EME 2012 Q2
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 June 30, 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 July 31, 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

v
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
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS

EDISON MISSION ENERGY AND SUBSIDIARIES
 

CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, unaudited)
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2012
 
2011
 
2012
 
2011
Operating Revenues
$
406

 
$
536

 
$
849

 
$
1,086

Operating Expenses
 
 
 
 
 
 
 
Fuel
215

 
174

 
421

 
356

Plant operations
172

 
240

 
328

 
432

Plant operating leases
40

 
44

 
78

 
88

Depreciation and amortization
67

 
79

 
135

 
151

Loss on disposal and asset impairments
12

 
8

 
26

 
8

Administrative and general
48

 
45

 
94

 
88

Total operating expenses
554

 
590

 
1,082

 
1,123

Operating loss
(148
)
 
(54
)
 
(233
)
 
(37
)
Other Income (Expense)
 
 
 
 
 
 
 
Equity in income from unconsolidated affiliates
18

 
17

 
17

 
12

Dividend income
11

 
27

 
11

 
28

Interest income
—

 
—

 
—

 
1

Interest expense
(84
)
 
(80
)
 
(170
)
 
(160
)
Other income, net
—

 
2

 
—

 
5

Total other expense
(55
)
 
(34
)
 
(142
)
 
(114
)
Loss from continuing operations before income taxes
(203
)
 
(88
)
 
(375
)
 
(151
)
Benefit for income taxes
(99
)
 
(57
)
 
(190
)
 
(102
)
Loss From Continuing Operations
(104
)
 
(31
)
 
(185
)
 
(49
)
Loss from Operations of Discontinued Subsidiaries, net of tax (Note 13)
—

 
(1
)
 
(1
)
 
(3
)
Net Loss
(104
)
 
(32
)
 
(186
)
 
(52
)
Net Income Attributable to Noncontrolling Interests (Note 3)
(5
)
 
—

 
(7
)
 
—

Net Loss Attributable to Edison Mission Energy Common Shareholder
$
(109
)
 
$
(32
)
 
$
(193
)
 
$
(52
)
Amounts Attributable to Edison Mission Energy Common Shareholder
 
 
 
 
 
 
 
Loss from continuing operations, net of tax
$
(109
)
 
$
(31
)
 
$
(192
)
 
$
(49
)
Loss from discontinued operations, net of tax
—

 
(1
)
 
(1
)
 
(3
)
Net Loss Attributable to Edison Mission Energy Common Shareholder
$
(109
)
 
$
(32
)
 
$
(193
)
 
$
(52
)

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
June 30,
 
Six Months Ended
June 30,
 
2012
 
2011
 
2012
 
2011
Net Loss
$
(104
)
 
$
(32
)
 
$
(186
)
 
$
(52
)
Other comprehensive income (loss), net of tax
 
 
 
 
 
 
 
Pension and postretirement benefits other than pensions
 
 
 
 
 
 
 
Net gain adjustment, net of tax
—

 
—

 
1

 
—

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

 
—

 
1

 
1

Unrealized losses on derivatives qualified as cash flow hedges
 
 
 
 
 
 
 
Unrealized holding losses arising during the periods, net of income tax benefit of $19 and $9 for the three months and $2 and $5 for the six months ended June 30, 2012 and 2011, respectively
(28
)
 
(14
)
 
(3
)
 
(8
)
Reclassification adjustments included in net loss, net of income tax benefit of $6 and $6 for the three months and $13 and $12 for the six months ended June 30, 2012 and 2011, respectively
(9
)
 
(7
)
 
(20
)
 
(17
)
Other comprehensive loss, net of tax
(37
)
 
(21
)
 
(21
)
 
(24
)
Comprehensive Loss
(141
)
 
(53
)
 
(207
)
 
(76
)
Comprehensive Income Attributable to Noncontrolling Interests
(5
)
 
—

 
(7
)
 
—

Comprehensive Loss Attributable to Edison Mission Energy Common Shareholder
$
(146
)
 
$
(53
)
 
$
(214
)
 
$
(76
)


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)

 
June 30,
2012
 
December 31,
2011
Assets
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
1,009

