Exelon 2001 Annual Report Download - page 45

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Energy contracts that are considered derivatives may be eligible for designation as hedges. If a contract is designated as
a hedge, the change in its market value is generally deferred as a component of other comprehensive income until the
transaction it is hedging is completed. Conversely, the change in the market value of derivatives not designated as hedges
is recorded in current period earnings. To qualify as a cash flow hedge, the fair value changes in the derivative must be
expected to offset 80%-120% of the changes in fair value or cash flows of the hedged item. The effectiveness of an energy
contract designated as a hedge is determined by internal models that measure the statistical correlation between the
derivative and the associated hedged item.
When external quoted market prices are not available, Exelon utilizes the Black model, a standard industry valuation
model to determine the fair value of energy derivative contracts marked to market. The valuation model uses volatility
assumptions relating to future energy prices based on specific energy markets and utilizes externally available forward
market price curves.
Interest Rate Derivatives Exelon utilizes derivatives to manage its exposure to fluctuation in interest rates related to
outstanding variable rate debt instruments and planned future debt issuances as well as exposure to changes in the fair
value of outstanding debt that is planned for early retirement. Hedge accounting is used for all interest rate derivatives to
date based on the probability of the transaction and the expected highly effective nature of the hedging relationship
between the interest rate swap contract and the interest payment or changes in fair value of the hedged debt. Dealer
quotes are available for all of Exelon’s interest rate swap agreement derivatives.
Regulatory Assets and Liabilities
Regulatory assets represent incurred costs that have been deferred because they are probable of future recovery in customer
rates. Regulatory liabilities represent previous collections from customers to fund costs which have not yet been incurred.
Both ComEd and PECO are currently subject to rate freezes that limit the opportunity to recover increased costs and the
costs of new investment in facilities through rates during the rate freeze period. Current rates include the recovery of Exelon’s
existing regulatory assets. Exelon continually assesses whether the regulatory assets are probable of future recovery by
considering factors such as applicable regulatory environment changes, recent rate orders to other regulated entities in the
same jurisdiction, and the status of any pending or potential deregulation legislation. If future recovery of costs ceases to be
probable the assets would be required to be recognized in current period earnings.
Nuclear Decommissioning
Exelon’s current estimate of its nuclear facilities’ decommissioning cost is $7.2 billion in current year (2002) dollars.
Calculating this estimate involves significant assumptions with respect to the expected increases in decommissioning
costs relative to general inflation rates, changes in the regulatory environment or regulatory requirements, and the timing
of decommissioning. The estimated service life of the nuclear station is also a significant assumption because
decommissioning costs are generally recognized over the life of the generating station. Cost estimates for decommissioning
Exelon’s nuclear facilities have been prepared by an independent engineering firm and reflect currently existing regulatory
requirements and available technology. Nuclear station service lives, over which the decommissioning costs are recognized,
were extended by 20 years in 2001. The life extension is subject to NRC approval of an extension of existing NRC operating
licenses, which generally are 40 years. The obligation for decommissioning currently operating plants is recorded in
accumulated depreciation consistent with industry practice. As discussed in New Accounting Pronouncements, this
accounting will be affected by the adoption of SFAS No. 143,“Asset Retirement Obligations” (SFAS No.143) effective January 1, 2003.
See Notes 1 and 12 of the Notes to the Consolidated Financial Statements for further information regarding the accounting
for decommissioning.