Allegheny Power 2013 Annual Report Download - page 119

104
Sale and Leaseback
FirstEnergy has variable interests in certain sale and leaseback transactions. FirstEnergy is not the primary beneficiary of these
interests as it does not have control over the significant activities affecting the economics of the arrangements. See Note 6, Leases
for additional details.
FES, and other FE subsidiaries are exposed to losses under their applicable sale and leaseback agreements upon the occurrence
of certain contingent events. The maximum exposure under these provisions represents the net amount of casualty value payments
due upon the occurrence of specified casualty events. Net discounted lease payments would not be payable if the casualty loss
payments were made. The following table discloses each company’s net exposure to loss based upon the casualty value provisions
as of December 31, 2013:
Maximum
Exposure
Discounted Lease
Payments, net(1) Net Exposure
(In millions)
FES $ 1,274 $ 1,063 $ 211
Other FE subsidiaries 752 289 463
(1) The net present value of FirstEnergy’s consolidated sale and leaseback operating lease commitments is $1.1 billion.
9. FAIR VALUE MEASUREMENTS
RECURRING FAIR VALUE MEASUREMENTS
Authoritative accounting guidance establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. This
hierarchy gives the highest priority to Level 1 measurements and the lowest priority to Level 3 measurements. The three levels of
the fair value hierarchy and a description of the valuation techniques are as follows:
Level 1 - Quoted prices for identical instruments in active market
Level 2 - Quoted prices for similar instruments in active market
- Quoted prices for identical or similar instruments in markets that are not active
- Model-derived valuations for which all significant inputs are observable market data
Models are primarily industry-standard models that consider various assumptions, including quoted forward prices
for commodities, time value, volatility factors and current market and contractual prices for the underlying
instruments, as well as other relevant economic measures.
Level 3 - Valuation inputs are unobservable and significant to the fair value measurement
FirstEnergy produces a long-term power and capacity price forecast annually with periodic updates as market
conditions change. When underlying prices are not observable, prices from the long-term price forecast, which has
been reviewed and approved by FirstEnergy's Risk Policy Committee, are used to measure fair value. A more
detailed description of FirstEnergy's valuation process for FTRs, NUGs and LCAPPs are as follows:
FTRs are financial instruments that entitle the holder to a stream of revenues (or charges) based on the hourly day-
ahead congestion price differences across transmission paths. FTRs are acquired by FirstEnergy in the annual,
monthly and long-term RTO auctions and are initially recorded using the auction clearing price less cost. After initial
recognition, FTRs' carrying values are periodically adjusted to fair value using a mark-to-model methodology, which
approximates market. The primary inputs into the model, which are generally less observable than objective sources,
are the most recent RTO auction clearing prices and the FTRs' remaining hours. The model calculates the fair value
by multiplying the most recent auction clearing price by the remaining FTR hours less the prorated FTR cost.
Generally, significant increases or decreases in inputs in isolation could result in a higher or lower fair value
measurement. See Note 10, Derivative Instruments, for additional information regarding FirstEnergy's FTRs.
NUG contracts represent purchase power agreements with third-party non-utility generators that are transacted to
satisfy certain obligations under PURPA. NUG contract carrying values are recorded at fair value and adjusted
periodically using a mark-to-model methodology, which approximates market. The primary unobservable inputs
into the model are regional power prices and generation MWH. Pricing for the NUG contracts is a combination of