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Derivatives and Fair Value Measurements
 12 Months Ended
Dec. 31, 2011
Derivatives and Fair Value Measurements  
Derivatives and Fair Value Measurements

13  Derivatives and Fair Value Measurements

Use of Derivative Instruments

Nature of Our Business and Associated Risks

Our business activities primarily include our Generation, NewEnergy, regulated electric and gas businesses. Our Generation and NewEnergy businesses include:

  • •
    the generation of electricity from our owned and contractually- controlled physical assets,
    •
    the sale of power, gas, and other energy commodities to wholesale and retail customers, and
    •
    risk management services and energy trading activities.

        Our regulated electric and gas businesses engage in electricity and gas transmission and distribution activities in Central Maryland at prices set by the Maryland PSC that are generally designed to recover our costs, including purchased fuel and energy. Substantially all of our risk management activities involving derivatives occur outside our regulated businesses.

        In carrying out our competitive business activities, we purchase and sell power, fuel, and other energy-related commodities in competitive markets. These activities expose us to significant risks, including market risk from price volatility for energy commodities and the credit risks of counterparties with which we enter into contracts. The sources of these risks include, but are not limited to, the following:

  • •
    the risks of unfavorable changes in power prices in the wholesale forward and spot markets in which we sell a portion of the power from our power generation facilities and purchase power to meet our load-serving requirements,
    •
    the risk of unfavorable fuel price changes for the purchase of a portion of the fuel for our generation facilities under short-term contracts or on the spot market. Fuel prices can be volatile, and the price that can be obtained for power produced from such fuel may not change at the same rate as fuel costs.
    •
    the risk that one or more counterparties may fail to perform under their obligations to make payments or deliver fuel or power,
    •
    interest rate risk associated with variable-rate debt and the fair value of fixed-rate debt used to finance our operations; and
    •
    foreign currency exchange rate risk associated with international investments and purchases of equipment and commodities in currencies other than U.S. dollars.

Objectives and Strategies for Using Derivatives

Risk Management Activities

To lower our exposure to the risk of unfavorable fluctuations in commodity prices, interest rates, and foreign currency rates, we routinely enter into derivative contracts, such as fixed-price forward physical purchase and sales contracts, futures, financial swaps, and option contracts traded in the over-the-counter markets or on exchanges, for hedging purposes. The objectives for entering into such hedging transactions primarily include:

  • •
    fixing the price for a portion of anticipated future electricity sales from our generation operations,
    •
    fixing the price of a portion of anticipated fuel purchases for the operation of our power plants,
    •
    fixing the price for a portion of anticipated energy purchases to supply our load-serving customers, and
    •
    managing our exposure to interest rate risk and foreign currency exchange risks.

Non-Risk Management Activities

In addition to the use of derivatives for risk management purposes, we also enter into derivative contracts for trading purposes primarily for:

  • •
    optimizing the margin on surplus electricity generation and load positions and surplus fuel supply and demand positions,
    •
    price discovery and verification, and
    •
    deploying limited risk capital in an effort to generate returns.

Accounting for Derivative Instruments

        The accounting requirements for derivatives require recognition of all qualifying derivative instruments on the balance sheet at fair value as either assets or liabilities.

Accounting Designation

We must evaluate new and existing transactions and agreements to determine whether they meet the definition of a derivative, for which there are several possible accounting treatments. The permissible accounting treatments include:

  • •
    normal purchase normal sale (NPNS),
    •
    cash flow hedge,
    •
    fair value hedge, and
    •
    mark-to-market.

        Mark-to-market is required as the default accounting treatment for all derivatives unless they qualify, and we specifically designate them, for one of the other accounting treatments. Derivatives designated for any of the elective accounting treatments must meet specific, restrictive criteria, both at the time of designation and on an ongoing basis.

        We discuss our accounting policies for derivatives and hedging activities and their impacts on our financial statements in Note 1.

NPNS

We elect NPNS accounting for derivative contracts that provide for the purchase or sale of a physical commodity that will be delivered in quantities expected to be used or sold over a reasonable period in the normal course of business. Once we elect NPNS classification for a given contract, we cannot subsequently change the election and treat the contract as a derivative using mark-to-market or hedge accounting.

Cash Flow Hedging

We generally elect cash flow hedge accounting for most of the derivatives that we use to hedge market price risk for our physical energy delivery activities because hedge accounting more closely aligns the timing of earnings recognition and cash flows for the underlying business activities. Management monitors the potential impacts of commodity price changes and, where appropriate, may enter into or close out (via offsetting transactions) derivative transactions designated as cash flow hedges.

Commodity Cash Flow Hedges

We have designated fixed-price forward contracts as cash-flow hedges of forecasted sales of energy, fuel and other related commodities and forecasted purchases of fuel and energy for the years 2012 through 2017. We had net unrealized pre-tax losses on these cash-flow hedges recorded in "Accumulated other comprehensive loss" of $652.7 million at December 31, 2011 and $388.0 million at December 31, 2010.

        We expect to reclassify $392.6 million of net pre-tax losses on cash-flow hedges from "Accumulated other comprehensive loss" into earnings during the next twelve months based on market prices at December 31, 2011. However, the actual amount reclassified into earnings could vary from the amounts recorded at December 31, 2011, due to future changes in market prices.

        When we determine that a forecasted transaction originally designated as a hedged item has become probable of not occurring, we immediately reclassify net unrealized gains or losses associated with those hedges from "Accumulated other comprehensive loss" to earnings. We recognized in earnings the following pre-tax amounts on such contracts:

Year ended December 31,
   2011
   2010
   2009
  
   
 
   (In millions)
  

Pre-tax losses

   $ (4.0 ) $ (0.3 ) $ (241.0 )
   

Interest Rate Swaps Designated as Cash Flow Hedges

We use interest rate swaps designated as cash flow hedges to manage our interest rate exposures associated with new debt issuances and to manage our exposure to fluctuations in interest rates on variable rate debt. The effective portion of gains and losses on these interest rate cash flow hedges, net of associated deferred income tax effects, is recorded in "Accumulated other comprehensive loss" in our Consolidated Statements of Shareholders' Equity and Comprehensive Income (Loss). We reclassify gains and losses on the hedges from "Accumulated other comprehensive loss" into "Interest expense" in our Consolidated Statements of Income (Loss) during the periods in which the interest payments being hedged occur.

        Accumulated other comprehensive loss includes net unrealized pre-tax gains on interest rate cash-flow hedges of prior debt issuances totaling $8.9 million at December 31, 2011 and $10.1 million at December 31, 2010. We expect to reclassify $0.1 million of pre-tax net losses on these cash-flow hedges from "Accumulated other comprehensive loss" into "Interest expense" during the next twelve months. We had no hedge ineffectiveness on these swaps.

        During the third quarter of 2011, a subsidiary of Constellation Energy entered into forward-starting interest rate swap contracts to manage a portion of our interest rate exposure for anticipated long-term borrowings to finance our solar projects. The swaps have contract amounts that total $30.6 million with an average interest rate of 3.6% and expire in 2027. At December 31, 2011, the fair value of these swap contracts was an unrealized pre-tax loss of $3.6 million.

Fair Value Hedging

We elect fair value hedge accounting for a limited portion of our derivative contracts including certain interest rate swaps, certain forward contracts, and swaps associated with natural gas fuel in storage. The objectives for electing fair value hedging in these situations are to manage our exposure to changes in the fair value of our assets and liabilities, to optimize the mix of our fixed and floating-rate debt, and to hedge the value of our natural gas in storage.

