FAIR VALUE MEASUREMENTS

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

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

•

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

•

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

•

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

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

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

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

Probable loss of default by either us or our counterparties is considered in determining the fair value of derivative assets and liabilities. These non-performance risk adjustments take into consideration credit enhancements and the credit risks associated with our credit standing and the credit standing of our counterparties (see Note 9 for additional information regarding credit risk associated with our derivatives). We utilize published credit ratings, default rate factors and bond trading values in calculating these fair value measurement adjustments.

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

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

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

Assets and liabilities measured at fair value consisted of the following:



September 30, 2013
	Level 1		Level 2		Level 3 (a)		Reclassification (b)		Total
Assets:
Commodity contracts	$	140	$	941	$	48	$	2	$	1,131
Interest rate swaps	—		1		—		—		1
Nuclear decommissioning trust – equity securities (c)	299		172		—		—		471
Nuclear decommissioning trust – debt securities (c)	—		266		—		—		266
Total assets	$	439	$	1,380	$	48	$	2	$	1,869
Liabilities:
Commodity contracts	$	129	$	26	$	52	$	2	$	209
Interest rate swaps	—		—		1,167		—		1,167
Total liabilities	$	129	$	26	$	1,219	$	2	$	1,376



December 31, 2012
	Level 1		Level 2		Level 3 (a)		Total
Assets:
Commodity contracts	$	180	$	1,784	$	83	$	2,047
Interest rate swaps	—		2		—		2
Nuclear decommissioning trust – equity securities (c)	249		144		—		393
Nuclear decommissioning trust – debt securities (c)	—		261		—		261
Total assets	$	429	$	2,191	$	83	$	2,703
Liabilities:
Commodity contracts	$	208	$	121	$	54	$	383
Interest rate swaps	—		2,067		—		2,067
Total liabilities	$	208	$	2,188	$	54	$	2,450

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


(b)	Fair values are determined on a contract basis, but certain contracts result in a current asset and a noncurrent liability, or vice versa, as presented in the balance sheet.


(c)	The nuclear decommissioning trust investment is included in the investments line in the balance sheet. See Note 12.

Commodity contracts consist primarily of natural gas, electricity, fuel oil, uranium and coal derivative instruments entered into for hedging purposes and include physical contracts that have not been designated "normal" purchases or sales. See Note 9 for further discussion regarding the company's use of derivative instruments.

Interest rate swaps include variable-to-fixed rate swap instruments that are economic hedges of interest on long-term debt as well as interest rate basis swaps designed to effectively reduce the hedged borrowing costs. See Note 5 for discussion of interest rate swaps.

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

There were no significant transfers between Level 1 and Level 2 of the fair value hierarchy for the three and nine months ended September 30, 2013 and 2012. See the table of changes in fair values of Level 3 assets and liabilities below for discussion of transfers between Level 2 and Level 3.

The following tables present the fair value of the Level 3 assets and liabilities by major contract type and the significant unobservable inputs used in the valuations at September 30, 2013 and December 31, 2012:



September 30, 2013
	Fair Value
Contract Type (a)	Assets		Liabilities			Total			Valuation Technique	Significant Unobservable Input	Range (b)
Electricity purchases and sales	$	5	$	(2	)	$	3		Valuation Model	Illiquid pricing locations (c)	$30 to $45/MWh
										Hourly price curve shape (d)	$20 to $70/MWh

Electricity spread options	—		(19		)	(19		)	Option Pricing Model	Gas to power correlation (e)	45% to 100%
										Power volatility (f)	10% to 30%

Electricity congestion revenue rights	37		(5		)	32			Market Approach (g)	Illiquid price differences between settlement points (h)	$0.00 to $30.00

Coal purchases	1		(12		)	(11		)	Market Approach (g)	Illiquid price variances between mines (i)	$0.00 to $1.00
										Probability of default (j)	0% to 40%
										Recovery rate (k)	0% to 40%

Interest rate swaps	—		(1,167		)	(1,167		)	Valuation Model	Nonperformance risk adjustment (l)	30% to 35%

Other	5		(14		)	(9		)

