Fair Value Measurements

3 Months Ended

Mar. 31, 2015

FAIR VALUE MEASUREMENTS

Accounting standards related to the determination of fair value define fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between willing market participants at the measurement date. We use a "mid-market" valuation convention (the mid-point price between bid and ask prices) as a practical expedient to measure fair value for the majority of our assets and liabilities subject to fair value measurement on a recurring basis. We primarily use the market approach for recurring fair value measurements and use valuation techniques to maximize the use of observable inputs and minimize the use of unobservable inputs.

We categorize our assets and liabilities recorded at fair value based upon the following fair value hierarchy:

•

Level 1 valuations use quoted prices in active markets for identical assets or liabilities that are accessible at the measurement date. An active market is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis. Our Level 1 assets and liabilities include exchange-traded commodity contracts. For example, some of our derivatives are NYMEX or ICE futures and swaps transacted through clearing brokers for which prices are actively quoted.

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Level 2 valuations use inputs that, in the absence of actively quoted market prices, are observable for the asset or liability, either directly or indirectly. Level 2 inputs include: (a) quoted prices for similar assets or liabilities in active markets, (b) quoted prices for identical or similar assets or liabilities in markets that are not active, (c) inputs other than quoted prices that are observable for the asset or liability such as interest rates and yield curves observable at commonly quoted intervals and (d) inputs that are derived principally from or corroborated by observable market data by correlation or other mathematical means. Our Level 2 valuations utilize over-the-counter broker quotes, quoted prices for similar assets or liabilities that are corroborated by correlations or other mathematical means, and other valuation inputs. For example, our Level 2 assets and liabilities include forward commodity positions at locations for which over-the-counter broker quotes are available.

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Level 3 valuations use unobservable inputs for the asset or liability. Unobservable inputs are used to the extent observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date. We use the most meaningful information available from the market combined with internally developed valuation methodologies to develop our best estimate of fair value. For example, our Level 3 assets and liabilities include certain derivatives with values derived from pricing models that utilize multiple inputs to the valuations, including inputs that are not observable or easily corroborated through other means. See further discussion below.

Our valuation policies and procedures are developed, maintained and validated by an EFH Corp. centralized risk management group that reports to the EFH Corp. Chief Financial Officer, who also functions as the Chief Risk Officer. Risk management functions include commodity price reporting and validation, valuation model validation, risk analytics, risk control, credit risk management and risk reporting.

We utilize several different valuation techniques to measure the fair value of assets and liabilities, relying primarily on the market approach of using prices and other market information for identical and/or comparable assets and liabilities for those items that are measured on a recurring basis. These methods include, among others, the use of broker quotes and statistical relationships between different price curves.

In utilizing broker quotes, we attempt to obtain multiple quotes from brokers (generally non-binding) that are active in the commodity markets in which we participate (and require at least one quote from two brokers to determine a pricing input as observable); however, not all pricing inputs are quoted by brokers. The number of broker quotes received for certain pricing inputs varies depending on the depth of the trading market, each individual broker's publication policy, recent trading volume trends and various other factors. In addition, for valuation of interest rate swaps, we used generally accepted interest rate swap valuation models utilizing month-end interest rate curves.

Probable loss from default by either us or our counterparties is considered in determining the fair value of derivative assets and liabilities. These non-performance risk adjustments take into consideration credit enhancements and the credit risks associated with our credit standing and the credit standing of our counterparties (see Note 13 for additional information regarding credit risk associated with our derivatives). We utilize published credit ratings, default rate factors and debt trading values in calculating these fair value measurement adjustments.

Certain derivatives and financial instruments are valued utilizing option pricing models that take into consideration multiple inputs including, but not limited to, commodity prices, volatility factors, discount rates and other market based factors. Additionally, when there is not a sufficient amount of observable market data, valuation models are developed that incorporate proprietary views of market factors. Significant unobservable inputs used to develop the valuation models include volatility curves, correlation curves, illiquid pricing locations and credit/non-performance risk assumptions. Those valuation models are generally used in developing long-term forward price curves for certain commodities. We believe the development of such curves is consistent with industry practice; however, the fair value measurements resulting from such curves are classified as Level 3.