 
$
1,300

Accounts receivable—trade
107

 
107

Receivables from affiliates
5

 
4

Inventory
232

 
274

Derivative assets
46

 
40

Restricted cash and cash equivalents
110

 
103

Margin and collateral deposits
59

 
41

Prepaid expenses and other
90

 
72

Total current assets
1,658

 
1,941

Investments in Unconsolidated Affiliates
529

 
523

Property, Plant and Equipment, less accumulated depreciation of $1,428 and $1,295 at respective dates
4,463

 
4,472

Other Assets
 
 
 
Deferred financing costs
68

 
71

Long-term derivative assets
52

 
59

Restricted deposits
95

 
48

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

 
760

Deferred taxes
349

 
205

Other long-term assets
242

 
244

Total other assets
1,604

 
1,387

Total Assets
$
8,254

 
$
8,323


EDISON MISSION ENERGY AND SUBSIDIARIES
 

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

 
June 30,
2012
 
December 31,
2011
Liabilities and Shareholder's Equity
 
 
 
Current Liabilities
 
 
 
Accounts payable
$
70

 
$
99

Payables to affiliates
91

 
188

Accrued liabilities
133

 
168

Derivative liabilities
—

 
1

Interest payable
30

 
33

Deferred taxes
26

 
2

Current portion of long-term debt
566

 
57

Short-term debt
9

 
—

Total current liabilities
925

 
548

Long-term debt net of current portion
4,430

 
4,855

Deferred revenues
517

 
530

Long-term derivative liabilities
114

 
90

Other long-term liabilities
606

 
636

Total Liabilities
6,592

 
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
1,309

 
1,327

Retained earnings
160

 
365

Accumulated other comprehensive loss
(115
)
 
(94
)
Total Edison Mission Energy common shareholder's equity
1,418

 
1,662

Noncontrolling Interests
244

 
2

Total Equity
1,662

 
1,664

Total Liabilities and Equity
$
8,254

 
$
8,323




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

CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions, unaudited)
 
Six Months Ended June 30,
 
2012
 
2011
Cash Flows From Operating Activities
 
 
 
Net loss
$
(186
)
 
$
(52
)
Loss from discontinued operations
1

 
3

Loss from continuing operations, net
(185
)
 
(49
)
Adjustments to reconcile loss to net cash used in operating activities:
 
 
 
Equity in income from unconsolidated affiliates
(17
)
 
(12
)
Distributions from unconsolidated affiliates
6

 
15

Depreciation and amortization
148

 
164

Deferred taxes and tax credits
(112
)
 
(30
)
Loss on disposal and asset impairments
26

 
—

Changes in operating assets and liabilities:
 
 
 
(Increase) decrease in margin and collateral deposits
(18
)
 
9

Increase in receivables
(1
)
 
—

Decrease (increase) in inventory
42

 
(22
)
Increase in prepaid expenses and other
(9
)
 
(12
)
Increase in restricted cash and cash equivalents
(4
)
 
(9
)
Increase in rent payments in excess of levelized rent expense
(38
)
 
(101
)
(Decrease) increase in payables and other current liabilities
(159
)
 
1

Increase in interest payable
3

 
—

Decrease in derivative assets and liabilities
(14
)
 
(23
)
Increase in other operating—assets
9

 
8

Increase in other operating—liabilities
(30
)
 
(31
)
Operating cash flow from continuing operations
(353
)
 
(92
)
Operating cash flow from discontinued operations
(1
)
 
(3
)
Net cash used in operating activities
(354
)
 
(95
)
Cash Flows From Financing Activities
 
 
 
Borrowings on long-term debt
99

 
76

Payments on debt
(25
)
 
(28
)
Borrowings under short-term debt
9

 
32

Cash contributions from noncontrolling interests
242

 
—

Cash dividends to noncontrolling interests
(7
)
 
—

Payments to affiliates related to stock-based awards
(12
)
 
(4
)
Excess tax benefits related to stock-based exercises
1

 
1

Financing costs
(7
)
 
