Accounting for Derivative Instruments, Trading Activities and Hedging Activities

6 Months Ended

Jun. 30, 2011

Accounting for Derivative Instruments, Trading Activities and Hedging Activities [Abstract]

ACCOUNTING FOR DERIVATIVE INSTRUMENTS, TRADING ACTIVITIES AND HEDGING ACTIVITIES

NOTE 14. ACCOUNTING FOR DERIVATIVE INSTRUMENTS, TRADING ACTIVITIES AND HEDGING ACTIVITIES

RISKS AND OVERVIEW

TEP, UNS Gas and UNS Electric are exposed to energy price risk associated with their gas and purchased power requirements, volumetric risk associated with their seasonal load, and operational risk associated with their power plants, transmission and transportation systems. TEP, UNS Gas and UNS Electric reduce their energy price risk through a variety of derivative and non-derivative instruments. The objectives for entering into such contracts include: creating price stability; ensuring the companies can meet their load and reserve requirements; and reducing exposure to price volatility that may result from delayed recovery under the PPFAC or PGA. See Note 2.

We consider the effect of counterparty credit risk in determining the fair value of derivative instruments that are in a net asset position after incorporating collateral posted by counterparties and allocate the credit risk adjustment to individual contracts. We also consider the impact of our own credit risk after considering collateral posted on instruments that are in a net liability position and allocate the credit risk adjustment to all individual contracts.

We present cash collateral and derivative assets and liabilities associated with the same counterparty separately in our financial statements, and we bifurcate all derivatives into their current and long-term portions on the balance sheet.

DERIVATIVES POLICY

There have been no significant changes to our derivative instrument or credit risk policies as described in our Annual Report on Form 10-K for the year ended December 31, 2010.

FINANCIAL IMPACT OF DERIVATIVES

Cash Flow Hedges

At June 30, 2011 and December 31, 2010, UniSource Energy and TEP had liabilities related to their cash flow hedges of $13 million and $12 million, respectively. UniSource Energy and TEP had net after-tax unrealized losses on derivative activities reported in AOCI of $1 million for the three months ended June 30, 2011 and $2 million in net after-tax unrealized gains for the three months ended June 30, 2010. UniSource Energy and TEP had net after-tax unrealized losses on derivative activities reported in AOCI of $1 million for the six months ended June 30, 2011 and $5 million in net after-tax unrealized gains for the six months ended June 30, 2010.

Regulatory Treatment of Commodity Derivatives

The following table discloses unrealized gains and losses on energy contracts that are recoverable through the PPFAC or PGA on the balance sheet as a regulatory asset or a regulatory liability rather than as a component of AOCI or in the income statement.

	UniSource Energy						TEP
				Three Months Ended June 30,
	2011			2010			2011		2010
	-Millions of Dollars-
Decrease to Regulatory Assets	$	(3	)	$	(9	)	$	—	$	(6	)

	Six Months Ended June 30,
	2011			2010		2011			2010
	-Millions of Dollars-
Increase (Decrease) to Regulatory Assets	$	(10	)	$	4	$	(2	)	$	(3	)

The fair value of assets and liabilities related to energy derivatives that will be recovered through the PPFAC or PGA were as follows:

	UniSource Energy						TEP
	June 30,			December 31,			June 30,			December 31,
	2011			2010			2011			2010
	-Millions of Dollars-
Assets	$	14		$	15		$	4		$	3
Liabilities		(31	)		(42	)		(6	)		(7	)
Net Liabilities	$	(17	)	$	(27	)	$	(2	)	$	(4	)

Realized gains and losses on settled gas swaps are fully recovered through the PPFAC or PGA. For the three months ended June 30, 2011, UniSource Energy and TEP realized losses of $3 million and $2 million, respectively and $5 million and $3 million, respectively for the three months ended June 30, 2010. For the six months ended June 30, 2011, UniSource Energy and TEP realized losses of $9 million and $2 million, respectively; and $9 million and $3 million, respectively for the six months ended June 30, 2010.

At June 30, 2011, UniSource Energy and TEP had contracts that will settle through the third quarter of 2015.

Other Commodity Derivatives

UniSource Energy and TEP record realized and unrealized gains and losses on other energy contracts on a net basis in Wholesale Sales. The settlement of forward power purchase and sales contracts that did not result in physical delivery were as follows:

	UniSource Energy and TEP
	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2011			2010			2011			2010
	-Millions of Dollars-
Recorded in Wholesale Sales:
Forward Power Sales	$	2		$	5		$	3		$	7
Forward Power Purchases		(3	)		(6	)		(4	)		(7	)
Total Sales and Purchases Not Resulting in Physical Delivery	$	(1	)	$	(1	)	$	(1	)	$	—

DERIVATIVE VOLUMES

At June 30, 2011, UniSource Energy and TEP had gas swaps totaling 19,119 GBtu and 10,098 GBtu, respectively, and power contracts totaling 4,051 GWh and 1,154 GWh, respectively, which were accounted for as derivatives. At December 31, 2010, UniSource Energy and TEP had gas swaps totaling 14,973 GBtu and 6,424 GBtu, respectively, and power contracts totaling 4,807 GWh and 1,144 GWh, respectively, which were accounted for as derivatives.

CREDIT RISK ADJUSTMENT

At June 30, 2011, and at December 31, 2010, the impact of counterparty credit risk and the impact of our own credit risk on the fair value of derivative asset contracts was less than $0.1 million.

CONCENTRATION OF CREDIT RISK

The following table shows the sum of the fair value of all derivative instruments under contracts with credit-risk related contingent features that are in a net liability position at June 30, 2011. It also shows cash collateral and letters of credit posted, and additional collateral to be posted if credit-risk related contingent features were triggered.

	UniSource Energy		TEP
	June 30, 2011
	-Millions of Dollars-
Net Liability	$	65	$	35
Cash Collateral Posted		1		1
Letters of Credit		12		1
Additional Collateral to Post if Contingent Features Triggered		58		34

As of June 30, 2011, TEP had $15 million of credit exposure to other counterparties’ creditworthiness related to its wholesale marketing and gas hedging activities, of which four counterparties individually comprised greater than 10% of the total credit exposure. At June 30, 2011, UNS Electric had $3 million related to its supply and hedging contracts, concentrated primarily with one counterparty. At June 30, 2011, UNS Gas had immaterial exposure to other counterparties’ creditworthiness.