Derivative and Hedging Instruments

9 Months Ended

Sep. 30, 2019

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative and Hedging Instruments

Derivative and Hedging Instruments - MGE Energy and MGE.

a.Purpose.

As part of its regular operations, MGE enters into contracts, including options, swaps, futures, forwards, and other contractual commitments, to manage its exposure to commodity prices. To the extent that these contracts are derivatives, MGE assesses whether or not the normal purchases or normal sales exclusion applies. For contracts to which this exclusion cannot be applied, the derivatives are recognized in the consolidated balance sheets at fair value. MGE's financial commodity derivative activities are conducted in accordance with its electric and gas risk management program, which is approved by the PSCW and limits the volume MGE can hedge with specific risk management strategies. The maximum length of time over which cash flows related to energy commodities can be hedged is four years. If the derivative qualifies for regulatory deferral, the derivatives are marked to fair value and are offset with a corresponding regulatory asset or liability depending on whether the derivative is in a net loss or net gain position, respectively. The deferred gain or loss is recognized in earnings in the delivery month applicable to the instrument. Gains and losses related to hedges qualifying for regulatory treatment are recoverable in gas rates through the PGA or in electric rates as a component of the fuel rules mechanism.

b.Notional Amounts.

The gross notional volume of open derivatives is as follows:

	September 30, 2019		December 31, 2018
Commodity derivative contracts	466,760	MWh	386,440	MWh
Commodity derivative contracts	9,190,000	Dth	5,260,000	Dth
FTRs	4,282	MW	2,252	MW
PPA	1,600	MW	2,050	MW

c.Financial Statement Presentation.

MGE purchases and sells exchange-traded and over-the-counter options, swaps, and future contracts. These arrangements are primarily entered into to help stabilize the price risk associated with gas or power purchases. These transactions are employed by both MGE's gas and electric segments. Additionally, as a result of the firm transmission agreements that MGE holds on electricity transmission paths in the MISO market, MGE holds financial transmission rights (FTRs). An FTR is a financial instrument that entitles the holder to a stream of revenues or charges based on the differences in hourly day-ahead energy prices between two points on the transmission grid. The fair values of these instruments are offset with a corresponding regulatory asset/liability depending on whether they are in a net loss/gain position. Depending on the nature of the instrument, the gain or loss associated with these transactions will be reflected as cost of gas sold, fuel for electric generation, or purchased power expense in the delivery month applicable to the instrument. As of September 30, 2019, the cost basis of exchange traded derivatives and FTRs exceeded their fair value by $0.2 million. As of December 31, 2018, the fair value of exchange traded derivatives and FTRs exceeded their cost basis by $0.7 million.

MGE is a party to a purchased power agreement that provides MGE with firm capacity and energy during a base term from June 1, 2012, through May 31, 2022. The agreement also allows MGE an option to extend the contract after the base term. The agreement is accounted for as a derivative contract and is recognized at its fair value on the consolidated balance sheets. However, the derivative qualifies for regulatory deferral and is recognized with a corresponding regulatory asset or liability depending on whether the fair value is in a loss or gain position. The fair value of the contract as of September 30, 2019, and December 31, 2018, reflects a loss position of $29.0 million and $32.5 million, respectively. The actual cost will be recognized in purchased power expense in the month of purchase.

The following table summarizes the fair value of the derivative instruments on the consolidated balance sheets. All derivative instruments in this table are presented on a gross basis and are calculated prior to the netting of instruments with the same counterparty under a master netting agreement as well as the netting of collateral. For financial statement purposes, instruments are netted with the same counterparty under a master netting agreement as well as the netting of collateral. As of September 30, 2019, and December 31, 2018, the receivable margin account balance of $1.6 million and $1.2 million, respectively, is shown net of any collateral posted against derivative positions.

		Derivative		Derivative
(In thousands)		Assets		Liabilities	Balance Sheet Location
September 30, 2019
Commodity derivative contracts	$	668	$	996	Other current assets(a)
Commodity derivative contracts		81		289	Other deferred charges(a)
FTRs		344		-	Other current assets
PPA		N/A		10,390	Derivative liability (current)
PPA		N/A		18,600	Derivative liability (long-term)
December 31, 2018
Commodity derivative contracts	$	727	$	270	Other current assets
Commodity derivative contracts		74		72	Other deferred charges
FTRs		241		-	Other current assets
PPA		N/A		8,550	Derivative liability (current)
PPA		N/A		23,980	Derivative liability (long-term)

(a)As of September 30, 2019, collateral of $0.7 million was posted against and netted with derivative liability positions on the consolidated balance sheets. No collateral was posted against derivative positions as of December 31, 2018.

