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Derivative Instruments and Hedging Activities
 9 Months Ended
Sep. 30, 2013
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative Instruments and Hedging Activities
Derivative Instruments and Hedging Activities (EME, Midwest Generation)
EME and Midwest Generation use derivative instruments to reduce their 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 and Midwest Generation do 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 and Midwest Generation'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 and Midwest Generation's consolidated balance sheets as derivative assets or liabilities with offsetting changes in fair value, to the extent effective, recognized in AOCI 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. The results of derivative activities are recorded in cash flows from operating activities on the consolidated statements of cash flows.
Derivative instruments that are utilized by EME 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.
Where EME's and Midwest Generation's derivative instruments are subject to a master netting agreement or contain collateral deposit requirements and the criteria of authoritative guidance are met, EME presents its derivative assets and liabilities on a net basis on its consolidated balance sheets. EME's and Midwest Generation's master netting agreements allow for the right of offset for contracts with physical settlement. They do not allow for cross commodity settlement unless all positions are liquidated.
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. Future changes in power prices could expose EME and Midwest Generation to additional collateral postings.
EME's and Midwest Generation'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 their financial position, EME and Midwest Generation have limited access to enter into such transactions and have been subject to increased initial collateral and margin requirements. There is no assurance that EME and Midwest Generation will continue to be able to utilize clearing brokers. If EME and Midwest Generation become unable to utilize clearing brokers, they may seek to execute bilateral transactions with third parties which could be unavailable on commercially reasonable terms or at all.
Notional Volumes of Derivative Instruments
The following table summarizes notional volumes of derivatives used for hedging and trading activities:
 
 
 
 
September 30, 2013
 
 
 
 
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
908

—

908

 
—

13

13

2 
—

 
Electricity
Forwards/ Futures
Purchases, net
GWh
—

—

—

 
—

—

—

 
734

 
Electricity
Congestion
Purchases, net
GWh
—

—

—

 
—

112

112

4 
266,795

4 
Natural gas
Forwards/ Futures
Sales, net
bcf1
—

—

—

 
—

—

—

 
13.4

 
Fuel oil
Forwards/Futures
Sales, net
barrels
—

—

—

 
—

—

—

 
40,000

 
Weather
Forwards/ Futures
Purchases, net
CDD1
—

—

—

 
—

—

—

 
15,000

 
 
 
 
 
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
GWh
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
Sales, net
bcf1
—

—

—

 
—

—

—

 
9.9

 
1 
gigawatt-hours (GWh); gigawatts-day (GW-Day); billion cubic feet (bcf); cooling degree day (CDD).
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.
EME
Interest Rate Risk Management
EME mitigates the risk of interest rate fluctuations for a number of its project financings by arranging for fixed rate financing or variable rate financing with interest rate swaps, interest rate options, or other hedging mechanisms.
Through July 2013, as a result of the Chapter 11 Cases and the short-term forbearance agreements that had been executed with the lenders and the EME subsidiary borrowers, EME could no longer conclude it was probable that the future interest payments associated with the Viento II Financing would occur. Accordingly, the cash flow hedges associated with these interest rate swaps were prospectively discontinued. Unrealized gains of $1 million and $6 million during the three and nine months ended September 30, 2013, respectively, were recorded in interest expense on the consolidated statements of operations from changes in the fair value of interest rate swaps. In conjunction with the amendment of the Viento II Financing in July 2013, EME entered into new interest rate swaps and re-designated the existing interest rate swaps as cash flow hedges. Interest rate swap termination fees of $6 million were recorded as reduction to derivative liabilities on the consolidated balance sheets. For additional information, see Note 5—Debt and Credit Agreements.
The following table summarizes EME's interest rate swaps:
 
 
 
 
 
 
 
Notional Value (in millions)
 
Effective Date
 
Expiration Date
 
Fixed Swap Rate Paid
 
September 30, 2013
 
December 31, 2012
Project Financing
 
 
 
 
 
 
 
 
 
