10-K 1 homercity201110k.htm Homer City 2011 10K
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2011
Commission File Number 333-92047-03
_______________________
EME Homer City Generation L.P.
(Exact name of registrant as specified in its charter)
Pennsylvania
(State or other jurisdiction of incorporation
or organization)
33-0826938
(I.R.S. Employer Identification No.)
1750 Power Plant Road
Homer City, Pennsylvania
(Address of principal executive offices)
15748
(Zip Code)
Registrant's telephone number, including area code: (724) 479-9011
Securities registered pursuant to Section 12(b) of the Act:
None
 
Not Applicable
(Title of Class)
 
(Name of each exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act:
None 
(Title of Class)
_______________________

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES o NO ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES x NO o
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES ý NO o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K ý.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES o NO o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "accelerated filer," "large accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o
 
Accelerated filer o
 
Non-accelerated filer ý
 
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO ý
Aggregate market value of the registrant's common equity held by non-affiliates of the registrant as of June 30, 2011: $0. Number of shares outstanding of the registrant's Common Stock as of March 28, 2012: Not applicable.
The registrant meets the conditions set forth in General Instruction I.(1)(a) and (b) of Form 10-K and is therefore filing this Form 10-K under the reduced disclosure format.
DOCUMENTS INCORPORATED BY REFERENCE
None
 








TABLE OF CONTENTS

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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GLOSSARY
When the following terms and abbreviations appear in the text of this report, they have the meanings indicated below.
ARO(s)
asset retirement obligation(s)
BACT
best available control technology
BART
best available retrofit technology
Btu
British thermal units
CAA
Clean Air Act
CAIR
Clean Air Interstate Rule
CAMR
Clean Air Mercury Rule
CO2
carbon dioxide
CSAPR
Cross-State Air Pollution Rule
EME
Edison Mission Energy
EMMT
Edison Mission Marketing & Trading, Inc.
FERC
Federal Energy Regulatory Commission
GAAP
United States generally accepted accounting principles
GHG
greenhouse gas
GWh
gigawatt-hours
HAP(s)
hazardous air pollutant(s)
Homer City
EME Homer City Generation L.P.
ISO(s)
independent system operator(s)
MATS
Mercury and Air Toxics Standards
MMBtu
million British thermal units
Moody's
Moody's Investors Service, Inc.
MW
megawatts
MWh
megawatt-hours
NAAQS
National Ambient Air Quality Standard(s)
NERC
North American Electric Reliability Corporation
NOX
nitrogen oxide
NSR
New Source Review
NYISO
New York Independent System Operator
NYSEG
New York State Electric & Gas Corporation
PADEP
Pennsylvania Department of Environmental Protection
Penelec
Pennsylvania Electric Company
PJM
PJM Interconnection, LLC
PSD
Prevention of Significant Deterioration
RPM
Reliability Pricing Model
RTO(s)
regional transmission organization(s)
S&P
Standard & Poor's Ratings Services
SIP(s)
state implementation plan(s)
SO2
sulfur dioxide
US EPA
United States Environmental Protection Agency

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FORWARD-LOOKING STATEMENTS
This annual report on Form 10-K contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements reflect Homer City's current expectations and projections about future events based on Homer City's knowledge of present facts and circumstances and assumptions about future events and include any statement that does not directly relate to a historical or current fact. Other information distributed by Homer City that is incorporated in this annual report, or that refers to or incorporates this annual report, may also contain forward-looking statements. In this annual report and elsewhere, the words "expects," "believes," "anticipates," "estimates," "projects," "intends," "plans," "probable," "may," "will," "could," "would," "should" and variations of such words and similar expressions, or discussions of strategy or plans, are intended to identify forward-looking statements. Such statements necessarily involve risks and uncertainties that could cause actual results to differ materially from those anticipated. Some of the risks, uncertainties and other important factors that could cause results to differ from those currently expected, or that otherwise could impact Homer City, include but are not limited to:
Homer City's assumptions about its ability to continue as a going concern;
Homer City's significant cash requirements and its limited ability to borrow funds and access the capital markets on reasonable terms;
environmental laws and regulations, at both state and federal levels, or changes in the application of those laws, that could require additional expenditures or otherwise affect Homer City's cost and manner of doing business, including compliance with the CAIR or CSAPR (as applicable) and the MATS rule;
supply and demand for electric capacity and energy, and the resulting prices and dispatch volumes, in the wholesale markets to which Homer City's generating units have access;
the cost and availability of fuel and fuel transportation services;
the cost and availability of emission credits or allowances;
transmission congestion in and to each market area and the resulting differences in prices between delivery points;
the difficulty of predicting wholesale prices, transmission congestion, energy demand, and other aspects of the complex and volatile markets in which Homer City participates;
the availability and creditworthiness of counterparties, and the resulting effects on liquidity in the power and fuel markets in which Homer City operates and/or the ability of counterparties to pay amounts owed in excess of collateral provided in support of their obligations;
governmental, statutory, regulatory or administrative changes or initiatives affecting Homer City or the electricity industry generally, including market structure rules and price mitigation strategies adopted by ISOs and RTOs;
weather conditions, natural disasters and other unforeseen events;
the extent of additional supplies of capacity, energy and ancillary services from current competitors or new market entrants, including the development of new generation facilities, and technologies that may be able to produce electricity at a lower cost than Homer City's generating facilities and/or increased access by competitors to Homer City's markets as a result of transmission upgrades;
competition in all aspects of Homer City's business;
operating risks, including equipment failure, availability, heat rate, output, costs of repairs and retrofits, and availability and cost of spare parts;
creditworthiness of suppliers and their ability to deliver goods and services under their contractual obligations to Homer City or to pay damages if they fail to fulfill those obligations;
effects of legal proceedings, changes in or interpretations of tax laws, rates or policies, and changes in accounting standards; and
general political, economic and business conditions.
Certain of the risk factors listed above are discussed in more detail in "Item 1A. Risk Factors" and in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Market Risk Exposures." Additional information about the risk factors listed above and other risks and uncertainties is contained throughout this annual report. Readers are

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urged to read this entire annual report, including the information incorporated by reference, and carefully consider the risks, uncertainties and other factors that affect Homer City's business. Forward-looking statements speak only as of the date they are made, and Homer City is not obligated to publicly update or revise forward-looking statements. Readers should review future reports filed by Homer City with the Securities and Exchange Commission.

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PART I

ITEM 1.  BUSINESS

Overview
Homer City is a Pennsylvania limited partnership with Chestnut Ridge Energy Company as a limited partner with a 99.9 percent interest and Mission Energy Westside Inc. as a general partner with a 0.1 percent interest. Both Chestnut Ridge Energy and Mission Energy Westside are wholly owned subsidiaries of Edison Mission Holdings Co., a wholly owned subsidiary of EME. EME is an indirect wholly owned subsidiary of Edison International. Homer City was formed for the purpose of acquiring, owning and operating three coal-fired electric generating units and related facilities located in Indiana County, Pennsylvania with an aggregate capacity of 1,884 MW, which Homer City collectively refers to as the "Homer City plant," for the purpose of producing electric energy. Homer City acquired the Homer City plant on March 18, 1999 and completed a sale-leaseback of its facilities to third parties in December 2001.
Homer City is a party to a contract with EMMT, an EME subsidiary engaged in asset management and trading activities, under which EMMT sells energy and capacity from the Homer City plant into the wholesale market and provides scheduling and other services. When appropriate market and financial conditions exist, EMMT may also engage in hedging activities for Homer City.

Substantial Doubt that Homer City will Continue as a Going Concern
The accompanying consolidated financial statements have been prepared assuming that Homer City will continue as a going concern. Financial statements prepared on this basis assume the realization of assets and the satisfaction of liabilities in the normal course of business for the 12-month period following the date of these consolidated financial statements. The reduction in energy prices experienced in the fourth quarter of 2011 and into 2012 has adversely impacted cash flow, and Homer City is not expected to be able to generate sufficient cash flow from operations necessary to meet its obligations, including the obligations under the Homer City lease. As described further below under Homer City Lease, it is unlikely that Homer City will continue as a going concern throughout 2012. For discussion of the asset impairment recorded with respect to the Homer City plant, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 12—Asset Impairments and Other Charges."
Homer City Lease
During the fourth quarter of 2011, Homer City failed to obtain sufficient interest from market participants necessary to fund the capital needed to make environmental improvements under the current lease arrangement. The estimated cost of installing SO2 and particulate emissions control equipment for Units 1 and 2 of the Homer City plant is expected to be approximately $700 million to $750 million. Homer City does not currently have sufficient capital and does not expect to generate sufficient funds from operations to complete retrofits. Restrictions under the agreements entered into as part of Homer City's 2001 sale-leaseback transaction affect, and in some cases significantly limit or prohibit, Homer City's ability to incur indebtedness or make capital expenditures. Consequently, Homer City's ability to install environmental compliance equipment will be dependent on funding from the owner-lessors or third parties. Homer City is currently engaged in discussions with the owner-lessors regarding the potential for such funding. Homer City expects that the outcome of any such discussions, if successful in providing funding for the Homer City plant, will likely result in Homer City's loss of substantially all beneficial economic interest in and material control of the Homer City plant. Failure to resolve the source of funding of necessary capital expenditures for the Homer City plant could result in Homer City's default under the lease agreements giving rise to remedies for the owner-lessors and secured lease obligation bondholders, which could include foreclosing on the leased assets, the general partner of Homer City, or both. For further discussion of these matters, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Management's Overview—Homer City Lease."

Location and Available Information
Homer City's principal executive offices are located at 1750 Power Plant Road, Homer City, Pennsylvania, 15748-8009, and its telephone number is (724) 479-9011.
Homer City's Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports, are electronically filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and are available on the Securities and Exchange Commission's internet web site at http://www.sec.gov.
EME files separately an Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. Such reports are available on the Securities and Exchange Commission's internet website at http://www.sec.gov.


4


Electric Power Industry
The United States electric industry, including companies engaged in providing generation, transmission, distribution and retail sales and service of electric power, has undergone significant deregulation over the last three decades, which has led to increased competition, especially in the generation sector. See further discussion of regulations under "Regulatory Matters."
In areas where ISOs and RTOs have been formed, market participants have open access to transmission service typically at a system-wide rate. ISOs and RTOs may also operate real-time and day-ahead energy and ancillary service markets, which are governed by FERC-approved tariffs and market rules. The development of such organized markets into which independent power producers are able to sell has reduced their dependence on bilateral contracts with electric utilities. In addition, capacity markets in various regional wholesale power markets compensate supply resources for the capability to supply electricity when needed, and demand resources for the electricity they avoid using.

Wholesale Markets
Power generated at the Homer City plant is primarily sold into PJM, an RTO which includes all or parts of Delaware, Illinois, Indiana, Kentucky, Maryland, Michigan, New Jersey, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia, West Virginia and the District of Columbia. Sales may also be made into the NYISO, which controls the transmission grid and energy and capacity markets for New York State. Subject to PJM and NYISO transmission availability and reliability considerations, Homer City can transmit up to 1,884 MW from its generating units into NYISO and can deliver up to 1,884 MW into PJM. Homer City does not incur any access or wheeling charges for energy delivered into PJM.

PJM
PJM operates a wholesale spot energy market and determines the market-clearing price for each hour based on bids submitted by participating generators indicating the minimum prices at which a bidder is willing to dispatch energy at various incremental generation levels. PJM requires all load-serving entities and generators, such as Homer City, to maintain prescribed levels of capacity, including a reserve margin, to ensure system reliability. PJM's capacity markets have a single market-clearing price for each capacity zone. In May of each year, PJM conducts an annual capacity auction (RPM) to commit generation, energy efficiency, and demand side resources three years forward, and to provide a long-term pricing signal for the construction of capacity resources.

NYISO
The NYISO operates a competitive, non-discriminatory wholesale power market in New York State in response to the FERC's Open Access Rules and includes bid-based electricity and transmission usage markets. The market-clearing price for NYISO's day-ahead and real-time energy markets is set by supplier generation bids and customer demand bids.

Competition
Homer City is subject to competition from energy marketers, public utilities, government-owned power agencies, industrial companies, financial institutions, and other independent power producers. These companies may have competitive advantages as a result of scale, the location of their generation facilities or other factors. Some of Homer City's competitors have a lower cost of capital than Homer City and, in the case of utilities, may be able to recover fixed costs through rate base mechanisms, allowing them to build, buy and upgrade generation without relying exclusively on market clearing prices to recover their investments.
State and local environmental regulations, particularly those that impose stringent state specific emission limits, could put the Homer City plant at a disadvantage compared with competing power plants operating in nearby states and subject to less stringent state emission limits or to federal emission limits alone. Federal air quality regulations such as CSAPR and the MATS rule will put the Homer City plant at a disadvantage compared with plants utilizing other fuels. Potential future climate change regulations could also put the Homer City plant at a disadvantage compared to power plants utilizing other fuels as well as utilities that may be able to recover climate change compliance costs through rate-base mechanisms. The ability of the Homer City plant to compete can also be affected by future environmental regulations, by governmental and regulatory activities designed to support the construction and operation of power generation facilities fueled by renewable energy sources, and by developments such as shale gas technology that lower the price of other fuels.


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Overview of Facilities Under Lease
The business description of Homer City is presented for an understanding of the historical operations of generation from this plant. For a discussion of the status of the Homer City lease, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Management's Overview—Homer City Lease."
The Homer City plant is located on a 2,413-acre site approximately 45 miles northeast of Pittsburgh within Indiana County, Pennsylvania. Homer City owns a fee interest in the land and leases the facilities on which the generating units are located pursuant to a sale-leaseback transaction completed in December 2001. As a result of the sale-leaseback transaction, Homer City leased the property on which the generating units are located to the owner lessors through site leases and each owner lessor in turn subleased its undivided ground interest in the property to Homer City through site subleases. The term of the site leases is 45 years from the date of the sale-leaseback, with specified renewal options. The term of the site subleases is 33.67 years, the term of the sale-leaseback financing, and is renewable upon renewal of the Homer City facility leases.
The Homer City plant consists of the generating units, a coal cleaning facility, water supply provided by a 1,800-acre reservoir site known as Two Lick Dam, which is not part of the 2,413-acre site, and associated support facilities. The Homer City generating units benefit from direct transmission access to both PJM and NYISO through seven high voltage lines which interconnect through a switchyard located on the site.
The Homer City units are coal-fired boilers and steam turbine-generator units (referred to as Units 1, 2 and 3 in this annual report). Units 1 and 2 were placed into commercial operation in 1969. Unit 1 has an installed capacity of 620 MW, and Unit 2 has an installed capacity of 614 MW. The Unit 1 and 2 boilers have been retrofitted with low NOx burners to meet Phase I NOx 1990 CAA standards. In addition, both boilers have supplemental over-fired air systems to further reduce NOx emissions to satisfy Pennsylvania Title I (ozone) requirements. Selective catalytic reduction units have been installed on Units 1 and 2 for further reduction of NOx emissions.
Unit 3 commenced commercial operation in 1977 and has an installed capacity of 650 MW. The boiler for Unit 3 was originally constructed with low NOx burners which satisfied Phase I NOx 1990 CAA standards, and a supplemental over-fired air system was installed in 1995 to further reduce NOx emissions. In addition, a FGD system and a selective catalytic reduction system were installed on Unit 3 in 2001.
These improvements were made to enable the Homer City generating units to comply with Phase II of Title IV of the 1990 CAA regarding SO2 emissions, the Pennsylvania NOx allowance regulations and Pennsylvania's response to the US EPA SIP Call regarding NOx emissions.

