EME 2012 Q1
Table of Contents

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________

FORM 10-Q
(Mark one)
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2012
 
or
¨
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 333-68630

_______________________

EDISON MISSION ENERGY
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation
or organization)
95-4031807
(I.R.S. Employer Identification No.)
3 MacArthur Place, Suite 100
Santa Ana, California
(Address of principal executive offices)
92707
(Zip Code)

Registrant's telephone number, including area code: (714) 513-8000
_______________________

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. YES x NO o
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). YES x NO o
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.
Large accelerated filer o
 
Accelerated filer o
 
Non-accelerated filer x
 
Smaller reporting company o
 
 
 
 
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO x
Number of shares outstanding of the registrant's Common Stock as of May 2, 2012: 100 shares (all shares held by an affiliate of the registrant).
 



Table of Contents

TABLE OF CONTENTS

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

i
Table of Contents

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

ii
Table of Contents

 
 
 
 

iii
Table of Contents


















(This page has been left blank intentionally.)

iv
Table of Contents

GLOSSARY
When the following terms and abbreviations appear in the text of this report, they have the meanings indicated below.
2010 Tax Relief Act
Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010
ACI
activated carbon injection
AOI
adjusted operating income (loss)
ARO(s)
asset retirement obligation(s)
BACT
best available control technology
BART
best available retrofit technology
bcf
billion cubic feet
Big 4
Kern River, Midway-Sunset, Sycamore and Watson natural gas power projects
Btu
British thermal units
CAA
Clean Air Act
CAIR
Clean Air Interstate Rule
CAMR
Clean Air Mercury Rule
CARB
California Air Resources Board
CO2
carbon dioxide
coal plants
Midwest Generation coal plants and Homer City electric generating station
Commonwealth Edison
Commonwealth Edison Company
CPS
Combined Pollutant Standard
CPUC
California Public Utilities Commission
CSAPR
Cross-State Air Pollution Rule
EIA
Energy Information Administration
EME
Edison Mission Energy
EMMT
Edison Mission Marketing & Trading, Inc.
ERCOT
Electric Reliability Council of Texas
FASB
Financial Accounting Standards Board
FERC
Federal Energy Regulatory Commission
FGD
flue gas desulfurization
FPA
Federal Power Act
GAAP
United States generally accepted accounting principles
GECC
General Electric Capital Corporation
GHG
greenhouse gas
GWh
gigawatt-hours
Homer City
EME Homer City Generation L.P.
Illinois EPA
Illinois Environmental Protection Agency
ISO(s)
independent system operator(s)
Lehman
Lehman Brothers Commodity Services, Inc. and Lehman Brothers Holdings, Inc.
LIBOR
London Interbank Offered Rate
MATS
Mercury and Air Toxics Standards
Midwest Generation
Midwest Generation, LLC
MISO
Midwest Independent Transmission System Operator
MMBtu
million British thermal units

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Table of Contents

Moody's
Moody's Investors Service, Inc.
MW
megawatts
MWh
megawatt-hours
NAAQS
National Ambient Air Quality Standard(s)
NAPP
Northern Appalachian
NERC
North American Electric Reliability Corporation
NID
Novel Integrated Desulfurization
NOX
nitrogen oxide
NSR
New Source Review
NYISO
New York Independent System Operator
PADEP
Pennsylvania Department of Environmental Protection
PG&E
Pacific Gas & Electric Company
PJM
PJM Interconnection, LLC
PRB
Powder River Basin
PSD
Prevention of Significant Deterioration
RPM
Reliability Pricing Model
RTO(s)
regional transmission organization(s)
S&P
Standard & Poor's Ratings Services
SCE
Southern California Edison Company
SIP(s)
state implementation plan(s)
SNCR
selective non-catalytic reduction
SO2
sulfur dioxide
US EPA
United States Environmental Protection Agency
U.S. Treasury grants
Cash grants, under the American Recovery and Reinvestment Act of 2009
VIE(s)
variable interest entity(ies)



vi
Table of Contents

PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS

EDISON MISSION ENERGY AND SUBSIDIARIES
 

CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, unaudited)

 
Three Months Ended March 31,
 
2012
 
2011
Operating Revenues
$
443

 
$
550

Operating Expenses
 
 
 
Fuel
206

 
182

Plant operations
156

 
192

Plant operating leases
38

 
44

Depreciation and amortization
68

 
72

Loss on disposal and asset impairments
14

 
—

Administrative and general
46

 
43

Total operating expenses
528

 
533

Operating income (loss)
(85
)
 
17

Other Income (Expense)
 
 
 
Equity in loss from unconsolidated affiliates
(1
)
 
(5
)
Dividend income
—

 
1

Interest income
—

 
1

Interest expense
(86
)
 
(80
)
Other income (expense), net
—

 
3

Total other expense
(87
)
 
(80
)
Loss from continuing operations before income taxes
(172
)
 
(63
)
Benefit for income taxes
(91
)
 
(45
)
Loss From Continuing Operations
(81
)
 
(18
)
Loss from Operations of Discontinued Subsidiaries, net of tax (Note 13)
(1
)
 
(2
)
Net Loss
(82
)
 
(20
)
Net Income Attributable to Noncontrolling Interests (Note 3)
(2
)
 
—

Net Loss Attributable to Edison Mission Energy Common Shareholder
$
(84
)
 
$
(20
)
Amounts Attributable to Edison Mission Energy Common Shareholder
 
 
 
Loss from continuing operations, net of tax
$
(83
)
 
$
(18
)
Loss from discontinued operations, net of tax
(1
)
 
(2
)
Net Loss Attributable to Edison Mission Energy Common Shareholder
$
(84
)
 
$
(20
)


The accompanying notes are an integral part of these consolidated financial statements.
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EDISON MISSION ENERGY AND SUBSIDIARIES
 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in millions, unaudited)

 
Three Months Ended March 31,
 
2012
 
2011
Net Loss
$
(82
)
 
$
(20
)
Other comprehensive income (loss), net of tax
 
 
 
Pension and postretirement benefits other than pensions
 
 
 
Net gain (loss) adjustment, net of tax
1

 
—

Amortization of net loss and prior service adjustment included in expense, net of tax
1

 
1

Unrealized gains (losses) on derivatives qualified as cash flow hedges
 
 
 
Unrealized holding gain arising during period, net of income tax expense of $17 and $4 for the three months ended March 31, 2012 and 2011
25

 
6

Reclassification adjustments included in net loss, net of income tax benefit of $8 and $6 for the three months ended March 31, 2012 and 2011
(11
)
 
(10
)
Other comprehensive income (loss), net of tax
16

 
(3
)
Comprehensive Loss
(66
)
 
(23
)
Comprehensive Income Attributable to Noncontrolling Interests
(2
)
 
—

Comprehensive Loss Attributable to Edison Mission Energy Common Shareholder
$
(68
)
 
$
(23
)


The accompanying notes are an integral part of these consolidated financial statements.
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EDISON MISSION ENERGY AND SUBSIDIARIES
 

CONSOLIDATED BALANCE SHEETS
(in millions, unaudited)

 
March 31,
2012
 
December 31,
2011
Assets
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
1,307

 
$
1,300

Accounts receivable—trade
75

 
107

Receivables from affiliates
8

 
4

Inventory
240

 
274

Derivative assets
39

 
40

Restricted cash and cash equivalents
187

 
103

Margin and collateral deposits
76

 
41

Prepaid expenses and other
60

 
72

Total current assets
1,992

 
1,941

Investments in Unconsolidated Affiliates
520

 
523

Property, Plant and Equipment, less accumulated depreciation of $1,362 and $1,295 at respective dates
4,472

 
4,472

Other Assets
 
 
 
Deferred financing costs
74

 
71

Long-term derivative assets
52

 
59

Restricted deposits
57

 
48

Rent payments in excess of levelized rent expense under plant operating leases
798

 
760

Deferred taxes
183

 
205

Other long-term assets
237

 
244

Total other assets
1,401

 
1,387

Total Assets
$
8,385

 
$
8,323


EDISON MISSION ENERGY AND SUBSIDIARIES
 

CONSOLIDATED BALANCE SHEETS
(in millions, except share and per share amounts, unaudited)

 
March 31,
2012
 
December 31,
2011
Liabilities and Shareholder's Equity
 
 
 
Current Liabilities
 
 
 
Accounts payable
$
67

 
$
99

Payables to affiliates
146

 
188

Accrued liabilities
115

 
168

Derivative liabilities
1

 
1

Interest payable
102

 
33

Deferred taxes
2

 
2

Current portion of long-term debt
61

 
57

Total current liabilities
494

 
548

Long-term debt net of current portion
4,902

 
4,855

Deferred revenues
524

 
530

Long-term derivative liabilities
79

 
90

Other long-term liabilities
599

 
636

Total Liabilities
6,598

 
6,659

Commitments and Contingencies (Notes 5, 6, 9 and 10)

 

Equity
 
 
 
Common stock, par value $0.01 per share (10,000 shares authorized; 100 shares issued and outstanding at each date)
64

 
64

Additional paid-in capital
1,279

 
1,327

Retained earnings
276

 
365

Accumulated other comprehensive loss
(78
)
 
(94
)
Total Edison Mission Energy common shareholder's equity
1,541

 
1,662

Noncontrolling Interests
246

 
2

Total Equity
1,787

 
1,664

Total Liabilities and Equity
$
8,385

 
$
8,323




The accompanying notes are an integral part of these consolidated financial statements.
3
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EDISON MISSION ENERGY AND SUBSIDIARIES
 

CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions, unaudited)
 
Three Months Ended March 31,
 
2012
 
2011
Cash Flows From Operating Activities
 
 
 
Net loss
$
(82
)
 
$
(20
)
Loss from discontinued operations
1

 
2

Loss from continuing operations, net
(81
)
 
(18
)
Adjustments to reconcile loss to net cash provided by operating activities:
 
 
 
Equity in loss from unconsolidated affiliates
1

 
5

Distributions from unconsolidated affiliates
—

 
5

Depreciation and amortization
74

 
81

Deferred taxes and tax credits
(60
)
 
(15
)
Loss on disposal and asset impairments
14

 
—

Loss on sale of assets
1

 
—

Changes in operating assets and liabilities:
 
 
 
(Increase) decrease in margin and collateral deposits
(35
)
 
