obtain our level 2 pricing inputs from market sources such as the Intercontinental Exchange and Bloomberg. To the extent we obtain prices from brokers in the marketplace, we have procedures in place to ensure that prices represent executable prices for market participants. In certain instances, our level 2 derivative instruments may utilize models to measure fair value. These models are primarily industry-standard models that incorporate various assumptions, including quoted interest rates, correlation, volatility, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace throughout the full term of the instrument, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace.

Our level 3 fair value derivative instruments may consist of OTC power and natural gas forwards and options where pricing inputs are unobservable, as well as other complex and structured transactions. Complex or structured transactions are tailored to our or our customers’ needs and can introduce the need for internally-developed model inputs which might not be observable in or corroborated by the market. When such inputs have a significant impact on the measurement of fair value, the instrument is categorized in level 3. Our valuation models may incorporate historical correlation information and extrapolate available broker and other information to future periods. In cases where there is no corroborating market information available to support significant model inputs, we initially use the transaction price as the best estimate of fair value. OTC options are valued using industry-standard models, including the Black-Scholes option-pricing model. At each balance sheet date, we perform an analysis of all instruments subject to fair value measurement and include in level 3 all of those whose fair value is based on significant unobservable inputs.

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment and may affect our estimate of the fair value of our assets and liabilities and their placement within the fair value hierarchy levels. The following tables present our financial assets and liabilities that were accounted for at fair value on a recurring basis as of March 31, 2013 and December 31, 2012, by level within the fair value hierarchy:

	Assets and Liabilities with Recurring Fair Value Measures as of March 31, 2013
	Level 1		Level 2		Level 3		Total
	(in millions)
Assets:
Cash equivalents(1)	$	1,124	$	—	$	—	$	1,124
Margin deposits	257		—		—		257
Commodity instruments:
Commodity exchange traded futures and swaps contracts	594		—		—		594
Commodity forward contracts(2)	—		43		21		64
Interest rate swaps	—		5		—		5
Total assets	$	1,975	$	48	$	21	$	2,044
Liabilities:
Margin deposits posted with us by our counterparties	$	1	$	—	$	—	$	1
Commodity instruments:
Commodity exchange traded futures and swaps contracts	655		—		—		655
Commodity forward contracts(2)	—		33		8		41
Interest rate swaps	—		188		—		188
Total liabilities	$	656	$	221	$	8	$	885

	Assets and Liabilities with Recurring Fair Value Measures as of December 31, 2012
	Level 1		Level 2		Level 3		Total
	(in millions)
Assets:
Cash equivalents(1)	$	1,502	$	—	$	—	$	1,502
Margin deposits	196		—		—		196
Commodity instruments:
Commodity exchange traded futures and swaps contracts	385		—		—		385
Commodity forward contracts(2)	—		24		24		48
Interest rate swaps	—		4		—		4
Total assets	$	2,083	$	28	$	24	$	2,135
Liabilities:
Margin deposits posted with us by our counterparties	$	11	$	—	$	—	$	11
Commodity instruments:
Commodity exchange traded futures and swaps contracts	424		—		—		424
Commodity forward contracts(2)	—		18		8		26
Interest rate swaps	—		200		—		200
Total liabilities	$	435	$	218	$	8	$	661

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(1) As of March 31, 2013 and December 31, 2012, we had cash equivalents of $952 million and $1,274 million included in cash and cash equivalents and $172 million and $228 million included in restricted cash, respectively.

(2) Includes OTC swaps and options.

At March 31, 2013 and December 31, 2012, the derivative instruments classified as level 3 primarily included a longer-term OTC traded commodity contract extending through 2014. This contract is classified as level 3 because the contract terms exceed the period for which liquid market rate information is available. As such, the fair value of the contract incorporates extrapolation assumptions made in the determination of the market price for future delivery periods in which applicable commodity prices were either not observable or lacked corroborative market data. The fair value of the net derivative position classified as level 3 is predominantly driven by market commodity prices; however, given the nature of our net derivative position, we do not believe that a significant change in market commodity prices would have a material impact on our level 3 net fair value. The following table presents quantitative information for the unobservable inputs used in our most significant level 3 fair value measurements at March 31, 2013 and December 31, 2012:

	Quantitative Information about Level 3 Fair Value Measurements
	March 31, 2013
	Fair Value, Net Asset			Significant Unobservable
	(Liability)		Valuation Technique	Input	Range
	(in millions)
Physical Power	$	8	Discounted cash flow	Market price (per MWh)	$31.75 — $56/MWh
	December 31, 2012
	Fair Value, Net Asset			Significant Unobservable
	(Liability)		Valuation Technique	Input	Range
	(in millions)
Physical Power	$	11	Discounted cash flow	Market price (per MWh)	$23.75 — $53.82/MWh

The following table sets forth a reconciliation of changes in the fair value of our net derivative assets (liabilities) classified as level 3 in the fair value hierarchy for the periods indicated (in millions):

	Three Months Ended March 31,
	2013			2012
Balance, beginning of period	$	16		$	17
Realized and unrealized gains (losses):
Included in net loss:
Included in operating revenues(1)	1			10
Included in fuel and purchased energy expense(2)	—			(4		)
Included in OCI	—			4
Purchases, issuances and settlements:
Purchases	—			1
Issuances	—			(1		)
Settlements	(3		)	(6		)
Transfers in and/or out of level 3(3):
Transfers into level 3(4)	—			—
Transfers out of level 3(5)	(1		)	(4		)
Balance, end of period	$	13		$	17
Change in unrealized gains relating to instruments still held at end of period	$	1		$	6

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(1) For power contracts and Heat Rate swaps and options, included on our Consolidated Condensed Statements of Operations.

(2) For natural gas contracts, swaps and options, included on our Consolidated Condensed Statements of Operations.

(3) We transfer amounts among levels of the fair value hierarchy as of the end of each period. There were no transfers into or out of level 1 during the three months ended March 31, 2013 and 2012.

(4) There were no transfers out of level 2 into level 3 for the three months ended March 31, 2013 and 2012.

(5) We had $1 million and $4 million in gains transferred out of level 3 into level 2 for the three months ended March 31, 2013 and 2012, respectively, due to changes in market liquidity in various power markets.