Fair Value Measurements

3 Months Ended

Mar. 31, 2013

Fair Value Disclosures [Abstract]

Fair Value Measurements

Fair Value

GAAP established a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy categorizes the inputs into three levels with the highest priority given to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority given to unobservable inputs (Level 3 measurement). The three levels of the fair value hierarchy are as follows:

Level 1 - Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Level 1 primarily consists of financial instruments such as exchange-traded derivatives and listed equities. Equity securities that are also classified as cash equivalents are considered Level 1 if there are unadjusted quoted prices in active markets for identical assets or liabilities.

Level 2 - Pricing inputs are other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reporting date. Level 2 includes those financial instruments that are valued using models or other valuation methodologies. Instruments in this category include non-exchange-traded derivatives such as over-the-counter forwards and options.

Level 3 - Pricing inputs include significant inputs that have little or no observability as of the reporting date. These inputs may be used with internally developed methodologies that result in management's best estimate of fair value.

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. If a fair value measurement relies on inputs from different levels of the hierarchy, the entire measurement must be placed based on the lowest level input that is significant to the fair value measurement. The Company's assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy. The Company primarily determines fair value measurements classified as Level 2 or Level 3 using a combination of the income and market valuation approaches. The process of determining the fair values is the responsibility of the derivative accounting department which reports to the Controller and Principal Accounting Officer. On a daily basis, the Company obtains quoted forward prices for the electric and natural gas market from an independent external pricing service. These forward price quotes are used in addition to other various inputs to determine the reported fair value. Some of the inputs, which are not significant, include the credit standing of the counterparties involved and the impact of credit enhancements (such as cash deposits, letters of credit and priority interests), assumptions for time value, and also the impact of the Company's nonperformance risk of its liabilities. For interest rate swaps, the Company obtains monthly mark-to-market values from an independent external pricing service for LIBOR forward rates, which is a significant input. Some of the inputs of the interest rate swap valuations, which are not significant, include the credit standing of the counterparties, assumptions for time value and the impact of the Company's nonperformance risk of its liabilities. Cash equivalents and restricted cash classified as Level 2 fair value instruments consist of special money market funds and premium checking accounts. The Company valued Level 2 cash equivalents and restricted cash using the market approach based on the fair value of underlying investments at reporting date.

The Company considers its electric, natural gas and interest rate swap contracts as Level 2 derivative instruments as such contracts are commonly traded as over-the-counter forwards with indirectly observable price quotes. However, certain energy derivative instruments are classified as Level 3 in the fair value hierarchy since Level 3 inputs are significant to the fair value measurement. Management's assessment was based on the trading activity in real-time and forward electric and natural gas markets. Each quarter, the Company confirms the validity of pricing service quoted prices (e.g., Level 2 in the fair value hierarchy) used to value commodity contracts with the actual prices of commodity contracts entered into during the most recent quarter.

Assets and Liabilities with Estimated Fair Value

The following table presents the fair value hierarchy by level, the carrying value for cash, cash equivalents, restricted cash, notes receivable and short-term debt. The carrying values below are representative of fair values due to the short-term nature of these financial instruments.

Puget Energy	Carrying / Fair Value At March 31, 2013						Carrying / Fair Value At December 31, 2012
(Dollars in Thousands)	Level 1		Level 2		Total		Level 1		Level 2		Total
Assets:
Cash and Cash Equivalents	$	—	$	113,988	$	113,988	$	105,000	$	30,542	$	135,542
Restricted Cash	896		2,205		3,101		914		2,786		3,700
Notes Receivable and Other	—		55,397		55,397		—		63,802		63,802
Total assets	$	896	$	171,590	$	172,486	$	105,914	$	97,130	$	203,044
Liabilities:
Short Term Debt	$	25,000	$	—	$	25,000	$	181,000	$	—	$	181,000
Long Term Debt (variable rate) net of discount	—		—		—		—		—		—
Total liabilities	$	25,000	$	—	$	25,000	$	181,000	$	—	$	181,000

