COMMITMENTS, CONTINGENCIES, AND ENVIRONMENTAL MATTERS

COMMITMENTS

At December 31, 2013, UNS Energy and TEP had the following firm, non-cancelable, minimum purchase obligations and operating leases. UNS Energy's commitments represent the obligations of TEP, UNS Electric, and UNS Gas:



	UNS Energy Purchase Commitments
	2014		2015		2016		2017		2018		Thereafter		Total
	Millions of Dollars
Fuel, Including Transportation	$	103	$	83	$	80	$	75	$	49	$	345	$	735
Purchased Power	75		17		—		—		—		—		92
Transmission	7		13		12		12		11		27		82
Renewable Power Purchase Agreements	36		37		37		37		37		485		669
RES Performance-Based Incentives	9		9		9		9		9		85		130
Operating Leases	4		4		3		2		2		14		29
Total Purchase Commitments	$	234	$	163	$	141	$	135	$	108	$	956	$	1,737

At December 31, 2013, TEP had the following firm, non-cancelable, minimum purchase obligations and operating leases:



	TEP Purchase Commitments
	2014		2015		2016		2017		2018		Thereafter		Total
	Millions of Dollars
Fuel, Including Transportation	$	77	$	63	$	64	$	62	$	36	$	285	$	587
Purchased Power	27		5		—		—		—		—		32
Transmission	3		6		6		6		6		21		48
Renewable Power Purchase Agreements	30		31		31		31		31		410		564
RES Performance-Based Incentives	8		8		8		8		8		83		123
Operating Leases	3		3		2		2		2		14		26
Total Purchase Commitments	$	148	$	116	$	111	$	109	$	83	$	813	$	1,380

Fuel

TEP has long-term contracts for the purchase and delivery of coal with various expiration dates through 2031. Amounts paid under these contracts depend on actual quantities purchased and delivered. Some of these contracts include a price adjustment clause that will affect the future cost. TEP expects to spend more than the minimum purchase obligations to meet its fuel requirements. TEP's fuel costs are recoverable from customers through the PPFAC.

UNS Gas purchases gas from various supplies at market prices. However, UNS Gas' risk of loss due to increased costs is mitigated through the use of the PGA, which provides for the pass-through of actual commodity costs to customers. UNS Gas' forward gas purchase agreements expire through 2016. Certain of these contracts are at a fixed price per Million British Thermal Units (MMbtu) and others are indexed to natural gas prices. The commitment amounts included in the table are based on projected marked prices as of December 31, 2013. UNS Gas has firm transportation agreements with capacity sufficient to meet its load requirements. These contracts expire in various years between 2016 and 2023.

Purchased Power and Transmission

TEP and UNS Electric have agreements with utilities and other energy suppliers for purchased power to meet system load and energy requirements, replace generation from company-owned units under maintenance and during outages, and meet operating reserve obligations. In general, these contracts provide for capacity payments and energy payments based on actual power taken under the contracts. These contracts expire in 2014 and 2015. Certain of these contracts are at a fixed price per MW and others are indexed to natural gas prices. The commitment amounts included in the table are based on projected market prices as of December 31, 2013.

TEP has agreements with other utilities to provide transmission services. These contracts expire in various years between 2018 and 2028. UNS Electric imports the power it purchases over the Western Area Power Administration's (WAPA) transmission lines. UNS Electric's transmission capacity agreements with WAPA provide for annual rate adjustments and expire in 2016.

TEP's and UNS Electric's purchased power and transmission costs are recoverable from customers through their respective PPFAC mechanisms.

Renewable Power Purchase Agreements and RES Performance-Based Incentives

TEP and UNS Electric have entered into 20 year Renewable Power Purchase Agreements (PPAs) which require TEP and UNS Electric to purchase 100% of the output of certain renewable energy generation facilities that have achieved commercial operation. TEP has entered into additional long-term renewable PPAs to comply with RES requirements; however, TEP’s obligation to purchase power under these agreements does not begin until the facilities are operational. A portion of the cost of renewable energy is recoverable through the PPFAC, with the balance of costs recoverable through the RES tariff. See Note 3.

