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Assets and Liabilities with Recurring Fair Value Measurements
 12 Months Ended
Dec. 31, 2011
Fair Value Measurements [Abstract]  
Assets and Liabilities with Recurring Fair Value Measurements
Assets and Liabilities with Recurring Fair Value Measurements
Cash Equivalents — Highly liquid investments which meet the definition of cash equivalents, primarily investments in money market accounts, are included in both our cash and cash equivalents and in restricted cash on our Consolidated Balance Sheets. Certain of our money market accounts invest in U.S. Treasury securities or other obligations issued or guaranteed by the U.S. Government, its agencies or instrumentalities. Our cash equivalents are classified within level 1 of the fair value hierarchy.
Margin Deposits and Margin Deposits Held by Us Posted by Our Counterparties — Margin deposits and margin deposits held by us posted by our counterparties represent cash collateral paid between our counterparties and us to support our commodity contracts. Our margin deposits and margin deposits held by us posted by our counterparties are generally cash and cash equivalents and are classified within level 1 of the fair value hierarchy.
Derivatives — The primary factors affecting the fair value of our derivative instruments at any point in time are the volume of open derivative positions (MMBtu, MWh and $ notional amounts); market price levels, primarily for power and natural gas; our credit standing and that of our counterparties; and prevailing interest rates for our interest rate swaps. Prices for power and natural gas and interest rates are volatile, which can result in material changes in the fair value measurements reported in our financial statements in the future.
We utilize market data, such as pricing services and broker quotes, and assumptions that we believe market participants would use in pricing our assets or liabilities including assumptions about risks and the risks inherent to the inputs in the valuation technique. These inputs can be either readily observable, market corroborated or generally unobservable. The market data obtained from broker pricing services is evaluated to determine the nature of the quotes obtained and, where accepted as a reliable quote, used to validate our assessment of fair value; however, other qualitative assessments can also be used to determine the level of activity in any given market. We primarily apply the market approach and income approach for recurring fair value measurements and utilize what we believe to be the best available information. We utilize valuation techniques that seek to maximize the use of observable inputs and minimize the use of unobservable inputs. We classify fair value balances based on the observability of those inputs.
The fair value of our derivatives includes consideration of our credit standing, the credit standing of our counterparties and the impact of credit enhancements, if any. We have also recorded credit reserves in the determination of fair value based on our expectation of how market participants would determine fair value. Such valuation adjustments are generally based on market evidence, if available, or our best estimate.
Our level 1 fair value derivative instruments primarily consist of natural gas swaps, futures and options traded on the NYMEX.
Our level 2 fair value derivative instruments primarily consist of interest rate swaps and OTC power and natural gas forwards for which market-based pricing inputs are observable. Generally, we obtain our level 2 pricing inputs from market sources such as the Intercontinental Exchange and Bloomberg. To the extent we obtain prices from brokers in the marketplace, we have procedures in place to ensure that prices represent executable prices for market participants. In certain instances, our level 2 derivative instruments may utilize models to measure fair value. These models are primarily industry-standard models that incorporate various assumptions, including quoted interest rates, correlation, volatility, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace throughout the full term of the instrument, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace.
Our level 3 fair value derivative instruments primarily consist of our OTC power and natural gas forwards and options where pricing inputs are unobservable, as well as other complex and structured transactions. Complex or structured transactions are tailored to our or our customers’ needs and can introduce the need for internally-developed model inputs which might not be observable in or corroborated by the market. When such inputs have a significant impact on the measurement of fair value, the instrument is categorized in level 3. Our valuation models may incorporate historical correlation information and extrapolate available broker and other information to future periods. In cases where there is no corroborating market information available to support significant model inputs, we initially use the transaction price as the best estimate of fair value. OTC options are valued using industry-standard models, including the Black-Scholes option-pricing model. At each balance sheet date, we perform an analysis of all instruments subject to fair value measurement and include in level 3 all of those whose fair value is based on significant unobservable inputs.
The following tables present our financial assets and liabilities that were accounted for at fair value on a recurring basis as of December 31, 2011 and 2010, by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment and may affect our estimate of the fair value of our assets and liabilities and their placement within the fair value hierarchy levels.
 