Interest Rate Swaps Designated as Fair Value Hedges

We use interest rate swaps designated as fair value hedges to optimize the mix of fixed and floating-rate debt. We record any gains or losses on swaps that qualify for fair value hedge accounting treatment, as well as changes in the fair value of the debt being hedged, in "Interest expense." We record changes in fair value of the swaps in "Derivative assets and liabilities" and changes in the fair value of the debt in "Long-term debt" in our Consolidated Balance Sheets. In addition, we record the difference between interest on hedged fixed-rate debt and floating-rate swaps in "Interest expense" in the periods that the swaps settle.

        As of December 31, 2011, we have interest rate swaps qualifying as fair value hedges relating to $550 million of our fixed-rate debt maturing in 2015, and converted this notional amount of debt to floating-rate. The fair value of these hedges was an unrealized gain of $43.8 million at December 31, 2011.

        As of December 31, 2010, we had interest rate swaps qualifying as fair value hedges relating to $400 million of our fixed-rate debt. The fair value of these hedges was an unrealized gain of $35.7 million at December 31, 2010.

        We recorded the fair value of these hedges as an increase in our "Derivative assets" and an increase in our "Long-term debt." We had no hedge ineffectiveness on these interest rate swaps.

        In January 2011, we terminated $200 million of these interest rate swaps as a result of retiring all of our fixed-rate debt maturing in 2012 and received $13.8 million in cash.

        During February 2011, we entered into interest rate swaps qualifying as fair value hedges related to $350 million of our fixed rate debt maturing in 2015, and converted this notional amount of debt to floating rate. We also entered into $150 million of interest rate swaps related to our fixed rate debt maturing in 2020 that do not qualify as fair value hedges, which are discussed under Mark-to-Market below.

Hedge Ineffectiveness

For all categories of derivative instruments designated in hedging relationships, we recorded in earnings the following pre-tax gains (losses) related to hedge ineffectiveness:

Year ended December 31,
   2011
   2010
   2009
  
   
 
   (In millions)
  

Cash-flow hedges

   $ (132.4 ) $ (91.3 ) $ 11.3  

Fair value hedges

     (0.7 )   —     23.9  
   

Total

   $ (133.1 ) $ (91.3 ) $ 35.2  
   

        The ineffectiveness in the table above excludes pre-tax gains of $5.8 million related to the change in our fair value hedges excluded from hedge ineffectiveness for the year ended December 31, 2011. We did not have any gains excluded from the above table in 2010 and 2009. We did not recognize any gain or loss related to the change in our fair value hedges excluded from hedge ineffectiveness during the years ended December 31, 2011, 2010, and 2009.

Mark-to-Market

We generally apply mark-to-market accounting for risk management and trading activities for which changes in fair value more closely reflect the economic performance of the underlying business activity. However, we also use mark-to-market accounting for derivatives related to the following activities:

  • •
    our competitive retail gas customer supply activities, which are managed using economic hedges that we have not designated as cash-flow hedges in order to match the timing of recognition of the earnings impacts of those activities to the greatest extent permissible,
    •
    economic hedges of activities that require accrual accounting for which the related hedge requires mark-to-market accounting, and
    •
    during February 2011, we entered into interest rate swaps related to $150 million of our fixed rate debt maturing in 2020, and converted this notional amount of debt to floating rate. However, these interest rate swaps do not qualify as fair value hedges and will be marked to market through earnings.

Origination Gains

We may record origination gains associated with commodity derivatives subject to mark-to-market accounting. Origination gains represent the initial fair value of certain structured transactions that our wholesale marketing, risk management, and trading operation executes to meet the risk management needs of our customers. Historically, transactions that result in origination gains have been unique and resulted in individually significant gains from a single transaction. We generally recognize origination gains when we are able to obtain observable market data to validate that the initial fair value of the contract differs from the contract price. We have recorded a $14.8 million pre-tax origination gain related to one transaction in 2011. We recorded no origination gains during 2010 or 2009.

Termination or Restructuring of Commodity Derivative Contracts

We may terminate or restructure commodity derivative contracts in exchange for upfront cash payments and a reduction or cancellation of future performance obligations. The termination or restructuring of contracts allows us to lower our exposure to performance risk under these contracts. We had no such transactions in 2011, 2010 and 2009.

Quantitative Information About Derivatives and Hedging Activities

Background

Effective January 1, 2009, we adopted an accounting standard that addresses disclosures about derivative instruments and hedging activities. This standard does not change the accounting for derivatives; rather, it requires expanded disclosure about derivative instruments and hedging activities regarding:

  • •
    the ways in which an entity uses derivatives,
    •
    the accounting for derivatives and hedging activities, and
    •
    the impact that derivatives have (or could have) on an entity's financial position, financial performance, and cash flows.

Balance Sheet Tables

We present our derivative assets and liabilities in our Consolidated Balance Sheets on a net basis, including cash collateral, whenever we have a legally enforceable master netting agreement with a counterparty to a derivative contract. We use master netting agreements whenever possible to manage and substantially reduce our potential counterparty credit risk. The net presentation in our Consolidated Balance Sheets reflects our actual credit exposure after giving effect to the beneficial effects of these agreements and cash collateral, and our credit risk is reduced further by other forms of collateral.

        The following tables provide information about the risks we manage using derivatives. These tables only include derivatives and do not reflect the price risks we are hedging that arise from physical assets or nonderivative accrual contracts within our Generation and NewEnergy businesses.

        As discussed more fully following the table, we present this information by disaggregating our net derivative assets and liabilities into gross components on a contract-by-contract basis before giving effect to the risk-reducing benefits of master netting arrangements and collateral. As a result, we must present each individual contract as an "asset value" if it is in the money or a "liability value" if it is out of the money, regardless of whether the individual contracts offset market or credit risks of other contracts in full or in part. Therefore, the gross amounts in these tables do not reflect our actual economic or credit risk associated with derivatives. This gross presentation is intended only to show separately the various derivative contract types we use, such as commodities, interest rate, and foreign exchange.

        In order to identify how our derivatives impact our financial position, at the bottom of the table we provide a reconciliation of the gross fair value components to the net fair value amounts as presented in the Fair Value Measurements section of this note and our Consolidated Balance Sheets.

        The gross asset and liability values in the tables below are segregated between those derivatives designated in qualifying hedge accounting relationships and those not designated in hedge accounting relationships. Derivatives not designated in hedging relationships include our NewEnergy retail power and gas customer supply operation, economic hedges of accrual activities, and risk management and trading activities which we have substantially curtailed as part of our effort to reduce risk in our business. We use the end of period accounting designation to determine the classification for each derivative position.

As of December 31, 2011
   Derivatives
Designated as Hedging
Instruments for
Accounting Purposes
   Derivatives Not
Designated As Hedging
Instruments for
Accounting Purposes
   All Derivatives
Combined
  
   
Contract type
   Asset
Values (3)
   Liability
Values (4)
   Asset
Values (3)
   Liability
Values (4)
   Asset
Values (3)
   Liability
Values (4)
  
   
 
   (In millions)
  

Power contracts

   $ 1,617.2   $ (1,686.9 ) $ 4,785.8   $ (5,105.9 ) $ 6,403.0   $ (6,792.8 )

Gas contracts

     1,624.5     (2,108.4 )   4,842.8     (4,858.1 )   6,467.3     (6,966.5 )

Coal contracts

     34.0     (36.0 )   73.0     (66.3 )   107.0     (102.3 )

Other commodity contracts (1)

     —     —     153.8     (144.2 )   153.8     (144.2 )

Interest rate contracts

     43.9     (3.6 )   55.1     (49.0 )   99.0     (52.6 )

Foreign exchange contracts

     —     —     10.5     (2.8 )   10.5     (2.8 )

Equity contracts

     —     —     0.2     —     0.2     —  
   

Total gross fair values

   $ 3,319.6   $ (3,834.9 ) $ 9,921.2   $ (10,226.3 ) $ 13,240.8   $ (14,061.2 )

 

                  

Netting arrangements (5)

                             (12,989.5 )   12,989.5  

Cash collateral

                             (167.2 )   23.8  
                               

Net fair values

                           $ 84.1   $ (1,047.9 )

 

                              

Net fair value by balance sheet line item:

                                      

Accounts receivable (2)

                           $ (533.1 )      

Derivative assets—current

                             357.9        

Derivative assets—noncurrent

                             259.3        

Derivative liabilities—current

                                   (779.5 )

Derivative liabilities—noncurrent

                                   (268.4 )
                               

Total Derivatives

                           $ 84.1   $ (1,047.9 )
   
(1)
Other commodity contracts include oil, freight, emission allowances, renewable energy credits, and weather contracts.

