Derivative Instruments and Hedging Activities (EME and Midwest Generation, except as noted)

Notional Volumes of Derivative Instruments

The following table summarizes EME's and Midwest Generation's consolidated notional volumes of derivatives used for hedging and trading activities:



December 31, 2012
				Cash Flow Hedges			Economic Hedges				Trading Activities
Commodity	Instrument	Classification	Unit of Measure	Midwest Generation	Other EME Sub- sidiaries	EME	Midwest Generation	Other EME Sub- sidiaries	EME		Other EME Sub- sidiaries
Electricity	Forwards/Futures	Sales, net	GWh¹	3,615	—	3,615	1	47	48	²	—
Electricity	Forwards/Futures	Purchases, net	GWh	—	—	—	—	—	—		492
Electricity	Capacity	Purchases, net	GW-Day¹	—	—	—	—	—	—		60	³
Electricity	Congestion	Purchases, net	GWh	—	—	—	—	263	263	⁴	268,529	⁴
Natural gas	Forwards/Futures	Purchases, net	bcf¹	—	—	—	—	—	—		9.9



December 31, 2011
				Cash Flow Hedges				Economic Hedges				Trading Activities
Commodity	Instrument	Classification	Unit of Measure	Midwest Generation	Other EME Sub- sidiaries	EME		Midwest Generation	Other EME Sub- sidiaries	EME		Other EME Sub- sidiaries
Electricity	Forwards/Futures	Sales, net	GWh	7,978	342	8,320		227	108	335	²	—
Electricity	Forwards/Futures	Purchases, net	GWh	—	—	—		—	—	—		2,926
Electricity	Capacity	Sales, net	GW-Day	61	—	61	³	—	—	—		—
Electricity	Capacity	Purchases, net	GW-Day	—	—	—		—	—	—		184	³
Electricity	Congestion	Purchases, net	GWh	—	—	—		608	653	1,261	⁴	230,798	⁴
Natural gas	Forwards/Futures	Sales, net	bcf	—	—	—		—	—	—		0.2
Fuel oil	Forwards/Futures	Purchases, net	barrels	—	—	—		240,000	—	240,000		—


¹	gigawatt-hours (GWh); gigawatts-day (GW-Day); billion cubic feet (bcf).


²	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.


³	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.


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.

Interest Rate Risk Management (EME only)

Interest rate changes affect the cost of capital needed to operate EME's projects. EME mitigates the risk of interest rate fluctuations by arranging for fixed rate financing or variable rate financing with interest rate swaps, interest rate options or other hedging mechanisms for a number of EME's project financings. At December 31, 2012 and 2011, EME had the following interest rate swaps:



December 31, 2012
Project Financing	Effective Date	Expiration Date	Fixed Swap Rate Paid	Notional Value (in millions)
Viento Funding II	June 2009	June 2016	3.18%	$	65
Viento Funding II	March 2011	December 2020	3.42%	108
Cedro Hill	December 2010	December 2025	4.29%	112
Laredo Ridge	March 2011	March 2026	3.46%	64
WCEP Holdings	July 2011	May 2013	0.79%	26
Walnut Creek Energy	November 2011	May 2013	0.81%	181
Tapestry	December 2011	December 2021	2.21%	189
Broken Bow ¹	December 2012	December 2013	0.83%	47
Crofton Bluffs ¹	December 2012	December 2013	0.78%	24
				$	816
Forward Starting Swaps
Walnut Creek Energy	June 2013	May 2023	3.54%	$	398
WCEP Holdings	June 2013	May 2023	4.00%	48
Broken Bow	December 2013	December 2027	2.96%	45
Crofton Bluffs	December 2013	December 2027	2.75%	23
Tapestry	December 2021	December 2029	3.57%	60
				$	574


¹	The construction loan converted to a term loan in December 2012 and the swap became effective on December 31, 2012. For additional information, see Note 5—Debt and Credit Agreements.



December 31, 2011
Project Financing	Effective Date	Expiration Date	Fixed Swap Rate Paid	Notional Value (in millions)
Viento Funding II	June 2009	June 2016	3.18%	$	79
Viento Funding II	March 2011	December 2020	3.42%	109
Cedro Hill	December 2010	December 2025	4.29%	118
Laredo Ridge	March 2011	March 2026	3.46%	67
WCEP Holdings	July 2011	May 2013	0.79%	25
Walnut Creek Energy	November 2011	May 2013	0.81%	53
Tapestry	December 2011	December 2021	2.21%	193
				$	644
Forward Starting Swaps
Walnut Creek Energy	June 2013	May 2023	3.54%	$	398
WCEP Holdings	June 2013	May 2023	4.00%	48
Tapestry	December 2021	December 2029	3.57%	60
				$	506

