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Derivative Accounting | 9 Months Ended
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Sep. 30, 2016
Derivative Instruments and Hedging Activities Disclosure [Abstract] |
Derivative Accounting | Derivative Accounting We are exposed to the impact of market fluctuations in the commodity price and transportation costs of electricity, natural gas, coal, emissions allowances and in interest rates. We manage risks associated with market volatility by utilizing various physical and financial derivative instruments, including futures, forwards, options and swaps. As part of our overall risk management program, we may use derivative instruments to hedge purchases and sales of electricity and fuels. Derivative instruments that meet certain hedge accounting criteria may be designated as cash flow hedges and are used to limit our exposure to cash flow variability on forecasted transactions. The changes in market value of such instruments have a high correlation to price changes in the hedged transactions. We also enter into derivative instruments for economic hedging purposes. While we believe the economic hedges mitigate exposure to fluctuations in commodity prices, these instruments have not been designated as accounting hedges. Contracts that have the same terms (quantities, delivery points and delivery periods) and for which power does not flow are netted, which reduces both revenues and fuel and purchased power costs in our Condensed Consolidated Statements of Income, but does not impact our financial condition, net income or cash flows. Our derivative instruments, excluding those qualifying for a scope exception, are recorded on the balance sheet as an asset or liability and are measured at fair value. See Note 10 for a discussion of fair value measurements. Derivative instruments may qualify for the normal purchases and normal sales scope exception if they require physical delivery and the quantities represent those transacted in the normal course of business. Derivative instruments qualifying for the normal purchases and sales scope exception are accounted for under the accrual method of accounting and excluded from our derivative instrument discussion and disclosures below. Hedge effectiveness is the degree to which the derivative instrument contract and the hedged item are correlated and is measured based on the relative changes in fair value of the derivative instrument contract and the hedged item over time. We assess hedge effectiveness both at inception and on a continuing basis. These assessments exclude the time value of certain options. For accounting hedges that are deemed an effective hedge, the effective portion of the gain or loss on the derivative instrument is reported as a component of OCI and reclassified into earnings in the same period during which the hedged transaction affects earnings. We recognize in current earnings, subject to the PSA, the gains and losses representing hedge ineffectiveness, and the gains and losses on any hedge components which are excluded from our effectiveness assessment. As cash flow hedge accounting has been discontinued for the significant majority of our contracts, after May 31, 2012, effectiveness testing is no longer being performed for these contracts. For its regulated operations, APS defers for future rate treatment 100% of the unrealized gains and losses on derivatives pursuant to the PSA mechanism that would otherwise be recognized in income. Realized gains and losses on derivatives are deferred in accordance with the PSA to the extent the amounts are above or below the Base Fuel Rate (see Note 3). Gains and losses from derivatives in the following tables represent the amounts reflected in income before the effect of PSA deferrals. As of September 30, 2016, we had the following outstanding gross notional volume of derivatives, which represent both purchases and sales (does not reflect net position):
Commodity |  | Quantity
Power |  | 1,630 |  |  | GWh
Gas |  | 193 |  |  | Billion cubic feet
Gains and Losses from Derivative Instruments The following table provides information about gains and losses from derivative instruments in designated cash flow accounting hedging relationships during the three and nine months ended September 30, 2016 and 2015 (dollars in thousands):
|  | Financial Statement Location |  | Three Months Ended September 30, |  | Nine Months Ended September 30,
Commodity Contracts |  |  | 2016 |  | 2015 |  | 2016 |  | 2015
Gain (loss) recognized in OCI on derivative instruments (effective portion) |  | OCI — derivative instruments |  | $ | (47 | ) |  | $ | (247 | ) |  | $ | 13 |  |  | $ | (534 | )
Loss reclassified from accumulated OCI into income (effective portion realized) (a) |  | Fuel and purchased power (b) |  | (1,298 | ) |  | (1,459 | ) |  | (3,255 | ) |  | (5,232 | )
(a) | During the three and nine months ended September 30, 2016 and 2015, we had no losses reclassified from accumulated OCI to earnings related to discontinued cash flow hedges.
(b) | Amounts are before the effect of PSA deferrals.