(2)
Represents the unrealized fair value of exchange traded derivatives, exclusive of cash margin posted.

(3)
Represents in-the-money contracts without regard to potentially offsetting out-of-the-money contracts under master netting agreements.

(4)
Represents out-of-the-money contracts without regard to potentially offsetting in-the-money contracts under master netting agreements.

(5)
Represents the effect of legally enforceable master netting agreements.

As of December 31, 2010
   Derivatives
Designated as Hedging
Instruments for
Accounting Purposes
   Derivatives Not
Designated As Hedging
Instruments for
Accounting Purposes
   All Derivatives
Combined
  
   
Contract type
   Asset
Values (3)
   Liability Values (4)
   Asset Values (3)
   Liability Values (4)
   Asset Values (3)
   Liability Values (4)
  
   
 
   (In millions)
  

Power contracts

   $ 1,167.9   $ (1,362.8 ) $ 6,795.0   $ (7,166.5 ) $ 7,962.9   $ (8,529.3 )

Gas contracts

     1,902.3     (1,832.8 )   3,390.1     (3,155.3 )   5,292.4     (4,988.1 )

Coal contracts

     97.0     (48.6 )   266.0     (259.7 )   363.0     (308.3 )

Other commodity contracts (1)

     —     —     61.4     (61.6 )   61.4     (61.6 )

Interest rate contracts

     35.7     —     34.4     (35.7 )   70.1     (35.7 )

Foreign exchange contracts

     —     —     11.0     (8.4 )   11.0     (8.4 )
   

Total gross fair values

   $ 3,202.9   $ (3,244.2 ) $ 10,557.9   $ (10,687.2 ) $ 13,760.8   $ (13,931.4 )

 

                  

Netting arrangements (5)

                             (12,955.5 )   12,955.5  

Cash collateral

                             (28.4 )   0.6  
                               

Net fair values

                           $ 776.9   $ (975.3 )

 

                              

Net fair value by balance sheet line item:

                                      

Accounts receivable (2)

                           $ (16.4 )      

Derivative assets—current

                             534.4        

Derivative assets—noncurrent

                             258.9        

Derivative liabilities—current

                                   (622.3 )

Derivative liabilities—noncurrent

                                   (353.0 )
                               

Total Derivatives

                           $ 776.9   $ (975.3 )
   
(1)
Other commodity contracts include oil, freight, emission allowances, and weather contracts.

(2)
Represents the unrealized fair value of exchange traded derivatives, exclusive of cash margin posted.

(3)
Represents in-the-money contracts without regard to potentially offsetting out-of-the-money contracts under master netting agreements.

(4)
Represents out-of-the-money contracts without regard to potentially offsetting in-the-money contracts under master netting agreements.

(5)
Represents the effect of legally enforceable master netting agreements.

        The magnitude of and changes in the gross derivatives components in these tables do not indicate changes in the level of derivative activities, the level of market risk, or the level of credit risk. The primary factors affecting the magnitude of the gross amounts in the table are changes in commodity prices and the total number of contracts. If commodity prices change, the gross amounts could increase, even if the level of contracts stays the same, because separate presentation is required for contracts that are in the money from those that are out of the money. As a result, the gross amounts of even fully hedged positions could increase if prices change. Additionally, if the number of contracts increases, the gross amounts also could increase. Thus, the execution of new contracts to reduce economic risk could actually increase the gross amounts in the table because of the requirement to present the gross value of each individual contract separately.

        The primary purpose of these tables is to disaggregate the risks being managed using derivatives. In order to achieve this objective, we prepare this table by separating each individual derivative contract that is in the money from each contract that is out of the money and present such amounts on a gross basis, even for offsetting contracts that have identical quantities for the same commodity, location, and delivery period. We must also present these components excluding the substantive credit-risk reducing effects of master netting agreements and collateral. As a result, the gross "asset" and "liability" amounts for each contract type far exceed our actual economic exposure to commodity price risk and credit risk. Our actual economic exposure consists of the net derivative position combined with our nonderivative accrual contracts, such as those for load-serving, and our physical assets, such as our power plants. Our actual derivative credit risk exposure after master netting agreements and cash collateral is reflected in the net fair value amounts shown at the bottom of the table above. Our total economic and credit exposures, including derivatives, are managed in a comprehensive risk framework that includes risk measures such as economic value at risk, stress testing, and maximum potential credit exposure.

Gain and (Loss) Tables

The tables below summarize the gain and loss impacts of our derivative instruments segregated into the following categories:

  • •
    cash flow hedges,
    •
    fair value hedges, and
    •
    mark-to-market derivatives.

        The tables only include this information for derivatives and do not reflect the related gains or losses that arise from generation and generation-related assets, nonderivative accrual contracts, or NPNS contracts within our Generation and NewEnergy businesses, other than fair value hedges, for which we separately show the gain or loss on the hedged asset or liability. As a result, for mark-to-market and cash-flow hedge derivatives, these tables only reflect the impact of derivatives themselves and therefore do not necessarily include all of the income statement impacts of the transactions for which derivatives are used to manage risk. For a more complete discussion of how derivatives affect our financial performance, see our accounting policy for Revenues, Fuel and Purchased Energy Expenses, and Derivatives and Hedging Activities in Note 1.

        The following tables present gains and losses on derivatives designated as cash flow hedges. As discussed more fully in our accounting policy, we record the effective portion of unrealized gains and losses on cash flow hedges in Accumulated Other Comprehensive Loss until the hedged forecasted transaction affects earnings. We record the ineffective portion of gains and losses on cash flow hedges in earnings as they occur. When the hedged forecasted transaction settles and is recorded in earnings, we reclassify the related amounts from Accumulated Other Comprehensive Loss into earnings, with the result that the combination of revenue or expense from the forecasted transaction and gain or loss from the hedge are recognized in earnings at a total amount equal to the hedged price. Accordingly, the amount of derivative gains and losses recorded in Accumulated Other Comprehensive Loss and reclassified from Accumulated Other Comprehensive Loss into earnings does not reflect the total economics of the hedged forecasted transactions. The total impact of our forecasted transactions and related hedges is reflected in our Consolidated Statements of Income (Loss).

