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FAIR VALUE MEASUREMENTS & DERIVATIVE INSTRUMENTS
 12 Months Ended
Dec. 31, 2013
Text Block [Abstract]  
FAIR VALUE MEASUREMENTS & DERIVATIVE INSTRUMENTS
FAIR VALUE MEASUREMENTS AND DERIVATIVE INSTRUMENTS
We categorize our assets and liabilities accounted for at fair value into the three-level hierarchy based on inputs used to determine the fair value. Level 1 inputs are unadjusted quoted prices for identical assets or liabilities in an active market. Level 2 inputs include quoted prices for similar assets or liabilities, quoted prices in non-active markets, and pricing models whose inputs are observable, directly or indirectly. Level 3 inputs are unobservable and supported by little or no market activity.
FINANCIAL INSTRUMENTS MEASURED AT FAIR VALUE ON A RECURRING BASIS
The following tables present, by level within the fair value hierarchy, UNS Energy’s and TEP’s assets and liabilities accounted for at fair value on a recurring basis. These assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
 
UNS Energy
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Counterparty Netting of Energy Contracts Not Offset on the Balance Sheets(5)
 
Net Amount
 
December 31, 2013
 
Millions of Dollars
Assets
 
 
 
Cash Equivalents(1)
$
14

 
$
14

 
$
—

 
$
—

 
$
—

 
$
14

Restricted Cash(1)
2

 
2

 
—

 
—

 
—

 
2

Rabbi Trust Investments(2)
22

 
—

 
22

 
—

 
—

 
22

Energy Contracts - Regulatory Recovery(3)
7

 
—

 
3

 
4

 
(5
)
 
2

Total Assets
45

 
16

 
25

 
4

 
(5
)
 
40

Liabilities
 
 
 
 
 
 
 
 
 
 
 
Energy Contracts - Regulatory Recovery(3)
(7
)
 
—

 
(2
)
 
(5
)
 
5

 
(2
)
Energy Contracts - Cash Flow Hedge(3)
(1
)
 
—

 
—

 
(1
)
 
—

 
(1
)
Interest Rate Swaps(4)
(7
)
 
—

 
(7
)
 
—

 
—

 
(7
)
Total Liabilities
(15
)
 
—

 
(9
)
 
(6
)
 
5

 
(10
)
Net Total Assets (Liabilities)
$
30

 
$
16

 
$
16

 
$
(2
)
 
$
—

 
$
30

 
UNS Energy
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Counterparty Netting of Energy Contracts Not Offset on the Balance Sheets(5)
 
Net Amount
 
December 31, 2012
 
Millions of Dollars
Assets
 
 
 
Cash Equivalents(1)
$
20

 
$
20

 
$
—

 
$
—

 
$
—

 
$
20

Restricted Cash(1)
7

 
7

 
—

 
—

 
—

 
7

Rabbi Trust Investments(2)
19

 
—

 
19

 
—

 
—

 
19

Energy Contracts - Regulatory Recovery(3)
7

 
—

 
2

 
5

 
(5
)
 
2

Total Assets
53

 
27

 
21

 
5

 
(5
)
 
48

Liabilities
 
 
 
 
 
 
 
 
 
 
 
Energy Contracts - Regulatory Recovery(3)
(15
)
 
—

 
(7
)
 
(8
)
 
5

 
(10
)
Energy Contracts - Cash Flow Hedge(3)
(2
)
 
—

 
—

 
(2
)
 
—

 
(2
)
Interest Rate Swaps(4)
(10
)
 
—

 
(10
)
 
—

 
—

 
(10
)
Total Liabilities
(27
)
 
—

 
(17
)
 
(10
)
 
5

 
(22
)
Net Total Assets (Liabilities)
$
26

 
$
27

 
$
4

 
$
(5
)
 
$
—

 
$
26

 
TEP
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Counterparty Netting of Energy Contracts Not Offset on the Balance Sheets(5)
 
Net Amount
 
December 31, 2013
 
Millions of Dollars
Assets
 
 
 
Cash Equivalents(1)
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

Restricted Cash(1)
2

 
2

 
—

 
—

 
—

 
2

Rabbi Trust Investments(2)
22

 
—

 
22

 
—

 
—

 
22

Energy Contracts - Regulatory Recovery(3)
2

 
—

 
1

 
1

 
(1
)
 
