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REGULATORY MATTERS

12 Months Ended

Dec. 31, 2019

The ACC and the FERC each regulate portions of the 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 rates and services for electric transmission and wholesale power sales in interstate commerce.

2019 ACC RATE CASE

In April 2019, TEP filed a general rate case with the ACC based on a test year ended December 31, 2018.

TEP's key proposals of the rate case, adjusted for rebuttal testimony filed in November 2019 include:


•	a non-fuel retail revenue increase of $99 million, partially offset by a reduction in base fuel revenue of approximately $39 million for a net increase of $60 million over test year retail revenues;


•	a 7.49% return on original cost rate base of $2.7 billion, which includes a cost of equity of 10.00% and an average cost of debt of 4.65%;


•	a request to recover costs of changes in generation resources, including: (i) the retirement of Navajo and Sundt Units 1 and 2; and (ii) the replacement generation capacity associated with the purchase of Gila River Unit 2 and the installation of RICE units at Sundt;


•	a TEAM that would be updated for income tax changes that materially affect TEP’s authorized revenue requirement; and


•	a TCA mechanism, updated annually, allowing TEP to recover any changes in transmission costs approved by the FERC.

Hearings before an ALJ were held in January and February 2020. The hearing will resume in April 2020. TEP requested new rates to be implemented by May 1, 2020.

TEP cannot predict the timing or outcome of the proceeding.

2019 FERC RATE CASE

In 2019, the FERC issued an order approving TEP's proposed OATT revisions effective August 1, 2019, subject to refund.

Provisions of the order include, but are not limited to:


•	replacing TEP's stated transmission rates with a forward-looking formula rate;


•	a 10.4% return on equity; and


•	elimination of transmission rates that are bifurcated between high-voltage and lower-voltage facilities, as well as elimination of the bifurcated loss factor rate.

The requested forward-looking formula rate is intended to allow for more timely recovery of transmission related costs. As part of the order, the FERC established hearing and settlement procedures, and all revisions to the OATT in the FERC order are subject to refund. As of December 31, 2019, TEP had reserved $4 million of wholesale revenues in Current Liabilities—Regulatory Liabilities on the Consolidated Balance Sheets as a result of the FERC proceedings. TEP cannot predict the outcome of the proceeding.

Abandoned Plant Costs

Also in May 2019, TEP filed with the FERC a request to recover through its OATT abandoned plant costs related to the abandoned Sahuarita, Arizona to Nogales, Arizona transmission line. TEP requested authorization to recover 100% of the approximately $9 million that it incurred in developing the transmission line. The filing requests that the abandoned plant costs be included in TEP's transmission rate. On September 19, 2019, the FERC issued an order allowing TEP to recover 50% of its costs in its formula rate and established hearing and settlement procedures. TEP plans to incorporate the abandoned plant costs into its formula rate effective January 1, 2020, subject to refund. On September 26, 2019, the FERC issued an order consolidating the 2019 FERC Rate Case and Abandoned Plant Costs proceedings. In 2012, TEP wrote-off a portion of the deferred costs related to the Nogales transmission line. As of December 31, 2019, there was $4 million related to the Nogales transmission line recorded in Regulatory and Other Assets—Regulatory Assets on the Consolidated Balance Sheets.

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 issued the ACC Refund Order. The ACC Refund Order represents the reduction in the federal corporate income tax rate and an estimate of EDIT amortization that will be trued-up annually for actuals. The bill credit was designed to return the refund amount to customers based on forecasted kWh sales for the calendar year. Any over or under collected amounts are deferred to a regulatory liability or asset and will be used to adjust the following year's bill credit amounts. Customer bill credits are trued-up annually to reflect actuals for both kWh sales and EDIT amortization. TEP filed an information filing with the ACC to establish a 2020 customer refund of $35 million. The refund will be returned to customers through a combination of a customer bill credit and a regulatory liability in 2020. The customer bill credit will account for 50% of the returned savings in 2020 and through the completion of our next rate case.

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



	Years Ended December 31,
(in millions)	2019			2018
Beginning of Period	$	4		$	—
ACC Approved Refund (Reduction in Operating Revenues)	(34		)	(33		)
Amount Returned to Customers Through Bill Credits	22			37
Regulatory Deferral	8			—
End of Period	$	—		$	4

See Note 14 for additional information regarding the TCJA.

Federal Energy Regulatory Commission

In 2018, the FERC issued the FERC Refund Order. In May 2018, TEP responded to the order and the FERC approved TEP's proposal of an overall transmission rate reduction of approximately 5.3%, reflecting the lower federal tax rate, to be effective March 21, 2018. As a result, TEP recognized a reduction in Operating Revenues on the Consolidated Statements of Income of $1 million in 2018.