Water Supply and Other Support Facilities
The Homer City generating units receive their water supply from Two Lick Creek. The water supply to Two Lick Creek is regulated by releases from Two Lick Dam, which is located approximately eight miles upstream from the Homer City plant and is owned, operated and maintained by Homer City in accordance with a dam safety permit and a drought management plan and related consent order and agreement with the PADEP. These facilities were not sold to third parties as part of the 2001 sale-leaseback transaction. Each of the Homer City generating units has a natural draft-cooling tower.
Other support facilities located on the site include a dry ash disposal area, a coal refuse disposal area, coal receiving and storage facilities and water treatment and pumping facilities.

Interconnection Agreement
Homer City is a party to an interconnection agreement with New York State Electric & Gas Corporation (NYSEG) and Pennsylvania Electric Company (Penelec) to provide interconnection services necessary to interconnect the Homer City plant with NYSEG's and Penelec's transmission systems. Unless terminated earlier in accordance with specified terms, the interconnection agreement will terminate on a date mutually agreed to by Homer City, NYSEG and Penelec. The termination date will not exceed the retirement date of the Homer City units. NYSEG and Penelec have agreed to extend the interconnection services (but not the expiration of the agreement) to modifications, additions or upgrades to, or repowering of the Homer City units. Homer City is required to compensate NYSEG and Penelec for all reasonable costs associated with any modifications, additions or replacements made to NYSEG's or Penelec's interconnection facilities or transmission systems in connection with any modification, addition or upgrade to, or repowering of the Homer City units.


6


Power Sales
Energy and capacity from the Homer City plant are sold under terms, including price, duration and quantity, arranged by EMMT with customers through a combination of bilateral agreements (resulting from negotiations or from auctions), forward energy sales and spot market sales. The Homer City plant is situated in the PJM control area and has direct, high-voltage interconnections to PJM and also to the NYISO. Electric power generated at the Homer City plant is primarily sold into the PJM market. Effective April 1, 2011, EMMT allocated to Homer City the benefit of an arrangement that allows EMMT to deliver a portion of Homer City's power into the NYISO. To the extent this arrangement is not utilized, Homer City's power is delivered into PJM.

Fuel Supply
Homer City's Units 1 and 2 have historically consumed approximately 2.8 million to 3.3 million tons of mid-range sulfur coal per year. Two types of coal are purchased, ready-to-burn and raw coal. Ready-to-burn coal is of the quality that can be burned directly in Units 1 and 2, whereas the raw coal purchased for consumption by Units 1 and 2 must be cleaned in the Homer City coal cleaning facility, which has the capacity to clean up to 5 million tons of coal per year. Unit 3 has historically consumed approximately 1.5 million to 2 million tons of coal per year and can consume either raw or ready-to-burn coal. Coal consumption in the current low natural gas price environment may be lower than the historical range. A wet scrubber FGD system for Unit 3 enables this unit to burn less expensive, higher sulfur coal, while still meeting environmental standards for emission control. In general, the coal purchased for all three units is acquired locally. For additional information, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Market Risk Exposures—Commodity Price Risk—Coal Price Risk."

Emission Allowances
The federal Acid Rain Program requires electric generating stations to hold SO2 allowances sufficient to cover their annual emissions. Pursuant to Pennsylvania's implementation of the CAIR, the Homer City plant is required to hold seasonal and annual NOx allowances. The CAIR remains in effect until a replacement regulation becomes effective.
CSAPR, like the CAIR, is an allowance-based regulation that provides for emissions trading. Under CSAPR, the amount of actual SO2 or NOX emissions from plant operations will need to be matched by a sufficient amount of SO2 or NOX allowances that are either allocated or purchased in the open market. SO2 allowances under the federal Acid Rain Program cannot be used to satisfy the requirements under CSAPR. In December 2011, the United States Court of Appeals for the District of Columbia granted a stay of CSAPR pending completion of its review of the rule's validity. If the stay is lifted and CSAPR becomes effective, Homer City expects that additional SO2 allowances under CSAPR will be required for the Homer City plant. The availability and market prices for those allowances are uncertain, but the associated costs could be significant. For additional information, see "Environmental Matters and Regulations—Air Quality."

Significant Customers
For a discussion of significant customers, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 5. Derivative Instruments and Hedging Activities—Credit Risk."

Insurance
For a discussion of insurance, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 8. Commitments and Contingencies—Contingencies—Insurance."

Seasonality
Due to fluctuations in electric demand resulting from warm weather during the summer months and cold weather during the winter months, electric revenues from the Homer City plant normally vary substantially on a seasonal basis. In addition, maintenance outages generally are scheduled during periods of lower projected electric demand (spring and fall), further reducing generation and increasing major maintenance costs which are recorded as an expense when incurred. Accordingly, earnings from the Homer City plant are seasonal and have significant variability from quarter to quarter. Seasonal fluctuations may also be affected by changes in market prices. For further discussion regarding market prices, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Market Risk Exposures—Commodity Price Risk—Energy Price Risk."


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Regulatory Matters

General
Homer City's operations are subject to extensive regulation. Homer City is subject to energy, environmental and other governmental laws and regulations at the federal, state and local levels in connection with the operation of its facilities, and the use of electric energy, capacity and related products, including ancillary services, from those facilities. In addition, Homer City is subject to the market rules, procedures, and protocols of the markets in which it participates.

Federal Power Act
The FERC has exclusive jurisdiction over the rates, terms and conditions of wholesale sales of electricity and transmission services in interstate commerce (other than transmission that is "bundled" with retail sales), including ongoing, as well as initial, rate jurisdiction. The FERC also has jurisdiction over the sale or transfer of specified assets, including wholesale power sales contracts and generation facilities and, in some cases, jurisdiction over the issuance of securities or the assumption of specified liabilities and some interlocking directorates. Dispositions of Homer City's jurisdictional assets and certain types of financing arrangements may require FERC approval.
Homer City, an exempt wholesale generator (EWG), is subject to the FERC's ratemaking jurisdiction under the Federal Power Act, but has been authorized to sell power at market-based rates to purchasers which are not affiliated electric utility companies as long as the absence of market power is shown. If Homer City were to lose its EWG status, defaults under the covenants in Homer City's agreements could be triggered.

Reliability Standards
NERC establishes and enforces reliability standards for the bulk power system. Homer City believes it has taken appropriate steps to be compliant with current NERC reliability standards that apply to its operations.

Transmission of Wholesale Power
Homer City utilizes power lines owned by others for the transmission of electricity. The prices and other terms and conditions of transmission contracts are regulated by the FERC when the entity providing the transmission service is subject to FERC jurisdiction.

Environmental Matters and Regulations
Legislative and regulatory activities by federal, state, and local authorities in the United States relating to energy and the environment impose numerous restrictions and requirements with respect to the operation of the Homer City plant and affect the timing, cost, design and construction of capital improvements to the Homer City plant as well as the cost of mitigating the environmental impacts of past operations. In addition, as discussed in "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 8. Commitments and Contingencies," the US EPA and others have from time to time involved Homer City in litigation. Additional information about environmental matters affecting Homer City, including projected environmental capital expenditures, is included in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Capital Investment Plan" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates and Policies—Impairment of Long-Lived Assets."

Air Quality
The CAA, which regulates air pollutants from mobile and stationary sources, has a significant impact on the operation of the Homer City plant. The CAA requires the US EPA to establish concentration levels in the ambient air for six criteria pollutants to protect public health and welfare. These concentration levels are known as National Ambient Air Quality Standards, or NAAQS. The six criteria pollutants are carbon monoxide, lead, nitrogen dioxide, ozone, particulate matter, and SO2.
Federal environmental regulations require states to adopt state implementation plans, known as SIPs, for certain pollutants, which detail how the state will attain the standards that are mandated by the relevant law or regulation. The SIPs must be equal to or more stringent than the federal requirements and must be submitted to the US EPA for approval. Each state identifies the areas within its boundaries that meet the NAAQS (attainment areas) and those that do not (non-attainment areas), and must develop a SIP both to bring non-attainment areas into compliance with the NAAQS and to maintain good air quality in attainment areas. If the attainment status of areas changes, states may be required to develop new SIPs that address the changes. The Homer City plant is located in a county that has not attained NAAQS for ozone (affected by NOx emissions from power plants) and fine particulate matter (affected by SO2 and NOx emissions from power plants).


8


Nitrogen Oxide and Sulfur Dioxide

Clean Air Interstate and Cross-State Air Pollution Rules
The CAIR, issued by the US EPA on March 10, 2005, mandated significant reductions in NOx and SO2 emission allowance caps under the CAA in 28 eastern states and the District of Columbia. In 2008, the U.S. Court of Appeals for the D.C. Circuit initially vacated the CAIR, but later remanded the CAIR to the US EPA for the issuance of a revised rule. The CAIR remains in effect until a replacement regulation becomes effective.
On July 6, 2011, the US EPA adopted the Cross-State Air Pollution Rule (CSAPR). CSAPR establishes emissions reductions for annual sulfur dioxide (SO2) emissions and annual and ozone season nitrogen oxide (NOx) emissions in two phases: a first phase originally scheduled to be effective January 1, 2012 and, in most states subject to the program (including Pennsylvania), a second phase effective January 1, 2014 that requires additional reductions in annual SO2 emissions.
In December 2011, the United States Court of Appeals for the District of Columbia granted a stay of CSAPR pending completion of its review of the rule's validity. Oral argument is scheduled for April 13, 2012, and a court decision is expected during the third quarter of 2012. The court directed the US EPA to continue administering the CAIR until its review is completed.
CSAPR, like the CAIR, is an allowance-based regulation that provides for emissions trading. If the stay is lifted and CSAPR becomes effective, the amount of actual SO2 or NOx emissions from plant operations will need to be matched by a sufficient amount of SO2 or NOx allowances that are either allocated or purchased in the open market. In connection with CSAPR, the US EPA has, for each phase, established SO2 and NOx allowance allocations for each state and each generating unit subject to the regulation, and at the close of the annual or seasonal compliance period, units will need to surrender allowances for each ton of SO2 and NOx emitted or face penalties.
With the staying of CSAPR, CAIR SO2 allowances have been provided and a sufficient supply is available for purchase to permit Homer City to continue operations consistent with 2011 levels. If the stay is lifted, the SO2 allowances allocated to Homer City in CSAPR Phase I (25,797 tons in 2012 and 2013) would be significantly lower than the amount that would be required based on Homer City's historical emissions. It is unclear at this time whether Homer City would be able to acquire allowances in sufficient quantity to cover its normal operations during Phase I of CSAPR and whether it would be able to pass through the cost of such allowances in the marketplace. Accordingly, despite the stay, Homer City continues to evaluate alternative options, including reduced dispatch and fuel modifications, for complying with Phase I of CSAPR. The cost of allowances, together with possible operational impacts or reductions of output that may be required to comply with Phase I of CSAPR, could have a material effect on Homer City.
Homer City has begun work on designing SO2 and particulate emissions control equipment for Units 1 and 2 and preparing the site for their installation. The estimated cost of installing SO2 and particulate emissions control equipment for Units 1 and 2of the Homer City plant is expected to be approximately $700 million to $750 million. In order for this emissions control equipment to be operational by early 2014, which is the expected deadline under the currently applicable Federal environmental regulations, the construction process would need to begin in the second quarter of 2012.A contractor for engineering, procurement and construction services has been selected to install and construct the emissions control equipment for the Homer City plant. However, construction of these improvements is dependent upon funding from the owner-lessors or third parties. For further discussion of the Homer City lease and environmental improvements, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Management's Overview—Homer City Lease."

Revised NAAQS for SO2 
In June 2010, the US EPA finalized the primary NAAQS for SO2 by establishing a new one-hour standard at a level of 75 parts per billion. In June 2011, Pennsylvania submitted its initial recommended attainment/nonattainment designations in connection with the standard. Pennsylvania recommended designating Indiana County, where the Homer City plant is located, as nonattainment for the SO2 NAAQS.

Pennsylvania
The Homer City plant was subject to the federal CAIR during 2011 and complied with both the NOx and SO2 requirements by using existing equipment and purchasing SO2 allowances. Pennsylvania adopted a state version of the CAIR, which the US EPA approved in December 2009. Homer City expects to comply with the Pennsylvania CAIR, which is substantially similar to the federal CAIR as it existed prior to the implementation of CSAPR, in the same manner in which it complies with the federal standards.


9


Mercury/Hazardous Air Pollutants

Mercury and Air Toxics Standards Rule
In December 2011, the US EPA announced the Mercury and Air Toxics Standards (MATS) rule, limiting emissions of hazardous air pollutants (HAPs) from coal- and oil-fired electrical generating units. The rule was published in the Federal Register on February 16, 2012, and becomes effective on April 16, 2012. Homer City does not expect that these standards will require Homer City to make additional capital expenditures beyond those that would be required for compliance with CSAPR Phase II.

Pennsylvania
Pennsylvania currently has no state-level mercury regulations.

Ozone

National Ambient Air Quality Standards
In January 2010, the US EPA proposed a revision to the primary and secondary NAAQS for 8-hour ozone that it had finalized in 2008. The 8-hour ozone standard established in 2008 was 0.075 parts per million. In January 2010, the US EPA proposed establishing a primary 8-hour ozone NAAQS between 0.060 and 0.070 parts per million and a distinct secondary standard to protect sensitive vegetation and ecosystems. In September 2011, President Obama announced that the proposed revision was being withdrawn. The ozone NAAQS established in 2008 remains in place, but the implementation process must be completed before the 0.075 parts-per-million standard can be enforced. The US EPA has indicated that it intends to issue initial area designations of attainment, nonattainment, and unclassifiable areas across the nation in 2012. States will then be required to develop and submit SIPs outlining how compliance with the 2008 NAAQS will be achieved. New primary and secondary ozone standards are expected in 2014.
In December 2011, the US EPA indicated that it intended to designate Indiana County, where the Homer City plant is located, as in attainment with the 2008 NAAQS.

Regional Haze
The regional haze rules under the CAA are designed to prevent impairment of visibility in certain federally designated areas. The goal of the rules is to restore visibility in mandatory federal Class I areas, such as national parks and wilderness areas, to natural background conditions by 2064. Sources such as power plants that are reasonably anticipated to contribute to visibility impairment in Class I areas may be required to install BART or implement other control strategies to meet regional haze control requirements.
Pennsylvania submitted its proposed SIP revisions to the US EPA to address regional haze. Pennsylvania proposed that the existing particulate matter emission limits on the Homer City plant, as well as the plant's participation in the CAIR, would satisfy the BART requirement in that state. Because the CAIR was scheduled to expire on December 31, 2011, the US EPA proposed, on December 30, 2011, a limited disapproval of Pennsylvania's SIP, as well as a Federal Implementation Plan that would allow the Homer City plant's participation in CSAPR to satisfy the BART requirement. It is unclear how the stay of CSAPR will affect the Pennsylvania SIP. Homer City believes that the control measures being undertaken to comply with other environmental regulations will likely satisfy the requirements of these SIPs.

New Source Review Requirements
The NSR regulations impose certain requirements on facilities, such as electric generating stations, if modifications are made to air emissions sources at the facility. Since 1999, the US EPA has pursued a coordinated compliance and enforcement strategy to address NSR compliance issues at the nation's coal-fired power plants. The US EPA has filed an enforcement action against Homer City alleging NSR violations. For further discussion, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 8. Commitments and Contingencies—Contingencies."

