Derivative Instruments and Hedging Activities

3 Months Ended

Mar. 31, 2012

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Instruments and Hedging Activities

Derivative Instruments and Hedging Activities

EME uses derivative instruments to reduce its exposure to market risks that arise from price fluctuations of electricity, capacity, fuel, emission allowances, transmission rights and interest rates. The derivative financial instruments vary in duration, ranging from a few days to several years, depending upon the instrument. To the extent that EME does not use derivative instruments to hedge these market risks, the unhedged portions will be subject to the risks and benefits of spot market price movements.

Risk management positions may be designated as cash flow hedges or economic hedges, which are derivatives that are not designated as cash flow hedges. Economic hedges are accounted for at fair value on EME's consolidated balance sheets as derivative assets or liabilities with offsetting changes recorded on the consolidated statements of operations. For derivative instruments that qualify for hedge accounting treatment, the fair value is recognized on EME's consolidated balance sheets as derivative assets or liabilities with offsetting changes in fair value, to the extent effective, recognized in accumulated other comprehensive loss until reclassified into earnings when the related forecasted transaction occurs. The portion of a cash flow hedge that does not offset the change in the fair value of the transaction being hedged, which is commonly referred to as the ineffective portion, is immediately recognized in earnings.

Derivative instruments that are utilized for trading purposes are measured at fair value and included on the consolidated balance sheets as derivative assets or liabilities, with offsetting changes recognized in operating revenues on the consolidated statements of operations.

The results of derivative activities are recorded in cash flows from operating activities on the consolidated statements of cash flows.

Where EME's derivative instruments are subject to a master netting agreement and the criteria of authoritative guidance are met, EME presents its derivative assets and liabilities on a net basis on its consolidated balance sheets.

Notional Volumes of Derivative Instruments

The following table summarizes the notional volumes of derivatives used for hedging and trading activities:

March 31, 2012
				Hedging Activities				Trading Activities
Commodity	Instrument	Classification	Unit of Measure	Cash Flow Hedges		Economic Hedges
Electricity	Forwards/Futures	Sales, net	GWh	5,850	1	102	3	—
Electricity	Forwards/Futures	Purchases, net	GWh	—		—		2,425
Electricity	Capacity	Sales, net	MW-Day (in thousands)	58	2	—		—
Electricity	Capacity	Purchases, net	MW-Day (in thousands)	—		—		161	2
Electricity	Congestion	Purchases, net	GWh	—		1,079	4	165,365	4
Natural gas	Forwards/Futures	Purchases, net	bcf	—		—		12.0
Fuel oil	Forwards/Futures	Purchases, net	barrels	—		360,000		—

At March 31, 2012, EME had interest rate contracts with notional values totaling $681 million that converted floating rate LIBOR-based debt to fixed rates ranging from 0.79% to 4.29%. These contracts expire May 2013 through March 2026. In addition, at March 31, 2012, EME had forward starting interest rate contracts with notional values totaling $502 million that will convert floating rate LIBOR-based debt to fixed rates ranging from 3.5429% to 4.0025%. These contracts have effective dates beginning June 2013 through December 2021 and expire May 2023 through December 2029.

In April 2012 pursuant to the agreements for financing of its interests in the Broken Bow and Crofton Bluffs wind projects, EME's subsidiaries entered into forward starting interest rate swap agreements with notional value totaling $139 million that converted floating rate LIBOR based debt to fixed rates ranging from 0.7825% to 2.96%. These contracts have effective dates beginning December 2012 through December 2013 and expire December 2013 through December 2027.

December 31, 2011
				Hedging Activities				Trading Activities
Commodity	Instrument	Classification	Unit of Measure	Cash Flow Hedges		Economic Hedges
Electricity	Forwards/Futures	Sales, net	GWh	8,320	1	425	3	—
Electricity	Forwards/Futures	Purchases, net	GWh	—		—		2,926
Electricity	Capacity	Sales, net	MW-Day (in thousands)	89	2	—		—
Electricity	Capacity	Purchases, net	MW-Day (in thousands)	—		—		184	2
Electricity	Congestion	Purchases, net	GWh	—		2,528	4	230,798	4
Natural gas	Forwards/Futures	Sales, net	bcf	—		—		0.2
Fuel oil	Forwards/Futures	Purchases, net	barrels	—		240,000		—

¹  EME's hedge products include forward and futures contracts that qualify for hedge accounting.

²  EME's hedge transactions for capacity result from bilateral trades. Capacity sold in the PJM Interconnection, LLC Reliability Pricing Model (PJM RPM) auction is not accounted for as a derivative.

³  These positions adjust financial and physical positions, or day-ahead and real-time positions, to reduce costs or increase gross margin. The net sales positions of these categories are primarily related to hedge transactions that are not designated as cash flow hedges.

