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Fair Value Measurements

9 Months Ended

Sep. 30, 2019

Fair Value

The Company’s fair value measurements incorporate various factors, including the credit standing and performance risk of the counterparties, the applicable exit market, and specific risks inherent in the instrument. Nonperformance and credit risk adjustments on risk management instruments are based on current market inputs when available, such as credit default hedge spreads. When such information is not available, internal models may be used.

Assets and liabilities recorded at fair value in the consolidated financial statements are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels directly related to the amount of subjectivity associated with the inputs to valuation of these assets or liabilities are set forth below. Transfers between levels are recognized at the end of each quarter. The Company did not recognize any transfers between levels during the periods presented.

Level 1—Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

Level 2—Inputs (other than quoted prices included in Level 1) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.

Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities and which reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.

Financial Instruments

The carrying value of financial instruments classified as current assets and current liabilities approximates their fair value, based on the nature and short maturity of these instruments, and they are presented in the Company’s financial statements at carrying cost. Certain other assets and liabilities were measured at fair value upon initial recognition and unless conditions give rise to an impairment, are not remeasured.

Financial Instruments Measured at Fair Value on a Recurring Basis

The Company’s financial assets and liabilities which require fair value measurement on a recurring basis are classified within the fair value hierarchy as follows (in millions):



	September 30, 2019
	Level 1		Level 2		Level 3		Total
Assets
Foreign currency forward contracts	$	—	$	10	$	—	$	10
Congestion revenue rights ⁽¹⁾	—		—		—		—
	$	—	$	10	$	—	$	10
Liabilities
Interest rate swaps	$	—	$	87	$	—	$	87
Foreign currency forward contracts ⁽¹⁾	—		—		—		—
Contingent consideration	—		—		122		122
	$	—	$	87	$	122	$	209


⁽¹⁾	As of September 30, 2019, the fair value was less than $1 million.



	December 31, 2018
	Level 1		Level 2		Level 3		Total
Assets
Interest rate swaps	$	—	$	3	$	—	$	3
Energy derivative	—		—		7		7
Foreign currency forward contracts	—		12		—		12
Congestion revenue rights	—		—		1		1
	$	—	$	15	$	8	$	23
Liabilities
Interest rate swaps	$	—	$	31	$	—	$	31
Foreign currency forward contracts	—		2		—		2
Contingent consideration	—		—		130		130
	$	—	$	33	$	130	$	163

Level 2 Inputs

Derivative instruments subject to re-measurement are presented in the financial statements at fair value. The Company's interest rate swaps were valued by discounting the net cash flows using the forward LIBOR curve with the valuations adjusted by the Company’s credit default hedge rate. The Company’s foreign currency forward contracts were valued using the income approach based on the present value of the forward rates less the contract rates, multiplied by the notional amounts.

Level 3 Inputs

Energy Hedge

The fair value of the energy derivative instrument is determined based on a third-party valuation model. The methodology and inputs were evaluated by management for consistency and reasonableness by comparing inputs used by the third-party valuation provider to another third-party pricing service for identical or similar instruments and also reconciling inputs used in the third-party valuation model to the derivative contract for accuracy. Any significant changes were further evaluated for reasonableness by obtaining additional documentation from the third-party valuation provider.

The energy derivative instrument was valued by discounting the projected net cash flows over the remaining life of the derivative instrument using future electricity price curves with little or no market activity. Significant increases or decreases in this input would result in a significantly lower or higher fair value measurement. The energy derivative instrument expired in April 2019 and was replaced with a secured short-term derivative that qualified for the NPNS scope exception and expired on September 30, 2019.

The following table presents a reconciliation of the energy derivative instrument measured at fair value on a recurring basis using significant unobservable inputs (in millions):



	Three months ended September 30,					Nine months ended September 30,
Energy Derivative	2019		2018			2019			2018
Balances, beginning of period	$	—	$	12		$	7		$	27
Total gain (loss) included in electricity sales	—		2			1			(2		)
Settlements	—		(2		)	(8		)	(13		)
Balances, end of period	$	—	$	12		$	—		$	12

During the three and nine months ended September 30, 2019, the Company recognized unrealized losses of $0 million and $7 million, respectively, and $0 million and $15 million for the same periods in 2018, respectively, relating to the energy derivative instrument which were recorded to electricity sales on the consolidated statements of operations.

