CALPINE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

June 30, 2011

(Unaudited)

1.  Basis of Presentation and Summary of Significant Accounting Policies

We are an independent wholesale power generation company engaged in the ownership and operation of primarily natural gas-fired and geothermal power plants in North America. We have a significant presence in the major competitive wholesale power markets in California, Texas and the Mid-Atlantic region of the U.S. We sell wholesale power, steam, regulatory capacity, renewable energy credits and ancillary services to our customers, including industrial companies, retail power providers, utilities, municipalities, independent electric system operators, marketers and others. We engage in the purchase of natural gas and fuel oil as fuel for our power plants and in related natural gas transportation and storage transactions, and in the purchase of electric transmission rights to deliver power to our customers. We also enter into natural gas and power physical and financial contracts to economically hedge our business risks and optimize our portfolio of power plants.

Basis of Interim Presentation — The accompanying unaudited, interim Consolidated Condensed Financial Statements of Calpine Corporation, a Delaware corporation, and consolidated subsidiaries have been prepared pursuant to the rules and regulations of the SEC. In the opinion of management, the Consolidated Condensed Financial Statements include the normal, recurring adjustments necessary for a fair statement of the information required to be set forth therein. Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted from these statements pursuant to such rules and regulations and, accordingly, these financial statements should be read in conjunction with our audited Consolidated Financial Statements for the year ended December 31, 2010, included in our 2010 Form 10-K. The results for interim periods are not necessarily indicative of the results for the entire year primarily due to acquisitions and disposals of assets, seasonal fluctuations in our revenues, timing of major maintenance expense, volatility of commodity prices and unrealized gains and losses from commodity and interest rate derivative contracts.

Reclassifications — Certain reclassifications have been made to our Consolidated Condensed Statements of Operations and Cash Flows for the three and six months ended June 30, 2010 to conform to the current period presentation. Our reclassifications are summarized as follows:

Use of Estimates in Preparation of Financial Statements — The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures included in our Consolidated Condensed Financial Statements. Actual results could differ from those estimates.

Cash and Cash Equivalents — We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents. We have certain project finance facilities and lease agreements that require us to establish and maintain segregated cash accounts which have been pledged as security in favor of the lenders under such project finance facilities, and the use of certain cash balances on deposit in such accounts is limited, at least temporarily, to the operations of the respective projects. At June 30, 2011, and December 31, 2010, we had cash and cash equivalents of $301 million and $269 million, respectively, that were subject to such project finance facilities and lease agreements.

Restricted Cash — Certain of our debt agreements, lease agreements or other operating agreements require us to establish and maintain segregated cash accounts, the use of which is restricted. These amounts are held by depository banks in order to comply with the contractual provisions requiring reserves for payments such as for debt service, rent, major maintenance and debt repurchases or with applicable regulatory requirements. Funds that can be used to satisfy obligations due during the next 12 months are classified as current restricted cash, with the remainder classified as non-current restricted cash. Restricted cash is generally invested in accounts earning market rates; therefore, the carrying value approximates fair value. Such cash is excluded from cash and cash equivalents on our Consolidated Condensed Balance Sheets and Consolidated Condensed Statements of Cash Flows. The table below represents the components of our restricted cash at June 30, 2011, and December 31, 2010 (in millions):

Inventory — At June 30, 2011 and December 31, 2010, we had inventory of $246 million and $262 million, respectively. Inventory primarily consists of spare parts, stored natural gas and fuel oil, emission reduction credits and natural gas exchange imbalances. Inventory, other than spare parts, is stated primarily at the lower of cost under the weighted average cost method or market value. Spare parts inventory is valued at the weighted average cost and are expensed to plant operating expense or capitalized to property, plant and equipment as the parts are utilized and consumed.

Property, Plant and Equipment — At June 30, 2011 and December 31, 2010, the components of property, plant and equipment were stated at cost less accumulated depreciation as follows (in millions):

Capitalized Interest — The total amount of interest capitalized was $4 million and $1 million for the three months ended June 30, 2011 and 2010, respectively, and $11 million and $2 million for the six months ended June 30, 2011 and 2010, respectively.  