Cash Flow Hedges
    
    
    
    
    
    
   Year Ended December 31,
  
   
 
   Gain (Loss) Recorded
in AOCI 		   
   Gain (Loss)
Reclassified from AOCI
into Earnings 		  Ineffectiveness Gain
(Loss) Recorded
in Earnings 		 
 
   Statement of Income
(Loss) Line Item
  
Contract type:
   2011
   2010
   2009
   2011
   2010
   2009
   2011
   2010
   2009
  
   
 
   (In millions)
    
  

Hedges of forecasted sales:

                    

Nonregulated revenues

                                      

Power contracts

   $ 162.3   $ 144.5   $ 362.5       $ 19.2   $ (165.8 ) $ (180.6 ) $ 70.9   $ 8.9   $ 77.5  

Gas contracts

     63.5     (59.1 )   (65.1 )       198.5     90.8     (67.3 )   (49.6 )   (0.3 )   6.3  

Coal contracts

     —     —     10.0         —     —     (229.9 )   —     —     —  

Other commodity contracts (1)

     —     —     6.8         —     (0.7 )   (0.4 )   —     —     (6.2 )

Interest rate contracts

     —     —     (0.3 )       —     —     (0.3 )   —     —     —  

Foreign exchange contracts

     —     —     2.5         —     (1.0 )   (1.1 )   —     —     —  
   

Total gains (losses)

   $ 225.8   $ 85.4   $ 316.4  

Total included in nonregulated revenues

   $ 217.7   $ (76.7 ) $ (479.6 ) $ 21.3   $ 8.6   $ 77.6  
   

Hedges of forecasted purchases:

                    

Fuel and purchased energy expense

                                      

Power contracts

   $ (295.5 ) $ (377.4 ) $ (1,056.0 )     $ (476.7 ) $ (1,036.1 ) $ (1,905.3 ) $ (52.0 ) $ (40.7 ) $ (42.2 )

Gas contracts

     (471.6 )   (141.5 )   103.7         (51.8 )   216.5     165.8     (102.5 )   (64.3 )   (15.2 )

Coal contracts

     (11.8 )   65.9     (77.7 )       22.4     (34.6 )   (187.6 )   0.8     4.9     (8.9 )

Other commodity contracts (2)

     —     (0.2 )   (12.3 )       —     (0.3 )   8.2     —     0.2     —  

Foreign exchange contracts

     —     —     —         —     —     —     —     —     —  
   

Total losses

   $ (778.9 ) $ (453.2 ) $ (1,042.3 )

Total included in fuel and purchased energy expense

   $ (506.1 ) $ (854.5 ) $ (1,918.9 ) $ (153.7 ) $ (99.9 ) $ (66.3 )
   

Hedges of interest rates:

                    

Interest expense

                                      

Interest rate contracts

     (3.6 )   —     —         1.2     4.3     0.6     —     —     —  
   

Total (losses) gains

   $ (3.6 ) $ —   $ —  

Total included in interest expense

   $ 1.2   $ 4.3   $ 0.6   $ —   $ —   $ —  
   

Grand total (losses) gains

   $ (556.7 ) $ (367.8 ) $ (725.9 )     $ (287.2 ) $ (926.9 ) $ (2,397.9 ) $ (132.4 ) $ (91.3 ) $ 11.3  
   
(1)
Other commodity sale contracts include oil and freight contracts.

(2)
Other commodity purchase contracts include freight and emission allowances.

        The following table presents gains and losses on derivatives designated as fair value hedges and, separately, the gains and losses on the hedged item. As discussed earlier, we record the unrealized gains and losses on fair value hedges as well as changes in the fair value of the hedged asset or liability in earnings as they occur. The difference between these amounts represents hedge ineffectiveness.

Fair Value Hedges
   Year Ended December 31,
  
   
 
    
   Amount of Gain (Loss)
Recognized in Income
on Derivative 		  Amount of Gain (Loss)
Recognized in Income
on Hedged Item 		 
 
   Statement of Income (Loss) Line Item
  
Contract type:
   2011
   2010
   2009
   2011
   2010
   2009
  
   
 
    
   (In millions)
  

Gas contracts

   Nonregulated revenues   $ 23.4   $ —   $ 40.6   $ (15.9 ) $ —   $ (16.7 )

Interest rate contracts

   Interest expense     32.9     18.0     (0.1 )   (32.8 )   (15.6 )   0.7  
   

Total gains (losses)

       $ 56.3   $ 18.0   $ 40.5   $ (48.7 ) $ (15.6 ) $ (16.0 )
   

        The following table presents gains and losses on mark-to-market derivatives, contracts that have not been designated as hedges for accounting purposes. As discussed more fully in Note 1, we record the unrealized gains and losses on mark-to-market derivatives in earnings as they occur. While we use mark-to-market accounting for risk management and trading activities because changes in fair value more closely reflect the economic performance of the activity, we also use mark-to-market accounting for certain derivatives related to portions of our physical energy delivery activities. Accordingly, the total amount of gains and losses from mark-to-market derivatives does not necessarily reflect the total economics of related transactions.

Mark-to-Market Derivatives
   Year Ended December 31,
  
   
 
    
   Amount of Gain (Loss)
Recorded in Income
on Derivative 		 
 
   Statement of Income (Loss) Line Item
  
Contract type:
   2011
   2010
   2009
  
   
 
    
   (In millions)
  

Commodity contracts:

                        

Power contracts

   Nonregulated revenues   $ (51.4 ) $ (26.2 ) $ 250.9  

Gas contracts

   Nonregulated revenues     (224.3 )   41.4     (360.0 )

Coal contracts

   Nonregulated revenues     (9.2 )   13.3     14.0  

Other commodity contracts (1)

   Nonregulated revenues     (4.4 )   (15.4 )   (11.7 )

Coal contracts

   Fuel and purchased energy expense     —     —     (109.8 )

Interest rate contracts

   Nonregulated revenues     1.6     (2.3 )   (27.2 )

Interest rate contracts

   Interest expense     5.2     —     —  

Foreign exchange contracts

   Nonregulated revenues     0.4     (1.2 )   7.6  

Equity contracts

   Nonregulated revenues     (0.4 )   —     —  
   

Total gains (losses)

       $ (282.5 ) $ 9.6   $ (236.2 )
   
(1)
Other commodity contracts include oil, freight, weather, renewable energy credits, and emission allowances.

        In computing the amounts of derivative gains and losses in the above tables, we include the changes in fair values of derivative contracts up to the date of maturity or settlement of each contract. This approach facilitates a comparable presentation for both financial and physical derivative contracts. In addition, for cash flow hedges we include the impact of intra-quarter transactions (i.e., those that arise and settle within the same quarter) in both gains and losses recognized in Accumulated Other Comprehensive Loss and amounts reclassified from Accumulated Other Comprehensive Loss into earnings.

Volume of Derivative Activity

The volume of our derivatives activity is directly related to the fundamental nature and scope of our business and the risks we manage. We own or control electric generating facilities, which exposes us to both power and fuel price risk; we serve electric and gas wholesale and retail customers within our NewEnergy business, which exposes us to electricity and natural gas price risk; and we provide risk management services and engage in trading activities, which can expose us to a variety of commodity price risks. In order to manage the risks associated with these activities, we are required to be an active participant in the energy markets, and we routinely employ derivative instruments to conduct our business.

        Derivative instruments provide an efficient and effective way to conduct our business and to manage the associated risks. As such, we use derivatives in the following ways:

  • •
    We manage our generating resources and NewEnergy business based upon established policies and limits, and we use derivatives to establish a portion of our hedges and to adjust the level of our hedges from time to time.
    •
    We engage in trading activities which enable us to execute hedging transactions in a cost-effective manner. We manage those activities based upon various risk measures, including position limits, economic value at risk (EVaR) and value at risk (VaR), and we use derivatives to establish and maintain those activities within the prescribed limits.
    •
    We also use derivatives to execute, control, and reduce the overall level of our trading positions and risk as well as to manage a portion of our interest rate risk associated with debt and our foreign currency risk from non-dollar denominated transactions.