—

Net cash provided by financing activities from continuing operations
300

 
77

Cash Flows From Investing Activities
 
 
 
Capital expenditures
(166
)
 
(219
)
Proceeds from return of capital and loan repayments and sale of assets
5

 
12

Proceeds from settlement of insurance claims
2

 
—

Investments in and loans to unconsolidated affiliates
—

 
(7
)
(Increase) decrease in restricted deposits and restricted cash and cash equivalents
(69
)
 
19

Investments in other assets
(9
)
 
(29
)
Net cash used in investing activities from continuing operations
(237
)
 
(224
)
Net decrease in cash and cash equivalents
(291
)
 
(242
)
Cash and cash equivalents at beginning of period
1,300

 
1,075

Cash and cash equivalents at end of period
$
1,009

 
$
833


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
June 30, 2012
(Unaudited)

Note 1. Summary of Significant Accounting Policies
Liquidity and Restructuring Activities
At June 30, 2012, Edison Mission Energy (EME), and its subsidiaries without contractual dividend restrictions, had corporate cash and cash equivalents of $879 million, which includes Midwest Generation, LLC's (Midwest Generation) cash and cash equivalents of $177 million. EME and Midwest Generation's previous revolving credit agreements have been terminated or expired and no longer are sources of liquidity. At June 30, 2012, EME had $3.7 billion of unsecured notes outstanding, $500 million of which mature in June 2013.
EME is currently experiencing operating losses due to lower realized energy and capacity prices, higher fuel costs and lower generation at the Midwest Generation plants. Forward market prices indicate that these trends are expected to continue for a number of years. As a result, EME expects that it will incur further reductions in cash flow and losses in the current year and in subsequent years. A continuation of these adverse trends coupled with pending debt maturities and the need to retrofit its Midwest Generation plants to comply with governmental regulations will exhaust EME's liquidity. Consequently, EME will need to consider all options available to it, including potential sales of assets, restructuring, reorganization of its capital structure, or conservation of cash that would be otherwise applied to the payment of obligations. EME has entered into non-disclosure and engagement agreements with advisors representing certain of its unsecured bondholders for the purpose of engaging in discussions with such advisors and Edison International regarding EME's financial condition. Absent a restructuring of its obligations, based on current projections, EME is not expected to have sufficient liquidity to repay the $500 million debt obligation due in June 2013. As a result, EME may need to file for protection under Chapter 11 of the U.S. Bankruptcy Code.
Bankruptcy proceedings could lead to a change of control of EME , which would result in the termination of EME's tax-allocation agreement. At June 30, 2012, EME had recognized $323 million of net deferred tax benefits based on continued ownership by Edison International and inclusion of EME in the consolidated income tax returns of Edison International and its subsidiaries. If it is more likely than not that EME would no longer continue to participate as part of the consolidated group of Edison International, EME would record a valuation allowance to reduce the carrying value of its net deferred tax benefit and record a material charge against earnings. The termination of the tax-allocation agreement could adversely affect EME's long-term liquidity because realization of the value of tax benefits generated by EME could be deferred until such time that EME, or a subsequent owner of EME, had the ability to utilize such benefits. There is no assurance as to when, or whether, this might occur.
The accompanying consolidated financial statements have been prepared assuming that EME will continue as a going concern. Financial statements prepared on this basis assume the realization of assets and the satisfaction of liabilities in the normal course of business for the 12-month period following the date of these financial statements. There is no assurance that EME will be able to continue as a going concern.
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- and six-month periods ended June 30, 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.

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The consolidated statement of cash flows for the six months ended June 30, 2011 was revised to correct an error in the presentation of vendor financed property, plant and equipment in the amount of $19 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 $873 million and $1.2 billion at June 30, 2012 and December 31, 2011, respectively. The carrying value of cash equivalents equals the fair value as all investments have original maturities of less than three months.
Restricted Cash and Cash Equivalents, and Restricted Deposits
Restricted cash and cash equivalents at June 30, 2012 and December 31, 2011 included $97 million received from a wind project financing that was held in escrow at those dates. At June 30, 2012, restricted deposits included $51 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)
June 30, 2012
 
December 31, 2011
Coal, fuel oil and other raw materials
$
142

 
$
188

Spare parts, materials and supplies
90

 
86

Total inventory
$
232

 
$
274

Allocation of Net Income or Losses to Investors in Certain Variable Interest Entities
Capistrano Wind Partners' partnership agreements contain complex allocation provisions for taxable income and losses, tax credits and cash distributions. EME allocates net income for this consolidated investment to third-party investors based on 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 (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

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guidance January 1, 2012 and elected to present two separate but consecutive statements. 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.

