REGULATORY MATTERS

The ACC and the FERC each regulate portions of utility accounting practices and rates of TEP. The ACC regulates rates charged to retail customers, the siting of generation and transmission facilities, the issuance of securities, transactions with affiliated parties, and other utility matters. The ACC also enacts other regulations and policies that can affect the Company's business decisions and accounting practices. The FERC regulates terms and prices of transmission services and wholesale electricity sales.

TEP RATE CASE

Provisions of the 2017 Rate Order, which were effective February 27, 2017, included, but are not limited to:


•	a non-fuel base rate increase of $81.5 million; and


•	adoption of TEP's proposed depreciation and amortization rates, which included a reduction in the depreciable life for San Juan Unit 1.

The ACC deferred matters related to net metering and rate design for new DG customers to a second phase of TEP's rate case (Phase 2).

Phase 2 Order

On September 20, 2018, the ACC issued an order related to Phase 2 proceedings. The Phase 2 Order established, among other things, an export rate that replaced net metering. Residential and small commercial customers who apply to interconnect their solar generation systems to TEP's distribution system after the date of the order will no longer qualify for net metering. Customers who applied before the date of the order, and complete interconnection within a specified time frame, were grandfathered under previous net metering rules for a period of 20 years from the date of interconnection of their solar generation system.

Provisions of the Phase 2 Order for new DG customers include:


•	an option to select from existing Time-of-Use rate schedules;


•	a monthly bill credit for customer excess solar generation exported to TEP's grid calculated using an export rate approved by the ACC; and


•	an annual update to the export rate based on TEP's actual solar PPA and generation facilities costs, which are expected to decline. The export rate at the time of customers' applications to interconnect will be locked for 10 years. The initial export rate was set at 9.64 cents per kWh.

FEDERAL TAX LEGISLATION

Arizona Corporation Commission

In December 2017, the ACC opened a docket requesting that all regulated utilities submit proposals to address passing the benefits of the TCJA through to customers. In 2018, the ACC approved the ACC Refund Order effective May 1, 2018. The refund represents the reduction in the federal corporate income tax rate and an estimate of EDIT amortization trued up annually for actuals. The refund amount, after the EDIT amortization true-up, totaled $33 million. The 2018 bill credit was designed to return the refund amount to customers based on forecasted kWh sales for the calendar year 2018. Any over or under collected amounts are deferred to a regulatory liability or asset and will be used to adjust the 2019 bill credit amounts.

The table below summarizes the regulatory asset (liability) balance related to the ACC Refund Order:



	Year Ended December 31,
(in millions)	2018
Beginning of Period	$	—
ACC Approved Refund (Reduction in Operating Revenues)	(33		)
Amount Returned to Customers Through Bill Credits	37
End of Period	$	4

Customer bill credits are trued-up annually to reflect actuals for kWh sales and EDIT amortization. TEP filed an application with the ACC to establish the 2019 customer refund of $34 million. The refund will be returned to customers through a combination of a customer bill credit and a regulatory liability in 2019.

See Note 13 for additional information regarding the TCJA.

Federal Energy Regulatory Commission

In 2018, the FERC issued the FERC Refund Order. TEP submitted a proposal for an overall transmission rate reduction of approximately 5.3%, reflecting the lower federal tax rate, effective March 21, 2018 which was approved by the FERC. As a result, TEP recognized a reduction in Operating Revenues on the Consolidated Statements of Income of $1 million in 2018.

In addition, the FERC issued a NOPR regarding the effect of the TCJA and related EDIT amortization. TEP cannot predict the final outcome of the NOPR or the impact on TEP's financial statements.

See Note 13 for additional information regarding the TCJA.

COST RECOVERY MECHANISMS

TEP has received regulatory decisions that allow for more timely recovery of certain costs through the recovery mechanisms described below.

Purchased Power and Fuel Adjustment Clause

TEP's PPFAC rate is adjusted annually each April 1st for the subsequent 12-month period unless modified by the ACC. The PPFAC rate includes: (i) a forward component which is calculated by taking the difference between forecasted fuel and purchased power costs and the amount of those costs established in Retail Rates; and (ii) a true-up component that reconciles the difference between actual costs and those recovered in the preceding 12-month period.