Puget Sound Energy	Carrying / Fair Value At March 31, 2013						Carrying / Fair Value At December 31, 2012
(Dollars in Thousands)	Level 1		Level 2		Total		Level 1		Level 2		Total
Assets:
Cash and Cash Equivalents	$	—	$	113,947	$	113,947	$	105,000	$	30,530	$	135,530
Restricted Cash	896		2,205		3,101		914		2,786		3,700
Notes Receivable and Other	—		55,397		55,397		—		63,802		63,802
Total assets	$	896	$	171,549	$	172,445	$	105,914	$	97,118	$	203,032
Liabilities:
Short Term Debt	$	25,000	$	—	$	25,000	$	181,000	$	—	$	181,000
Short Term Debt owed to parent	—		29,598		29,598		—		29,598		29,598
Total liabilities	$	25,000	$	29,598	$	54,598	$	181,000	$	29,598	$	210,598

The fair value of the junior subordinated and long-term notes were estimated using the discounted cash flow method with U.S. Treasury yields and Company credit spreads as inputs, interpolating to the maturity date of each issue. Carrying values and estimated fair values were as follows:

Puget Energy		March 31, 2013				December 31, 2012
(Dollars in Thousands)	Level	Carrying Value		Fair Value		Carrying Value		Fair Value
Liabilities:
Junior subordinated notes	2	$	250,000	$	266,968	$	250,000	$	264,842
Long-term debt (fixed-rate), net of discount	2	4,665,278		6,117,038		4,662,200		6,197,179
Long-term debt (variable-rate), net of discount	2	405,000		405,000		434,000		434,000
Total		$	5,320,278	$	6,789,006	$	5,346,200	$	6,896,021
Puget Sound Energy		March 31, 2013				December 31, 2012
(Dollars in Thousands)	Level	Carrying Value		Fair Value		Carrying Value		Fair Value
Liabilities:
Junior subordinated notes	2	$	250,000	$	266,968	$	250,000	$	264,842
Long-term debt (fixed-rate), net of discount	2	3,526,258		4,522,526		3,526,258		4,628,509
Total		$	3,776,258	$	4,789,494	$	3,776,258	$	4,893,351

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following tables present the Company's financial assets and liabilities by level, within the fair value hierarchy, that were accounted for at fair value on a recurring basis and the reconciliation of the changes in the fair value of Level 3 derivatives in the fair value hierarchy. The Company did not have any transfers between Level 2 and Level 1 during the three months ended March 31, 2013 and 2012.

Puget Energy	Fair Value						Fair Value
	At March 31, 2013						At December 31, 2012
(Dollars in Thousands)	Level 2		Level 3		Total		Level 2		Level 3		Total
Interest rate derivative instruments	$	19,966	$	—	$	19,966	$	21,524	$	—	$	21,524
Total derivative liabilities	$	19,966	$	—	$	19,966	$	21,524	$	—	$	21,524

Puget Energy and Puget Sound Energy	Fair Value						Fair Value
	At March 31, 2013						At December 31, 2012
(Dollars in Thousands)	Level 2		Level 3		Total		Level 2		Level 3		Total
Assets:
Electric derivative instruments	$	7,500	$	8,632	$	16,132	$	1,259	$	8,298	$	9,557
Natural gas derivative instruments	13,837		4,893		18,730		6,769		5,357		12,126
Total assets	$	21,337	$	13,525	$	34,862	$	8,028	$	13,655	$	21,683
Liabilities:
Electric derivative instruments	$	27,166	$	35,074	$	62,240	$	88,971	$	42,221	$	131,192
Natural gas derivative instruments	44,552		6,427		50,979		101,119		6,960		108,079
Total liabilities	$	71,718	$	41,501	$	113,219	$	190,090	$	49,181	$	239,271