During the next twelve months, we estimate that a net loss of $4 million before income taxes will be reclassified from accumulated OCI as an offset to the effect of market price changes for the related hedged transactions. In accordance with the PSA, most of these amounts will be recorded as either a regulatory asset or liability and have no immediate effect on earnings. The following table provides information about gains and losses from derivative instruments not designated as accounting hedging instruments during the three and nine months ended September 30, 2016 and 2015 (dollars in thousands):
|  | Financial Statement Location |  | Three Months Ended September 30, |  | Nine Months Ended September 30,
Commodity Contracts |  |  | 2016 |  | 2015 |  | 2016 |  | 2015
Net gain recognized in income |  | Operating revenues |  | $ | 41 |  |  | $ | 560 |  |  | $ | 524 |  |  | $ | 445 |
Net loss recognized in income |  | Fuel and purchased power (a) |  | (35,103 | ) |  | (50,909 | ) |  | (5,145 | ) |  | (85,099 | )
Total |  |  |  | $ | (35,062 | ) |  | $ | (50,349 | ) |  | $ | (4,621 | ) |  | $ | (84,654 | )
(a) | Amounts are before the effect of PSA deferrals.
Derivative Instruments in the Condensed Consolidated Balance Sheets Our derivative transactions are typically executed under standardized or customized agreements, which include collateral requirements and, in the event of a default, would allow for the netting of positive and negative exposures associated with a single counterparty. Agreements that allow for the offsetting of positive and negative exposures associated with a single counterparty are considered master netting arrangements. Transactions with counterparties that have master netting arrangements are offset and reported net on the Condensed Consolidated Balance Sheets. Transactions that do not allow for offsetting of positive and negative positions are reported gross on the Condensed Consolidated Balance Sheets. We do not offset a counterparty’s current derivative contracts with the counterparty’s non-current derivative contracts, although our master netting arrangements would allow current and non-current positions to be offset in the event of a default. Additionally, in the event of a default, our master netting arrangements would allow for the offsetting of all transactions executed under the master netting arrangement. These types of transactions may include non-derivative instruments, derivatives qualifying for scope exceptions, trade receivables and trade payables arising from settled positions, and other forms of non-cash collateral (such as letters of credit). These types of transactions are excluded from the offsetting tables presented below. The significant majority of our derivative instruments are not currently designated as hedging instruments. The Condensed Consolidated Balance Sheets as of September 30, 2016 and December 31, 2015, include gross liabilities of $2 million and $3 million, respectively, of derivative instruments designated as hedging instruments. The following tables provide information about the fair value of our risk management activities reported on a gross basis, and the impacts of offsetting as of September 30, 2016 and December 31, 2015. These amounts relate to commodity contracts and are located in the assets and liabilities from risk management activities lines of our Condensed Consolidated Balance Sheets.
As of September 30, 2016: (dollars in thousands) |  | Gross Recognized Derivatives (a) |  | Amounts Offset (b) |  | Net Recognized Derivatives |  | Other (c) |  | Amount Reported on Balance Sheet
Current assets |  | $ | 24,894 |  |  | $ | (18,816 | ) |  | $ | 6,078 |  |  | $ | 157 |  |  | $ | 6,235 |
Investments and other assets |  | 4,146 |  |  | (4,146 | ) |  | — |  |  | — |  |  | — |
Total assets |  | 29,040 |  |  | (22,962 | ) |  | 6,078 |  |  | 157 |  |  | 6,235 |
Current liabilities |  | (59,586 | ) |  | 18,816 |  |  | (40,770 | ) |  | (4,405 | ) |  | (45,175 | )
Deferred credits and other |  | (62,489 | ) |  | 4,146 |  |  | (58,343 | ) |  | — |  |  | (58,343 | )
Total liabilities |  | (122,075 | ) |  | 22,962 |  |  | (99,113 | ) |  | (4,405 | ) |  | (103,518 | )
Total |  | $ | (93,035 | ) |  | $ | — |  |  | $ | (93,035 | ) |  | $ | (4,248 | ) |  | $ | (97,283 | )
(a) | All of our gross recognized derivative instruments were subject to master netting arrangements.
(b) | No cash collateral has been provided to counterparties, or received from counterparties, that is subject to offsetting.
