Allegheny Power 2010 Annual Report Download - page 53

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38
Commodity Price Risk
FirstEnergy is exposed to financial and market risks resulting from the fluctuation of interest rates and commodity prices
associated with electricity, energy transmission, natural gas, coal, nuclear fuel and emission allowances. To manage the
volatility relating to these exposures, FirstEnergy uses a variety of non-derivative and derivative instruments, including
forward contracts, options, futures contracts and swaps. The derivatives are used principally for hedging purposes.
The valuation of derivative contracts is based on observable market information to the extent that such information is
available. In cases where such information is not available, FirstEnergy relies on model-based information. The model
provides estimates of future regional prices for electricity and an estimate of related price volatility. FirstEnergy uses
these results to develop estimates of fair value for financial reporting purposes and for internal management decision
making (see Note 6 to the consolidated financial statements). Sources of information for the valuation of commodity
derivative contracts as of December 31, 2010 are summarized by contract year in the following table:
Source of Information-
Fair Value by Contract Year 2011 2012 2013 2014 2015 Thereafter Total
(In millions)
Prices actively quoted(1) $ - $ - $ - $ - $ - $ - $ -
Other external sources(2) (331) (157) (52) (36) - - (576)
Prices based on models - - - - 24 110 134
Total(3) $ (331) $ (157) $ (52) $ (36) $ 24 $ 110 $ (442)
(1)
Represents futures and options traded on the New York Mercantile Exchange.
(2)
Primarily represents contracts based on broker and IntercontinentalExchange quotes.
(3)
Includes $335 million in non-hedge commodity derivative contracts that are primarily related to NUG contracts. NUG contracts are
subject to regulatory accounting and do not impact earnings.
FirstEnergy performs sensitivity analyses to estimate its exposure to the market risk of its commodity positions. 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 12 months.
Interest Rate Swap Agreements – 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.
Interest Rate Risk
FirstEnergy’s exposure to fluctuations in market interest rates is reduced since a significant portion of debt has fixed
interest rates, as noted in the table below. FirstEnergy is subject to the inherent interest rate risks related to refinancing
maturing debt by issuing new debt securities. As discussed in Note 7 to the consolidated financial statements,
FirstEnergy’s investments in capital trusts effectively reduce future lease obligations, also reducing interest rate risk.