Forward Contracts Classified as Derivatives

6 Months Ended

Jun. 30, 2013

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Forward Contracts Classified as Derivatives

5. Forward Contracts Classified as Derivatives

Electricity Contracts

All of OTP’s wholesale purchases and sales of energy under forward contracts that do not meet the definition of capacity contracts are considered derivatives subject to mark-to-market accounting. OTP’s objective in entering into forward contracts for the purchase and sale of energy is to optimize the use of its generating and transmission facilities and leverage its knowledge of wholesale energy markets in the region to maximize financial returns for the benefit of both its customers and shareholders. OTP’s intent in entering into certain of these contracts is to settle them through the physical delivery of energy when physically possible and economically feasible. OTP also enters into certain contracts for trading purposes with the intent to profit from fluctuations in market prices through the timing of purchases and sales.

As of June 30, 2013 OTP had recognized, on a pretax basis, $40,000 in net unrealized gains on open forward contracts for the purchase and sale of electricity. The market prices used to value OTP’s forward contracts for the purchases and sales of electricity and electricity generating capacity are determined by survey of counterparties or brokers used by OTP’s power services’ personnel responsible for contract pricing, as well as prices gathered from daily settlement prices published by the Intercontinental Exchange and CME Globex. For certain contracts, prices at illiquid trading points are based on a basis spread between that trading point and more liquid trading hub prices. These basis spreads are determined based on available market price information and the use of forward price curve models. The fair value measurements of these forward energy contracts fall into level 3 of the fair value hierarchy set forth in ASC 820, Fair Value Measurement.

The following tables show the effect of marking to market forward contracts for the purchase and sale of electricity and the location and fair value amounts of the related derivatives reported on the Company’s consolidated balance sheets as of June 30, 2013 and December 31, 2012, and the change in the Company’s consolidated balance sheet position from December 31, 2012 to June 30, 2013 and December 31, 2011 to June 30, 2012:

(in thousands)	June 30, 2013			December 31, 2012
Current Asset – Marked-to-Market Gain	$	1,180		$	502
Regulatory Asset – Current Deferred Marked-to-Market Loss		5,572			7,949
Regulatory Asset – Long-Term Deferred Marked-to-Market Loss		7,037			10,050
Total Assets		13,789			18,501
Current Liability – Marked-to-Market Loss		(13,294	)		(18,234	)
Regulatory Liability – Current Deferred Marked-to-Market Gain		(19	)		(8	)
Regulatory Liability – Long-Term Deferred Marked-to-Market Gain		(436	)		(210	)
Total Liabilities		(13,749	)		(18,452	)
Net Fair Value of Marked-to-Market Energy Contracts	$	40		$	49

(in thousands)	Year-to-Date June 30, 2013			Year-to-Date June 30, 2012
Cumulative Fair Value Adjustments Included in Earnings - Beginning of Year	$	49		$	894
Less: Amounts Realized on Settlement of Contracts Entered into in Prior Periods		(49	)		(700	)
Changes in Fair Value of Contracts Entered into in Prior Periods		--			(33	)
Cumulative Fair Value Adjustments in Earnings of Contracts Entered into in Prior Years at End of Period		--			161
Changes in Fair Value of Contracts Entered into in Current Period		40			(30	)
Cumulative Fair Value Adjustments Included in Earnings - End of Period	$	40		$	131

The $40,000 in recognized but unrealized net gains on the forward energy and capacity purchases and sales marked to market on June 30, 2013 are expected to be realized on settlement as scheduled over the following period in the amount listed:

(in thousands)	3rd Qtr 2013		Total
Net Gain	$	40	$	40

The following realized and unrealized net gains and losses on forward energy contracts are included in electric operating revenues on the Company’s consolidated statements of income:

	Three Months Ended					Six Months Ended
	June 30,					June 30,
(in thousands)	2013		2012			2013		2012
Net Gains (Losses) on Forward Electric Energy Contracts	$	28	$	(50	)	$	254	$	144

OTP has credit risk associated with the nonperformance or nonpayment by counterparties to its forward energy and capacity purchases and sales agreements. The Company has established guidelines and limits to manage credit risk associated with wholesale power and capacity purchases and sales. Specific limits are determined by a counterparty’s financial strength.

The following table provides information on OTP’s credit risk exposure on delivered and marked-to-market forward contracts as of June 30, 2013 and December 31, 2012:

	June 30, 2013				December 31, 2012
(in thousands)	Exposure		Counterparties		Exposure		Counterparties
Net Credit Risk on Forward Energy Contracts	$	1,290		3	$	580		6
Net Credit Risk to Single Largest Counterparty	$	850			$	285

OTP had a net credit risk exposure to three counterparties with investment grade credit ratings. OTP had no exposure at June 30, 2013 or December 31, 2012 to counterparties with credit ratings below investment grade. Counterparties with investment grade credit ratings have minimum credit ratings of BBB- (Standard & Poor’s), Baa3 (Moody’s) or BBB- (Fitch). The credit risk exposures include net amounts due to OTP on receivables/payables from completed transactions billed and unbilled plus marked-to-market gains/losses on forward contracts for the purchase and sale of electricity scheduled for delivery subsequent to the reporting date. Individual counterparty exposures are offset according to legally enforceable netting arrangements. However, the Company does not net offsetting payables and receivables or derivative assets and liabilities under legally enforceable netting arrangements on the face of its consolidated balance sheet. The amount of derivative asset and derivative liability balances that were subject to legally enforceable netting arrangements as of June 30, 2013 and December 31, 2012 are indicated in the following table:

(in thousands)	June 30, 2013			December 31, 2012
Derivative assets subject to legally enforceable netting arrangements	$	1,274		$	638
Derivative liabilities subject to legally enforceable netting arrangements		(13,294	)		(18,234	)
Net balance subject to legally enforceable netting arrangements	$	(12,020	)	$	(17,596	)

The following table provides a breakdown of OTP’s credit risk standing on forward energy contracts in marked-to-market loss positions as of June 30, 2013 and December 31, 2012:

Current Liability – Marked-to-Market Loss  (in thousands)	June 30, 2013			December 31, 2012
Loss Contracts Covered by Deposited Funds or Letters of Credit	$	--		$	2,176
Contracts Requiring Cash Deposits if OTP’s Credit Falls Below Investment Grade1		13,294			16,058
Loss Contracts with No Ratings Triggers or Deposit Requirements		--			--
Total Current Liability – Marked-to-Market Loss	$	13,294		$	18,234
1Certain OTP derivative energy contracts contain provisions that require an investment grade credit rating from each of the major credit rating agencies on OTP’s debt. If OTP’s debt ratings were to fall below investment grade, the counterparties to these forward energy contracts could request the immediate deposit of cash to cover contracts in net liability positions.
Contracts Requiring Cash Deposits if OTP’s Credit Falls Below Investment Grade	$	13,294		$	16,058
Offsetting Gains with Counterparties under Master Netting Agreements		(917	)		(416	)
Reporting Date Deposit Requirement if Credit Risk Feature Triggered	$	12,377		$	15,642