New Accounting Standards and Disclosure Requirements

Fair Value Measurement — In May 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-04, “Fair Value Measurement” to clarify and amend the application or requirements relating to fair value measurements and disclosures relating to fair value measurements. The update stems from the Financial Accounting Standards Board and the International Accounting Standards Board project to develop common requirements for measuring fair value and for disclosing information about fair value measurements. The update is not expected to impact any of our fair value measurements but will require disclosure of the following:

The new requirements relating to fair value measurements are prospective and effective for interim and annual periods beginning after December 15, 2011 with early adoption prohibited. We do not expect that the adoption of this standard will have a material impact on our results of operations, cash flows or financial condition.

Comprehensive Income — In June 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-05, “Comprehensive Income” to amend requirements relating to the presentation of comprehensive income. The update eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders‘ equity and provides an entity with the option to present comprehensive income in a single continuous financial statement or in two separate but consecutive statements. The new requirements relating to the presentation of comprehensive income are retrospective and effective for interim and annual periods beginning after December 15, 2011 with early adoption permitted. We have not elected to early adopt the requirements related to the update at June 30, 2011. Since the update only requires a change in presentation, we do not expect that the adoption of this standard will have a material impact on our results of operations, cash flows or financial condition.

2.  Acquisitions, Divestitures and Discontinued Operations

Conectiv Acquisition

On July 1, 2010, we, through our indirect, wholly owned subsidiary NDH, completed the Conectiv Acquisition. The assets acquired include 18 operating power plants and the York Energy Center that was under construction and achieved COD on March 2, 2011, totaling approximately 4,490 MW of capacity (including completion of the scheduled upgrades). We did not acquire Conectiv‘s trading book, load serving auction obligations or collateral requirements. Additionally, we did not assume any of Conectiv‘s off-site environmental liabilities, environmental remediation liabilities in excess of $10 million related to assets located in New Jersey that are subject to ISRA, or pre-close accumulated pension and retirement welfare liabilities; however, we did assume pension liabilities on future services and compensation increases for past services for approximately 129 union employees who joined Calpine as a result of the Conectiv Acquisition. The net proceeds of $1.3 billion received from the NDH Project Debt were used, together with available operating cash, to pay the Conectiv Acquisition purchase price of approximately $1.64 billion and also fund a cash contribution from Calpine Corporation to NDH of $110 million to fund completion of the York Energy Center.

The Conectiv Acquisition provided us with a significant presence in the Mid-Atlantic market, one of the most robust competitive power markets in the U.S., and positioned us with three scale markets instead of two (California and Texas) giving us greater geographic diversity. We accounted for the Conectiv Acquisition under the acquisition method of accounting in accordance with U.S. GAAP.

During the second quarter of 2011, we finalized the valuations we assigned to the net assets acquired in the Conectiv Acquisition which is summarized in the following table (in millions). We did not record any material valuation adjustments during the three and six months ended June 30, 2011, and we did not recognize any goodwill as a result of this acquisition.

Sale of Blue Spruce and Rocky Mountain

On December 6, 2010, we, through our indirect, wholly owned subsidiaries Riverside Energy Center, LLC and Calpine Development Holdings, Inc., completed the sale of 100% of our ownership interests in Blue Spruce and Rocky Mountain for approximately $739 million, and we recorded a pre-tax gain of approximately $209 million during the fourth quarter of 2010. The results of operations for Blue Spruce and Rocky Mountain are reported as discontinued operations on our Consolidated Condensed Statement of Operations for the three and six months ended June 30, 2010.

The table below presents the components of our discontinued operations for the periods presented (in millions):

3.  Variable Interest Entities and Unconsolidated Investments

We consolidate all of our VIEs where we have determined that we are the primary beneficiary. We have the following types of VIEs consolidated in our financial statements:

Subsidiaries with Project Debt — All of our subsidiaries with project debt guaranteed by Calpine have PPAs that provide financial support and are thus considered VIEs. We retain ownership and absorb the full risk of loss and potential for reward once the project debt is paid in full. Actions by the lender to assume control of collateral can occur only under limited circumstances such as upon the occurrence of an event of default, which we have determined to be unlikely. See Note 5 for further information regarding our project debt and Note 1 for information regarding our restricted cash balances.

Subsidiaries with PPAs — Certain of our majority owned subsidiaries have PPAs that limit the risk and reward of our ownership and thus constitute a VIE.