TEP and UNS Electric have entered into REC purchase agreements to purchase the environmental attributes from retail customers with solar installations. Payments for the RECs are termed Performance-Based Incentives (PBIs) and are paid in contractually agreed-upon intervals (usually quarterly) based on metered renewable energy production. PBIs are recoverable through the RES tariff. See Note 3.

Operating Leases

Our operating lease expense is primarily for rail cars, office facilities, land easements, and rights of way with varying terms, provisions, and expiration dates. UNS Energy's operating lease expense totaled $3 million in each of 2013, 2012, and 2011, and TEP's operating lease expense totaled $2 million in each of 2013, 2012, and 2011.

TEP CONTINGENCIES

Potential Purchase of Gas-Fired Generation Facility

In 2013, TEP and UNS Electric entered into an agreement to purchase a gas-fired generation facility; see Note 8.

Claim Related to San Juan Generating Station

San Juan Coal Company (SJCC) operates an underground coal mine in an area where certain gas producers have oil and gas leases with the federal government, the State of New Mexico, and private parties. These gas producers allege that SJCC’s underground coal mine interferes with their operations, reducing the amount of natural gas they can recover. SJCC compensated certain gas producers for any remaining production from wells deemed close enough to the mine to warrant plugging and abandoning them. These settlements, however, do not resolve all potential claims by gas producers in the area. TEP owns 50% of Units 1 and 2 at San Juan Generating Station (San Juan), which represents approximately 20% of the total generation capacity at San Juan, and is responsible for its share of any settlements. TEP cannot estimate the impact of any future claims by these gas producers on the cost of coal at San Juan.

In August 2013, the Bureau of Land Management (BLM) proposed regulations that, among other things, redefine the term “underground mine” to exclude high-wall mining operations and impose a higher surface mine coal royalty on high-wall mining. SJCC utilized high-wall mining techniques at its surface mines prior to beginning underground mining operations in January 2003. If the proposed regulations become effective, SJCC may be subject to additional royalties on coal delivered to San Juan between August 2000 and January 2003 totaling approximately $5 million of which TEP’s proportionate share would approximate $1 million. TEP cannot predict the final outcome of the BLM’s proposed regulations.

Claims Related to Four Corners Generating Station

In October 2011, EarthJustice, on behalf of several environmental organizations, filed a lawsuit in the United States District Court for the District of New Mexico against Arizona Public Service Company (APS) and the other Four Corners Generating Station (Four Corners) participants alleging violations of the Prevention of Significant Deterioration (PSD) provisions of the Clean Air Act at Four Corners. In January 2012, EarthJustice amended their complaint alleging violations of New Source Performance Standards resulting from equipment replacements at Four Corners. Among other things, the plaintiffs seek to have the court issue an order to cease operations at Four Corners until any required PSD permits are issued and order the payment of civil penalties, including a beneficial mitigation project. In April 2012, APS filed motions to dismiss with the court for all claims asserted by EarthJustice in the amended complaint. The joint participants have applied to have the matter stayed until March 17, 2014 in furtherance of settlement talks.

TEP owns 7% of Four Corners Units 4 and 5 and is liable for its share of any resulting liabilities. TEP cannot predict the final outcome of the claims relating to Four Corners, and, due to the general and non-specific nature of the claims and the indeterminate scope and nature of the injunctive relief sought for this claim, TEP cannot determine estimates of the range of loss at this time. TEP accrued estimated losses of less than $1 million in 2011 for this claim based on its share of a settlement offer to resolve the claim.

In May 2013, the New Mexico Taxation and Revenue Department issued a notice of assessment for coal severance tax, penalties, and interest totaling $30 million to the coal supplier at Four Corners. The coal supplier and Four Corners’ operating agent intend to contest the validity of the assessment on behalf of the participants in Four Corners, who will be liable for their share of any resulting liabilities. TEP’s share of the assessment based on its ownership of Four Corners is approximately $1 million. TEP cannot predict the outcome or timing of resolution of this claim.