        The following tables present information designed to provide insight into the overall volume of our derivatives usage. However, the volumes presented in these tables should only be used as an indication of the extent of our derivatives usage and the risks they are intended to manage and are subject to a number of limitations as follows:

  • •
    The volume information is not a complete representation of our market price risk because it only includes derivative contracts. Accordingly, these tables do not present a complete picture of our overall net economic exposure, and should not be interpreted as an indication of open or unhedged commodity positions, because the use of derivatives is only one of the means by which we engage in and manage the risks of our business. For example, the table does not include power or fuel quantities and risks arising from our physical assets, non-derivative contracts, and forecasted transactions that we manage using derivatives; a portion of these volumes reduces those risks.
    •
    The tables also do not include volumes of commodities under nonderivative contracts that we use to serve customers or manage our risks. Our actual net economic exposure from our generating facilities and NewEnergy activities is reduced by derivatives, and the exposure from our trading activities is managed and controlled through the risk measures discussed above. Therefore, the information in the tables below is only an indication of that portion of our business that we manage through derivatives and serves primarily to identify the extent of our derivatives activities and the types of risks that they are intended to manage.
    •
    We have computed the derivative volumes for commodities by aggregating the absolute value of net positions within commodities for each year. This provides an indication of the level of derivatives activity, but it does not indicate either the direction of our position (long or short), or the overall size of our position. We believe this presentation gives an appropriate indication of the level of derivatives activity without unnecessarily revealing the size and direction of our derivatives positions. The disclosure of such information could limit the effectiveness and profitability of our business activities.
    •
    The volume information for commodity derivatives represents "delta equivalent" quantities, not gross notional amounts. We believe that the delta equivalent quantity is the most relevant measure of the volume associated with commodity derivatives. The delta-equivalent quantity represents a risk-adjusted notional quantity for each contract that takes into account the probability that an option will be exercised. For interest rate contracts and foreign currency contracts we have presented the notional amounts of such contracts in the table below.

        The following tables present the volume of our derivative activities as of December 31, 2011 and 2010, shown by contractual settlement year.

Quantities (1) Under Derivative Contracts
    
    
   As of December 31, 2011
  
   
Contract Type (Unit)
   2012
   2013
   2014
   2015
   2016
   Thereafter
   Total
  
   
 
   (In millions)
  

Power (MWH)

     20.8     13.0     0.9     0.4     1.7     0.4     37.2  

Gas (mmBTU)

     263.6     47.7     49.4     18.4     1.8     1.8     382.7  

Coal (Tons)

     0.8     0.7     —     —     —     —     1.5  

Oil (BBL)

     0.1     0.3     0.1     —     —     —     0.5  

Emission Allowances (Tons)

     0.1     0.1     —     —     —     —     0.2  

Renewable Energy Credits (Number of credits)

     0.3     0.3     0.3     0.3     0.3     0.2     1.7  

Equity contracts (Number of shares)

     —     —     0.1     0.1     —     —     0.2  

Interest Rate Contracts

   $ 6.7   $ 515.2   $ 173.0   $ 800.0   $ 387.0   $ 255.6   $ 2,137.5  

Foreign Exchange Rate Contracts

   $ 44.1   $ 8.0   $ 16.8   $ 15.5   $ —   $ —   $ 84.4  
   


 

Quantities (1) Under Derivative Contracts
    
    
   As of December 31, 2010
  
   
Contract Type (Unit)
   2011
   2012
   2013
   2014
   2015
   Thereafter
   Total
  
   
 
   (In millions)
  

Power (MWH)

     21.2     —     3.8     4.2     2.3     0.2     31.7  

Gas (mmBTU)

     175.3     90.1     80.2     64.7     24.1     —     434.4  

Coal (Tons)

     4.4     2.5     0.1     —     —     —     7.0  

Oil (BBL)

     0.2     0.1     0.1     —     —     —     0.4  

Emission Allowances (Tons)

     1.5     —     —     —     —     —     1.5  

Renewable Energy Credits (Number of credits)

     0.4     0.3     0.3     0.3     0.3     0.7     2.3  

Interest Rate Contracts

   $ 639.4   $ 490.7   $ 941.8   $ 405.0   $ 460.0   $ 175.0   $ 3,111.9  

Foreign Exchange Rate Contracts

   $ 48.7   $ 8.7   $ 16.8   $ 16.8   $ 15.5   $ —   $ 106.5  
   
(1)
Amounts in the table are only intended to provide an indication of the level of derivatives activity and should not be interpreted as a measure of any derivative position or overall economic exposure to market risk. Quantities are expressed as "delta equivalents" on an absolute value basis by contract type by year. Additionally, quantities relate only to derivatives and do not include potentially offsetting quantities associated with physical assets and nonderivative accrual contracts.

        In addition to the commodities in the tables above, we also hold derivative instruments related to weather that are insignificant relative to the overall level of our derivative activity.

Credit-Risk Related Contingent Features

Certain of our derivative instruments contain provisions that would require additional collateral upon a credit-related event such as an adequate assurance provision or a credit rating decrease in the senior unsecured debt of Constellation Energy. The amount of collateral we could be required to post would be determined by the fair value of contracts containing such provisions that represent a net liability, after offset for the fair value of any asset contracts with the same counterparty under master netting agreements and any other collateral already posted. This collateral amount is a component of, and is not in addition to, the total collateral we could be required to post for all contracts upon a credit rating decrease.

        The following tables present information related to these derivatives at December 31, 2011 and 2010.

        We present the gross fair value of derivatives in a net liability position that have credit-risk-related contingent features in the first column in the table below. This gross fair value amount represents only the out-of-the-money contracts containing such features that are not fully collateralized by cash on a stand-alone basis. Thus, this amount does not reflect the offsetting fair value of in-the-money contracts under legally-binding master netting agreements with the same counterparty, as shown in the second column in the table. These in-the-money contracts would offset the amount of any gross liability that could be required to be collateralized, and as a result, the actual potential collateral requirements would be based upon the net fair value of derivatives containing such features, not the gross amount. The amount of any possible contingent collateral for such contracts in the event of a downgrade would be further reduced to the extent that we have already posted collateral related to the net liability.

        Because the amount of any contingent collateral obligation would be based on the net fair value of all derivative contracts under each master netting agreement, we believe that the "net fair value of derivative contracts containing this feature" as shown in the tables below is the most relevant measure of derivatives in a net liability position with credit-risk-related contingent features. This amount reflects the actual net liability upon which existing collateral postings are computed and upon which any additional contingent collateral obligation would be based.

Credit-Risk Related Contingent Feature
   As of December 31, 2011
  
   
Gross Fair Value
of Derivative
Contracts Containing
This Feature (1)
   Offsetting Fair Value
of In-the-Money
Contracts Under Master
Netting Agreements (2)
   Net Fair Value
of Derivative
Contracts Containing
This Feature (3)
   Amount of
Posted
Collateral (4)
   Contingent
Collateral
Obligation (5)
  
   
 
    
   (In billions)
    
    
  
$3.3   $ (2.4 ) $ 0.9   $ 0.6   $ 0.2  
   


 

Credit-Risk Related Contingent Feature
   As of December 31, 2010
  
   
Gross Fair Value
of Derivative
Contracts Containing
This Feature (1)
   Offsetting Fair Value
of In-the-Money
Contracts Under Master
Netting Agreements (2)
   Net Fair Value
of Derivative
Contracts Containing
This Feature (3)
   Amount of
Posted
Collateral (4)
   Contingent
Collateral
Obligation (5)
  
   
 
    
   (In billions)
    
    
  
$4.6   $ (3.7 ) $ 0.9   $ 0.7   $ 0.1  
   
(1)
Amount represents the gross fair value of out-of-the-money derivative contracts containing credit-risk-related contingent features that are not fully collateralized by posted cash collateral on an individual, contract-by-contract basis ignoring the effects of master netting agreements.