The table below summarizes the PPFAC regulatory asset (liability) balance:



	Years Ended December 31,
(in millions)	2018			2017
Beginning of Period	$	(9	)	$	(38	)
Deferred Fuel and Purchased Power Costs	2			14
PPFAC Refunds (Recoveries) ⁽¹⁾	(10		)	15
End of Period	$	(17	)	$	(9	)


⁽¹⁾	The ACC approved a PPFAC credit to begin returning the over-collected PPFAC balance to customers for the period of March 2017 through April 2018.

Environmental Compliance Adjustor

The Environmental Compliance Adjustor (ECA) allows for the recovery of capital carrying costs and incremental operations and maintenance costs related to environmental investments, provided that they are not already recovered in base rates or recovered through another commission-approved mechanism.

The eligible costs for the ECA are subject to a cap equal to 0.5% of total annual retail revenue. The Company recognized $3 million in 2018 and $1 million in both 2017 and 2016 related to the return on company-owned environmental investments included in Operating Revenues on the Consolidated Statements of Income.

Renewable Energy Standard

The ACC’s RES requires Arizona regulated utilities to increase their use of renewable energy each year until it represents at least 15% of their total annual retail energy requirements by 2025, with DG accounting for 30% of the annual renewable energy requirement. Arizona utilities are required to file an annual RES implementation plan for review and approval by the ACC.

In January 2018, the ACC approved TEP's 2018 RES implementation plan with a budget amount of $54 million. The recovery funds the following: (i) the above market cost of renewable power purchases; (ii) previously awarded incentives for customer-installed DG; and (iii) various other program costs. In 2018, TEP recognized $1 million of revenue as a return on company-owned solar projects. The return on company-owned solar projects is included in Operating Revenues on the Consolidated Statements of Income. TEP is no longer requesting recovery on company-owned solar projects through the RES mechanism and plans to request recovery of these types of costs through its rate case process. As part of the Phase 2 Order, the ACC approved a separate residential community solar program for TEP.

In July 2018, TEP submitted its application for approval of the 2019 RES implementation plan with a budget amount of $55 million. The Company cannot predict when the ACC will consider its 2019 RES implementation plan.

In 2018, the percentage of TEP's retail kWh sales attributable to the RES was approximately 14%, exceeding the overall 2018 RES requirement of 8%. The ACC approved a waiver of the 2018 DG requirement.

Energy Efficiency Standards

Under the EE Standards, the ACC requires electric utilities to implement cost-effective programs to reduce customers' energy consumption. The EE Standards require increasing cumulative annual targeted retail kWh savings equal to 22% by 2020. As of December 31, 2018, TEP’s cumulative annual energy savings were approximately 16%.

TEP is required to implement cost-effective DSM programs to comply with the ACC’s EE Standards. The EE Standards provide regulated utilities a DSM surcharge to recover from retail customers the costs to implement DSM programs, as well as an annual performance incentive. TEP records its annual DSM performance incentive for the prior calendar year in the first quarter of each year. TEP recorded $2 million in each of 2018, 2017, and 2016 related to the performance incentive in Operating Revenues on the Consolidated Statements of Income.

TEP is currently operating under the ACC approved 2016 energy efficiency implementation plan. On February 6, 2019, the ACC approved TEP’s 2018 energy efficiency implementation plan with a budget of approximately $23 million, which will be collected through the DSM surcharge.

Lost Fixed Cost Recovery Mechanism

The LFCR mechanism provides for recovery of certain non-fuel costs that would go unrecovered due to reduced retail kWh sales as a result of implementing ACC-approved energy efficiency programs and customer-installed DG. TEP records a regulatory asset and recognizes LFCR revenues when the amounts are verifiable regardless of when the lost retail kWh sales occur. TEP is required to make an annual filing with the ACC requesting recovery of the LFCR revenues recognized in the prior year. The recovery is subject to a year-over-year cap of 2% of TEP's applicable retail revenues, as approved in the 2017 Rate Order.

TEP recorded regulatory assets and recognized LFCR revenues of $26 million in 2018, $22 million in 2017, and $18 million in 2016. LFCR revenues are included in Operating Revenues on the Consolidated Statements of Income.