Assets and Liabilities with Recurring Fair Value Measures as of December 31, 2011
 
Level 1    
 
Level 2    
 
Level 3    
 
Total    
 
(in millions)
Assets:
 
 
 
 
 
 
 
Cash equivalents(1)
$
1,415

 
$
—

 
$
—

 
$
1,415

Margin deposits
140

 
—

 
—

 
140

Commodity instruments:
 
 
 
 
 
 
 
Commodity futures contracts
1,043

 
—

 
—

 
1,043

Commodity forward contracts(2)
—

 
74

 
37

 
111

Interest rate swaps
—

 
10

 
—

 
10

Total assets
$
2,598

 
$
84

 
$
37

 
$
2,719

Liabilities:
 
 
 
 
 
 
 
Margin deposits held by us posted by our counterparties
$
34

 
$
—

 
$
—

 
$
34

Commodity instruments:
 
 
 
 
 
 
 
Commodity futures contracts
899

 
—

 
—

 
899

Commodity forward contracts(2)
—

 
184

 
20

 
204

Interest rate swaps
—

 
320

 
—

 
320

Total liabilities
$
933

 
$
504

 
$
20

 
$
1,457

 
 
 
 
 
 
 
 
 
Assets and Liabilities with Recurring Fair Value Measures as of December 31, 2010
 
Level 1    
 
Level 2    
 
Level 3    
 
Total    
 
(in millions)
Assets:
 
 
 
 
 
 
 
Cash equivalents(1)
$
1,297

 
$
—

 
$
—

 
$
1,297

Margin deposits
162

 
—

 
—

 
162

Commodity instruments:
 
 
 
 
 
 
 
Commodity futures contracts
550

 
—

 
—

 
550

Commodity forward contracts(2)
—

 
287

 
54

 
341

Interest rate swaps
—

 
4

 
—

 
4

Total assets
$
2,009

 
$
291

 
$
54

 
$
2,354

Liabilities:
 
 
 
 
 
 
 
Margin deposits held by us posted by our counterparties
$
6

 
$
—

 
$
—

 
$
6

Commodity instruments:
 
 
 
 
 
 
 
Commodity futures contracts
574

 
—

 
—

 
574

Commodity forward contracts(2)
—

 
119

 
24

 
143

Interest rate swaps
—

 
371

 
—

 
371

Total liabilities
$
580

 
$
490

 
$
24

 
$
1,094

___________
(1)
As of December 31, 2011 and 2010, we had cash equivalents of $1,249 million and $1,094 million included in cash and cash equivalents and $166 million and $203 million included in restricted cash, respectively.
(2)
Includes OTC swaps and options.
The following table sets forth a reconciliation of changes in the fair value of our net derivative assets (liabilities) classified as level 3 in the fair value hierarchy for the years ended December 31, 2011, 2010 and 2009 (in millions):
 
2011
 
2010
 
2009
Balance, beginning of period
$
30

 
$
38

 
$
105

Realized and unrealized gains (losses):
 
 
 
 
 
Included in net income:
 
 
 
 
 
Included in operating revenues(1)
5

 
7

 
14

Included in fuel and purchased energy expense(2)
—

 
—

 
5

Included in OCI
2

 
2

 
(4
)
Purchases, issuances and settlements:
 
 
 
 
 
Settlements
(18
)
 
(20
)
 
(48
)
Transfers in and/or out of level 3(3):
 
 
 
 
 
Transfers into level 3(4)
(2
)
 
—

 
—

Transfers out of level 3(5)
—

 
3

 
(34
)
Balance, end of period
$
17

 
$
30

 
$
38

Change in unrealized gains relating to instruments still held at end of period(2)
$
5

 
$
7

 
$
19

___________
(1)
For power contracts and Heat Rate swaps and options, included on our Consolidated Statements of Operations.
(2)
For natural gas contracts, swaps and options, included on our Consolidated Statements of Operations.
(3)
We transfer amounts among levels of the fair value hierarchy as of the end of each period. There were no significant transfers into/out of level 1 during the years ended December 31, 2011, 2010 and 2009.
(4)
We had $2 million in losses transferred out of level 2 into level 3 for the year ended December 31, 2011, due to changes in market liquidity in various power and natural gas markets.There were no significant transfers into level 3 for the years ended December 31, 2010 and 2009.
(5)
There were no significant transfers out of level 3 for the year ended 2011. We had $3 million in losses and $(34) million in (gains) transferred out of level 3 into level 2 for the years ended December 31, 2010 and 2009, respectively, due to changes in market liquidity in various power markets.