## CAPITAL POWER CORPORATION 

Notes to the Consolidated Financial Statements (Tabular amounts in millions of Canadian dollars, except share and per share amounts) 

## 30. Risk management, continued: 

## Market risk 

Market risk is the risk of loss that results from changes in market factors such as commodity prices, foreign currency exchange rates, interest rates and equity prices. The level of market risk to which the Company is exposed at any point in time varies depending on market conditions, expectations of future price or market rate movements and the composition of the Company’s financial assets and liabilities held, non-trading physical asset and contract portfolios, and trading portfolios. 

To manage the exposure related to changes in market risk, the Company uses various risk management techniques including derivative instruments. Derivative instruments may include forward contracts, fixed-for-floating swaps (or contracts-for-differences), and option contracts. Such derivative instruments may be used to establish a fixed price for an energy commodity, an interest-bearing obligation or an obligation denominated in a foreign currency. Commodity risk exposures are monitored daily against approved risk limits, and control processes are in place to monitor that only authorized activities are undertaken. 

The sensitivities provided in each of the following risk discussions disclose the effect of reasonably possible changes in relevant prices and rates on net income at the reporting date. The sensitivities are hypothetical and should not be considered to be predictive of future performance or indicative of income on these contracts. The Company’s actual exposure to market risks is constantly changing as the Company’s portfolio of debt, foreign currency and commodity contracts changes. Changes in fair values or cash flows based on market variable fluctuations cannot be extrapolated since the relationship between the change in the market variable and the change in fair value or cash flows may not be linear. In addition, the effect of a change in a particular market variable on fair values or cash flows is calculated without considering interrelationships between the various market rates or mitigating actions that would be taken by the Company. 

## Commodity price risk 

The Company is exposed to commodity price risk as part of its normal business operations, including energy procurement activities in Alberta, Ontario and the U.S. The Company’s energy procurement activities consist of power generation, non-market traded and market traded electricity and natural gas purchase and sales contracts, and derivative contracts. The Company is primarily exposed to changes in the prices of electricity, and to a lesser extent is exposed to changes in the prices of natural gas and coal. The Company actively manages commodity price risk by optimizing its asset and contract portfolios utilizing the following methods variously: 

 The Company reduces its exposure to the volatility of commodity prices related to electricity sales by entering into offsetting contracts such as contracts-for-differences and firm price physical contracts for periods of varying duration. 

 The Company enters into fixed-price energy sales contracts and power purchase arrangements which limit the exposure to electricity prices. The Company has entered into long-term tolling arrangements whereby variable changes linked to the price of natural gas and coal are assumed by the counterparty. 

 The Company enters into back-to-back electricity and natural gas physical and financial contracts in order to lock in a margin. 

The Company also engages in taking market risk positions within authorized limits approved by Capital Power’s executive team and Board of Directors. The trading portfolio consists of electricity and natural gas physical and financial derivative contracts which are transacted with the intent of benefiting from short-term actual or expected differences between their buying and selling prices or to lock in arbitrage opportunities. 

The fair value of the Company’s energy related derivatives as at December 31, 2012, that are required to be measured at fair value with the respective changes in fair value recognized in net income are disclosed in note 14. 