Also in 2018, the FERC issued a NOPR regarding the effect of the TCJA and related EDIT amortization on rates. In November 2019, the FERC issued a final rule on the NOPR which required TEP to address the effect of the TCJA and related EDIT amortization in its next FERC rate case. As required by the final rule, TEP's 2019 FERC Rate Case addressed the effects of the TCJA and related EDIT amortization.

See Note 14 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 and goes into effect for the subsequent 12-month period unless the schedule is 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)	2019			2018
Beginning of Period	$	(17	)	$	(9	)
Deferred Fuel and Purchased Power Costs	31			2
PPFAC Refunds (Recoveries) ⁽¹⁾	22			(10		)
End of Period	$	36		$	(17	)


⁽¹⁾	In March 2019, the ACC approved a PPFAC credit as part of TEP's annual rate adjustment request.

Environmental Compliance Adjustor

The 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 $2 million in 2019, $3 million in 2018, and $1 million in 2017 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 September 2019, the ACC approved TEP's 2019 RES implementation plan with a budget amount of $55 million. The recovery funds the following: (i) above market cost of renewable power purchases; (ii) previously awarded incentives for customer-installed DG; and (iii) various other program costs. The Company recognized less than $1 million in 2019, and $1 million in 2018 and 2017 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 requests recovery of these types of costs through its rate case process.

In 2019, the percentage of TEP's retail kWh sales attributable to the RES was approximately 16%, exceeding the overall 2019 RES requirement of 9%. The ACC approved the waiver of the 2019 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, 2019, TEP's cumulative annual energy savings was approximately 19%.

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 2019, 2018, and 2017 related to performance in Operating Revenues on the Consolidated Statements of Income.

In February 2019, the ACC approved TEP’s 2018 energy efficiency implementation plan with a budget of approximately $23 million, which is 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 LFCR revenues recognized in the prior year. The recovery is subject to a year-over-year increase cap of 2% of TEP's applicable retail revenues.

The table below summarizes the LFCR revenues recognized in Operating Revenues on the Consolidated Statements of Income:



	Years Ended December 31,
(in millions)	2019		2018		2017
LFCR Revenues	$	33	$	26	$	22

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)	2019		2018
Regulatory Assets
Pension and Other Postretirement Benefits (Note 10)	Various	$	135	$	126
Derivatives (Note 13)	10	72		27
Early Generation Retirement Costs	Various	68		72
Lost Fixed Cost Recovery	2	46		35
Income Taxes Recoverable through Future Rates ⁽¹⁾	Various	38		47
Under Recovered Purchased Energy Costs	1	36		—
Property Tax Deferrals ⁽²⁾	1	24		23
Final Mine Reclamation and Retiree Healthcare Costs ⁽³⁾	19	19		29
Springerville Unit 1 Leasehold Improvements ⁽⁴⁾	4	9		11
Other Regulatory Assets	Various	18		30
Total Regulatory Assets		465		400
Less Current Portion	1	138		107
Total Non-Current Regulatory Assets		$	327	$	293



Regulatory Liabilities
Income Taxes Payable through Future Rates ⁽¹⁾	Various	$	327	$	354
Net Cost of Removal ⁽⁵⁾	Various	164		171
Renewable Energy Standard	Various	59		52
Deferred Investment Tax Credits ⁽⁶⁾	Various	3		7
Over Recovered Purchased Energy Costs	Various	—		17
Other Regulatory Liabilities	Various	20		6
Total Regulatory Liabilities		573		607
Less Current Portion	1	96		95
Total Non-Current Regulatory Liabilities		$	477	$	512


⁽¹⁾	Amortized over the life of the assets. See Note 14 for additional information regarding income taxes.

⁽²⁾

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.


⁽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⁾	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 period.


⁽⁵⁾	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.


⁽⁶⁾	Represents federal energy credits generated after 2011 that are amortized over the tax life of the underlying asset.

Early Generation Retirement Costs

Navajo Generating Station

In 2017, the Navajo Nation approved a land lease extension allowing TEP and the co-owners of Navajo to continue operations through December 2019 and begin decommissioning activities thereafter. TEP and the co-owners of Navajo retired the generation station in November 2019, with related decommissioning activities continuing through 2054. TEP is currently recovering the capital and operating costs in base rates using a useful life of 2030 for Navajo. Due to the early retirement, TEP requested recovery of final retirement costs over a 10-year period in the 2019 Rate Case.

Sundt Generating Station

In 2018, the Pima County Department of Environmental Quality approved TEP's air permit application. Under the project outlined in the application, TEP is placing in service 10 RICE units and was required to retire Sundt Units 1 and 2 in November 2019. TEP is currently recovering the capital and operating costs in base rates using useful lives of 2028 and 2030 for Sundt Units 1 and 2, respectively. Due to the early retirement, TEP requested recovery of final retirement costs over a 10-year period in the 2019 Rate Case. See Note 3 for additional information on the RICE units.

Regulatory Assets and Liabilities

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, TEP does not pay a return on regulatory liabilities.

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.