REGULATORY ASSETS AND LIABILITIES

Regulatory assets and liabilities recorded in the balance sheet are summarized in the table below:



	Remaining Recovery Period (years)	December 31,
($ in millions)	Remaining Recovery Period (years)	2018		2017
Regulatory Assets
Pension and Other Postretirement Benefits (Note 9)	Various	$	126	$	126
Early Generation Retirement Costs ⁽¹⁾	Various	72		84
Income Taxes Recoverable through Future Rates ⁽²⁾	Various	47		40
Lost Fixed Cost Recovery	2	35		29
Final Mine Reclamation and Retiree Healthcare Costs ⁽³⁾	20	29		31
Derivatives (Note 12)	11	27		18
Property Tax Deferrals ⁽⁴⁾	1	23		24
Springerville Unit 1 Leasehold Improvements ⁽⁵⁾	5	11		14
Other Regulatory Assets	Various	30		22
Total Regulatory Assets		400		388
Less Current Portion	1	107		94
Total Non-Current Regulatory Assets		$	293	$	294



Regulatory Liabilities
Income Taxes Payable through Future Rates ⁽²⁾	Various	$	354	$	353
Net Cost of Removal ⁽⁶⁾	Various	171		180
Renewable Energy Standard	Various	52		44
Purchased Power and Fuel Adjustment Clause	1	17		9
Deferred Investment Tax Credits ⁽⁷⁾	Various	7		14
Other Regulatory Liabilities	Various	6		5
Total Regulatory Liabilities		607		605
Less Current Portion	1	95		89
Total Non-Current Regulatory Liabilities		$	512	$	516

⁽¹⁾

Includes the NBV and other related costs of Navajo and Sundt Units 1 and 2 reclassified from Utility Plant, Net on the Consolidated Balance Sheets due to the planned early retirement of the facilities. As of December 31, 2018, Navajo and Sundt Units 1 and 2 are being fully recovered in base rates using various useful lives through 2030. See Note 3 for additional information related to the planned early retirement of Navajo and Sundt Units 1 and 2.


⁽²⁾	Amortized over the life of the assets. The balances include changes related to the revaluation of tax assets and liabilities as a result of the TCJA. See Note 1 and Note 13 for additional information regarding income taxes.


⁽³⁾	Represents costs associated with TEP’s jointly-owned facilities at San Juan, Four Corners, and Navajo. TEP recognizes these costs at future value and is permitted to fully recover these costs on a pay-as-you-go basis through the PPFAC mechanism. The majority of final mine reclamation costs are expected to occur through 2038.

⁽⁴⁾

Property taxes are recorded as a regulatory asset based on historical ratemaking treatment allowing regulated utilities recovery of property taxes on a pay-as-you-go or cash basis. TEP records a liability to reflect the accrual for financial reporting purposes and an offsetting regulatory asset to reflect recovery for regulatory purposes. This asset is fully recovered in rates with a recovery period of approximately six months.


⁽⁵⁾	Represents investments TEP made, which were previously recorded in Plant in Service on the Consolidated Balance Sheets, to ensure that the facilities continued to provide safe, reliable service to TEP's customers. TEP received ACC authorization to recover leasehold improvement costs at Springerville Unit 1 over a 10-year amortization period.


⁽⁶⁾	Represents an estimate of the future cost of retirement net of salvage value. These are amounts collected through revenue for transmission, distribution, generation plant, and general and intangible plant which are not yet expended.


⁽⁷⁾	Represents federal energy credits generated after 2011 that are amortized over the tax life of the underlying asset.

Regulatory assets are either being collected or are expected to be collected through Retail Rates. With the exception of Early Generation Retirement Costs and Springerville Unit 1 Leasehold Improvements, TEP does not earn a return on regulatory assets. Regulatory liabilities represent items that TEP either expects to pay to customers through billing reductions in future periods or plans to use for the purpose for which they were collected from customers. With the exception of over-recovered PPFAC costs and Income Taxes Payable through Future Rates related to the EDIT balances, TEP does not pay a return on regulatory liabilities.

FERC COMPLIANCE

In 2016, the FERC issued orders relating to certain late-filed TSAs, which resulted in TEP recording a liability and paying time-value refunds to the counterparties of these TSAs. In May 2017, the FERC informed TEP that the related investigation was closed. See Note 8 for additional information related to FERC compliance associated with these transmission contracts.

IMPACTS OF REGULATORY ACCOUNTING

If TEP determines that it no longer meets the criteria for continued application of regulatory accounting, TEP would be required to write off its regulatory assets and liabilities related to those operations not meeting the regulatory accounting requirements. Discontinuation of regulatory accounting could have a material impact on TEP's financial statements.