Fair Value of Derivative Instruments

EME

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



December 31, 2012
	Derivative Assets									Derivative Liabilities									Net Assets (Liabilities)
(in millions)	Short-term			Long-term			Subtotal			Short-term			Long-term			Subtotal			Net Assets (Liabilities)
Non-trading activities
Cash flow hedges
Commodity contracts	$	3		$	—		$	3		$	5		$	—		$	5		$	(2	)
Interest rate contracts	—			—			—			—			118			118			(118		)
Economic hedges	9			—			9			8			—			8			1
Trading activities	192			69			261			145			32			177			84
	204			69			273			158			150			308			(35		)
Netting and collateral received¹	(151		)	(32		)	(183		)	(158		)	(32		)	(190		)	7
Total	$	53		$	37		$	90		$	—		$	118		$	118		$	(28	)



December 31, 2011
	Derivative Assets									Derivative Liabilities									Net Assets (Liabilities)
(in millions)	Short-term			Long-term			Subtotal			Short-term			Long-term			Subtotal			Net Assets (Liabilities)
Non-trading activities
Cash flow hedges
Commodity contracts	$	40		$	1		$	41		$	2		$	—		$	2		$	39
Interest rate contracts	—			—			—			—			90			90			(90		)
Economic hedges	24			—			24			20			—			20			4
Trading activities	276			142			418			232			79			311			107
	340			143			483			254			169			423			60
Netting and collateral received¹	(300		)	(81		)	(381		)	(253		)	(79		)	(332		)	(49		)
Total	$	40		$	62		$	102		$	1		$	90		$	91		$	11


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.

Midwest Generation

The following table summarizes the fair value of commodity derivative instruments for non-trading purposes reflected on Midwest Generation's consolidated balance sheets:



December 31, 2012
	Derivative Assets								Derivative Liabilities
(in millions)	Short-term			Long-term		Subtotal			Short-term			Long-term		Subtotal			Net Assets
Cash flow hedges	$	3		$	—	$	3		$	5		$	—	$	5		$	(2	)
Economic hedges	9			—		9			8			—		8			1
	12			—		12			13			—		13			(1		)
Netting¹	(10		)	—		(10		)	(10		)	—		(10		)	—
Total	$	2		$	—	$	2		$	3		$	—	$	3		$	(1	)
December 31, 2011
Cash flow hedges	$	39		$	1	$	40		$	2		$	—	$	2		$	38
Economic hedges	24			—		24			20			—		20			4
	63			1		64			22			—		22			42
Netting¹	(20		)	—		(20		)	(20		)	—		(20		)	—
Total	$	43		$	1	$	44		$	2		$	—	$	2		$	42


¹	Netting of derivative receivables and derivative payables is permitted when a legally enforceable master netting agreement exists with a derivative counterparty.

Income Statement Impact of Derivative Instruments

EME

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



	Cash Flow Hedge Activity¹
	Years Ended December 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	5			(28		)	55			(74		)
Reclassification to earnings	(41		)	—			(63		)	—			Operating revenues
End of period derivative gains (losses)	$	(1	)	$	(118	)	$	35		$	(90	)


¹	Unrealized derivative gains (losses) are before income taxes. Amounts recorded in accumulated other comprehensive loss include commodity and interest rate contracts. For additional information, see Note 11—Accumulated Other Comprehensive Loss.

EME recorded losses of none, $4 million and $6 million in 2012, 2011 and 2010, 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:



		Years Ended December 31,
(in millions)	Income Statement Location	2012		2011
Economic hedges	Operating revenues	$	31	$	5
	Fuel	2		3
Trading activities	Operating revenues	68		76

Midwest Generation

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



	Cash Flow Hedge Activity¹						Income Statement Location
(in millions)	2012			2011			Income Statement Location
Beginning of period derivative gains	$	34		$	37
Effective portion of changes in fair value	7			38
Reclassification to earnings	(43		)	(41		)	Operating revenues
End of period derivative gains (losses)	$	(2	)	$	34


¹	Unrealized derivative gains (losses) are before income taxes. Amounts recorded in accumulated other comprehensive loss include commodity contracts. For additional information, see Note 11—Accumulated Other Comprehensive Loss.