The following tables show the effect of netting arrangements for recognized derivative assets and liabilities that are subject to a master netting arrangement or similar arrangement on the consolidated balance sheets.

Offsetting of Derivative Assets
(In thousands)		Gross Amounts		Gross Amounts Offset in Balance Sheets		Collateral Posted Against Derivative Positions		Net Amount Presented in Balance Sheets
September 30, 2019
Commodity derivative contracts	$	749	$	(561)	$	-	$	188
FTRs		344		-		-		344
December 31, 2018
Commodity derivative contracts	$	801	$	(342)	$	-	$	459
FTRs		241		-		-		241

Offsetting of Derivative Liabilities
(In thousands)		Gross Amounts		Gross Amounts Offset in Balance Sheets		Collateral Posted Against Derivative Positions		Net Amount Presented in Balance Sheets
September 30, 2019
Commodity derivative contracts	$	1,285	$	(561)	$	(724)	$	-
PPA		28,990		-		-		28,990
December 31, 2018
Commodity derivative contracts	$	342	$	(342)	$	-	$	-
PPA		32,530		-		-		32,530

The following tables summarize the unrealized and realized gains (losses) related to the derivative instruments on the consolidated balance sheets and the consolidated statements of income.

		2019				2018
(In thousands)		Current and Long-Term Regulatory Asset		Other Current Assets		Current and Long-Term Regulatory Asset		Other Current Assets
Three Months Ended September 30:
Balance at July 1,	$	33,515	$	878	$	36,924	$	640
Unrealized gain		(4,560)		-		(2,007)		-
Realized (loss) gain reclassified to a deferred account		(411)		411		(316)		316
Realized gain (loss) reclassified to income statement		638		(258)		29		(62)
Balance as of September 30,	$	29,182	$	1,031	$	34,630	$	894
Nine Months Ended September 30:
Balance at January 1,	$	31,830	$	377	$	41,958	$	806
Unrealized gain		(2,256)		-		(5,906)		-
Realized (loss) gain reclassified to a deferred account		(1,402)		1,402		(837)		837
Realized gain (loss) reclassified to income statement		1,010		(748)		(585)		(749)
Balance as of September 30,	$	29,182	$	1,031	$	34,630	$	894

		Realized Losses (Gains)
		2019				2018
(In thousands)		Fuel for Electric Generation/ Purchased Power		Cost of Gas Sold		Fuel for Electric Generation/ Purchased Power		Cost of Gas Sold
Three Months Ended September 30:
Commodity derivative contracts	$	471	$	83	$	(145)	$	-
FTRs		(429)		-		(150)		-
PPA		(505)		-		328		-
Nine Months Ended September 30:
Commodity derivative contracts	$	1,038	$	460	$	39	$	637
FTRs		(503)		-		(625)		-
PPA		(1,257)		-		1,283		-

MGE's commodity derivative contracts, FTRs, and PPA are subject to regulatory deferral. These derivatives are marked to fair value and are offset with a corresponding regulatory asset or liability. Realized gains and losses are deferred on the consolidated balance sheets and are recognized in earnings in the delivery month applicable to the instrument. As a result of the above described treatment, there are no unrealized gains or losses that flow through earnings.

The PPA has a provision that may require MGE to post collateral if MGE's debt rating falls below investment grade (i.e., below BBB-). The amount of collateral that it may be required to post varies from $20.0 million to $40.0 million, depending on MGE's nominated capacity amount. As of September 30, 2019, no collateral is required to be, or has been, posted. Certain counterparties extend MGE a credit limit. If MGE exceeds these limits, the counterparties may require collateral to be posted. No counterparties were in a net liability position as of September 30, 2019, and December 31, 2018.

Nonperformance of counterparties to the non-exchange traded derivatives could expose MGE to credit loss. However, MGE enters into transactions only with companies that meet or exceed strict credit guidelines, and it monitors these counterparties on an ongoing basis to mitigate nonperformance risk in its portfolio. As of September 30, 2019, no counterparties have defaulted.