REGULATORY MATTERS

6 Months Ended

Jun. 30, 2023

Regulated Operations [Abstract]

REGULATORY MATTERS

REGULATORY MATTERSThe 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 facilities and transmission systems, the issuance of securities, transactions with affiliated parties, and other utility matters. The ACC also enacts other regulations and policies that can affect TEP's business decisions and accounting practices. The FERC regulates rates and services for electric transmission and wholesale power sales in interstate commerce.

RATE CASE MATTERS

2022 Rate Case

In 2022, TEP filed a general rate case with the ACC based on a test year ended December 31, 2021. TEP requested new rates to be implemented by September 1, 2023.

On July 12, 2023, an ACC ALJ issued a ROO in TEP's 2022 Rate Case. Key recommendations of the ROO, include:

•a non-fuel retail revenue increase of $102 million over test year non-fuel retail revenues;

•a 6.85% return on original cost rate base of $3.6 billion, which includes a return on equity of 9.40% and an average cost of debt of 3.82%;

•approval to recover costs of changes in generation resources, including the addition of Oso Grande in rates;

•denial of a request for a System Reliability Benefit adjustor that was designed to provide more timely recovery of TEP's energy resource investments; and

•the establishment of a second phase of the 2022 Rate Case to consider updates to TEP's PPFAC plan of administration.

In January 2023, the ACC ordered that the just and equitable transition away from fossil-based generation facilities be considered as part of the 2022 Rate Case. The ROO proposes establishing a task force to review matters related to just and equitable transition but proposes no ratepayer funding for the transition as part of the 2022 Rate Case. TEP cannot predict the timing or outcome of this proceeding.

OTHER FERC MATTERS

In January 2021, the FERC notified TEP that it was commencing an audit with the intent to evaluate TEP's compliance with: (i) the accounting requirements of the Uniform System of Accounts; and (ii) the reporting requirements of the FERC Form 1 Annual Report and Supplemental Form 3-Q Quarterly Financial Reports. The audit covered the period of January 1, 2018 to December 31, 2021. In November 2022, the FERC published its findings and recommendations. TEP accepted the findings therein and, in May 2023, issued refunds to customers of $1 million related to the audit. All compliance activities related to the audit were completed by the end of the second quarter of 2023, and a final status update was submitted to the FERC on July 28, 2023.

COST RECOVERY MECHANISMS

TEP has received regulatory decisions that allow for timely recovery of certain costs through recovery mechanisms. Cost recovery mechanisms that have a material impact on TEP's operations or financial results are described below.

Purchased Power and Fuel Adjustment Clause

TEP's PPFAC rate is typically adjusted annually on 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 allows for reconciliation of differences between actual costs and those recovered in the preceding period.

In April 2022, the ACC approved a rate adjustment for the PPFAC that set the true-up component of the PPFAC rate to recover the then existing uncollected true-up balance over 18 months. The ACC also set the forward-looking component of the PPFAC rate to zero, which contributed to under-collection of PPFAC costs. In May 2023, the ACC approved a rate adjustment for the PPFAC to collect the remaining uncollected balance over 12 months.

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

	Three Months Ended June 30,				Six Months Ended June 30,
(in millions)	2023		2022		2023		2022
Beginning of Period	$	118	$	102	$	124	$	91
Deferred Fuel and Purchased Power Costs (1)	65		88		123		153
PPFAC and Base Power Recoveries	(90)		(87)		(154)		(141)
End of Period	$	93	$	103	$	93	$	103

(1)Includes costs eligible for recovery through the PPFAC and base power rates.

Transmission Cost Adjustor

The Transmission Cost Adjustor (TCA) allows for timely recovery of actual costs required to provide transmission services to retail customers. The TCA is limited to the recovery, or refund, of costs associated with future changes in TEP's OATT rate. TEP files new TCA rates with the ACC in December each year based on changes in the OATT formula rate. New TCA rates take effect in January of each year.

