Fair Value of Financial Instruments

9 Months Ended

Sep. 30, 2012

Fair Value of Financial Instruments Disclosure [Abstract]

Fair Value of Financial Instruments

Fair Value of Financial Instruments

This footnote should be read in conjunction with the complete description under Note 5, Fair Value of Financial Instruments, to the Company's 2011 Form 10-K.

For cash and cash equivalents, funds deposited by counterparties, restricted cash, and cash collateral paid and received in support of energy risk management activities, the carrying amount approximates fair value because of the short-term maturity of those instruments. Debt securities, equity securities, trust fund investments, which are comprised of various U.S. debt and equity securities, and derivative assets and liabilities are carried at fair market value.

The estimated carrying values and fair values of NRG's recorded financial instruments not carried at fair market value are as follows:

	As of September 30, 2012				As of December 31, 2011
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
	(In millions)
Assets:
Notes receivable	$	84	$	84	$	156	$	161
Liabilities:
Long-term debt, including current portion	11,342		11,817		9,729		9,716

The fair value of the Company's publicly-traded long-term debt is based on quoted market prices and is classified as Level 1 within the fair value hierarchy. The fair value of debt securities, non publicly-traded long-term debt, and certain notes receivable of the Company are based on expected future cash flows discounted at market interest rates, or current interest rates for similar instruments with equivalent credit quality and are classified as Level 3 within the fair value hierarchy.

Recurring Fair Value Measurements

For cash and cash equivalents, funds deposited by counterparties, restricted cash, and cash collateral paid and received in support of energy risk management activities, the carrying amount approximates fair value because of the nature and short-term maturity of those instruments and are classified as Level 1 within the fair value hierarchy.

The following tables present assets and liabilities measured and recorded at fair value on the Company's condensed consolidated balance sheet on a recurring basis and their level within the fair value hierarchy:

	As of September 30, 2012
	Fair Value
(In millions)	Level 1		Level 2		Level 3		Total
Investment in available-for-sale securities (classified within other     non-current assets):
Debt securities	$	—	$	—	$	11	$	11
Marketable equity securities	1		—		—		1
Trust fund investments:
Cash and cash equivalents	4		—		—		4
U.S. government and federal agency obligations	34		—		—		34
Federal agency mortgage-backed securities	—		63		—		63
Commercial mortgage-backed securities	—		6		—		6
Corporate debt securities	—		72		—		72
Equity securities	240		—		46		286
Foreign government fixed income securities	—		5		—		5
Derivative assets:
Commodity contracts	1,733		1,226		27		2,986
Total assets	$	2,012	$	1,372	$	84	$	3,468
Derivative liabilities:
Commodity contracts	$	1,601	$	1,263	$	25	$	2,889
Interest rate contracts	—		134		—		134
Total liabilities	$	1,601	$	1,397	$	25	$	3,023

	As of December 31, 2011
	Fair Value
(In millions)	Level 1		Level 2		Level 3		Total
Investment in available-for-sale securities (classified within other non-current assets):
Debt securities	$	—	$	—	$	7	$	7
Marketable equity securities	1		—		—		1
Trust fund investments:
Cash and cash equivalents	2		—		—		2
U.S. government and federal agency obligations	44		—		—		44
Federal agency mortgage-backed securities	—		63		—		63
Commercial mortgage-backed securities	—		7		—		7
Corporate debt securities	—		54		—		54
Equity securities	209		—		42		251
Foreign government fixed income securities	—		4		—		4
Derivative assets:
Commodity contracts	2,661		1,930		75		4,666
Total assets	$	2,917	$	2,058	$	124	$	5,099
Derivative liabilities:
Commodity contracts	$	2,757	$	1,283	$	67	$	4,107
Interest rate contracts	—		108		—		108
Total liabilities	$	2,757	$	1,391	$	67	$	4,215

There were no transfers during the three and nine months ended September 30, 2012, and 2011, between Levels 1 and 2. The following tables reconcile, for the three and nine months ended September 30, 2012, and 2011, the beginning and ending balances for financial instruments that are recognized at fair value in the consolidated financial statements at least annually using significant unobservable inputs:

	Fair Value Measurement Using Significant Unobservable Inputs (Level 3)
	Three months ended September 30, 2012										Nine months ended September 30, 2012
	Debt Securities		Trust Fund Investments								Debt Securities		Trust Fund Investments
(In millions)					Derivatives(a)			Total							Derivatives(a)			Total
Beginning balance	$	9	$	43	$	171		$	223		$	7	$	42	$	8		$	57
Total gains/(losses) - realized/unrealized:
Included in earnings	—		—		(9		)	(9		)	—		—		(3		)	(3		)
Included in OCI	2		—		—			2			4		—		—			4
Included in nuclear decommissioning obligations	—		3		—			3			—		3		—			3
Purchases	—		—		(109		)	(109		)	—		1		(1		)	—
Transfers into Level 3 (b)	—		—		(31		)	(31		)	—		—		4			4
Transfers out of Level 3 (b)	—		—		(20		)	(20		)	—		—		(6		)	(6		)
Ending balance as of September 30, 2012	$	11	$	46	$	2		$	59		$	11	$	46	$	2		$	59
The amount of the total (losses)/gains for the period included in earnings attributable to the change in unrealized gains relating to assets still held as of September 30, 2012	$	—	$	—	$	(5	)	$	(5	)	$	—	$	—	$	1		$	1

	Fair Value Measurement Using Significant Unobservable Inputs (Level 3)
	Three months ended September 30, 2011												Nine months ended September 30, 2011
	Debt Securities			Trust Fund Investments									Debt Securities		Trust Fund Investments
(In millions)							Derivatives(a)			Total								Derivatives(a)			Total
Beginning balance	$	9		$	41		$	(26	)	$	24		$	8	$	39		$	(27	)	$	20
Total gains/(losses) - realized/unrealized:
Included in earnings	—			—			—			—			—		—			19			19
Included in OCI	(1		)	—			—			(1		)	—		—			—			—
Included in nuclear decommissioning obligations	—			(8		)	—			(8		)	—		(7		)	—			(7		)
Purchases	—			—			(2		)	(2		)	—		1			6			7
Transfers into Level 3 (b)	—			—			13			13			—		—			(17		)	(17		)
Transfers out of Level 3 (b)	—			—			8			8			—		—			12			12
Ending balance as of September 30, 2011	$	8		$	33		$	(7	)	$	34		$	8	$	33		$	(7	)	$	34
The amount of the total gains for the period included in earnings attributable to the change in unrealized gains relating to assets still held as of September 30, 2011	$	—		$	—		$	(1	)	$	(1	)	$	—	$	—		$	6		$	6

(a) Consists of derivatives assets and liabilities, net.

(b) Transfers in/out of Level 3 are related to the availability of external broker quotes, and are valued as of the end of the reporting period. All transfers in/out are with Level 2.

Realized and unrealized gains and losses included in earnings that are related to the energy derivatives are recorded in operating revenues and cost of operations.

Derivative fair value measurements

The majority of NRG's contracts are exchange-traded contracts with readily available quoted market prices. A portion of NRG's contracts are non-exchange-traded contracts valued using prices provided by external sources, primarily price quotations available through brokers or over-the-counter and on-line exchanges. For the majority of NRG markets, the Company receives quotes from multiple sources. To the extent that NRG receives multiple quotes, the Company's prices reflect the average of the bid-ask mid-point prices obtained from all sources that NRG believes provide the most liquid market for the commodity. If the Company receives one quote, then the mid-point of the bid-ask spread for that quote is used. The terms for which such price information is available vary by commodity, region and product. A significant portion of the fair value of the Company's derivative portfolio is based on price quotes from brokers in active markets who regularly facilitate those transactions and the Company believes such price quotes are executable. The Company does not use third party sources that derive price based on proprietary models or market surveys. The remainder of the assets and liabilities represent contracts for which external sources or observable market quotes are not available for the whole term or for certain delivery months or the contracts are retail and load following power contracts. These contracts are valued using various valuation techniques including but not limited to internal models that apply fundamental analysis of the market and corroboration with similar markets. Contracts valued with prices provided by models and other valuation techniques make up 1% of the total derivative assets and 1% of the total derivative liabilities.

The fair value of each contract is discounted using a risk free interest rate. In addition, the Company applies a credit reserve to reflect credit risk which is calculated based on published default probabilities. To the extent that NRG's net exposure under a specific master agreement is an asset, the Company uses the counterparty's default swap rate. If the exposure under a specific master agreement is a liability, the Company uses NRG's default swap rate. The credit reserve is added to the discounted fair value to reflect the exit price that a market participant would be willing to receive to assume NRG's liabilities or that a market participant would be willing to pay for NRG's assets. As of September 30, 2012, the credit reserve resulted in a $9 million increase in fair value which is composed of a $4 million gain in Other Comprehensive Income, or OCI, and a $5 million gain in operating revenue and cost of operations. As of September 30, 2011, the credit reserve resulted in a $15 million decrease in fair value which is composed of a $5 million loss in OCI and a $10 million loss in operating revenue and cost of operations.