⁴  Congestion contracts include financial transmission rights, transmission congestion contracts or congestion revenue rights. These positions are similar to a swap, where the buyer is entitled to receive a stream of revenues (or charges) based on the hourly day-ahead price differences between two locations.

At December 31, 2011, EME had interest rate contracts with notional values totaling $644 million that converted floating rate LIBOR-based debt to fixed rates ranging from 0.79% to 4.29%. These contracts expire May 2013 through March 2026. In addition, EME had forward starting interest rate contracts with notional values totaling $506 million that will convert floating rate LIBOR-based debt to fixed rates of 3.5429%, 3.57% and 4.0025%. These contracts have effective dates of June 2013 and December 2021 and expire May 2023 and December 2029.

Fair Value of Derivative Instruments

The following table summarizes the fair value of derivative instruments reflected on EME's consolidated balance sheets:

March 31, 2012
	Derivative Assets									Derivative Liabilities									Net Assets (Liabilities)
(in millions)	Short-term			Long-term			Subtotal			Short-term			Long-term			Subtotal
Non-trading activities
Cash flow hedges
Commodity contracts	$	51		$	2		$	53		$	1		$	3		$	4		$	49
Interest rate contracts	—			—			—			—			78			78			(78		)
Economic hedges	57			3			60			47			2			49			11
Trading activities	408			180			588			360			117			477			111
	516			185			701			408			200			608			93
Netting and collateral received1	(477		)	(133		)	(610		)	(407		)	(121		)	(528		)	(82		)
Total	$	39		$	52		$	91		$	1		$	79		$	80		$	11

December 31, 2011
	Derivative Assets									Derivative Liabilities									Net Assets (Liabilities)
(in millions)	Short-term			Long-term			Subtotal			Short-term			Long-term			Subtotal
Non-trading activities
Cash flow hedges
Commodity contracts	$	41		$	1		$	42		$	2		$	3		$	5		$	37
Interest rate contracts	—			—			—			—			90			90			(90		)
Economic hedges	31			1			32			26			1			27			5
Trading activities	276			142			418			232			79			311			107
	348			144			492			260			173			433			59
Netting and collateral received1	(308		)	(85		)	(393		)	(259		)	(83		)	(342		)	(51		)
Total	$	40		$	59		$	99		$	1		$	90		$	91		$	8

¹  Netting of derivative receivables and derivative payables and the related cash collateral received and paid is permitted when a legally enforceable master netting agreement exists with a derivative counterparty.

Income Statement Impact of Derivative Instruments

The following table provides the cash flow hedge activity as part of accumulated other comprehensive loss:

	Cash Flow Hedge Activity1
	Three Months Ended March 31,
	2012						2011
(in millions)	Commodity Contracts			Interest Rate Contracts			Commodity Contracts			Interest Rate Contracts			Income Statement Location
Beginning of period derivative gains (losses)	$	35		$	(90	)	$	43		$	(16	)
Effective portion of changes in fair value	30			12			8			2
Reclassification to earnings	(19		)	—			(16		)	—			Operating revenues
End of period derivative gains (losses)	$	46		$	(78	)	$	35		$	(14	)

¹  Unrealized derivative gains (losses) are before income taxes. The after-tax amounts recorded in accumulated other comprehensive loss at March 31, 2012 and 2011 for commodity and interest rate contracts were $27million and $(47) million, and $21 million and $(9) million, respectively.

For additional information, see Note 11—Accumulated Other Comprehensive Loss.

EME recorded net gains of $1 million and $2 million during the first quarters of 2012 and 2011, respectively, in operating revenues on the consolidated statements of operations representing the amount of cash flow hedge ineffectiveness.

The effect of realized and unrealized gains from derivative instruments used for economic hedging and trading purposes on the consolidated statements of operations is presented below:

		Three Months Ended March 31,
(in millions)	Income Statement Location	2012		2011
Economic hedges	Operating revenues	$	11	$	6
	Fuel	5		6
Trading activities	Operating revenues	20		16

Margin and Collateral Deposits

Certain derivative instruments contain margin and collateral deposit requirements. Since EME's and its subsidiaries' credit ratings are below investment grade, EME and its subsidiaries have provided collateral in the form of cash and letters of credit for the benefit of derivative counterparties and brokers. The amount of margin and collateral deposits generally varies based on changes in fair value of the related positions. EME nets counterparty receivables and payables where balances exist under master netting arrangements. EME presents the portion of its margin and collateral deposits netted with its derivative positions on its consolidated balance sheets. Future increases in power prices could expose EME, Midwest Generation or Edison Mission Marketing & Trading, Inc. (EMMT) to additional collateral postings. The following table summarizes margin and collateral deposits provided to and received from counterparties:

(in millions)	March 31, 2012		December 31, 2011
Collateral provided to counterparties
Offset against derivative liabilities	$	2	$	2
Reflected in margin and collateral deposits	76		41
Collateral received from counterparties
Offset against derivative assets	84		53