13

Decrease in receivables
27

 
20

(Increase) decrease in inventory
34

 
(22
)
(Increase) decrease in prepaid expenses and other
12

 
(2
)
(Increase) decrease in restricted cash and cash equivalents
(7
)
 
—

Increase in rent payments in excess of levelized rent expense
(38
)
 
(32
)
Increase (decrease) in payables and other current liabilities
(118
)
 
(13
)
Increase in interest payable
73

 
72

Decrease in derivative assets and liabilities
19

 
4

Increase in other operating—assets
3

 
—

Increase (decrease) in other operating—liabilities
(18
)
 
16

Operating cash flow from continuing operations
(99
)
 
114

Operating cash flow from discontinued operations
(1
)
 
(2
)
Net cash (used in) provided by operating activities
(100
)
 
112

Cash Flows From Financing Activities
 
 
 
Borrowings on long-term debt
54

 
76

Payments on debt
(7
)
 
(8
)
Borrowings under short-term debt
—

 
32

Cash contributions from noncontrolling interests
242

 
—

Payments to affiliates related to stock-based awards
(5
)
 
(2
)
Financing costs
(3
)
 
—

Net cash provided by financing activities from continuing operations
281

 
98

Cash Flows From Investing Activities
 
 
 
Capital expenditures
(86
)
 
(105
)
Proceeds from return of capital and loan repayments and sale of assets
1

 
9

Investments in and loans to unconsolidated affiliates
—

 
(4
)
Increase in restricted deposits and restricted cash and cash equivalents
(86
)
 
(1
)
Investments in other assets
(3
)
 
(1
)
Net cash used in investing activities from continuing operations
(174
)
 
(102
)
Net increase in cash and cash equivalents
7

 
108

Cash and cash equivalents at beginning of period
1,300

 
1,075

Cash and cash equivalents at end of period
$
1,307

 
$
1,183


The accompanying notes are an integral part of these consolidated financial statements.
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EDISON MISSION ENERGY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2012
(Unaudited)

Note 1. Summary of Significant Accounting Policies
At March 31, 2012, Edison Mission Energy (EME), and its subsidiaries without contractual dividend restrictions, had corporate cash and cash equivalents of $927 million and Midwest Generation, LLC (Midwest Generation) had cash and cash equivalents of $230 million and $500 million of available borrowing capacity under its credit facility maturing in June 2012. EME terminated its revolving credit facility in February 2012, and there can be no assurance that Midwest Generation will be eligible to draw on its credit facility prior to maturity. Any replacements of these credit lines will likely be on less favorable terms and conditions, and there is no assurance that EME will, or will be able to, replace these credit lines or any portion of them. In conjunction with the termination of its credit facility, EME entered into replacement letter of credit facilities secured by cash collateral. For additional information, see Note 5—Debt and Credit Agreements—2012 Letter of Credit Facilities. EME had $3.7 billion of unsecured notes outstanding at March 31, 2012, $500 million of which mature in 2013. Unless energy and capacity prices increase substantially, EME expects that it will experience further reductions in cash flow and losses in 2012 and subsequent years. EME's liquidity will be strained by a continuation of recent adverse trends, combined with pending debt maturities, higher operating costs and the need to retrofit its coal-fired plants to comply with governmental regulations. To address such a scenario, EME would need to consider all options available to it, including potential sales of assets or restructurings or reorganization of the capital structure of EME and its subsidiaries.
EME Homer City Generation L.P. (Homer City) has been engaged in discussions with the owner-lessors regarding the orderly transfer of the Homer City plant to the owner-lessors, which will result in EME's loss of substantially all beneficial economic interest in and material control of the Homer City plant. Failure to reach an agreement for the orderly transfer of the Homer City plant could result in Homer City's default under the lease agreements giving rise to remedies for the owner-lessors and secured lease obligation bondholders, which could include foreclosing on the leased assets, the general partner of Homer City, or both. For additional information, see Note 9—Commitments and Contingencies—Homer City Lease and Environmental Project.
Basis of Presentation
EME's significant accounting policies were described in "Note 1. Summary of Significant Accounting Policies" on page 68 of EME's annual report on Form 10-K for the year ended December 31, 2011. EME follows the same accounting policies for interim reporting purposes, with the exception of accounting principles adopted as of January 1, 2012, as discussed below in "—New Accounting Guidance." This quarterly report should be read in conjunction with such financial statements and notes.
In the opinion of management, all adjustments, consisting of recurring accruals, have been made that are necessary to fairly state the consolidated financial position and results of operations and cash flows in accordance with accounting principles generally accepted in the United States of America (GAAP) for the periods covered by this quarterly report on Form 10-Q. The results of operations for the three-month period ended March 31, 2012 are not necessarily indicative of the operating results for the full year. Except as indicated, amounts reflected in the notes to the consolidated financial statements relate to continuing operations of EME.
The December 31, 2011 condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP.
The consolidated statement of cash flows for the three months ended March 31, 2011 was revised to correct an error in the presentation of vendor financed property, plant and equipment in the amount of $6 million. This correction, to present the amount on a net rather than gross basis, decreased cash flows used in investing activities and cash flows provided by financing activities by this amount, but had no impact on the net change in cash and cash equivalents. Management believes the revision does not have a material impact on the prior year financial statements.
Cash Equivalents
Cash equivalents included money market funds totaling $1.1 billion and $1.2 billion at March 31, 2012 and December 31, 2011, respectively. The carrying value of cash equivalents equals the fair value as all investments have maturities of less than three months.

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Restricted Cash and Cash Equivalents
Restricted cash and cash equivalents at March 31, 2012 and December 31, 2011 included $97 million received from a wind financing that was held in escrow at those dates and is expected to be released in the second quarter of 2012 when the project achieves certain completion milestones. At March 31, 2012, restricted cash and cash equivalents also included $74 million to support outstanding letters of credit issued under EME's letter of credit facilities.
Inventory
Inventory is stated at the lower of weighted-average cost or market. Inventory is recorded at actual cost when purchased and then expensed at weighted-average cost as used. Inventory consisted of the following:
(in millions)
March 31,
2012
 
December 31,
2011
Coal, fuel oil and other raw materials
$
152

 
$
188

Spare parts, materials and supplies
88

 
86

Total inventory
$
240

 
$
274

Allocation of Net Income or Losses to Investors in Certain Variable Interest Entities
For consolidated investments that allocate taxable income and losses, tax credits and cash distributions under complex allocation provisions of agreements with third-party investors, net income or loss is allocated to third-party investors for accounting purposes using the Hypothetical Liquidation Book Value (HLBV) method. HLBV is a balance sheet oriented approach that calculates the change in the claims of each partner on the net assets of the investment at the beginning and end of each period. Each partner's claim is equal to the amount each party would receive or pay if the net assets of the investment were to liquidate at book value and the resulting cash was then distributed to investors in accordance with their respective liquidation preferences. EME reports the net income or loss attributable to the third-party investors as income (loss) attributable to noncontrolling interests in the consolidated statements of operations. For further information, see Note 3—Variable Interest Entities—Projects or Entities that are Consolidated—Capistrano Wind Equity Capital.
New Accounting Guidance
Accounting Guidance Adopted in 2012
Fair Value Measurement
In May 2011, the Financial Accounting Standards Board (FASB) issued an accounting standards update modifying the fair value measurement and disclosure guidance. This guidance prohibits grouping of financial instruments for purposes of fair value measurement and requires the value be based on the individual security. This amendment also results in new disclosures primarily related to Level 3 measurements including quantitative disclosure about unobservable inputs and assumptions, a description of the valuation processes and a narrative description of the sensitivity of the fair value to changes in unobservable inputs. EME adopted this guidance effective January 1, 2012. For further information, see Note 4—Fair Value Measurements.
Presentation of Comprehensive Income
In June 2011 and December 2011, the FASB issued accounting standards updates on the presentation of comprehensive income. An entity can elect to present items of net income and other comprehensive income in one continuous statement, referred to as the statement of comprehensive income, or in two separate but consecutive statements. EME adopted this guidance January 1, 2012. The adoption of these accounting standards updates did not change the items that constitute net income and other comprehensive income.
Accounting Guidance Not Yet Adopted
Offsetting Assets and Liabilities
In December 2011, the FASB issued an accounting standards update modifying the disclosure requirements about the nature of an entity's rights of offsetting assets and liabilities in the statement of financial position under master netting agreements and related arrangements associated with financial and derivative instruments. The guidance requires increased disclosure of the gross and net recognized assets and liabilities, collateral positions and narrative descriptions of setoff rights. EME will adopt this guidance effective January 1, 2013.

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Note 2. Consolidated Statements of Changes in Equity
The following table provides the changes in equity for the three months ended March 31, 2012:
 
EME Shareholder's Equity
 
 
 
 
(in millions)
Common Stock
 
Additional Paid-in Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Loss
 
Non-controlling interest
 
Total Equity
Balance at December 31, 2011
$
64

 
$
1,327

 
$
365

 
$
(94
)
 
$
2

 
$
1,664

Net income (loss)
—

 
—

 
(84
)
 
—

 
2

 
(82
)
Other comprehensive income
—

 
—

 
—

 
16

 
—

 
16

Payments to Edison International for stock purchases related to stock-based compensation
—

 
—

 
(5
)
 
—

 
—

 
(5
)
Other stock transactions, net
—

 
2

 
—

 
—

 
—

 
2

Contributions from noncontrolling interests1
—

 
—

 
—

 
—

 
242

 
242

Transfers of assets to Capistrano Wind Partners2
—

 
(50
)
 
—

 
—

 
—

 
(50
)
Balance at March 31, 2012
$
64

 
$
1,279

 
$
276

 
$
(78
)
 
$
246

 
$
1,787

1 
Funds contribution by third-party investors related to the Capistrano Wind equity capital raise are reported in noncontrolling interest. For further information, see Note 3—Variable Interest Entities—Projects or Entities that are Consolidated—Capistrano Wind Equity Capital.
2 
Additional paid in capital was reduced $50 million related to a new tax basis in the assets transferred to Capistrano Wind Partners. For further information, see Note 3—Variable Interest Entities—Projects or Entities that are Consolidated—Capistrano Wind Equity Capital.
The following table provides the changes in equity for the three months ended March 31, 2011:
 
EME Shareholder's Equity
 
 
 
 
(in millions)
Common Stock
 
Additional Paid-in Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Loss
 
Non-controlling interest
 
Total Equity
Balance at December 31, 2010
$
64

 
$
1,336

 
$
1,448

 
$
(31
)
 
$
4

 
$
2,821

Net loss
—

 
—

 
(20
)
 
—

 
—

 
(20
)
Other comprehensive loss
—

 
—

 
—

 
(3
)
 
—

 
(3
)
Payments to Edison International for stock purchases related to stock-based compensation
—

 
—

 
(2
)
 
—

 
—

 
(2
)
Other stock transactions, net
—

 
2

 
—

 
—

 
—

 
2

Balance at March 31, 2011
$
64

 
$
1,338

 
$
1,426

 
$
(34
)
 
$
4

 
$
2,798


Note 3. Variable Interest Entities
Projects or Entities that are Consolidated
At March 31, 2012 and December 31, 2011, EME consolidated 16 and 13 projects, respectively, with a total generating capacity of 861 MW and 570 MW, respectively, that have noncontrolling interests held by others. Projects consolidated at March 31, 2012 increased from the projects consolidated at December 31, 2011, due to the Capistrano Wind equity capital transaction as discussed below. In determining that EME was the primary beneficiary of the projects that are consolidated, key factors considered were EME's ability to direct commercial and operating activities and EME's obligation to absorb losses of the variable interest entities.