(2)
Amount represents the offsetting fair value of in-the-money derivative contracts under legally-enforceable master netting agreements with the same counterparty, which reduces the amount of any liability for which we potentially could be required to post collateral.

(3)
Amount represents the net fair value of out-of-the-money derivative contracts containing credit-risk related contingent features after considering the mitigating effects of offsetting positions under master netting arrangements and reflects the actual net liability upon which any potential contingent collateral obligations would be based.

(4)
Amount includes cash collateral posted of $23.8 million and letters of credit of $563.6 million at December 31, 2011 and cash collateral posted of $0.6 million and letters of credit of $656.9 million at December 31, 2010.

(5)
Amounts represent the additional collateral that we could be required to post with counterparties, including both cash collateral and letters of credit, in the event of a credit downgrade to below investment grade after giving consideration to offsetting derivative and non-derivative positions under master netting agreements.

Concentrations of Derivative-Related Credit Risk

We discuss our concentrations of credit risk, including derivative-related positions, in Note 1. At December 31, 2011, we had credit exposure to two counterparties, both large investment grade power cooperatives, equal to 29% of our total credit exposure.

Fair Value Measurements

        We determine the fair value of our assets and liabilities using unadjusted quoted prices in active markets (Level 1) or pricing inputs that are observable (Level 2) whenever that information is available. We use unobservable inputs (Level 3) to estimate fair value only when relevant observable inputs are not available.

        We classify assets and liabilities within the fair value hierarchy based on the lowest level of input that is significant to the fair value measurement of each individual asset and liability taken as a whole. We determine fair value for assets and liabilities classified as Level 1 by multiplying the market price by the quantity of the asset or liability. We primarily determine fair value measurements classified as Level 2 or Level 3 using the income valuation approach, which involves discounting estimated cash flows using assumptions that market participants would use in pricing the asset or liability.

        We present all derivatives recorded at fair value net with the associated fair value cash collateral. This presentation of the net position reflects our credit exposure for our on-balance sheet positions but excludes the impact of any off-balance sheet positions and collateral. Examples of off-balance sheet positions and collateral include in-the-money accrual contracts for which the right of offset exists in the event of default and letters of credit. We discuss our letters of credit in more detail in Note 8.

Recurring Measurements

Our assets and liabilities measured at fair value on a recurring basis consist of the following (immaterial for BGEs assets and liabilities):

 
   As of December 31,
2011
  
 
   Assets
   Liabilities
  
   
 
   (In millions)
  

Cash equivalents

   $ 344.2   $ —  

Debt and equity securities

     39.8     —  

Derivative instruments:

              

Classified as derivative assets and liabilities:

              

Current

     357.9     (779.5 )

Noncurrent

     259.3     (268.4 )
   

Total classified as derivative assets and liabilities

     617.2     (1,047.9 )

Classified as accounts receivable (1)

     (533.1 )   —  
   

Total derivative instruments

     84.1     (1,047.9 )
   

Total recurring fair value measurements

   $ 468.1   $ (1,047.9 )
   
(1)
Represents the unrealized fair value of exchange traded derivatives, exclusive of cash margin posted.

 
   As of December 31,
2010
  
 
   Assets
   Liabilities
  
   
 
   (In millions)
  

Cash equivalents

   $ 1,545.4   $ —  

Debt and equity securities

     47.8     —  

Derivative instruments:

              

Classified as derivative assets and liabilities:

              

Current

     534.4     (622.3 )

Noncurrent

     258.9     (353.0 )
   

Total classified as derivative assets and liabilities

     793.3     (975.3 )

Classified as accounts receivable (1)

     (16.4 )   —  
   

Total derivative instruments

     776.9     (975.3 )
   

Total recurring fair value measurements

   $ 2,370.1   $ (975.3 )
   
(1)
Represents the unrealized fair value of exchange traded derivatives, exclusive of cash margin posted.

        Cash equivalents represent money market funds which are included in "Cash and cash equivalents" in the Consolidated Balance Sheets. Debt securities primarily represent available-for-sale investments in private companies included in "Other assets" in the Consolidated Balance Sheets. Equity securities primarily represent mutual fund investments which are included in "Other assets" in the Consolidated Balance Sheets. Derivative instruments represent unrealized amounts related to all derivatives. We classify exchange-listed derivatives as part of "Accounts Receivable" in our Consolidated Balance Sheets. We classify the remainder of our derivatives as "Derivative assets" or "Derivative liabilities" in our Consolidated Balance Sheets.

        The tables below set forth by level within the fair value hierarchy the gross components of the Company's assets and liabilities that were measured at fair value on a recurring basis as of December 31, 2011 and 2010. We disaggregate our net derivative assets and liabilities by separating each individual derivative contract that is in-the-money from each contract that is out-of-the-money regardless of master netting agreements and collateral. As a result, the gross "asset" and "liability" amounts in each of the three fair value levels far exceed our actual economic exposure to commodity price risk and credit risk. The objective of these tables is to provide information about how each individual derivative contract is valued within the fair value hierarchy, regardless of whether a particular contract is eligible for netting against other contracts or whether it has been collateralized. Therefore, these gross balances are intended solely to provide information on sources of inputs to fair value and proportions of fair value involving objective versus subjective valuations and do not represent either our actual credit exposure or net economic exposure.

At December 31, 2011
   Level 1
   Level 2
   Level 3
   Netting and
Cash Collateral (1)
   Total Net
Fair Value
  
   
 
   (In millions)
  

Cash equivalents

   $ 344.2   $ —   $ —   $ —   $ 344.2  

Debt and equity securities

     30.5     —     9.3     —     39.8  

Derivative assets:

                                

Power contracts

     —     5,835.2     567.8              

Gas contracts

     430.5     5,371.2     665.6              

Coal contracts

     —     106.8     0.2              

Other commodity contracts

     2.0     35.2     116.6              

Interest rate contracts

     48.2     50.8     —              

Foreign exchange contracts

     —     10.5     —              

Equity contracts

     —     —     0.2              
   

Total derivative assets

     480.7     11,409.7     1,350.4     (13,156.7 )   84.1  
   

Derivative liabilities:

                                

Power contracts

     —     (6,175.0 )   (617.8 )            

Gas contracts

     (450.4 )   (6,046.9 )   (470.3 )            

Coal contracts

     —     (101.6 )   (0.7 )            

Other commodity contracts

     (2.2 )   (25.2 )   (116.8 )            

Interest rate contracts

     (47.9 )   —     (3.6 )            

Foreign exchange contracts

     —     (2.8 )   —              
   

Total derivative liabilities

     (500.5 )   (12,351.5 )   (1,209.2 )   13,013.3     (1,047.9 )
   

Net derivative position

     (19.8 )   (941.8 )   141.2     (143.4 )   (963.8 )
   

Total

   $ 354.9   $ (941.8 ) $ 150.5   $ (143.4 ) $ (579.8 )
   
(1)
We present our derivative assets and liabilities in our Consolidated Balance Sheets on a net basis. We net derivative assets and liabilities, including cash collateral, when a legally enforceable master netting agreement exists between us and the counterparty to a derivative contract. At December 31, 2011, we included $167.2 million of cash collateral held and $23.8 million of cash collateral posted (excluding margin posted on exchange traded derivatives) in netting amounts in the above table.

