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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

2022-02-24 compared with 2021-03-01 · 37 added, 43 removed, 71 unchanged (53% of the section changed)

1 unchanged sentence

NRG is exposed to several market risks in the Company's normal business activities.

Market risk is the potential loss that may result from market changes associated with the Company's retail operations, merchant power generation, or with an existing or forecasted financial or commodity transaction.

The types of market risks the Company is exposed to are commodity price risk, interest rate risk, liquidity risk, credit risk and currency exchange risk.

In order to manage these risks, the Company uses various fixed-price forward purchase and sales contracts, futures and option contracts traded on NYMEX, and swaps and options traded in the over-the-counter financial markets to:

In order to manage these risks, the Company uses various fixed-price forward purchase and sales contracts, futures and option contracts traded on NYMEX and other exchanges, and swaps and options traded in the over-the-counter financial markets to:

• Manage and hedge fixed-price purchase and sales commitments;

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Commodity price risks result from exposures to changes in spot prices, forward prices, volatilities, and correlations between various commodities, such as natural gas, electricity, coal, oil, and emissions credits.

NRG manages the commodity price risk of the Company's merchant generation operations and load serving obligations by entering into various derivative or non-derivative instruments to hedge the variability in future cash flows from forecasted sales and purchases of electricity, natural gas and fuel.

These instruments include forwards, futures, swaps, and option contracts traded on various exchanges, such as NYMEX and ICE, as well as over-the-counter markets.

The portion of forecasted transactions hedged may vary based upon management's assessment of market, weather, operation and other factors.

While some of the contracts the Company uses to manage risk represent commodities or instruments for which prices are available from external sources, other commodities and certain contracts are not actively traded and are valued using other pricing sources and modeling techniques to determine expected future market prices, contract quantities, or both.

NRG uses the Company's best estimates to determine the fair value of those derivative contracts.

However, it is likely that future market prices could vary from those used in recording mark-to-market derivative instrument valuation and such variations could be material.

NRG manages the commodity price risk of the Company's load servicing obligations and merchant generation operations by entering into various derivative or non-derivative instruments to hedge the variability in future cash flows from forecasted sales and purchases of electricity and fuel.

NRG measures the risk of the Company's portfolio using several analytical methods, including sensitivity tests, scenario tests, stress tests, position reports and VaR.

NRG uses a Monte Carlo simulation based VaR model to estimate the potential loss in the fair value of the Company's energy assets and liabilities, which includes generation assets, load obligations, and bilateral physical and financial transactions.

The key assumptions for the Company's VaR model include:

(i) lognormal distribution of prices;

(ii) one-day holding period;

(iii) 95% confidence interval;

(iv) rolling 36-month forward looking period;

and (v) market implied volatilities and historical price correlations.

As of December 31, 2020, the VaR for NRG's commodity portfolio, including generation assets, load obligations and bilateral physical and financial transactions calculated using the VaR model was $30 million.

The following table summarizes average, maximum and minimum VaR for NRG for the years ended December 31, 2020 and 2019:

NRG uses a Monte Carlo simulation based VaR model to estimate the potential loss in the fair value of its energy assets and liabilities, which includes generation assets, gas transportation and storage assets, load obligations and bilateral physical and financial transactions, based on historical and forward values for factors such as customer demand, weather, commodity availability and commodity prices.

The Company's VaR model is based on a one-day holding period at a 95% confidence interval for the forward 36 months, not including the spot month.

The VaR model is not a complete picture of all risks that may affect the Company's results.

Certain events such as counterparty defaults, regulatory changes, and extreme weather and prices that deviate significantly from historically observed values are not reflected in the model.

The following table summarizes average, maximum and minimum VaR for NRG's commodity portfolio, calculated using the VaR model for the years ended December 31, 2021 and 2020:

(In millions) 2021 2020

VaR as of December 31, $ 30 $ 42

VaR as of December 31, (a)

For the year ended December 31,

Average $ 30 $ 44

Maximum 47 55

Minimum 22 33

Due to the inherent limitations of statistical measures such as VaR, the evolving nature of the competitive markets for electricity and related derivatives, and the seasonality of changes in market prices, the VaR calculation may not capture the full extent of commodity price exposure.

