By Jonathan Weil

NRG Energy, one of the S&P 500's biggest year-to-date gainers, has volatile earnings due to its large derivatives-trading operation. Late last year, an accounting switcheroo let it start acting like some of those gyrations don't exist.

While that smooths the company's results, it poses a dilemma for investors. NRG's stock, up 65% this year, trades at 23 times trailing earnings.

But the multiple could be higher or lower if real-life fluctuations in the value of all its derivative contracts were included. That complicates investors' ability to gauge if the stock is trading at an appropriate valuation, or if the company is trying to obscure looming losses.

So far, that hasn't hurt shares in the retail energy supplier. They have surged on investor enthusiasm for power producers tapping into artificial-intelligence demand.

NRG in May said it would double its generation capacity by acquiring a group of power plants from closely held LS Power in a deal originally valued at about $9 billion. The move could mark a shift from its asset-light business model, though financial details on LS Power's holdings were scant.

The treatment of some derivative contracts makes NRG's numbers even murkier.

During last year's fourth quarter, NRG elected to freeze balance-sheet values for a large portion of its derivative contracts. The company said it qualified for an exception to normal accounting rules. Usually, such contracts must be carried at fair market value with changes included in quarterly earnings.

NRG didn't say what impact the maneuver had on earnings, positive or negative.

NRG showed $992 million of net derivative assets , or derivative assets minus derivative liabilities, at year-end. That was equivalent to more than half its book value, or net worth. Of that, $770 million was on contracts with frozen values that NRG relabeled as "normal purchase normal sale," or NPNS. By March 31, the frozen amount was down to $687 million, after some contracts settled and NRG reversed previous gains.

The NPNS label means NRG decided it probably would settle the contracts through physical delivery of the underlying items, such as electricity or natural gas. It then stopped normal derivatives accounting and froze their values. The contracts extend through 2036.

During the third quarter of 2024, before the switch, NRG had a $1.25 billion unrealized, mark-to-market loss on derivatives. This exceeded its $1 billion pretax loss.

NRG's earnings remained volatile even after the switch. Unrealized, mark-to-market gains on derivatives were $506 million for the fourth quarter and $512 million last quarter. In both quarters, they accounted for most of pretax profit.

Energy companies commonly use the NPNS exception for commodity contracts. What is unusual at NRG is that it switched to NPNS after the contracts began, which isn't the way this typically works.

NRG did so based on its interpretation of a loophole in the accounting rules. In effect, it is saying it can initially use fair value for a contract but later switch to NPNS, so long as it makes a determination at the outset that the contract could qualify for NPNS treatment. This reading is consistent with what NRG's outside auditor, KPMG, has said in a derivatives handbook on its website. The other Big Four accounting firms have published similar interpretations.

The issue with this approach? For one thing, it potentially lets companies freeze unrealized gains that they believe are likely to turn into losses later.

"The ability to apply the NPNS exception mid-contract provides a strategic opportunity to suppress the reporting of unwanted volatility," said Tom Linsmeier, an accounting professor at the University of Wisconsin.

This wouldn't be so bad if NRG disclosed the frozen portion's fair values. It hasn't. Investors could be forgiven for thinking there is an unpleasant reason for that.

Write to Jonathan Weil at jonathan.weil@wsj.com

(END) Dow Jones Newswires

June 11, 2025 05:30 ET (09:30 GMT)

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