Puget Energy and Puget Sound Energy	Three Months Ended March 31,
Level 3 Roll-Forward Net (Liability)	2013									2012
(Dollars in Thousands)	Electric			Gas			Total			Electric			Gas			Total
Balance at beginning of period	$	(33,924	)	$	(1,602	)	$	(35,526	)	$	(90,311	)	$	(5,041	)	$	(95,352	)
Changes during period
Realized and unrealized energy derivatives:
Included in earnings 1	1,598			—			1,598			(21,947		)	—			(21,947		)
Included in regulatory assets / liabilities	—			674			674			—			(1,283		)	(1,283		)
Settlements 2	6,384			(733		)	5,651			21,042			(218		)	20,824
Transferred into Level 3	(7,700		)	—			(7,700		)	(16,874		)	—			(16,874		)
Transferred out of Level 3	7,200			127			7,327			726			3,375			4,101
Balance at end of period	$	(26,442	)	$	(1,534	)	$	(27,976	)	$	(107,364	)	$	(3,167	)	$	(110,531	)

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¹  Income Statement location: Unrealized (gain) loss on derivative instruments, net. Includes unrealized gains (losses) on derivatives still held in position as of the reporting date for electric derivatives of $1.4 million and $(19.0) million for the three months ended March 31, 2013 and 2012, respectively.

²The Company had no purchases, sales or issuances during the reported periods.

Realized gains and losses on energy derivatives for Level 3 recurring items are included in energy costs in the Company's consolidated statements of income under purchased electricity, electric generation fuel or purchased natural gas when settled. Unrealized gains and losses on energy derivatives for Level 3 recurring items are included in net unrealized (gain) loss on derivative instruments in the Company's consolidated statements of income.

In order to determine which assets and liabilities are classified as Level 3, the Company receives market data from its independent external pricing service defining the tenor of observable market quotes. To the extent any of the Company's commodity contracts extend beyond what is considered observable as defined by its independent pricing service, the contracts are classified as Level 3. The actual tenor of what the independent pricing service defines as observable is subject to change depending on market conditions. Therefore, as the market changes, the same contract may be designated Level 3 one month and Level 2 the next, and vice versa. The changes of fair value classification into or out of Level 3 are recognized each month, and reported in the Level 3 Roll-forward table above. The Company does periodically transact at locations, or market price points, that are illiquid or for which no prices are available from the independent pricing service. In such circumstances the Company uses a more liquid price point and performs a 15-month regression against the illiquid locations to serve as a proxy for market prices. Such transactions are classified as Level 3. The Company does not use internally developed models to make adjustments to significant unobservable pricing inputs.

The only significant unobservable input into the fair value measurement of the Company's Level 3 assets and liabilities is the forward price for electric and natural gas contracts. Below are the forward price ranges for the Company's purchased commodity contracts, as of March 31, 2013:

(Dollars in Thousands)
	Fair Value						Range
Derivative Instrument	Assets 1		Liabilities 1		Valuation Technique	Unobservable Input	Low	High	Weighted Average
Electric	$	8,632	$	35,074	Discounted cash flow	Power Prices	$8.48 per MWh	$47.07 per MWh	$33.57 per MWh
Natural gas	$	4,893	$	6,427	Discounted cash flow	Natural Gas Prices	$3.44 per MMBtu	$4.91 per MMBtu	$4.25 per MMBtu

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¹  The valuation techniques, unobservable inputs and ranges are the same for asset and liability positions.

The significant unobservable inputs listed above would have a direct impact on the fair values of the above instruments if they were adjusted. Consequently significant increases or decreases in the forward prices of electricity or natural gas in isolation would result in a significantly higher or lower fair value for Level 3 assets and liabilities. Generally, interrelationships exist between market prices of natural gas and power. As such, an increase in natural gas pricing would potentially have a similar impact on forward power markets. At March 31, 2013, a hypothetical 10% increase or decrease in market prices of natural gas and electricity would change the fair value of the Company's derivative portfolio, classified as Level 3 within the fair value hierarchy, by $20.8 million.