Constellation Energy Corp 10-Q

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to market risks associated with adverse changes in commodity prices, counterparty credit, interest rates, and equity prices. We manage these risks through risk management policies and objectives for risk assessment, control and valuation, counterparty credit approval, and the monitoring and reporting of risk exposures. After the separation on February 1, 2022, reporting on risk management issues is to the Executive Committee, the Risk Management Committees of our generation and customer-facing businesses, and the Audit and Risk Committee of the Board of Directors. The following discussion serves as an update to ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK of our 2021 Annual Report on Form 10-K incorporated herein by reference. Commodity Price Risk Commodity price risk is associated with price movements resulting from changes in supply and demand, fuel costs, market liquidity, weather conditions, governmental, regulatory and environmental policies, and other factors. To the extent the total amount of energy we generate and purchase differs from the amount of energy we have contracted to sell, we are exposed to market fluctuations in commodity prices. We seek to mitigate our commodity price risk through the sale and purchase of electricity, natural gas and oil, and other commodities. Electricity available from our owned or contracted generation supply in excess of our obligations to customers is sold into the wholesale markets. To reduce commodity price risk caused by market fluctuations, we enter into non-derivative contracts as well as derivative contracts, including swaps, futures, forwards, and options, with approved counterparties to hedge anticipated exposures. We use derivative instruments as economic hedges to mitigate exposure to fluctuations in commodity prices. We expect the settlement of the majority of our economic hedges will occur during 2022 through 2024. As of March 31, 2022, the percentage of expected generation hedged for the Mid-Atlantic, Midwest, New York, and ERCOT reportable segments is 97%-100% and 86%-89% for 2022 and 2023, respectively. Market price risk exposure is the risk of a change in the value of unhedged positions. The forecasted market price risk exposure for our entire economic hedge portfolio associated with a $2.50/MWh reduction in the annual average around-the-clock energy price based on March 31, 2022 market conditions and hedged position would be an increase in pre-tax net income of approximately $3 million for 2022 and a decrease in pre-tax net income of approximately $64 million for 2023. See Note 11 — Derivative Financial Instruments of the Combined Notes to Consolidated Financial Statements for additional information. Fuel Procurement We procure natural gas through long-term and short-term contracts, and spot-market purchases. Nuclear fuel assemblies are obtained predominantly through long-term uranium concentrate supply contracts, contracted conversion services, contracted enrichment services, or a combination thereof, and contracted fuel fabrication services. The supply markets for uranium concentrates and certain nuclear fuel services are subject to price fluctuations and availability restrictions. Supply market conditions may make our procurement contracts subject to credit risk related to the potential non-performance of counterparties to deliver the contracted commodity or service at the contracted prices. Approximately 50% of our uranium concentrate requirements from 2022 through 2026 are supplied by three suppliers. In the event of non-performance by these or other suppliers, we believe that replacement uranium concentrates can be obtained, although at prices that may be unfavorable when compared to the prices under the current supply agreements. Geopolitical developments, including the Russia and Ukraine conflict and United States sanctions against Russia, have the potential to impact delivery from multiple suppliers in the international uranium processing industry. Non-performance by these counterparties could have a material adverse impact in our financial statements. 76 Table of Contents Trading and Non-Trading Marketing Activities The following table detailing our trading and non-trading marketing activities is included to address the recommended disclosures by the energy industry’s Committee of Chief Risk Officers (CCRO). The following table provides detail on changes in our commodity mark-to-market net asset or liability balance sheet position from December 31, 2021 to March 31, 2022. It indicates the drivers behind changes in the balance sheet amounts. This table incorporates the mark-to-market activities that are immediately recorded in earnings. This table excludes all NPNS contracts and does not segregate proprietary trading activity. See Note 11 — Derivative Financial Instruments of the Combined Notes to Consolidated Financial Statements for additional information on the balance sheet classification of the mark-to-market energy contract net assets (liabilities) recorded as of March 31, 2022 and December 31, 2021. Mark-to-market Energy Contract Net Assets (Liabilities) Balance as of December 31, 2021 $ 1,622 (a) Total change in fair value during 2022 of contracts recorded in result of operations 586 Reclassification to realized at settlement of contracts recorded in results of operations (678) Changes in allocated collateral (1,185) Net option premium paid 31 Option premium amortization (188) Upfront payments and amortizations (b) (108) Balance as of March 31, 2022 $ 80 (a) __________ (a) Amounts are shown net of collateral paid to and received from counterparties. (b) Includes derivative contracts acquired or sold through upfront payments or receipts of cash, excluding option premiums, and the associated amortizations. 77 Table of Contents Fair Values The following table presents maturity and source of fair value for mark-to-market commodity contract net assets (liabilities). The table provides two fundamental pieces of information. First, the table provides the source of fair value used in determining the carrying amount of our total mark-to-market net assets (liabilities), net of allocated collateral. Second, the table shows the maturity, by year, of our commodity contract net assets (liabilities), net of allocated collateral, giving an indication of when these mark-to-market amounts will settle and either generate or require cash. See Note 13 — Fair Value of Financial Assets and Liabilities of the Combined Notes to Consolidated Financial Statements for additional information regarding fair value measurements and the fair value hierarchy. Maturities Within Total Fair Value 2022 2023 2024 2025 2026 2027 and Beyond Normal Operations, Commodity derivative contracts (a)(b) : Actively quoted prices (Level 1) $ 875 $ 211 $ 108 $ 84 $ 42 $ — $ 1,320 Prices provided by external sources (Level 2) (346) 538 (148) (5) (1) — 38 Prices based on model or other valuation methods (Level 3) (545) (534) (50) (49) (38) (62) (1,278) Total $ (16) $ 215 $ (90) $ 30 $ 3 $ (62) $ 80 __________ (a) Mark-to-market gains and losses on other economic hedge and trading derivative contracts that are recorded in the results of operations. (b) Amounts are shown net of collateral paid/(received) from counterparties (and offset against mark-to-market assets and liabilities) of $(675) million at March 31, 2022. 