At December 31, 2010
   Level 1
   Level 2
   Level 3
   Netting and
Cash Collateral (1)
   Total Net
Fair Value
  
   
 
   (In millions)
  

Cash equivalents

   $ 1,545.4   $ —   $ —   $ —   $ 1,545.4  

Debt and equity securities

     43.7     —     4.1     —     47.8  

Derivative assets:

                                

Power contracts

     —     7,509.6     453.3              

Gas contracts

     63.9     5,113.3     115.2              

Coal contracts

     —     355.6     7.4              

Other commodity contracts

     6.6     54.8     —              

Interest rate contracts

     33.1     37.0     —              

Foreign exchange contracts

     —     11.0     —              
   

Total derivative assets

     103.6     13,081.3     575.9     (12,983.9 )   776.9  
   

Derivative liabilities:

                                

Power contracts

     —     (7,758.2 )   (771.1 )            

Gas contracts

     (72.7 )   (4,910.3 )   (5.1 )            

Coal contracts

     —     (307.4 )   (0.9 )            

Other commodity contracts

     (7.1 )   (54.5 )   —              

Interest rate contracts

     (35.7 )   —     —              

Foreign exchange contracts

     —     (8.4 )   —              
   

Total derivative liabilities

     (115.5 )   (13,038.8 )   (777.1 )   12,956.1     (975.3 )
   

Net derivative position

     (11.9 )   42.5     (201.2 )   (27.8 )   (198.4 )
   

Total

   $ 1,577.2   $ 42.5   $ (197.1 ) $ (27.8 ) $ 1,394.8  
   
(1)
We present our derivative assets and liabilities in our Consolidated Balance Sheets on a net basis. We net derivative assets and liabilities, including cash collateral, when a legally enforceable master netting agreement exists between us and the counterparty to a derivative contract. At December 31, 2010, we included $28.4 million of cash collateral held and $0.6 million of cash collateral posted (excluding margin posted on exchange traded derivatives) in netting amounts in the above table.

        The factors that cause changes in the gross components of the derivative amounts in the tables above are unrelated to the existence or level of actual market or credit risk from our operations. We describe the primary factors that change the gross components below.

        Increases and decreases in the gross components presented in each of the levels in these tables do not indicate changes in the level of derivative activities. Rather, the primary factors affecting the gross amounts are commodity prices and the total number of contracts. If commodity prices change, the gross amounts could increase, even if the level of contracts stays the same, because separate presentation is required for contracts that are in the money from those that are out of the money. As a result, even fully hedged positions could exhibit increases in the gross amounts if prices change. Additionally, if the number of contracts increases, the gross amounts also could increase. Thus, the execution of new contracts to reduce economic risk could actually increase the gross amounts in the table because of the required separation of contracts discussed above.

        Cash equivalents consist of exchange-traded money market funds, which are valued by multiplying unadjusted quoted prices in active markets by the quantity of the asset and are classified within Level 1.

        Debt securities consist of Series A Preferred Stock in two privately owned companies, which are valued based on the purchase price of the security and are classified within Level 3.

        Equity securities consist of mutual funds and common shares in public companies, which are valued by multiplying unadjusted quoted prices in active markets by the quantity of the asset and are classified within Level 1.

        Derivative instruments include exchange-traded and bilateral contracts. Exchange-traded derivative contracts include futures and options. Bilateral derivative contracts include swaps, forwards, options and structured transactions. We have classified derivative contracts within the fair value hierarchy as follows:

  • •
    Exchange-traded derivative contracts valued by multiplying unadjusted quoted prices in active markets by the quantity of the asset or liability are classified within Level 1.
    •
    Exchange-traded derivative contracts valued using pricing inputs based upon market quotes or market transactions are classified within Level 2. These contracts generally trade in less active markets (i.e., for certain contracts the exchange sets the closing price, which may not be reflective of an actual trade).
    •
    Bilateral derivative contracts where observable inputs are available for substantially the full term and value of the asset or liability are classified within Level 2.
    •
    Bilateral derivative contracts with a lower availability of pricing information are classified in Level 3. In addition, structured transactions, such as certain options, may require us to use internally developed model inputs, which might not be observable in or corroborated by the market, to determine fair value. When such unobservable inputs have more than an insignificant impact on the measurement of fair value, we classify the instrument within Level 3.

        During 2011, there were no significant transfers of derivatives between Level 1 and Level 2 of the fair value hierarchy.

        We utilize models based upon the income approach to measure the fair value of derivative contracts classified as Level 2 or 3. Generally, we use similar models to value similar instruments. In order to determine fair value, we utilize various inputs and factors including market data and assumptions that market participants would use in pricing assets or liabilities as well as assumptions about the risks inherent in the inputs to the valuation technique. The inputs and factors include:

  • •
    forward commodity prices,
    •
    price volatility,
    •
    volumes,
    •
    location,
    •
    interest rates,
    •
    credit quality of counterparties and Constellation Energy, and
    •
    credit enhancements.

        The primary input to our valuation models is the forward commodity curve for the respective instrument. Forward commodity curves are derived from published exchange transaction prices, executed bilateral transactions, broker quotes, and other observable or public data sources. The relevant forward commodity curve used to value each of our derivatives will depend on a number of factors including commodity type, location, and expected delivery period. Price volatility would vary by commodity and location. When appropriate, we discount future cash flows using risk free interest rates with adjustments to reflect the credit quality of each counterparty for assets and our own credit quality for liabilities.

        We also record valuation adjustments to reflect uncertainty associated with certain estimates inherent in the determination of the fair value of derivative assets and liabilities. The effect of these uncertainties is not incorporated in market price information of other market-based estimates used to determine fair value of our mark-to-market energy contracts.

        We describe below the main types of valuation adjustments we record and the process for establishing each. Generally, increases in valuation adjustments reduce our earnings, and decreases in valuation adjustments increase our earnings. However, all or a portion of the effect on earnings of changes in valuation adjustments may be offset by changes in the value of the underlying positions.

  • •
    Close-out adjustment—represents the estimated cost to close out or sell to a third party open mark-to-market positions. This valuation adjustment has the effect of valuing "long" positions (the purchase of a commodity) at the bid price and "short" positions (the sale of a commodity) at the offer price. We compute this adjustment using a market-based estimate of the bid/offer spread for each commodity and option price and the absolute quantity of our net open positions for each year. The level of total close-out valuation adjustments increases as we have larger unhedged positions, bid-offer spreads increase, or market information is not available, and it decreases as we reduce our unhedged positions, bid-offer spreads decrease, or market information becomes available.
    •
    Unobservable input valuation adjustment—this adjustment is necessary when we determine fair value for derivative positions using internally developed models that use unobservable inputs due to the absence of observable market information. Unobservable inputs to fair value may arise due to a number of factors, including but not limited to, the term of the transaction, contract optionality, delivery location, or product type. In the absence of observable market information that supports the model inputs, there is a presumption that the transaction price is equal to the market value of the contract when we transact in our principal market and thus we recalibrate our estimate of fair value to equal the transaction price. Therefore we do not recognize a gain or loss at contract inception on these transactions. We will recognize such gains or losses in earnings as we realize cash flows under the contract or when observable market data becomes available.
    •
    Credit-spread adjustment—for risk management purposes, we compute the value of our derivative assets and liabilities using a risk-free discount rate. In order to compute fair value for financial reporting purposes, we adjust the value of our derivative assets to reflect the credit-worthiness of each counterparty based upon either published credit ratings or equivalent internal credit ratings and associated default probability percentages. We compute this adjustment by applying a default probability percentage to our outstanding credit exposure, net of collateral, for each counterparty. The level of this adjustment increases as our credit exposure to counterparties increases, the maturity terms of our transactions increase, or the credit ratings of our counterparties deteriorate, and it decreases when our credit exposure to counterparties decreases, the maturity terms of our transactions decrease, or the credit ratings of our counterparties improve. As part of our evaluation, we assess whether the counterparties' published credit ratings are reflective of current market conditions. We review available observable data including bond prices and yields and credit default swaps to the extent it is available. We also consider the credit risk measurement implied by that data in determining our default probability percentages, and we evaluate its reliability based upon market liquidity, comparability, and other factors. We also use a credit-spread adjustment in order to reflect our own credit risk in determining the fair value of our derivative liabilities.

