DERIVATIVE INSTRUMENTS

FirstEnergy is exposed to financial risks resulting from fluctuating interest rates and commodity prices, including prices for electricity, natural gas, coal and energy transmission. To manage the volatility related to these exposures, FirstEnergy’s Risk Policy Committee, comprised of senior management, provides general management oversight for risk management activities throughout FirstEnergy. The Risk Policy Committee is responsible for promoting the effective design and implementation of sound risk management programs and oversees compliance with corporate risk management policies and established risk management practice. FirstEnergy also uses a variety of derivative instruments for risk management purposes including forward contracts, options, futures contracts and swaps.

FirstEnergy accounts for derivative instruments on its Consolidated Balance Sheets at fair value (unless they meet the normal purchases and normal sales criteria) as follows:


•	Changes in the fair value of derivative instruments that are designated and qualify as cash flow hedges are recorded to AOCI with subsequent reclassification to earnings in the period during which the hedged forecasted transaction affects earnings.


•	Changes in the fair value of derivative instruments that are designated and qualify as fair value hedges are recorded as an adjustment to the item being hedged. When fair value hedges are discontinued, the adjustment recorded to the item being hedged is amortized into earnings.


•	Changes in the fair value of derivative instruments that are not designated in a hedging relationship are recorded in earnings on a mark-to-market basis, unless otherwise noted.

Derivative instruments meeting the normal purchases and normal sales criteria are accounted for under the accrual method of accounting with their effects included in earnings at the time of contract performance.

FirstEnergy has contractual derivative agreements through 2020.

Cash Flow Hedges

FirstEnergy has used cash flow hedges for risk management purposes to manage the volatility related to exposures associated with fluctuating commodity prices and interest rates.

Total pre-tax net unamortized losses included in AOCI associated with instruments previously designated as cash flow hedges totaled $10 million and $12 million as of December 31, 2017 and December 31, 2016, respectively. Since the forecasted transactions remain probable of occurring, these amounts will be amortized into earnings over the life of the hedging instruments. Net unamortized losses to be amortized to income during the next twelve months are not material.

FirstEnergy has used forward starting interest rate swap agreements to hedge a portion of the consolidated interest rate risk associated with anticipated issuances of fixed-rate, long-term debt securities of its subsidiaries. These derivatives were designated as cash flow hedges, protecting against the risk of changes in future interest payments resulting from changes in benchmark U.S. Treasury rates between the date of hedge inception and the date of the debt issuance. Total pre-tax unamortized losses included in AOCI associated with prior interest rate cash flow hedges totaled $25 million (FES $3 million) and $33 million (FES $3 million) as of December 31, 2017 and December 31, 2016, respectively. Unamortized losses expected to be amortized to interest expense during the next twelve months are not material.

Refer to Note 3, "Accumulated Other Comprehensive Income," for reclassifications from AOCI during the years ended December 31, 2017 and 2016.

As of December 31, 2017 and December 31, 2016, no commodity or interest rate derivatives were designated as cash flow hedges.

Fair Value Hedges

FirstEnergy has used fixed-for-floating interest rate swap agreements to hedge a portion of the consolidated interest rate risk associated with the debt portfolio of its subsidiaries. As of December 31, 2017 and December 31, 2016, no fixed-for-floating interest rate swap agreements were outstanding.

Unamortized gains included in long-term debt associated with prior fixed-for-floating interest rate swap agreements totaled $3 million and $10 million as of December 31, 2017 and December 31, 2016, respectively. During the next twelve months, approximately $2 million of unamortized gains are expected to be amortized to interest expense. Amortization of unamortized gains included in long-term debt totaled approximately $7 million and $10 million during the years ended December 31, 2017 and 2016, respectively.

As of December 31, 2017 and December 31, 2016, no commodity or interest rate derivatives were designated as fair value hedges.

Commodity Derivatives

FirstEnergy uses both physically and financially settled derivatives to manage its exposure to volatility in commodity prices. Commodity derivatives are used for risk management purposes to hedge exposures when it makes economic sense to do so, including circumstances where the hedging relationship does not qualify for hedge accounting.

