Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk that in the normal course of business we may experience a loss in value due to changes in market conditions that affect economic factors such as commodity prices, interest rates and counterparty credit. Our exposure to market risk is affected by several factors, including the size, duration and composition of our energy and financial portfolio, as well as the volatility and liquidity of markets.
Risk Oversight
We manage the commodity price, counterparty credit and commodity-related operational risk related to the competitive energy business within limitations established by senior management and in accordance with overall risk management framework established and overseen by the Company's board of directors (Board) and the sustainability and risk committee of the Board, as applicable. Interest rate risk is managed centrally by our treasury function. Market risks are monitored by risk management groups that operate independently of the wholesale commercial operations, utilizing defined practices and analytical methodologies. These techniques measure the risk of change in value of the portfolio of contracts and the hypothetical effect on this value from changes in market conditions and include, but are not limited to, position reporting and review, Value at Risk (VaR) methodologies and stress test scenarios. Key risk control activities include, but are not limited to, transaction review and approval (including credit review), operational and market risk measurement, transaction authority oversight, validation of transaction capture, market price validation and reporting, and portfolio valuation and reporting.
Commodity Price Risk
Our business is subject to the inherent risks of market fluctuations in the price of electricity, natural gas and other energy-related products it markets or purchases. We actively manage the portfolio of generation assets, fuel supply and retail sales load to mitigate the near-term impacts of these risks on results of operations. Similar to other participants in the market, we cannot fully manage the long-term value impact of structural declines or increases in natural gas and power prices.
In managing energy price risk, we enter into a variety of market transactions including, but not limited to, short- and long-term contracts for physical delivery, exchange-traded and over-the-counter financial contracts and bilateral contracts with customers. Activities include hedging, the structuring of long-term contractual arrangements and proprietary trading. We continuously monitor the valuation of identified risks and adjust positions based on current market conditions.
VaR Methodology — A VaR methodology is used to measure the amount of market risk that exists within the portfolio under a variety of market conditions. The resultant VaR produces an estimate of a portfolio's potential for loss given a specified confidence level and considers, among other things, market movements utilizing standard statistical techniques given historical and projected market prices and volatilities.
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Parametric processes are used to calculate VaR and are considered by management to be the most effective way to estimate changes in a portfolio's value based on assumed market conditions for liquid markets. The use of this method requires a number of key assumptions, such as use of (i) an assumed confidence level, (ii) an assumed holding period ( i.e. , the time necessary for management action, such as to liquidate positions) and (iii) historical estimates of volatility and correlation data. The table below details a VaR measure related to various portfolios of contracts.
VaR for Underlying Generation Assets and Energy-Related Contracts — This measurement estimates the potential loss in value, due to changes in market conditions, of all underlying generation assets and contracts, based on a 95% confidence level and an assumed holding period of 60 days. The forward period covered by this calculation includes the current and subsequent calendar year at the time of calculation.
Year Ended December 31,
2020 2019
Month-end average VaR $ 234 $ 263
Month-end high VaR $ 361 $ 520
Month-end low VaR $ 164 $ 103
The VaR risk measures in 2020 were primarily comparable to the prior year. Month-end high VaR was lower in 2020 due to lower prices and a decrease in volatility in ERCOT as compared to the prior year.
Interest Rate Risk
The following table provides information concerning our financial instruments at December 31, 2020 and 2019 that are sensitive to changes in interest rates. Debt amounts consist of the Vistra Operations Credit Facilities. See Note 11 to the Financial Statements for further discussion of these financial instruments.
Expected Maturity Date 2020
Total Carrying
Amount 2020
Total Fair
Value 2019
Total Carrying
Amount 2019
Total Fair
Value
2021 2022 2023 2024 2025 There-after
Long-term debt, including current maturities (a):
Variable rate debt amount $ 28 $ 29 $ 28 $ 29 $ 2,458 $ — $ 2,572 $ 2,565 $ 2,700 $ 2,717
Average interest rate (b) 1.90 % 1.90 % 1.90 % 1.90 % 1.90 % — % 1.90 % 3.55 %
Debt swapped to fixed (c):
Notional amount $ — $ — $ 2,300 $ — $ — $ 2,300 $ 4,600 $ 4,600
Average pay rate 3.76 % 3.76 % 4.18 % 4.77 % 4.77 % 4.77 %
Average receive rate 1.90 % 1.90 % 1.97 % 2.06 % 2.06 % 2.06 %
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(a) Unamortized premiums, discounts and debt issuance costs are excluded from the table.
