Note 8. Power Supply Contract

Power Supply Contract and Demand Response Services Programs

In May 2020, the Company entered into a Power Supply Agreement with TXU Energy Retail Company LLC (“TXU”) (the “Power Supply Agreement”) to provide the delivery of 130 MW of electricity by TXU to the Rockdale Facility, via the facility owned by Oncor Electric Delivery Company, LLC (“Oncor”), at fixed prices through April 30, 2030. In March and November 2022, the Company and TXU agreed to increase the amount of electricity to be provided under the Power Supply Agreement by 65 MW and 150 MW, respectively, of electricity at fixed prices through April 30, 2030 and October 31, 2027, respectively, for a total of 345 MW under contract at fixed prices.

If electricity used exceeds the amount contracted, the cost of the excess electricity is incurred at the current spot rate. Concurrently with the Power Supply Agreement, the Company entered into an agreement with Oncor for the extension of delivery system transmission/substation facilities to facilitate delivery of the electricity to the Rockdale Facility (the “Facilities Agreement”). Power costs incurred under the Facilities Agreement are determined every 15 minutes using settlement information provided by the Electric Reliability Council of Texas (“ERCOT”) and are recorded in Cost of revenue: Data Center Hosting on the Condensed Consolidated Statements of Operations.

In collaboration with market participants such as the Company, ERCOT has a Demand Response Services Program for customers that have the ability to reduce or modify electricity use in response to instructions or signals. The Demand Response Services Program provides the ERCOT market with valuable reliability and economic services by helping to preserve system reliability, enhancing competition, mitigating price spikes, and encouraging the demand side of the market to respond better to wholesale price signals. Market participants with electrical loads like the Company may participate in the Demand Response Service Program directly by offering their electrical loads into the ERCOT markets, or indirectly by voluntarily reducing their energy usage in response to increasing wholesale prices.

Under the Demand Response Services Program, the Company can participate in a variety of programs by electing to designate a portion of its available electrical load for participation in such programs on an hourly basis. The Company receives a cash payment from ERCOT based on hourly rates for electricity and the amount of electrical load it bids into each respective Demand Response Services Program.

Under the Company’s Power Supply Agreement with TXU, we may offer electricity back to TXU for sale on the ERCOT marketplace, in exchange for credits against future power costs, rather than using the power for the Company’s operations, when there is a benefit to our Company, depending on the spot market price of electricity. Our power strategy combines our participation in Demand Response Services Programs and sales of power during times of peak demand, to most efficiently manage our operating costs. During the three months ended March 31, 2023 and 2022, we sold approximately $3.1 million and $2.6 million, respectively, in electricity back to ERCOT in exchange for credits against future power costs. These sales back to ERCOT are recorded in Power curtailment credits on the Condensed Consolidated Statements of Operations.

The Company determined the Power Supply Agreement meets the definition of a derivative because it allows for net settlement. However, because we have the ability to offer the power back to the grid rather than take physical delivery, physical delivery is not probable through the entirety of the contract and therefore, we do not believe the normal purchases and normal sales scope exception applies to the Power Supply Agreement. Accordingly, the Power Supply Agreement (a non-hedging derivative contract) is accounted for as a derivative and recorded at its estimated fair value each reporting period in Derivative asset on the Condensed Consolidated Balance Sheets with the change in the fair value recorded in Change in fair value of derivative asset on the Condensed Consolidated Statements of Operations. The Power Supply Agreement is not designated as a hedging instrument.

The estimated fair value of the Company’s derivate asset is classified under 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 December 2030. The significant assumptions used to estimate fair value of the derivative contract include a discount rate of 21.7%, 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. The discount rate utilized of approximately 21.7% 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, calculated as exposure resulting from fluctuations in the market cost rate of electricity versus the fixed price stated in the contract. As of March 31, 2023, the margin-based collateral requirement of the Company was zero.

While the Company manages operating costs at the Rockdale Facility in part by periodically selling unused or uneconomical power back to TXU for sale on the ERCOT marketplace, the Company does not consider such actions to be trading activities and does not engage in speculation in the power market as part of its ordinary activities.

The following table presents changes in the estimated fair value of the Derivative asset:

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