Coal Combustion Wastes
US EPA regulations currently classify coal ash and other coal combustion residuals as solid wastes that are exempt from hazardous waste requirements. This classification enables beneficial uses of coal combustion residuals, such as for cement production and fill materials. In June 2010, the US EPA published proposed regulations relating to coal combustion residuals that could result in their reclassification. For further discussion see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 9. Environmental Developments."


10


Climate Change
There have been a number of federal and state legislative and regulatory initiatives to reduce greenhouse gas (GHG) emissions. Any climate change regulation or other legal obligation that would require substantial reductions in GHG emissions or that would impose additional costs or charges for the GHG emissions could significantly increase the cost of generating electricity from fossil fuels, and especially from coal-fired plants, which could adversely affect Homer City's business.

Federal Legislative/Regulatory Developments
In June 2010, the US EPA issued the Prevention of Significant Deterioration (PSD) and Title V Greenhouse Gas Tailoring Rule, known as the "GHG tailoring rule." This regulation generally subjects newly constructed sources of GHG emissions and newly modified existing major sources to the PSD air permitting program beginning in January 2011 (and later, to the Title V permitting program under the CAA); however, the GHG tailoring rule significantly increases the emissions thresholds that apply before facilities are subjected to these programs. The emissions thresholds for CO2 equivalents in the final rule vary from 75,000 tons per year to 100,000 tons per year depending on the date and whether the sources are new or modified.
Regulation of GHG emissions pursuant to the PSD program could affect efforts to modify the Homer City plant in the future and could subject new capital projects to additional permitting or emissions control requirements that could delay such projects. In December 2010, the US EPA announced that it had entered into a settlement with various states and environmental groups to resolve a long-standing dispute over regulation of GHGs from electrical generating units pursuant to the New Source Performance Standards in the CAA and would propose performance standards for emissions from new and modified power plants and emissions guidelines for existing power plants. The specific requirements will not be known until the regulations are finalized. Since January 2010, the US EPA's Final Mandatory Greenhouse Gas Reporting Rule has required all sources within specified categories, including electric generation facilities, to monitor emissions and to submit annual reports to the US EPA by March 31 of each year. Homer City's 2011 GHG emissions were approximately 9 million metric tons.

Litigation Developments
Litigation alleging that GHG is a public and private nuisance may affect Homer City whether or not it is named as a defendant. The law is unsettled on whether or not this litigation presents questions capable of judicial resolution or political questions that should be resolved by the legislative or executive branches. For further discussion, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 9. Environmental Developments."

Employees
At December 31, 2011, Homer City employed 252 employees, approximately 179 of whom are covered by a collective bargaining agreement governing wages, benefits and working conditions. This collective bargaining agreement expires on December 31, 2012.

ITEM 1A.  RISK FACTORS

Liquidity Risks
Homer City is not expected to generate sufficient cash flow from operations necessary to meet its obligations.
At December 31, 2011, Homer City had cash and cash equivalents of $84 million. Homer City is obligated to pay $95 million, $84 million and $98 million of senior rent and $65 million, $65 million and $40 million of equity rent in each of 2012, 2013 and 2014, respectively. Current and forthcoming environmental requirements will require Homer City to install SO2 and particulate emissions control equipment for Units 1 and 2 at a cost of approximately $700 million to $750 million.
The accompanying consolidated financial statements have been prepared assuming that Homer City will continue as a going concern. Financial statements prepared on this basis assume the realization of assets and the satisfaction of liabilities in the normal course of business for the 12-month period following the date of these consolidated financial statements. The reduction in energy prices experienced in the fourth quarter of 2011 and into 2012 has adversely impacted cash flow, and Homer City is not expected to be able to generate sufficient cash flow from operations necessary to meet its obligations, including the obligations under the Homer City lease. As described further below, it is unlikely that Homer City will continue as a going concern throughout 2012.
During the fourth quarter of 2011, Homer City failed to obtain sufficient interest from market participants necessary to fund the capital needed to make environmental improvements under the current lease arrangement. The estimated cost of installing SO2 and particulate emissions control equipment for Units 1 and 2 of the Homer City plant is expected to be approximately $700 million to $750 million. Homer City does not currently have sufficient capital and does not expect to generate sufficient funds

11


from operations to complete retrofits. Restrictions under the agreements entered into as part of Homer City's 2001 sale-leaseback transaction affect, and in some cases significantly limit or prohibit, Homer City's ability to incur indebtedness or make capital expenditures. Consequently, Homer City's ability to install environmental compliance equipment will be dependent on funding from the owner-lessors or third parties. Homer City is currently engaged in discussions with the owner-lessors regarding the potential for such funding. Homer City expects that the outcome of any such discussions, if successful in providing funding for the Homer City plant, will likely result in Homer City's loss of substantially all beneficial economic interest in and material control of the Homer City plant. Failure to resolve the source of funding of necessary capital expenditures for the Homer City plant could result in Homer City's default under the lease agreements giving rise to remedies for the owner-lessors and secured lease obligation bondholders, which could include foreclosing on the leased assets, the general partner of Homer City, or both. For further discussion, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Management's Overview—Homer City Lease."
The interests of EME as Homer City's equity holder may conflict with the interests of holders of debt.
Homer City is indirectly owned and controlled by EME. The directors appointed by EME are able to make decisions affecting Homer City's capital structure which could include, subject to contractual obligations and applicable law, decisions on the ultimate disposition of the Homer City plant. The interests of EME may not in all cases be aligned with the interests of the holders of Homer City's debt. As Homer City addresses its financial difficulties or becomes unable to pay its debts as they mature, the interests of EME might conflict with the interests of holders of Homer City's debt.

Regulatory and Environmental Risks
Homer City is subject to extensive environmental regulation and permitting requirements that may involve significant and increasing costs.
Homer City's operations are subject to extensive and frequently changing environmental regulations with respect to, among other things, air quality, water quality and waste disposal which involve significant and increasing costs and substantial uncertainty. Homer City is required to obtain, and comply with conditions established by, licenses, permits and other approvals in order to construct, operate or modify its facilities. Failure to comply with these requirements could subject Homer City to civil or criminal liability, the imposition of liens or fines, or actions by regulatory agencies seeking to curtail Homer City's operations. Homer City may also be exposed to risks arising from past, current or future contamination at its facilities or with respect to off-site waste disposal sites that have been used in its operations.
Homer City devotes significant resources to environmental monitoring, emissions control equipment and emission allowances to comply with environmental regulatory requirements. Homer City believes that it is currently in substantial compliance with environmental regulatory requirements. However, the US EPA has filed an enforcement action against Homer City alleging violations of the CAA and other regulations at the Homer City plant. For more detail with respect to these matters, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 8. Commitments and Contingencies."
The current trend is toward more stringent standards, stricter regulation, and more expansive application of environmental regulations. The adoption of laws and regulations to implement CO2 controls could adversely affect coal-fired power plants. Other environmental laws, particularly with respect to air emissions, disposal of ash, wastewater discharge and cooling water systems, are also generally becoming more stringent. The continued operation of the Homer City plant is expected to require substantial capital expenditures for environmental controls. If Homer City cannot comply with all applicable regulations, it could be required to retire or suspend operations at its facilities, or restrict or modify the operations of its facilities, and its business, results of operations and financial condition could be adversely affected.
Homer City is required to surrender emission allowances equal to emissions of specific substances in connection with the operation of its facilities. This may require the purchase of allowances, which are subject to price volatility and which could be unavailable.
Typically, environmental laws require a lengthy and complex process for obtaining licenses, permits and approvals prior to construction, operation or modification of a project or generating facility. Homer City cannot provide assurance that it will be able to obtain and comply with all necessary licenses, permits and approvals for the Homer City plant. If there is a delay in obtaining required approvals or permits or if Homer City fails to obtain and comply with such permits, the operation of the Homer City plant may be interrupted or become subject to additional costs.
The controls imposed on the Homer City plant as a result of environmental regulations may require material expenditures or unit shutdowns.
Capital expenditures relating to required environmental controls for the Homer City plant are expected to be significant and could make some units uneconomic to maintain or operate. Homer City may ultimately decide to shut down units rather than

12


making improvements. Unit shutdowns could have an adverse effect on Homer City's business, results of operation and financial condition. For more information about Homer City's plans for environmental compliance, see "Item 1. Business—Environmental Matters and Regulations—Air Quality—Nitrogen Oxide and Sulfur Dioxide," "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Management's Overview—Homer City Lease" and "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 9. Environmental Developments."
Homer City is subject to extensive energy industry regulation.
Homer City's operations are subject to extensive regulation by governmental agencies. Federal laws and regulations govern, among other things, transactions by and with purchasers of power, including utility companies, the development and construction of generation facilities, the ownership and operations of generation facilities, and access to transmission. Generation facilities are also subject to federal, state and local laws and regulations that govern, among other things, the geographical location, zoning, land use, and operation of a project. Homer City, in the course of its business, must obtain and periodically renew licenses, permits and approvals for the Homer City plant. The FERC may impose various forms of market mitigation measures, including price caps and operating restrictions, where it determines that potential market power might exist and that the public interest requires mitigation. RTOs and ISOs may impose bidding and scheduling rules, both to curb the potential exercise of market power and to facilitate market functions. Such actions may materially affect Homer City's results of operations. The Homer City plant is also subject to mandatory reliability standards promulgated by NERC, compliance with which can increase the facilities' operating costs or capital expenditures.
This extensive governmental regulation creates significant risks and uncertainties for Homer City's business. Existing regulations may be revised or reinterpreted and new laws and regulations may be adopted or become applicable to Homer City or its facilities or operations in a manner that may have a detrimental effect on its business or result in significant additional costs.
The generation and transmission of electricity are dangerous and involve inherent risks of injury to employees and the general public.
Electricity is dangerous for employees and the general public should they come in contact with power lines or electrical equipment. Injuries caused by such contact can subject Homer City to liability that, despite the existence of insurance coverage, can be significant. Such liabilities could be significant but are very difficult to predict. The range of possible liabilities includes amounts that could adversely affect Homer City's liquidity and results of operations.

Market Risks
Homer City's operations are subject to market risks related to wholesale energy prices because it operates without long-term power purchase agreements. Wholesale energy prices have substantially declined in recent years.
The Homer City plant does not have long-term power purchase agreements. Because the output of the Homer City plant is not committed to be sold under long-term contracts, the plant is subject to market forces which determine the amount and price of energy, capacity and ancillary services sold from the plant. Unlike most other commodities, electric power can only be stored on a very limited basis and generally must be produced when it is to be used. As a result, the wholesale power markets are subject to significant and unpredictable price fluctuations over relatively short periods of time. Due to the volume of sales into PJM from the Homer City plant, Homer City has concentrated exposure to market conditions and fluctuations in PJM. Prices for power and capacity have declined significantly due largely to lower natural gas prices and have been affected in recent years by increased use of demand response technology, changes in final demand for power during the economic slowdown, and technological developments that have increased access to natural gas shale reserves, resulting in substantial declines in market prices for natural gas which supplies power plants that compete with the Homer City plant.
Market prices of energy, capacity and ancillary services sold from the Homer City plant are influenced by multiple factors beyond Homer City's control, and thus there is considerable uncertainty whether or when current depressed prices will recover. Homer City's hedging activities may not cover the entire exposure of its assets or positions to market price volatility, and the level of hedging, which is currently low, will vary over time. The effectiveness of Homer City's hedging activities may depend on the amount of credit available for EMMT to post collateral, either in support of performance guarantees or as cash margin, and liquidity requirements may be greater than Homer City anticipates or will be able to meet. Homer City cannot provide assurance that its hedging strategies will successfully mitigate market risks. For more detail with respect to these matters, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Market Risk Exposures—Commodity Price Risk."

13


Homer City's financial results can be affected by changes in fuel prices, fuel transportation cost and interruptions in fuel supply.
In addition to volatile power prices, Homer City's business is subject to changes in fuel costs and fuel transportation costs. Fuel costs are volatile and can be influenced by many factors outside Homer City's control. The price at which Homer City can sell its energy may not rise or fall at the same rate as a corresponding rise or fall in fuel costs. Operations at the Homer City plant are dependent upon the availability and affordability of coal which is available only from a limited number of suppliers. All of these factors may have an adverse effect on Homer City's financial condition and results of operations. For additional information, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Market Risk Exposures—Coal Price Risk."
Competition could adversely affect Homer City's business.
Homer City has numerous competitors in all aspects of its business, some of whom may have greater liquidity, greater access to credit and other financial resources, lower cost structures, greater ability to withstand losses, larger staffs or more experience than Homer City. Multiple participants in the wholesale markets, including many regulated utilities, have a lower cost of capital than most merchant generators and often are able to recover fixed costs through rate base mechanisms, allowing them to build, buy and upgrade generation assets without relying exclusively on market clearing prices to recover their investments. These factors could affect Homer City's ability to compete effectively in the markets in which those entities operate. Newer plants owned by Homer City's competitors are often more efficient than the Homer City plant and may also have lower costs of operation. Over time, the Homer City plant may become obsolete in its markets, or be unable to compete with such plants.

Operating Risks
The Homer City plant may be affected by general operating risks and hazards customary in the power generation industry. Homer City may not have adequate insurance to cover all these hazards.
The operation of power generation facilities is a potentially dangerous activity that involves many operating risks, including transmission disruptions and constraints, equipment failures or shortages, and system limitations, degradation and interruption. Homer City's operations are also subject to risks of human performance and workforce capabilities. There can be no assurance that Homer City's insurance will be sufficient or effective under all circumstances or protect against all hazards to which Homer City may be subject or that the insurance proceeds received for any loss of the facilities or any damage to the facilities would be sufficient to permit Homer City to make any payments of rent under the facility leases. Homer City has older facilities that are subject to higher risks of failure or outage.
Due to the current market environment, the minimum insurance coverage specified under the Homer City sale-leaseback documents is not commercially available at reasonable prices. Homer City has obtained a waiver under the participation agreements that permits it to maintain its current insurance coverage through June 1, 2012. Failure to maintain insurance
pursuant to the sale-leaseback documents, absent a waiver, could result in an event of default under the documents, which could have a material adverse effect on Homer City.

ITEM 1B.  UNRESOLVED STAFF COMMENTS
Inapplicable.

ITEM 2.  PROPERTIES
Properties of Homer City are described above under "Item 1. Business—Overview of Facilities Under Lease," and "—Water Supply and Other Support Facilities."

ITEM 3.  LEGAL PROCEEDINGS
For a discussion of the material legal proceedings specifically affecting Homer City, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 8. Commitments and Contingencies."


14


PART II

ITEM 5.
MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
All the partners' equity of Homer City is, as of the date hereof, owned by Mission Energy Westside Inc. and Chestnut Ridge Energy Company. There is no market for Homer City's partnership interests.
Dividends will be paid when declared by Homer City's general partner. No cash dividends were paid by Homer City during 2011, 2010 or 2009.


15


ITEM 6. SELECTED FINANCIAL DATA
The selected financial data was derived from Homer City's audited financial statements and is qualified in its entirety by the more detailed information and financial statements, including notes to these financial statements, included in this annual report.

