Fair Value

A fair value measurement is required to reflect the assumptions market participants would use in pricing an asset or liability based on the best available information.

Fair value is 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 (exit price). We use a mid-market pricing convention (the mid-point price between bid and ask prices) as a practical measure for valuing certain derivative assets and liabilities.

Fair value accounting rules provide a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). The three levels of the fair value hierarchy are defined as follows:

Level 1 – Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

Level 2 – Pricing inputs are observable, either directly or indirectly, but are not quoted prices included within Level 1. Level 2 includes those financial instruments that are valued using external inputs within models or other valuation methods.

Level 3 – Pricing inputs include significant inputs that are generally less observable from objective sources. These inputs may be used with internally developed methods that result in management's best estimate of fair value. Level 3 instruments include those that may be more structured or otherwise tailored to customers' needs.

Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

When possible, we base the valuations of our risk management assets and liabilities on quoted prices for identical assets in active markets. These valuations are classified in Level 1. The valuations of certain contracts not classified as Level 1 may be based on quoted market prices received from counterparties and/or observable inputs for similar instruments. Transactions valued using these inputs are classified in Level 2.

Certain derivatives are categorized in Level 3 due to the significance of unobservable or internally-developed inputs. The primary reasons for a Level 3 classification are as follows:


•	Financial contracts used to manage transmission congestion costs in the MISO market are valued using historical prices.


•	The valuations for certain physical coal contracts are based on significant assumptions made to extrapolate prices from the last observable period through the end of the transaction term.


•	Certain natural gas contracts are valued using internally-developed inputs due to the absence of available market data for certain locations.

We have established risk oversight committees whose primary responsibility includes directly or indirectly ensuring that all valuation methods are applied in accordance with predefined policies. The development and maintenance of our forward price curves has been assigned to our risk management department. This department is separate and distinct from any of the supply functions within the organization. To validate the reasonableness of our fair value inputs, our risk management department compares changes in valuation and researches any significant differences in order to determine the underlying cause. Changes to the fair value inputs are made if necessary.

We conduct a thorough review of fair value hierarchy classifications on a quarterly basis.

The following tables show assets and liabilities that were accounted for at fair value on a recurring basis, categorized by level within the fair value hierarchy:



	June 30, 2015
(Millions)	Level 1		Level 2		Level 3		Total
Assets
Risk Management Assets
Natural gas contracts	$	1.4	$	2.2	$	—	$	3.6
Financial transmission rights (FTRs)	—		—		4.1		4.1
Total Risk Management Assets	$	1.4	$	2.2	$	4.1	$	7.7

Investment in exchange-traded funds	$	107.5	$	—	$	—	$	107.5

Liabilities
Risk Management Liabilities
Natural gas contracts	$	1.4	$	21.0	$	—	$	22.4
Petroleum product contracts	0.9		—		—		0.9
Coal contracts	—		0.8		5.4		6.2
Total Risk Management Liabilities	$	2.3	$	21.8	$	5.4	$	29.5



	December 31, 2014
(Millions)	Level 1		Level 2		Level 3		Total
Assets
Risk Management Assets
Natural gas contracts	$	—	$	2.3	$	—	$	2.3
FTRs	—		—		2.2		2.2
Total Risk Management Assets	$	—	$	2.3	$	2.2	$	4.5

Investment in exchange-traded funds	$	102.4	$	—	$	—	$	102.4

Liabilities
Risk Management Liabilities
Natural gas contracts	$	4.8	$	31.2	$	6.6	$	42.6
FTRs	—		—		0.3		0.3
Petroleum product contracts	2.8		—		—		2.8
Coal contracts	—		1.2		2.2		3.4
Total Risk Management Liabilities	$	7.6	$	32.4	$	9.1	$	49.1

The risk management assets and liabilities listed in the tables above include options, swaps, futures, physical commodity contracts, and other instruments used to manage market risks related to changes in commodity prices. They also include FTRs, which are used to manage electric transmission congestion costs in the MISO market. See Note 17, Risk Management Activities, for more information.

There were no transfers between the levels of the fair value hierarchy during the three or six months ended June 30, 2015, and 2014.