Midwest Generation recorded net gains of none, $4 million and $7 million in 2012, 2011 and 2010, 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 non-trading purposes on the consolidated statements of operations is presented below:



(in millions)	Income Statement Location	Years Ended December 31,
(in millions)	Income Statement Location	2012		2011
Economic hedges	Operating revenues	$	31	$	2
	Fuel	2		3

Energy Trading Derivative Instruments (EME only)

The change in the fair value of energy trading derivative instruments was as follows:



(in millions)	2012			2011
Fair value of trading contracts at beginning of period	$	107		$	110
Net gains from energy trading activities	68			76
Amount realized from energy trading activities	(93		)	(84		)
Other changes in fair value	2			5
Fair value of trading contracts at end of period	$	84		$	107

Margin and Collateral Deposits

Certain derivative instruments contain margin and collateral deposit requirements. Since EME's and Midwest Generation's 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’s approach to trading and risk management depends, in part, on the ability to use clearing brokers to enter into market transactions. As a result of its financial position, EME has limited access to enter into such transactions and has been subject to increased initial collateral and margin requirements. There is no assurance that EME will continue to be able to utilize clearing brokers. If EME becomes unable to utilize clearing brokers, it may seek to execute bilateral transactions with third parties which could be unavailable on commercially reasonable terms or at all.

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 to additional collateral postings. The following table summarizes EME's margin and collateral deposits provided to and received from counterparties:



	December 31,
(in millions)		2012		2011
Collateral provided to counterparties
Offset against derivative liabilities		$	9	$	2
Reflected in margin and collateral deposits		61		41
Collateral received from counterparties
Offset against derivative assets		—		53

Commodity Price Risk Management

EME's and Midwest Generation's merchant operations are exposed to commodity price risk, which reflects the potential impact of a change in the market value of a particular commodity. Commodity price risks are actively monitored, with oversight provided by a risk management committee, to ensure compliance with EME's risk management policies. EME uses estimates of the variability in gross margin to help identify, measure, monitor and control its overall market risk exposure and earnings volatility with respect to hedge positions at the coal plants and the merchant wind projects, and uses "value at risk" metrics to help identify, measure, monitor and control its overall risk exposure in respect to its trading positions. These measures allow management to aggregate overall commodity risk, compare risk on a consistent basis and identify changes in risk factors. Value at risk measures the possible loss, and variability in gross margin measures the potential change in value, of an asset or position, in each case over a given time interval, under normal market conditions, at a given confidence level. Given the inherent limitations of these measures and reliance on a single type of risk measurement tool, EME supplements these approaches with the use of stress testing and worst-case scenario analysis for key risk factors, as well as stop-loss triggers and volumetric exposure limits. When appropriate, EME manages the spread between the electric prices and fuel prices, and uses forward contracts, swaps, futures, or options contracts to achieve those objectives.

Credit Risk

In conducting EME's hedging and trading activities and Midwest Generation's marketing activities, EMMT enters into transactions with utilities, energy companies, financial institutions, and other companies, collectively referred to as counterparties. In the event a counterparty were to default on its trade obligation, EME and Midwest Generation would be exposed to the risk of possible loss associated with market price changes occurring since the original contract was executed if the nonperforming counterparty were unable to pay the resulting damages owed to EME or Midwest Generation. Midwest Generation's agreement with EMMT transfers the risk of non-payment of accounts receivable from counterparties to EMMT; therefore, EMMT would be exposed to the risk of non-payment of accounts receivable accrued for products delivered prior to the time a counterparty defaulted.

Credit risk is measured as the loss that EME would expect to incur if a counterparty failed to perform pursuant to the terms of its contractual obligations. To manage credit risk, EME evaluates the risk of potential defaults by counterparties. To mitigate credit risk from counterparties, master netting agreements are used whenever possible and counterparties may be required to pledge collateral when deemed necessary.

The majority of EME's consolidated wind projects and unconsolidated affiliates that own power plants sell power under power purchase agreements. Generally, each project or plant sells its output to one counterparty. A default by the counterparty, including a default as a result of a bankruptcy, would likely have a material adverse effect on the operations of the project or plant.

The majority of the coal for the Midwest Generation plants is purchased from suppliers under contracts which may be for multiple years. None of the coal suppliers to the coal plants have investment grade credit ratings and, accordingly, Midwest Generation may have limited recourse to collect damages in the event of default by a supplier.

The Midwest Generation plants sell electric power generally into the PJM market by participating in PJM's capacity and energy markets or transacting in capacity and energy on a bilateral basis. Sales into PJM accounted for 92%, 81% and 79% of Midwest Generation's consolidated operating revenues for the years ended December 31, 2012, 2011 and 2010, respectively. Sales into PJM accounted for approximately 64%, 63% and 65% of EME's consolidated operating revenues for the years ended December 31, 2012, 2011 and 2010, respectively. Moody's Investors Service, Inc. (Moody's) rates PJM's debt Aa3. PJM, a regional transmission organization (RTO) with over 300 member companies, maintains its own credit risk policies and does not extend unsecured credit to non-investment grade companies. Losses resulting from a PJM member default are shared by all other members using a predetermined formula. At December 31, 2012 and 2011, EME's account receivable due from PJM was $40 million and $62 million, respectively.