Mine Closure Reclamation at Generating Stations Not Operated by TEP

TEP pays ongoing reclamation costs related to coal mines that supply generating stations in which TEP has an ownership interest but does not operate. TEP is liable for a portion of final reclamation costs upon closure of the mines servicing Navajo, San Juan, and Four Corners. TEP’s share of reclamation costs at all three mines is expected to be $44 million upon expiration of the coal supply agreements, which expire between 2017 and 2031. The reclamation liability (present value of future liability) recorded was $18 million at December 31, 2013 and $16 million at December 31, 2012.

Amounts recorded for final reclamation are subject to various assumptions, such as estimations of reclamation costs, the dates when final reclamation will occur, and the credit-adjusted risk-free interest rate to be used to discount future liabilities. As these assumptions change, TEP will prospectively adjust the expense amounts for final reclamation over the remaining coal supply agreements’ terms. TEP does not believe that recognition of its final reclamation obligations will be material to TEP in any single year because recognition will occur over the remaining terms of its coal supply agreements.

TEP’s PPFAC allows us to pass through most fuel costs, including final reclamation costs, to customers. Therefore, TEP classifies these costs as a regulatory asset by increasing the regulatory asset and the reclamation liability over the remaining life of the coal supply agreements and recovers the regulatory asset through the PPFAC as final mine reclamation costs are paid to the coal suppliers.

Discontinued Transmission Project

TEP and UNS Electric had initiated a project to jointly construct a 60-mile transmission line from Tucson, Arizona to Nogales, Arizona in response to an order by the ACC to UNS Electric to improve the reliability of electric service in Nogales. TEP and UNS Electric will not proceed with the project based on the cost of the proposed 345-kV line, the difficulty in reaching agreement with the Forest Service on a path for the line, and concurrence by the ACC of recent transmission plans filed by TEP and UNS Electric supporting elimination of this project. As part of the 2013 TEP Rate Order, TEP agreed to seek recovery of the project costs from FERC before seeking rate recovery from the ACC. See Note 3. In 2012, TEP wrote off $5 million of the capitalized costs believed not probable of recovery and recorded a regulatory asset of $5 million for the balance deemed probable of recovery.

Performance Guarantees

The participants in each of the remote generating stations in which TEP participates, including TEP, have guaranteed certain performance obligations of the other participants. Specifically, in the event of payment default of a participant, the non-defaulting participants have agreed to bear a proportionate share of expenses otherwise payable by the defaulting participant. In exchange, the non-defaulting participants are entitled to receive their proportionate share of the generating capacity of the defaulting participants. TEP's joint participation agreements expire in 2016 through 2046.

UNS ELECTRIC CONTINGENCIES

Potential Purchase of Gas-Fired Generation Facility

In 2013, TEP and UNS Electric entered into an agreement to purchase a gas-fired generation facility. See Note 8.

ENVIRONMENTAL MATTERS

Environmental Regulation

The Environmental Protection Agency (EPA) limits the amount of sulfur dioxide (SO₂), nitrogen oxide (NOx), particulate matter, mercury and other emissions released into the atmosphere by power plants. TEP capitalized $5 million in 2013, $2 million in 2012, and $8 million in 2011 in construction costs to comply with environmental requirements. TEP expects to capitalize environmental compliance costs of $12 million in 2014 and $36 million in 2015. In addition, TEP recorded O&M expenses of $8 million in 2013, $15 million in 2012, and $12 million in 2011. TEP expects environmental O&M expenses to be $5 million in each of 2014 and 2015.

TEP may incur added costs to comply with future changes in federal and state environmental laws, regulations, and permit requirements at its power plants. Complying with these changes may reduce operating efficiency. TEP expects to recover the cost of environmental compliance from its ratepayers.