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The following table presents summarized financial information of the projects that were consolidated by EME:
(in millions)
March 31,
2012
 
December 31,
2011
Current assets
$
87

 
$
36

Net property, plant and equipment
1,194

 
675

Other long-term assets
18

 
5

Total assets
$
1,299

 
$
716

Current liabilities
$
32

 
$
28

Long-term debt net of current portion
179

 
57

Deferred revenues
174

 
69

Other long-term liabilities
56

 
22

Total liabilities
$
441

 
$
176

Noncontrolling interests
$
246

 
$
2

Assets serving as collateral for the debt obligations had a carrying value of $474 million and $136 million at March 31, 2012 and December 31, 2011, respectively, and primarily consist of property, plant and equipment.
Capistrano Wind Equity Capital
As part of its plan to obtain third-party equity capital to finance the development of a portion of EME's wind portfolio, on February 13, 2012, Edison Mission Wind sold its indirect equity interests in the Cedro Hill wind project (150 MW in Texas), the Mountain Wind Power I project (61 MW in Wyoming) and the Mountain Wind Power II project (80 MW in Wyoming) to a new venture, Capistrano Wind Partners. Outside investors provided $238 million of the funding. Capistrano Wind Partners also agreed to acquire the Broken Bow I wind project (80 MW in Nebraska) and the Crofton Bluffs wind project (40 MW in Nebraska) for consideration expected to include $140 million from the same outside investors upon the satisfaction of specified conditions, including commencement of commercial operation and conversion of project debt financing to term. In March 2012, EME received a distribution of the proceeds from outside investors, which will be used for general corporate purposes. Through their ownership of Capistrano Wind Holdings, an indirect subsidiary of EME, Edison Mission Wind, and EME's parent company, Mission Energy Holding Company (MEHC), own 100% of the Class A equity interests in Capistrano Wind Partners, and the Class B preferred equity interests are held by outside investors. Under the terms of the formation documents, preferred equity interests receive 100% of the cash available for distribution, up to a scheduled amount to target a return and thereafter cash distributions are shared. Cash available for distribution includes 90% of the tax benefits realized by MEHC and contributed to Capistrano Wind Partners.
Edison Mission Wind retains indirect beneficial ownership of the common equity in the projects, net of a $4 million preferred investment made by MEHC, and retains responsibilities for managing the operations of Capistrano Wind Holdings and its projects, and accordingly, EME will continue to consolidate these projects. The $238 million contributed by the third-party interests and the $4 million preferred investment made by MEHC are reflected in noncontrolling interests on EME's consolidated balance sheet at March 31, 2012. This transaction was accounted for as a transfer among entities under common control and, therefore, resulted in no change in the book basis of the transferred assets. However, the transaction did trigger a taxable gain and new tax basis in the assets with a corresponding adjustment to deferred taxes and a reduction to equity of $50 million.
EME's share in the earnings or losses of the Capistrano Wind entities is calculated under the HLBV method due to complex preferences in distribution provisions. The income from the Cedro Hill, Mountain Wind Power I and Mountain Wind Power II wind projects attributable to noncontrolling interests was $2 million for the first quarter of 2012.


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Note 4. Fair Value Measurements
Recurring Fair Value Measurements
Fair value is defined as 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 (referred to as an "exit price"). Fair value of an asset or liability considers assumptions that market participants would use in pricing the asset or liability, including assumptions about nonperformance risk, which was not material as of March 31, 2012 and December 31, 2011.
Assets and liabilities are categorized into a three-level fair value hierarchy based on valuation inputs used to derive fair value. The hierarchy gives the highest priority to unadjusted quoted market prices in active markets for identical assets and liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements).
The following table sets forth assets and liabilities that were accounted for at fair value by level within the fair value hierarchy:
 
March 31, 2012
(in millions)
Level 1
 
Level 2
 
Level 3
 
Netting and
Collateral1
 
Total
Assets at Fair Value
 
 
 
 
 
 
 
 
 
Money market funds2
$
1,144

 
$
—

 
$
—

 
$
—

 
$
1,144

Derivatives contracts
 
 
 
 
 
 
 
 
 
Electricity
$
—

 
$
144

 
$
40

 
$
(93
)
 
$
91

Natural gas
6

 
—

 
—

 
(6
)
 
—

Fuel oil
7

 
—

 
—

 
(7
)
 
—

Total commodity contracts
13

 
144

 
40

 
(106
)
 
91

Total assets
$
1,157

 
$
144

 
$
40

 
$
(106
)
 
$
1,235

Liabilities at Fair Value
 
 
 
 
 
 
 
 
 
Derivatives contracts
 
 
 
 
 
 
 
 
 
Electricity
$
—

 
$
10

 
$
16

 
$
(24
)
 
$
2

Interest rate contracts
—

 
78

 
—

 
—

 
78

Total liabilities
$
—

 
$
88

 
$
16

 
$
(24
)
 
$
80


 
December 31, 2011
(in millions)
Level 1
 
Level 2
 
Level 3
 
Netting and
Collateral1
 
Total
Assets at Fair Value
 
 
 
 
 
 
 
 
 
Money market funds2
$
1,207

 
$
—

 
$
—

 
$
—

 
$
1,207

Derivative contracts
 
 
 
 
 
 
 
 
 
Electricity
$
—

 
$
66

 
$
95

 
$
(62
)
 
$
99

Natural gas
4

 
—

 
—

 
(4
)
 
—

Fuel oil
4

 
—

 
—

 
(4
)
 
—

Total commodity contracts
8

 
66

 
95

 
(70
)
 
99

Total assets
$
1,215

 
$
66

 
$
95

 
$
(70
)
 
$
1,306

Liabilities at Fair Value
 
 
 
 
 
 
 
 
 
Derivative contracts
 
 
 
 
 
 
 
 
 
Electricity
$
—

 
$
8

 
$
12

 
$
(19
)
 
$
1

Interest rate contracts
—

 
90

 
—

 
—

 
90

Total liabilities
$
—

 
$
98

 
$
12

 
$
(19
)
 
$
91

1 
Represents cash collateral and the impact of netting across the levels of the fair value hierarchy. Netting among positions classified within the same level is included in that level.
2 
Money market funds are included in cash and cash equivalents and in restricted cash and cash equivalents on EME's consolidated balance sheets at March 31, 2012 and December 31, 2011.

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The following table sets forth a summary of changes in the fair value of Level 3 net derivative assets and liabilities:
 
Three Months Ended March 31,
(in millions)
2012
 
2011
Fair value, net assets at beginning of period
$
83

 
$
91

Total realized/unrealized gain
 
 
 
Included in earnings1
(15
)
 
—

Included in accumulated other comprehensive loss2
2

 
1

Purchases
6

 
5

Settlements
(1
)
 
(12
)
Transfers out of Level 33
(51
)
 
(2
)
Fair value, net assets at end of period
$
24

 
$
83

Change during the period in unrealized gains related to assets and liabilities, net held at end of period1
$
(7
)
 
$
(6
)
1 
Reported in operating revenues on EME's consolidated statements of operations.
2 
Included in reclassification adjustments in EME's consolidated statement of other comprehensive loss.
3 
Transfers out of Level 3 into Level 2 occurred due to significant observable inputs becoming available as the transactions near maturity.
The fair value of transfers in and out of each level is determined at the end of each reporting period. There were no transfers between Levels 1 and 2 during the three months ended March 31, 2012 and 2011.
Valuation Techniques Used to Determine Fair Value
Level 1
The fair value of Level 1 assets and liabilities is determined using unadjusted quoted prices in active markets that are available at the measurement date for identical assets and liabilities. This level includes exchange-traded derivatives and money market funds.
Level 2
The fair value of Level 2 assets and liabilities is determined using quoted prices for similar assets and liabilities in active markets and inputs that are observable either directly or indirectly for substantially the full term of the instrument. This level includes over-the-counter derivatives and interest rate swaps.
Over-the-counter derivative contracts are valued using standard pricing models to determine the net present value of estimated future cash flows. Inputs to the pricing models include forward published or posted clearing prices from exchanges (New York Mercantile Exchange and Intercontinental Exchange) for similar instruments and discount rates. A primary price source that best represents trade activity for each market is used to develop observable forward market prices in determining the fair value of these positions. Broker quotes, prices from exchanges or comparison to executed trades are used to validate and corroborate the primary price source. These price quotations reflect mid-market prices (average of bid and ask) and are obtained from sources believed to provide the most liquid market for the commodity.
Level 3
The fair value of Level 3 assets and liabilities is determined using models and techniques that require significant unobservable inputs. This level includes over-the-counter options and derivative contracts that trade infrequently, such as congestion revenue rights and long-term power agreements.
Assumptions are made in order to value derivative contracts in which observable inputs are not available. Changes in fair value are based on changes to forward market prices, including extrapolation of short-term observable inputs into forecasted prices for illiquid forward periods. In circumstances where fair value cannot be verified with observable market transactions, it is possible that a different valuation model could produce a materially different estimate of fair value. Modeling methodologies, inputs and techniques are reviewed and assessed as markets continue to develop and more pricing information becomes available and the fair value is adjusted when it is concluded that a change in inputs or techniques would result in a new valuation that better reflects the fair value of those derivative contracts.