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 sales by 2025, with DG accounting for 30%. The renewable energy requirement in 2023 is 13% of retail electric sales. Consistent with prior years, TEP expects to meet these requirements through a combination of utility-owned resources, PPAs, and customer-sited DG. Arizona utilities are required to file an annual RES implementation plan for review and approval by the ACC. TEP recovers approved costs of carrying out this plan from retail customers through a RES Tariff.

In 2021, the ACC approved TEP's 2021 RES implementation plan for the years 2021 and 2022 with a budget of $66 million. The approved amounts fund: (i) above market cost of renewable power purchases; (ii) previously awarded incentives for customer-installed DG; and (iii) various other program costs. In June 2023, the ACC approved an extension of the 2021 RES implementation plan through 2024.

Energy Efficiency Standards

TEP is required to implement cost-effective DSM programs to comply with the ACC’s Energy Efficiency Standards. The Energy Efficiency Standards provide regulated utilities a DSM surcharge to recover from retail customers the costs of implementing 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.

In November 2022, the ACC approved TEP’s 2022 energy efficiency implementation plan, with a budget of $24 million, which is collected through the DSM surcharge. The 2022 plan will remain in effect until another plan is approved.

In March 2022, the ACC set an annual 1.3% energy efficiency target measured by retail MWh savings over three years.

Lost Fixed Cost Recovery Mechanism

The LFCR mechanism provides for recovery of certain non-fuel costs that would go unrecovered between rate cases due to reduced retail kWh sales as a result of implementing ACC-approved energy efficiency programs and customer-installed DG. The LFCR mechanism is adjusted in each rate case when the ACC approves new base rates. TEP records a regulatory asset and recognizes LFCR revenues when amounts are verifiable regardless of when the lost retail kWh sales occurred. 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.

REGULATORY ASSETS AND LIABILITIES

Regulatory assets and liabilities recorded on the Condensed Consolidated Balance Sheets are summarized in the table below:

($ in millions)	Remaining Recovery Period (years)	June 30, 2023		December 31, 2022
Regulatory Assets
Under Recovered Purchased Energy Costs	1	$	93	$	124
Pension and Other Postretirement Benefits (Note 8)	Various	87		90
Early Generation Retirement Costs	Various	55		58
Lost Fixed Cost Recovery	1	33		25
Property Tax Deferrals (1)	1	30		29
Final Mine Reclamation and Retiree Healthcare Costs (2)	6	11		11
Income Taxes Recoverable through Future Rates (3)	Various	6		6
Unamortized Loss on Reacquired Debt	Various	5		5
Derivatives (Note 9)	7	3		3
Other Regulatory Assets	Various	18		19
Total Regulatory Assets		341		370
Less Current Portion	1	163		185
Total Non-Current Regulatory Assets		$	178	$	185

Regulatory Liabilities
Income Taxes Payable through Future Rates (3)	Various	$	236	$	244
Renewable Energy Standard	Various	73		73
Derivatives (Note 9)	7	39		86
Net Cost of Removal (4)	Various	31		43
Demand Side Management	1	15		16
Transmission Balancing Accounts	1	9		9
Pension and Other Postretirement Benefits (Note 8)	Various	8		8
Deferred Investment Tax Credits	Various	7		7
Other Regulatory Liabilities	Various	—		3
Total Regulatory Liabilities		418		489
Less Current Portion	1	98		111
Total Non-Current Regulatory Liabilities		$	320	$	378

(1)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.

(2)Represents costs associated with TEP’s jointly-owned facilities at San Juan and Four Corners. 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. Final mine reclamation costs are expected to be funded by TEP through 2028. San Juan Unit 1 was retired in June 2022.

(3)Amortized over five years, 10 years, or the lives of the assets.

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

Regulatory assets are either being collected or are expected to be collected through Retail Rates. With the exception of Early Generation Retirement Costs, Income Taxes Recoverable through Future Rates, and Under Recovered Purchased Energy Costs, 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. TEP pays a return on most of its regulatory liability balances.