Viento Funding II
June 2009
 
June 2016
 
3.18%
 
$
55

 
$
65

Viento Funding II
March 2011
 
December 2020
 
3.42%
 
30

 
108

Viento Funding II
July 2013
 
July 2023
 
3.03%
 
96

 
—

Cedro Hill
December 2010
 
December 2025
 
4.29%
 
107

 
112

Laredo Ridge
March 2011
 
March 2026
 
3.46%
 
63

 
64

Tapestry
December 2011
 
December 2021
 
2.21%
 
184

 
189

Broken Bow
December 2012
 
December 2013
 
0.83%
 
46

 
47

Crofton Bluffs
December 2012
 
December 2013
 
0.78%
 
24

 
24

Walnut Creek Energy1
November 2011
 
May 2013
 
0.81%
 
—

 
181

Walnut Creek Energy1
June 2013
 
May 2023
 
3.54%
 
383

 
—

WCEP Holdings1
July 2011
 
May 2013
 
0.79%
 
—

 
26

WCEP Holdings1
June 2013
 
May 2023
 
4.00%
 
48

 
—

Forward Starting Swaps
 
 
 
 
 
 
 
 
 
Broken Bow
December 2013
 
December 2027
 
2.96%
 
45

 
45

Crofton Bluffs
December 2013
 
December 2027
 
2.75%
 
23

 
23

Tapestry
December 2021
 
December 2029
 
3.57%
 
60

 
60

Viento Funding II
July 2023
 
June 2028
 
4.99%
 
65

 
—


1 
During the second quarter of 2013, the existing interest rate swaps for the Walnut Creek Project expired and, in conjunction with the conversion to term loans, the forward starting swaps became effective.
Summary of Derivative Instruments
The following table summarizes EME's derivative instruments, including amounts offset by collateral and under master netting agreements:
 
September 30, 2013
 
Short Term
 
Long Term
 
 
(in millions)
Gross
Netting and Collateral
Subtotal
 
Gross
Netting and Collateral
Subtotal
 
Net
Assets
 
 
 
 
 
 
 
 
 
Electricity contracts
$
96

$
(61
)
$
35

 
$
36

$
(17
)
$
19

 
$
54

Natural gas contracts
30

(30
)
—

 
4

(4
)
—

 
—

Coal contracts
1

(1
)
—

 
—

—

—

 
—

Total derivatives subject to a master netting agreement
127

(92
)
35

 
40

(21
)
19

 
54

Total derivatives not subject to a master netting agreement1
—

—

—

 
2

—

2

 
2

Total assets
$
127

$
(92
)
$
35

 
$
42

$
(21
)
$
21

 
$
56

Liabilities
 
 
 
 
 
 
 
 
 
Electricity contracts
$
60

$
(60
)
$
—

 
$
17

$
(17
)
$
—

 
$
—

Natural gas contracts
26

(26
)
—

 
5

(5
)
—

 
—

Coal contracts
1

(1
)
—

 
—

—

—

 
—

Total derivatives subject to a master netting agreement
$
87

$
(87
)
$
—

 
$
22

$
(22
)
$
—

 
$
—

Total derivatives not subject to a master netting agreement1
—

—

—

 
69

—

69

 
69

Total liabilities
$
87

$
(87
)
$
—

 
$
91

$
(22
)
$
69

 
$
69

1    EME's interest rate swaps are not subject to master netting agreements and do not require EME to post collateral.
 
December 31, 2012
 
Short Term
 
Long Term
 
 
(in millions)
Gross
Netting and Collateral
Subtotal
 
Gross
Netting and Collateral
Subtotal
 
Net
Assets
 
 
 
 
 
 
 
 
 
Electricity contracts
$
120

$
(67
)
$
53

 
$
52

$
(15
)
$
37

 
$
90

Natural gas contracts
33

(33
)
—

 
1

(1
)
—

 
—

Coal contracts
2

(2
)
—

 
—

—

—

 
—

Total assets
$
155

$
(102
)
$
53

 
$
53

$
(16
)
$
37

 
$
90

Liabilities
 
 
 
 
 
 
 
 
 