Electricity forwards are used to balance expected sales with expected generation and purchased power. Natural gas futures are entered into based on expected consumption of natural gas primarily for use in FirstEnergy’s combustion turbine units. Derivative instruments are not used in quantities greater than forecasted needs.

As of December 31, 2017, FirstEnergy's net asset position under commodity derivative contracts was not material. Under these commodity derivative contracts, FES posted $1 million of collateral.

Based on commodity derivative contracts held as of December 31, 2017, an increase in commodity prices of 10% would decrease net income by approximately $6 million (FES $4 million) during the next twelve months.

NUGs

As of December 31, 2017, FirstEnergy's net liability position under NUG contracts was $79 million representing contracts held at JCP&L and PN. Changes in the market value of NUG contracts are subject to regulatory accounting treatment and changes in market values do not impact earnings.

FTRs

As of December 31, 2017, FirstEnergy's and FES' net position associated with FTRs was not material. FirstEnergy holds FTRs that generally represent an economic hedge of future congestion charges that will be incurred in connection with FirstEnergy’s load obligations. FirstEnergy acquires the majority of its FTRs in an annual auction through a self-scheduling process involving the use of ARRs allocated to members of PJM that have load serving obligations.

The future obligations for the FTRs acquired at auction are reflected on the Consolidated Balance Sheets and have not been designated as cash flow hedge instruments. FirstEnergy initially records these FTRs at the auction price less the obligation due to PJM, and subsequently adjusts the carrying value of remaining FTRs to their estimated fair value at the end of each accounting period prior to settlement. Changes in the fair value of FTRs held by FES and AE Supply are included in other operating expenses as unrealized gains or losses. Unrealized gains or losses on FTRs held by FirstEnergy’s Utilities are recorded as regulatory assets or liabilities. Directly allocated FTRs are accounted for under the accrual method of accounting, and their effects are included in earnings at the time of contract performance.

FirstEnergy records the fair value of derivative instruments on a gross basis. The following table summarizes the fair value and classification of derivative instruments on FirstEnergy’s Consolidated Balance Sheets:



Derivative Assets					Derivative Liabilities
	Fair Value					Fair Value
	December 31, 2017		December 31, 2016			December 31, 2017			December 31, 2016
	(In millions)					(In millions)
Current Assets - Derivatives					Current Liabilities - Other
Commodity Contracts	$	33	$	133	Commodity Contracts	$	(27	)	$	(72	)
FTRs	4		7		FTRs	(1		)	(6		)
	37		140			(28		)	(78		)

					Noncurrent Liabilities - Adverse Power Contract Liability
Deferred Charges and Other Assets - Other					NUGs⁽¹⁾	(79		)	(108		)
Commodity Contracts	—		77		Noncurrent Liabilities - Other
FTRs	—		—		Commodity Contracts	—			(52		)
NUGs⁽¹⁾	—		1		FTRs	—			—
	—		78			(79		)	(160		)
Derivative Assets	$	37	$	218	Derivative Liabilities	$	(107	)	$	(238	)


⁽¹⁾	NUG contracts are subject to regulatory accounting treatment and changes in market values do not impact earnings.

FES records the fair value of derivative instruments on a gross basis. The following table summarizes the fair value and classification of derivative instruments on FES' Consolidated Balance Sheets:



Derivative Assets					Derivative Liabilities
	Fair Value					Fair Value
	December 31, 2017		December 31, 2016			December 31, 2017			December 31, 2016
	(In millions)					(In millions)
Current Assets - Derivatives					Current Liabilities - Derivatives
Commodity Contracts	$	33	$	133	Commodity Contracts	$	(23	)	$	(72	)
FTRs	1		4		FTRs	(1		)	(5		)
	34		137			(24		)	(77		)