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Level 3 Valuation Process
The process of determining fair value is the responsibility of the risk department, which reports to the chief financial officer. This department obtains observable and unobservable inputs through broker quotes, exchanges and internal valuation techniques and uses both standard and proprietary models to determine fair value. Each reporting period, the risk and key finance departments collaborate to determine the appropriate fair value methodologies and classifications for each derivative. Inputs are validated for reasonableness by comparison against prior prices, other broker quotes and volatility fluctuation thresholds. Inputs used and valuations are reviewed period-over-period and compared with market conditions to determine reasonableness.
The following table sets forth the valuation techniques and significant unobservable inputs used to derive fair value for Level 3 assets and liabilities:
March 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Quantitative Information About Level 3 Fair Value Measurements
 
Fair Value
 
 
 
Significant Unobservable Input
 
 
 
Assets
 
Liabilities
 
Valuation Technique(s)
 
 
Range
(Weighted Average)
Electricity
(in millions)
 
 
 
 
 
 
Congestion contracts
$
49

 
 
$
13

 
 
Latest auction pricing
 
Congestion prices
 
$(8.20) - $10.32
($0.21)
Power contracts
37

 
 
49

 
 
Discounted cash flows
 
Power prices
 
$15.58-$54.00
($32.97)
Netting
(46
)
 
 
(46
)
 
 
 
 
 
 
 
Total
$
40

 
 
$
16

 
 
 
 
 
 
 
Level 3 Fair Value Sensitivity
For congestion contracts, generally, an increase (decrease) in congestion prices in the last auction relative to the contract price will increase (decrease) fair value. For power contracts, generally, an increase (decrease) in long-term forward power prices at illiquid locations relative to the contract price will increase (decrease) fair value.
Long-term Debt
The carrying amounts and fair values of EME's long-term debt were as follows:
 
March 31, 2012
 
December 31, 2011
(in millions)
Carrying
Amount
 
Fair Value
 
Carrying
Amount
 
Fair Value
Long-term debt, including current portion
$
4,963

 
$
3,676

 
$
4,912

 
$
3,716

In assessing the fair value of EME's long-term debt, EME primarily uses quoted market prices, except for floating-rate debt for which the carrying amounts were considered a reasonable estimate of fair value. The fair value of EME's long-term debt is classified as Level 2.

Note 5. Debt and Credit Agreements
2012 Project Financings
Broken Bow and Crofton Bluffs
Effective March 30, 2012, EME completed through its subsidiaries, Broken Bow Wind, LLC and Crofton Bluffs Wind, LLC, two nonrecourse financings of its interests in the Broken Bow and Crofton Bluffs wind projects. The financings included construction loans totaling $79 million that are required to be converted to 15-year amortizing term loans by March 31, 2013, subject to meeting specified conditions, $13.1 million letter of credit facilities and $5.5 million working capital facilities.
Interest under the construction and term loans will accrue at London Interbank Offered Rate (LIBOR) plus 2.875%, with the term loan rate increasing 0.125% after the third, sixth, ninth, and twelfth years. Pursuant to the financing agreements, on April 2, 2012 and April 17, 2012, EME's subsidiaries entered into forward starting interest rate swap agreements at 0.8275%

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Table of Contents

and 0.7825%, respectively, to hedge the majority of the variable interest rate debt beginning December 31, 2012 through December 31, 2013 and at 2.96% and 2.7475%, respectively, to hedge the majority of the variable interest rate debt beginning December 31, 2013 through December 31, 2027.
Upon conversion to a term loan, distributions from such subsidiaries are subject to compliance with the terms and conditions of their financing agreements, including a 12-month historic debt service coverage ratio test as specified in the agreements of at least 1.20 to 1.00.
As of March 31, 2012, no amounts were outstanding under the construction loans and letters of credit facilities.
Capistrano Wind Partners agreed to acquire the Broken Bow I wind project and the Crofton Bluffs wind project for consideration expected to include $140 million from the same outside investors of the Capistrano Wind equity capital transaction upon the satisfaction of specified conditions, including commencement of commercial operation and conversion of project debt financing to term.
2012 Letter of Credit Facilities
In February 2012, EME terminated its $564 million revolving credit facility and entered into $55 million bridge letter of credit facilities which expire June 8, 2012 and which are secured by cash collateral of at least equal to the issued amount. In the first quarter of 2012, EME also completed a $100 million letter of credit facility for EME's general corporate needs and for its projects, which expires on June 30, 2014. Letters of credit issued under this facility are secured by cash collateral at least equal to the issued amount.
2011 Project Financings
Tapestry Wind
In December 2011, EME completed through its subsidiary, Tapestry Wind, LLC, a nonrecourse financing of its interests in the Taloga, Buffalo Bear and Pinnacle wind projects. A total of $97 million of cash proceeds received from the $214 million 10-year partially amortizing term loan was deposited into an escrow account as of December 31, 2011. On February 22, 2012, a neighbor of the Pinnacle project filed a formal complaint with the West Virginia Public Service Commission requesting that the Commission order the project to shut down at night due to alleged noise emissions. The release of the loan proceeds in escrow is subject to resolution of the complaint or further due diligence from the lenders. EME expects the loan proceeds to be released in the second quarter of 2012.
Standby Letters of Credit
Letters of credit under EME's and its subsidiaries' credit facilities aggregated $179 million and were scheduled to expire as follows: $122 million in 2012, $29 million in 2013, $10 million in 2017, and $18 million in 2018. Standby letters of credit include $40 million issued in connection with the power purchase agreement with Southern California Edison Company, an affiliate of EME, under the Walnut Creek credit facility. Certain letters of credit are subject to automatic annual renewal provisions. At March 31, 2012, EME had $71 million in letters of credit which were supported by $74 million of cash collateral.

Note 6. Derivative Instruments and Hedging Activities
EME uses derivative instruments to reduce its exposure to market risks that arise from price fluctuations of electricity, capacity, fuel, emission allowances, transmission rights and interest rates. The derivative financial instruments vary in duration, ranging from a few days to several years, depending upon the instrument. To the extent that EME does not use derivative instruments to hedge these market risks, the unhedged portions will be subject to the risks and benefits of spot market price movements.
Risk management positions may be designated as cash flow hedges or economic hedges, which are derivatives that are not designated as cash flow hedges. Economic hedges are accounted for at fair value on EME's consolidated balance sheets as derivative assets or liabilities with offsetting changes recorded on the consolidated statements of operations. For derivative instruments that qualify for hedge accounting treatment, the fair value is recognized on EME's consolidated balance sheets as derivative assets or liabilities with offsetting changes in fair value, to the extent effective, recognized in accumulated other comprehensive loss until reclassified into earnings when the related forecasted transaction occurs. The portion of a cash flow hedge that does not offset the change in the fair value of the transaction being hedged, which is commonly referred to as the ineffective portion, is immediately recognized in earnings.

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Table of Contents

Derivative instruments that are utilized for trading purposes are measured at fair value and included on the consolidated balance sheets as derivative assets or liabilities, with offsetting changes recognized in operating revenues on the consolidated statements of operations.
The results of derivative activities are recorded in cash flows from operating activities on the consolidated statements of cash flows.
Where EME's derivative instruments are subject to a master netting agreement and the criteria of authoritative guidance are met, EME presents its derivative assets and liabilities on a net basis on its consolidated balance sheets.
Notional Volumes of Derivative Instruments
The following table summarizes the notional volumes of derivatives used for hedging and trading activities:
March 31, 2012
 
 
 
 
 
 
 
 
Hedging Activities
 
Trading
Activities
 
Commodity
 
Instrument
 
Classification
 
Unit of
Measure
 
Cash Flow
Hedges
 
Economic
Hedges
 
 
Electricity
 
Forwards/Futures
 
Sales, net
 
GWh
 
5,850

1 
102

3 
—

  
Electricity
 
Forwards/Futures
 
Purchases, net
 
GWh
 
—

 
—

 
2,425

  
Electricity
 
Capacity
 
Sales, net
 
MW-Day
(in thousands)
 
58

2 
—

  
—

 
Electricity
 
Capacity
 
Purchases, net
 
MW-Day
(in thousands)
 
—

 
—

  
161

2 
Electricity
 
Congestion
 
Purchases, net
 
GWh
 
—

  
1,079

4 
165,365

4 
Natural gas
 
Forwards/Futures
 
Purchases, net
 
bcf
 
—

  
—

  
12.0

  
Fuel oil
 
Forwards/Futures
 
Purchases, net
 
barrels
 
—

  
360,000

  
—

  
At March 31, 2012, EME had interest rate contracts with notional values totaling $681 million that converted floating rate LIBOR-based debt to fixed rates ranging from 0.79% to 4.29%. These contracts expire May 2013 through March 2026. In addition, at March 31, 2012, EME had forward starting interest rate contracts with notional values totaling $502 million that will convert floating rate LIBOR-based debt to fixed rates ranging from 3.5429% to 4.0025%. These contracts have effective dates beginning June 2013 through December 2021 and expire May 2023 through December 2029.
In April 2012 pursuant to the agreements for financing of its interests in the Broken Bow and Crofton Bluffs wind projects, EME's subsidiaries entered into forward starting interest rate swap agreements with notional value totaling $139 million that converted floating rate LIBOR based debt to fixed rates ranging from 0.7825% to 2.96%. These contracts have effective dates beginning December 2012 through December 2013 and expire December 2013 through December 2027.
December 31, 2011
 
 
 
 
 
 
 
 
Hedging Activities
  
Trading
Activities
  
Commodity
 
Instrument
 
Classification
 
Unit of
Measure
 
Cash Flow
Hedges
  
Economic
Hedges
  
  
Electricity
 
Forwards/Futures
 
Sales, net
 
GWh
 
8,320

1 
425

3 

—

  
Electricity
 
Forwards/Futures
 
Purchases, net
 
GWh
 
—

 
—

 
2,926

  
Electricity
 
Capacity
 
Sales, net
 
MW-Day
(in thousands)
 
89

2 
—

  
—

 
Electricity
 
Capacity
 
Purchases, net
 
MW-Day
(in thousands)
 
—

 
—

  
184

2 
Electricity
 
Congestion
 
Purchases, net
 
GWh
 
—

  
2,528

4 
230,798

4 
Natural gas
 
Forwards/Futures
 
Sales, net
 
bcf
 
—

  
—

  
0.2

  
Fuel oil
 
Forwards/Futures
 
Purchases, net
 
barrels
 
—

  
240,000

  
—

  
1 
EME's hedge products include forward and futures contracts that qualify for hedge accounting.
2 
EME's hedge transactions for capacity result from bilateral trades. Capacity sold in the PJM Interconnection, LLC Reliability Pricing Model (PJM RPM) auction is not accounted for as a derivative.

