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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

x       QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

OR

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number: 1-16455

GenOn Energy, Inc.

(Exact Name of Registrant as Specified in Its Charter)

(832) 357-3000

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  x Yes  o No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  x Yes  o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  o Yes  x No

As of August 2, 2012, there were 772,908,115 shares of the registrant’s Common Stock, $0.001 par value per share, outstanding.

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Glossary of Certain Defined Terms

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

In addition to historical information, the information presented in this report includes forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act.  These statements involve known and unknown risks and uncertainties and relate to our revenues, income, capital structure and other financial items, future events, our future financial performance or our projected business results and our view of economic and market conditions.  In some cases, one can identify forward-looking statements by words such as “may,” “will,” “should,” “could,” “objective,” “projection,” “forecast,” “goal,” “guidance,” “outlook,” “expect,” “intend,” “seek,” “plan,” “think,” “anticipate,” “estimate,” “predict,” “target,” “potential” or “continue” or the negative of these terms or comparable words.

Forward-looking statements are only predictions.  Actual events or results may differ materially from any forward-looking statement as a result of various factors, which include:

·                  more stringent (or changes in the application of) environmental laws and regulations (including the cumulative effect of many such regulations) that restrict our ability or render it uneconomic to operate our assets, including regulations related to air emissions, disposal of ash and other byproducts, wastewater discharge and cooling water systems;

·                  changes in market conditions, including developments in the supply, demand, volume and pricing of electricity and other commodities such as coal and natural gas in the energy markets, including efforts to reduce demand for electricity and to encourage the development of renewable sources of electricity, and the extent and timing of the entry of additional competition in our markets;

·                  legislative and regulatory initiatives regarding deregulation, regulation or restructuring of the industry of generating, transmitting and distributing electricity (the electricity industry); changes in state, federal and other regulations affecting the electricity industry (including rate and other regulations); changes in tax laws and regulations to which we and our subsidiaries are subject; and changes in, or changes in the application of, other laws and regulations to which we and our subsidiaries and affiliates are or could become subject;

·                  conflicts between reliability needs and environmental rules, particularly with increasingly stringent environmental restrictions;

·                  price mitigation strategies employed by ISOs or RTOs that reduce our revenue and may result in a failure to compensate our generating units adequately for all of their costs;

·                  legal and political challenges to or changes in the rules used to calculate payments for capacity, energy and ancillary services or the establishment of bifurcated markets, incentives or other market design changes that give preferential treatment to new generating facilities over existing generating facilities;

·                  the failure of our generating facilities to perform as expected, including outages for unscheduled maintenance or repair;

·                  our failure to use new or advanced power generation technologies;

·                  strikes, union activity or labor unrest;

·                  our ability to develop or recruit capable leaders and our ability to retain or replace the services of key employees;

·                  weather and other natural phenomena, including hurricanes and earthquakes;

·                  our failure to provide a safe working environment for our employees and visitors thereby increasing our exposure to additional liability, loss of productive time, other costs and a damaged reputation;

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·                  hazards customary to the power generation industry, including those listed in this cautionary statement and elsewhere in this report,  and the possibility that we may not have adequate insurance to cover losses resulting from such hazards or the inability of our insurers to provide agreed upon coverage;

·                  our ability to execute our plan in respect of our Marsh Landing generating facility, including obtaining and maintaining the governmental authorizations necessary for construction and operation of the generating facility and completing the construction of the generating facility by mid-2013;

·                  our relative lack of geographic diversification of revenue sources resulting in concentrated exposure to the PJM market;

·                  our ability to enter into intermediate and long-term contracts to sell power or to hedge economically our expected future generation of power, and to obtain adequate supplies and deliveries of fuel for our generating facilities, at our required specifications and on terms and prices acceptable to us;

·                  failure to obtain adequate supplies of fuels, including from curtailments of the transportation of fuels;

·                  the cost and availability of emissions allowances;

·                  the curtailment of operations and reduced prices for electricity resulting from transmission constraints;

