Commitments and Contingencies

9 Months Ended

Sep. 30, 2011

Commitments and Contingencies

Commitments and Contingencies

10. Commitments and Contingencies

Palo Verde Nuclear Generating Station

Spent Nuclear Fuel and Waste Disposal

APS currently estimates it will incur $122 million (in 2011 dollars) over the current life of Palo Verde for its share of the costs related to the on-site interim storage of spent nuclear fuel.  At September 30, 2011, APS had a regulatory liability of $48 million that represents amounts recovered in retail rates in excess of amounts spent for on-site interim spent fuel storage.

Nuclear Insurance

The Palo Verde participants are insured against public liability for a nuclear incident up to $12.6 billion per occurrence.  As required by the Price Anderson Nuclear Industries Indemnity Act, Palo Verde maintains the maximum available nuclear liability insurance in the amount of $375 million, which is provided by commercial insurance carriers.  The remaining balance of $12.2 billion is provided through a mandatory industry wide retrospective assessment program.  If losses at any nuclear power plant covered by the program exceed the accumulated funds, APS could be assessed retrospective premium adjustments.  The maximum assessment per reactor under the program for each nuclear incident is approximately $118 million, subject to an annual limit of $18 million per incident, to be periodically adjusted for inflation.  Based on APS’s interest in the three Palo Verde units, APS’s maximum potential assessment per incident for all three units is approximately $103 million, with an annual payment limitation of approximately $15 million.

The Palo Verde participants maintain “all risk” (including nuclear hazards) insurance for property damage to, and decontamination of, property at Palo Verde in the aggregate amount of $2.75 billion, a substantial portion of which must first be applied to stabilization and decontamination.  APS has also secured insurance against portions of any increased cost of generation or purchased power and business interruption resulting from a sudden and unforeseen accidental outage of any of the three units.  The property damage, decontamination, and replacement power coverages are provided by Nuclear Electric Insurance Limited (“NEIL”).  APS is subject to retrospective assessments under all NEIL policies if NEIL’s losses in any policy year exceed accumulated funds.  The maximum amount APS could incur under the current NEIL policies totals approximately $18 million for each retrospective assessment declared by NEIL’s Board of Directors due to losses.  In addition, NEIL policies contain rating triggers that would result in APS providing approximately $46 million of collateral assurance within 20 business days of a rating downgrade to non-investment grade.  The insurance coverage discussed in this and the previous paragraph is subject to certain policy conditions and exclusions.

Contractual Obligations

As of September 30, 2011, certain contractual obligations have increased approximately $0.75 billion from December 31, 2010 as discussed in the 2010 Form 10-K.  The updated contractual obligations are as follows (dollars in billions):

Year	2011		2012		2013		2014		2015		Thereafter		Total
Purchase obligations (a)	$	—	$	—	$	0.10	$	—	$	—	$	0.15	$	0.25
Fuel and purchased power commitments	0.20		—		0.05		—		—		—		0.25
Renewable energy credits	—		—		—		—		—		0.25		0.25

(a) Payments for the transmission rights-of-way are subject to change based on changes in the Consumer Price Index.

FERC Market Issues

On July 25, 2001, the FERC ordered an evidentiary proceeding to discuss and evaluate possible refunds for wholesale sales in the Pacific Northwest.  The FERC affirmed the administrative law judge’s conclusion that the prices in the Pacific Northwest were not unreasonable or unjust and refunds should not be ordered in this proceeding.  This decision was appealed to the U.S. Court of Appeals for the Ninth Circuit and ultimately remanded to the FERC for further consideration.  On October 3, 2011, the FERC ordered an evidentiary, trial-type hearing before an administrative law judge to address possible activity that may have influenced prices in the Pacific Northwest spot market during the period from December 25, 2000 through June 20, 2001.  FERC rejected a market-wide remedy approach and instead directed that buyers seeking refunds must demonstrate that a particular seller engaged in unlawful market activity in the spot market and that such unlawful activity directly affected the particular contract or contracts to which the seller was a party.

This hearing has been held in abeyance to provide an opportunity for the parties to engage in settlement negotiations.  Although the FERC has not yet determined whether any refunds will ultimately be required, we do not expect that the resolution of these issues will have a material adverse impact on our financial position, results of operations or cash flows.

Superfund

The Comprehensive Environmental Response, Compensation and Liability Act (“Superfund”) establishes liability for the cleanup of hazardous substances found contaminating the soil, water or air.  Those who generated, transported or disposed of hazardous substances at a contaminated site are among those who are potentially responsible parties (“PRPs”).  PRPs may be strictly, and often are jointly and severally, liable for clean-up.  On September 3, 2003, the United States Environmental Protection Agency (“EPA”) advised APS that the EPA considers APS to be a PRP in the Motorola 52nd Street Superfund Site, Operable Unit 3 (OU3) in Phoenix, Arizona.  APS has facilities that are within this Superfund site.  APS and Pinnacle West have agreed with the EPA to perform certain investigative activities of the APS facilities within OU3.  In addition, on September 23, 2009, APS agreed with the EPA and one other PRP to voluntarily assist with the funding and management of the site-wide groundwater remedial investigation and feasibility study work plan.  We estimate that our costs related to this investigation and study will be approximately $1 million.  We anticipate incurring additional expenditures in the future, but because the overall investigation is not complete and ultimate remediation requirements are not yet finalized, at the present time we cannot accurately estimate our total expenditures.

