Exelon 2014 Annual Report Download - page 204

Combined Notes to Consolidated Financial Statements—(Continued)
(Dollars in millions, except per share data unless otherwise noted)
Commodity Price Risk
To the extent the amount of energy Exelon generates differs from the amount of energy it has contracted to sell, the Registrants are
exposed to market fluctuations in the prices of electricity, fossil fuels and other commodities. The Registrants employ established
policies and procedures to manage their risks associated with market fluctuations by entering into physical and financial derivative
contracts, including swaps, futures, forwards, options and short-term and long-term commitments to purchase and sell energy and
energy-related products. The Registrants believe these instruments, which are classified as either economic hedges or non-
derivatives, mitigate exposure to fluctuations in commodity prices.
Derivative accounting guidance requires that derivative instruments be recognized as either assets or liabilities at fair value, with
changes in fair value of the derivative recognized in earnings each period. Other accounting treatments are available through special
election and designation, provided they meet specific, restrictive criteria both at the time of designation and on an ongoing basis.
These alternative permissible accounting treatments include normal purchase normal sale (NPNS), cash flow hedge, and fair value
hedge. For commodity transactions, Generation no longer utilizes the special election provided for by the cash flow hedge
designation and de-designated all of its existing cash flow hedges prior to the Constellation merger. Because the underlying
forecasted transactions remained probable, the fair value of the effective portion of these cash flow hedges was frozen in
Accumulated OCI and was reclassified to results of operations when the forecasted purchase or sale of the energy commodity
occurred. The effect of this decision is that all derivative economic hedges related to commodities are recorded at fair value through
earnings for the combined company, referred to as economic hedges in the following tables. The Registrants have applied the NPNS
scope exception to certain derivative contracts for the forward sale of generation, power procurement agreements, and natural gas
supply agreements. Non-derivative contracts for access to additional generation and certain sales to load-serving entities are
accounted for primarily under the accrual method of accounting, which is further discussed in Note 22—Commitments and
Contingencies. Additionally, Generation is exposed to certain market risks through its proprietary trading activities. The proprietary
trading activities are a complement to Generation’s energy marketing portfolio, but represent a small portion of Generation’s overall
energy marketing activities.
Economic Hedging. The Registrants are exposed to commodity price risk primarily relating to changes in the market price of
electricity, fossil fuels, and other commodities associated with price movements resulting from changes in supply and demand, fuel
costs, market liquidity, weather conditions, governmental regulatory and environmental policies, and other factors. Within Exelon,
Generation has the most exposure to commodity price risk. As such, Generation uses a variety of derivative and non-derivative
instruments to manage the commodity price risk of its electric generation facilities, including power and gas sales, fuel and energy
purchases, natural gas transportation and pipeline capacity agreements and other energy-related products marketed and purchased.
In order to manage these risks, Generation may enter into fixed-price derivative or non-derivative contracts to hedge the variability in
future cash flows from forecasted sales of energy and purchases of fuel and energy. The objectives for entering into such hedges
include fixing the price for a portion of anticipated future electricity sales at a level that provides an acceptable return on electric
generation operations, fixing the price of a portion of anticipated fuel purchases for the operation of power plants, and fixing the price
for a portion of anticipated energy purchases to supply load-serving customers. The portion of forecasted transactions hedged may
vary based upon management’s policies and hedging objectives, the market, weather conditions, operational and other factors.
Generation is also exposed to differences between the locational settlement prices of certain economic hedges and the hedged
generating units. This price difference is actively managed through other instruments which include derivative congestion products,
whose changes in fair value are recognized in earnings each period, and auction revenue rights, which are accounted for on an
accrual basis.
In general, increases and decreases in forward market prices have a positive and negative impact, respectively, on Generation’s
owned and contracted generation positions that have not been hedged. Generation hedges commodity price risk on a ratable basis
over three-year periods. As of December 31, 2014, the percentage of expected generation hedged for the major reportable
segments was 93%-96%, 61%-64% and 31%-34% for 2015, 2016, and 2017, respectively. The percentage of expected generation
hedged is the amount of equivalent sales divided by the expected generation (which reflects the divestiture impact of Quail Run).
Expected generation is the volume of energy that best represents our commodity position in energy markets from owned or
contracted for capacity based upon a simulated dispatch model that makes assumptions regarding future market conditions, which
are calibrated to market quotes for power, fuel, load following products, and options. Equivalent sales represent all hedging products,
which include economic hedges and certain non-derivative contracts, including Generation’s sales to ComEd, PECO and BGE to
serve their retail load. See Note 4—Mergers, Acquisitions, and Dispositions of the Combined Notes to Consolidated Financial
Statements for more detail regarding divestitures.
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