·                  the potential of additional limitation or loss of our income tax NOLs as a result of an ownership change as defined in IRC § 382;

·                  terrorist activities, cyberterrorism and inadequate cybersecurity, or the occurrence of a catastrophic loss and the possibility that we may not have adequate insurance to cover losses resulting from such hazards or the inability of our insurers to provide agreed upon coverage;

·                  deterioration in the financial condition of our counterparties, including financial counterparties, and the failure of such parties to pay amounts owed to us beyond collateral posted or to perform obligations or services due to us;

·                  poor economic and financial market conditions, including impacts on financial institutions and other current and potential counterparties, and negative impacts on liquidity in the power and fuel markets in which we hedge economically and transact;

·                  increased credit standards, margin requirements, market volatility or other market conditions that could increase our obligations to post collateral beyond amounts that are expected, including additional collateral costs associated with OTC hedging activities as a result of new or proposed laws, rules and regulations governing derivative financial instruments (such as the Dodd-Frank Act and related pending rulemaking proceedings);

·                  our inability to access effectively the OTC and exchange-based commodity markets or changes in commodity market conditions and liquidity, including as a result of new or proposed laws, rules and regulations governing derivative financial instruments (such as the Dodd-Frank Act and related pending rulemaking proceedings), which may affect our ability to engage in hedging and proprietary trading activities as expected, or may result in material losses from open positions;

·                  volatility in our gross margin as a result of changes in the fair value of our derivative financial instruments used in our hedging and proprietary trading activities and volatility in our cash flow from operations resulting from working capital requirements, including collateral, to support our hedging and proprietary trading activities;

·                  the disposition of pending or threatened litigation, including environmental litigation;

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·                  our ability to access contractors and equipment necessary to operate and maintain our generating facilities and to design, engineer, procure and construct capital improvements required or deemed advisable;

·                  the inability of our operating subsidiaries to generate sufficient cash to support our operations;

·                  the ability of lenders under our revolving credit facility and the Marsh Landing credit facility to perform their obligations;

·                  our consolidated indebtedness and the possibility that we or our subsidiaries may incur additional indebtedness in the future;

·                  restrictions on the ability of our subsidiaries to pay dividends, make distributions or otherwise transfer funds to us, including restrictions on GenOn Mid-Atlantic and REMA contained in their respective operating lease documents, which may affect our ability to access the cash flows of those subsidiaries to make debt service and other payments;

·                  our failure or inability to comply with provisions of our leases, loan agreements and debt, which may lead to a breach and, if not remedied, result in an event of default thereunder, which could result in such lessors, lenders and debt holders exercising remedies, limit access to needed liquidity and damage our reputation and relationships with financial institutions;

·                  covenants contained in our credit facilities, debt and leases that restrict our current and future operations, particularly our ability to respond to changes or take certain actions that may be in our long-term best interests;

·                  our ability to borrow additional funds and access capital markets; and

·                  the successful and timely completion of the proposed NRG Merger, which could be materially and adversely affected by, among other things, resolving any litigation brought in connection with the proposed NRG Merger, the timing and terms and conditions of required stockholder, governmental and regulatory approvals, and the ability to maintain relationships with employees, customers or suppliers as well as the ability to integrate the businesses and realize cost savings.

Many of these risks, uncertainties and assumptions are beyond our ability to control or predict.  All forward-looking statements contained herein are expressly qualified in their entirety by cautionary statements contained throughout this report.  Because of these risks, uncertainties and assumptions, you should not place undue reliance on these forward-looking statements.  Furthermore, forward-looking statements speak only as of the date they are made.  We undertake no obligation to update publicly or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this report.

In addition to the discussion of certain risks in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the accompanying notes to GenOn’s interim financial statements, other factors that could affect our future performance are set forth in our 2011 Annual Report on Form 10-K.  Our filings and other important information are also available on our investor relations page at www.genon.com/investors.aspx.

Certain Terms

As used in this report, unless the context requires otherwise, “we,” “us,” “our” and “GenOn” refer to GenOn Energy, Inc. and its consolidated subsidiaries.