The significant unobservable inputs and valuation models are developed by employees trained and experienced in market operations and fair value measurements and validated by the company's risk management group, which also further analyzes any significant changes in Level 3 measurements. Significant changes in the unobservable inputs could result in significant upward or downward changes in the fair value measurement.

With respect to amounts presented in the following fair value hierarchy tables, the fair value measurement of an asset or liability (e.g., a contract) is required to fall in its entirety in one level, based on the lowest level input that is significant to the fair value measurement. Certain assets and liabilities would be classified in Level 2 instead of Level 3 of the hierarchy except for the effects of credit reserves and non-performance risk adjustments, respectively. Assessing the significance of a particular input to the fair value measurement in its entirety requires judgment, considering factors specific to the asset or liability being measured.

Assets and liabilities measured at fair value on a recurring basis consisted of the following:



March 31, 2015
	Level 1		Level 2		Level 3 (a)		Total
Assets:
Commodity contracts	$	361	$	54	$	69	$	484
Nuclear decommissioning trust – equity securities (b)	378		219		—		597
Nuclear decommissioning trust – debt securities (b)	—		308		—		308
Total assets	$	739	$	581	$	69	$	1,389
Liabilities:
Commodity contracts	$	173	$	22	$	9	$	204
Total liabilities	$	173	$	22	$	9	$	204



December 31, 2014
	Level 1		Level 2		Level 3 (a)		Total
Assets:
Commodity contracts	$	402	$	46	$	49	$	497
Nuclear decommissioning trust – equity securities (b)	375		217		—		592
Nuclear decommissioning trust – debt securities (b)	—		301		—		301
Total assets	$	777	$	564	$	49	$	1,390
Liabilities:
Commodity contracts	$	278	$	25	$	14	$	317
Total liabilities	$	278	$	25	$	14	$	317

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(a)	See table below for description of Level 3 assets and liabilities.


(b)	The nuclear decommissioning trust investment is included in the investments line in the condensed consolidated balance sheets. See Note 15.

Commodity contracts consist primarily of natural gas, electricity, fuel oil, uranium and coal agreements and include financial instruments entered into for hedging purposes as well as physical contracts that have not been designated normal purchases or sales. See Note 13 for further discussion regarding derivative instruments, including the termination of certain natural gas hedging agreements shortly after the Bankruptcy Filing.

Nuclear decommissioning trust assets represent securities held for the purpose of funding the future retirement and decommissioning of our nuclear generation facility. These investments include equity, debt and other fixed-income securities consistent with investment rules established by the NRC and the PUCT.

There were no significant transfers between Level 1 and Level 2 of the fair value hierarchy for the three months ended March 31, 2015 and 2014. See the table of changes in fair values of Level 3 assets and liabilities below for discussion of transfers between Level 2 and Level 3 for the three months ended March 31, 2015 and 2014.

The following tables present the fair value of the Level 3 assets and liabilities by major contract type and the significant unobservable inputs used in the valuations at March 31, 2015 and December 31, 2014:



March 31, 2015
	Fair Value
Contract Type (a)	Assets		Liabilities			Total			Valuation Technique	Significant Unobservable Input	Range (b)
Electricity purchases and sales	$	11	$	(2	)	$	9		Valuation Model	Illiquid pricing locations (c)	$25 to $45/MWh
										Hourly price curve shape (d)	$20 to $60/MWh

Electricity spread options	4		(2		)	2			Option Pricing Model	Gas to power correlation (e)	20% to 95%
										Power volatility (f)	10% to 30%

Electricity congestion revenue rights	42		(3		)	39			Market Approach (g)	Illiquid price differences between settlement points (h)	$0.00 to $20.00