INCOME STATEMENT DATA
 
 
 
 
 
 
 
 
 
(in millions)
 
 
 
 
 
 
 
 
 
 
Years Ended December 31,
 
2011
 
2010
 
2009
 
2008
 
2007
Operating revenues from marketing affiliate
$
527

 
$
636

 
$
663

 
$
717

 
$
764

Operating expenses1
973

 
471

 
424

 
464

 
491

Operating income (loss)
(446
)
 
165

 
239

 
253

 
273

Interest and other income

 

 

 
5

 
8

Interest expense
(122
)
 
(127
)
 
(128
)
 
(124
)
 
(139
)
Income (loss) before income taxes
(568
)
 
38

 
111

 
134

 
142

Provision for income taxes2
118

 
11

 
44

 
49

 
54

Net income (loss)
$
(686
)
 
$
27

 
$
67

 
$
85

 
$
88

1 
Operating expenses in 2011 included asset impairment charges of $478 million. For additional information, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 12. Asset Impairments and Other Charges."
2 
Provision for income taxes in 2011 included the impact of a $344 million valuation allowance on its deferred tax asset position. For additional information, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 6. Income Taxes."

BALANCE SHEET DATA
 
 
 
 
 
 
 
 
 
(in millions)
 
 
 
 
 
 
 
 
 
 
As of December 31,
 
2011
 
2010
 
2009
 
2008
 
2007
Current assets
$
213

 
$
290

 
$
342

 
$
267

 
$
254

Total assets
1,346

 
2,079

 
2,160

 
2,186

 
2,135

Current liabilities
225

 
189

 
217

 
309

 
309

Long-term debt to affiliate
490

 
479

 
459

 
358

 
394

Lease financing, net of current portion
922

 
1,006

 
1,084

 
1,150

 
1,207

Other long-term obligations
63

 
59

 
43

 
44

 
70

Partners' equity (deficit)
(354
)
 
346

 
357

 
325

 
155


CASH FLOW DATA
 
 
 
 
 
 
 
 
 
(in millions)
 
 
Years Ended December 31,
 
2011
 
2010
 
2009
 
2008
 
2007
Cash provided by operating activities
$
34

 
$
106

 
$
151

 
$
50

 
$
152

Cash used in financing activities
(68
)
 
(78
)
 
(74
)
 
(89
)
 
(122
)
Cash used in investing activities
(14
)
 
(17
)
 
(15
)
 
(44
)
 
(2
)



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ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

MANAGEMENT'S OVERVIEW
Homer City is a Pennsylvania limited partnership engaged in the business of operating and selling energy and capacity from its three coal-fired electric generating units and related facilities located near Pittsburgh, Pennsylvania with an aggregate capacity of 1,884 MW. Homer City's operating results were significantly lower in 2011 compared to 2010 as a result of lower generation and lower realized energy and capacity prices. Homer City is engaged in discussions with the owner-lessors regarding funding of retrofit expenditures for the Homer City plant that, if successful in providing funding, will likely result in Homer City's loss of substantially all beneficial economic interest in and material control of the Homer City plant. In addition, as discussed below, Homer City recorded significant impairment charges during the fourth quarter of 2011.

Highlights of Operating Results
Homer City had a net loss of $686 million in 2011 compared to net income of $27 million in 2010. The 2011 results included a $295 million after-tax ($478 million pre-tax) charge resulting from the impairment of the property, plant and equipment related to the Homer City plant and the impact of a $344 million valuation allowance on its deferred tax asset position due to the uncertainty of Homer City's ability to realize such tax benefits. The 2011 decrease in earnings, excluding the impairment charge and the deferred tax valuation allowance,was due to lower generation, lower average realized energy and capacity prices, and higher average fuel costs per MWh.
For further discussion of Homer City's impairment charge, see "Critical Accounting Estimates and Policies—Impairment of Long-Lived Assets" and "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 12. Asset Impairments and Other Charges." For further discussion of the deferred tax valuation allowance, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 6. Income Taxes."
Homer City's net income decreased $40 million in 2010 compared to 2009. The 2010 decrease in earnings was primarily due to unrealized losses in 2010 compared to unrealized gains in 2009, higher coal costs, lower generation and higher plant maintenance costs in 2010, partially offset by higher capacity revenues. Energy related unrealized losses in 2010 were $20 million compared to unrealized gains of $15 million in 2009. Results in 2010 included the benefit of power hedge contracts entered into during earlier periods at higher prices than current energy prices.

Substantial Doubt that Homer City will Continue as a Going Concern
Homer City's accompanying financial statements have been prepared assuming that it will continue as a going concern, which contemplates realization of assets and the satisfaction of liabilities in the normal course of business for the 12-month period following the date of these financial statements. The reduction in energy prices experienced in the fourth quarter of 2011 and into 2012 has adversely impacted cash flow, and Homer City is not expected to be able to generate sufficient cash flow from operations necessary to meet its obligations, including the obligations under the Homer City lease. As described further below under Homer City Lease, it is unlikely that Homer City will continue as a going concern throughout 2012.

Homer City Lease
Homer City and its indirect parent, EME, engaged a financial advisor and conducted a bidding process to obtain capital funding from third parties during the second half of 2011 to partially finance the installation of the environmental improvements at the Homer City plant. During the fourth quarter of 2011, such efforts failed to obtain sufficient interest from market participants necessary to fund the capital needed to make such improvements under the current lease arrangement. Homer City does not currently have sufficient capital and does not expect to generate sufficient funds from operations to complete retrofits. Restrictions under the agreements entered into as part of Homer City's 2001 sale-leaseback transaction affect, and in some cases significantly limit or prohibit, Homer City's ability to incur indebtedness or make capital expenditures. Consequently, Homer City's ability to install environmental compliance equipment will be dependent on funding from the owner-lessors or third parties. Homer City is currently engaged in discussions with the owner-lessors regarding the potential for such funding. Homer City expects that the outcome of any such discussions, if successful in providing funding for the Homer City plant, will likely result in Homer City's loss of substantially all beneficial economic interest in and material control of the Homer City plant. Failure to resolve the source of funding of necessary capital expenditures for the Homer City plant could result in Homer City's default under the lease agreements giving rise to remedies for the owner-lessors and secured lease obligation bondholders, which could include foreclosing on the leased assets, the general partner of Homer City, or both.
Homer City is currently engaged in discussions with the owner-lessors through General Electric Capital Corporation (GECC), one of the owner participants, regarding the funding of capital improvements at the Homer City plant. Under the existing

17


Homer City sale-leaseback documents, Homer City would be obligated to reimburse GECC for any amount GECC ultimately agrees to fund for these capital improvements. If these discussions are successful, it is expected that an affiliate of GECC will obtain the economic benefit and majority ownership of all the operating assets of Homer City. The transfer of ownership would be effected on a consensual basis. In addition, GECC is currently engaged in discussions with certain of the holders of the secured lease obligation bonds regarding amendments to the terms of the 8.137% Senior Secured Bonds due 2019 and the 8.734% Senior Secured Bonds due 2026, each issued by Homer City Funding LLC.
There is no assurance that an agreement will be reached with the owner-lessors or the existing secured lease obligation bondholders on funding the capital improvements. Homer City is not expected to meet the covenant requirements of its sale-leaseback documents relating to the payment of equity rent at April 1, 2012 and Homer City will be unable to make the required equity rent payment. There is no assurance that subsequent rent payments will be made.Under the sale-leaseback documents, rent payments are comprised of two components, senior rent and equity rent. Senior rent is used exclusively for debt service to secured lease obligation bondholders, while equity rent is paid to the owner-lessors. In order to pay equity rent, among other requirements, Homer City must meet historical and projected senior rent service coverage ratios of 1.7 to 1 (subject to reduction to 1.3 to 1 under certain circumstances). A failure to pay equity rent does not entitle the owner-lessors to foreclose upon Homer City's leasehold interest, but it does result in the suspension of Homer City's ability to make permitted distributions. Moreover, Homer City would be permanently restricted in its ability to make permitted distributions if a failure to pay equity rent when due was not cured within nine months, or even if cured, occurred more than one additional time during the term of the lease. Homer City is not subject to any minimum historical and projected senior rent service coverage ratios except as conditions to distributions and equity rent payments. Also, failure by Homer City to pay equity rent when due in April 2012 could trigger termination of the $48 million senior rent reserve letter of credit. Homer City would then be required to fund the senior rent reserve, and failure to do so could entitle counterparties to seek available remedies under the sale-leaseback documents, including termination or foreclosure upon the leasehold interest. As a result of the expectation that Homer City is likely to lose substantially all beneficial economic interest in and material control of the Homer City plant, Homer City recorded an impairment charge of $478 million for the fourth quarter of 2011. For further discussion, see "Critical Accounting Estimates and Policies—Impairment of Long-Lived Assets" and "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 12. Asset Impairments and Other Charges."
As a result of the financial outlook of Homer City, EMMT has ceased to enter into hedging activities related to future power sales, but continues to enter into spot market energy transactions on behalf of Homer City pursuant to an intercompany agreement. Those transactions are generally back-to-back transactions in which EMMT enters into a transaction with a third party as a principal and then enters into an equivalent transaction with Homer City. In the case of capacity, EMMT has sold Homer City capacity in the annual PJM base residual auctions through May 2015. If Homer City were to default on its obligations to supply capacity, then Homer City would be liable to EMMT, and potentially also to PJM, to supply that capacity, and for refunds of capacity payments received and penalties (equal to the greater of 20% of the capacity payments or $20 per MW-day) under the PJM tariffs if it failed to do so.

Environmental Regulation Developments
For discussion of environmental regulation developments, see “Item 1. Business—Environmental Matters and Regulations" and "Item 8 EME Homer City Generation L.P. Notes to Financial Statements—Note 9. Environmental Developments."


18


RESULTS OF OPERATIONS

Summary
The table below summarizes total revenues as well as key performance measures related to the Homer City plant.
 
Years Ended December 31,
 
2011
 
2010
 
2009
Operating Revenues1 (in millions)
$
527

 
$
636

 
$
663

Statistics
 
 
 
 
 
Generation (in GWh)
9,428

 
11,028

 
11,446

Equivalent availability
75.8
%
 
79.7
%
 
84.7
%
Capacity factor
57.1
%
 
66.8
%
 
69.2
%
Load factor
75.4
%
 
83.8
%
 
81.7
%
Forced outage rate
13.8
%
 
10.8
%
 
9.4
%
Average realized energy price/MWh
$
46.38

 
$
49.04

 
$
48.85

Capacity revenues only (in millions)
$
84

 
$
114

 
$
89

Average fuel costs/MWh
$
28.58

 
$
25.26

 
$
21.89

1 
Effective April 1, 2011, EMMT allocated to Homer City the benefit of an arrangement that allows EMMT to deliver a portion of Homer City's power into the NYISO. To the extent this arrangement is not utilized, Homer City's power is delivered into PJM.

Reconciliation of Non-GAAP Disclosures and Statistical Definitions

Average Realized Energy Price
The average realized energy price reflects the average price at which energy is sold into the market including the effects of hedges, real-time and day-ahead sales and PJM fees and ancillary services. It is determined by dividing (i) operating revenues less unrealized gains (losses) and other non-energy related revenues by (ii) generation as shown in the table below. Revenues related to capacity sales are excluded from the calculation of average realized energy price.
 
Years Ended December 31,
(in millions)
2011
 
2010
 
2009
Operating revenues
$
527

 
$
636

 
$
663

Less:
 
 
 
 
 
Unrealized (gains) losses
(5
)
 
20

 
(15
)
Capacity and other revenues
(85
)
 
(115
)
 
(89
)
Realized revenues
$
437

 
$
541

 
$
559

Generation (in GWh)
9,428

 
11,028

 
11,446

Average realized energy price/MWh
$
46.38

 
$
49.04

 
$
48.85


The average realized energy price is presented as an aid in understanding the operating results of the Homer City plant. Average realized energy price is a non-GAAP performance measure since such statistical measure excludes unrealized gains or losses recorded as operating revenues. Management believes that the average realized energy price is meaningful for investors as this information reflects the impact of hedge contracts at the time of actual generation in period-over-period comparisons or as compared to real-time market prices.

Statistical Definitions
Equivalent availability reflects the impact of the unit's inability to achieve full load, referred to as derating, as well as outages which result in a complete unit shutdown. The coal plants are not available during periods of planned and unplanned maintenance. The equivalent availability factor is defined as the number of MWh the coal plants are available to

19


generate electricity divided by the product of the capacity of the coal plants (in MW) and the number of hours in the period.
The capacity factor indicates how much power a unit generated compared to the maximum amount of power that could be generated according to its rating. It is defined as the actual number of MWh generated by the coal plants divided by the product of the capacity of the coal plants (in MW) and the number of hours in the period.
The load factor indicates how much power a unit generated compared to the maximum amount of power that a unit was available to generate electricity. It is determined by dividing capacity factor by the equivalent availability factor.
The forced outage rate refers to forced outages and deratings excluding events outside of management's control as defined by NERC. Examples include floods, tornado damage and transmission outages.

Operating Income (Loss)
Operating loss from the Homer City plant was $446 million in 2011 compared to operating income of $165 million in 2010. Operating income decreased $74 million in 2010 compared to 2009. The 2011 decrease in operating income, excluding the $478 million impairment charge previously discussed in "Management's Overview—Highlights of Operating Results," was primarily attributable to lower energy revenues, driven by lower generation and average realized energy prices, lower capacity revenues, and higher plant maintenance costs from outages at Units 1 and 2, partially offset by unrealized gains in 2011 compared to unrealized losses in 2010 related to hedge contracts and lower fuel costs. The decline in fuel costs was primarily due to lower generation, mostly offset by higher coal costs. Coal costs increased due to higher coal prices. The Homer City plant continued to have a high forced outage rate during 2011 partially as a result of the steam pipe rupture on Unit 1 and the related precautionary maintenance on Unit 2.
The 2010 decrease in operating income from 2009 was primarily attributable to unrealized losses in 2010 compared to unrealized gains in 2009 related to hedge contracts, higher coal costs, lower generation, and higher plant operations costs related to scheduled plant outages, partially offset by an increase in capacity revenues. The Homer City plant experienced increased forced outages in 2010 compared to 2009 due to deratings to comply with opacity restrictions and unscheduled outages. Plant maintenance and overhaul related expenses were higher in 2010 due to the deferral of plant outages in 2009. Coal costs increased due to higher coal prices and changes in the mix of ready-to-burn coal and raw coal consumed.
Included in operating revenues were unrealized gains (losses) from hedging activities of $5 million, $(20) million and $15 million for 2011, 2010 and 2009, respectively. Unrealized gains (losses) were primarily attributable to the ineffective portion of hedge contracts at the Homer City plant attributable to changes in the difference between energy prices at the PJM West Hub (the settlement point under forward contracts) and the energy prices at the Homer City busbar (the delivery point where power generated by the Homer City plant is delivered into the transmission system). Included in fuel costs were $9 million, $7 million and $16 million in 2011, 2010 and 2009, respectively, related to the net cost of emission allowances.
For additional discussion, see "Management's Overview—Homer City Lease."

Other Income (Expense)
Interest expense was $122 million, $127 million and $128 million during 2011, 2010 and 2009, respectively. Interest expense primarily relates to the lease financing of the Homer City plant. Interest expense also included $40 million, $38 million and $36 million during 2011, 2010 and 2009, respectively, related to Homer City's subordinated revolving loan agreement with Edison Mission Finance Co. Homer City had higher long-term debt balances during 2011 as compared to 2010 and 2009 on the subordinated revolving loan agreement.