VIEs with a Purchase Option — Riverside Energy Center and OMEC have agreements that provide third parties a fixed price option to purchase power plant assets with an aggregate capacity of 1,211 MW exercisable in the years 2013 and 2019. These purchase options limit the risk and reward of our ownership and, thus, constitute a VIE.

Consolidation of VIEs

We consolidate our VIEs where we determine that we have both the power to direct the activities of a VIE that most significantly impact the VIE‘s economic performance and the obligation to absorb losses or receive benefits from the VIE. We have determined that we hold the obligation to absorb losses and receive benefits in all of our VIEs where we hold the majority equity interest. Therefore, our determination of whether to consolidate is based upon which variable interest holder has the power to direct the most significant activities of the VIE (the primary beneficiary). Our analysis includes consideration of the following primary activities which we believe to have a significant impact on a power plant‘s financial performance: operations and maintenance, plant dispatch, and fuel strategy as well as our ability to control or influence contracting and overall plant strategy. Our approach to determining which entity holds the powers and rights is based on powers held as of the balance sheet date. Contractual terms that may change the powers held in future periods, such as a purchase or sale option, are not considered in our analysis. Based on our analysis, we believe that we hold the power and rights to direct the most significant activities of all our majority owned VIEs.

Under our consolidation policy and under U.S. GAAP we also:

There were no changes to our determination of whether we are the primary beneficiary of our VIEs during the first half of 2011.

VIE Disclosures

U.S. GAAP also requires separate disclosure on the face of our Consolidated Condensed Balance Sheets of the significant assets of a consolidated VIE that can only be used to settle obligations of the consolidated VIE and the significant liabilities of a consolidated VIE for which creditors (or beneficial interest holders) do not have recourse to the general credit of the primary beneficiary. In determining which assets of our VIEs met the separate disclosure criteria, we determined this separate disclosure requirement is met where Calpine Corporation is substantially limited or prohibited from access to assets (primarily cash and cash equivalents, restricted cash and property, plant and equipment), and where there are agreements that prohibit the VIE from guaranteeing the debt of Calpine Corporation or its other subsidiaries. In determining which liabilities of our VIEs met the separate disclosure criteria, we reviewed all of our VIEs and determined this separate disclosure requirement was met where our VIEs had project financing that prohibits the VIE from providing guarantees on the debt of others and where the amounts were material to our financial statements.

The VIEs meeting the above disclosure criteria are majority owned subsidiaries of Calpine Corporation and include natural gas-fired power plants with an aggregate capacity of approximately 11,064 MW and 13,553 MW at June 30, 2011 and December 31, 2010, respectively. For these VIEs, we may provide other operational and administrative support through various affiliate contractual arrangements between the VIEs, Calpine Corporation and its other wholly owned subsidiaries whereby we support the VIE through the reimbursement of costs and/or the purchase and sale of energy. Calpine Corporation provided support to these VIEs in the form of cash and other contributions other than amounts contractually required of nil for both the three months ended June 30, 2011 and 2010, and $52 million and $1 million during the six months ended June 30, 2011 and 2010, respectively.

Unconsolidated VIEs and Investments

We have a 50% partnership interest in Greenfield LP and in Whitby. Greenfield LP and Whitby are also VIEs; however, we do not have the power to direct the most significant activities of these entities and therefore do not consolidate them. We account for these entities under the equity method of accounting and include our net equity interest in investments on our Consolidated Condensed Balance Sheets in accordance with U.S. GAAP. Our ownership interest in the net income for Greenfield LP and Whitby for the three and six months ended June 30, 2011 and 2010, are recorded in (income) loss from unconsolidated investments in power plants. At June 30, 2011 and December 31, 2010, our equity method investments included on our Consolidated Condensed Balance Sheets were comprised of the following (in millions):

_________

The following table sets forth details of our (income) loss from unconsolidated investments in power plants for the periods indicated (in millions):

Greenfield LP — Greenfield LP is a limited partnership between certain subsidiaries of ours and of Mitsui & Co., Ltd., which operates the Greenfield Energy Centre, a 1,038 MW natural gas-fired power plant in Ontario, Canada. We and Mitsui & Co., Ltd. each hold a 50% interest in Greenfield LP. Greenfield LP holds an 18-year term loan in the amount of CAD $648 million. Borrowings under the project finance facility bear interest at Canadian LIBOR plus 1.125% or Canadian prime rate plus 0.125%. Distributions from Greenfield LP were $2 million for both the three and six months ended June 30, 2011. We did not receive any distributions from Greenfield LP during the three and six months ended June 30, 2010.

