Allegheny Power 2013 Annual Report Download - page 60

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established risk management practice. FirstEnergy uses a variety of derivative instruments for risk management purposes including
forward contracts, options, futures contracts and swaps.
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 9, Fair Value Measurements,
of the Combined Notes to Consolidated Financial Statements). Sources of information for the valuation of net commodity derivative
contracts assets and liabilities as of December 31, 2013 are summarized by year in the following table:
Source of Information-
Fair Value by Contract Year 2014 2015 2016 2017 2018 Thereafter Total
(In millions)
Prices actively quoted(1) $ (6) $ — $ — $ — $ — $ — $ (6)
Other external sources(2) (12) (32) (21) (10) — — (75)
Prices based on models (5) — 1 1 (9) (15) (27)
Total(3) $ (23) $ (32) $ (20) $ (9) $ (9) $ (15) $ (108)
(1) Represents exchange traded New York Mercantile Exchange futures and options.
(2) Primarily represents contracts based on broker and ICE quotes.
(3) Includes $(202) million in non-hedge derivative contracts that are primarily related to NUG contracts. NUG contracts are generally subject to
regulatory accounting and do not materially 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, 2013, a 10% adverse change in commodity prices would decrease net income by approximately
$27 million during the next 12 months.
Equity Price Risk
As of December 31, 2013, the FirstEnergy pension plan assets were approximately allocated as follows: 18% in equity securities,
40% in fixed income securities, 23% in absolute return strategies, 6% in real estate and 13% in cash and short-term securities. A
decline in the value of pension plan assets could result in additional funding requirements. FirstEnergy’s funding policy is based
on actuarial computations using the projected unit credit method. During the year ended December 31, 2013, FirstEnergy made
no contributions to its qualified pension plans. See Note 3, Pensions and Other Postemployment Benefits, of the Combined Notes
to Consolidated Financial Statements for additional details on FirstEnergy's pension plans and OPEB. In 2013, FirstEnergy's pension
plan assets lost approximately (1.0)% as compared to an expected return on plan assets of 7.75%.
NDT funds have been established to satisfy NG’s and other FirstEnergy subsidiaries' nuclear decommissioning obligations. As of
December 31, 2013, approximately 77% of the funds were invested in fixed income securities, 15% of the funds were invested in
equity securities and 8% were invested in short-term investments, with limitations related to concentration and investment grade
ratings. The investments are carried at their market values of approximately $1,695 million, $316 million and $179 million for fixed
income securities, equity securities and short-term investments, respectively, as of December 31, 2013, excluding $11 million of
net receivables, payables and accrued income. A hypothetical 10% decrease in prices quoted by stock exchanges would result in
a $32 million reduction in fair value as of December 31, 2013. Certain FirstEnergy subsidiaries recognize in earnings the unrealized
losses on AFS securities held in its NDT as OTTI. A decline in the value of FirstEnergy’s NDT or a significant escalation in estimated
decommissioning costs could result in additional funding requirements. During 2013, FirstEnergy contributed approximately $5
million to the NDT.
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 6, Leases of the Combined Notes to Consolidated Financial Statements, FirstEnergy’s
investments in capital trusts effectively reduce future lease obligations, also reducing interest rate risk.