(c) | Represents cash collateral and cash margin that is not subject to offsetting. Amounts relate to non-derivative instruments, derivatives qualifying for scope exceptions, or collateral and margin posted in excess of the recognized derivative instrument. Includes cash collateral received from counterparties of $4,405, and cash margin provided to counterparties of $157.
As of December 31, 2015: (dollars in thousands) |  | Gross Recognized Derivatives (a) |  | Amounts Offset (b) |  | Net Recognized Derivatives |  | Other (c) |  | Amount Reported on Balance Sheet
Current assets |  | $ | 37,396 |  |  | $ | (22,163 | ) |  | $ | 15,233 |  |  | $ | 672 |  |  | $ | 15,905 |
Investments and other assets |  | 15,960 |  |  | (3,854 | ) |  | 12,106 |  |  | — |  |  | 12,106 |
Total assets |  | 53,356 |  |  | (26,017 | ) |  | 27,339 |  |  | 672 |  |  | 28,011 |
Current liabilities |  | (113,560 | ) |  | 40,223 |  |  | (73,337 | ) |  | (4,379 | ) |  | (77,716 | )
Deferred credits and other |  | (93,827 | ) |  | 3,854 |  |  | (89,973 | ) |  | — |  |  | (89,973 | )
Total liabilities |  | (207,387 | ) |  | 44,077 |  |  | (163,310 | ) |  | (4,379 | ) |  | (167,689 | )
Total |  | $ | (154,031 | ) |  | $ | 18,060 |  |  | $ | (135,971 | ) |  | $ | (3,707 | ) |  | $ | (139,678 | )
(a) | All of our gross recognized derivative instruments were subject to master netting arrangements.
(b) | Includes cash collateral provided to counterparties of $18,060.
(c) | Represents cash collateral and cash margin that is not subject to offsetting. Amounts relate to non-derivative instruments, derivatives qualifying for scope exceptions, or collateral and margin posted in excess of the recognized derivative instrument. Includes cash collateral received from counterparties of $4,379, and cash margin provided to counterparties of $672.
Credit Risk and Credit Related Contingent Features We are exposed to losses in the event of nonperformance or nonpayment by counterparties and have risk management contracts with many counterparties. As of September 30, 2016 we have no counterparties with positive exposures of greater than 10% of risk management assets. Our risk management process assesses and monitors the financial exposure of all counterparties. Despite the fact that the great majority of trading counterparties’ debt is rated as investment grade by the credit rating agencies, there is still a possibility that one or more of these companies could default, resulting in a material impact on consolidated earnings for a given period. Counterparties in the portfolio consist principally of financial institutions, major energy companies, municipalities and local distribution companies. We maintain credit policies that we believe minimize overall credit risk to within acceptable limits. Determination of the credit quality of our counterparties is based upon a number of factors, including credit ratings and our evaluation of their financial condition. To manage credit risk, we employ collateral requirements and standardized agreements that allow for the netting of positive and negative exposures associated with a single counterparty. Valuation adjustments are established representing our estimated credit losses on our overall exposure to counterparties. Certain of our derivative instrument contracts contain credit-risk-related contingent features including, among other things, investment grade credit rating provisions, credit-related cross-default provisions, and adequate assurance provisions. Adequate assurance provisions allow a counterparty with reasonable grounds for uncertainty to demand additional collateral based on subjective events and/or conditions. For those derivative instruments in a net liability position, with investment grade credit contingencies, the counterparties could demand additional collateral if our debt credit rating were to fall below investment grade (below BBB- for Standard & Poor’s or Fitch or Baa3 for Moody’s). The following table provides information about our derivative instruments that have credit-risk-related contingent features at September 30, 2016 (dollars in thousands):
| September 30, 2016
Aggregate fair value of derivative instruments in a net liability position | $ | 122,075 |
Cash collateral posted | — |
Additional cash collateral in the event credit-risk-related contingent features were fully triggered (a) | 61,177 |
(a) | This amount is after counterparty netting and includes those contracts which qualify for scope exceptions, which are excluded from the derivative details above.
We also have energy-related non-derivative instrument contracts with investment grade credit-related contingent features, which could also require us to post additional collateral of approximately $149 million if our debt credit ratings were to fall below investment grade.

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