Whitby — Whitby is a limited partnership between certain subsidiaries of ours and Atlantic Packaging Ltd., which operates the Whitby facility, a 50 MW natural gas-fired simple-cycle cogeneration power plant in Ontario, Canada. We and Atlantic Packaging Ltd. each hold a 50% partnership interest in Whitby. Distributions from Whitby were $4 million for both the three and six months ended June 30, 2011, and $2 million for both the three and six months ended June 30, 2010.

Inland Empire Energy Center Put and Call Options — We hold a call option to purchase the Inland Empire Energy Center (a 775 MW natural gas-fired power plant located in California which achieved COD on May 3, 2010) from GE that may be exercised between years 7 and 14 after the start of commercial operation. GE holds a put option whereby they can require us to purchase the power plant, if certain plant performance criteria are met during year 15 after the start of commercial operation. We determined that we were not the primary beneficiary of the Inland Empire power plant, and we do not consolidate it due to, but not limited to, the fact that GE directs the most significant activities of the power plant including operations and maintenance.

Noncontrolling Interest — We own a 75% interest in Russell City Energy Company, LLC, one of our VIEs, which also contains a 25% ownership interest by a third party. We fully consolidate this entity in our Consolidated Condensed Financial Statements and account for the third party ownership interest as a noncontrolling interest under U.S. GAAP.

4.  Comprehensive Loss

Comprehensive loss includes our net loss, unrealized gains and losses from derivative instruments, net of tax that qualify as cash flow hedges, our share of equity method investees‘ OCI and the effects of foreign currency translation adjustments. See Note 7 for further discussion of our accounting for derivative instruments designated as cash flow hedges and the related amounts recorded in OCI. We report AOCI on our Consolidated Condensed Balance Sheets. The table below details the components of our comprehensive loss for the periods indicated (in millions):

5.  Debt

Our debt at June 30, 2011 and December 31, 2010, was as follows (in millions):

_________

Our First Lien Notes and Termination of the First Lien Credit Facility

Our First Lien Notes are summarized in the table below (in millions):

_________

Following our emergence from Chapter 11, our First Lien Credit Facility served as our primary debt facility. Beginning in late 2009, we began to repay or exchange our First Lien Credit Facility term loans through proceeds received from the issuances of the First Lien Notes, together with operating cash. On January 14, 2011, we repaid the remaining approximately $1.2 billion from the proceeds from the issuance of the 2023 First Lien Notes, together with operating cash, thereby terminating the First Lien Credit Facility in accordance with its terms.

Our First Lien Notes are secured equally and ratably with indebtedness incurred under our Corporate Revolving Facility, Term Loan and New Term Loan (described below), subject to certain exceptions and permitted liens, on substantially all of our and certain of the guarantors‘ existing and future assets. Additionally, our First Lien Notes rank equally in right of payment with all of our and the guarantors‘ other existing and future senior indebtedness, and will be effectively subordinated in right of payment to all existing and future liabilities of our subsidiaries that do not guarantee our First Lien Notes. Repayment of the NDH Project Debt also eliminated the restrictions against our NDH subsidiaries being guarantors to our First Lien Notes and Corporate Revolving Facility. On March 9, 2011, we executed assumption agreements to the amended and restated guarantee and collateral agreement, to add our NDH subsidiaries as guarantors to our Corporate Revolving Facility and Term Loan. On April 26, 2011, we executed supplemental indentures for the First Lien Notes to add the NDH subsidiaries as guarantors. On June 17, 2011, we executed assumption agreements to the amended and restated guarantee and collateral agreement, to add Deer Park Holdings, LLC, Metcalf Holdings, LLC, Deer Park Energy Center LLC and Metcalf Energy Center, LLC as guarantors of our Corporate Revolving Facility, Term Loan and New Term Loan. On July 22, 2011, we executed supplemental indentures for the First Lien Notes to add Deer Park Holdings, LLC, Metcalf Holdings, LLC, Deer Park Energy Center LLC and Metcalf Energy Center, LLC as guarantors.

