Accounting for Derivative Instruments, Trading Activities and Hedging Activities

9 Months Ended

Sep. 30, 2011

Accounting for Derivative Instruments, Trading Activities and Hedging Activities [Abstract]

ACCOUNTING FOR DERIVATIVE INSTRUMENTS, TRADING ACTIVITIES AND HEDGING ACTIVITIES

NOTE 14. ACCOUNTING FOR DERIVATIVE INSTRUMENTS, TRADING ACTIVITIES AND HEDGING ACTIVITIES

RISKS AND OVERVIEW

TEP, UNS Gas and UNS Electric are exposed to energy price risk associated with their gas and purchased power requirements, volumetric risk associated with their seasonal load, and operational risk associated with their power plants, transmission and transportation systems. TEP, UNS Gas and UNS Electric reduce their energy price risk through a variety of derivative and non-derivative instruments. The objectives for entering into such contracts include: creating price stability; ensuring the companies can meet their load and reserve requirements; and reducing exposure to price volatility that may result from delayed recovery under the PPFAC or PGA. See Note 2.

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.

We present cash collateral and derivative assets and liabilities associated with the same counterparty separately in our financial statements, and we bifurcate all derivatives into their current and long-term portions on the balance sheet.

DERIVATIVES POLICY

We have not made significant changes to our derivative instrument or credit risk policies as described in our Annual Report on Form 10-K for the year ended December 31, 2010.

FINANCIAL IMPACT OF DERIVATIVES

Cash Flow Hedges

UNS Electric entered into a cash flow hedge in August 2011 to fix the UNS Electric term loan variable interest rate. The company accounts for this hedge using the same policies that TEP applies to its cash flow hedges. See Note 4.

UniSource Energy and TEP had liabilities related to their cash flow hedges of $14 million at September 30, 2011, and $12 million at December 31, 2010.

The after-tax unrealized losses on derivative activities reported in AOCI were as follows:

	UniSource Energy				TEP
	Three Months Ended September 30,
	2011		2010		2011		2010
	-Millions of Dollars-
After-Tax Unrealized Losses	$	2	$	3	$	2	$	3

	Nine Months Ended September 30,
	2011		2010		2011		2010
	-Millions of Dollars-
After-Tax Unrealized Losses	$	3	$	8	$	3	$	8

Regulatory Treatment of Commodity Derivatives

We disclose unrealized gains and losses on energy contracts recoverable through the PPFAC or PGA on the balance sheet as a regulatory asset or liability rather than as a component of AOCI or in the income statement, as shown in the following table:

	UniSource Energy				TEP
	Three Months Ended September 30,
	2011		2010		2011			2010
	-Millions of Dollars-
Increase (Decrease) to Regulatory Assets	$	2	$	6	$	(1	)	$	(1	)

	Nine Months Ended September 30,
	2011			2010		2011			2010
	-Millions of Dollars-
Increase (Decrease) to Regulatory Assets	$	(7	)	$	10	$	(3	)	$	(4	)

The fair value of assets and liabilities for energy derivatives recoverable through the PPFAC or PGA were as follows:

	UniSource Energy						TEP
	September 30,			December 31,			September 30,			December 31,
	2011			2010			2011			2010
	-Millions of Dollars-
Assets	$	14		$	15		$	3		$	3
Liabilities		(33	)		(42	)		(4	)		(7	)
Net Liabilities	$	(19	)	$	(27	)	$	(1	)	$	(4	)

The realized gains and losses on settled gas swaps that are fully recoverable through the PPFAC or PGA were as follows:

	UniSource Energy				TEP
	Three Months Ended September 30,
	2011		2010		2011		2010
	-Millions of Dollars-
Realized Losses on Settled Gas Swaps	$	6	$	8	$	4	$	5

	Nine Months Ended September 30,
	2011		2010		2011		2010
	-Millions of Dollars-
Realized Losses on Settled Gas Swaps	$	15	$	17	$	6	$	8

At September 30, 2011, UniSource Energy and TEP had contracts that will settle through the third quarter of 2015.

Other Commodity Derivatives

UniSource Energy and TEP record realized and unrealized gains and losses on other energy contracts on a net basis in Wholesale Sales. The settlement of forward power purchase and sales contracts that did not result in physical delivery were as follows:

	UniSource Energy and TEP
	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2011			2010			2011			2010
	-Millions of Dollars-
Recorded in Wholesale Sales:
Forward Power Sales	$	6		$	19		$	9		$	25
Forward Power Purchases		(8	)		(25	)		(12	)		(32	)
Total Purchases Not Resulting in Physical Delivery	$	(2	)	$	(6	)	$	(3	)	$	(7	)

DERIVATIVE VOLUMES

At September 30, 2011, UniSource Energy had gas swaps totaling 13,963 GBtu and power contracts totaling 3,647 GWh while TEP had gas swaps totaling 5,977 GBtu and power contracts totaling 964 GWh, At December 31, 2010, UniSource Energy had gas swaps totaling 14,973 GBtu and power contracts totaling 4,807 GWh while TEP had gas swaps totaling 6,424 GBtu and power contracts totaling 1,144 GWh. We account for gas swaps and power contracts as derivatives.

CREDIT RISK ADJUSTMENT

The impact of counterparty credit risk and the impact of our own credit risk on the fair value of derivative asset contracts was less than $0.1 million at September 30, 2011, and at December 31, 2010.

CONCENTRATION OF CREDIT RISK

The following table shows the sum of the fair value of all derivative instruments under contracts with credit-risk related contingent features that are in a net liability position at September 30, 2011. It also shows cash collateral and letters of credit posted, and additional collateral to be posted if credit-risk related contingent features were triggered.

	UniSource Energy		TEP
	September 30, 2011
	-Millions of Dollars-
Net Liability	$	58	$	21
Cash Collateral Posted		—		—
Letters of Credit		8		1
Additional Collateral to Post if Contingent Features Triggered		52		21

As of September 30, 2011, TEP had $17 million of credit exposure to other counterparties’ creditworthiness related to its wholesale marketing and gas hedging activities; five of these counterparties individually comprised greater than 10% of the total credit exposure. At September 30, 2011, UNS Electric had $3 million of credit exposure related to its supply and hedging contracts; this amount was concentrated primarily with one counterparty. At September 30, 2011, UNS Gas had immaterial exposure to other counterparties’ creditworthiness.