Note 2. Consolidated Statements of Changes in Equity
The following table provides the changes in equity for the six months ended June 30, 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)
—

 
—

 
(193
)
 
—

 
7

 
(186
)
Other comprehensive loss
—

 
—

 
—

 
(21
)
 
—

 
(21
)
Payments to Edison International for stock purchases related to stock-based compensation
—

 
—

 
(12
)
 
—

 
—

 
(12
)
Other stock transactions, net
—

 
3

 
—

 
—

 
—

 
3

Contributions from noncontrolling interests1
—

 
—

 
—

 
—

 
242

 
242

Distributions to noncontrolling interests
—

 
—

 
—

 
—

 
(7
)
 
(7
)
Transfers of assets to Capistrano Wind Partners2
—

 
(21
)
 
—

 
—

 
—

 
(21
)
Balance at June 30, 2012
$
64

 
$
1,309

 
$
160

 
$
(115
)
 
$
244

 
$
1,662

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 by $21 million during the six months ended June 30, 2012 due to a new tax basis in the assets transferred to Capistrano Wind Partners. The tax basis allocation to the transferred assets was updated during the three months ended June 30, 2012. For further information, see Note 3—Variable Interest Entities—Projects or Entities that are Consolidated—Capistrano Wind Equity Capital.

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The following table provides the changes in equity for the six months ended June 30, 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
—

 
—

 
(52
)
 
—

 
—

 
(52
)
Other comprehensive loss
—

 
—

 
—

 
(24
)
 
—

 
(24
)
Payments to Edison International for stock purchases related to stock-based compensation
—

 
—

 
(3
)
 
—

 
—

 
(3
)
Excess tax benefits related to stock option exercises
—

 
1

 
—

 
—

 
—

 
1

Other stock transactions, net
—

 
2

 
—

 
—

 
—

 
2

Purchase of noncontrolling interest1
—

 
(4
)
 
—

 
—

 
(1
)
 
(5
)
Balance at June 30, 2011
$
64

 
$
1,335

 
$
1,393

 
$
(55
)
 
$
3

 
$
2,740

1 
During the second quarter of 2011, EME purchased a noncontrolling interest in Pinnacle Wind Force, LLC, which is now 100% owned by EME.

Note 3. Variable Interest Entities
Projects or Entities that are Consolidated
At June 30, 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 June 30, 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.
The following table presents summarized financial information of the projects that were consolidated by EME:
(in millions)
June 30,
2012
 
December 31,
2011
Current assets
$
118

 
$
36

Net property, plant and equipment
1,107

 
675

Other long-term assets
22

 
5

Total assets
$
1,247

 
$
716

Current liabilities
$
34

 
$
28

Long-term debt net of current portion
175

 
57

Deferred revenues
173

 
69

Long-term derivative liabilities
22

 
—

Other long-term liabilities
37

 
22

Total liabilities
$
441

 
$
176

Noncontrolling interests
$
244

 
$
2

Assets serving as collateral for the debt obligations had a carrying value of $472 million and $136 million at June 30, 2012 and December 31, 2011, respectively, and primarily consist of property, plant and equipment.

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Table of Contents

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 Inc. (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 loans. 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 certain 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 June 30, 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 $21 million.