Concentration of Credit Risk

In addition to the credit risk discussion as disclosed in Note 2, Summary of Significant Accounting Policies, to the Company's 2011 Form 10-K, the following item is a discussion of the concentration of credit risk for the Company's contractual obligations. Credit risk relates to the risk of loss resulting from non-performance or non-payment by counterparties pursuant to the terms of their contractual obligations. NRG is exposed to counterparty credit risk through various activities including wholesale sales, fuel purchases and retail supply arrangements, and retail customer credit risk through its retail load activities.

Counterparty Credit Risk

The Company monitors and manages counterparty credit risk through credit policies that include: (i) an established credit approval process; (ii) daily monitoring of counterparties' credit limits; (iii) the use of credit mitigation measures such as margin, collateral, prepayment arrangements, or volumetric limits; (iv) the use of payment netting arrangements; and (v) the use of master netting agreements that allow for the netting of positive and negative exposures of various contracts associated with a single counterparty. Risk surrounding counterparty performance and credit could ultimately impact the amount and timing of expected cash flows. The Company seeks to mitigate counterparty credit risk with a diversified portfolio of counterparties. The Company also has credit protection within various agreements to call on additional collateral support if and when necessary. Cash margin is collected and held at NRG to cover the credit risk of the counterparty until positions settle.

As of September 30, 2012, counterparty credit exposure to a portion of the Company's counterparties was $620 million and NRG held collateral (cash and letters of credit) against those positions of $28 million, resulting in a net exposure of $592 million. Counterparty credit exposure is valued through observable market quotes and discounted at the risk free rate. The following tables highlight net counterparty credit exposure by industry sector and by counterparty credit quality. Net counterparty credit exposure is defined as the aggregate net asset position for NRG with counterparties where netting is permitted under the enabling agreement and includes all cash flow, mark-to-market and Normal Purchase Normal Sale, or NPNS, and non-derivative transactions. The exposure is shown net of collateral held, and includes amounts net of receivables or payables.

	Net Exposure (a)
Category	(% of Total)
Financial institutions	46	%
Utilities, energy merchants, marketers and other	51
Coal and emissions	1
Independent System Operators, or ISOs	2
Total as of September 30, 2012	100	%

	Net Exposure (a)
Category	(% of Total)
Investment grade	63	%
Non-Investment grade	2
Non-rated (b)	35
Total as of September 30, 2012	100	%

(a) Counterparty credit exposure excludes uranium and coal transportation contracts because of the unavailability of market prices.

(b) For non-rated counterparties, the majority are related to ISO and municipal public power entities, which are considered investment grade equivalent ratings based on NRG's internal credit ratings.

NRG has counterparty credit risk exposure to certain counterparties representing more than 10% of total net exposure discussed above and the aggregate of such counterparties' exposure was $124 million. Approximately 83% of NRG's positions relating to this credit risk exposure roll-off by the end of 2013. Changes in hedge positions and market prices will affect credit exposure and counterparty concentration. Given the credit quality, diversification and term of the exposure in the portfolio, NRG does not anticipate a material impact on the Company's financial position or results of operations from nonperformance by any of NRG's counterparties.

Counterparty credit exposure described above excludes credit risk exposure under certain long term agreements, including California tolling agreements, South Central load obligations, and solar Power Purchase Agreements, or PPAs. As external sources or observable market quotes are not available to estimate such exposure, the Company valued these contracts based on various techniques including, but not limited to, internal models based on a fundamental analysis of the market and extrapolation of observable market data with similar characteristics. Based on these valuation techniques, as of September 30, 2012, credit risk exposure to these counterparties attributable to NRG's ownership interests was approximately $1.1 billion for the next five years. This amount excludes potential credit exposures for projects with long term PPAs that have not reached commercial operations. Many of these power contracts are with utilities or public power entities that have strong credit quality and specific public utility commission or other regulatory support. These factors significantly reduce the risk of loss.

Retail Customer Credit Risk

NRG is exposed to retail credit risk through the Company's retail electricity providers, which serve commercial, industrial and governmental/institutional, or C&I, customers and the residential and small business, or mass, market. Retail credit risk results when a customer fails to pay for services rendered. The losses may result from both nonpayment of customer accounts receivable and the loss of in-the-money forward value. NRG manages retail credit risk through the use of established credit policies that include monitoring of the portfolio, and the use of credit mitigation measures such as deposits or prepayment arrangements.

As of September 30, 2012, the Company's retail customer credit exposure was diversified across many customers and various industries, with a significant portion of the exposure with government entities.