Deferred Charges and Other Assets - Derivatives					Noncurrent Liabilities - Other
Commodity Contracts	—		77		Commodity Contracts	—			(52		)
	—		77			—			(52		)
Derivative Assets	$	34	$	214	Derivative Liabilities	$	(24	)	$	(129	)

FirstEnergy enters into contracts with counterparties that allow for the offsetting of derivative assets and derivative liabilities under netting arrangements with the same counterparty. Certain of these contracts contain margining provisions that require the use of collateral to mitigate credit exposure between FirstEnergy and these counterparties. In situations where collateral is pledged to mitigate exposures related to derivative and non-derivative instruments with the same counterparty, FirstEnergy allocates the collateral based on the percentage of the net fair value of derivative instruments to the total fair value of the combined derivative and non-derivative instruments. The following tables summarize the fair value of derivative assets and derivative liabilities on FirstEnergy’s Consolidated Balance Sheets and the effect of netting arrangements and collateral on its financial position:



				Amounts Not Offset in Consolidated Balance Sheet
December 31, 2017	Fair Value			Derivative Instruments			Cash Collateral (Received)/Pledged		Net Fair Value
	(In millions)
Derivative Assets
Commodity contracts	$	33		$	(19	)	$	—	$	14
FTRs	4			(1		)	—		3
	$	37		$	(20	)	$	—	$	17

Derivative Liabilities
Commodity contracts	$	(27	)	$	19		$	3	$	(5	)
FTRs	(1		)	1			—		—
NUG contracts	(79		)	—			—		(79		)
	$	(107	)	$	20		$	3	$	(84	)



				Amounts Not Offset in Consolidated Balance Sheet
December 31, 2016	Fair Value			Derivative Instruments			Cash Collateral (Received)/Pledged		Net Fair Value
	(In millions)
Derivative Assets
Commodity contracts	$	210		$	(117	)	$	—	$	93
FTRs	7			(6		)	—		1
NUG contracts	1			—			—		1
	$	218		$	(123	)	$	—	$	95

Derivative Liabilities
Commodity contracts	$	(124	)	$	117		$	1	$	(6	)
FTRs	(6		)	6			—		—
NUG contracts	(108		)	—			—		(108		)
	$	(238	)	$	123		$	1	$	(114	)

The following tables summarize the fair value of derivative assets and derivative liabilities on FES’ Consolidated Balance Sheets and the effect of netting arrangements and collateral on its financial position:



				Amounts Not Offset in Consolidated Balance Sheet
December 31, 2017	Fair Value			Derivative Instruments			Cash Collateral (Received)/Pledged		Net Fair Value
	(In millions)
Derivative Assets
Commodity contracts	$	33		$	(19	)	$	—	$	14
FTRs	1			(1		)	—		—
	$	34		$	(20	)	$	—	$	14

Derivative Liabilities
Commodity contracts	$	(23	)	$	19		$	—	$	(4	)
FTRs	(1		)	1			—		—
	$	(24	)	$	20		$	—	$	(4	)



				Amounts Not Offset in Consolidated Balance Sheet
December 31, 2016	Fair Value			Derivative Instruments			Cash Collateral (Received)/Pledged		Net Fair Value
	(In millions)
Derivative Assets
Commodity contracts	$	210		$	(117	)	$	—	$	93
FTRs	4			(4		)	—		—
	$	214		$	(121	)	$	—	$	93

Derivative Liabilities
Commodity contracts	$	(124	)	$	117		$	1	$	(6	)
FTRs	(5		)	4			1		—
	$	(129	)	$	121		$	2	$	(6	)

The following table summarizes the volumes associated with FirstEnergy’s outstanding derivative transactions as of December 31, 2017:



	Purchases	Sales	Net		Units
	(In millions)
Power Contracts	2	11	(9	)	MWH
FTRs	9	—	9		MWH
NUGs	2	—	2		MWH

The following table summarizes the volumes associated with FES' outstanding derivative transactions as of December 31, 2017:



	Purchases	Sales	Net		Units
	(In millions)
Power Contracts	2	11	(9	)	MWH
FTRs	5	—	5		MWH