Subject to certain qualifications and exceptions, our First Lien Notes will, among other things, limit our ability and the ability of the guarantors to:

We recorded approximately $19 million in debt extinguishment costs in the first quarter of 2011 from the write-off of unamortized deferred financing costs related to the repayment and termination of the First Lien Credit Facility, and we recorded approximately $22 million of deferred financing costs during the first quarter of 2011 related to the issuance of the 2023 First Lien Notes.

The Term Loan and New Term Loan and Repayment of the NDH Project Debt and Other Project Debt

On March 9, 2011, we entered into and borrowed $1.3 billion under the Term Loan. We used the net proceeds received, together with operating cash on hand to fully retire the approximately $1.3 billion NDH Project Debt in accordance with its repayment terms. The NDH Project Debt was originally established to partially fund the Conectiv Acquisition.

The Term Loan provides for a senior secured term loan facility in an aggregate principal amount of $1.3 billion and bears interest, at our option, at either (i) the base rate, equal to the higher of the Federal Funds effective rate plus 0.5% per annum or the Prime Rate (as such terms are defined in the Term Loan credit agreement), plus an applicable margin of 2.25%, or (ii) LIBOR plus 3.25% per annum subject to a LIBOR floor of 1.25%.

An aggregate amount equal to 0.25% of the aggregate principal amount of the Term Loan will be payable at the end of each quarter commencing on June 30, 2011, with the remaining balance payable on the maturity date (April 1, 2018). We may elect from time to time to convert all or a portion of the Term Loan from initial LIBOR rate loans to base rate loans or vice versa. In addition, we may at any time, and from time to time, prepay the Term Loan, in whole or in part, without premium or penalty, upon irrevocable notice to the administrative agent. We may also reprice the Term Loan, subject to approval from the Lenders and subject to a 1% premium if a repricing transaction occurs prior to the first anniversary of the closing date. We may elect to extend the maturity of any term loans under the Term Loan, in whole or in part subject to approval from those lenders holding such term loans. The Term Loan is subject to certain qualifications and exceptions, similar to our First Lien Notes.

If a change of control triggering event occurs, the Company shall notify the Administrative Agent in writing and shall make an offer to prepay the entire principal amount of the Term Loan outstanding within thirty (30) days after the date of such change of control triggering event.

In connection with the Term Loan, the Company and its subsidiaries (subject to certain exceptions) have made certain representations and warranties and are required to comply with various affirmative and negative covenants. The Term Loan is subject to customary events of default included in financing transactions, including, among others, failure to make payments when due, certain defaults under other material indebtedness, breach of certain covenants, breach of certain representations and warranties, involuntary or voluntary bankruptcy, and material judgments. If an event of default arises from certain events of bankruptcy or insolvency, all amounts outstanding under the Term Loan will become due and payable immediately without further action or notice. If other events of default arise (as defined in the Credit Agreement) and are continuing, the lenders holding more than 50% of the outstanding Term Loan amounts (as defined in the Credit Agreement) may declare all the Term Loan amounts outstanding to be due and payable immediately.

In connection with the Term Loan, we recorded deferred financing costs of approximately $14 million on our Consolidated Condensed Balance Sheet as of June 30, 2011, and we recorded approximately $74 million in debt extinguishment costs during the first quarter of 2011, which includes approximately $36 million from the write-off of unamortized deferred financing costs, the write-off of approximately $25 million of debt discount and approximately $13 million in prepayment premiums related to the NDH Project Debt.

On June 17, 2011, we repaid approximately $340 million of project debt with the proceeds received from $360 million in borrowings under the New Term Loan. The New Term Loan carries substantially the same terms as the Term Loan and matures on April 1, 2018. The New Term Loan also contains very similar covenants, qualifications, exceptions and limitations as the Term Loan and First Lien Notes. 

In connection with the New Term Loan, we recorded deferred financing costs of approximately $5 million on our Consolidated Condensed Balance Sheet as of June 30, 2011, and we recorded approximately $5 million in debt extinguishment costs during the three and six months ended June 30, 2011.