Income Taxes
Homer City's effective tax rates were 29% and 40% in 2010 and 2009, respectively. The effective tax rate for 2011 was not meaningful due to Homer City providing a full valuation allowance against its net deferred tax assets at December 31, 2011. Homer City's effective income tax rate in 2010 and 2009 varied from the federal statutory rate of 35% primarily due to state income taxes and estimated benefits from a federal deduction related to qualified domestic production activities under Section 199 of the Internal Revenue Code. For further discussion, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 6. Income Taxes."
On March 15, 2012, Homer City made an election to be treated as a partnership for federal and state income tax purposes. As a result, the income or loss of Homer City will be allocated to the individual partners. Accordingly, on a prospective basis, no recognition will be given to income taxes in Homer City's financial statements and deferred taxes and the related valuation allowance will be eliminated in the first quarter of 2012.


20


Related Party Transactions
For a discussion of related party transactions, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 1. Summary of Significant Accounting Policies—Income Taxes and Tax-Allocation Agreements" and "—Note 13. Related Party Transactions."

New Accounting Guidance
For a discussion of new accounting guidance affecting Homer City, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 1. Summary of Significant Accounting Policies—New Accounting Guidance."


21


LIQUIDITY AND CAPITAL RESOURCES

Liquidity
The use of Homer City's cash generated from operations is restricted by the sale-leaseback agreements. Under the participation agreements entered into as part of the sale-leaseback transaction, Homer City's ability to enter into specified transactions and to engage in specified business activities, including financing and investment activities, is subject to significant restrictions. These restrictions could affect, and in some cases significantly limit or prohibit, its ability to, among other things, merge, consolidate or sell its assets, create liens on its properties or assets, enter into non-permitted trading activities, enter into transactions with its affiliates, incur indebtedness, create, incur, assume or suffer to exist guarantees or contingent obligations, make restricted payments to its partners, make capital expenditures, own subsidiaries, liquidate or dissolve, engage in non-permitted business activities, sublease its leasehold interests in the facilities or make improvements to the facilities. Accordingly, Homer City's liquidity is substantially based on its ability to generate cash flow from operations. The reduction in energy prices experienced in the fourth quarter of 2011 and into 2012 has adversely impacted cash flow, and Homer City is not expected to be able to generate sufficient cash flow from operations necessary to meet its obligations, including the obligations under the Homer City lease. It is unlikely that Homer City will continue as a going concern throughout 2012. For further discussion, see "—Management's Overview—Homer City Lease" and "Item 1A. Risk Factors—Liquidity Risks."

Capital Investment Plan
Forecasted capital expenditures through 2014 by Homer City are as follows:
(in millions)
2012
 
2013
 
2014
Environmental
$

 
$

 
$

Plant capital
39

 
23

 
14

Total
$
39

 
$
23

 
$
14

The capital investment plan set forth above does not include environmental capital expenditures to retrofit the Homer City plant because Homer City does not have the funds for retrofits and has not yet been able to raise capital needed for such retrofits. The funding of Homer City's environmental expenditures will be dependent on external funding. The cost of the SO2 and particulate emissions control equipment for Units 1 and 2 of the Homer City plant is expected to be approximately $700 million to $750 million. See "Management's Overview—Homer City Lease" for additional discussion.
Plant capital expenditures relate to non-environmental projects such as boiler and turbine controls, major boiler components, coal-cleaning plant refuse disposal and ash disposal. To the extent available, Homer City plans to fund these expenditures with cash on hand or cash generated from operations.
Homer City's use of cash in its bank accounts is limited to specific operating and capital expenditures as set forth in the security deposit agreement executed as part of the sale-leaseback transaction. The amount in certain reserve accounts will be available for payments due on the equity portion of lease rent during specified periods, and in accordance with the sale-leaseback documents, unless there is a default in the payment of the senior portion of lease rent, in which case the amount will be available to pay such senior portion of the lease rent. The release of funds from these restricted cash accounts is permitted, provided Homer City maintains specified reserve balances in accordance with the sale-leaseback documents, no event of default shall have occurred or be continuing and no two failed rent payments shall have occurred. Homer City had $20 million included in restricted deposits at December 31, 2011 related to these reserve accounts.

Cash Flow
At December 31, 2011, Homer City had cash and cash equivalents of $84 million compared to $132 million at December 31, 2010. Net cash provided by operating activities totaled $34 million, $106 million and $151 million in 2011, 2010 and 2009, respectively. The 2011 decrease in net cash provided by operating activities was primarily attributable to lower generation from outages at Units 1 and 2, lower energy and capacity prices, and the timing of cash receipts and disbursements related to working capital items, partially offset by an increase in interest payable to affiliate under the subordinated revolving loan agreement. The 2010 decrease was primarily due to lower net income in 2010, partially offset by changes in derivative assets and liabilities.
Net cash used in financing activities totaled $68 million, $78 million and $74 million in 2011, 2010 and 2009, respectively. In 2011, Homer City borrowed $24 million, net more from its affiliate subordinated revolving loan, and lease financing payments were $14 million higher, as compared to 2010. In 2010, Homer City paid $4 million, net less on its affiliate subordinated revolving loan, and lease financing payments were $8 million higher, as compared to 2009.

22


Net cash used in investing activities primarily related to capital expenditures of $14 million, $18 million and $26 million in 2011, 2010 and 2009, respectively. In 2009, Homer City also had a $10 million receipt from restricted cash related to permitted withdrawals from restricted deposits pursuant to the sale-leaseback agreements.

Credit Ratings
Homer City is not currently rated. Credit ratings for EME and EMMT are as follows:
 
Moody's Rating
 
S&P Rating
 
Fitch Rating
EME1
Caa1
 
CCC+
 
CCC
EMMT
Not Rated
 
CCC+
 
Not Rated
1 
Senior unsecured rating.
All the above ratings are on negative outlook. Homer City cannot provide assurance that the current credit ratings above will remain in effect for any given period of time or that one or more of these ratings will not be lowered. Homer City notes that these credit ratings are not recommendations to buy, sell or hold securities and may be revised at any time by a rating agency.

Payments Made Under Subordinated Revolving Loan and Tax Payments
The following table summarizes the payments by Homer City under its subordinated revolving loan with Edison Mission Finance Co., a subsidiary of EME, that constitute permitted distributions pursuant to the terms of the sale-leaseback transaction and any payments made pursuant to tax-allocation agreements:
 
Years Ended December 31,
(in millions)
2011
 
2010
 
2009
Payment of interest
$

 
$
38

 
$
33

Payment of principal

 
36

 
42

Subordinated revolving loan payments

 
74

 
75

Tax payments under tax-allocation agreements

 

 

Total payments
$

 
$
74

 
$
75

For additional information on the tax-allocation agreements, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 1. Summary of Significant Accounting Policies—Income Taxes and Tax-Allocation Agreements."

Key Ratio Affecting Distributions
Set forth below is the key ratio required under the lease covenants contained in Homer City's sale-leaseback agreements for the 12 months ended December 31, 2011:
Financial Ratio
Covenant
Actual
Senior rent service coverage ratio
Greater than 1.7 to 1
1.18 to 1
As indicated above, the actual senior rent service coverage ratio of Homer City was below the covenant threshold for the 12 months ended December 31, 2011, and Homer City also did not meet the threshold for the prospective two 12-month periods, which currently precludes Homer City from making distributions, including repayment of certain intercompany loans and from paying the equity portion of the rent payment. For additional information, see "Management's Overview—Homer City Lease."

Sale-Leaseback Restrictions on Distributions
In order to make a distribution, Homer City must be in compliance with the covenants specified in the lease agreements, including the following financial performance requirements measured on the date of distribution. At the end of each quarter, the equity and debt portions of rent then due and payable must have been paid and the senior rent service coverage ratio for the prior 12-month period (taken as a whole and projected for each of the prospective two 12-month periods) must be greater than 1.7 to 1 in order to make the equity portion of the rent payment and other restricted payments. Homer City would be

23


permanently restricted in its ability to make distributions if a failure to pay equity rent when due was not cured within nine months, or even if cured, occurred more than one additional time during the term of the lease. EME has not guaranteed Homer City's obligations under the leases. Homer City is not expected to meet the covenant requirements of its sale-leaseback agreements relating to the payment of equity rent at April 1, 2012, and Homer City will be unable to make the required equity rent payment. There is no assurance that subsequent rent payments will be made. For additional information, see "Management's Overview—Homer City Lease."

Contractual Obligations, Commercial Commitments and Contingencies
Homer City has contractual obligations and other commercial commitments that represent prospective cash requirements. The following table summarizes Homer City's significant contractual obligations as of December 31, 2011:
 
 
 
Payments Due by Period
(in millions)
Total
 
Less than
1 year
 
1 to 3
years
 
3 to 5
years
 
More than
5 years
Long-term debt to affiliate1
$
626

 
$

 
$
626

 
$

 
$

Lease financing2
1,814

 
160

 
287

 
196

 
1,171

Operating lease obligations3
2

 
1

 
1

 

 

Purchase obligations3
 
 
 
 
 
 
 
 
 
Fuel supply contracts
267

 
214

 
53

 

 

Capital expenditures
7

 
7

 

 

 

Coal cleaning agreement
6

 
6

 

 

 

Other contractual obligations
11

 
3

 
8

 

 

Employee benefit plan contribution4
20

 
4

 
8

 
8

 

Total Contractual Obligations5
$
2,753

 
$
395

 
$
983

 
$
204

 
$
1,171

1 
For additional details, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 4. Long-term Debt." Table assumes long-term debt is held to maturity. Amount also includes interest payments totaling $136 million over life of debt.
2 
Amount represents lease payments related to the sale-leaseback of the Homer City plant and includes interest payments over the life of the lease. For further discussion, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 8. Commitments and Contingencies."
3 
For additional details, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 8. Commitments and Contingencies."
4 
Amount includes estimated contribution for pension plans and postretirement benefits other than pensions. The estimated contributions beyond 2016 are not available. For more information, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 7. Compensation and Benefit Plans—Pension Plans and Postretirement Benefits Other than Pensions."
5 
The contractual obligations table does not include derivative obligations and AROs, which are discussed in "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 5. Derivative Instruments and Hedging Activities," and "—Note 2. Property, Plant and Equipment," respectively.

Contingencies
Homer City has contingencies related to the NSR and other litigation, ash disposal site and insurance, which are discussed in "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 8. Commitments and Contingencies."

Off-Balance Sheet Transactions
Homer City has no material off-balance sheet transactions.


24


MARKET RISK EXPOSURES

Introduction
Homer City's primary market risk exposures are associated with the sale of electricity and capacity from, and the procurement of fuel for, its electric generating facilities. These market risks arise from price fluctuations of electricity, capacity, fuel, emission allowances, and transmission rights. Homer City manages these risks in part by using derivative instruments in accordance with established policies and procedures.

Derivative Instruments
Homer City uses derivative instruments to reduce its exposure to market risks that arise from price fluctuations of electricity, capacity, fuel, emission allowances, and transmission rights. For derivative instruments recorded at fair value, changes in fair value are recognized in earnings at the end of each accounting period unless the instrument qualifies for hedge accounting. For derivatives that qualify for cash flow hedge accounting, changes in their fair value are recognized in other comprehensive income until the hedged item settles and is recognized in earnings. However, the ineffective portion of a derivative that qualifies for cash flow hedge accounting is recognized currently in earnings.

Unrealized Gains and Losses
Homer City classifies unrealized gains and losses from derivative instruments (other than the effective portion of derivatives that qualify for hedge accounting) as part of operating revenues. The following table summarizes unrealized gains (losses):
 
Years Ended December 31,
(in millions)
2011
 
2010
 
2009
Non-qualifying hedges
$
(1
)
 
$
(1
)
 
$
1

Ineffective portion of cash flow hedges
6

 
(19
)
 
14

Total unrealized gains (losses)
$
5

 
$
(20
)
 
$
15

At December 31, 2011, cumulative unrealized gains were immaterial.

Fair Value Disclosures
In determining the fair value of Homer City's derivative positions, Homer City uses third-party market pricing where available. For further explanation of the fair value hierarchy and a discussion of Homer City's derivative instruments, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 3. Fair Value Measurements" and "—Note 5. Derivative Instruments and Hedging Activities," respectively.
The net fair value of Homer City's commodity derivative instruments at December 31, 2011 was a $2 million liability. A 10% change in the market price of the underlying commodity at December 31, 2011 would not be material.

Commodity Price Risk

Introduction
Homer City's operations are exposed to commodity price risk, which reflects the potential impact of a change in the market value of a particular commodity. Commodity price risks are actively monitored, with oversight provided by a risk management committee, to ensure compliance with Homer City's risk management policies, through EMMT. Despite this, there can be no assurance that all risks have been accurately identified, measured and/or mitigated.

Energy Price Risk
Energy and capacity from the Homer City plant are sold under terms, including price, duration and quantity, arranged by EMMT with customers through a combination of bilateral agreements (resulting from negotiations or from auctions), forward energy sales and spot market sales. Power is sold into PJM at spot prices based upon locational marginal pricing.

25


The following table depicts the average historical market prices for energy per megawatt-hour at the locations indicated during the past three years:
 
24-Hour Average Historical Market Prices1
 
2011
 
2010
 
2009
PJM West Hub
$
43.57

 
$
46.56

 
$
38.75

Homer City Busbar
39.58

 
39.18

 
34.27

1 
Energy prices were calculated at the Homer City busbar (delivery point) and the PJM West Hub using historical hourly day-ahead prices as published by PJM or provided on the PJM web-site.
The following table sets forth the forward market prices for energy per megawatt-hour as quoted for sales into the PJM West Hub at December 31, 2011:
 
24-Hour Forward Energy Prices1
2012 calendar "strip"2
$
38.85

2013 calendar "strip"2
$
41.26

1 
Energy prices were determined by obtaining broker quotes and information from other public sources relating to the PJM West Hub delivery point.
2 
Market price for energy purchases for the entire calendar year.
Forward market prices at the PJM West Hub fluctuate as a result of a number of factors, including natural gas prices, transmission congestion, changes in market rules, electricity demand (which in turn is affected by weather, economic growth, and other factors), plant outages in the region, and the amount of existing and planned power plant capacity. The actual spot prices for electricity delivered by the Homer City plant into these markets may vary materially from the forward market prices set forth in the preceding table.
EMMT engages in hedging activities for the Homer City plant to hedge the risk of future change in the price of electricity. The following table summarizes Homer City's hedge positions for transactions primarily entered into at the PJM West Hub and to a lesser extent at other trading locations (including forward contracts accounted for on the accrual basis) at December 31, 2011 for electricity expected to be generated in 2012:
 
2012
MWh (in thousands)
90

Average price/MWh1
$
49.54

1 
The above hedge positions include forward contracts for the sale of power and futures contracts during different periods of the year and the day. Market prices tend to be higher during on-peak periods and during summer months, although there is significant variability of power prices during different periods of time. Accordingly, the above hedge positions are not directly comparable to the 24-hour PJM West Hub prices set forth above.