(b) The weighted average interest rate presented is based on the rates in effect at December 31, 2020.
(c) Interest rate swaps have maturity dates through July 2026. Excludes $2.12 billion of debt swapped to variable that is matched against the terms of $2.12 billion of debt swapped to fixed that effectively fix the out-of-the-money position of such swaps (see Note 11 to the Financial Statements).
At December 31, 2020, the potential reduction of annual pretax earnings over the next twelve months due to a one percentage-point (100 basis points) increase in floating interest rates on long-term debt totaled approximately $6 million taking into account the interest rate swaps discussed in Note 11 to Financial Statements.
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Credit Risk
Credit risk relates to the risk of loss associated with nonperformance by counterparties. We minimize credit risk by evaluating potential counterparties, monitoring ongoing counterparty risk and assessing overall portfolio risk. This includes review of counterparty financial condition, current and potential credit exposures, credit rating and other quantitative and qualitative credit criteria. We also employ certain risk mitigation practices, including utilization of standardized master agreements that provide for netting and setoff rights, as well as credit enhancements such as margin deposits and customer deposits, letters of credit, parental guarantees and surety bonds. See Note 16 to the Financial Statements for further discussion of this exposure.
Bankruptcies — We are party to (i) certain gas transportation agreements with PG&E and (ii) a long-term resource adequacy contract with PG&E in connection with the Moss Landing battery storage project, which was originally approved by the California Public Utilities Commission (CPUC) in November 2018. PG&E filed for Chapter 11 bankruptcy protection in January 2019. In November 2019, the bankruptcy court approved PG&E's motion requesting approval of the assumption of the resource adequacy contract subject to the CPUC approving the terms of an amendment to the resource adequacy contract, and the CPUC approved the terms of the amendment in January 2020. PG&E emerged from bankruptcy protection in July 2020.
Credit Exposure — Our gross credit exposure (excluding collateral impacts) associated with retail and wholesale trade accounts receivable and net derivative assets arising from commodity contracts and hedging and trading activities totaled $1.282 billion at December 31, 2020.
At December 31, 2020, Retail segment credit exposure totaled $990 million, including $982 million of trade accounts receivable and $8 million related to derivative assets. Cash deposits and letters of credit held as collateral for these receivables totaled $80 million, resulting in a net exposure of $910 million. Allowances for uncollectible accounts receivable are established for the potential loss from nonpayment by these customers based on historical experience, market or operational conditions and changes in the financial condition of large business customers.
At December 31, 2020, aggregate Texas, East and Sunset segments credit exposure totaled $292 million including $163 million related to derivative assets and $129 million of trade accounts receivable, after taking into account master netting agreement provisions but excluding collateral impacts.
Including collateral posted to us by counterparties, our net Texas, East and Sunset segments exposure was $281 million substantially all of which is with investment grade customers as seen in the following table that presents the distribution of credit exposure at December 31, 2020. Credit collateral includes cash and letters of credit but excludes other credit enhancements such as guarantees or liens on assets.
Exposure
Before Credit
Collateral Credit
Collateral Net
Exposure
Investment grade $ 254 $ 5 $ 249
Below investment grade or no rating 38 6 32
Totals
$ 292 $ 11 $ 281
Significant ( i.e. , 10% or greater) concentration of credit exposure exists with one counterparty, which represented an aggregate $85 million, or 30%, of the total net exposure. We view exposure to this counterparty to be within an acceptable level of risk tolerance due to the counterparty's credit ratings, which is rated as investment grade, the counterparty's market role and deemed creditworthiness and the importance of our business relationship with the counterparty. An event of default by one or more counterparties could subsequently result in termination-related settlement payments that reduce available liquidity if amounts such as margin deposits are owed to the counterparties or delays in receipts of expected settlements owed to us.
Contracts classified as "normal" purchase or sale and non-derivative contractual commitments are not marked-to-market in the financial statements and are excluded from the detail above. Such contractual commitments may contain pricing that is favorable considering current market conditions and therefore represent economic risk if the counterparties do not perform.
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FORWARD-LOOKING STATEMENTS
This report and other presentations made by us contain "forward-looking statements." All statements, other than statements of historical facts, that are included in this report, or made in presentations, in response to questions or otherwise, that address activities, events or developments that may occur in the future, including (without limitation) such matters as activities related to our financial or operational projections, capital allocation, capital expenditures, liquidity, dividend policy, business strategy, competitive strengths, goals, future acquisitions or dispositions, development or operation of power generation assets, market and industry developments and the growth of our businesses and operations (often, but not always, through the use of words or phrases such as "intends," "plans," "will likely," "unlikely," "expected," "anticipated," "estimated," "should," "may," "projection," "target," "goal," "objective" and "outlook"), are forward-looking statements. Although we believe that in making any such forward-looking statement our expectations are based on reasonable assumptions, any such forward-looking statement involves uncertainties and risks and is qualified in its entirety by reference to the discussion under Item 1A. Risk Factors and Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in this annual report on Form 10-K and the following important factors, among others, that could cause our actual results to differ materially from those projected in or implied by such forward-looking statements:
• the actions and decisions of judicial and regulatory authorities;
• prohibitions and other restrictions on our operations due to the terms of our agreements;
• prevailing federal, state and local governmental policies and regulatory actions, including those of the legislatures and other government actions of states in which we operate, the U.S. Congress, the FERC, the NERC, the TRE, the public utility commissions of states and locales in which we operate, CAISO, ERCOT, ISO-NE, MISO, NYISO, PJM, the RCT, the NRC, the EPA, the environmental regulatory bodies of states in which we operate, the MSHA and the CFTC, with respect to, among other things:
▪ allowed prices;
▪ industry, market and rate structure;
▪ purchased power and recovery of investments;
▪ operations of nuclear generation facilities;
▪ operations of fossil-fueled generation facilities;
▪ operations of mines;
▪ acquisition and disposal of assets and facilities;
▪ development, construction and operation of facilities;
▪ decommissioning costs;
▪ present or prospective wholesale and retail competition;
▪ changes in federal, state and local tax laws, rates and policies, including additional regulation, interpretations, amendments, or technical corrections to the TCJA;
▪ changes in and compliance with environmental and safety laws and policies, including the Coal Combustion Residuals Rule, National Ambient Air Quality Standards, the Cross-State Air Pollution Rule, the Mercury and Air Toxics Standard, regional haze program implementation and GHG and other climate change initiatives; and
▪ clearing over-the-counter derivatives through exchanges and posting of cash collateral therewith;
• expectations regarding, or impacts of, environmental matters, including costs of compliance, availability and adequacy of emission credits, and the impact of ongoing proceedings and potential regulations or changes to current regulations, including those relating to climate change, air emissions, cooling water intake structures, coal combustion byproducts, and other laws and regulations that we are, or could become, subject to, which could increase our costs, result in an impairment of our assets, cause us to limit or terminate the operation of certain of our facilities, or otherwise negatively impact our financial results or stock price;
• legal and administrative proceedings and settlements;
• general industry trends;
• economic conditions, including the impact of any recession or economic downturn;
• investor sentiment relating to climate change and utilization of fossil fuels in connection with power generation could reduce demand for, or increase potential volatility in the market price of, our common stock;
• the severity, magnitude and duration of pandemics, including the COVID-19 pandemic, and the resulting effects on our results of operations, financial condition and cash flows;
• the severity, magnitude and duration of extreme weather events (including winter storm Uri), drought and limitations on access to water, and other weather conditions and natural phenomena, and the resulting effects on our results of operations, financial condition and cash flows;
• acts of sabotage, wars or terrorist or cybersecurity threats or activities;
• risk of contract performance claims by us or our counterparties, and risks of, or costs associated with, pursuing or defending such claims;
• our ability to collect trade receivables from counterparties in the amount or at the time expected, if at all;
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• our ability to attract, retain and profitably serve customers;
• restrictions on competitive retail pricing or direct-selling businesses;
• adverse publicity associated with our retail products or direct selling businesses, including our ability to address the marketplace and regulators regarding our compliance with applicable laws;
• changes in wholesale electricity prices or energy commodity prices, including the price of natural gas;
• changes in prices of transportation of natural gas, coal, fuel oil and other refined products;
• sufficiency of, access to, and costs associated with coal, fuel oil, and natural gas inventories and transportation and storage thereof;
• changes in the ability of vendors to provide or deliver commodities as needed;
• beliefs and assumptions about the benefits of state- or federal-based subsidies to our market competition, and the corresponding impacts on us, including if such subsidies are disproportionately available to our competitors;
• the effects of, or changes to, market design and the power and capacity procurement processes in the markets in which we operate;
• changes in market heat rates in the CAISO, ERCOT, ISO-NE, MISO, NYISO and PJM electricity markets;
• our ability to effectively hedge against unfavorable commodity prices, including the price of natural gas, market heat rates and interest rates;
• population growth or decline, or changes in market supply or demand and demographic patterns, particularly in ERCOT, MISO and PJM;
• our ability to mitigate forced outage risk, including managing risk associated with CP in PJM and performance incentives in ISO-NE;
• efforts to identify opportunities to reduce congestion and improve busbar power prices;
• access to adequate transmission facilities to meet changing demands;
• changes in interest rates, commodity prices, rates of inflation or foreign exchange rates;
• changes in operating expenses, liquidity needs and capital expenditures;
• commercial bank market and capital market conditions and the potential impact of disruptions in U.S. and international credit markets;
• access to capital, the attractiveness of the cost and other terms of such capital and the success of financing and refinancing efforts, including availability of funds in capital markets;
• our ability to maintain prudent financial leverage and achieve our capital allocation objectives;
• our ability to generate sufficient cash flow to make principal and interest payments in respect of, or refinance, our debt obligations;
• our expectation that we will continue to pay a comparable cash dividend on a quarterly basis;
• our ability to implement and successfully execute upon\ our growth strategy, including the completion and integration of mergers, acquisitions and/or joint venture activity, the identification and completion of sales and divestitures activity, and the completion and commercialization of our other business development and construction projects;
• competition for new energy development and other business opportunities;
• inability of various counterparties to meet their obligations with respect to our financial instruments;
• counterparties' collateral demands and other factors affecting our liquidity position and financial condition;
• changes in technology (including large scale electricity storage) used by and services offered by us;
• changes in electricity transmission that allow additional power generation to compete with our generation assets;
• our ability to attract and retain qualified employees;
• significant changes in our relationship with our employees, including the availability of qualified personnel, and the potential adverse effects if labor disputes or grievances were to occur or changes in laws or regulations relating to independent contractor status;
• changes in assumptions used to estimate costs of providing employee benefits, including medical and dental benefits, pension and OPEB, and future funding requirements related thereto, including joint and several liability exposure under ERISA;
• hazards customary to the industry and the possibility that we may not have adequate insurance to cover losses resulting from such hazards;
• the impact of our obligations under the TRA;
• our ability to optimize our assets through targeted investment in cost-effective technology enhancements and operations performance initiatives;
• our ability to effectively and efficiently plan, prepare for and execute expected asset retirements and reclamation obligations and the impacts thereof;
• our ability to successfully complete the integration of businesses acquired by Vistra and our ability to successfully capture the full amount of projected operational and financial synergies relating to such transactions; and
• actions by credit rating agencies.
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Any forward-looking statement speaks only at the date on which it is made, and except as may be required by law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which it is made or to reflect the occurrence of unanticipated events or circumstances. New factors emerge from time to time, and it is not possible for us to predict them. In addition, we may be unable to assess the impact of any such event or condition or the extent to which any such event or condition, or combination of events or conditions, may cause results to differ materially from those contained in or implied by any forward-looking statement. As such, you should not unduly rely on such forward-looking statements.
INDUSTRY AND MARKET INFORMATION
Certain industry and market data and other statistical information used throughout this report are based on independent industry publications, government publications, reports by market research firms or other published independent sources, including certain data published by CAISO, ERCOT, ISO-NE, MISO, NYISO, PJM, the environmental regulatory bodies of states in which we operate and NYMEX. We did not commission any of these publications, reports or other sources. Some data is also based on good faith estimates, which are derived from our review of internal surveys, as well as the independent sources listed above. Industry publications, reports and other sources generally state that they have obtained information from sources believed to be reliable, but do not guarantee the accuracy and completeness of such information. While we believe that each of these studies, publications, reports and other sources is reliable, we have not independently investigated or verified the information contained or referred to therein and make no representation as to the accuracy or completeness of such information. Forecasts are particularly likely to be inaccurate, especially over long periods of time, and we do not know what assumptions were used in preparing such forecasts. Statements regarding industry and market data and other statistical information used throughout this report involve risks and uncertainties and are subject to change based on various factors.
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