Fair Value Measurements

3 Months Ended

Mar. 31, 2012

Fair Value Disclosures [Abstract]

Fair Value Measurements

Fair Value Measurements

Recurring Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (referred to as an "exit price"). Fair value of an asset or liability considers assumptions that market participants would use in pricing the asset or liability, including assumptions about nonperformance risk, which was not material as of March 31, 2012 and December 31, 2011.

Assets and liabilities are categorized into a three-level fair value hierarchy based on valuation inputs used to derive fair value. The hierarchy gives the highest priority to unadjusted quoted market prices in active markets for identical assets and liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements).

The following table sets forth assets and liabilities that were accounted for at fair value by level within the fair value hierarchy:

	March 31, 2012
(in millions)	Level 1		Level 2		Level 3		Netting and Collateral1			Total
Assets at Fair Value
Money market funds2	$	1,144	$	—	$	—	$	—		$	1,144
Derivatives contracts
Electricity	$	—	$	144	$	40	$	(93	)	$	91
Natural gas	6		—		—		(6		)	—
Fuel oil	7		—		—		(7		)	—
Total commodity contracts	13		144		40		(106		)	91
Total assets	$	1,157	$	144	$	40	$	(106	)	$	1,235
Liabilities at Fair Value
Derivatives contracts
Electricity	$	—	$	10	$	16	$	(24	)	$	2
Interest rate contracts	—		78		—		—			78
Total liabilities	$	—	$	88	$	16	$	(24	)	$	80

	December 31, 2011
(in millions)	Level 1		Level 2		Level 3		Netting and Collateral1			Total
Assets at Fair Value
Money market funds2	$	1,207	$	—	$	—	$	—		$	1,207
Derivative contracts
Electricity	$	—	$	66	$	95	$	(62	)	$	99
Natural gas	4		—		—		(4		)	—
Fuel oil	4		—		—		(4		)	—
Total commodity contracts	8		66		95		(70		)	99
Total assets	$	1,215	$	66	$	95	$	(70	)	$	1,306
Liabilities at Fair Value
Derivative contracts
Electricity	$	—	$	8	$	12	$	(19	)	$	1
Interest rate contracts	—		90		—		—			90
Total liabilities	$	—	$	98	$	12	$	(19	)	$	91

¹  Represents cash collateral and the impact of netting across the levels of the fair value hierarchy. Netting among positions classified within the same level is included in that level.

²  Money market funds are included in cash and cash equivalents and in restricted cash and cash equivalents on EME's consolidated balance sheets at March 31, 2012 and December 31, 2011.

The following table sets forth a summary of changes in the fair value of Level 3 net derivative assets and liabilities:

	Three Months Ended March 31,
(in millions)	2012			2011
Fair value, net assets at beginning of period	$	83		$	91
Total realized/unrealized gain
Included in earnings1	(15		)	—
Included in accumulated other comprehensive loss2	2			1
Purchases	6			5
Settlements	(1		)	(12		)
Transfers out of Level 33	(51		)	(2		)
Fair value, net assets at end of period	$	24		$	83
Change during the period in unrealized gains related to assets and liabilities, net held at end of period1	$	(7	)	$	(6	)

¹  Reported in operating revenues on EME's consolidated statements of operations.

²  Included in reclassification adjustments in EME's consolidated statement of other comprehensive loss.

³  Transfers out of Level 3 into Level 2 occurred due to significant observable inputs becoming available as the transactions near maturity.

The fair value of transfers in and out of each level is determined at the end of each reporting period. There were no transfers between Levels 1 and 2 during the three months ended March 31, 2012 and 2011.

Valuation Techniques Used to Determine Fair Value

Level 1

The fair value of Level 1 assets and liabilities is determined using unadjusted quoted prices in active markets that are available at the measurement date for identical assets and liabilities. This level includes exchange-traded derivatives and money market funds.

Level 2

The fair value of Level 2 assets and liabilities is determined using quoted prices for similar assets and liabilities in active markets and inputs that are observable either directly or indirectly for substantially the full term of the instrument. This level includes over-the-counter derivatives and interest rate swaps.

Over-the-counter derivative contracts are valued using standard pricing models to determine the net present value of estimated future cash flows. Inputs to the pricing models include forward published or posted clearing prices from exchanges (New York Mercantile Exchange and Intercontinental Exchange) for similar instruments and discount rates. A primary price source that best represents trade activity for each market is used to develop observable forward market prices in determining the fair value of these positions. Broker quotes, prices from exchanges or comparison to executed trades are used to validate and corroborate the primary price source. These price quotations reflect mid-market prices (average of bid and ask) and are obtained from sources believed to provide the most liquid market for the commodity.

Level 3

The fair value of Level 3 assets and liabilities is determined using models and techniques that require significant unobservable inputs. This level includes over-the-counter options and derivative contracts that trade infrequently, such as congestion revenue rights and long-term power agreements.

Assumptions are made in order to value derivative contracts in which observable inputs are not available. Changes in fair value are based on changes to forward market prices, including extrapolation of short-term observable inputs into forecasted prices for illiquid forward periods. In circumstances where fair value cannot be verified with observable market transactions, it is possible that a different valuation model could produce a materially different estimate of fair value. Modeling methodologies, inputs and techniques are reviewed and assessed as markets continue to develop and more pricing information becomes available and the fair value is adjusted when it is concluded that a change in inputs or techniques would result in a new valuation that better reflects the fair value of those derivative contracts.

Level 3 Valuation Process

The process of determining fair value is the responsibility of the risk department, which reports to the chief financial officer. This department obtains observable and unobservable inputs through broker quotes, exchanges and internal valuation techniques and uses both standard and proprietary models to determine fair value. Each reporting period, the risk and key finance departments collaborate to determine the appropriate fair value methodologies and classifications for each derivative. Inputs are validated for reasonableness by comparison against prior prices, other broker quotes and volatility fluctuation thresholds. Inputs used and valuations are reviewed period-over-period and compared with market conditions to determine reasonableness.

The following table sets forth the valuation techniques and significant unobservable inputs used to derive fair value for Level 3 assets and liabilities:

March 31, 2012
				Quantitative Information About Level 3 Fair Value Measurements
	Fair Value							Significant Unobservable Input
	Assets			Liabilities			Valuation Technique(s)		Range (Weighted Average)
Electricity	(in millions)
Congestion contracts	$	49		$	13		Latest auction pricing	Congestion prices	$(8.20) - $10.32 ($0.21)
Power contracts	37			49			Discounted cash flows	Power prices	$15.58-$54.00 ($32.97)
Netting	(46		)	(46		)
Total	$	40		$	16

Level 3 Fair Value Sensitivity

For congestion contracts, generally, an increase (decrease) in congestion prices in the last auction relative to the contract price will increase (decrease) fair value. For power contracts, generally, an increase (decrease) in long-term forward power prices at illiquid locations relative to the contract price will increase (decrease) fair value.

Long-term Debt

The carrying amounts and fair values of EME's long-term debt were as follows:

	March 31, 2012				December 31, 2011
(in millions)	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Long-term debt, including current portion	$	4,963	$	3,676	$	4,912	$	3,716

In assessing the fair value of EME's long-term debt, EME primarily uses quoted market prices, except for floating-rate debt for which the carrying amounts were considered a reasonable estimate of fair value. The fair value of EME's long-term debt is classified as Level 2.