Allegheny Power 2010 Annual Report Download - page 104

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89
6. DERIVATIVE INSTRUMENTS
FirstEnergy is exposed to financial risks resulting from fluctuating interest rates and commodity prices, including prices
for electricity, natural gas and energy transmission. To manage the volatility relating to these exposures, FirstEnergy
uses a variety of derivative instruments, including forward contracts, options, futures contracts and swaps. The
derivatives are used for risk management purposes. In addition to derivatives, FirstEnergy also enters into master netting
agreements with certain third parties. FirstEnergy's Risk Policy Committee, comprised of members of senior
management, provides general management oversight for risk management activities throughout FirstEnergy. The
Committee is responsible for promoting the effective design and implementation of sound risk management programs
and oversees compliance with corporate risk management policies and established risk management practices.
FirstEnergy accounts for derivative instruments on its Consolidated Balance Sheets at fair value unless they meet the
normal purchases and normal sales criteria. Derivatives that meet those criteria are accounted for at cost under the
accrual method of accounting. The changes in the fair value of derivative instruments that do not meet the normal
purchases and normal sales criteria are included in purchased power, other expense, unrealized gain (loss) on derivative
hedges in other comprehensive income (loss), or as part of the value of the hedged item. Based on derivative contracts
held as of December 31, 2010, an adverse 10% change in commodity prices would decrease net income by
approximately $16 million ($10 million net of tax) during the next twelve months. A hypothetical 10% increase in the
interest rates associated with variable-rate debt would decrease annual net income by approximately $1 million.
Cash Flow Hedges
FirstEnergy has used forward starting swap agreements to hedge a portion of the consolidated interest rate risk
associated with anticipated issuances of fixed-rate, long-term debt securities of its subsidiaries. These derivatives were
treated as cash flow hedges, protecting against the risk of changes in future interest payments resulting from changes in
benchmark U.S. Treasury rates between the date of hedge inception and the date of the debt issuance. As of December
31, 2010, no forward starting swap agreements were outstanding.
Total unamortized losses included in AOCL associated with prior interest rate cash flow hedges totaled $92 million ($60
million net of tax) as of December 31, 2010. Based on current estimates, approximately $11 million will be amortized to
interest expense during the next twelve months. The table below provides the activity of AOCL related to interest rate
cash flow hedges for the years ended December 31, 2010 and 2009.
Years Ended December 31,
2010 2009
(In millions)
Effective Portion
Loss Recognized in AOCL $ - $(18)
Reclassification from AOCL into Interest Expense (11) (40)
Fair Value Hedges
FirstEnergy has used fixed-for-floating interest rate swap agreements to hedge a portion of the consolidated interest rate
risk associated with the debt portfolio of its subsidiaries. These derivatives were treated as fair value hedges of fixed-
rate, long-term debt issues, protecting against the risk of changes in the fair value of fixed-rate debt instruments due to
lower interest rates. As of December 31, 2010, no fixed-for-floating interest rate swap agreements were outstanding.
Total unamortized gains included in long-term debt associated with prior fixed-for-floating interest rate swap agreements
totaled $124 million ($80 million net of tax) as of December 31, 2010. Based on current estimates, approximately $22
million will be amortized to interest expense during the next twelve months. Reclassifications from long-term debt into
interest expense totaled $12 million during 2010.
Commodity Derivatives
FirstEnergy uses both physically and financially settled derivatives to manage its exposure to volatility in commodity
prices. Commodity derivatives are used for risk management purposes to hedge exposures when it makes economic
sense to do so, including circumstances where the hedging relationship does not qualify for hedge accounting.