Total	$	48	$	(1,219	)	$	(1,171	)



December 31, 2012
	Fair Value
Contract Type (a)	Assets		Liabilities			Total			Valuation Technique	Significant Unobservable Input	Range (b)
Electricity purchases and sales	$	5	$	(9	)	$	(4	)	Valuation Model	Illiquid pricing locations (c)	$20 to $40/MWh
										Hourly price curve shape (d)	$20 to $50/MWh

Electricity spread options	34		(10		)	24			Option Pricing Model	Gas to power correlation (e)	20% to 90%
										Power volatility (f)	20% to 40%

Electricity congestion revenue rights	41		(2		)	39			Market Approach (g)	Illiquid price differences between settlement points (h)	$0.00 to $0.50

Coal purchases	—		(32		)	(32		)	Market Approach (g)	Illiquid price variances between mines (i)	$0.00 to $1.00
										Probability of default (j)	5% to 40%
										Recovery rate (k)	0% to 40%

Other	3		(1		)	2

Total	$	83	$	(54	)	$	29

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(a)

Electricity purchase and sales contracts include wind generation agreements and hedging positions in the ERCOT west region as well as power contracts, the valuations of which include unobservable inputs related to the hourly shaping of the price curve. Electricity spread option contracts consist of physical electricity call options. Electricity congestion revenue rights contracts consist of forward purchase contracts (swaps and options) used to hedge electricity price differences between settlement points within ERCOT. Coal purchase contracts relate to western (Powder River Basin) coal. Interest rate swaps are held by TCEH to hedge exposure to its variable rate debt.


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


(c)	Based on the historical range of forward average monthly ERCOT West Hub prices.


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


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


(f)	Based on historical forward price changes.


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


(h)	Based on the historical price differences between settlement points in the ERCOT North Hub and the ERCOT West Hub.


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


(j)	Estimate of the range of probabilities of default based on past experience and the length of the contract as well as our and counterparties' credit ratings.


(k)	Estimate of the default recovery rate based on historical corporate rates.


(l)	Estimate of nonperformance risk adjustment based on TCEH senior secured bond trading values. See discussion immediately below regarding transfers into Level 3.

The following table presents the changes in fair value of the Level 3 assets and liabilities for the three and nine months ended September 30, 2013 and 2012. Transfers into Level 3 during 2013 as noted below reflect a nonperformance risk adjustment in the valuation of the TCEH interest rate swaps, which are secured by a first-lien interest in the same assets of TCEH (on a pari passu basis) with the TCEH Senior Secured Facilities and the TCEH Senior Secured Notes (see Note 5). At September 30, 2013, the estimated fair value of these interest rate swaps totaled $1.518 billion before consideration of nonperformance risk adjustment and $1.167 billion after consideration of such adjustment. The amount of the nonperformance risk adjustment was after consideration of derivative assets related to contracts with the same counterparties that are also secured by a first-lien interest in the assets of TCEH, and a master netting agreement is in place that provides for netting and setoff of amounts related to these contracts.



	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Net asset balance at beginning of period	$	88		$	12		$	29		$	53
Total unrealized valuation gains (losses)	(24		)	12			(41		)	(5		)
Purchases, issuances and settlements (a):
Purchases	6			17			66			30
Issuances	—			(4		)	(6		)	(15		)
Settlements	(62		)	(56		)	(45		)	(34		)
Transfers into Level 3 (b)	(1,179		)	3			(1,178		)	(42		)
Transfers out of Level 3 (b)	—			—			4			(3		)
Net change (c)	(1,259		)	(28		)	(1,200		)	(69		)
Net liability balance at end of period	$	(1,171	)	$	(16	)	$	(1,171	)	$	(16	)
Unrealized valuation gains (losses) relating to instruments held at end of period	$	254		$	15		$	280		$	(22	)

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


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

(c)

Substantially all changes in values of commodity contracts are reported in the income statement in net gain (loss) from commodity hedging and trading activities. Changes in values of interest rate swaps are reported in the income statement in interest expense and related charges. Activity excludes changes in fair value in the month the position settled as well as amounts related to positions entered into and settled in the same month.