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PART I

FINANCIAL INFORMATION

ITEM 1.      FINANCIAL STATEMENTS

GENON ENERGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements

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GENON ENERGY, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (UNAUDITED)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements

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GENON ENERGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements

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GENON ENERGY, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements

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GENON ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1.  Description of Business and Accounting and Reporting Policies

Background

We are a wholesale generator with approximately 22,700 MW of net electric generating capacity located, in many cases, near major metropolitan load centers in the PJM, MISO, Northeast and Southeast regions, and California.  We also operate integrated asset management and proprietary trading operations.  See note 2 for a discussion of generating facilities in the Eastern PJM, Western PJM/MISO and California segments that have units we have deactivated or expect to deactivate between 2012 and 2015.

We were formed as a Delaware corporation in August 2000.  “We,” “us,” “our” and “GenOn” refer to GenOn Energy, Inc. and, except where the context indicates otherwise, its subsidiaries, after giving effect to the Mirant/RRI Merger.

On July 20, 2012, we entered into the NRG Merger Agreement with NRG Energy, Inc. and a direct wholly-owned subsidiary of NRG.  See note 11.

Basis of Presentation

The consolidated interim financial statements and notes (interim financial statements) are unaudited, omit certain disclosures and should be read in conjunction with our audited consolidated financial statements and notes in our 2011 Annual Report on Form 10-K.  These interim financial statements have been prepared in accordance with GAAP from records maintained by us.  All significant intercompany accounts and transactions have been eliminated in consolidation.  The interim financial statements reflect all normal recurring adjustments necessary, in management’s opinion, to present fairly our financial position and results of operations for the reported periods.  Amounts reported for interim periods may not be indicative of a full year period because of seasonal fluctuations in demand for electricity and energy services, changes in commodity prices, and changes in regulations, timing of maintenance and other expenditures, dispositions, changes in interest expense and other factors.

At June 30, 2012 and December 31, 2011, substantially all of our subsidiaries are wholly-owned and located in the United States.  We do not consolidate five power generating facilities, which are under operating leases; a 50% equity investment in a cogeneration facility; and a VIE (MC Asset Recovery) for which we are not the primary beneficiary.  See note 10 for further discussion of MC Asset Recovery.

The preparation of interim financial statements in conformity with GAAP requires management to make various estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the interim financial statements and the reported amounts of revenues and expenses during the period.  Actual results could differ from those estimates.  Our significant estimates include:

·                  estimating the fair value of certain derivative contracts;

·                  estimating the inventory reserve;

·                  estimating future taxable income in evaluating the deferred tax asset valuation allowance;

·                  estimating the useful lives of long-lived assets;

·                  estimating future costs and the valuation of asset retirement obligations;

·                  estimating future cash flows in determining impairments of long-lived assets and definite-lived intangible assets;

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·                  estimating the fair value and expected return on plan assets, discount rates and other actuarial assumptions used in estimating pension and other postretirement benefit plan liabilities; and

·                  estimating losses to be recorded for contingent liabilities.

We evaluate events that occur after the balance sheet date but before the financial statements are issued for potential recognition or disclosure.  Based on the evaluation, we determined that there were no material subsequent events for recognition or disclosure other than those disclosed herein.

Our results of operations for the three and six months ended June 30, 2011 have been retroactively amended for the revisions to the provisional purchase price allocation in connection with the Mirant/RRI Merger.

We had disclosed in our 2011 Annual Report on Form 10-K that it was possible that RRI Energy had experienced an ownership change under the applicable tax rules as a result of the Mirant/RRI Merger.  Based on further inquiries, we do not think that RRI Energy experienced an ownership change as a result of the Mirant/RRI Merger or following the Mirant/RRI Merger through December 31, 2011.

Funds on Deposit

Funds on deposit are included in current and noncurrent assets in the consolidated balance sheets.  Funds on deposit include the following:

(1)   Includes $32 million related to the Potomac River obligation under the 2008 agreement with the City of Alexandria.  See note 2.

