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Derivative Accounting
 9 Months Ended
Sep. 30, 2018
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative Accounting Derivative Accounting
 
Derivative financial instruments are used to manage exposure to commodity price and transportation costs of electricity, natural gas, coal and emissions allowances, and in interest rates.  Risks associated with market volatility are managed by utilizing various physical and financial derivative instruments, including futures, forwards, options and swaps.  As part of our overall risk management program, we may use derivative instruments to hedge purchases and sales of electricity and fuels.  Derivative instruments that meet certain hedge accounting criteria may be designated as cash flow hedges and are used to limit our exposure to cash flow variability on forecasted transactions.  The changes in market value of such instruments have a high correlation to price changes in the hedged transactions.  Derivative instruments are also entered into for economic hedging purposes.  While economic hedges may mitigate exposure to fluctuations in commodity prices, these instruments have not been designated as accounting hedges.  Contracts that have the same terms (quantities, delivery points and delivery periods) and for which power does not flow are netted, which reduces both revenues and fuel and purchased power costs in our Condensed Consolidated Statements of Income, but does not impact our financial condition, net income or cash flows.
 
Our derivative instruments, excluding those qualifying for a scope exception, are recorded on the balance sheets as an asset or liability and are measured at fair value.  See Note 11 for a discussion of fair value measurements.  Derivative instruments may qualify for the normal purchases and normal sales scope exception if they require physical delivery and the quantities represent those transacted in the normal course of business.  Derivative instruments qualifying for the normal purchases and sales scope exception are accounted for under the accrual method of accounting and excluded from our derivative instrument discussion and disclosures below.
 
For its regulated operations, APS defers for future rate treatment 100% of the unrealized gains and losses on derivatives pursuant to the PSA mechanism that would otherwise be recognized in income.  Realized gains and losses on derivatives are deferred in accordance with the PSA to the extent the amounts are above or below the Base Fuel Rate (see Note 4).  Gains and losses from derivatives in the following tables represent the amounts reflected in income before the effect of PSA deferrals.
 
As of September 30, 2018 and December 31, 2017, we had the following outstanding gross notional volume of derivatives, which represent both purchases and sales (does not reflect net position): 
 
 
 
Quantity
Commodity
 
Unit of Measure
September 30, 2018
 
December 31, 2017
Power
 
GWh
287

 
583

Gas
 
Billion cubic feet
192

 
240


 
Gains and Losses from Derivative Instruments
 
The following table provides information about gains and losses from derivative instruments in designated cash flow accounting hedging relationships during the three and nine months ended September 30, 2018 and 2017 (dollars in thousands):
 
 
 
Financial Statement Location
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
Commodity Contracts
 
 
2018
 
2017
 
2018
 
2017
Gain (Loss) Recognized in OCI on Derivative Instruments (Effective Portion)
 
OCI — derivative instruments
 
$
—

 
$
14

 
$
—

 
$
(70
)
Loss Reclassified from Accumulated OCI into Income (Effective Portion Realized) (a)
 
Fuel and purchased power (b)
 
(600
)
 
(1,148
)
 
(1,697
)
 
(2,910
)

(a)
During the three and nine months ended September 30, 2018 and 2017, we had no gains or losses reclassified from accumulated OCI to earnings due to the discontinuance of cash flow hedges where the forecasted transaction is not probable of occurring.
(b)
Amounts are before the effect of PSA deferrals.
 
During the next twelve months, we estimate that a net loss of $2 million before income taxes will be reclassified from accumulated OCI as an offset to the effect of market price changes for the related hedged transactions.  In accordance with the PSA, these amounts will be recorded as either a regulatory asset or liability and have no immediate effect on earnings.

The following table provides information about gains and losses from derivative instruments not designated as accounting hedging instruments during the three and nine months ended September 30, 2018 and 2017 (dollars in thousands):
 
 
 
Financial Statement Location
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
Commodity Contracts
 
 
2018
 
2017
 
2018
 
2017
Net Loss Recognized in Income
 
Operating revenues
 
$
(1,029
)
 
$
(128
)
 
$
(2,590
)
 
$
(474
)
Net Gain (Loss) Recognized in Income
 
Fuel and purchased power (a)
 
4,263

 
(6,100
)
 
(26,442
)
 
(64,143
)
Total
 
 
 
$
3,234

 
$
(6,228
)
 
$
(29,032
)
 
$
(64,617
)

(a)
Amounts are before the effect of PSA deferrals.
 
Derivative Instruments in the Condensed Consolidated Balance Sheets
 
Our derivative transactions are typically executed under standardized or customized agreements, which include collateral requirements and, in the event of a default, would allow for the netting of positive and negative exposures associated with a single counterparty.  Agreements that allow for the offsetting of positive and negative exposures associated with a single counterparty are considered master netting arrangements.  Transactions with counterparties that have master netting arrangements are offset and reported net on the
Condensed Consolidated Balance Sheets.  Transactions that do not allow for offsetting of positive and negative positions are reported gross on the Condensed Consolidated Balance Sheets.
 
We do not offset a counterparty’s current derivative contracts with the counterparty’s non-current derivative contracts, although our master netting arrangements would allow current and non-current positions to be offset in the event of a default.  Additionally, in the event of a default, our master netting arrangements would allow for the offsetting of all transactions executed under the master netting arrangement.  These types of transactions may include non-derivative instruments, derivatives qualifying for scope exceptions, trade receivables and trade payables arising from settled positions, and other forms of non-cash collateral (such as letters of credit).  These types of transactions are excluded from the offsetting tables presented below.
 