The effect of active derivative instruments not in a hedging relationship on FirstEnergy's Consolidated Statements of Income (Loss) during 2017, 2016 and 2015 are summarized in the following tables:



	Year Ended December 31
	Commodity Contracts			FTRs			Total
	(In millions)
2017
Unrealized Gain (Loss) Recognized in:
Other Operating Expense	$	(82	)	$	1		$	(81	)

Realized Gain (Loss) Reclassified to:
Revenues	$	54		$	(4	)	$	50
Purchased Power Expense	(17		)	—			(17		)
Other Operating Expense	—			(14		)	(14		)
Fuel Expense	5			—			5



	Year Ended December 31
	Commodity Contracts			FTRs			Total
	(In millions)
2016
Unrealized Gain (Loss) Recognized in:
Other Operating Expense	$	(14	)	$	5		$	(9	)

Realized Gain (Loss) Reclassified to:
Revenues	$	210		$	8		$	218
Purchased Power Expense	(131		)	—			(131		)
Other Operating Expense	—			(35		)	(35		)
Fuel Expense	(8		)	—			(8		)



	Year Ended December 31
	Commodity Contracts			FTRs			Total
	(In millions)
2015
Unrealized Gain (Loss) Recognized in:
Other Operating Expense	$	93		$	(20	)	$	73

Realized Gain (Loss) Reclassified to:
Revenues	$	111		$	50		$	161
Purchased Power Expense	(130		)	—			(130		)
Other Operating Expense	—			(49		)	(49		)
Fuel Expense	(34		)	—			(34		)

The effect of active derivative instruments not in a hedging relationship on FES' Consolidated Statements of Income (Loss) during 2017, 2016 and 2015 are summarized in the following tables:



	Year Ended December 31
	Commodity Contracts			FTRs			Total
	(In millions)
2017
Unrealized Gain (Loss) Recognized in:
Other Operating Expense	$	(79	)	$	1		$	(78	)

Realized Gain (Loss) Reclassified to:
Revenues	$	54		$	(4	)	$	50
Purchased Power Expense	(17		)	—			(17		)
Other Operating Expense	—			(14		)	(14		)



	Year Ended December 31
	Commodity Contracts			FTRs			Total
	(In millions)
2016
Unrealized Gain (Loss) Recognized in:
Other Operating Expense	$	(14	)	$	5		$	(9	)

Realized Gain (Loss) Reclassified to:
Revenues	$	210		$	8		$	218
Purchased Power Expense	(131		)	—			(131		)
Other Operating Expense	—			(35		)	(35		)



	Year Ended December 31
	Commodity Contracts			FTRs			Total
	(In millions)
2015
Unrealized Gain (Loss) Recognized in:
Other Operating Expense	$	93		$	(19	)	$	74

Realized Gain (Loss) Reclassified to:
Revenues	$	111		$	49		$	160
Purchased Power Expense	(130		)	—			(130		)
Other Operating Expense	—			(49		)	(49		)

The following table provides a reconciliation of changes in the fair value of FirstEnergy's derivative instruments subject to regulatory accounting during 2017 and 2016. Changes in the value of these contracts are deferred for future recovery from (or credit to) customers:



	Year Ended December 31
Derivatives Not in a Hedging Relationship with Regulatory Offset	NUGs			Regulated FTRs			Total
	(In millions)
Outstanding net asset (liability) as of January 1, 2017	$	(107	)	$	2		$	(105	)
Unrealized loss	(9		)	(1		)	(10		)
Purchases	—			3			3
Settlements	37			(1		)	36
Outstanding net asset (liability) as of December 31, 2017	$	(79	)	$	3		$	(76	)

Outstanding net asset (liability) as of January 1, 2016	$	(136	)	$	1		$	(135	)
Unrealized loss	(15		)	(3		)	(18		)
Purchases	—			4			4
Settlements	44			—			44
Outstanding net asset (liability) as of December 31, 2016	$	(107	)	$	2		$	(105	)