The amounts listed in the table below represent the range of unobservable inputs used in the valuations that individually had a significant impact on the fair value determination and caused a derivative to be classified as Level 3 at June 30, 2015:

Fair Value (Millions)

Assets

Liabilities

Valuation Technique

Unobservable Input

Average or Range

FTRs

4.1

—

Market-based

Forward market prices ($/megawatt-month)⁽¹⁾

$172.71

Coal contracts

—

5.4

Market-based

Forward market prices ($/ton) ⁽²⁾

$9.86 – $13.23


⁽¹⁾	Represents forward market prices developed using historical cleared pricing data from MISO.


⁽²⁾	Represents third-party forward market pricing.

Significant changes in historical settlement prices or forward coal prices would result in a directionally similar significant change in fair value.

The following tables set forth a reconciliation of changes in the fair value of items categorized as Level 3 measurements:



Three Months Ended June 30, 2015
(Millions)				FTRs			Coal Contracts			Total
Balance at the beginning of the period				$	0.6		$	(6.2	)	$	(5.6	)
Net realized losses included in earnings				(1.2		)	—			(1.2		)
Net unrealized (losses) gains recorded as regulatory assets or liabilities				(4.8		)	0.3			(4.5		)
Purchases				9.8			—			9.8
Settlements				(0.3		)	0.5			0.2
Balance at the end of the period				$	4.1		$	(5.4	)	$	(1.3	)

Three Months Ended June 30, 2014
(Millions)				FTRs			Coal Contracts			Total
Balance at the beginning of the period				$	0.5		$	0.3		$	0.8
Net realized gains included in earnings				0.1			—			0.1
Net unrealized gains recorded as regulatory assets or liabilities				0.1			0.8			0.9
Purchases				4.4			—			4.4
Settlements				(1.1		)	(0.2		)	(1.3		)
Balance at the end of the period				$	4.0		$	0.9		$	4.9

Six Months Ended June 30, 2015
(Millions)	Natural Gas Contracts			FTRs			Coal Contracts			Total
Balance at the beginning of the period	$	(6.6	)	$	1.9		$	(2.2	)	$	(6.9	)
Net realized losses included in earnings	—			(2.4		)	—			(2.4		)
Net unrealized losses recorded as regulatory assets or liabilities	—			(5.0		)	(4.0		)	(9.0		)
Purchases	—			9.8			—			9.8
Settlements	6.6			(0.2		)	0.8			7.2
Balance at the end of the period	$	—		$	4.1		$	(5.4	)	$	(1.3	)

Six Months Ended June 30, 2014
(Millions)				FTRs			Coal Contracts			Total
Balance at the beginning of the period				$	1.2		$	(2.5	)	$	(1.3	)
Net realized gains included in earnings				0.8			—			0.8
Net unrealized gains recorded as regulatory assets or liabilities				0.1			3.0			3.1
Purchases				4.3			—			4.3
Settlements				(2.4		)	0.4			(2.0		)
Balance at the end of the period				$	4.0		$	0.9		$	4.9

Unrealized gains and losses on Level 3 derivatives are deferred as regulatory assets or liabilities. Therefore, these fair value measurements have no impact on earnings. Realized gains and losses on these instruments flow through cost of sales on the statements of income.

Fair Value of Financial Instruments

The following table shows the financial instruments included on our balance sheets that are not recorded at fair value:



	June 30, 2015				December 31, 2014
(Millions)	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Long-term debt	$	3,081.3	$	3,112.9	$	3,081.3	$	3,271.4
Preferred stock of subsidiary	51.1		53.1		51.1		51.8

The fair values of long-term debt instruments are estimated based on the quoted market price for the same or similar issues, or on the current rates offered to us for debt of the same remaining maturity. The fair values of preferred stock are estimated based on quoted market prices when available, or by using a perpetual dividend discount model. The fair values of long-term debt instruments and preferred stock are categorized within Level 2 of the fair value hierarchy.

Due to the short-term nature of cash and cash equivalents, accounts receivable, accounts payable, and outstanding commercial paper, the carrying amount for each of these items approximates fair value.