Dominion Power 2000 Annual Report Download - page 65

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Note 24 Derivative Transactions
Dominion uses derivative financial instruments for the purposes of
managing commodity price and interest rate risks.
Commodity-Based Instruments — Non-Trading
Dominion manages the price risk associated with purchases and
sales of natural gas and oil by selecting derivative commodity
instruments whose historical price fluctuations correlate strongly
with those of the transactions being hedged. These commodity-
based financial derivatives include swaps, options, and collars
which require settlement in cash. As these instruments qualify and
have been designated as hedges, any gains or losses resulting
from market price changes are expected to be generally offset by
the related physical transaction.
At December 31, 2000, Dominion held swaps with notional quan-
tities of approximately 267 Bcf of natural gas maturing through
2001-2005 with an aggregate unrealized gain of $158 million. Net
notional quantities do not represent the quantities exchanged
by the parties and are not a measure of Dominion’s exposure
through the use of swaps but are used in the determination of
cash settlements under the swap agreements.
At December 31, 2000, Dominion held options and collars cover-
ing approximately 202 Bcf of natural gas and 11 million barrels of
crude oil maturing through 2001 with an aggregate unrealized loss
of $435 million.
At December 31, 1999, Dominion held swaps, options and collars
covering approximately 42 Bcf of natural gas maturing through
2002 with an aggregate unrealized gain of $5 million.
Commodity-based Instruments — Trading
As part of Dominion’s strategy to market energy from its generation
capacity and to manage related risks, the Company manages a
portfolio of commodity contracts held for trading purposes. These
contracts are reported at fair value on the Consolidated Balance
Sheet. Commodity contract assets (including long-term) totaled
$1.1 billion and $367 million at December 31, 2000 and 1999, respec-
tively. Commodity contract liabilities (including long-term) totaled
$1.1 billion and $354 million at December 31, 2000 and 1999, respec-
tively. As disclosed in Note 23, included in these amounts was a net
commodity-based derivative liability consisting of swaps and
options totaling $71 million and a net commodity-based derivative
asset of $1 million at December 31, 2000 and 1999, respectively. Net
gains and losses associated with Dominion’s commodity trading
activities are reported net of related cost of sales in Operating rev-
enue and income — other and totaled $95 million and $65 million
for 2000 and 1999, respectively.
Interest Rate Contracts
Dominion enters into interest rate sensitive financial derivative
instruments, including swaps and futures, in order to manage
exposure to the effects of interest rate changes on outstanding
debt and mortgage loans that the Company has funded or has com-
mitted to fund, as well as residual interests retained. Net notional
quantities or amounts do not represent the quantities or amounts
exchanged by the parties, and are not a measure of Dominion’s
exposure through the use of swaps and futures but are used in the
determination of cash settlements under the agreements.
At December 31, 2000, Dominion held swaps used to syntheti-
cally convert approximately $450 million of variable-rate debt to
fixed rates, and approximately $1.0 billion of fixed-rate debt to
variable-rate debt.
Also, at December 31, 2000, Dominion recorded its interest rate
swaps and futures held for trading purposes at fair value, a net lia-
bility of $13 million. These contracts had notional quantities of $5.0
billion and resulted in net trading losses of $14 million for 2000.
At December 31, 1999, all interest rate swaps and futures were
held for purposes other than trading with notional quantities of
$3.7 billion. The net deferred hedging losses were not material.
Risk Management Policies
Dominion has operating procedures in place that are administered
by experienced management to help ensure that proper internal
controls regarding the use of derivatives are maintained. In addi-
tion, Dominion has established an independent function to monitor
compliance with the price risk management policies of all sub-
sidiaries. In addition, Dominion maintains credit policies with
respect to its counterparties that management believes minimize
overall credit risk. Such policies include the evaluation of a
prospective counterparty's financial condition, collateral require-
ments where deemed necessary, and the use of standardized
agreements which facilitate the netting of cash flows associated
with a single counterparty. Dominion also monitors the financial
condition of existing counterparties on an ongoing basis.
Considering the system of internal controls in place and credit
reserve levels at December 31, 2000, management believes it
unlikely that a material adverse effect on its financial position,
results of operations or cash flows would occur as a result of
counterparty nonperformance.
In addition to the financial derivatives disclosed above, Dominion
held futures and forwards that may be settled through the purchase
or delivery of commodities. As of December 31, 2000, these instru-
ments were not considered financial derivatives. However, effective
January 1, 2001, Dominion adopted SFAS No. 133 which changed the
scope and method of accounting for derivatives. See Note 4 for a
discussion of impact of adoption of this standard.
Other Derivatives
In 1998, Dominion entered into total return swap agreements with
swap counterparties. The notional amount of the swaps is based on
the purchase price of the securities to be acquired by the swap
counterparties. As a result of the winding down of the financial ser-
vices business, the total return swap agreement was terminated in
2000. At December 31, 1999, the notional amount was $249 million.
The gains or losses from the sale, settlement or mark to market of
the total return swaps are recorded in Other revenue. Earnings due
to swap transactions were $2 million and $18 million in 2000 and