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Table of Contents

3 
These positions adjust financial and physical positions, or day-ahead and real-time positions, to reduce costs or increase gross margin. The net sales positions of these categories are primarily related to hedge transactions that are not designated as cash flow hedges.
4 
Congestion contracts include financial transmission rights, transmission congestion contracts or congestion revenue rights. These positions are similar to a swap, where the buyer is entitled to receive a stream of revenues (or charges) based on the hourly day-ahead price differences between two locations.
At December 31, 2011, EME had interest rate contracts with notional values totaling $644 million that converted floating rate LIBOR-based debt to fixed rates ranging from 0.79% to 4.29%. These contracts expire May 2013 through March 2026. In addition, EME had forward starting interest rate contracts with notional values totaling $506 million that will convert floating rate LIBOR-based debt to fixed rates of 3.5429%, 3.57% and 4.0025%. These contracts have effective dates of June 2013 and December 2021 and expire May 2023 and December 2029.
Fair Value of Derivative Instruments
The following table summarizes the fair value of derivative instruments reflected on EME's consolidated balance sheets:
March 31, 2012
 
Derivative Assets
 
Derivative Liabilities
 
Net Assets (Liabilities)
(in millions)
Short-term
 
Long-term
 
Subtotal
 
Short-term
 
Long-term
 
Subtotal
 
Non-trading activities
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash flow hedges
 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity contracts
$
51

 
$
2

 
$
53

 
$
1

 
$
3

 
$
4

 
$
49

Interest rate contracts
—

 
—

 
—

 
—

 
78

 
78

 
(78
)
Economic hedges
57

 
3

 
60

 
47

 
2

 
49

 
11

Trading activities
408

 
180

 
588

 
360

 
117

 
477

 
111

 
516

 
185

 
701

 
408

 
200

 
608

 
93

Netting and collateral received1
(477
)
 
(133
)
 
(610
)
 
(407
)
 
(121
)
 
(528
)
 
(82
)
Total
$
39

 
$
52

 
$
91

 
$
1

 
$
79

 
$
80

 
$
11

December 31, 2011
 
Derivative Assets
 
Derivative Liabilities
 
Net Assets (Liabilities)
(in millions)
Short-term
 
Long-term
 
Subtotal
 
Short-term
 
Long-term
 
Subtotal
 
Non-trading activities
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash flow hedges
 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity contracts
$
41

 
$
1

 
$
42

 
$
2

 
$
3

 
$
5

 
$
37

Interest rate contracts
—

 
—

 
—

 
—

 
90

 
90

 
(90
)
Economic hedges
31

 
1

 
32

 
26

 
1

 
27

 
5

Trading activities
276

 
142

 
418

 
232

 
79

 
311

 
107

 
348

 
144

 
492

 
260

 
173

 
433

 
59

Netting and collateral received1
(308
)
 
(85
)
 
(393
)
 
(259
)
 
(83
)
 
(342
)
 
(51
)
Total
$
40

 
$
59

 
$
99

 
$
1

 
$
90

 
$
91

 
$
8

1 
Netting of derivative receivables and derivative payables and the related cash collateral received and paid is permitted when a legally enforceable master netting agreement exists with a derivative counterparty.

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Table of Contents

Income Statement Impact of Derivative Instruments
The following table provides the cash flow hedge activity as part of accumulated other comprehensive loss:
 
Cash Flow Hedge Activity1
 
 
 
Three Months Ended March 31,
 
 
 
2012
 
2011
 
 
(in millions)
Commodity Contracts
 
Interest Rate Contracts
 
Commodity Contracts
 
Interest Rate Contracts
 
Income Statement
Location
Beginning of period derivative gains (losses)
$
35

 
$
(90
)
 
$
43

 
$
(16
)
 
 
Effective portion of changes in fair value
30

 
12

 
8

 
2

 
 
Reclassification to earnings
(19
)
 
—

 
(16
)
 
—

 
Operating revenues
End of period derivative gains (losses)
$
46

 
$
(78
)
 
$
35

 
$
(14
)
 
 
1 
Unrealized derivative gains (losses) are before income taxes. The after-tax amounts recorded in accumulated other comprehensive loss at March 31, 2012 and 2011 for commodity and interest rate contracts were $27 million and $(47) million, and $21 million and $(9) million, respectively.
For additional information, see Note 11—Accumulated Other Comprehensive Loss.
EME recorded net gains of $1 million and $2 million during the first quarters of 2012 and 2011, respectively, in operating revenues on the consolidated statements of operations representing the amount of cash flow hedge ineffectiveness.
The effect of realized and unrealized gains from derivative instruments used for economic hedging and trading purposes on the consolidated statements of operations is presented below:
 
 
Three Months Ended March 31,
(in millions)
Income Statement Location
2012
 
2011
Economic hedges
Operating revenues
$
11

 
$
6

 
Fuel
5

 
6

Trading activities
Operating revenues
20

 
16

Margin and Collateral Deposits
Certain derivative instruments contain margin and collateral deposit requirements. Since EME's and its subsidiaries' credit ratings are below investment grade, EME and its subsidiaries have provided collateral in the form of cash and letters of credit for the benefit of derivative counterparties and brokers. The amount of margin and collateral deposits generally varies based on changes in fair value of the related positions. EME nets counterparty receivables and payables where balances exist under master netting arrangements. EME presents the portion of its margin and collateral deposits netted with its derivative positions on its consolidated balance sheets. Future increases in power prices could expose EME, Midwest Generation or Edison Mission Marketing & Trading, Inc. (EMMT) to additional collateral postings. The following table summarizes margin and collateral deposits provided to and received from counterparties:
(in millions)
March 31,
2012
 
December 31,
2011
Collateral provided to counterparties
 
 
 
Offset against derivative liabilities
$
2

 
$
2

Reflected in margin and collateral deposits
76

 
41

Collateral received from counterparties
 
 
 
Offset against derivative assets
84

 
53



15
Table of Contents

Note 7. Income Taxes
Effective Tax Rate
The table below provides a reconciliation of income tax benefit computed at the federal statutory income tax rate to the income tax benefit:
 
Three Months Ended March 31,
(in millions)
2012
 
2011
Loss from continuing operations before income taxes
$
(172
)
 
$
(63
)
Benefit for income taxes at federal statutory rate of 35%
$
(60
)
 
$
(23
)
Increase (decrease) in income tax from
 
 
 
State tax-net of federal benefit
(15
)
 
(5
)
Production tax credits, net
(19
)
 
(18
)
Other
3

 
1

Total benefit for income taxes from continuing operations
$
(91
)
 
$
(45
)
Effective tax rate
53
%
 
72
%
Tax Dispute
The Internal Revenue Service examination phase of tax years 2003 through 2006 was completed in the fourth quarter of 2010, which included a proposed adjustment related to EME. The EME-related proposed adjustment increases the taxable gain on the 2004 sale of EME's international assets, which if sustained, would result in a federal tax payment of approximately $194 million, including interest and penalties through March 31, 2012 (the Internal Revenue Service has asserted a 40% penalty for understatement of tax liability related to this matter). Edison International disagrees with the proposed adjustment and filed a protest with the Internal Revenue Service in the first quarter of 2011. The disputed tax matter is currently being considered in appeals.
Tax Election at Homer City
On March 15, 2012, Homer City made an election to be treated as a partnership for federal and state income tax purposes. As a result of this election, Homer City is treated for tax purposes as distributing its assets and liabilities to its partners, both of which are wholly owned subsidiaries of EME, and triggering tax deductions of approximately $1 billion. Such tax deductions will be included in EME's 2011 tax returns.
Deferred Taxes
At March 31, 2012, EME had recognized $908 million of income tax benefits related to federal tax credit carryforwards, federal net operating loss carryforwards and state net operating loss carryforwards, including the federal and state tax deductions related to the change in tax classification at Homer City.


16
Table of Contents

Note 8. Compensation and Benefit Plans
Pension Plans and Postretirement Benefits Other than Pensions
Pension Plans
During the three months ended March 31, 2012, EME made contributions of $4 million, and during the remainder of 2012, expects to make $14 million of additional contributions. The following were components of pension expense:
 
Three Months Ended March 31,
(in millions)
2012
 
2011
Service cost
$
5

 
$
4

Interest cost
3

 
4

Expected return on plan assets
(3
)
 
(3
)
Net amortization
1

 
1

Total expense
$
6

 
$
6

Postretirement Benefits Other Than Pensions
During the three months ended March 31, 2012, EME made contributions of $1 million, and during the remainder of 2012, expects to make $2 million of additional contributions.
The following were components of postretirement benefits expense:
 
Three Months Ended March 31,
(in millions)
2012
 
2011
Service cost
$
1

 
$
1

Interest cost
2

 
2

Total expense
$
3

 
$
3

Transfer of Certain Post Retirement Benefits to Edison International
In March 2012, Edison International agreed to assume the liabilities for active employees of EME and its subsidiaries under the specified plans related to deferred compensation and executive post retirement benefits. In consideration for such assumption, EME and its subsidiaries paid Edison International the after tax amount of such liabilities as of March 1, 2012 ($25 million) and will fund additional liabilities in future periods.