As a result, actual changes in the fair value of mark-to-market energy assets and liabilities could differ from the calculated VaR, and such changes could have a material impact on the Company's financial results.

(a) Calculation includes entire NRG portfolio as of December 31, 2021

(b) Calculation is based on NRG generation assets and load obligations excluding the acquisition of Direct Energy assets and load obligations in the first quarter of 2021

In order to provide additional information, the Company also uses VaR to estimate the potential loss of derivative financial instruments that are subject to mark-to-market accounting.

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The VaR for the derivative financial instruments calculated using the diversified VaR model for the entire term of these instruments entered into for both asset management and trading was $242 million as of December 31, 2021, primarily driven by asset-backed transactions.

The increase in the VaR for derivative financial instruments was primarily due to the acquisition of Direct Energy.

Retail Customer Credit Risk

NRG is exposed to retail credit risk related to its C&I and Mass Market customers.

NRG is exposed to retail credit risk related to its Business and Home customers.

Retail credit risk results in losses when a customer fails to pay for services rendered.

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NRG manages retail credit risk through the use of established credit policies that include monitoring of the portfolio and the use of credit mitigation measures, such as deposits or prepayment arrangements.

As of December 31, 2020, the Company's retail customer credit exposure to C&I and Mass customers was diversified across many customers and various industries, as well as government entities.

As of December 31, 2021, the Company's retail customer credit exposure to Home and Business customers was diversified across many customers and various industries, as well as government entities.

The Company's provision for credit losses resulting from credit risk was $698 million, $108 million and $95 million for the years ending December 31, 2021, 2020 and 2019, respectively.

Current economic conditions may affect the Company's customers' ability to pay bills in a timely manner, which could increase customer delinquencies and may lead to an increase in credit losses.

As a result of Winter Storm Uri, the Company incurred additional credit losses from Business customers primarily due to a segment of customers whose contracts included a pass through of wholesale power prices which were significantly escalated during the storm and from customers who failed to meet their obligations in ERCOT load curtailment programs.

Liquidity Risk

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Cash margin is collected and held at the Company to cover the credit risk of the counterparty until positions settle.

As of December 31, 2020, aggregate counterparty credit exposure to a significant portion of the Company's counterparties totaled $210 million, of which the Company held collateral (cash and letters of credit) against those positions of $14 million resulting in a net exposure of $204 million.

As of December 31, 2021, counterparty credit exposure, excluding credit exposure from RTOs, ISOs, and registered commodity exchanges and certain long-term agreements, was $2.2 billion, of which the Company held collateral (cash and letters of credit) against those positions of $598 million resulting in a net exposure of $1.6 billion.

NRG periodically receives collateral from counterparties in excess of their exposure.

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(b) The figures in the tables above exclude potential counterparty credit exposure related to RTOs, ISOs, registered commodity exchanges and certain long-term contracts

The Company has $47 million of exposure to two wholesale counterparties in excess of 10% of the total net exposure discussed above as of December 31, 2020.

The Company has no exposure to wholesale counterparties in excess of 10% of the total net exposure discussed above as of December 31, 2021.

Changes in hedge positions and market prices will affect credit exposure and counterparty concentration.

Given the credit quality, diversification and term of the exposure in the portfolio, the Company does not anticipate a material impact on its financial position or results of operations from nonperformance by any counterparty.

During Winter Storm Uri, the Company experienced nonperformance by a counterparty in one of its bilateral financial hedging transactions, resulting in exposure of $403 million.

The Company is pursuing all means available to enforce its rights under this transaction but, given the size of the exposure, cannot determine with certainty what the amount of its ultimate recovery will be.

The full exposure was recorded as a provision for credit losses during the year ended December 31, 2021.

RTOs and ISOs

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As external sources or observable market quotes are not available to estimate such exposure, the Company values these contracts based on various techniques including, but not limited to, internal models based on a fundamental analysis of the market and extrapolation of observable market data with similar characteristics.

Based on these valuation techniques, as of December 31, 2020, aggregate credit risk exposure managed by NRG to these counterparties was approximately $645 million for the next five years.

Based on these valuation techniques, as of December 31, 2021, aggregate credit risk exposure managed by NRG to these counterparties was approximately $1.1 billion for the next five years.