26


Capacity Price Risk
Under the RPM, capacity commitments are made in advance to provide a long-term pricing signal for construction of capacity resources. The following table summarizes the status of capacity sales for Homer City at December 31, 2011:
 
 
 
 
 
 
 
RPM Capacity Sold in Base Residual Auction
 
Other Capacity Sales, Net of Purchases2
 
Aggregate Average Price per MW-day
 
 
Installed Capacity
MW
 
Unsold Capacity1
MW
 
Capacity Sold
MW
 
MW
 
Price per
MW-day
 
MW
 
Average Price per MW-day
 
 
January 1, 2012 to May 31, 2012
1,884

 
(163
)
 
1,721

 
1,771

 
$
110.00

 
(50
)
 
$
30.00

 
$
112.32

 
June 1, 2012 to May 31, 2013
1,884

 
(232
)
 
1,652

 
1,736

 
133.37

 
(84
)
 
16.46

 
139.31

 
June 1, 2013 to May 31, 2014
1,884

 
(104
)
 
1,780

 
1,780

 
226.15

 

 

 
221.03

3 
June 1, 2014 to May 31, 2015
1,884

 
(190
)
 
1,694

 
1,694

 
136.50

 

 

 
136.50

 
1 
Capacity not sold arises from: (i) capacity retained to meet forced outages under the RPM auction guidelines, and (ii) capacity that PJM does not purchase at the clearing price resulting from the RPM auction.
2 
Other capacity sales and purchases, net includes contracts executed in advance of the RPM base residual auction to hedge the price risk related to such auction, participation in RPM incremental auctions and other capacity transactions entered into to manage capacity risks.
3 
Includes the impact of a 100 MW capacity swap transaction executed prior to the base residual auction at $135 per MW-day.
Revenues from the sale of capacity from Homer City beyond the periods set forth above will depend upon the amount of capacity available and future market prices either in PJM or nearby markets if Homer City has an opportunity to capture a higher value associated with those markets.
For additional information regarding capacity sold by Homer City, see "Management's Overview—Homer City Lease."

Basis Risk
Sales made from the Homer City plant in the real-time or day-ahead market receive the actual real-time or day-ahead prices, as the case may be, at the Homer City busbar. In order to mitigate price risk from changes in forward spot prices at the Homer City busbar, Homer City may enter into cash settled futures contracts as well as forward contracts with counterparties for energy to be delivered in future periods. Currently, a liquid market for entering into these contracts at the Homer City busbar does not exist. A liquid market does exist at the PJM West Hub. Homer City's hedging activities use this settlement point to enter into hedging contracts. To the extent that, on the settlement date of a hedge contract, spot prices at the relevant busbar are lower than spot prices at the settlement point, the proceeds actually realized from the related hedge contract are effectively reduced by the difference. This is referred to as "basis risk." During 2011, day-ahead prices at the Homer City busbar were lower than those at the PJM West Hub by an average of 9%, compared to 16% during 2010 and 12% during 2009, due to transmission congestion in PJM.
In order to mitigate basis risk, Homer City may purchase financial transmission rights and basis swaps in PJM. A financial transmission right is a financial instrument that entitles the holder to receive the difference between actual day-ahead prices for two delivery points in exchange for a fixed amount.

Coal Price Risk
The Homer City plant purchases coal primarily from mines located near the facilities in Pennsylvania. Coal purchases are made under a variety of supply agreements. The following table summarizes the amount of coal under contract at December 31, 2011 for the following two years:
 
2012
 
2013
Amount of Coal Under Contract in Millions of Equivalent Tons1
3.3
 
0.8
1 
The amount of coal under contract in equivalent tons is calculated based on contracted tons and applying a 13,000 Btu equivalent.
Homer City is subject to price risk for purchases of coal that are not under contract. Market prices of NAPP coal, which are related to the price of coal purchased for the Homer City plant, increased during the past two years. The market price of NAPP coal based on 13,000 Btu per pound heat content and <3.0 pounds of SO2 per MMBtu sulfur content was $73.30 per ton at December 30, 2011, compared to a price of $70 per ton and $52.50 per ton at December 31, 2010 and 2009, respectively, as

27


reported by the EIA. In 2011, the price of NAPP coal ranged from $70 per ton to $78.20 per ton, as reported by the EIA. The 2011 increase in NAPP coal prices was primarily driven by the export market demand and global coal pricing.
Based on Homer City's anticipated coal requirements in excess of the amount under contract, Homer City expects that a 10% change in the price of coal at December 31, 2011 would increase or decrease 2012 pre-tax income by approximately $4 million.

Emission Allowances Price Risk
If CSAPR becomes effective as issued, the amount of SO2 that a plant emits in its operation will need to be matched by a sufficient amount of SO2 allowances designated under this program (CSAPR SO2 allowances) that are either allocated to the plant under the CSAPR program or purchased in the open market. SO2 allowances under the federal Acid Rain Program cannot be used to satisfy the requirements under CSAPR. For additional information on CSAPR, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 9. Environmental Developments—Cross-State Air Pollution Rule."

Credit Risk
For further information related to credit risk and how Homer City manages credit risk, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 5. Derivative Instruments and Hedging Activities."

Interest Rate Risk
Homer City has mitigated the risk of interest rate fluctuations by obtaining fixed rate financing on its subordinated revolving loan with Edison Mission Finance. Homer City does not believe that interest rate fluctuations will have a material adverse effect on its financial position or results of operations.


28


CRITICAL ACCOUNTING ESTIMATES AND POLICIES

Introduction
The accounting policies described below are considered critical to obtaining an understanding of Homer City's financial statements because their application requires the use of significant estimates and judgments by management in preparing Homer City's financial statements. Management estimates and judgments are inherently uncertain and may differ significantly from actual results achieved. Management considers an accounting estimate to be critical if the estimate requires significant assumptions and changes in the estimate or if different estimates that could have been selected had been used could have a material impact on Homer City's results of operations or financial position. For more information on Homer City's accounting policies, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 1. Summary of Significant Accounting Policies."

Impairment of Long-Lived Assets
Nature of Estimates Required.    Long-lived assets, including intangible assets, are evaluated for impairment in accordance with applicable authoritative guidance. Authoritative guidance requires that if the undiscounted expected future cash flow from a company's assets or group of assets (without interest charges) is less than its carrying value, asset impairment must be recognized on the financial statements. The impairment charges, if applicable, are calculated as the excess of the asset's carrying value over its fair value, which represents the discounted expected future cash flows attributable to the asset or, in the case of assets expected to be sold, at fair value less costs to sell. Long-lived assets are evaluated for impairment whenever indicators exist or when there is a commitment to sell or dispose of the asset. These evaluations may result from significant decreases in the market price of an asset, a significant adverse change in the extent or manner in which an asset is being used in its physical condition, a significant adverse change in legal factors or in the business climate that could affect the value of an asset, as well as economic or operational analyses.
Key Assumptions and Approach Used.    The assessment of impairment requires significant management judgment to determine: (1) if an indicator of impairment has occurred, (2) the forecast of undiscounted expected future cash flow over the asset's estimated useful life to determine if an impairment exists, and (3) if an impairment exists, the fair value of the asset or asset group. Factors that are considered important, which could trigger an impairment, include operating losses, projected future operating losses, the financial condition of counterparties, or significant negative industry or economic trends. The determination of fair value requires management to apply judgment in: (1) estimating future prices of energy and capacity in wholesale energy markets and fuel prices that are susceptible to significant change, (2) environmental and maintenance expenditures, and (3) the time period due to the length of the estimated remaining useful lives.
In preparing long-term cash forecasts, Homer City includes assumptions about future prices for electricity, capacity, fuel and related products and services, as applicable, future operations and maintenance costs and future capital expenditure requirements under different scenarios. As appropriate, Homer City uses a probability weighted approach when determining whether impairment indicators exist. Assumptions included in the long-term cash flow forecasts for merchant projects include:
Observable market prices for electricity, fuel and related products and services to the extent available and long-term prices developed based on a fundamental price model;
Long-term capacity prices based on the assumption that capacity markets would continue consistent with their current structure, with expected increases in revenues as a result of declines in reserve margins beyond the price of the latest auctions;
Trends for additions and retirements for generation resources; and
Plans for compliance with both existing and possible future environmental regulations.
Homer City includes allocated acquired emission allowances as part of its power plant asset group. Homer City's unit of account is at the plant level and, accordingly, the closure of one of Homer City's units would not result in an impairment of property, plant and equipment unless such condition were to affect an impairment assessment on the entire plant.
Effect if Different Assumptions Used.    The estimates and assumptions used to determine whether an impairment exists are subject to a high degree of uncertainty. The estimated fair value of an asset would change materially if different estimates and assumptions were used to determine the amounts or timing of future revenues, environmental compliance costs or operating expenditures.
Effect on 2011 Results.    As described in "Management's Overview," Homer City failed to obtain sufficient interest from market participants to fund the capital improvements during the process undertaken in the fourth quarter of 2011, and Homer

29


City is currently engaged in discussions with the owner-lessors regarding the potential for such funding. Homer City expects that the outcome of any such discussions, if successful in providing funding for the Homer City plant, will likely result in Homer City's loss of substantially all beneficial economic interest in and material control of the Homer City plant. Failure to resolve the source of funding of necessary capital expenditures for the Homer City plant could result in Homer City's default under the lease agreements giving rise to remedies for the owner-lessors and secured lease obligation bondholders, which could include foreclosing on the leased assets, the general partner of Homer City, or both. In connection with the preparation of its year-end financial statements, Homer City concluded that these events, combined with the current and projected financial condition of Homer City, were indicators of impairment. The long-lived asset group subject to the impairment evaluation was determined to include Homer City's property, plant and equipment. Homer City concluded that the future undiscounted cash flows were insufficient to recover the carrying amount of the asset group. To measure the amount of impairment loss, the income approach was considered the most relevant and resulted in a fair value of $1,085 million. Discounted cash flow analysis based on estimates of future energy, capacity and coal prices and operations and maintenance costs along with the estimated costs of constructing the environmental control equipment was the technique utilized to determine fair value. Accordingly, Homer City recorded an impairment charge of $478 million for the fourth quarter of 2011.

Derivatives
Homer City uses derivative instruments to manage exposure to changes in electricity, fuel oil and interest rates. Derivative instruments that do not meet the normal purchases and sales exception at fair value are recorded with changes in the derivative's fair value recognized currently in earnings unless specific hedge accounting criteria are met. For derivatives that qualify for cash flow hedge accounting treatment, the effective portion of the changes in the derivative's fair value is recognized in other comprehensive income until the hedged item is recognized in earnings.
Management's judgment is required to determine if a transaction meets the definition of a derivative and, if it does, whether the normal purchases and sales exception applies or whether individual transactions qualify for hedge accounting treatment. Management's judgment is also required to determine the fair value of derivative transactions.
Key Assumptions and Approach Used.    Homer City determines the fair value of derivative instruments based on forward market prices in active markets adjusted for nonperformance risk. If quoted market prices are not available, internally developed models are used to determine the fair value. When actual market prices, or relevant observable inputs are not available, it is appropriate to use unobservable inputs which reflect management assumptions, including extrapolating limited short-term observable data and developing correlations between liquid and non-liquid trading hubs. In assessing nonperformance risks, Homer City reviews credit ratings of counterparties (and related default rates based on such credit ratings) and prices of credit default swaps. The market price (or premium) for credit default swaps represents the price that a counterparty would pay to transfer the risk of default, typically bankruptcy, to another party. A credit default swap is not directly comparable to the credit risks of derivative contracts, but provides market information of the related risk of nonperformance.
In addition, a fair value hierarchy is established that prioritizes the inputs to valuation techniques used to measure fair value. For further information, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 3. Fair Value Measurements."
Effect if Different Assumptions Used.    As described above, fair value is determined using a combination of market information or observable data and unobservable inputs which reflect management's assumptions. Changes in observable data and unobservable inputs would impact results.
For Homer City's derivative instruments that are measured at fair value using quantitative pricing models, a significant change in estimate could affect Homer City's results of operations. For further sensitivities in Homer City's assumptions used to calculate fair value, see "Market Risk Exposures—Derivative Instruments—Fair Value Disclosures." For further information on derivative instruments, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 5. Derivative Instruments and Hedging Activities."

Income Taxes
Nature of Estimates Required.    As part of the process of preparing its financial statements, Homer City is required to estimate its income taxes for each jurisdiction in which it operates. This process involves estimating actual current period tax expense together with assessing temporary differences resulting from differing treatment of items, such as depreciation, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within Homer City's balance sheets. Homer City records a deferred tax asset valuation allowance when it is more likely than not that all or a portion of its deferred tax assets will not be realized.

30


Homer City takes certain tax positions it believes are applied in accordance with the applicable tax laws. However, these tax positions are subject to interpretation by the Internal Revenue Service, state tax authorities and the courts. Homer City determines its uncertain tax positions in accordance with the authoritative guidance.
Key Assumptions and Approach Used.    Accounting for tax obligations requires management judgment. Management uses judgment in determining whether the evidence indicates it is more likely than not, based solely on the technical merits, that a tax position will be sustained and to determine the amount of tax benefits to be recognized. Judgment is also used in determining the likelihood a tax position will be settled and possible settlement outcomes. Management must also assess the likelihood that Homer City's deferred tax assets will be recovered from future taxable income or the utilization of losses through a reduction in the loan with Edison Mission Finance. In assessing its uncertain tax positions, Homer City considers, among others, the following factors: the facts and circumstances of the position, regulations, rulings, and case law, opinions or views of legal counsel and other advisers, and the experience gained from similar tax positions. Management evaluates uncertain tax positions at the end of each reporting period and makes adjustments when warranted based on changes in fact or law.
Effect if Different Assumptions Used.    Actual income taxes may differ from the estimated amounts which could have a significant impact on the liabilities, revenues and expenses recorded in the financial statements. Homer City continues to be under audit or subject to audit for multiple years in various jurisdictions. Significant judgment is required to determine the tax treatment of particular tax positions that involve interpretations of complex tax laws. A tax liability has been recorded with respect to tax positions in which the outcome is uncertain and the effect is estimable. Such liabilities are based on judgment and a final determination could take many years from the time the liability is recorded and the related filing position is no longer subject to review. Furthermore, settlement of tax positions included in open tax years may be resolved by compromises of tax positions based on current factors and business considerations that may result in material adjustments to income taxes previously estimated.
Effect on 2011 Results.    After assessing the realization of its net deferred tax assets, management believes it is more likely than not that it will not be able to realize the tax benefits from any of its net deferred tax assets and, therefore, recorded a valuation allowance of $344 million during the fourth quarter of 2011. For further discussion, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 6. Income Taxes."

Accounting for Contingencies, Guarantees and Indemnities
Nature of Estimates Required.    Homer City records loss contingencies when it determines that the outcome of future events is probable of occurring and when the amount of the loss can be reasonably estimated. When a guarantee or indemnification subject to authoritative guidance is entered into, Homer City records a liability for the estimated fair value of the underlying guarantee or indemnification. Gain contingencies are recognized in the financial statements when they are realized.
Key Assumptions and Approach Used.    The determination of a reserve for a loss contingency is based on management judgment and estimates with respect to the likely outcome of the matter, including the analysis of different scenarios. Liabilities are recorded or adjusted when events or circumstances cause these judgments or estimates to change. In assessing whether a loss is a reasonable possibility, Homer City may consider the following factors, among others: the nature of the litigation, claim or assessment, available information, opinions or views of legal counsel and other advisors, and the experience gained from similar cases. Homer City provides disclosures for material contingencies when there is a reasonable possibility that a loss or an additional loss may be incurred. Some guarantees and indemnifications could have a significant financial impact under certain circumstances, and management also considers the probability of such circumstances occurring when estimating the fair value.
Effect if Different Assumptions Used.    Actual amounts realized upon settlement of contingencies may be different than amounts recorded and disclosed and could have a significant impact on the liabilities, revenues and expenses recorded on the financial statements. In addition, for guarantees and indemnities actual results may differ from the amounts recorded and disclosed and could have a significant impact on Homer City's financial statements. For a discussion of contingencies, guarantees and indemnities, see "Item 8. EME Homer City Generation L.P. Notes to Financial Statements—Note 8. Commitments and Contingencies—Guarantees and Indemnities," "—Contingencies" and "Item 1. Business—Environmental Matters and Regulations."

ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information responding to Item 7A is filed with this report under "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations."


31


ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.