(2)   Represents cash under surety bonds posted primarily with the PADEP related to environmental obligations.

(3)   Represents cash-collateralized letters of credit to support the Marsh Landing development project.

(4)   Represents deposits with the State of Pennsylvania to guarantee our obligations related to future closures of coal ash landfill sites and with the State of New Jersey to satisfy our obligations to remediate site contamination.  See note 10.

(5)   Represents cash reserved in respect of interlocutory liens related to the scrubber contract litigation, which was settled in June 2012.  See note 10.

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Inventories

Inventories were comprised of the following:

(1)         Amount is net of an inventory reserve of $35 million and $0 at June 30, 2012 and December 31, 2011, respectively.  See note 2.

During the three months ended June 30, 2012 and 2011, we recorded $19 million and $1 million, respectively, and during the six months ended June 30, 2012 and 2011, we recorded $65 million and $1 million, respectively, for lower of average cost or market valuation adjustments in cost of fuel, electricity and other products.

Capitalization of Interest Cost

We incurred the following interest costs:

The amounts of capitalized interest above include interest accrued.  During the three months ended June 30, 2012 and 2011, cash paid for interest was $164 million and $201 million, respectively, of which $10 million and $4 million, respectively, were capitalized.  During the six months ended June 30, 2012 and 2011, cash paid for interest was $180 million and $218 million, respectively, of which $15 million and $5 million, respectively, were capitalized.

Guarantees and Indemnifications

We generally conduct business through various operating subsidiaries which enter into contracts as part of their business activities.  In certain instances, the contractual obligations of such subsidiaries are guaranteed by, or otherwise supported by, us or another of our subsidiaries, including by letters of credit issued under the GenOn credit facilities.  See note 4.

In addition, we, including our subsidiaries, enter into various contracts that include indemnification and guarantee provisions.  Examples of these contracts include financing and lease arrangements, purchase and sale agreements, agreements to purchase or sell commodities, construction agreements and agreements with vendors.  Although the primary obligation under such contracts is to pay money or render performance, such contracts may include obligations to indemnify the counterparty for damages arising from the breach thereof and, in certain instances, other existing or potential liabilities.  In many cases, our maximum potential liability cannot be estimated because some of the underlying agreements contain no limits on potential liability.

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We have guaranteed some non-qualified benefits of CenterPoint’s existing retirees at September 20, 2002.  The estimated maximum potential amount of future payments under the guarantee is $55 million at June 30, 2012 and $3 million is recorded in the consolidated balance sheet for this item.

Recently Adopted Accounting Guidance

Fair Value Measurement and Disclosure.  We adopted FASB accounting guidance for the quarter ended March 31, 2012 that requires disclosure of the following:

·                  quantitative information about the unobservable inputs used in a fair value measurement that is categorized within Level 3 of the fair value hierarchy;

·                  for those fair value measurements categorized within Level 3 of the fair value hierarchy, both the valuation processes used and the sensitivity of the fair value measurement to changes in unobservable inputs and the interrelationships between those unobservable inputs, if any; and

·                  the categorization by level of the fair value hierarchy for items that are not measured at fair value in the statement of financial position but for which the fair value is required to be disclosed.

See note 3 for these additional disclosures.

Comprehensive Income.  We adopted FASB accounting guidance for the quarter ended March 31, 2012 that requires companies to report the components of comprehensive income in either (a) a continuous statement of comprehensive income or (b) two separate but consecutive statements.  The guidance does not change the items that must be reported in comprehensive income.  See the consolidated statements of comprehensive loss and note 8.

New Accounting Guidance Not Yet Adopted at June 30, 2012

Balance Sheet Offsetting.  In December 2011, the FASB issued updated guidance to provide enhanced disclosures such that users of the financial statements will be able to better evaluate the effect or potential effect of netting arrangements in the balance sheet.  The guidance requires improved information about financial instruments and derivative instruments that are either offset according to specific guidance or subject to an enforceable master netting agreement or similar arrangement.  The disclosures will provide both net and gross information for these assets and liabilities.  Although we do not currently elect to offset assets and liabilities within the scope of the guidance, expanded disclosures will be required starting for the quarter ended March 31, 2013, along with retrospective presentation of prior periods.

