Algonquin Power & Utilities Corp. – Consolidated Financial Statements ALGONQUIN POWER & UTILITIES CORP.  Notes to the Consolidated Financial Statements  December 31, 2012 and 2011   (in thousands of Canadian dollars except as noted and amounts per share)  24. Financial instruments (continued) The Company’s Level 2 fair value derivative instruments primarily consist of swaps,  options, and forward physical deals where market data for pricing inputs are observable. Level 2 pricing inputs are obtained from various market indices and utilize discounting based on quoted interest rate curves which are observable in the marketplace.  The Red Lily conversion option is measured at fair value on a recurring basis using  unobservable inputs (Level 3). The fair value is based on an income approach using an  option pricing model that includes various inputs such as energy yield function from wind,  estimated cash flows and a discount rate of 8.5%. The Company used a discount rate  believed to be most relevant given the business strategy. There was no change in fair value  of $nil during the years ended December 31, 2012 or 2011.  Fair value estimates are made at a specific point in time, using available information about  the financial instrument. These estimates are subjective in nature and often cannot be  determined with precision. The Company’s accounting policy is to recognize transfers between levels of the fair value  hierarchy on the date of the event or change in circumstances that caused the transfer.  There was no transfer into or out of level 1, level 2 or level 3 during the years ended  December 31, 2012 or 2011. Derivative instruments are recognized on the balance sheet as either assets or liabilities and  measured at fair value each reporting period. The Company uses derivative financial instruments to reduce the cash flow variability associated with the purchase price for a portion of future natural gas purchases associated  with its regulated gas service territories. The Company’s strategy is to minimize fluctuations in gas sales prices to regulated customers. The accounting for these derivative instruments is subject to current guidance for rate-regulated enterprises. Therefore, the fair value of these derivatives is recorded as current or long-term  assets and liabilities, with offsetting positions recorded as regulatory assets and regulatory  liabilities in the accompanying balance sheets. Gains or losses on the settlement of these  contracts are included in the calculation of deferred gas costs (note 7 (v)).  The following are commodity volumes, in dekatherms (“dths”) associated with the above  derivative contracts: 2012 Annual Report 133  2012  Financial contracts: Gas swaps  3,353,420 Gas options  787,960 4,141,380 (a)  Fair value of financial instruments (continued)  (b) Derivative instruments  (i)  Commodity derivatives – regulated accounting 