Coal purchases	—		(2		)	(2		)	Market Approach (g)	Illiquid price variances between heat content (j)	$0.00 to $0.50

Other (k)	12		—			12

Total	$	69	$	(9	)	$	60



December 31, 2014
	Fair Value
Contract Type (a)	Assets		Liabilities			Total			Valuation Technique	Significant Unobservable Input	Range (b)
Electricity purchases and sales	$	4	$	(5	)	$	(1	)	Valuation Model	Illiquid pricing locations (c)	$30 to $50/MWh
										Hourly price curve shape (d)	$20 to $70/MWh

Electricity spread options	2		(1		)	1			Option Pricing Model	Gas to power correlation (e)	15% to 95%
										Power volatility (f)	10% to 30%

Electricity congestion revenue rights	38		(4		)	34			Market Approach (g)	Illiquid price differences between settlement points (h)	$0.00 to $20.00

Coal purchases	—		(4		)	(4		)	Market Approach (g)	Illiquid price variances between mines (i)	$0.00 to $1.00
										Illiquid price variances between heat content (j)	$0.30 to $0.40

Other (k)	5		—			5

Total	$	49	$	(14	)	$	35

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(a)

Electricity purchase and sales contracts include hedging positions in the ERCOT regions, as well as power contracts, the valuations of which include unobservable inputs related to the hourly shaping of the price curve. Electricity spread option contracts consist of physical electricity call options. Electricity congestion revenue rights contracts consist of forward purchase contracts (swaps and options) used to hedge electricity price differences between settlement points within ERCOT. Coal purchase contracts relate to western (Powder River Basin) coal.


(b)	The range of the inputs may be influenced by factors such as time of day, delivery period, season and location.


(c)	Based on the historical range of forward average monthly ERCOT hub and load zone prices.


(d)	Based on the historical range of forward average hourly ERCOT North Hub prices.


(e)	Estimate of the historical range based on forward natural gas and on-peak power prices for the ERCOT hubs most relevant to our spread options.


(f)	Based on historical forward price changes.


(g)	While we use the market approach, there is either insufficient market data to consider the valuation liquid or the significance of credit reserves or non-performance risk adjustments results in a Level 3 designation.


(h)	Based on the historical price differences between settlement points within the ERCOT hubs and load zones.


(i)	Based on the historical range of price variances between mine locations.


(j)	Based on historical ranges of forward average prices between different heat contents (potential energy in coal for a given mass).


(k)	Other includes contracts for ancillary services, natural gas, diesel options, coal options and weather dependent power options.

The following table presents the changes in fair value of the Level 3 assets and liabilities for the three months ended March, 31 2015 and 2014.



	Three Months Ended March 31,
	2015			2014
Net asset (liability) balance at beginning of period	$	35		$	(973	)
Total unrealized valuation gains (losses)	16			(85		)
Purchases, issuances and settlements (a):
Purchases	19			9
Issuances	(3		)	(1		)
Settlements	(8		)	151
Transfers into Level 3 (b)	—			—
Transfers out of Level 3 (b)	1			2
Net change (c)	25			76
Net asset (liability) balance at end of period	$	60		$	(897	)
Unrealized valuation gains (losses) relating to instruments held at end of period	$	15		$	(71	)

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(a)	Settlements reflect reversals of unrealized mark-to-market valuations previously recognized in net income. Purchases and issuances reflect option premiums paid or received.


(b)	Includes transfers due to changes in the observability of significant inputs. Transfers in and out occur at the end of each quarter, which is when the assessments are performed. All Level 3 transfers during the periods presented are in and out of Level 2.


(c)	Substantially all changes in values of commodity contracts are reported in the condensed statements of consolidated income (loss) in net gain (loss) from commodity hedging and trading activities. Activity excludes changes in fair value in the month the positions settled as well as amounts related to positions entered into and settled in the same month.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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