        We regularly evaluate and validate the inputs we use to estimate fair value by a number of methods, consisting of various market price verification procedures, including the use of pricing services and multiple broker quotes to support the market price of the various commodities in which we transact, as well as review and verification of models and changes to those models. These activities are undertaken by individuals that are independent of those responsible for estimating fair value.

        The Company's assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the classification of assets and liabilities within the fair value hierarchy. Because of the long-term nature of certain assets and liabilities measured at fair value as well as differences in the availability of market prices and market liquidity over their terms, inputs for some assets and liabilities may fall into any one of the three levels in the fair value hierarchy or some combination thereof. Thus, even though we are required to classify these assets and liabilities in the lowest level in the hierarchy for which inputs are significant to the fair value measurement, a portion of that measurement may be determined using inputs from a higher level in the hierarchy.

        The following table sets forth a reconciliation of changes in Level 3 fair value measurements, which predominantly relate to power contracts:

 
   Year Ended December 31,
  
 
   2011
   2010
  
   
 
   (In millions)
  

Balance at beginning of period

   $ (197.1 ) $ (291.5 )

Realized and unrealized (losses) gains:

              

Recorded in income

     265.0     157.1  

Recorded in other comprehensive income

     28.2     95.2  

Purchases

     (3.0 )      

Sales

     —        

Issuances

     24.8        

Settlements

     —        
   

Net purchases, sales, issuances, and settlements (1)

     21.8     (65.6 )

Transfers into Level 3 (2)

     81.6     73.6  

Transfers out of Level 3 (2)

     (49.0 )   (165.9 )
   

Balance at end of year

   $ 150.5   $ (197.1 )
   

Change in unrealized gains recorded in income relating to derivatives still held at end of period

   $ 51.3   $ 189.6  
   
(1)
Effective January 1, 2011, we are required to present separately purchases, sales, issuances, and settlements.

(2)
For purposes of this reconciliation, we assumed transfers into and out of Level 3 occurred on the last day of the quarter.

        We have defined the categories of purchases, sales, issuances, and settlements to include the inflow or outflow of value as follows:

  • •
    purchases—includes the acquisition of pre-existing derivative contracts,
    •
    sales—includes the sale or assignment of pre-existing derivative contracts,
    •
    issuances—includes the acquisition of derivative contracts and debt securities at inception, and
    •
    settlements—includes the termination of existing derivative contracts prior to normal maturity or settlement.

        During 2011, we had purchases related to our business acquisition and issuances related to premiums paid for option contracts and payments for transmission congestion contracts.

        Realized and unrealized gains (losses) are included primarily in "Nonregulated revenues" for our derivative contracts that are marked-to-market in our Consolidated Statements of Income (Loss) and are included in "Accumulated other comprehensive loss" for our derivative contracts designated as cash-flow hedges in our Consolidated Balance Sheets. We discuss the income statement classification for realized gains and losses related to cash-flow hedges for our various hedging relationships in Note 1.

        Realized and unrealized gains (losses) include the realization of derivative contracts through maturity. This includes the fair value, as of the beginning of each quarterly reporting period, of contracts that matured during each quarterly reporting period. Purchases, sales, issuances, and settlements represent cash paid or received for option premiums, and the acquisition or termination of derivative contracts prior to maturity. Transfers into Level 3 represent existing assets or liabilities that were previously categorized at a higher level for which the inputs to the model became unobservable. Transfers out of Level 3 represent assets and liabilities that were previously classified as Level 3 for which the inputs became observable based on the criteria discussed previously for classification in either Level 1 or Level 2. Because the depth and liquidity of the power markets varies substantially between regions and time periods, the availability of observable inputs for substantially the full term and value of our bilateral derivative contracts changes frequently. As a result, we also expect derivatives balances to transfer into and out of Level 3 frequently based on changes in the observable data available as of the end of the period.

Nonrecurring Measurements

The tables below sets forth our assets and liabilities that were measured at fair value on a nonrecurring basis during the year ended December 31, 2011 and 2010:

 
   Fair Value at
December 31,
2011
   Losses for the
year ended
December 31,
2011
  
   
 
   (In millions)
  

Investment in CENG

   $ 2,150.4   $ 824.2  

Other investments:

              

Qualifying facilities—coal

     22.5     36.7  

Qualifying facilities—biomass

     24.6     23.3  

Qualifying facilities—solar

     —     6.8  
   

Total other investments

     47.1     66.8  
   

Total

   $ 2,197.5   $ 891.0  
   

        During the quarter ended December 31, 2011, we recorded other-than-temporary impairment charges of $891.0 million on our equity method investments including CENG and certain of our qualifying facilities. These fair value measurements included significant unobservable inputs, and, as such, the entire amounts of the measurements were classified as Level 3. We discuss these impairment charges, including the inputs and valuation techniques used to estimate the fair value of these equity method investments, in more detail in Note 2.

 
   Fair Value at
September 30,
2010
   Fair Value at
December 31,
2010
   Losses for the
year ended
December 31,
2010
  
   
 
   (In millions)
  

Investment in CENG

   $ 2,970.4   $ N/A   $ 2,275.0  

Other investments:

                    

UNE

     —     N/A     143.4  

Qualifying facilities—coal

     36.7     N/A     50.0  

Qualifying facilities—hydroelectric

     N/A     14.8     8.4  
   

Total other investments

     36.7     14.8     201.8  
   

Total

   $ 3,007.1   $ 14.8   $ 2,476.8  
   

        During the quarter ended September 30, 2010, we recorded other-than-temporary impairment charges of $2,468.4 million on our equity method investments including CENG, UNE, and three coal-fired generating facilities located in California. Additionally, during the quarter ended December 31, 2010, we recorded an other-than-temporary impairment charge of $8.4 million on one of our equity investments that own a hydroelectric generating facility in California. These fair value measurements included significant unobservable inputs, and, as such, the entire amounts of the measurements were classified as Level 3. We discuss these impairment charges, including the inputs and valuation techniques used to estimate the fair value of these equity method investments, in more detail in Note 2.

        There were no nonrecurring measurements in 2009.

Fair Value of Financial Instruments

        We show the carrying amounts and fair values of financial instruments included in our Consolidated Balance Sheets in the following table:

At December 31,
   2011
   2010
  
   
 
   Carrying
Amount
   Fair
Value
   Carrying
Amount
   Fair
Value
  
   
 
   (In millions)
  

Investments and other assets—Constellation Energy

   $ 146.8   $ 146.8   $ 135.7   $ 136.2  

Fixed-rate long-term debt:

                          

Constellation Energy (including BGE)

     4,132.5     4,702.8     4,229.3     4,518.4  

BGE

     2,361.9     2,636.8     2,143.6     2,301.8  

Variable-rate long-term debt:

                          

Constellation Energy (including BGE)

     892.3     892.3     528.7     528.7  

BGE

     —     —     —     —  
   

        We use the following methods and assumptions for estimating fair value disclosures for financial instruments:

  • •
    cash and cash equivalents, net accounts receivable, restricted cash, other current assets, certain current liabilities, short-term borrowings, current portion of long-term debt, and certain deferred credits and other liabilities: because of their short-term nature, the amounts reported in our Consolidated Balance Sheets approximate fair value,
    •
    investments and other assets: the fair value is based on quoted market prices where available, and
    •
    long-term debt: the fair value is based on quoted market prices where available or by discounting remaining cash flows at current market rates.