2.  Expected Retirements, Mothballing or Long-Term Protective Layup of Generating Facilities

Facilities Announced in February and March 2012

We are subject to extensive environmental regulation by federal, state and local authorities under a variety of statutes, regulations and permits that address discharges into the air, water and soil, and the proper handling of solid, hazardous and toxic materials and waste.  Complying with increasingly stringent environmental requirements involves significant capital and operating expenses.  To the extent forecasted returns on investments necessary to comply with environmental regulations are insufficient for a particular facility, we plan to deactivate that facility.  In determining the forecasted returns on investments, we factor in forecasted energy and capacity prices, expected capital expenditures, operating costs, property taxes and other factors.  We deactivated the following coal-fired units at the referenced times:  Niles unit 2 (108 MW) June 2012 and Elrama units 1-3 (289 MW) mothballed June 2012 (plan to retire in March 2014).  We expect to deactivate the following generating capacity, primarily coal-fired units, at the referenced times:  Niles unit 1 (109 MW) October 2012, Elrama unit 4 (171 MW) mothball October 2012 (plan to retire in March 2014), Portland (401 MW) January 2015, Avon Lake (732 MW) April 2015, New Castle (330 MW) April 2015, Titus (243 MW) April 2015, Shawville (597 MW) place in long-term protective layup in April 2015 and Glen Gardner (160 MW) May 2015.  We filed for RMR arrangements for Niles unit 1 and Elrama unit 4 that are in effect from June 1 through September 30, 2012.  These RMR arrangements are subject to final FERC rulings.

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Potomac River Generating Facility

During 2011, we entered into an agreement with the City of Alexandria, Virginia to remove permanently from service our Potomac River generating facility. The agreement, which amends our Project Schedule and Agreement, dated July 2008 with the City of Alexandria, provides for the retirement of the Potomac River generating facility on October 1, 2012, subject to the determination of PJM that the retirement of the facility will not affect reliability and the consent of PEPCO.  PJM made the necessary determination and in June 2012 PEPCO gave its consent.  As a result, the Potomac River generating facility will be retired on October 1, 2012.  Upon retirement of the Potomac River generating facility, all funds in the escrow account ($32 million) established under the July 2008 agreement will be distributed to us, provided, that, if the retirement of the facility occurs after January 1, 2014, $750,000 of such funds will be paid to the City of Alexandria.  We therefore reversed $31 million of the previously recorded obligation under the 2008 agreement with the City of Alexandria as a reduction in operations and maintenance expense during the three months ended June 30, 2012.

Contra Costa Generating Facility

We entered into an agreement with PG&E in September 2009 for 674 MW at Contra Costa for the period from November 2011 through April 2013.  At the end of the agreement, and subject to any necessary regulatory approvals, we have agreed to retire the Contra Costa facility.

Expenses, Property, Plant and Equipment, and Materials and Supplies Inventory Related to Deactivations

In connection with our decision to deactivate the generating facilities, we evaluated our materials and supplies inventory and determined that we have excess inventory.  We established a reserve of $35 million (or $(0.04) per basic share) recorded to operations and maintenance expense during the three months ended March 31, 2012 relating to our excess inventory.  We will continue to monitor the inventory balances and could have changes to the reserve in the future.  At June 30, 2012, the aggregate carrying value of property, plant and equipment, net and materials and supplies inventory, net for the ten generating facilities to be deactivated was $181 million and $25 million, respectively.  In addition to the excess materials and supplies inventory reserve recorded in the first quarter, we incurred $3 million during the three months ended June 30, 2012 for costs to deactivate generating facilities, which is included in operations and maintenance expense.  We expect to incur additional costs in the future in connection with the deactivations, such as severance and other shutdown costs.

