Fair Value Measurements

3 Months Ended

Mar. 31, 2012

Fair Value Measurements [Abstract]

FAIR VALUE MEASUREMENTS

NOTE 9. FAIR VALUE MEASUREMENTS

The following tables present, by level within the fair value hierarchy, UniSource 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. There were no transfers between Levels 1, 2, or 3 for either reporting period.

	UniSource Energy
	Quoted Prices In Active  Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Total
	March 31, 2012 -Millions of Dollars-
Assets
Cash Equivalents (1)	$	22	$	—		$	—		$	22
Rabbi Trust Investments to Support the Deferred Compensation and Supplemental Executive Retirement Plans (SERP) (2)		—		18			—			18
Energy Contracts (3)		—		1			14			15
Total Assets		22		19			14			55
Liabilities
Energy Contracts (3)		—		(28	)		(27	)		(55	)
Interest Rate Swaps (4)		—		(11	)		—			(11	)
Total Liabilities		—		(39	)		(27	)		(66	)
Net Total Assets and (Liabilities)	$	22	$	(20	)	$	(13	)	$	(11	)

	UniSource Energy
	Quoted Prices In Active  Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Total
	December 31, 2011 -Millions of Dollars-
Assets
Cash Equivalents (1)	$	23	$	—		$	—		$	23
Rabbi Trust Investments to Support the Deferred Compensation and SERP (2)		—		16			—			16
Energy Contracts (3)		—		—			14			14
Total Assets		23		16			14			53
Liabilities
Energy Contracts (3)		—		(21	)		(24	)		(45	)
Interest Rate Swaps (4)		—		(12	)		—			(12	)
Total Liabilities		—		(33	)		(24	)		(57	)
Net Total Assets and (Liabilities)	$	23	$	(17	)	$	(10	)	$	(4	)

	TEP
	Quoted Prices In Active  Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Total
	March 31, 2012 -Millions of Dollars-
Assets
Cash Equivalents (1)	$	8	$	—		$	—		$	8
Rabbi Trust Investments to Support the Deferred Compensation and SERP (2)		—		18			—			18
Energy Contracts (3)		—		—			3			3
Total Assets		8		18			3			29
Liabilities
Energy Contracts (3)		—		(15	)		(3	)		(18	)
Interest Rate Swaps (4)		—		(11	)		—			(11	)
Total Liabilities		—		(26	)		(3	)		(29	)
Net Total Assets and (Liabilities)	$	8	$	(8	)	$	—		$	—

	TEP
	Quoted Prices In Active  Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Total
	December 31, 2011 -Millions of Dollars-
Assets
Cash Equivalents (1)	$	8	$	—		$	—		$	8
Rabbi Trust Investments to Support the Deferred Compensation and SERP (2)		—		16			—			16
Energy Contracts (3)		—		—			3			3
Total Assets		8		16			3			27
Liabilities
Energy Contracts (3)		—		(9	)		(3	)		(12	)
Interest Rate Swaps (4)		—		(11	)		—			(11	)
Total Liabilities		—		(20	)		(3	)		(23	)
Net Total Assets and (Liabilities)	$	8	$	(4	)	$	—		$	4

⁽¹⁾  Cash Equivalents are based on observable market prices and include the fair value of money market funds and certificates of deposit. These amounts are included in Cash and Cash Equivalents and Investments and Other Property—Other on the balance sheets.

⁽²⁾  Rabbi Trust Investments include amounts held in mutual and money market funds related to deferred compensation and SERP benefits. The valuation is based on 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), gas and power 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 and Other on the balance sheets. The valuation techniques are described below. See Note 12.

⁽⁴⁾  Interest Rate Swaps are valued based on the 3-month or 6-month London Interbank Offered Rate (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.

ENERGY CONTRACTS

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 — such as gas swap derivatives valued using New York Mercantile Exchange pricing, adjusted for basis differences — we categorize the instrument in Level 2. We categorize derivatives in Level 3 when we use 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, and 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 options using a Black-Scholes-Merton option pricing model which includes inputs such as implied volatility, correlations, interest rates, and forward price curves.

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.

The following table provides quantitative information regarding significant unobservable inputs in UniSource Energy’s Level 3 fair value measurements:

	Fair Value at March 31, 2012		Valuation Technique	Unobservable Input	Range of Unobservable Input
	-Millions of Dollars-
Energy Contracts	$	(13)	Market approach and option models	Historical price curve relationships	+/- 5%
				Adjustments for non-standard delivery points	+/- 5%
				Correlation factors	+/- 5%

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, or as a component of other comprehensive income rather than in the income statement. A 5% increase or decrease in all the unobservable inputs collectively would result in a change in the fair value of energy contracts of $1 million. TEP had no exposure to Level 3 energy contracts with unobservable inputs.

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:

	Three Months Ended March 31, 2012
	UniSource Energy Energy Contracts			TEP Energy Contracts
	-Millions of Dollars-
Balance as of December 31, 2011	$	(10	)	$	—
Realized/Unrealized Gains/(Losses) Recorded to:
Net Regulatory Assets/(Liabilities) — Derivative Instruments		(5	)		1
Other Comprehensive Loss		(1	)		(1	)
Settlements		3			—
Balance as of March 31, 2012	$	(13	)	$	—
Total (Losses) Attributable to the Change in Unrealized Gains/(Losses) Relating to Assets/(Liabilities) Still Held at the End of the Period	$	(2	)	$	—

	Three Months Ended March 31, 2011
	UniSource Energy Energy Contracts			TEP Energy Contracts
	-Millions of Dollars-
Balance as of December 31, 2010	$	(10	)	$	1
Realized/Unrealized Gains/(Losses) Recorded to:
Net Regulatory Assets/(Liabilities) — Derivative Instruments		(3	)		1
Settlements		2			(1	)
Balance as of March 31, 2011	$	(11	)	$	1
Total Gains/(Losses) Attributable to the Change in Unrealized Gains/(Losses) Relating to Assets/(Liabilities) Still Held at the End of the Period	$	(3	)	$	1

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 calculate 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 incorporate the impact of counterparty credit risk using market credit default swap data.

• 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 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 amount recorded on the balance sheet (carrying value) and the estimated fair values of our financial instruments included the following:

			March 31, 2012				December 31, 2011
	Fair Value Hierarchy		Carrying Value		Fair Value		Carrying Value		Fair Value
			-Millions of Dollars-
Assets:
TEP Investment in Lease Debt		Level 2	$	10	$	10	$	29	$	29
TEP Investment in Lease Equity		Level 3		36		23		37		21
Liabilities:
Long-Term Debt
UniSource Energy		Level 2		1,447		1,476		1,517		1,543
TEP		Level 2		1,074		1,072		1,080		1,061

TEP intends to hold the $10 million investment in Springerville Lease Debt to maturity. This investment is stated at amortized cost, which means the purchase cost has been adjusted for the amortization of the premium and discount to maturity.