Electricity contracts
$
71

$
(71
)
$
—

 
$
15

$
(15
)
$
—

 
$
—

Natural gas contracts
36

(36
)
—

 
1

(1
)
—

 
—

Coal contracts
2

(2
)
—

 
—

—

—

 
—

Total derivatives subject to a master netting agreement
$
109

$
(109
)
$
—

 
$
16

$
(16
)
$
—

 
$
—

Total derivatives not subject to a master netting agreement1
—

—

—

 
118

—

118

 
118

Total liabilities
$
109

$
(109
)
$
—

 
$
134

$
(16
)
$
118

 
$
118

1 
EME's interest rate swaps are not subject to master netting agreements and do not require EME to post collateral.
EME's subsidiaries have posted $85 million and $61 million cash margin in the aggregate with various counterparties at September 30, 2013 and December 31, 2012, respectively, to support hedging and trading activities. The cash margin posted is required by counterparties as an initial collateral deposit and cannot be offset against the fair value of open contracts except in the event of default. EME's exposure is composed of $42 million and $44 million of net accounts receivable at September 30, 2013 and December 31, 2012, respectively. For positions subject to a master netting agreement, EME is in a net asset position, and in the event of default, cash collateral would be returned to EME. EME did not have any collateral received from counterparties as of September 30, 2013 and December 31, 2012.
Income Statement Impact of Derivative Instruments
The following table provides the cash flow hedge activity as part of EME's AOCI:
 
Nine Months Ended September 30,
 
2013
 
2012
(in millions)
Commodity Contracts
 
Interest Rate Contracts
 
Commodity Contracts
 
Interest Rate Contracts
Beginning of period derivative gains (losses)
$
(1
)
 
$
(118
)
 
$
35

 
$
(90
)
Effective portion of changes in fair value
(2
)
 
38

 
3

 
(35
)
Reclassification to operating revenues
3

 
—

 
(31
)
 
—

Reclassification to interest expense
—

 
4

 
—

 
—

End of period derivative gains (losses)1
$
—

 
$
(76
)
 
$
7

 
$
(125
)
1 
Unrealized derivative gains (losses) are before income taxes. Amounts recorded in AOCI include commodity and interest rate contracts. For additional information, see Note 11—Accumulated Other Comprehensive Loss.
EME recorded net gains (losses) of none and $(2) million during the third quarter of 2013 and 2012, respectively, and $(1) million and none during the nine months ended September 30, 2013 and 2012, respectively, in operating revenues on the consolidated statements of operations representing the amount of cash flow hedge ineffectiveness. EME also reclassified $4 million of unrealized losses in AOCI to interest expense on the consolidated statements of operations in the nine months ended September 30, 2013 due to the discontinuation of the Viento II interest rate swaps.
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 September 30,
 
Nine Months Ended September 30,
(in millions)
Income Statement Location
2013
 
2012
 
2013
 
2012
Economic hedges
Operating revenues
$
(4
)
 
$
8

 
$
(6
)
 
$
25

 
Fuel
—

 
3

 
—

 
2

Trading activities
Operating revenues
24

 
22

 
66

 
72


Midwest Generation
Summary of Derivative Instruments
The following table summarizes Midwest Generation's commodity short-term derivative instruments for non-trading purposes, including amounts offset by collateral and under master netting agreements:
 
September 30, 2013
 
December 31, 2012
(in millions)
Gross
Netting and Collateral
Net
 
Gross
Netting and Collateral
Net
Assets
 
 
 
 
 
 
 
Electricity contracts
$
5

$
(4
)
$
1

 
$
12

$
(10
)
$
2

Liabilities
 
 
 
 
 
 
 
Electricity contracts
$
6

$
(4
)
$
2

 
$
13

$
(10
)
$
3


Midwest Generation does not have any long-term derivative assets and liabilities at September 30, 2013 and December 31, 2012.
Income Statement Impact of Derivative Instruments
The following table provides the cash flow hedge activity as part of Midwest Generation's AOCI:
 
Nine Months Ended September 30,
(in millions)
2013
 
2012
Beginning of period derivative gains (losses)
$
(2
)
 
$
34

Effective portion of changes in fair value
(2
)
 
5

Reclassification to operating revenues
4

 
(32
)
End of period derivative gains (losses)1
$
—

 
$
7

1 
Unrealized derivative gains (losses) are before income taxes. Amounts recorded in AOCI include commodity contracts. For additional information, see Note 11—Accumulated Other Comprehensive Loss.
Midwest Generation recorded net gains (losses) of none and $(2) million during the third quarter of 2013 and 2012, respectively, and $(1) million and none during the nine months ended September 30, 2013 and 2012, 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
Three Months Ended September 30,
 
Nine Months Ended September 30,
2013
 
2012
 
2013
 
2012
Economic hedges
Operating revenues
$
(4
)
 
$
8

 
$
(6
)
 
$
24

 
Fuel
—

 
3

 
—

 
2