3.  Financial Instruments

Derivatives and Hedging Activities

In connection with the business of generating electricity, we are exposed to energy commodity price risk associated with the acquisition of fuel and emissions allowances needed to generate electricity, the price of electricity produced and sold, and the fair value of fuel inventories.  Through our asset management activities, we enter into a variety of exchange-traded and OTC energy and energy-related derivative financial instruments, such as forward contracts, futures contracts, option contracts and financial swap agreements to manage exposure to commodity price risks.  These contracts have varying terms and durations, which range from a few days to years, depending on the instrument.  Our proprietary trading activities also utilize similar derivative contracts in markets where we have a physical presence to attempt to generate incremental gross margin.  Our fuel oil management activities use derivative financial instruments to hedge economically the fair value of physical fuel oil inventories, optimize the approximately two million barrels of storage capacity that we own, and attempt to profit from market opportunities related to timing and/or differences in the pricing of various products.  The open positions in our trading activities comprising proprietary trading and fuel oil management activities expose us to risks associated with changes in energy commodity prices.

Derivative financial instruments are recorded in the consolidated balance sheets at fair value, except for derivative contracts that qualify for and for which we have elected the normal purchase or normal sale exceptions, which are not reflected in the consolidated balance sheet or results of operations prior to accrual of the settlement.  We present our derivative contract assets and liabilities on a gross basis (regardless of master netting arrangements with the same counterparty).  Cash collateral amounts are also presented on a gross basis.

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During the second quarter of 2012, we could no longer assert that physical delivery was probable for the remaining coal agreements for which we had elected the normal purchase exception.  As such, the normal purchase exception was removed, and we recorded the fair value of these contracts on the balance sheet at June 30, 2012 as a net derivative liability of $49 million and immediately recognized that amount in earnings as unrealized losses in cost of fuel, electricity and other products.

If certain criteria are met, a derivative financial instrument may be designated as a fair value hedge or cash flow hedge.  In 2010, GenOn Marsh Landing entered into interest rate protection agreements (interest rate swaps) in connection with its project financing, which have been designated as cash flow hedges.  GenOn Marsh Landing entered into the interest rate swaps to reduce the risks with respect to the variability of the interest rates for the term loan.  With the exception of these interest rate swaps, we did not have any other derivative financial instruments designated as fair value or cash flow hedges for accounting purposes during the six months ended June 30, 2012 or 2011.

The changes in fair value of cash flow hedges are deferred in accumulated other comprehensive loss, net of tax, to the extent the contracts are, or have been, effective as hedges, until the forecasted transactions affect earnings.  We record immediately into earnings the ineffective portion of changes in fair value of cash flow hedges.

Derivative financial instruments designated as cash flow hedges must have a high correlation between price movements in the derivative and the hedged item.  If and when an acceptable level of correlation no longer exists, hedge accounting ceases and changes in fair value are recognized in our results of operations.  If it becomes probable that a forecasted transaction will not occur, we immediately recognize the related deferred gains or losses in our results of operations.  Changes in fair value of the associated hedging instrument are then recognized immediately in earnings for the remainder of the contract term unless a new hedging relationship is designated.

For our derivative financial instruments that have not been designated as cash flow hedges for accounting purposes, changes in such instruments’ fair values are recognized currently in earnings.  Our derivative financial instruments are categorized based on the business objective the instrument is expected to achieve:  asset management or trading, which includes proprietary trading and fuel oil management.  For asset management activities, changes in fair value and settlement of derivative financial instruments used to hedge electricity economically are reflected in operating revenue and changes in fair value and settlement of derivative financial instruments used to hedge fuel economically are reflected in cost of fuel, electricity and other products in the consolidated statements of operations.  Changes in the fair value and settlements of derivative financial instruments for proprietary trading and fuel oil management activities are recorded on a net basis as operating revenue in the consolidated statements of operations.

We also consider risks associated with interest rates, counterparty credit and our own non-performance risk when valuing derivative financial instruments.  The nominal value of the derivative contract assets and liabilities is discounted to account for time value using a LIBOR forward interest rate curve based on the tenor of the transactions being valued.

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The following table presents the fair value of derivative financial instruments: