This excerpt taken from the CEG 10-Q filed Nov 10, 2008.
Constellation Energy's collateral requirements arise from its merchant energy business' need to participate in certain organized markets, such as Independent System Operators (ISOs) or financial exchanges as well as from our goal of remaining economically hedged in our power and gas customer supply businesses, third party coal business and our trading activities. To support wholesale and retail power customer supply business obligations, as well as some trading activities, Constellation Energy posts collateral to ISOs. Forward hedging of our Generation and Customer Supply activities' obligations, as well as our Global Commodities trading activities, creates the need to transact with exchanges such as NYMEX, ICE and NOS. We post initial margin based on exchange rules, as well as variation margin related to the change in value of the net open position with the exchange. Constellation Energy's initial margin requirements increased during the third quarter as a result of changes in exchange rules. Daily variation margin postings to each exchange depend on price moves in the underlying power, gas and coal exchange traded forward and option contracts.
In addition to the collateral posted to ISOs and exchanges, we post collateral with certain counterparties. These collateral amounts may be fixed or may vary with price levels.
There are certain asymmetries relating to the use of collateral that create liquidity requirements for our merchant energy businesses. These asymmetries arise as a result of our actions to be economically hedged and market conditions or conventions for conducting business that
result in some transactions being collateralized while others are not, including:
In an environment of stable commodity prices, Constellation Energy's net collateral position is relatively stable. However, during the six months ended June 30, 2008 and nine months ended September 30, 2008, the energy markets were affected by large fluctuations in commodity prices:
This price variability led to an increase in collateral held during the first six months of 2008 and our need to return and post additional collateral for the quarter ended September 30, 2008.
Customers of our merchant energy business rely on the creditworthiness of Constellation Energy. In this regard, we have certain agreements that contain provisions that would require additional collateral upon a credit rating decrease in the senior unsecured debt of Constellation Energy. A decline below investment grade by Constellation Energy may require us, under the terms of our counterparty contracts, to post additional collateral to provide necessary credit support for our merchant energy business' forward obligations. Based on contractual provisions at September 30, 2008, we estimate that if Constellation Energy's senior unsecured debt were downgraded we would have the following additional collateral obligations:
* If there are split ratings among the independent credit-rating agencies, the lowest credit rating is used to determine our incremental collateral obligations.
The estimated collateral obligation amounts above have declined compared to those reported in our quarterly report on Form 10-Q for the quarter ended June 30, 2008. This decrease is due to changes in open positions, price movements, and posting of additional collateral requirements resulting from our credit ratings being downgraded in the third quarter of 2008. As of October 31, 2008, incremental downgrade collateral postings for a one level and two level downgrade have changed to $178 million and $1,865 million, respectively. As a result, the cumulative obligation for a two level downgrade is $2,043 million.
Based on market conditions and contractual obligations at the time of a downgrade, we could be required to post collateral in an amount that could exceed the obligation amounts specified above, which could be material. We discuss our credit ratings in the Security Ratings section beginning on page 59 and in our 2007 Annual Report on Form 10-K. We discuss our credit facilities in the Available Sources of Funding section beginning on page 60.
Certain credit facilities of Constellation Energy contain a provision requiring Constellation Energy to maintain a ratio of debt to capitalization equal to or less than 65%. At September 30, 2008, the debt to capitalization ratios as defined in the credit agreements were no greater than 54%.
The credit agreement of BGE contains a provision requiring BGE to maintain a ratio of debt to capitalization equal to or less than 65%. At September 30, 2008, the debt to capitalization ratio for BGE as defined in this credit agreement was 54%.
Decreases in Constellation Energy's or BGE's credit ratings would not trigger an early payment on any of their credit facilities.