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 June 30, 2012 and December 31, 2011.
Assets and liabilities are categorized into a three-level fair value hierarchy based on valuation inputs used to determine 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:
 
June 30, 2012
(in millions)
Level 1
 
Level 2
 
Level 3
 
Netting and
Collateral1
 
Total
Assets at Fair Value
 
 
 
 
 
 
 
 
 
Money market funds2
$
873

 
$
—

 
$
—

 
$
—

 
$
873

Derivative contracts
 
 
 
 
 
 
 
 
 
Electricity
$
—

 
$
106

 
$
51

 
$
(59
)
 
$
98

Natural gas
4

 
—

 
—

 
(4
)
 
—

Total derivative contracts
4

 
106

 
51

 
(63
)
 
98

Total assets
$
877

 
$
106

 
$
51

 
$
(63
)
 
$
971

Liabilities at Fair Value
 
 
 
 
 
 
 
 
 
Derivative contracts
 
 
 
 
 
 
 
 
 
Electricity
$
—

 
$
7

 
$
10

 
$
(17
)
 
$
—

Interest rate contracts
—

 
114

 
—

 
—

 
114

Total liabilities
$
—

 
$
121

 
$
10

 
$
(17
)
 
$
114



9
Table of Contents

 
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 derivative 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.
The following table sets forth a summary of changes in the fair value of Level 3 net derivative assets and liabilities:
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
(in millions)
2012
 
2011
 
2012
 
2011
Fair value of net assets at beginning of period
$
24

 
$
83

 
$
83

 
$
91

Total realized/unrealized gains (losses)
 
 
 
 
 
 
 
Included in earnings1
23

 
18

 
8

 
18

Included in accumulated other comprehensive loss2
—

 
(4
)
 
2

 
(3
)
Purchases
13

 
6

 
19

 
11

Settlements
(19
)
 
(19
)
 
(20
)
 
(31
)
Transfers out of Level 33
—

 
—

 
(51
)
 
(2
)
Fair value of net assets at end of period
$
41

 
$
84

 
$
41

 
$
84

Change during the period in unrealized gains (losses) related to assets and liabilities held at end of period1
$
14

 
$
14

 
$
8

 
$
8

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 and six months ended June 30, 2012 and 2011.

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Table of Contents

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 the income approach by obtaining 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 the income approach through various 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.
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 determine fair value for Level 3 assets and liabilities:
June 30, 2012
 
 
 
Quantitative Information About Level 3 Fair Value Measurements
 
Fair Value (in millions)
 
Valuation Techniques
 
Significant Unobservable Input
 
Range
(Weighted Average)
 
Assets
 
Liabilities
Electricity
 
 
 
 
 
 
 
Congestion contracts
$
73

 
 
$
24

 
 
Latest auction pricing
 
Congestion prices
 
$(15.52) - $23.03 ($0.15)
Power contracts
19

 
 
27

 
 
Discounted cash flows
 
Power prices
 
$16.60 - $58.23
($35.80)
Netting
(41
)
 
 
(41
)
 
 
 
 
 
 
 
Total
$
51

 
 
$
10

 
 
 
 
 
 
 

11
Table of Contents

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.
Fair Value of Long-term Debt
The carrying amounts and fair values of EME's long-term debt were as follows:
 
June 30, 2012
 
December 31, 2011
(in millions)
Carrying
Amount
 
Fair Value
 
Carrying
Amount
 
Fair Value
Long-term debt, including current portion
$
4,996

 
$
3,369

 
$
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, through its subsidiaries, Broken Bow Wind, LLC and Crofton Bluffs Wind, LLC, completed 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% 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 June 30, 2012, $9 million and $6 million were outstanding under the construction loans included in short-term debt on EME's consolidated balance sheet, and letters of credit facilities, respectively.
2011 Project Financings
Tapestry Wind
In December 2011, EME, through its subsidiary, Tapestry Wind, LLC, completed 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 regarding, among other things, noise emissions and shadow flicker and requested that the Commission order the project to shut down at night due to alleged noise emissions. This complaint was dismissed on June 1, 2012. On June 27, 2012 and on July 3, 2012, nearly identical complaints were filed with the West Virginia Public Service Commission by two other neighbors. In addition, on June 25, 2012, each of the three neighbors filed separate civil complaints in the Circuit Court of Mineral County, West Virginia against Pinnacle Wind, LLC, EME, Edison Mission Operations and Maintenance, Inc., and other non-affiliated defendants. The civil complaints allege, among other things, that the noise emissions and shadow flicker from the Pinnacle wind farm constitute a nuisance and seek compensatory damages, punitive damages and other equitable relief. The release of the loan proceeds in escrow is subject to resolution of the complaints or further due diligence from the lenders.