Note 9. Commitments and Contingencies
Homer City Lease and Environmental Project
Homer City made the required April 1, 2012 senior rent payment but did not make the April 1, 2012 payment of equity rent. On March 30, 2012, Homer City was granted a waiver by the owner-lessors of any rent default event with respect to the payment of the equity rent for all purposes other than restrictions on distributions from Homer City, including repayment of its intercompany loan, and the $48 million senior rent reserve letter of credit remains in place. For further discussion of the Homer City lease, refer to "Item 8. Edison Mission Energy and Subsidiaries Notes to Consolidated Financial Statements—Note 9. Commitments and Contingencies—Power Plant and Other Lease Commitments—Sale-Leaseback Transactions" on page 105 of EME's annual report on Form 10-K for the year ended December 31, 2011.
On March 29, 2012, Homer City and General Electric Capital Corporation (GECC) entered into an Implementation Agreement (the Agreement) with respect to the Homer City plant. As addressed by the Agreement, an affiliate of the GECC-controlled owner-lessors of the Homer City plant has entered into an engineering, procurement and construction agreement and is in the process of executing related agreements for the construction of environmental improvements. GECC will have discretion over all decisions related to such agreements. Homer City agreed to conduct its business as set forth in the Agreement and to use commercially reasonable efforts to provide assistance to GECC and its affiliates in connection with the construction agreements. The Agreement also requires Homer City, at the request of GECC, to enter into one or more implementation transactions, as defined in the Agreement, for the divestiture of its leasehold interest in the Homer City plant

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(and, under certain circumstances, related assets and liabilities as specified) and to assist GECC in obtaining certain third-party consents or waivers. Homer City and GECC also agreed to enter into a transition services agreement in connection with any implementation transaction. There is no assurance that Homer City and GECC will actually consummate a divestiture transaction as contemplated by the Agreement.
The Agreement also contains certain indemnities by each party in favor of the other. The Agreement may be terminated by GECC in its sole discretion at any time effective immediately upon delivery of notice to Homer City. Homer City may terminate the Agreement in connection with certain terminations of the construction agreements, subject to certain conditions.
The estimated cost of installing sulfur dioxide (SO2) and particulate emissions control equipment for Units 1 and 2 of the Homer City plant is expected to be approximately $700 million to $750 million. On April 2, 2012, Homer City received the permit to construct such improvements from the Pennsylvania Department of Environmental Protection (PADEP).
Included in the consolidated balance sheet at March 31, 2012 are assets and liabilities of Homer City. In the event that Homer City completes a divestiture transaction with its owner-lessors or EME ceases to control Homer City, EME will record a loss on disposition and classify Homer City as a discontinued operation. At March 31, 2012, Homer City assets of $209 million were composed of cash, inventory, and other assets and liabilities of $84 million were composed of accounts payable, accrued liabilities and other liabilities. In addition, EMMT had an intercompany account receivable from Homer City of $13 million at March 31, 2012. Any loss on disposition will be determined based on the assets and liabilities as of the date of disposition, the terms and conditions of the relevant transaction and an assessment as to whether any ongoing contingencies exist.
Guarantees and Indemnities
EME and certain of its subsidiaries have various financial and performance guarantees and indemnity agreements which are issued in the normal course of business. The contracts discussed below included performance guarantees.
Environmental Indemnities Related to the Midwest Generation Plants
In connection with the acquisition of the Midwest Generation plants, EME agreed to indemnify Commonwealth Edison Company (Commonwealth Edison) with respect to specified environmental liabilities before and after December 15, 1999, the date of sale. The indemnification obligations are reduced by any insurance proceeds and tax benefits related to such indemnified claims and are subject to a requirement that Commonwealth Edison takes all reasonable steps to mitigate losses related to any such indemnification claim. Also, in connection with the sale-leaseback transaction related to the Powerton and Joliet Stations in Illinois, EME agreed to indemnify the owner-lessors for specified environmental liabilities. These indemnities are not limited in term or amount. Due to the nature of the obligations under these indemnities, a maximum potential liability cannot be determined. Commonwealth Edison has advised EME that Commonwealth Edison believes it is entitled to indemnification for all liabilities, costs, and expenses that it may be required to bear as a result of the litigation discussed below under "—Contingencies—Midwest Generation New Source Review and Other Litigation." Except as discussed below, EME has not recorded a liability related to these environmental indemnities.
Midwest Generation entered into a supplemental agreement with Commonwealth Edison and Exelon Generation Company LLC on February 20, 2003 to resolve a dispute regarding interpretation of Midwest Generation's reimbursement obligation for asbestos claims under the environmental indemnities set forth in the Asset Sale Agreement. Under this supplemental agreement, Midwest Generation agreed to reimburse Commonwealth Edison and Exelon Generation for 50% of specific asbestos claims pending as of February 2003 and related expenses less recovery of insurance costs, and agreed to a sharing arrangement for liabilities and expenses associated with future asbestos-related claims as specified in the agreement. The obligations under this agreement are not subject to a maximum liability. The supplemental agreement had an initial five-year term with an automatic renewal provision for subsequent one-year terms (subject to the right of either party to terminate); pursuant to the automatic renewal provision, it has been extended until February 2013. There were approximately 245 cases for which Midwest Generation was potentially liable that had not been settled and dismissed at March 31, 2012. Midwest Generation had recorded a liability of $54 million at March 31, 2012 related to this contractual indemnity.
Indemnities Related to the Homer City Plant
In connection with the acquisition of the Homer City plant, Homer City agreed to indemnify the sellers with respect to specified environmental liabilities before and after the date of sale. EME guaranteed this obligation of Homer City. Also, in connection with the sale-leaseback transaction related to the Homer City plant, Homer City agreed to indemnify the owner-lessors for specified environmental liabilities. Due to the nature of the obligations under these indemnity provisions, they are not subject to a maximum potential liability and do not have expiration dates. EME has not recorded a liability related to this indemnity. For discussion of the New Source Review lawsuit filed against Homer City, see "—Contingencies—Homer City New Source Review and Other Litigation." Also, in connection with the Implementation Agreement discussed above, Homer

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City has agreed to enter into one or more implementation transactions, at the request of GECC, on the terms outlined in the Implementation Agreement, which include indemnification for specified matters.
Indemnities Provided under Asset Sale and Sale-Leaseback Agreements
The asset sale agreements for the sale of EME's international assets contain indemnities from EME to the purchasers, including indemnification for taxes imposed with respect to operations of the assets prior to the sale and for pre-closing environmental liabilities. Not all indemnities under the asset sale agreements have specific expiration dates. At March 31, 2012, EME had recorded a liability of $34 million related to these matters.
In connection with the sale-leaseback transactions related to the Homer City plant in Pennsylvania, the Powerton and Joliet Stations in Illinois and, previously, the Collins Station in Illinois, EME and several of its subsidiaries entered into tax indemnity agreements. Under certain of these tax indemnity agreements, Homer City and Midwest Generation, as the lessees in the sale-leaseback transactions agreed to indemnify the respective owner-lessors for specified adverse tax consequences that could result from certain situations set forth in each tax indemnity agreement, including specified defaults under the respective leases. Although the Collins Station lease terminated in April 2004, Midwest Generation's indemnities in favor of its former lease equity investors are still in effect. EME provided similar indemnities in the sale-leaseback transactions related to the Powerton and Joliet Stations in Illinois. The potential indemnity obligations under these tax indemnity agreements could be significant. Due to the nature of these potential obligations, EME cannot determine a range of estimated obligation which would be triggered by a valid claim from the owner-lessors. EME has not recorded a liability for these matters.
In addition to the indemnity provided by Homer City, EME agreed to indemnify the owner-lessors in the sale-leaseback transaction related to the Homer City plant for certain negative federal income tax consequences should the rent payments be "levelized" for tax purposes and for potential foreign tax credit losses in the event that the owner-lessor's debt is characterized as recourse, rather than nonrecourse. This indemnity covers a limited range of possible tax consequences that are unrelated to performance under the lease.
Other Indemnities
EME provides other indemnifications through contracts entered into in the normal course of business. These include, among other things, indemnities for specified environmental liabilities and for income taxes with respect to assets sold. EME's obligations under these agreements may or may not be limited in terms of time and/or amount, and in some instances EME may have recourse against third parties. EME cannot determine a range of estimates and has not recorded a liability related to these indemnities.
Contingencies
In addition to the matters disclosed in these notes, EME is involved in other legal, tax and regulatory proceedings before various courts and governmental agencies regarding matters arising in the ordinary course of business. EME believes the outcome of these other proceedings, individually and in the aggregate, will not materially affect its results of operations or liquidity.
Midwest Generation New Source Review and Other Litigation
In August 2009, the United States Environmental Protection Agency (US EPA) and the State of Illinois filed a complaint in the Northern District of Illinois alleging that Midwest Generation or Commonwealth Edison performed repair or replacement projects at six Illinois coal-fired electric generating stations in violation of the Prevention of Significant Deterioration (PSD) requirements and of the New Source Performance Standards of the Clean Air Act (CAA), including alleged requirements to obtain a construction permit and to install controls sufficient to meet best available control technology (BACT) emission rates. The US EPA also alleged that Midwest Generation and Commonwealth Edison violated certain operating permit requirements under Title V of the CAA. Finally, the US EPA alleged violations of certain opacity and particulate matter standards at the Midwest Generation plants. In addition to seeking penalties ranging from $25,000 to $37,500 per violation, per day, the complaint called for an injunction ordering Midwest Generation to install controls sufficient to meet BACT emission rates at all units subject to the complaint and other remedies. The remedies sought by the plaintiffs in the lawsuit could go well beyond the requirements of the Combined Pollutant Standard (CPS). Several Chicago-based environmental action groups intervened in the case.
Nine of the ten PSD claims raised in the complaint have been dismissed, along with claims related to alleged violations of Title V of the CAA, to the extent based on the dismissed PSD claims, and all claims asserted against Commonwealth Edison and EME. The court denied a motion to dismiss a claim by the Chicago-based environmental action groups for civil penalties