1

Total Assets
26

 
2

 
23

 
1

 
(1
)
 
25

Liabilities
 
 
 
 
 
 
 
 
 
 
 
Energy Contracts - Regulatory Recovery(3)
(2
)
 
—

 
—

 
(2
)
 
1

 
(1
)
Energy Contracts - Cash Flow Hedge(3)
(1
)
 
—

 
—

 
(1
)
 
—

 
(1
)
Interest Rate Swaps(4)
(7
)
 
—

 
(7
)
 
—

 
—

 
(7
)
Total Liabilities
(10
)
 
—

 
(7
)
 
(3
)
 
1

 
(9
)
Net Total Assets (Liabilities)
$
16

 
$
2

 
$
16

 
$
(2
)
 
$
—

 
$
16

 
TEP
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Counterparty Netting of Energy Contracts Not Offset on the Balance Sheets(5)
 
Net Amount
 
December 31, 2012
 
Millions of Dollars
Assets
 
 
 
Cash Equivalents(1)
$
1

 
$
1

 
$
—

 
$
—

 
$
—

 
$
1

Restricted Cash(1)
7

 
7

 
—

 
—

 
—

 
7

Rabbi Trust Investments(2)
19

 
—

 
19

 
—

 
—

 
19

Energy Contracts - Regulatory Recovery(3)
3

 
—

 
1

 
2

 
(1
)
 
2

Total Assets
30

 
8

 
20

 
2

 
(1
)
 
29

Liabilities
 
 
 
 
 
 
 
 
 
 
 
Energy Contracts - Regulatory Recovery(3)
(3
)
 
—

 
(3
)
 
—

 
1

 
(2
)
Energy Contracts - Cash Flow Hedge(3)
(2
)
 
—

 
—

 
(2
)
 
—

 
(2
)
Interest Rate Swaps(4)
(10
)
 
—

 
(10
)
 
—

 
—

 
(10
)
Total Liabilities
(15
)
 
—

 
(13
)
 
(2
)
 
1

 
(14
)
Net Total Assets (Liabilities)
$
15

 
$
8

 
$
7

 
$
—

 
$
—

 
$
15

(1) 
Cash Equivalents and Restricted Cash represent amounts held in money market funds and certificates of deposit valued at cost, including interest. Cash Equivalents are included in Cash and Cash Equivalents on the balance sheets. Restricted Cash is included in Investments and Other Property – Other on the balance sheets.
(2) 
Rabbi Trust Investments include amounts related to deferred compensation and Supplement Executive Retirement Plan (SERP) benefits held in mutual and money market funds valued at quoted prices traded in active markets. These investments are included in Investments and Other Property – Other on the balance sheets.
(3) 
Energy Contracts include gas swap agreements (Level 2), power options (Level 2 or Level 3), gas options (Level 3), forward power purchase and sales contracts (Level 3), and forward power purchase contracts indexed to gas (Level 3), entered into to reduce exposure to energy price risk. These contracts are included in Derivative Instruments on the UNS Energy and TEP balance sheets. The valuation techniques are described below.
(4)
Interest Rate Swaps are valued based on the 3-month or 6-month LIBOR index or the Securities Industry and Financial Markets Association municipal swap index. These interest rate swaps are included in Derivative Instruments on the balance sheets.
(5) 
All energy contracts are subject to legally enforceable master netting arrangements to mitigate credit risk. We have presented the effect of offset by counterparty; however, we present derivatives on a gross basis on the balance sheets.
DERIVATIVE INSTRUMENTS
We primarily apply the market approach for recurring fair value measurements. When we have observable inputs for substantially the full term of the asset or liability or use quoted prices in an inactive market, we categorize the instrument in Level 2. We categorize derivatives in Level 3 when we use an aggregate pricing service or published prices that represent a consensus reporting of multiple brokers.
For both power and gas prices we obtain quotes from brokers, major market participants, exchanges, or industry publications and rely on our own price experience from active transactions in the market. We primarily use one set of quotations each for power and for gas and then validate those prices using other sources. We believe that the market information provided is reflective of market conditions as of the time and date indicated.
Published prices for energy derivative contracts may not be available due to the nature of contract delivery terms such as non-standard time blocks and non-standard delivery points. In these cases, we apply adjustments based on historical price curve relationships, transmission, and line losses.
We estimate the fair value of our gas options using a Black-Scholes-Merton option pricing model which includes inputs such as implied volatility, interest rates, and forward price curves. Beginning in the third quarter of 2013, the fair value of our power options is based on contractually specified option premiums instead of the Black-Scholes-Merton option pricing model because the needed inputs are no longer available. Based on the change, we transferred the power options out of Level 3 and in to Level 2 at the end of third quarter of 2013. The amount transferred was less than $0.5 million. We record transfers between levels in the fair value hierarchy at the end of the reporting period. There were no other transfers between levels in the periods presented.
We also consider the impact of counterparty credit risk using current and historical default and recovery rates, as well as our own credit risk using credit default swap data.
Our assessments of the significance of a particular input to the fair value measurements require judgment and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels. We review the assumptions underlying our contracts monthly.
Cash Flow Hedges
The interest rate swap agreements expire through January 2020. The power purchase swap agreement expires in September 2015. The after-tax unrealized gains and losses on cash flow hedge activities and amounts reclassified to earnings are reported in the statements of other comprehensive income and Note 16. The loss expected to be reclassified to earnings within the next twelve months is estimated to be $4 million.
Financial Impact of Energy Contracts
We record unrealized gains and losses on energy contracts that are recoverable through the PPFAC or PGA on the balance sheets as a regulatory asset or a regulatory liability rather than reporting the transaction in the income statements or in the statements of other comprehensive income, as shown in following tables:
 
