Regulatory Matters

6 Months Ended

Jun. 30, 2011

NOTE 2. REGULATORY MATTERS

ACCOUNTING FOR RATE REGULATION

The Arizona Corporation Commission (ACC) and the Federal Energy Regulatory Commission (FERC) each regulate portions of the utility accounting practices and rates used by TEP, UNS Gas, and UNS Electric. The ACC regulates rates charged to retail customers, siting of generation and transmission facilities, the issuance of securities, and transactions with affiliated parties. The FERC regulates terms and prices of transmission services and wholesale electricity sales.

PURCHASED POWER AND FUEL ADJUSTMENT CLAUSE (PPFAC) AND PURCHASED GAS ADJUSTMENT (PGA) MECHANISM

TEP’s and UNS Electric’s retail rates include a PPFAC. The PPFAC allows recovery of fuel and purchased power costs, including demand charges, transmission costs, and the prudent costs of contracts for hedging fuel and purchased power. UNS Gas’ retail rates include a PGA mechanism that allows UNS Gas to recover its actual commodity costs, including transportation, through a price adjustor on a per Therm basis. For each utility, the cumulative difference between its actual costs and those recovered through the PPFAC/PGA are tracked through the PPFAC/PGA Bank, a balancing account. The PPFAC balances factor into the formulas used to determine the PPFAC rates for TEP and UNS Electric, which are reset annually by the ACC each April and June, respectively. UNS Gas’ PGA mechanism is adjusted monthly based on a formula that reflects actual commodity costs over the previous 12 months. UNS Gas is required to request ACC approval of a surcredit if the PGA Bank balance reflects an over-collection of $10 million or more on a billed basis. UNS Gas is also authorized to request ACC approval of a surcharge if its PGA Bank reflects an under-collected balance.

The table below summarizes TEP’s and UNS Electric’s PPFAC surcharge (surcredit) in cents per kWh and UNS Gas’ PGA surcredit in cents per Therm:


	2011									2010
	June			April-May			First Quarter			June			April-May			First Quarter
TEP
PPFAC		0.53			0.53			0.09			0.09			0.09			0.18
CTC		(0.53	)		(0.53	)		(0.09	)		(0.09	)		(0.09	)		(0.18	)

Total PPFAC Rate		—			—			—			—			—			—
UNS Electric		(0.88	)		0.08			0.08			(0.28	)		(1.06	)		(1.06	)
UNS Gas		—			—			—			(8.00	)		(8.00	)		(8.00	)

TEP

TEP offsets the PPFAC surcharge with Competition Transition Charge (CTC) revenue to be refunded, resulting in a PPFAC rate of zero to customers. After the CTC revenue is fully refunded, which is expected to occur later this year, the PPFAC bank balance could increase until a new PPFAC rate is effective in April 2012.

The following table shows the changes in TEP’s PPFAC-related accounts and the impacts on revenue and expense:


	At June 30,			At December			Six Months Ended
	2011			31, 2010			June 30, 2011
									Reduction to
									Fuel and
									Purchased
							Increase to		Power
	Asset (Liability)						Revenue		Expense
	-Millions of Dollars-
PPFAC — Fixed CTC Revenue to be Refunded (current and non-current)	$	(21	)	$	(36	)	$	15

PPFAC (current and non-current)		66			58				$	8

For the three months ended June 30, 2011, there was a $13 million increase to revenue and a $2 million increase to fuel and purchased power expense.

UNS GAS RATE CASE

In April 2011, UNS Gas filed a general rate case (on a cost-of-service basis) with the ACC requesting a rate increase of 3.8% to cover a revenue deficiency of $5.6 million, and requesting a change in depreciation rates that, if approved, is expected to reduce annual depreciation expense by $1 million. In addition, the filing proposed to change UNS Gas’ rate design by separating the recovery of fixed costs from the level of energy consumed. The change in rate design aims to provide adequate revenue recovery for declining sales due to the implementation of the state’s energy efficiency standard.

UNS ELECTRIC PURCHASE OF BMGS

As part of its September 2010 UNS Electric rate order, the ACC approved UNS Electric’s purchase of BMGS from UED at book value, subject to FERC approval and other conditions. In June 2011, UNS Electric received FERC approval of its purchase of BMGS from UED. On July 1, 2011, UNS Electric completed the purchase of BMGS for $63 million. As of July 1, 2011, BMGS is included in UNS Electric’s rates through a revenue-neutral rate reclassification of approximately 0.7 cents per kWh from base power supply rate to non-fuel base rates.