Russell City Project Debt

On June 24, 2011, we, through our indirect, partially owned subsidiary Russell City Energy Company, LLC, closed on our approximately $845 million Russell City Project Debt to finance construction of Russell City, a 619 MW combined-cycle power plant under construction in Hayward, CA, which comprises a $700 million construction loan facility, an approximately $77 million project letter of credit facility and a $68 million debt service reserve letter of credit facility. The construction loan converts to a ten year term loan when commercial operations commence and borrowings bear interest initially at LIBOR plus 2.25%. At June 30, 2011, approximately $69 million had been drawn under the construction loan and approximately $61 million of letters of credit were issued under the letter of credit facilities. Calpine‘s pro rata share is 75% and the pro rata share related to the noncontrolling interest is 25%.

In connection with the closing of the Russell City Project Debt, we recorded deferred financing costs of approximately $26 million on our Consolidated Condensed Balance Sheet as of June 30, 2011.

Corporate Revolving Facility and Other Letter of Credit Facilities

The table below represents amounts issued under our letter of credit facilities at June 30, 2011, and December 31, 2010 (in millions):

_________

The Corporate Revolving Facility represents our primary revolving facility. Borrowings under the Corporate Revolving Facility bear interest, at our option, at either a base rate or LIBOR rate (with the exception of any swingline borrowings, which bear interest at the base rate). Base rate borrowings shall be at the base rate, plus an applicable margin ranging from 2.00% to 2.25% as provided in the Corporate Revolving Facility credit agreement. Base rate is defined as the higher of (i) the Federal Funds Effective Rate, as published by the Federal Reserve Bank of New York, plus 0.50% and (ii) the rate the administrative agent announces from time to time as its prime per annum rate. LIBOR rate borrowings shall be at the British Bankers‘ Association Interest Settlement Rates for the interest period as selected by us as a one, two, three, six or, if agreed by all relevant lenders, nine or twelve month interest period, plus an applicable margin ranging from 3.00% to 3.25%. Interest payments are due on the last business day of each calendar quarter for base rate loans and the earlier of (i) the last day of the interest period selected or (ii) each day that is three months (or a whole multiple thereof) after the first day for the interest period selected for LIBOR rate loans. Letter of credit fees for issuances of letters of credit include fronting fees equal to that percentage per annum as may be separately agreed upon between us and the issuing lenders and a participation fee for the lenders equal to the applicable interest margin for LIBOR rate borrowings. Drawings under letters of credit shall be repaid within 2 business days or be converted into borrowings as provided in the Corporate Revolving Facility credit agreement. We will incur an unused commitment fee ranging from 0.50% to 0.75% on the unused amount of commitments under the Corporate Revolving Facility.

The Corporate Revolving Facility does not contain any requirements for mandatory prepayments, except in the case of certain designated asset sales in excess of $3.0 billion in the aggregate. However, we may voluntarily repay, in whole or in part, the Corporate Revolving Facility, together with any accrued but unpaid interest, with prior notice and without premium or penalty. Amounts repaid may be reborrowed, and we may also voluntarily reduce the commitments under the Corporate Revolving Facility without premium or penalty. The Corporate Revolving Facility matures December 10, 2015.

The Corporate Revolving Facility is guaranteed and secured by each of our current domestic subsidiaries that was a guarantor under the First Lien Credit Facility and will also be additionally guaranteed by our future domestic subsidiaries that are required to provide such a guarantee in accordance with the terms of the Corporate Revolving Facility. The Corporate Revolving Facility ranks equally in right of payment with all of our and the guarantors‘ other existing and future senior indebtedness and will be effectively subordinated in right of payment to all existing and future liabilities of our subsidiaries that do not guarantee the Corporate Revolving Facility. The Corporate Revolving Facility also requires compliance with financial covenants that include a minimum cash interest coverage ratio and a maximum net leverage ratio.

We also have a letter of credit facility related to our subsidiary Calpine Development Holdings, Inc. which matures on December 11, 2012, under which up to $200 million is available for letters of credit.