UNS Energy
 
TEP
 
Years Ended December 31,
 
2013
 
2012
 
2011
 
2013
 
2012
 
2011
 
Millions of Dollars
Increase (Decrease) to Regulatory Assets/Liabilities
$
(9
)
 
$
(21
)
 
$
2

 
$
—

 
$
(6
)
 
$
2


Realized gains and losses on settled contracts are fully recoverable through the PPFAC or PGA. At December 31, 2013, UNS Energy and TEP have energy contracts that will settle through the fourth quarter of 2016.
Derivative Volumes
The volumes associated with our energy contracts were as follows:
 
UNS Energy
 
TEP
 
December 31, 2013
 
December 31, 2012
 
December 31, 2013
 
December 31, 2012
Power Contracts GWh
1,583

 
2,228

 
779

 
820

Gas Contracts GBtu
33,371

 
17,851

 
9,615

 
7,958


Level 3 Fair Value Measurements
The following table provides quantitative information regarding significant unobservable inputs in UNS Energy’s Level 3 fair value measurements:
 
 
 
Fair Value at 
 
 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
Range of
 
Valuation Approach
 
Assets
 
Liabilities
 
Unobservable Inputs
 
Unobservable Input
 
 
 
Millions of Dollars
 
 
 
 
 
 
Forward Contracts(1)
Market approach
 
$
1

 
$
(4
)
 
Market price per MWh
 
$
26.54

-
$
51.75


 
 
 
 
 
 
 
 
 
 
 
Option Contracts(2)
Option model
 
3

 
(2
)
 
Market Price per MMbtu
 
$
3.87

-
$
4.32


 
 
 
 
 
 
Gas Volatility
 
25.05
%
-
35.07
%
Level 3 Energy Contracts
 
 
$
4

 
$
(6
)
 
 
 
 
 
 
 
(1) 
TEP comprises $1 million of the forward contract assets and $3 million of the forward contract liabilities.
(2) 
TEP comprises less than $1 million of the option contract assets.
Our exposure to risk resulting from changes in the unobservable inputs identified above is mitigated as we report the change in fair value of energy contract derivatives as a regulatory asset or a regulatory liability recoverable through the PPFAC or PGA mechanisms, or as a component of other comprehensive income, rather than in the income statement.
The following tables present a reconciliation of changes in the fair value of assets and liabilities classified as Level 3 in the fair value hierarchy:
 
UNS Energy
 
TEP
 
Millions of Dollars
Balances at December 31, 2012
$
(5
)
 
$
—

Realized/Unrealized Gains/(Losses) Recorded to:
 
 
 
Net Regulatory Assets/Liabilities – Derivative Instruments
(1
)
 
(2
)
Settlements
4

 
—

Balances at December 31, 2013
$
(2
)
 
$
(2
)
 
