Leases

9 Months Ended

Sep. 30, 2021

We lease certain land, buildings, vehicles, equipment and other property through operating rental agreements with varying terms, provisions, and expiration dates. APS also has certain purchased power agreements that qualify as lease arrangements. Our leases have remaining terms that expire in 2021 through 2050. Substantially all of our leasing activities relate to APS.

In 1986, APS entered into agreements with three separate lessor trust entities in order to sell and lease back interests in Palo Verde Unit 2 and related common facilities. These lessor trust entities have been deemed VIEs for which APS is the primary beneficiary. As the primary beneficiary, APS consolidated these lessor trust entities. The impacts of these sale leaseback transactions are excluded from our lease disclosures as lease accounting is eliminated upon consolidation. See Note 6 for a discussion of VIEs.

On May 1, 2021, APS had a new purchased power lease contract that commenced. The lease term ends on October 31, 2027. This lease allows APS the right to the generation capacity from a natural-gas fueled generator during the months of May through October over the contract term. APS does not operate or maintain the leased asset. APS controls the dispatch of the leased asset during the months of May through October and is required to pay a fixed monthly capacity payment during these periods of use. For these types of leased assets APS has elected to combine both the lease and non-lease payment components and accounts for the entire fixed payment as a lease obligation. This purchased power lease contract is

accounted for as an operating lease. The contract does not contain a purchase option or a term extension option. In addition to the fixed monthly capacity payment, APS must also pay variable charges based on the actual production volume of the asset. The variable consideration is not included in the measurement of our lease obligation.

The following tables provide information related to our lease costs (dollars in thousands):


	Three Months Ended September 30, 2021						Three Months Ended September 30, 2020
	Purchased Power Lease Contracts		Land, Property & Equipment Leases		Total		Purchased Power Lease Contracts		Land, Property & Equipment Leases		Total
Operating lease cost	$	70,102	$	4,626	$	74,728	$	51,662	$	4,655	$	56,317
Variable lease cost	37,586		224		37,810		40,658		232		40,890
Short-term lease cost	—		902		902		—		1,038		1,038
Total lease cost	$	107,688	$	5,752	$	113,440	$	92,320	$	5,925	$	98,245


	Nine Months Ended September 30, 2021						Nine Months Ended September 30, 2020
	Purchased Power Lease Contracts		Land, Property & Equipment Leases		Total		Purchased Power Lease Contracts		Land, Property & Equipment Leases		Total
Operating lease cost	$	99,616	$	13,865	$	113,481	$	68,883	$	13,959	$	82,842
Variable lease cost	99,613		734		100,347		102,052		730		102,782
Short-term lease cost	—		3,151		3,151		—		2,824		2,824
Total lease cost	$	199,229	$	17,750	$	216,979	$	170,935	$	17,513	$	188,448

Lease costs are primarily included as a component of operating expenses on our Condensed Consolidated Statements of Income. Lease costs relating to purchased power lease contracts are recorded in fuel and purchased power on the Condensed Consolidated Statements of Income, and are subject to recovery under the PSA or RES (see Note 4). The tables above reflect the lease cost amounts before the effect of regulatory deferral under the PSA and RES. Variable lease costs are recognized in the period the costs are incurred, and primarily relate to renewable purchased power lease contracts. Payments under most renewable purchased power lease contracts are dependent upon environmental factors, and due to the inherent uncertainty associated with the reliability of the fuel source, the payments are considered variable and are excluded from the measurement of lease liabilities and right-of-use lease assets. Certain of our lease agreements have lease terms with non-consecutive periods of use. For these agreements, we recognize lease costs during the periods of use. Leases with initial terms of 12 months or less are considered short-term leases and are not recorded on the balance sheet.

The following table provides information related to the maturity of our operating lease liabilities (dollars in thousands):


	September 30, 2021
Year	Purchased Power Lease Contracts		Land, Property & Equipment Leases		Total
2021 (remaining three months of 2021)	$	28,240	$	3,311	$	31,551
2022	103,744		12,323		116,067
2023	106,161		9,995		116,156
2024	108,634		7,373		116,007
2025	111,166		5,564		116,730
2026	75,099		4,343		79,442
Thereafter	39,106		34,912		74,018
Total lease commitments	572,150		77,821		649,971
Less imputed interest	23,721		17,325		41,046
Total lease liabilities	$	548,429	$	60,496	$	608,925

We recognize lease assets and liabilities upon lease commencement. At September 30, 2021, we have lease arrangements that have been executed, but have not yet commenced. These arrangements primarily relate to energy storage agreements, with lease commencement dates expected to begin in June 2022 with terms ending through December 2042. We expect the total fixed consideration paid for these arrangements, which includes both lease and nonlease payments, will approximate $392 million over the term of the arrangements.

The following tables provide other additional information related to operating lease liabilities (dollars in thousands):


	Nine Months Ended September 30, 2021		Nine Months Ended September 30, 2020
Cash paid for amounts included in the measurement of lease liabilities — operating cash flows:	$	85,002	$	56,896
Right-of-use operating lease assets obtained in exchange for operating lease liabilities	251,119		436,587


	September 30, 2021		December 31, 2020
Weighted average remaining lease term	6 years		6 years
Weighted average discount rate (a)	1.75	%	1.69	%

(a) Most of our lease agreements do not contain an implicit rate that is readily determinable. For these agreements we use our incremental borrowing rate to measure the present value of lease liabilities. We determine our incremental borrowing rate at lease commencement based on the rate of interest that we would have to pay to borrow, on a collateralized basis over a similar term, an amount equal to the lease payments in a similar economic environment. We use the implicit rate when it is readily determinable.