Fair Value of Debt

We record our debt instruments based on contractual terms, net of any applicable premium or discount. We did not elect to apply the alternative U.S. GAAP provisions of the fair value option for recording financial assets and financial liabilities. We measured the fair value of our debt instruments at June 30, 2011, and December 31, 2010, using market information including credit default swap rates and historical default information, quoted market prices or dealer quotes for the identical liability when traded as an asset and discounted cash flow analyses based on our current borrowing rates for similar types of borrowing arrangements. The following table details the fair values and carrying values of our debt instruments at June 30, 2011, and December 31, 2010 (in millions):

_________

6.  Assets and Liabilities with Recurring Fair Value Measurements

Cash Equivalents — Highly liquid investments which meet the definition of cash equivalents, primarily investments in money market accounts, are included in both our cash and cash equivalents and in restricted cash on our Consolidated Condensed Balance Sheets. Certain of our money market accounts invest in U.S. Treasury securities or other obligations issued or guaranteed by the U.S. Government, its agencies or instrumentalities. Our cash equivalents are classified within level 1 of the fair value hierarchy.

Margin Deposits and Margin Deposits Held by Us Posted by Our Counterparties — Margin deposits and margin deposits held by us posted by our counterparties represent cash collateral paid between our counterparties and us to support our commodity contracts. Our margin deposits and margin deposits held by us posted by our counterparties are generally cash and cash equivalents and are classified within level 1 of the fair value hierarchy.

Derivatives — The primary factors affecting the fair value of our derivative instruments at any point in time are the volume of open derivative positions (MMBtu, MWh and $ notional amounts); market price levels, primarily for power and natural gas; our credit standing and that of our counterparties; and prevailing interest rates for our interest rate swaps. Prices for power and natural gas are volatile, which can result in material changes in the fair value measurements reported in our financial statements in the future.

We utilize market data, such as pricing services and broker quotes, and assumptions that we believe market participants would use in pricing our assets or liabilities including assumptions about risks and the risks inherent to the inputs in the valuation technique. These inputs can be either readily observable, market corroborated or generally unobservable. The market data obtained from broker pricing services is evaluated to determine the nature of the quotes obtained and, where accepted as a reliable quote, used to validate our assessment of fair value; however, other qualitative assessments can also be used to determine the level of activity in any given market. We primarily apply the market approach and income approach for recurring fair value measurements and utilize what we believe to be the best available information. We utilize valuation techniques that seek to maximize the use of observable inputs and minimize the use of unobservable inputs. We classify fair value balances based on the observability of those inputs.

The fair value of our derivatives includes consideration of our credit standing, the credit standing of our counterparties and the impact of credit enhancements, if any. We have also recorded credit reserves in the determination of fair value based on our expectation of how market participants would determine fair value. Such valuation adjustments are generally based on market evidence, if available, or our best estimate.

Our level 1 fair value derivative instruments primarily consist of natural gas swaps, futures and options traded on the NYMEX.

Our level 2 fair value derivative instruments primarily consist of interest rate swaps and OTC power and natural gas forwards for which market-based pricing inputs are observable. Generally, we obtain our level 2 pricing inputs from markets such as the Intercontinental Exchange and Bloomberg. To the extent we obtain prices from brokers in the marketplace, we have procedures in place to ensure that prices represent executable prices for market participants. In certain instances, our level 2 derivative instruments may utilize models to measure fair value. These models are primarily industry-standard models that incorporate various assumptions, including quoted interest rates, correlation, volatility, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace throughout the full term of the instrument, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace.

Our level 3 fair value derivative instruments primarily consist of our OTC power and natural gas forwards and options where pricing inputs are unobservable, as well as other complex and structured transactions. Complex or structured transactions are tailored to our or our customers‘ needs and can introduce the need for internally-developed model inputs which might not be observable in or corroborated by the market. When such inputs have a significant impact on the measurement of fair value, the instrument is categorized in level 3. Our valuation models may incorporate historical correlation information and extrapolate available broker and other information to future periods. In cases where there is no corroborating market information available to support significant model inputs, we initially use the transaction price as the best estimate of fair value. OTC options are valued using industry-standard models, including the Black-Scholes pricing model. At each balance sheet date, we perform an analysis of all instruments subject to fair value measurement and include in level 3 all of those whose fair value is based on significant unobservable inputs.

The following tables present our financial assets and liabilities that were accounted for at fair value on a recurring basis at June 30, 2011, and December 31, 2010, by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect our estimate of the fair value of our assets and liabilities and their placement within the fair value hierarchy levels.