ITEM 9A.  CONTROLS AND PROCEDURES

Disclosure Controls and Procedures
Homer City's management, under the supervision and with the participation of the partnership's principal executive officer and principal financial officer, has evaluated the effectiveness of Homer City's disclosure controls and procedures (as that term is defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based on that evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period, Homer City's disclosure controls and procedures were effective.

Management's Report on Internal Control over Financial Reporting
Homer City's management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f), for Homer City. Under the supervision and with the participation of the partnership's principal executive officer and principal financial officer, Homer City's management conducted an evaluation of the effectiveness of Homer City's internal control over financial reporting based on the framework set forth in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on its evaluation under the COSO framework, Homer City's management concluded that Homer City's internal control over financial reporting was effective as of December 31, 2011.

Internal Control over Financial Reporting
There were no changes in Homer City's internal control over financial reporting (as that term is defined in Rules 13a-15(f) or 15d-15(f) under the Exchange Act) during the period to which this report relates that have materially affected, or are reasonably likely to materially affect, Homer City's internal control over financial reporting.

ITEM 9B.  OTHER INFORMATION
None.


32


EME HOMER CITY GENERATION L.P.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the General Partner of EME Homer City Generation L.P.:
In our opinion, the financial statements listed in the index appearing under Item 8 present fairly, in all material respects, the financial position of EME Homer City Generation L.P. at December 31, 2011 and 2010, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
The financial statements listed in the index appearing under Item 8 have been prepared assuming that the Partnership will continue as a going concern. As discussed in Note 1 to the financial statements, the Partnership does not expect to generate sufficient capital from operations necessary to meet its obligations, which raises substantial doubt on its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ PricewaterhouseCoopers LLP
Los Angeles, California
March 28, 2012


33


EME HOMER CITY GENERATION L.P.
 
STATEMENTS OF OPERATIONS
(in millions)
 
Years Ended December 31,
 
2011
 
2010
 
2009
Operating Revenues from Marketing Affiliate
$
527

 
$
636

 
$
663

Operating Expenses
 
 
 
 
 
Fuel
269

 
279

 
251

Plant operations
137

 
116

 
103

Depreciation and amortization
68

 
66

 
63

Asset impairments and other charges (Note 12)
493

 
5

 
3

Administrative and general
6

 
5

 
4

Total operating expenses
973

 
471

 
424

Operating income (loss)
(446
)
 
165

 
239

Other Income (Expense)
 
 
 
 
 
Interest expense
(122
)
 
(127
)
 
(128
)
Income (loss) before income taxes
(568
)
 
38

 
111

Provision for income taxes
118

 
11

 
44

Net Income (Loss)
$
(686
)
 
$
27

 
$
67


The accompanying notes are an integral part of these financial statements.
34


EME HOMER CITY GENERATION L.P.
 
STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in millions)
 
Years Ended December 31,
 
2011
 
2010
 
2009
Net Income (Loss)
$
(686
)
 
$
27

 
$
67

Other comprehensive income (loss), net of tax
 
 
 
 
 
Pension and postretirement benefits other than pensions:
 
 
 
 
 
Prior service adjustment, net of tax benefit
1

 

 

Net gain (loss) adjustment, net of tax expense (benefit) of $4, $(2) and $2 for 2011, 2010 and 2009, respectively
(9
)
 
(3
)
 
3

Unrealized gains (losses) on derivatives qualified as cash flow hedges:
 
 
 
 
 
Unrealized holding gains arising during period, net of income tax expense (benefit) of $(3), $14 and $9 for 2011, 2010 and 2009, respectively
17

 
19

 
6

Reclassification adjustments included in net income (loss), net of income tax benefit of $0, $38 and $35 for 2011, 2010 and 2009, respectively
(23
)
 
(54
)
 
(44
)
Other comprehensive loss, net of tax
(14
)
 
(38
)
 
(35
)
Comprehensive Income (Loss)
$
(700
)
 
$
(11
)
 
$
32


The accompanying notes are an integral part of these financial statements.
35


EME HOMER CITY GENERATION L.P.
 
BALANCE SHEETS
(in millions)
 
December 31,
 
2011
 
2010
Assets
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
84

 
$
132

Due from affiliates
1

 

Inventory
105

 
109

Deferred taxes

 
2

Derivative assets
1

 
8

Emission allowances
19

 
29

Other current assets
3

 
10

Total current assets
213

 
290

Property, Plant and Equipment, less accumulated depreciation of none and $609 at respective dates
1,085

 
1,630

Deferred taxes

 
117

Restricted deposits
27

 
27

Long-term emission allowances
16

 
15

Other long-term assets
5

 

Total Assets
$
1,346

 
$
2,079

Liabilities and Partners' Equity (Deficit)
 
 
 
Current Liabilities
 
 
 
Accounts payable
$
21

 
$
20

Accrued liabilities
9

 
10

Due to affiliates
42

 
50

Interest payable
20

 
21

Interest payable to affiliate
49

 
9

Current portion of lease financing
84

 
79

Total current liabilities
225

 
189

Long-term debt to affiliate
490

 
479

Lease financing, net of current portion
922

 
1,006

Benefit plans and other long-term liabilities
60

 
53

Long-term derivative liabilities
3

 
6

Total Liabilities
1,700

 
1,733

Commitments and Contingencies (Notes 8 and 9)

 

Partners' Equity (Deficit)
(354
)
 
346

Total Liabilities and Partners' Equity (Deficit)
$
1,346

 
$
2,079



The accompanying notes are an integral part of these financial statements.
36


EME HOMER CITY GENERATION L.P.
 
STATEMENTS OF PARTNERS' EQUITY (DEFICIT)
(in millions)
 
Chestnut Ridge
Energy Company
 
Mission Energy
Westside Inc.
 
Total
Partners' Equity (Deficit)
Balance at December 31, 2008
$
324

 
$
1

 
$
325

Net income
67

 

 
67

Other comprehensive loss
(35
)
 

 
(35
)
Balance at December 31, 2009
356

 
1

 
357

Net income
27

 

 
27

Other comprehensive loss
(38
)
 

 
(38
)
Balance at December 31, 2010
345

 
1

 
346

Net loss
(686
)
 

 
(686
)
Other comprehensive loss
(14
)
 

 
(14
)
Balance at December 31, 2011
$
(355
)
 
$
1

 
$
(354
)

The accompanying notes are an integral part of these financial statements.
37


EME HOMER CITY GENERATION L.P.
 
STATEMENTS OF CASH FLOWS
(in millions)
 
Years Ended December 31,
 
2011
 
2010
 
2009
Cash Flows From Operating Activities
 
 
 
 
 
Net income (loss)
$
(686
)
 
$
27

 
$
67

Adjustments to reconcile income (loss) to net cash provided by operating activities:
 
 
 
 
 
Depreciation and amortization
68

 
67

 
63

Deferred taxes
119

 
(21
)
 
(1
)
Asset impairments and other charges
493

 
5

 
3

Other non-cash items

 

 
1

Decrease (increase) in due to/from affiliates
(8
)
 
22

 
26

Decrease (increase) in inventory
4

 
(20
)
 
(10
)
Decrease in other assets
2

 

 

Decrease in emission allowances
9

 
2

 
15

Increase (decrease) in accounts payable and other current liabilities
(1
)
 
4

 

Increase (decrease) in interest payable
38

 
(3
)
 

Increase in other liabilities
1

 
3

 
2

Decrease (increase) in derivative assets and liabilities
(5
)
 
20

 
(15
)
Net cash provided by operating activities
34

 
106

 
151

Cash Flows From Financing Activities
 
 
 
 
 
Borrowings on long-term debt to affiliate
11

 
23

 
25

Repayments of long-term debt to affiliate

 
(36
)
 
(42
)
Repayments of lease financing
(79
)
 
(65
)
 
(57
)
Net cash used in financing activities
(68
)
 
(78
)
 
(74
)
Cash Flows From Investing Activities
 
 
 
 
 
Capital expenditures
(14
)
 
(18
)
 
(26
)
Proceeds from sale of emission allowances

 
1

 
1

Decrease in restricted deposits

 

 
10

Net cash used in investing activities
(14
)
 
(17
)
 
(15
)
Net increase (decrease) in cash and cash equivalents
(48
)
 
11

 
62

Cash and cash equivalents at beginning of period
132

 
121

 
59

Cash and cash equivalents at end of period
$
84

 
$
132

 
$
121


The accompanying notes are an integral part of these financial statements.
38


EME HOMER CITY GENERATION L.P.
NOTES TO FINANCIAL STATEMENTS

Note 1. Summary of Significant Accounting Policies
EME Homer City Generation L.P. (Homer City) is a Pennsylvania limited partnership between Chestnut Ridge Energy Company, as a limited partner with a 99.9 percent interest, and Mission Energy Westside Inc., as a general partner with a 0.1 percent interest. Both Chestnut Ridge Energy and Mission Energy Westside are wholly owned subsidiaries of Edison Mission Holdings Co., a wholly owned subsidiary of Edison Mission Energy (EME). EME is an indirect wholly owned subsidiary of Edison International. The partnership was formed for the purpose of acquiring, owning or leasing and operating three coal-fired electric generating units, and related facilities, which is referred to as the "Homer City plant," located near Pittsburgh, Pennsylvania for the purpose of producing electric energy.
Homer City derives revenues from the sale of energy, capacity and ancillary services into PJM and from bilateral contracts with power marketers and load-serving entities within PJM. Homer City has a contract with Edison Mission Marketing & Trading, Inc. (EMMT), a marketing affiliate, to sell energy, capacity and ancillary services from the Homer City plant, which enables this marketing affiliate to engage in forward sales and hedging transactions to manage electricity price exposure.
On December 7, 2001, Homer City completed a sale-leaseback of the Homer City plant to third-party lessors for an aggregate purchase price of $1.591 billion, made up of $782 million in cash and assumption of debt (the fair value of which was $809 million). This transaction has been accounted for as a lease financing for accounting purposes.
Substantial Doubt that Homer City will Continue as a Going Concern
The accompanying consolidated financial statements have been prepared assuming that Homer City will continue as a going concern. Financial statements prepared on this basis assume the realization of assets and the satisfaction of liabilities in the normal course of business for the 12-month period following the date of these consolidated financial statements. The reduction in energy prices experienced in the fourth quarter of 2011 and into 2012 has adversely impacted cash flow, and Homer City is not expected to be able to generate sufficient cash flow from operations necessary to meet its obligations, including the obligations under the Homer City lease. As described further below under Homer City Lease, it is unlikely that Homer City will continue as a going concern throughout 2012. For discussion of the asset impairment recorded with respect to the Homer City plant, see Note 12—Asset Impairments and Other Charges.
Homer City Lease
During the fourth quarter of 2011, Homer City failed to obtain sufficient interest from market participants necessary to fund the capital needed to make environmental improvements under the current lease arrangement. The estimated cost of installing SO2 and particulate emissions control equipment for Units 1 and 2 of the Homer City plant is expected to be approximately $700 million to $750 million. Homer City does not currently have sufficient capital and does not expect to generate sufficient funds from operations to complete retrofits. Restrictions under the agreements entered into as part of Homer City's 2001 sale-leaseback transaction affect, and in some cases significantly limit or prohibit, Homer City's ability to incur indebtedness or make capital expenditures. Consequently, Homer City's ability to install environmental compliance equipment will be dependent on funding from the owner-lessors or third parties. Homer City is currently engaged in discussions with the owner-lessors regarding the potential for such funding. Homer City expects that the outcome of any such discussions, if successful in providing funding for the Homer City plant, will likely result in Homer City's loss of substantially all beneficial economic interest in and material control of the Homer City plant. Failure to resolve the source of funding of necessary capital expenditures for the Homer City plant could result in Homer City's default under the lease agreements giving rise to remedies for the owner-lessors and secured lease obligation bondholders, which could include foreclosing on the leased assets, the general partner of Homer City, or both. For further discussion with respect to the lease obligations, see Note 8—Commitments and Contingencies—Lease Commitments.
Basis of Presentation
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP) requires Homer City to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

39


Cash Equivalents
Cash equivalents included money market funds totaling $28 million and $31 million at December 31, 2011 and 2010, respectively. The carrying value of cash equivalents equals the fair value as all investments have maturities of less than three months.
Restricted Deposits
Certain cash balances are restricted to pay amounts required for lease payments and provide collateral. Included in restricted deposits were $20 million at each of December 31, 2011 and 2010 related to lease payments, and $7 million at each of December 31, 2011 and 2010 for collateral related to an environmental bond. For additional information regarding the lease payments, see Note 8—Commitments and Contingencies—Lease Commitments—Facilities Sale-Leaseback.
Inventory
Inventory is stated at the lower of weighted-average cost or market. Inventory is recorded at actual cost when purchased and then expensed at weighted-average cost as used. Cost is reduced to market value if the market value of inventory has declined and it is probable that revenues earned from the generation of power will not cover the cost of the inventory in the ordinary course of business or if the inventory is determined to be obsolete. Inventory consisted of the following:
 
December 31,
(in millions)
2011
 
2010
Coal, fuel oil and other raw materials
$
68

 
$
76

Spare parts, materials and supplies
37

 
33

Total inventory
$
105

 
$
109

Purchased Emission Allowances
Purchased emission allowances are stated at the lower of weighted-average cost or market. Purchased emission allowances are recorded at cost when purchased and then expensed at weighted-average cost as used. Cost is reduced to market value if the market value of emission allowances has declined and it is probable that revenues earned from the generation of power will not cover the amounts recorded in the ordinary course of business. Purchased emission allowances are classified as current or long-term assets based on the time the allowances are expected to be used. Emission allowances do not have a pre-determined contractual term or expiration date.
Property, Plant and Equipment
Property, plant and equipment are stated at cost. As part of the acquisition of the Homer City plant, Homer City acquired emission allowances under the United States Environmental Protection Agency's (US EPA's) Acid Rain Program. Homer City uses these emission allowances in the normal course of its business to generate electricity and has classified them as part of property, plant and equipment. Depreciation and amortization are computed on a straight-line basis over the following estimated useful lives:
Plant and equipment under lease financing
33.67 years
Leasehold improvements
Shorter of life of lease or estimated useful life
Emission allowances
33.67 years
Equipment, furniture and fixtures
3 to 7 years
Certain major pieces of Homer City's equipment require periodic repairs and maintenance. These costs, including major maintenance costs, are expensed as incurred.
Impairment of Long-Lived Assets
Homer City evaluates the impairment of its long-lived assets based on a review of estimated future cash flows expected to be generated whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Homer City's unit of account is at the plant level. If the carrying amount of a long-lived asset exceeds the expected future cash flows, undiscounted and without interest charges, then an impairment loss is recognized for the excess of the carrying amount over fair value. Fair value is determined via market, cost and income based valuation techniques, as appropriate. For further discussion, see Note 12—Asset Impairments and Other Charges.

