ComEd 2006 Annual Report Download - page 78

also utilizes energy option contracts and energy financial swap arrangements to limit the market price
risk exposure associated with forward energy commodity prices. Additionally, Generation enters into
energy-related derivatives for trading purposes. ComEd has derivatives related to one wholesale
contract and certain other contracts to manage the market price exposures to several wholesale
contracts that extend into 2007, which is beyond the expiration of ComEd’s PPA with Generation.
ComEd does not enter into derivatives for speculative or trading purposes. The Registrants’ derivative
activities are in accordance with Exelon’s Risk Management Policy (RMP).
The Registrants account for derivative financial instruments under SFAS No. 133, “Accounting for
Derivatives and Hedging Activities” (SFAS No. 133). Under the provisions of SFAS No. 133, all
derivatives are recognized on the balance sheet at their fair value unless they qualify for a normal
purchases or normal sales exception. Derivatives recorded at fair value on the balance sheet are
presented as current or noncurrent mark-to-market derivative assets or liabilities. Changes in the
derivatives recorded at fair value are recognized in earnings unless specific hedge accounting criteria
are met, in which case those changes are recorded in earnings as an offset to the changes in fair value
of the exposure being hedged or deferred in accumulated other comprehensive income and
recognized in earnings when the hedged transaction occur. Amounts recorded in earnings are included
in revenue, purchased power or fuel in the consolidated statements of income. Cash inflows and
outflows related to derivative instruments are included as a component of operating, investing or
financing cash flows in the statement of cash flows, depending on the underlying nature of the
Registrant’s hedged items.
Normal Purchases and Normal Sales Exception. The availability of the normal purchases and
normal sales exception is based upon the assessment of the ability and intent to deliver or take
delivery of the underlying item. If it was determined that a transaction designated as a “normal”
purchase or a “normal” sale no longer met the scope exceptions, the fair value of the related contract
would be recorded on the balance sheet and immediately recognized through earnings. In September
2006, Generation participated in and won portions of the ComEd and Ameren procurement auctions.
As a result of the expiration of Generation’s PPA with ComEd at the end of 2006 and the results of the
auctions, beginning in 2007, Generation will sell more power through bilateral agreements with other
new and existing counterparties. ComEd also entered into agreements with thirteen other suppliers as
part of the auction. Generation’s and ComEd’s agreements meet the normal purchases and normal
sales exception.
Energy Contracts. Identification of an energy contract as a qualifying cash-flow hedge requires
Generation to determine that the contract is in accordance with the RMP, the forecasted future
transaction is probable, and the hedging relationship between the energy contract and the expected
future purchase or sale of energy is expected to be highly effective at the initiation of the hedge and
throughout the hedging relationship. Internal models that measure the statistical correlation between
the derivative and the associated hedged item determine the effectiveness of such an energy contract
designated as a hedge. Generation reassesses its cash-flow hedges on a regular basis to determine if
they continue to be effective and that the forecasted future transactions are probable. When a contract
does not meet the effective or probable criteria of SFAS No. 133, hedge accounting is discontinued
and changes in the fair value of the derivative are recorded through earnings.
As a part of accounting for derivatives, the Registrants make estimates and assumptions
concerning future commodity prices, load requirements, interest rates, the timing of future transactions
and their probable cash flows, the fair value of contracts and the expected changes in the fair value in
deciding whether or not to enter into derivative transactions, and in determining the initial accounting
treatment for derivative transactions. Generation uses quoted exchange prices to the extent they are
available or external broker quotes in order to determine the fair value of energy contracts. When
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