78 Table of Contents Credit Risk We would be exposed to credit-related losses in the event of non-performance by counterparties that execute derivative instruments. The credit exposure of derivative contracts, before collateral, is represented by the fair value of contracts at the reporting date. See Note 11 — Derivative Financial Instruments of the Combined Notes to Consolidated Financial Statements for a detailed discussion of credit risk. The following tables provide information on our credit exposure for all derivative instruments, NPNS, and payables and receivables, net of collateral and instruments that are subject to master netting agreements, as of March 31, 2022. The tables further delineate that exposure by credit rating of the counterparties and provide guidance on the concentration of credit risk to individual counterparties and an indication of the duration of a company’s credit risk by credit rating of the counterparties. The amounts in the tables below exclude credit risk exposure from individual retail customers, uranium procurement contracts, and exposure through RTOs, ISOs, and commodity exchanges, which are discussed in ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK of our 2021 Annual Report on Form 10-K . Rating as of March 31, 2022 Total Exposure Before Credit Collateral Credit Collateral (a) Net Exposure Number of Counterparties Greater than 10% of Net Exposure Net Exposure of Counterparties Greater than 10% of Net Exposure Investment grade $ 927 $ 123 $ 804 — $ — Non-investment grade 18 — 18 — — No external ratings Internally rated—investment grade 71 — 71 — — Internally rated—non-investment grade 220 45 175 — — Total $ 1,236 $ 168 $ 1,068 — $ — __________ (a) As of March 31, 2022, credit collateral held from counterparties where we had credit exposure included $131 million of cash and $37 million of letters of credit. Maturity of Credit Risk Exposure Rating as of March 31, 2022 Less than 2 Years 2-5 Years Exposure Greater than 5 Years Total Exposure Before Credit Collateral Investment grade $ 739 $ 93 $ 95 $ 927 Non-investment grade 14 4 — 18 No external ratings Internally rated—investment grade 71 — — 71 Internally rated—non-investment grade 164 48 8 220 Total $ 988 $ 145 $ 103 $ 1,236 79 Table of Contents Net Credit Exposure by Type of Counterparty As of March 31, 2022 Financial institutions $ 25 Investor-owned utilities, marketers, power producers 900 Energy cooperatives and municipalities 55 Other 88 Total $ 1,068 Credit-Risk-Related Contingent Features As part of the normal course of business, we routinely enter into physical or financial contracts for the sale and purchase of electricity, natural gas, and other commodities. In accordance with the contracts and applicable law, if we are downgraded by a credit rating agency, especially if such downgrade is to a level below investment grade, it is possible that a counterparty would attempt to rely on such a downgrade as a basis for making a demand for adequate assurance of future performance. Depending on our net position with a counterparty, the demand could be for the posting of collateral. In the absence of expressly agreed-to provisions that specify the collateral that must be provided, collateral requested will be a function of the facts and circumstances of the situation at the time of the demand. See Note 11 — Derivative Financial Instruments of the Combined Notes to Consolidated Financial Statements for additional information regarding collateral requirements and Note 14 — Commitments and Contingencies of the Combined Notes to Consolidated Financial Statements for additional information regarding the letters of credit supporting the cash collateral. We transact output through bilateral contracts. The bilateral contracts are subject to credit risk, which relates to the ability of counterparties to meet their contractual payment obligations. Any failure to collect these payments from counterparties could have a material impact on our financial statements. As market prices rise above or fall below contracted price levels, we are required to post collateral with purchasers; as market prices fall below contracted price levels, counterparties are required to post collateral with us. In addition, we entered into supply forward contracts with certain utilities with one-sided collateral postings only from us. To post collateral, we depend on access to bank credit facilities, which serve as liquidity sources to fund collateral requirements. See ITEM 2. Liquidity and Capital Resources — Credit Matters — Credit Facilities for additional information. Interest Rate and Foreign Exchange Risk We use a combination of fixed-rate and variable-rate debt to manage interest rate exposure. We may also utilize interest rate swaps to manage our interest rate exposure. A hypothetical 50 basis point increase in the interest rates associated with unhedged variable-rate debt (excluding Commercial Paper) and fixed-to-floating swaps would not result in a material decrease in our pre-tax income for the three months ended March 31, 2022. To manage foreign exchange rate exposure associated with international energy purchases in currencies other than U.S. dollars, we utilize foreign currency derivatives, which are typically designated as economic hedges. See Note 11 — Derivative Financial Instruments of the Combined Notes to Consolidated Financial Statements for additional information. Equity Price Risk We maintain trust funds, as required by the NRC, to fund the costs of decommissioning our nuclear plants. Our NDT funds are reflected at fair value in the Consolidated Balance Sheets. The mix of securities in the trust funds is designed to provide returns to be used to fund decommissioning and to compensate us for inflationary increases in decommissioning costs; however, the equity securities in the trust funds are exposed to price fluctuations in equity markets, and the value of fixed-rate, fixed-income securities are exposed to changes in interest rates. We actively monitor the investment performance of the trust funds and periodically review asset allocations in accordance with our NDT fund investment policy. A hypothetical 25 basis points increase in interest rates and 10% decrease in equity prices would result in a $818 million reduction in the fair value of the trust assets as of March 31, 2022. This calculation holds all other variables constant and assumes only the discussed changes in interest rates and equity prices. 80 Table of Contents