Hazardous Air Pollutant Requirements

In February 2012, the EPA issued final rules for the control of mercury emissions and other hazardous air pollutants from power plants. Based on the EPA's final Mercury and Air Toxics (MATs) rule, additional emission control equipment will be required by 2015. The estimated costs include:



Estimated Emissions Control Costs:	Navajo		Four Corners		Springerville
	Millions of Dollars
Capital Expenditures - Mercury Emissions Control	$	1	$	1	$	5
Annual O&M Expenses	1		1		3

TEP expects Sundt and San Juan's current emission controls to be adequate to comply with the EPA's final standards.

Regional Haze Rules

The EPA's Regional Haze Rules require emission controls known as BART for certain industrial facilities emitting air pollutants that reduce visibility in national parks and wilderness areas. The rules call for all states to establish goals and emission reduction strategies for improving visibility. States must submit these goals and strategies to the EPA for approval. Because Navajo and Four Corners are located on the Navajo Indian Reservation, they are not subject to state oversight; the EPA oversees regional haze planning for these power plants.

In the western U.S., Regional Haze BART determinations have focused on controls for NOx, often resulting in a requirement to install SCRs. Complying with the EPA’s BART rules, and with other future environmental rules, may make it economically impractical to continue operating the Navajo, San Juan, and Four Corners power plants or for individual owners to continue to participate in these power plants. TEP cannot predict the ultimate outcome of these matters.

TEP's estimated potential costs involved in meeting these rules are:



Estimated Potential Emissions Control Costs:	Navajo⁽¹⁾		San Juan ⁽²⁾	Four Corners⁽³⁾		Sundt⁽⁴⁾
	Millions of Dollars
Capital - SCR	$	42	$ 180-200	$	35	$	—
Capital - SNCR	—		35	—		12
Annual O&M - SCR	1		6	2		—
Annual O&M - SNCR	—		1	—		5-6

⁽¹⁾

The EPA is considering a better-than-BART plan wherein: one unit at Navajo will be shut down by 2020; SCR installation (or the equivalent) will be installed on the remaining two units by 2030; and conventional coal-fired generation will cease by December 2044. TEP expects the EPA to reach a decision in 2014. In addition, the installation of SCR technology could increase particulates which may require that baghouses be installed. The additional capital cost of baghouses approximates $43 million with O&M on the baghouses expected to be less than $1 million per year.

⁽²⁾

The Federal Implementation Plan (FIP) requires SCR; as part of a proposal for an alternative, PNM, the State of New Mexico, and the EPA signed a non-binding agreement in which PNM agreed to close Units 2 & 3 by December 31, 2017 and install SNCRs on Units 1 & 4 by January 2016 or later. The State of New Mexico has submitted this plan to the EPA for approval. TEP expects the EPA will reach a decision in 2014. TEP owns 50% of San Juan Unit 2. At December 31, 2013, the net book value of TEP's share in San Juan Unit 2 was $113 million. If Unit 2 is retired early, we expect to request ACC approval to recover, over a reasonable time period, all costs associated with the early closure of the unit.


⁽³⁾	On December 30, 2013, APS, on behalf of the co-owners of Four Corners, notified the EPA that they have chosen the alternative BART compliance strategy; APS closed Units 1, 2, and 3 in December 2013 and has agreed to the installation of SCR on Units 4 & 5 by July 31, 2018. TEP owns 7% of Four Corners Units 4 and 5.

⁽⁴⁾ In January 2014, the EPA issued a proposal that would require TEP to either (i) install SNCR by mid-2017 or (ii) eliminate the use of coal by the end of 2017 as a better-than-BART alternative. Under the proposal, TEP would be required to notify the EPA of its decision by July 31, 2015. The EPA is expected to issue a final BART determination by July 2014. At December 31, 2013, the net book value of the Sundt coal handling facilities was $27 million. If the coal handling facilities are retired early, we expect to request ACC approval to recover, over a reasonable time period, all the remaining costs of the coal handling facilities.

BART provisions of Regional Haze Rules requiring emission control upgrades do not apply to Springerville because the plant was built after the BART-applicable dates.