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in the remaining PSD claim, but noted that the plaintiffs will be required to convince the court that the statute of limitations should be equitably tolled. The court did not address other counts in the complaint that allege violations of opacity and particulate matter limitations under the Illinois State Implementation Plan and Title V of the CAA. The dismissals have been certified as "partial final judgments" capable of appeal, and an appeal is pending before the Seventh Circuit Court of Appeals. The remaining claims have been stayed pending the appeal. In February 2012, certain of the environmental action groups that had intervened in the case entered into an agreement with Midwest Generation to dismiss without prejudice all of their opacity claims as to all defendants. The agreed upon motion to dismiss was approved by the court on March 26, 2012.
In January 2012, two complaints were filed against Midwest Generation in Illinois state court by residents living near the Crawford and Fisk Stations on behalf of themselves and all others similarly situated, each asserting claims of nuisance, negligence, trespass, and strict liability. The plaintiffs seek to have their suits certified as a class action and request injunctive relief, as well as compensatory and punitive damages. The complaints are similar to two complaints previously filed in the Northern District of Illinois, which were dismissed in October 2011 for lack of federal jurisdiction. In March 2012, Midwest Generation filed motions to dismiss the cases, which are pending.
Adverse decisions in these cases could involve penalties, remedial actions and damages that could have a material impact on the financial condition and results of operations of Midwest Generation and EME. EME cannot predict the outcome of these matters or estimate the impact on the Midwest Generation plants, or its and Midwest Generation's results of operations, financial position or cash flows. EME has not recorded a liability for these matters.
Homer City New Source Review and Other Litigation
In January 2011, the US EPA filed a complaint in the Western District of Pennsylvania against Homer City, the sale-leaseback owner participants of the Homer City plant, and two prior owners of the Homer City plant. The complaint alleged violations of the PSD and Title V provisions of the CAA, as a result of projects in the 1990s performed by prior owners without PSD permits and the subsequent failure to incorporate emissions limitations that meet BACT into the station's Title V operating permit. In addition to seeking penalties ranging from $32,500 to $37,500 per violation, per day, the complaint called for an injunction ordering Homer City to install controls sufficient to meet BACT emission rates at all units subject to the complaint and for other remedies. The PADEP, the State of New York and the State of New Jersey intervened in the lawsuit. In October 2011, all of the claims in the US EPA's lawsuit were dismissed with prejudice. An appeal of the dismissal is pending before the Third Circuit Court of Appeals.
Also in January 2011, two residents filed a complaint in the Western District of Pennsylvania, on behalf of themselves and all others similarly situated, against Homer City, the sale-leaseback owner participants of the Homer City plant, two prior owners of the Homer City plant, EME, and Edison International, claiming that emissions from the Homer City plant had adversely affected their health and property values. The plaintiffs sought to have their suit certified as a class action and requested injunctive relief, the funding of a health assessment study and medical monitoring, as well as compensatory and punitive damages. In October 2011, the claims in the purported class action lawsuit that were based on the federal CAA were dismissed with prejudice, while state law statutory and common law claims were dismissed without prejudice to re-file in state court should the plaintiffs choose to do so. EME does not know whether the plaintiffs will file a complaint in state court.
In February 2012, Homer City received a 60-day Notice of Intent to Sue indicating the Sierra Club’s intent to file a citizen lawsuit alleging violations of emissions standards and limitations under the CAA and the Pennsylvania Air Pollution Control Act.
Adverse decisions in these cases could involve penalties, remedial actions and damages that could have a material impact on the financial condition and results of operations of Homer City and EME. EME cannot predict the outcome of these matters or estimate the impact on the Homer City plant, or its and Homer City's results of operations, financial position or cash flows. EME has not recorded a liability for these matters.
Environmental Remediation
Legislative and regulatory activities by federal, state and local authorities in the United States relating to energy and the environment impose numerous restrictions and requirements with respect to the operation of EME subsidiaries' existing facilities and affect the timing, cost, location, design, construction, and operation of new facilities by EME's subsidiaries, as well as the cost of mitigating the environmental impacts of past operations.
With respect to potential liabilities arising under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, commonly referred to as CERCLA, or similar laws for the investigation and remediation of contaminated property, EME accrues a liability to the extent the costs are probable and can be reasonably estimated. Midwest Generation had accrued a probable amount of approximately $9 million at March 31, 2012 for estimated environmental investigation and

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remediation costs for four stations at the Midwest Generation plants. This estimate is based upon the number of sites, the scope of work and the estimated costs for investigation and/or remediation where such expenditures could be reasonably estimated. EME also has identified sites for which a reasonable estimate cannot be made. Future estimated costs may vary based on changes in regulations or requirements of federal, state or local governmental agencies, changes in technology, and actual costs of disposal. In addition, future remediation costs will be affected by the nature and extent of contamination discovered at the sites that require remediation. Given the prior history of the operations at its facilities, EME cannot be certain that the existence or extent of all contamination at its sites has been fully identified.

Note 10. Environmental Developments
Developments during the first quarter of 2012 include the following:
Hazardous Air Pollutant Regulations
In December 2011, the US EPA announced the Mercury and Air Toxics Standards (MATS) rule, limiting emissions of hazardous air pollutants from coal- and oil-fired electrical generating units. The rule was published in the Federal Register on February 16, 2012, and became effective on April 16, 2012. A number of parties have filed notices of appeal challenging the rule.
Greenhouse Gas Regulation
In March 2012, the US EPA announced proposed carbon dioxide emissions limits for new power plants. The status of the US EPA's efforts to develop greenhouse gas emissions performance standards for existing plants is unknown.
Greenhouse Gas Litigation
In March 2012, the federal district court in Mississippi dismissed, in its entirety, the purported class action complaint filed by private citizens in May 2011, naming a large number of defendants, including EME and three of its wholly owned subsidiaries, for damages allegedly arising from Hurricane Katrina. In April 2012, the plaintiffs filed an appeal with the Fifth Circuit Court of Appeals. Plaintiffs allege that the defendants' activities resulted in emissions of substantial quantities of greenhouse gases that have contributed to climate change and sea level rise, which in turn are alleged to have increased the destructive force of Hurricane Katrina. The lawsuit alleges causes of action for negligence, public and private nuisance, and trespass, and seeks unspecified compensatory and punitive damages. The claims in this lawsuit are nearly identical to a subset of the claims that were raised against many of the same defendants in a previous lawsuit that was filed in, and dismissed by, the same federal district court where the current case has been filed.

Note 11. Accumulated Other Comprehensive Loss
Accumulated other comprehensive loss consisted of the following:
(in millions)
Unrealized
Losses on Cash
Flow Hedges
 
Unrecognized
Losses and Prior Service
Adjustments, Net1
 
Accumulated
Other
Comprehensive
Loss
Balance at December 31, 2011
$
(34
)
 
$
(60
)
 
$
(94
)
Current period change
14

 
2

 
16

Balance at March 31, 2012
$
(20
)
 
$
(58
)
 
$
(78
)
1 
For further detail, see Note 8—Compensation and Benefit Plans.
Included in accumulated other comprehensive loss at March 31, 2012 was $27 million, net of tax, of unrealized gains on commodity-based cash flow hedges, and $47 million, net of tax, of unrealized losses related to interest rate hedges. The maximum period over which a commodity cash flow hedge is designated is through May 31, 2014.
Unrealized gains on commodity hedges consist of futures and forward electricity contracts that qualify for hedge accounting. These gains arise because current forecasts of future electricity prices in these markets are lower than the contract prices. Approximately $28 million of unrealized gains on cash flow hedges, net of tax, are expected to be reclassified into earnings during the next 12 months. Management expects that reclassification of net unrealized gains will increase energy revenues recognized at market prices. Actual amounts ultimately reclassified into earnings over the next 12 months could vary materially from this estimated amount as a result of changes in market conditions.

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Note 12. Supplemental Cash Flows Information
 
Three Months Ended March 31,
(in millions)
2012
 
2011
Cash paid (received)
 
 
 
Interest (net of amount capitalized)1
$
6

 
$
(4
)
Income taxes
1

 
9

Cash payments under plant operating leases
76

 
76

Non-cash activities from vendor financing
$
4

 
$
6

1 
Interest capitalized for the three months ended March 31, 2012 and 2011 was $6 million and $10 million, respectively. Interest paid for the three months ended March 31, 2011 was $6 million.
Accrued capital expenditures at March 31, 2012 and 2011 were $7 million and $38 million, respectively. Accrued capital expenditures will be included as an investing activity in the consolidated statements of cash flows in the period paid.

Note 13. Discontinued Operations
Summarized financial information for discontinued operations of foreign subsidiaries is as follows:
 
Three Months Ended March 31,
(in millions)
2012
 
2011
Loss before income taxes
$
—

 
$
(2
)
Provision for income taxes
1

 
—

Loss from operations of discontinued foreign subsidiaries
$
(1
)
 
$
(2
)
The 2012 and 2011 losses were primarily due to changes in foreign exchange rates and income taxes.


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ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This quarterly report on Form 10-Q contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements reflect EME's current expectations and projections about future events based on EME's knowledge of present facts and circumstances and assumptions about future events and include any statement that does not directly relate to a historical or current fact. Other information distributed by EME that is incorporated in this report, or that refers to or incorporates this report, may also contain forward-looking statements. In this quarterly report on Form 10-Q, the words "expects," "believes," "anticipates," "estimates," "projects," "intends," "plans," "probable," "may," "will," "could," "would," "should," and variations of such words and similar expressions, or discussions of strategy or plans, are intended to identify forward-looking statements. Such statements necessarily involve risks and uncertainties that could cause actual results to differ materially from those anticipated. Some of the risks, uncertainties and other important factors that could cause results to differ from those currently expected, or that otherwise could impact EME or its subsidiaries, include but are not limited to:
•
supply and demand for electric capacity and energy, and the resulting prices and dispatch volumes, in the wholesale markets to which EME's generating units have access;
•
volatility of market prices for energy and capacity;
•
the difficulty of predicting wholesale prices, transmission congestion, energy demand, and other aspects of the complex and volatile markets in which EME and its subsidiaries participate;
•
EME's continued participation and the continued participation by EME's subsidiaries in tax-allocation and payment agreements with EME's respective affiliates;
•
EME's ability to meet its liquidity requirements and stabilize its capital structure during periods of operating losses;
•
EME's significant cash requirements and its limited ability to borrow funds and access the capital markets on reasonable terms;
•
environmental laws and regulations, at both state and federal levels, or changes in the application of those laws, that could require additional expenditures or otherwise affect EME's cost and manner of doing business, including compliance with the CPS (at Midwest Generation), CAIR or CSAPR (as applicable) and the MATS rule;
•
the completion of the transactions for the divestiture of Homer City's leasehold interest and related assets and liabilities pursuant to the terms of the Implementation Agreement between Homer City and GECC, and the timing and structure of such transactions;
•
the cost and availability of fuel, sorbents, and other commodities used for power generation and emission controls, and of related transportation services;
•
the cost and availability of emission credits or allowances;
•
transmission congestion in and to each market area and the resulting differences in prices between delivery points;
•
the availability and creditworthiness of counterparties, and the resulting effects on liquidity in the power and fuel markets in which EME and its subsidiaries operate and/or the ability of counterparties to pay amounts owed to EME in excess of collateral provided in support of their obligations;
•
governmental, statutory, regulatory or administrative changes or initiatives affecting EME or the electricity industry generally, including the market structure rules applicable to each market and price mitigation strategies adopted by ISOs and RTOs;
•
market volatility and other market conditions that could increase EME's obligations to post collateral beyond the amounts currently expected, and the potential effect of such conditions on the ability of EME and its subsidiaries to provide sufficient collateral in support of their hedging activities and purchases of fuel;
•
actions taken by Edison International and EME's directors, each of whom is appointed by Edison International, in the interests of Edison International and its shareholders, which could include causing EME, subject to contractual obligations and applicable law, to distribute cash or assets or otherwise take actions that may alter the portion of Edison International's portfolio of assets held and developed by EME;
•
completion of permitting and construction of EME's capital projects;
•
weather conditions, natural disasters and other unforeseen events;

