Allegheny Power 2013 Annual Report Download - page 126

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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 primarily for use in FirstEnergy’s combustion turbine units. Derivative
instruments are not used in quantities greater than forecasted needs.
As of December 31, 2013, FES' net asset position under commodity derivative contracts was $102 million. Under these commodity
derivative contracts, FES posted $29 million of collateral. Certain commodity derivative contracts include credit risk related contingent
features that would require FES to post $1 million of additional collateral if the credit rating for its debt were to fall below investment
grade.
Based on commodity derivative contracts held as of December 31, 2013, an adverse change of 10% in commodity prices would
decrease net income by approximately $27 million during the next twelve months.
NUGs
As of December 31, 2013, FirstEnergy's net liability position under NUG contracts was $202 million representing contracts held at
JCP&L, ME and PN. NUG contracts represent purchased power agreements with third-party non-utility generators that are transacted
to satisfy certain obligations under PURPA. Changes in the fair value of NUG contracts are subject to regulatory accounting treatment
and do not impact earnings.
LCAPP
The LCAPP law was enacted in New Jersey during 2011 to promote the construction of qualified electric generation facilities. JCP&L
maintained two LCAPP contracts, which are financially settled agreements that allow eligible generators to receive payments from,
or make payments to, JCP&L pursuant to an annually calculated load-ratio share of the capacity produced by the generator based
upon the annual forecasted peak demand as determined by PJM. JCP&L expected to recover from its customers payments made
to the generators and give credit to customers for payments from the generators under these contracts. As a result, the projected
future obligations for the LCAPP contracts are considered derivative liabilities with a corresponding regulatory asset. Since the
LCAPP contracts were subject to regulatory accounting, changes in their fair value did not impact earnings. On October 11, 2013,
the U.S. District Court for the District of New Jersey declared that the LCAPP is preempted by the FPA and unconstitutional. On
October 22, 2013, the Superior Court of New Jersey Appellate Division dismissed two consolidated appeals which had been taken
from the final order of the NJBPU which accepted and adopted the recommendation of the NJBPU's Agent regarding implementation
of the LCAPP law. Dismissal of the consolidated appeals, along with pending matters currently on remand to the NJBPU, was
without prejudice subject to the parties exercising their appellate rights in the federal courts. The parties filed an appeal with the
U.S. Court of Appeals for the Third Circuit with briefing by the parties to be completed by March 5, 2014. Consistent with the
provisions of the LCAPP contracts, the U.S District Court's ruling is a termination event. During the fourth quarter of 2013, JCP&L
issued termination notices to the counterparties and reversed the derivative liability and corresponding regulatory asset on its
Consolidated Balance Sheet.
FTRs
As of December 31, 2013, FirstEnergy's and FES' net liability position under FTRs was $8 million and FES posted $5 million of
collateral. FirstEnergy holds FTRs that generally represent an economic hedge of future congestion charges that will be incurred
in connection with FirstEnergy’s load obligations. FirstEnergy acquires the majority of its FTRs in an annual auction through a self-
scheduling process involving the use of ARRs allocated to members of an RTO that have load serving obligations and through the
direct allocation of FTRs from the PJM RTO. The PJM RTO has a rule that allows directly allocated FTRs to be granted to LSEs in
zones that have newly entered PJM. For the first two planning years, PJM permits the LSEs to request a direct allocation of FTRs
in these new zones at no cost as opposed to receiving ARRs. The directly allocated FTRs differ from traditional FTRs in that the
ownership of all or part of the FTRs may shift to another LSE if customers choose to shop with the other LSE.
The future obligations for the FTRs acquired at auction are reflected on the Consolidated Balance Sheets and have not been
designated as cash flow hedge instruments. FirstEnergy initially records these FTRs at the auction price less the obligation due to
the RTO, and subsequently adjusts the carrying value of remaining FTRs to their estimated fair value at the end of each accounting
period prior to settlement. Changes in the fair value of FTRs held by FES and AE Supply are included in other operating expenses
as unrealized gains or losses. Unrealized gains or losses on FTRs held by FirstEnergy’s utilities are recorded as regulatory assets
or liabilities. Directly allocated FTRs are accounted for under the accrual method of accounting, and their effects are included in
earnings at the time of contract performance.