12
Table of Contents

Big Sky Turbine Financing
In October 2009, EME, through its subsidiary, Big Sky Wind, LLC (Big Sky), entered into turbine financing arrangements totaling approximately $206 million for wind turbine purchase obligations related to the 240 MW Big Sky wind project. The loan has a five-year final maturity, however, specific events, including project performance, may trigger earlier repayment which could occur as early as February 2013. Big Sky's repayment obligations were guaranteed by EME until certain conditions were met, including commercial operations. On February 1, 2012, the lender agreed that all conditions had been satisfied and released EME from such guarantee. The loan is secured by a leasehold mortgage on the project's real property assets, a pledge of all other collateral of the Big Sky wind project, as well as a cash reserve account into which one-third of distributable cash flow, if any, of the Big Sky wind project is to be deposited on a monthly basis. The loan is also secured by pledges of Big Sky's direct and indirect ownership interests in the project.
Big Sky will need to arrange alternative financing, if available, to repay the loan at maturity or reach agreement with the lender to extend the maturity date of the loan as EME does not plan to make an investment in the project and is under no obligation to do so. If these efforts are unsuccessful, the lender may foreclose on the project resulting in a write off of the entire investment in the project. At June 30, 2012, EME's net investment in the Big Sky wind project was $135 million.
Credit Facilities and Letters of Credit
In February 2012, EME terminated its $564 million revolving credit facility. Midwest Generation's $500 million credit facility expired in June 2012 as per its terms. In the first quarter of 2012, EME 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.
Letters of credit under EME's and its subsidiaries' credit facilities aggregated $165 million and were scheduled to expire as follows: $59 million in 2012, $75 million in 2013, $3 million in 2014, $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 June 30, 2012, EME had $51 million of cash collateral supporting its letters of credit.

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.
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.

13
Table of Contents

Notional Volumes of Derivative Instruments
The following table summarizes the notional volumes of derivatives used for hedging and trading activities:
June 30, 2012
 
 
 
 
 
 
 
 
Hedging Activities
 
Trading
Activities
 
Commodity
 
Instrument
 
Classification
 
Unit of
Measure
 
Cash Flow
Hedges
 
Economic
Hedges
 
 
Electricity
 
Forwards/Futures
 
Sales, net
 
GWh
 
4,630

1 
116

3 
—

  
Electricity
 
Forwards/Futures
 
Purchases, net
 
GWh
 
—

 
—

 
2,201

 
Electricity
 
Capacity
 
Sales, net
 
GW-Day
 
37

2 
—

  
—

 
Electricity
 
Capacity
 
Purchases, net
 
GW-Day
 
—

 
—

 
134

2 
Electricity
 
Congestion
 
Purchases, net
 
GWh
 
—

  
287

4 
331,418

4 
Natural gas
 
Forwards/Futures
 
Purchases, net
 
bcf
 
—

 
—

 
1.7

 
Fuel oil
 
Forwards/Futures
 
Purchases, net
 
barrels
 
—

  
240,000

  
20,000

  
At June 30, 2012, EME had interest rate contracts with notional values totaling $703 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 June 30, 2012, EME had forward starting interest rate contracts with notional values totaling $641 million that will convert floating rate LIBOR-based debt to fixed rates ranging from 0.7825% to 4.0025%. These contracts have effective dates beginning December 2012 through December 2021 and expire December 2013 through December 2029.
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
 
GW-Day
 
89

2 
—

  
—

 
Electricity
 
Capacity
 
Purchases, net
 
GW-Day
 
—

 
—

  
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.
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.

