Allegheny Power 2011 Annual Report Download - page 129

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10. DERIVATIVE INSTRUMENTS
FirstEnergy is exposed to financial risks resulting from fluctuating interest rates and commodity prices, including prices for electricity,
natural gas, coal and energy transmission. To manage the volatility relating to these exposures, FirstEnergy’s Risk Policy Committee,
comprised of senior management, provides general management oversight for risk management activities throughout FirstEnergy.
The Risk Policy 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 practice. FirstEnergy also
uses a variety of derivative instruments for risk management purposes including forward contracts, options, futures contracts and
swaps.
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 under the accrual method of accounting,
and their effects are included in earnings at the time of contract performance. Changes in the fair value of derivative instruments
that qualified and were designated as cash flow hedge instruments are recorded in AOCI. Changes in the fair value of derivative
instruments that are not designated as cash flow hedge instruments are recorded in net income on a mark-to-market basis.
FirstEnergy has contractual derivative agreements through December 2018.
Cash Flow Hedges
FirstEnergy has used cash flow hedges for risk management purposes to manage the volatility related to exposures associated
with fluctuating interest rates and commodity prices. The effective portion of gains and losses on a derivative contract are reported
as a component of AOCI with subsequent reclassification to earnings in the period during which the hedged forecasted transaction
affects earnings.
As of December 31, 2010, commodity derivative contracts designated in cash flow hedging relationships were $104 million of assets
and $101 million of liabilities. In February 2011, FirstEnergy elected to dedesignate all outstanding cash flow hedge relationships.
Total net unamortized gains included in AOCI associated with dedesignated cash flow hedges totaled $19 million as of December 31,
2011. Since the forecasted transactions remain probable of occurring, these amounts will be amortized into earnings over the life
of the hedging instruments. Reclassifications from AOCI into other operating expenses were $26 million for the year ended
December 31, 2011. Approximately $9 million is expected to be amortized to income during the next twelve months.
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, 2011, no forward starting swap agreements
were outstanding. Total unamortized losses included in AOCI associated with prior interest rate cash flow hedges totaled $79 million
as of December 31, 2011. Based on current estimates, approximately $9 million will be amortized to interest expense during the
next twelve months. Reclassifications from AOCI into interest expense totaled $12 million and $11 million during 2011 and 2010,
respectively.
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 portfolios of its subsidiaries. These derivative instruments 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, 2011, no fixed-for-floating interest rate swap agreements were outstanding.
Unamortized gains included in long-term debt associated with prior fixed-for-floating interest rate swap agreements totaled $102
million as of December 31, 2011. 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 approximately $22 million and $12
million during 2011 and 2010, respectively.
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.
Electricity forwards are used to balance expected sales with expected generation and purchased power. Natural gas futures are
entered into based on expected consumption of natural gas at FirstEnergy’s peaking units. Heating oil futures are entered into
based on expected consumption of oil and the financial risk in FirstEnergy’s coal transportation contracts. Derivative instruments
are not used in quantities greater than forecasted needs.
As of December 31, 2011, FirstEnergy’s net asset position under commodity derivative contracts was $17 million. Under these
commodity derivative contracts, FES posted $52 million and AE Supply posted $1 million in collateral. Certain commodity derivative
contracts include credit risk-related contingent features that would require FES to post $28 million and AE Supply to post $2 million