Interest Rate Risk

NRG was previously exposed to fluctuations in interest rates through its issuance of variable rate debt.

Exposures to interest rate fluctuations may be mitigated by entering into derivative instruments known as interest rate swaps, caps, collars and put or call options.

These contracts reduce exposure to interest rate volatility and result in primarily fixed rate debt obligations when taking into account the combination of the variable rate debt and the interest rate derivative instrument.

NRG's risk management policies allow the Company to reduce interest rate exposure from variable rate debt obligations.

The Company previously entered into interest rate swaps.

As of December 31, 2019, NRG had no interest rate derivative instruments, as a result of the early termination of such contracts in connection with the repayment of the 2023 Term Loan Facility during the second quarter of 2019.

During the fourth quarter of 2020, NRG entered into $1.6 billion of interest rate hedges associated with anticipated certain financing needs.

As of December 31, 2020 the interest rate hedges were settled in connection with the issuance of fixed rate debt resulting in a gain of $11 million that was recorded as a reduction to interest expense.

As of December 31, 2021, the Company's debt fair value was $8.3 billion and carrying value was $8.0 billion.

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Credit Risk Related Contingent Features

Certain of the Company's hedging agreements contain provisions that require the Company to post additional collateral if the counterparty determines that there has been deterioration in credit quality, generally termed "adequate assurance" under the agreements, or require the Company to post additional collateral if there were a downgrade in the Company's credit rating.

The collateral required for contracts that have adequate assurance clauses that are in a net liability position as of December 31, 2020, was $26 million.

Certain of the Company's hedging and trading agreements contain provisions that entitle the counterparty to demand that the Company post additional collateral if the counterparty determines that there has been deterioration in the Company's credit quality, generally termed “adequate assurance” under the agreements, or require the Company to post additional collateral if there were a downgrade in the Company's credit rating.

In addition, as a result of the acquisition of Direct Energy from Centrica, certain of the Company’s agreements as of December 31, 2021, were still supported by credit support posted by Centrica, and as a result could require the Company to post collateral upon a deterioration or downgrade of Centrica.

The collateral potentially required for contracts with adequate assurance clauses that are in a net liability position as of December 31, 2021, was $1.0 billion.

The Company is also a party to certain marginable agreements under which it has a net liability position, but the counterparty has not called for the collateral due, which was approximately $70 million as of December 31, 2021.

If called for by the counterparty, $1 million of additional collateral would be required for all contracts with credit rating contingent features as of December 31, 2020.

In the event of a downgrade in the Company's credit rating and if called for by the counterparty, $1 million of additional collateral would be required for all contracts with credit rating contingent features as of December 31, 2021.

Currency Exchange Risk

NRG's foreign earnings and investments may be subject to foreign currency exchange risk, which NRG generally does not hedge.

As these earnings and investments are not material to NRG's consolidated results, the Company's foreign currency exposure is limited.

NRG is subject to transactional exchange rate risk from transactions with customers in countries outside of the United States, primarily within Canada, as well as from intercompany transactions between affiliates.

Transactional exchange rate risk arises from the purchase and sale of goods and services in currencies other than our functional currency or the functional currency of an applicable subsidiary.

NRG hedges a portion of its forecasted currency transactions with foreign exchange forward contracts.

As of December 31, 2021, NRG is exposed to changes in foreign currency primarily associated with the purchase of U.S.

dollar denominated natural gas for its Canadian business and entered into foreign exchange contracts with notional amount of $279 million.

The Company is subject to translation exchange rate risk related to the translation of the financial statements of its foreign operations into U.S.

Costs incurred and sales recorded by subsidiaries operating outside of the United States are translated into U.S.

dollars using exchange rates effective during the respective period.

As a result, the Company is exposed to movements in the exchange rates of various currencies against the U.S.

dollar, primarily the Canadian and Australian dollars.

A hypothetical 10% appreciation in major currencies relative to the U.S.

dollar as of December 31, 2021 would have resulted in an increase of $10 million to net income within the Consolidated Statement of Operations.

Item 8 — Financial Statements and Supplementary Data

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What changed 10-K

Item 7A. Quantitative and Qualitative Disclosures About Market Risk