Fair Value Measurements
|6 Months Ended|
Jun. 30, 2022
|Fair Value Disclosures [Abstract]|
|Fair Value Measurements||
Note 15. Fair Value Measurements
Assets and liabilities measured at fair value on a recurring basis:
The Company’s assets and liabilities measured at fair value on a recurring basis consisted of the following as of June 30, 2022, and December 31, 2021:
Level 3 Assets:
Power Supply Agreement
During the year ended December 31, 2021, the Company recorded a derivative asset related to its Power Supply Agreement with TXU Energy Retail Company LLC (“TXU”), the energy supplier to the Company’s Whinstone Facility (the “Power Supply Agreement”). The Power Supply Agreement was classified as a derivative asset and measured at fair value on the date of the Company’s acquisition of Whinstone, with changes in fair value recognized in change in fair value of derivative asset in operating income or loss on the accompanying unaudited condensed consolidated statements of operations. The contract was not designated as a hedging instrument. Prior to the Whinstone Acquisition, the Company did not have any derivative contracts. The estimated fair value of the Company’s derivate asset is classified in Level 3 of the fair value hierarchy due to the significant unobservable inputs utilized in the valuation. Specifically, our discounted cash flow estimation models contain quoted commodity exchange spot and forward prices and are adjusted for basis spreads for load zone-to-hub differentials through the term of the Power Supply Agreement, which ends in April 2030. The discount rate utilized of approximately 21% includes observable market inputs, but also includes unobservable inputs based on qualitative judgment related to company-specific risk factors.
The terms of the Power Supply Agreement require margin-based collateral for both TXU and the Company, calculated as exposure resulting from fluctuations in the market cost rate of electricity versus the fixed price stated in the contract. The margin-based collateral requirement of the Company was zero as of June 30, 2022 and December 31, 2021.
Level 3 Liabilities:
Business Combination Contingent Consideration
The Company recorded a Level 3 financial liability during the year ended December 31, 2021, relating to the contingent consideration arrangement arising from the acquisition of Whinstone. Contingent consideration represents an obligation of the Company to transfer cash to the Whinstone Seller when Whinstone realizes or receives a benefit from utilization of certain defined power credits. The Company estimated the fair value of the contingent consideration using a discounted cash flow analysis, which includes estimates of both the timing and amounts of potential future power credits. These estimates were determined using the Company’s historical consumption quantities and patterns combined with management’s expectations of its future consumption requirements, which require significant judgment and depend on various factors outside the Company’s control, such as construction delays. The discount rate of approximately 2.5% includes observable market inputs, such as TXU’s parent company’s Standard & Poor’s credit rating of BB, but also includes unobservable inputs such as interest rate spreads, which were estimated based on qualitative judgment related to company-specific risk factors. Specifically, due to the power credits being subordinated obligations for TXU’s parent, we used one credit rating lower than BB in our yield curve to estimate a reasonable interest rate spread to determine the cost of debt input. The significant assumptions used to estimate fair value of the derivative contract include a discount rate of 21%, which reflected the nature of the contract as it relates to the risk and uncertainty of the estimated future mark-to-market adjustments, forward price curves of the power supply, broker/dealer quotes and other similar data obtained from quoted market prices or independent pricing vendors. Although these estimates are based on management’s best knowledge of current events, the estimates could change significantly from period to period. Actual results that differ from the assumptions used and any changes to the significant assumptions and unobservable inputs used could have a material impact on future results of operations.
Changes in Level 3 assets and liabilities measured at fair value on a recurring basis:
Unobservable inputs were used to determine the fair value of positions that the Company has classified within the Level 3 category. Unrealized gains and losses associated with the asset within the Level 3 category includes changes in fair value that were attributable to unobservable (e.g., changes in unobservable long-dated volatilities) inputs.
The following table presents the changes in the estimated fair value of the derivative asset measured using significant unobservable inputs (Level 3) for the six months ended June 30, 2022 and 2021:
For the three and six months ended June 30, 2022, there was a change of approximately $60.9 million and $104.6 million, respectively, in Level 3 assets measured at fair value. Additionally, during the three and six months ended June 30, 2022, power sales back into the Electric Reliability Council of Texas (“ERCOT”) marketplace through Whinstone’s participation in ERCOT’s energy demand response programs totaled $5.7 million and $8.3 million, respectively, which are recorded in power curtailment credits in the accompanying unaudited condensed consolidated statements of operations. During the three and six months ended June 30, 2021, power curtailment credits totaled $1.1 million in each period.
The following table presents the changes in the estimated fair value of our liability for contingent consideration measured using significant unobservable inputs (Level 3) for the six months ended June 30, 2022 and 2021:
For the three and six months ended June 30, 2022 and 2021, the change in Level 3 liabilities measured at fair value was $0.2 million for each period. The Company’s estimated liability for contingent consideration represents potential payments of additional consideration for the Whinstone Acquisition, payable if Whinstone realizes or receives a benefit from utilization of certain defined power credits. Changes in the fair value of contingent consideration are recorded in the unaudited condensed consolidated statements of operations within change in fair value of contingent consideration.
There were no transfers of financial instruments between Level 1, Level 2 and Level 3 during the periods presented.
The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.
Reference 1: http://www.xbrl.org/2003/role/disclosureRef