Southwest Power Outage

On September 8, 2011 at approximately 3:30PM, a 500 kilovolt transmission line running between the Hassayampa and North Gila substations in southwestern Arizona tripped out of service due to a fault that occurred at a switchyard operated by APS. At the time, an APS employee at the North Gila substation was performing a procedure to remove from service a capacitor bank that was believed not to be operating properly. Approximately ten minutes after the transmission line went off-line, generation and transmission resources for the Yuma area were lost, resulting in approximately 69,700 APS customers losing service.

Within the same time period that APS’s Yuma customers lost service, a series of transmission and generation disruptions occurred across the systems of several utilities that resulted in outages affecting portions of southern Arizona, southern California and northern Mexico. A total of approximately 7,900 MW of firm load and 2.8 million customers (1.6 million in the United States and 1.2 million in northern Mexico) were reported to have been affected. Service to all affected APS customers was restored by 9:15PM on September 8. Service to customers affected by the wider regional outages was restored by approximately 3:25AM on September 9.

APS has begun an internal review of the September 8 events.  In addition:

· the FERC and the North American Electric Reliability Corporation (“NERC”) are conducting a joint inquiry into the outages; and

· the California Independent System Operator Corporation (“Cal ISO”) initiated a joint task force to investigate the outages. Utilities impacted by the outages, including APS, San Diego Gas & Electric Company, Southern California Edison Company (“SCE”), Imperial Irrigation District, Western Area Power Administration and Comisión Federal de Electricidad of Mexico, have been asked to participate in the task force.

FERC and NERC stated that their inquiries will coordinate with any reviews by the Department of Energy and other federal agencies, the Cal ISO, the Western Electric Coordinating Council, and California and Arizona state regulators.

APS cannot predict the timing, results or potential impacts of any of the inquiries into the September 8 events, or any other claims that may be made as a result of the outages. If violations of NERC Reliability Standards are ultimately determined to have occurred, FERC has the legal authority to assert a possible fine of up to $1 million per violation per day that the violation is found to have been in existence.

New Source Review

On May 7, 2010, APS received a Notice of Intent to Sue from EarthJustice (the “Notice”), on behalf of several environmental organizations, related to alleged violations of the Clean Air Act at the Four Corners Power Plant (“Four Corners”). The Notice alleges New Source Review-related violations and New Source Performance Standards (“NSPS”) violations. Under the Clean Air Act, a citizens group is required to provide 60 days advance notice of its intent to file a lawsuit. Within that 60-day time period, the EPA may step in and file a lawsuit regarding the allegations. If the EPA does so, the citizens group is precluded from filing its own lawsuit, but it may still intervene in the EPA’s lawsuit, if it so desires. The 60-day period lapsed in early July 2010, and the EPA did not take any action.

On September 2, 2011, APS received a second Notice of Intent to Sue from EarthJustice (the “Second Notice”), and on October 26, 2011, APS received a Third Notice of Intent to Sue from EarthJustice (the “Third Notice”), on behalf of the same environmental organizations.  The Second Notice and Third Notice are virtually identical to the May 2010 Notice and allege violations of the New Source Review and NSPS programs.

On October 3, 2011, EarthJustice filed a lawsuit in the United States District Court for the District of New Mexico against APS and the other Four Corners participants alleging violations of the Prevention of Significant Deterioration (“PSD”) provisions of the Clean Air Act.  Among other things, the plaintiffs seek to have the court enjoin operations at Four Corners until any required PSD permits are issued and order the payment of civil penalties, including a beneficial mitigation project.  APS is evaluating the lawsuit and cannot currently predict the outcome of the case.

Financial Assurances

APS has entered into various agreements that require letters of credit for financial assurance purposes.  At September 30, 2011, approximately $44 million of letters of credit were outstanding to support existing pollution control bonds of a similar amount.  The letters of credit are available to fund the payment of principal and interest of such debt obligations.  These letters of credit expire in 2013 and 2016.  APS has also entered into letters of credit to support certain equity participants in the Palo Verde sale leaseback transactions (see Note 7 for further details on the Palo Verde sale leaseback transactions).  These letters of credit will expire in 2013, and at September 30, 2011, totaled approximately $52 million.  Additionally, APS has issued a letter of credit to support the collateral obligations under a certain natural gas tolling contract entered into with a third party.  At September 30, 2011, $10 million of letters of credit were outstanding to support this tolling contract obligation.  This letter of credit will expire in 2016.  We expect to renew expiring letters of credit in the ordinary course of business.

We enter into agreements that include indemnification provisions relating to liabilities arising from or related to certain of our agreements; most significantly, APS has agreed to indemnify the equity participants and other parties in the Palo Verde sale leaseback transactions with respect to certain tax matters.  Generally, a maximum obligation is not explicitly stated in the indemnification provisions and, therefore, the overall maximum amount of the obligation under such indemnification provisions cannot be reasonably estimated.  Based on historical experience and evaluation of the specific indemnities, we do not believe that any material loss related to such indemnification provisions is likely.

                Pinnacle West sold its investment in APSES on August 19, 2011.  Upon the closing of the sale, Pinnacle West was released from its parental guarantee and surety bond obligations related to the APSES business.  Pinnacle West has also issued parental guarantees and surety bonds for APS which were not material at September 30, 2011.