Contingent Consideration

As part of the Japan Acquisition, the Company is required to pay an additional earn-out of $118 million, which may be increased by $10 million if the final Tsugaru cost is less than or equal to the construction budget or may be decreased by $10 million if the final Tsugaru cost is greater than the construction budget, upon term conversion of the Tsugaru Construction Loan. The discounted fair value of the contingent consideration at the acquisition date was $103 million, subject to foreign currency exchange rate changes. In September 2019, the Company received a revised construction budget reflecting lower final construction costs than the original construction budget. Per the terms of the Japan Acquisition, to the extent construction costs are lower than budgeted, the contingent consideration will increase. As a result of the revised lower construction budget, an additional $10 million earn-out payment is due upon term conversion. The Company recorded $9 million as development expense for the three months ended September 30, 2019, with the additional $1 million to be recognized over the remaining construction period.

The Broadview Project acquisition includes contingent consideration, which requires the Company to make an additional payment upon the commercial operation of Grady, which occurred in August 2019. The contingent post-closing payment reflects the fair value of the Company's interest in the increase in the projected 25-year transmission wheeling revenue Western Interconnect will receive from Grady, adjusted for the estimated production loss incurred by Broadview due to wake effects and transmission losses induced by the operation of Grady. The fair value of the contingent consideration at the acquisition date was $21 million. Pursuant to the Fourth Amendment to the Purchase and Sale Agreement for the Broadview Project acquisition, the Company paid $25 million in contingent consideration in May 2019 to Pattern Energy Group LP, subject to a final adjustment. The Company recorded

an additional estimate of $4 million as development expense for the three months ended September 30, 2019 based on the expected final contingent consideration amount.

The estimated fair value of the contingent considerations were calculated by using a discounted cash flow technique which utilized unobservable inputs. This fair value measurement is based on significant inputs not observable in the market and thus represents a Level 3 measurement as defined in ASC 820, Fair Value Measurement. As of September 30, 2019, there were no significant changes in these unobservable inputs that may result in significant changes in fair value.

The following table presents a reconciliation of the contingent consideration liabilities measured at fair value on a recurring basis using significant unobservable inputs (in millions):



	Three months ended September 30,					Nine months ended September 30,
Contingent Consideration Liabilities	2019		2018			2019			2018
Balances, beginning of period	$	111	$	128		130			$	22
Purchase	—		—			—			106
Total loss included in development expenses	9		—			9			—
Total loss included in other expense, net	2		2			6			7
Foreign currency translation adjustments recognized in accumulated OCI	—		(2		)	2			(7		)
Settlement	—		(3		)	(25		)	(3		)
Balances, end of period	$	122	$	125		$	122		$	125

During the three and nine months ended September 30, 2019, the Company recognized unrealized losses of $2 million and $6 million, respectively, and during the three and nine months ended September 30, 2018, the Company recognized unrealized losses of $2 million and $7 million, respectively, relating to contingent liabilities which was recorded to other expense, net on the consolidated statements of operations.

The valuation techniques and significant unobservable inputs used in material recurring Level 3 fair value measurements were as follows (in millions, for fair value):



September 30, 2019	Fair Value	Valuation Technique	Significant Unobservable Inputs	Range
Tsugaru contingent consideration	$122	Discounted cash flow	Deferred purchase price	$109 - $128 million
			Discount rate	6.90%

December 31, 2018	Fair Value	Valuation Technique	Significant Unobservable Inputs	Range
Energy derivative	$7	Discounted cash flow	Forward electricity prices	$20.02-$32.58 ⁽¹⁾
			Discount rate	2.80%-2.81%

Broadview contingent consideration	$25	Discounted cash flow	Discount rate	4.0%-8.0%
			Annual energy production loss	0.70%

Tsugaru contingent consideration	$105	Discounted cash flow	Deferred purchase price	$109 - $128 million
			Discount rate	6.90%


⁽¹⁾	Represents price per MWh.

Financial Instruments Not Measured at Fair Value

The following table presents the carrying amount and fair value and the fair value hierarchy of the Company’s financial liabilities that are not measured at fair value in the consolidated balance sheets, but for which fair value is disclosed (in millions):



			Fair Value
	As reflected on the balance sheet		Level 1		Level 2		Level 3		Total
September 30, 2019
Total debt, net	$	2,565	$	—	$	2,584	$	—	$	2,584
December 31, 2018
Total debt, net	$	2,283	$	—	$	2,240	$	—	$	2,240

Long-term debt is presented on the consolidated balance sheets, net of financing costs, discounts and premiums. The fair value of variable interest rate long-term debt is approximated by its carrying cost. The fair value of fixed interest rate long-term debt is estimated based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied, using the net present value of cash flow streams over the term using estimated market rates for similar instruments and remaining terms.

- Definition

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

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