14
Table of Contents

Fair Value of Derivative Instruments
The following table summarizes the fair value of derivative instruments reflected on EME's consolidated balance sheets:
June 30, 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
$
24

 
$
2

 
$
26

 
$
1

 
$
3

 
$
4

 
$
22

Interest rate contracts
—

 
—

 
—

 
—

 
114

 
114

 
(114
)
Economic hedges
28

 
2

 
30

 
24

 
2

 
26

 
4

Trading activities
329

 
153

 
482

 
272

 
92

 
364

 
118

 
381

 
157

 
538

 
297

 
211

 
508

 
30

Netting and collateral received1
(335
)
 
(105
)
 
(440
)
 
(297
)
 
(97
)
 
(394
)
 
(46
)
Total
$
46

 
$
52

 
$
98

 
$
—

 
$
114

 
$
114

 
$
(16
)
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.
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
 
 
 
Six Months Ended June 30,
 
 
 
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
19

 
(24
)
 
(6
)
 
(7
)
 
 
Reclassification to earnings
(33
)
 
—

 
(29
)
 
—

 
Operating revenues
End of period derivative gains (losses)
$
21

 
$
(114
)
 
$
8

 
$
(23
)
 
 
1 
Unrealized derivative gains (losses) are before income taxes. The after-tax amounts recorded in accumulated other comprehensive loss at June 30, 2012 and 2011 for commodity and interest rate contracts were $12 million and $(69) million, and $5 million and $(14) million, respectively.

15
Table of Contents

For additional information, see Note 11—Accumulated Other Comprehensive Loss.
EME recorded no net gains or losses during the three months ended June 30, 2012 and 2011, and $1 million and $2 million during the six months ended June 30, 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 (losses) from derivative instruments used for economic hedging and trading purposes on the consolidated statements of operations is presented below:
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
(in millions)
Income Statement Location
2012
 
2011
 
2012
 
2011
Economic hedges
Operating revenues
$
6

 
$
20

 
$
17

 
$
26

 
Fuel
(6
)
 
(2
)
 
(1
)
 
4

Trading activities
Operating revenues
30

 
41

 
50

 
57

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)
June 30,
2012
 
December 31,
2011
Collateral provided to counterparties
 
 
 
 
 
 
 
Offset against derivative liabilities
 
$
3

 
 
 
$
2

 
Reflected in margin and collateral deposits
 
59

 
 
 
41

 
Collateral received from counterparties
 
 
 
 
 
 
 
Offset against derivative assets
 
49

 
 
 
53

 


16
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
June 30,
 
Six Months Ended
June 30,
(in millions)
2012
 
2011
 
2012
 
2011
Loss from continuing operations before income taxes
$
(203
)
 
$
(88
)
 
$
(375
)
 
$
(151
)
Benefit for income taxes at federal statutory rate of 35%
$
(71
)
 
$
(30
)
 
$
(131
)
 
$
(53
)
Increase (decrease) in income tax from
 
 
 
 
 
 
 
State tax-net of federal benefit
(6
)
 
(4
)
 
(21
)
 
(9
)
Production tax credits, net
(17
)
 
(18
)
 
(36
)
 
(36
)
Taxes on income allocated to noncontrolling interests
(5
)
 
(1
)
 
(4
)
 
(1
)
Other
—

 
(4
)
 
2

 
(3
)
Total benefit for income taxes from continuing operations
$
(99
)
 
$
(57
)
 
$
(190
)
 
$
(102
)
Effective tax rate
49
%
 
65
%
 
51
%
 
68
%
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 $196 million, including interest and penalties through June 30, 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 Edison International's 2011 consolidated tax returns and EME will be allocated the benefit for the deductions under the tax-allocation agreements.
Deferred Taxes
At June 30, 2012, EME had recognized $961 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. For further information, see Note 1—Summary of Significant Accounting Policies—Liquidity and Restructuring Activities.

Note 8. Compensation and Benefit Plans
Pension Plans and Postretirement Benefits Other than Pensions
Pension Plans
During the six months ended June 30, 2012, EME made contributions of $13 million, and during the remainder of 2012, expects to make $9 million of additional contributions.

17
Table of Contents

The following were components of pension expense:
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
(in millions)
2012
 
2011
 
2012
 
2011
Service cost
$
4

 
$
5

 
$
9

 
$
9

Interest cost
4

 
3

 
7