The following tables provide information about the fair value of our risk management activities reported on a gross basis, and the impacts of offsetting as of September 30, 2018 and December 31, 2017.  These amounts relate to commodity contracts and are located in the assets and liabilities from risk management activities lines of our Condensed Consolidated Balance Sheets.

As of September 30, 2018:
(dollars in thousands)
 
Gross
 Recognized
 Derivatives
 (a)
 
Amounts
Offset
 (b)
 
Net
 Recognized
 Derivatives
 
Other
 (c)
 
Amount Reported on Balance Sheets
Current assets
 
$
2,609

 
$
(2,273
)
 
$
336

 
$
888

 
$
1,224

Investments and other assets
 
314

 
(314
)
 
—

 
—

 
—

Total assets
 
2,923

 
(2,587
)
 
336

 
888

 
1,224

 
 
 
 
 
 
 
 
 
 
 
Current liabilities
 
(45,238
)
 
2,273

 
(42,965
)
 
(2,539
)
 
(45,504
)
Deferred credits and other
 
(34,540
)
 
314

 
(34,226
)
 
—

 
(34,226
)
Total liabilities
 
(79,778
)
 
2,587

 
(77,191
)
 
(2,539
)
 
(79,730
)
Total
 
$
(76,855
)
 
$
—

 
$
(76,855
)
 
$
(1,651
)
 
$
(78,506
)

(a)
All of our gross recognized derivative instruments were subject to master netting arrangements.
(b)
No cash collateral has been provided to counterparties, or received from counterparties, that is subject to offsetting.
(c)
Represents cash collateral and cash margin that are not subject to offsetting. Amounts relate to non-derivative instruments, derivatives qualifying for scope exceptions, or collateral and margin posted in excess of the recognized derivative instrument.  Amounts include cash collateral received from counterparties of $2,539 and cash margin provided to counterparties of $888.

As of December 31, 2017:
(dollars in thousands)
 
Gross
Recognized
Derivatives
 (a)
 
Amounts
Offset
(b)
 
Net
 Recognized
 Derivatives
 
Other
 (c)
 
Amount
Reported on
Balance Sheets
Current assets
 
$
5,427

 
$
(3,796
)
 
$
1,631

 
$
300

 
$
1,931

Investments and other assets
 
1,292

 
(1,241
)
 
51

 
—

 
51

Total assets
 
6,719

 
(5,037
)
 
1,682

 
300

 
1,982

 
 
 
 
 
 
 
 
 
 
 
Current liabilities
 
(59,527
)
 
3,796

 
(55,731
)
 
(3,521
)
 
(59,252
)
Deferred credits and other
 
(38,411
)
 
1,241

 
(37,170
)
 
—

 
(37,170
)
Total liabilities
 
(97,938
)
 
5,037

 
(92,901
)
 
(3,521
)
 
(96,422
)
Total
 
$
(91,219
)
 
$
—

 
$
(91,219
)
 
$
(3,221
)
 
$
(94,440
)

(a)
All of our gross recognized derivative instruments were subject to master netting arrangements.
(b)
No cash collateral has been provided to counterparties, or received from counterparties, that is subject to offsetting.
(c)
Represents cash collateral and cash margin that is not subject to offsetting. Amounts relate to non-derivative instruments, derivatives qualifying for scope exceptions, or collateral and margin posted in excess of the recognized derivative instrument.  Amounts include cash collateral received from counterparties of $3,521 and cash margin provided to counterparties of $300.

Credit Risk and Credit Related Contingent Features
 
We are exposed to losses in the event of nonperformance or nonpayment by counterparties and have risk management contracts with many counterparties. As of September 30, 2018, Pinnacle West has no counterparties with positive exposures of greater than 10% of risk management assets. Our risk management process assesses and monitors the financial exposure of all counterparties.  Despite the fact that the great majority of our trading counterparties' debt is rated as investment grade by the credit rating agencies, there is still a possibility that one or more of these counterparties could default, resulting in a material impact on consolidated earnings for a given period. Counterparties in the portfolio consist principally of financial institutions, major energy companies, municipalities and local distribution companies.  We maintain credit policies that we believe minimize overall credit risk to within acceptable limits.  Determination of the credit quality of our counterparties is based upon a number of factors, including credit ratings and our evaluation of their financial condition.  To manage credit risk, we employ collateral requirements and standardized agreements that allow for the netting of positive and negative exposures associated with a single counterparty.  Valuation adjustments are established representing our estimated credit losses on our overall exposure to counterparties.
 
Certain of our derivative instrument contracts contain credit-risk-related contingent features including, among other things, investment grade credit rating provisions, credit-related cross-default provisions, and adequate assurance provisions.  Adequate assurance provisions allow a counterparty with reasonable grounds for uncertainty to demand additional collateral based on subjective events and/or conditions.  For those derivative instruments in a net liability position, with investment grade credit contingencies, the counterparties could demand additional collateral if our debt credit rating were to fall below investment grade (below BBB- for Standard & Poor’s or Fitch or Baa3 for Moody’s).
 
The following table provides information about our derivative instruments that have credit-risk-related contingent features at September 30, 2018 (dollars in thousands):
 
September 30, 2018
Aggregate fair value of derivative instruments in a net liability position
$
79,778

Cash collateral posted
—

Additional cash collateral in the event credit-risk-related contingent features were fully triggered (a)
76,299


(a)
This amount is after counterparty netting and includes those contracts which qualify for scope exceptions, which are excluded from the derivative details above.
 
We also have energy-related non-derivative instrument contracts with investment grade credit-related contingent features, which could also require us to post additional collateral of approximately $94 million if our debt credit ratings were to fall below investment grade.