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•
the extent of additional supplies of capacity, energy and ancillary services from current competitors or new market entrants, including the development of new generation facilities, and technologies that may be able to produce electricity at a lower cost than EME's generating facilities and/or increased access by competitors to EME's markets as a result of transmission upgrades;
•
competition in all aspects of EME's business;
•
operating risks, including equipment failure, availability, heat rate, output, costs of repairs and retrofits, and availability and cost of spare parts;
•
creditworthiness of suppliers and other project participants and their ability to deliver goods and services under their contractual obligations to EME and its subsidiaries or to pay damages if they fail to fulfill those obligations;
•
effects of legal proceedings, changes in or interpretations of tax laws, rates or policies, and changes in accounting standards;
•
general political, economic and business conditions; and
•
EME's ability to attract and retain skilled people.
Additional information about risks and uncertainties, including more detail about the factors described above, is contained throughout this MD&A and in "Item 1A. Risk Factors" on page 20 of EME's annual report on Form 10-K for the year ended December 31, 2011. Readers are urged to read this entire quarterly report on Form 10-Q and the annual report on Form 10-K for the year ended December 31, 2011, including the information incorporated by reference, and to carefully consider the risks, uncertainties and other factors that affect EME's business. Forward-looking statements speak only as of the date they are made, and EME is not obligated to publicly update or revise forward-looking statements. Readers should review future reports filed by EME with the Securities and Exchange Commission.
This MD&A discusses material changes in the results of operations, financial condition and other developments of EME since December 31, 2011, and as compared to the first quarter ended March 31, 2011. This discussion presumes that the reader has read or has access to the MD&A included in Item 7 of EME's annual report on Form 10-K for the year ended December 31, 2011.

MANAGEMENT'S OVERVIEW
EME's operating results were lower in the first quarter of 2012 compared to the first quarter of 2011 due to lower realized energy and capacity prices at its coal plants and lower generation at the Midwest Generation plants. The abundance of low-priced natural gas has continued to result in increased competition from natural gas-fired generating units in the markets in which Midwest Generation operates, and generation from Midwest Generation's plants has been correspondingly affected. Effective January 1, 2012, a favorable long-term rail contract that supplied Midwest Generation's fleet expired and was replaced by a higher priced contract. EME expects that Midwest Generation's average fuel cost ($/MWh) will increase by approximately one-third in 2012.
At March 31, 2012, EME and its subsidiaries without contractual dividend restrictions, had corporate cash and cash equivalents of $927 million and Midwest Generation had cash and cash equivalents of $230 million and $500 million of available borrowing capacity under its credit facility maturing in June 2012. EME terminated its revolving credit facility in February 2012, and there can be no assurance that Midwest Generation will be eligible to draw on its credit facility prior to maturity. Any replacements of these credit lines will likely be on less favorable terms and conditions, and there is no assurance that EME will, or will be able to, replace these credit lines or any portion of them. In conjunction with the termination of its credit facility, EME entered into replacement letter of credit facilities secured by cash collateral. EME had $3.7 billion of unsecured notes outstanding at March 31, 2012, $500 million of which mature in 2013.
Unless energy and capacity prices increase substantially, EME expects that it will incur further reductions in cash flow and losses in years subsequent to 2012 as well as in 2012, and a continuation of these adverse trends coupled with pending debt maturities and the need to retrofit its plants to comply with governmental regulations will strain EME's liquidity. To address such scenario, EME would need to consider all options available to it, including potential sales of assets or restructurings or reorganization of the capital structure of EME and its subsidiaries.


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Highlights of Operating Results
Net loss attributable to EME common shareholder is composed of the following components:
 
Three Months Ended
March 31,
 
 
(in millions)
2012
 
2011
 
Change
Net loss attributable to EME common shareholder
$
(84
)
 
$
(20
)
 
$
(64
)
Less: Non-core items - net of tax
 
 
 
 
 
Homer City
(23
)
 
(10
)
 
(13
)
Loss from discontinued operations
(1
)
 
(2
)
 
1

Total non-core items
(24
)
 
(12
)
 
(12
)
Core Loss
$
(60
)
 
$
(8
)
 
$
(52
)
EME's earnings (losses) are prepared in accordance with GAAP. Management uses core earnings (losses) internally for financial planning and for analysis of performance. Core earnings (losses) are also used when communicating with analysts and investors regarding EME's earnings results to facilitate comparisons of EME's performance from period to period. Core earnings (losses) are a non-GAAP financial measure and may not be comparable to those of other companies. Core earnings (losses) are defined as net income attributable to EME's shareholder excluding income (losses) from discontinued operations and income or loss from significant discrete items that management does not consider representative of ongoing earnings, such as: exit activities, sale of assets, early debt extinguishment costs, other activities that are no longer continuing, asset impairments, and certain tax, regulatory or legal proceedings. EME classified the results of Homer City, including the costs incurred in connection with the expected divestiture, as non-core for both the first quarter of 2012 and 2011 due to the plan described below to transition ownership of the leasehold interest to the owner-lessors.
EME's core loss in the first quarter 2012 increased compared to the first quarter 2011 primarily due to the following pre-tax items:
•
$95 million decrease in Midwest Generation results primarily due to lower average realized energy prices, lower capacity prices, higher fuel prices and reduced generation.
•
$6 million increase in interest expense due to new energy project financings ($2 million) and lower capitalized interest ($4 million).
The decrease was partially offset by the following pre-tax items:
•
$4 million increase in energy trading due to increased revenues from trading power contracts and congestion.
•
$9 million increase in renewable energy income due to the increase in wind projects in operation coupled with higher generation and more favorable wind conditions.

Midwest Generation Environmental Compliance Plans and Costs
During the first quarter of 2012, Midwest Generation continued to develop and implement a compliance program that includes the operation of ACI systems, upgrades to particulate removal systems and the use of dry sorbent injection, combined with the use of low sulfur PRB coal, to meet emissions limits for criteria pollutants, such as NOx and SO2 as well as for hazardous air pollutants, such as mercury, acid gas and non-mercury metals.
EME has decided to shut down its Fisk and Crawford Stations in September 2012. The shut downs also have been approved by PJM, the regional transmission organization that controls the area where these plants are located. In total, Midwest Generation estimates that 150 to 180 employees will be affected. The timing and amount of severance benefits, if any, will be determined after completion of an ongoing review of personnel based on seniority and other factors. Severance benefits are not required under the existing collective bargaining agreement. Midwest Generation has sold capacity forward through May 31, 2015 for both Fisk and Crawford. However, Midwest Generation has not sold its full capacity forward during those periods. Midwest Generation would expect to cover its capacity obligations associated with the Fisk and Crawford units through a combination of improved fleet performance, fleet capacity not previously sold forward and, if necessary, market transactions. In connection with the shut down of these stations, EME expects to receive a tax deduction equal to its tax basis in the facilities, although realization of these tax benefits may not occur for several years. At March 31, 2012, the tax basis of the Fisk and Crawford Stations were $64 million and $87 million, respectively.

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Decisions regarding whether or not to proceed with retrofitting any particular remaining units to comply with CPS requirements for SO2 emissions, including those that have received permits, are subject to a number of factors, such as market conditions, regulatory and legislative developments, liquidity and forecasted commodity prices and capital and operating costs applicable at the time decisions are required or made. Midwest Generation may also elect to shut down units, instead of installing controls, to be in compliance with the CPS. Final decisions on whether to install controls, to install particular kinds of controls, and to actually expend capital or continue with the expenditure of capital will be made as required, subject to the requirements of the CPS and other applicable regulations. Units that are not retrofitted may continue to operate until required to shut down by applicable regulations or operate with reduced output.
Based on work to date, Midwest Generation estimates the cost of retrofitting the large stations (Powerton, Joliet Units 7 and 8 and Will County) using dry scrubbing with sodium-based sorbents to comply with CPS requirements for SO2 emissions, and the associated upgrading of existing particulate removal systems, would be up to approximately $628 million. The cost of retrofitting Joliet Unit 6 is not included in the large unit amounts as it is less likely that Midwest Generation will make retrofits for this unit. The estimated cost of retrofitting Joliet Unit 6, if made, would be approximately $75 million, while the estimated cost of retrofitting the Waukegan Station, if made, would be approximately $160 million. For further discussion related to the impairment policy on Midwest Generation's unit of account, refer to "Critical Accounting Estimates and Policies—Impairment of Long-Lived Assets" in Item 7 on page 56 of EME's annual report on Form 10-K for the year ended December 31, 2011.

Homer City Lease
Homer City is not expected to have sufficient cash flow to meet its obligations, including funding capital improvements. Homer City made the required April 1, 2012 senior rent payment but did not make the April 1, 2012 payment of equity rent. On March 30, 2012, Homer City was granted a waiver by the owner-lessors of any rent default event with respect to the payment of the equity rent for all purposes other than restrictions on distributions from Homer City, including repayment of its intercompany loan, and the $48 million senior rent reserve letter of credit remains in place. Homer City's liquidity has continued to deteriorate during the first quarter of 2012. Absent a working capital loan or other infusion of cash, Homer City is not expected to have sufficient cash flow to meet its operating expenses and other obligations either in the near term or during 2012, including the rent payment due on October 1, 2012. This may require Homer City to temporarily suspend plant operations until sufficient working capital is obtained. For further discussion of the Homer City lease, refer to "Management's Overview—Homer City Lease" in Item 7 on page 30 of EME's annual report on Form 10-K for the year ended December 31, 2011.
Homer City has been engaged in discussions with the owner-lessors through GECC, beneficial owner of a majority of the owner-participants, regarding the funding of capital improvements at the Homer City plant and transfer to an affiliate of GECC of the economic benefit and majority ownership of all the operating assets of Homer City. On March 29, 2012, Homer City and GECC entered into an Implementation Agreement (the Agreement) with respect to the Homer City plant. As addressed by the Agreement, an affiliate of the GECC-controlled owner-lessors of the Homer City plant has entered into an engineering, procurement and construction agreement and is in the process of executing related agreements for the construction of environmental improvements. GECC will have discretion over all decisions related to such agreements. Homer City