40


Revenue Recognition
Generally, revenues and related costs are recognized when electricity is generated or services are provided unless the transaction is accounted for as a derivative and does not qualify for the normal purchases and sales exception. Homer City enters into power and fuel hedging and optimization transactions under a contract with EMMT. These transactions are executed primarily through the use of physical forward commodity purchases and sales and financial commodity swaps and options. With respect to its physical forward contracts, Homer City takes title to the commodities, and assumes the risks and rewards of ownership. Homer City records the settlement of non-trading physical forward contracts on a gross basis. Homer City nets the cost of purchased power against related third-party sales in markets that use locational marginal pricing, currently PJM. Financial swap and option transactions are settled net and, accordingly, Homer City does not take title to the underlying commodity. Therefore, gains and losses from settlement of financial swaps and options are recorded net in operating revenues in the accompanying statements of operations.
Derivative Instruments and Hedging Activities
Authoritative guidance on derivatives and hedging establishes accounting and reporting standards for derivative instruments (including certain derivative instruments embedded in other contracts). Homer City is required to record derivatives on its balance sheets as either assets or liabilities measured at fair value unless otherwise exempted from derivative treatment as normal purchases and sales. All changes in the fair value of derivative instruments are recognized currently in earnings, unless specific hedge criteria are met, which requires that Homer City formally document, designate, and assess the effectiveness of transactions that receive hedge accounting.
The accounting guidance for cash flow hedges provides that the effective portion of gains or losses on derivative instruments designated and qualifying as cash flow hedges be reported as a component of other comprehensive loss and be reclassified into earnings in the same period during which the hedged forecasted transaction affects earnings. The remaining gains or losses on the derivative instruments, if any, must be recognized currently in earnings.
Where Homer City's derivative instruments are subject to a master netting agreement and the criteria of authoritative guidance are met, Homer City presents its derivative assets and liabilities on a net basis on its balance sheets. The results of derivative activities are recorded in cash flows from operating activities on the statements of cash flows. Derivative and hedging accounting policies are discussed further in Note 5—Derivative Instruments and Hedging Activities.
Income Taxes and Tax-Allocation Agreements
Homer City has historically made an election to be taxed as a corporation for federal and California state tax purposes. Homer City is included in the consolidated federal and state income tax returns of Edison International and is party to a tax-allocation agreement with its indirect parent, Edison Mission Holdings Co. In accordance with the agreement and the tax-allocation procedures in effect, its current tax liability or benefit is generally determined on a separate return basis, except for calculating consolidated state income taxes, for which Homer City uses the state tax apportionment factors of the Edison International group. Also, while Homer City is generally subject to separate return limitations for net losses, under the tax-allocation agreement it is permitted to transfer to Edison Mission Holdings, or its subsidiaries, net operating loss benefits which would not yet be realized in a separate return in exchange for a reduction in Homer City's intercompany account balances (including the subordinated revolving loan). Homer City also has the option, at Homer City's discretion, under its tax-allocation agreement with Edison Mission Holdings to settle federal and state income tax liabilities under the tax-allocation agreement through an increase in indebtedness under the subordinated revolving loan. In 2011 and 2010, Homer City elected its option and settled $1 million and $32 million, respectively, of intercompany tax liabilities through the subordinated revolving loan. Homer City also files a separate state income tax return in Pennsylvania. Amounts included in due to affiliates on the balance sheet associated with this tax-allocation agreement totaled $2 million and $4 million at December 31, 2011 and 2010, respectively.
Homer City accounts for deferred income taxes using the asset-and-liability method, wherein deferred tax assets and liabilities are recognized for future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities using enacted income tax rates. In assessing the realization of Homer City's deferred tax assets, management considered whether it is more likely than not that the deferred tax assets will be realized. Realization of Homer City's deferred tax assets depends upon its ability to generate taxable income in the future or utilize losses through a reduction in the loan with Edison Mission Finance. On a quarterly basis, management evaluates the recoverability of its deferred tax assets to ensure there is adequate support for the realization of the deferred tax assets. In the event management were to determine that Homer City would not be able to realize all or part of its net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged as a reduction to income in the period such determination was made. At December 31, 2011, Homer City provided a full valuation allowance against its net deferred tax assets. For further information regarding the valuation allowance, see Note 6—Income Taxes.

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On March 15, 2012, Homer City made an election to be treated as a partnership for federal and state income tax purposes. As a result, the income or loss of Homer City will be allocated to the individual partners. Accordingly, on a prospective basis, no recognition will be given to income taxes in Homer City's financial statements and deferred taxes and the related valuation allowance will be eliminated in the first quarter of 2012.
Interest income, interest expense and penalties associated with income taxes are reflected in provision for income taxes on Homer City's statements of operations.
New Accounting Guidance
Accounting Guidance Adopted in 2011
Fair Value Measurements and Disclosures
The Financial Accounting Standards Board (FASB) issued an accounting standards update modifying the disclosure requirements related to fair value measurements. Under these requirements, purchases and settlements for Level 3 fair value measurements are presented on a gross basis, rather than net. Homer City adopted this guidance effective January 1, 2011.
Accounting Guidance Not Yet Adopted
Fair Value Measurement
In May 2011, the FASB issued an accounting standards update modifying the fair value measurement and disclosure guidance. This guidance prohibits grouping of financial instruments for purposes of fair value measurement and requires the value be based on the individual security. This amendment also results in new disclosures primarily related to Level 3 measurements including quantitative disclosure about unobservable inputs and assumptions, a description of the valuation processes and a narrative description of the sensitivity of the fair value to changes in unobservable inputs. Homer City will adopt this guidance in the first quarter of 2012. The adoption of this standards update is not expected to have a material impact on Homer City's financial position.
Presentation of Comprehensive Income
In June 2011, the FASB issued an accounting standards update on the presentation of comprehensive income. An entity can elect to present items of net income and other comprehensive income in one continuous statement, referred to as the statement of comprehensive income, or in two separate but consecutive statements. Homer City will adopt this guidance in the first quarter of 2012. Homer City currently presents the statement of comprehensive income immediately following the statement of income and expects to continue to do so. The adoption of this accounting standards update does not change the items that constitute net income and other comprehensive income.
Offsetting Assets and Liabilities
In December 2011, the FASB issued an accounting standards update modifying disclosure requirements about the nature of an entity's rights of offsetting assets and liabilities in the statement of financial position under master netting agreements and related arrangements associated with financial and derivative instruments. The guidance requires increased disclosure of the gross and net recognized assets and liabilities, collateral positions and narrative descriptions of setoff rights. Homer City will adopt this guidance effective January 1, 2013. The guidance impacts disclosure only.


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Note 2. Property, Plant and Equipment
Property, plant and equipment consisted of the following:
 
December 31,
(in millions)
2011
 
2010
Land
$
7

 
$
7

Power plant facilities
2

 
4

Plant and equipment under lease financing
760

 
1,582

Leasehold improvements
110

 
172

Emission allowances
198

 
438

Construction in progress
7

 
25

Equipment, furniture and fixtures
1

 
10

Capitalized leased equipment

 
1

 
1,085

 
2,239

Less accumulated depreciation and amortization

 
609

Property, plant and equipment, net
$
1,085

 
$
1,630

As a result of the sale-leaseback transaction on December 7, 2001, a majority of the generating facilities and equipment were classified as power plant and equipment under lease financing. Homer City recorded amortization expense related to the leased facilities of $47 million for all three years ended December 31, 2011, 2010 and 2009. Accumulated amortization related to the leased facilities was none and $427 million at December 31, 2011 and 2010, respectively.
Homer City recorded $478 million of impairment charges related to property, plant and equipment at the Homer City plant in 2011. For additional information, see Note 12—Asset Impairments and Other Charges.
Asset Retirement Obligations
Authoritative guidance on asset retirement obligations (AROs) requires entities to record the fair value of a liability for an ARO in the period in which it is incurred, including a liability for the fair value of a conditional ARO, if the fair value can be reasonably estimated even though uncertainty exists about the timing and/or method of settlement. When an ARO liability is initially recorded, the entity capitalizes the cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is increased for accretion expense to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Settlement of an ARO liability for an amount other than its recorded amount results in an increase or decrease in expense.
Homer City recorded a liability representing expected future costs associated with site reclamation, facilities dismantlement and removal of environmental hazards, which is included in benefit plans and other long-term liabilities on Homer City's balance sheets. A reconciliation of the changes in the ARO liability is as follows:
 
Years Ended December 31,
(in millions)
2011
 
2010
 
2009
Beginning balance
$
7

 
$
5

 
$
3

Accretion expense
1

 
1

 

Liabilities added

 
1

 
2

Ending balance
$
8

 
$
7

 
$
5


Note 3. Fair Value Measurements
Recurring Fair Value Measurements
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (referred to as an "exit price"). Fair value of an asset or a liability should consider assumptions that market participants would use in pricing the asset or liability, including assumptions about

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nonperformance risk. The fair value of derivative assets' nonperformance risk was not material as of December 31, 2011 and 2010.
Homer City categorizes financial assets and liabilities into a fair value hierarchy based on valuation inputs used to derive fair value. The hierarchy, established by authoritative accounting guidance, gives the highest priority to unadjusted quoted market prices in active markets for identical assets and liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements).
The following table sets forth Homer City's assets and liabilities that were accounted for at fair value by level within the fair value hierarchy:
 
December 31, 2011
(in millions)
Level 1
 
Level 2
 
Level 3
 
Netting1
 
Total
Assets at Fair Value
 
 
 
 
 
 
 
 
 
Money market funds2
$
28

 
$

 
$

 
$

 
$
28

Electricity contracts

 
1

 

 

 
1

Liabilities at Fair Value
 
 
 
 
 
 
 
 
 
Electricity contracts
$

 
$
3

 
$

 
$

 
$
3

 
December 31, 2010
Assets at Fair Value
 
 
 
 
 
 
 
 
 
Money market funds2
$
31

 
$

 
$

 
$

 
$
31

Electricity contracts

 
5

 

 
3

 
8

Liabilities at Fair Value
 
 
 
 
 
 
 
 
 
Electricity contracts
$

 
$
3

 
$

 
$
3

 
$
6

1 
Represents the impact of netting across the levels of the fair value hierarchy. Netting among positions classified within the same level is included in that level.
2 
Money market funds are included in cash and cash equivalents on Homer City's balance sheets.
The following table sets forth a summary of changes in the fair value of derivative assets and liabilities, net categorized as Level 3:
(in millions)
2011
 
2010
Fair value, net asset at beginning of periods
$

 
$

Total realized/unrealized gains (losses):
 
 
 
Included in earnings1
(2
)
 

Included in accumulated other comprehensive income

 

Settlements
2

 

Transfers in or out of Level 3

 

Fair value, net asset at end of periods
$

 
$

1 
Reported in operating revenues on Homer City's statements of operations.
The change in unrealized gains (losses) related to assets and liabilities, net held at December 31, 2011 and 2010 for the years ended December 31, 2011 and 2010 was immaterial.
Homer City determines the fair value of transfers in and out of each level at the end of each reporting period. There were no significant transfers between levels during 2011, 2010 and 2009.

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Valuation Techniques used to Determine Fair Value
Level 1
Level 1 includes financial assets and liabilities where unadjusted quoted prices in active markets are available at the measurement date for identical assets and liabilities. Financial assets and liabilities classified as Level 1 include exchange-traded derivatives and money market funds.
Level 2
Level 2 pricing inputs include quoted prices for similar assets and liabilities in active markets and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the derivative instrument. Financial assets and liabilities utilizing Level 2 inputs include over-the-counter derivatives.
Derivative contracts that are over-the-counter traded are valued using pricing models and are generally classified as Level 2. Inputs to the pricing models include forward published or posted clearing prices from exchanges (New York Mercantile Exchange and Intercontinental Exchange) for similar instruments and discount rates. Forward market prices are developed based on the source that best represents trade activity in each market. Broker quotes or prices from exchanges are used to validate and corroborate the primary source. These price quotations reflect mid-market prices (average of bid and ask) and are obtained from sources believed to provide the most liquid market for the commodity. Broker quotes are incorporated when corroborated with other information which may include a combination of prices from exchanges, other brokers, and comparison to executed trades.
Level 3
Level 3 includes financial assets and liabilities where fair value is determined using techniques that require significant unobservable inputs. Over-the-counter options, bilateral contracts, capacity contracts, qualifying facilities contracts, derivative contracts that trade infrequently (such as financial transmission rights), and derivative contracts with counterparties that have significant nonperformance risks are classified as Level 3. In circumstances where EMMT cannot verify fair value with observable market transactions, it is possible that a different valuation model could produce a materially different estimate of fair value. As markets continue to develop and more pricing information becomes available, EMMT continues to assess valuation methodologies used to determine fair value.
For derivative contracts that trade infrequently (illiquid financial transmission rights), changes in fair value are based on the hypothetical sale of illiquid positions. Objective criteria are reviewed, including system congestion and other underlying drivers and fair value is adjusted when it is concluded that a change in objective criteria would result in a new valuation that better reflects fair value. For illiquid long-term power agreements, fair value is based upon a discounting of future electricity and natural gas prices derived from a proprietary model using the risk free discount rate for a similar duration contract, adjusted for credit risk and market liquidity. Changes in fair value are based on changes to forward market prices, including forecasted prices for illiquid forward periods. The fair value of the majority of Homer City's derivatives that are classified as Level 3 is determined using uncorroborated non-binding broker quotes and models that may require EMMT to extrapolate short-term observable inputs in order to calculate fair value. Broker quotes are obtained from several brokers and compared against each other for reasonableness.
Non-Recurring Fair Value Measurements
For a discussion of non-recurring fair value measurements, see Note 12—Asset Impairments and Other Charges.

Note 4. Long-Term Debt
Homer City has entered into a subordinated revolving loan agreement with Edison Mission Finance Co. This loan agreement bears interest at a fixed rate of 8.0% on outstanding amounts and terminates on March 18, 2014. The outstanding balance under the loan agreement was $490 million and $479 million at December 31, 2011 and 2010, respectively. Homer City is restricted as a part of the sale-leaseback transaction from making any payments under this facility unless specified conditions are met. Homer City incurred interest costs related to its affiliate debt of $40 million, $38 million and $36 million for the years ended December 31, 2011, 2010 and 2009, respectively. It is not practicable to estimate the fair value of this financial instrument due to the subordination features of the loan and the provisions of the sale-leaseback agreements for the Homer City plant.


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Note 5. Derivative Instruments and Hedging Activities
Homer City uses derivative instruments to reduce its exposure to market risks that arise from price fluctuations of electricity, capacity, fuel, emission allowances, and transmission rights. The derivative financial instruments vary in duration, ranging from a few days to several years, depending upon the instrument. To the extent that Homer City does not use derivative instruments to hedge these market risks, the unhedged portions will be subject to the risks and benefits of spot market price movements.
Risk management positions may be designated as cash flow hedges or economic hedges, which are derivatives that are not designated as cash flow hedges. Economic hedges are accounted for at fair value on Homer City's balance sheets as derivative assets or liabilities with offsetting changes recorded on the statements of operations. For derivative instruments that qualify for hedge accounting treatment, the fair value is recognized on Homer City's balance sheets as derivative assets or liabilities with offsetting changes in fair value, to the extent effective, recognized in accumulated other comprehensive loss until reclassified into earnings when the related forecasted transaction occurs. The portion of a cash flow hedge that does not offset the change in the fair value of the transaction being hedged, which is commonly referred to as the ineffective portion, is immediately recognized in earnings. The results of derivative activities are recorded in cash flows from operating activities on the statements of cash flows.
Where Homer City's derivative instruments are subject to a master netting agreement and the criteria of authoritative guidance are met, Homer City presents its derivative assets and liabilities on a net basis on its balance sheets.
Notional Volumes of Derivative Instruments
The following table summarizes the notional volumes of derivatives used for hedging activities:
December 31, 2011
 
 
 
 
 
 
Commodity
Instrument
Classification
Unit of Measure
Cash Flow
Hedges
 
Economic
Hedges
 
Electricity
Forwards/Futures
Sales, net
GWh

 
90

3 
Electricity
Capacity
Sales, net
MW-Day (in thousands)
29