 
 
 
Total Gains/(Losses) Attributable to the Change in Unrealized Gains/(Losses) Relating to Assets/Liabilities Still Held at the End of the Period
$
(1
)
 
$
(1
)
 
UNS Energy
 
TEP
 
Millions of Dollars
Balances at December 31, 2011
$
(10
)
 
$
—

Realized/Unrealized Gains/(Losses) Recorded to:
 
 
 
Net Regulatory Assets/Liabilities – Derivative Instruments
(5
)
 
1

Settlements
10

 
(1
)
Balances at December 31, 2012
$
(5
)
 
$
—

 
 
 
 
Total Gains/(Losses) Attributable to the Change in Unrealized Gains/(Losses) Relating to Assets/Liabilities Still Held at the End of the Period
$
(1
)
 
$
—


CREDIT RISK
The use of contractual arrangements to manage the risks associated with changes in energy commodity prices creates credit risk exposure resulting from the possibility of non-performance by counterparties pursuant to the terms of their contractual obligations. We enter into contracts for the physical delivery of energy and gas which contain remedies in the event of non-performance by the supply counterparties. In addition, volatile energy prices can create significant credit exposure from energy market receivables and subsequent measurement at fair value.
We have contractual agreements for energy procurement and hedging activities that contain certain provisions requiring each company to post collateral under certain circumstances. These circumstances include: exposures in excess of unsecured credit limits provided to TEP, UNS Electric, or UNS Gas; credit rating downgrades; or a failure to meet certain financial ratios. In the event that such credit events were to occur, we would have to provide certain credit enhancements in the form of cash or LOCs to fully collateralize our exposure to these counterparties.
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. 
Material adverse changes could trigger credit risk-related contingent features. At December 31, 2013, the fair value of derivative instruments in a net liability position under contracts with credit risk-related contingent features was $21 million for UNS Energy and $5 million for TEP. The additional collateral to be posted if credit-risk contingent features were triggered would be $21 million for UNS Energy and $5 million for TEP.
FINANCIAL INSTRUMENTS NOT CARRIED AT FAIR VALUE
The fair value of a financial instrument is the market price to sell an asset or transfer a liability at the measurement date. We use the following methods and assumptions for estimating the fair value of our financial instruments:
•
The carrying amounts of our current assets, current liabilities, including current maturities of long-term debt, and amounts outstanding under our credit agreements approximate the fair values due to the short-term nature of these financial instruments. These items have been excluded from the table below.
•
For Investment in Lease Debt, we calculated the present value of remaining cash flows using current market rates for instruments with similar characteristics such as credit rating and time-to-maturity. We also incorporated the impact of counterparty credit risk using market credit default swap data. TEP's Investment in Lease Debt matured in January 2013.
•
For Investment in Lease Equity, we estimate the price at which an investor would realize a target internal rate of return. Our estimates include: the mix of debt and equity an investor would use to finance the purchase; the cost of debt; the required return on equity; and income tax rates. The estimate assumes a residual value based on an appraisal of Springerville Unit 1 conducted in 2011.
•
For Long-Term Debt, we use quoted market prices, when available, or calculate the present value of remaining cash flows at the balance sheet date. When calculating present value, we use current market rates for bonds with similar characteristics such as credit rating and time-to-maturity. We consider the principal amounts of variable rate debt outstanding to be reasonable estimates of the fair value. We also incorporate the impact of our own credit risk using a credit default swap rate.
The use of different estimation methods and/or market assumptions may yield different estimated fair value amounts. The carrying values recorded on the balance sheets and the estimated fair values of our financial instruments include the following:
 
 
 
December 31, 2013
 
December 31, 2012
 
Fair Value
Hierarchy
 
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
 
 
 
Millions of Dollars
Assets:
 
 
 
 
 
 
 
 
 
TEP Investment in Lease Debt
Level 2
 
$
—

 
$
—

 
$
9

 
$
9

TEP Investment in Lease Equity
Level 3
 
36

 
25

 
36

 
23

Liabilities:
 
 
 
 
 
 
 
 
 
Long-Term Debt
 
 
 
 
 
 
 
 
 
UNS Energy
Level 2
 
1,507

 
1,521

 
1,498

 
1,583

TEP
Level 2
 
1,223

 
1,214

 
1,223

 
1,271