Commitments, Contingencies and Uncertainties

For a full discussion of commitments and contingencies, see Note J of Notes to Consolidated Financial Statements in the 2010 Form 10-K. In addition, see Note C above and Notes B and D of Notes to Consolidated Financial Statements in the 2010 Form 10-K regarding matters related to wholesale power sales contracts and transmission contracts subject to regulation and Palo Verde, including decommissioning, spent fuel storage, disposal of low-level radioactive waste, and liability and insurance matters.

Power Purchase and Sale Contracts

To supplement its own generation and operating reserves, the Company engages in firm power purchase arrangements which may vary in duration and amount based on evaluation of the Company’s resource needs and the economics of the transactions. For a full discussion of power purchase and sale contracts that the Company has entered into with various counterparties, see Note J of Notes to Consolidated Financial Statements in the 2010 Form 10-K. In addition to the contracts disclosed in the 2010 Form 10-K, in April 2011, the amount of energy purchased from Freeport-McMoran Copper and Gold Energy Services LLC was increased to 125 MW through December 2013, in accordance with the power purchase and sale agreement. In the third quarter of 2011, the purchase power agreement for the full capacity of two 12 MW solar photovoltaic plants to be built in southern New Mexico was modified to the full capacity of one 12 MW solar photovoltaic plant and one 10 MW solar photovoltaic plant scheduled for commercial operation in March 2012 and April 2012, respectively.

Environmental Matters

General. The Company is subject to laws and regulations with respect to air, soil and water quality, waste disposal and other environmental matters by federal, state, regional, tribal and local authorities. Those authorities govern facility operations and have continuing jurisdiction over facility modifications. Failure to comply with these environmental regulatory requirements can result in actions by regulatory agencies or other authorities that might seek to impose on the Company administrative, civil and/or criminal penalties or other sanctions. In addition, releases of pollutants or contaminants into the environment can result in costly cleanup obligations. These laws and regulations are subject to change and, as a result of those changes, the Company may face additional capital and operating costs to comply. Certain key environmental issues, laws and regulations facing the Company are described further below.

Air Emissions. The U.S. Clean Air Act (“CAA”) and comparable state laws and regulations relating to air emissions impose, among other obligations, limitations on pollutants generated during the Company’s operations, including sulfur dioxide (“SO₂”), particulate matter, nitrogen oxides (“NOx”) and mercury.

Clean Air Interstate Rule. The U.S. Environmental Protection Agency’s (“EPA”) Clean Air Interstate Rule (“CAIR”), as applied to the Company, involves requirements to limit emissions of NOx from the Company’s power plants in Texas and/or purchase allowances representing other parties’ emissions reductions starting in 2009. The U.S. Court of Appeals for the District of Columbia voided CAIR in 2008; however, the Company has complied with CAIR since 2009. The annual reconciliation to comply with CAIR is due by March 31 of the following year. The Company has purchased allowances and expensed the following costs to meet its annual requirements:



			Amount
Compliance Year			(in thousands)
2010			$370
2011			35

Clean Air Transport Rule/Cross-State Air Pollution Rule. On July 6, 2011, the EPA finalized the Clean Air Transport Rule (“CATR”), renaming it the Cross-State Air Pollution Rule (“CSAPR”). The rule replaces CAIR and addresses air quality issues in downwind states, specifically eastern, central and southern parts of the United States. CSAPR will require 27 states, including Texas, to issue regulations and develop a scheme by which power plants in their respective jurisdictions will further reduce SO2 and NOx. The CSAPR does not apply to the Company’s facilities in New Mexico. The rule becomes effective on January 1, 2012, but it is unclear when and how the states would issue implementing regulations. The Company continues to evaluate the rule, including recently proposed revisions, to determine potential impacts. Due to various uncertainties, the ultimate impact of this rule on the Company’s operations cannot currently be determined but it could be material.

Ozone. NOx emissions can lead to the formation of ozone. Ozone levels are limited by the National Ambient Air Quality Standards established by the EPA. The EPA was in the process of revising these standards; however, on September 2, 2011, EPA withdrew its draft proposal, indicating it does not plan to revisit this issue until 2013. If these future revisions result in more stringent standards, the Company could be required to place additional NOx pollution control measures on certain of its generating facilities. Without knowing the new ozone standards, the ultimate impact on the Company’s facilities cannot be determined. The impact of these regulations and associated costs, however, could be material.

Climate Change. A significant portion of the Company’s generation assets are nuclear or gas-fired, and as a result, the Company believes that its greenhouse gas (“GHG”) emissions are low relative to electric power companies who rely on more coal-fired generation. However, regulations governing the emission of GHGs, such as carbon dioxide, could impose significant costs or limitations on the Company. In recent years, the U.S. Congress has considered new legislation to restrict or regulate GHG emissions, although federal efforts directed at enacting comprehensive climate change legislation stalled in 2010 and appear highly unlikely to recommence in 2011. Nonetheless, it is possible that federal legislation related to GHG emissions will be considered by Congress in the future. The EPA has also proposed using the CAA to limit carbon dioxide and other GHG emissions.

In September 2009, the EPA adopted a rule requiring approximately 10,000 facilities comprising a substantial percentage of annual U.S. GHG emissions to inventory their emissions starting in 2010 and to report those emissions to the EPA beginning in 2011. The Company’s fossil fuel-fired power generating assets are subject to this rule, and the first report containing 2010 emissions was submitted to the EPA prior to the September 30, 2011 due date. The Company also has inventoried and implemented procedures for electrical equipment containing sodium hexafluoride ("SF₆"), another GHG. The Company is tracking these GHG emissions pursuant to the EPA’s new SF₆ reporting rule that was finalized in late 2010 and became effective January 1, 2011.

The EPA has also proposed and finalized other rulemakings on GHG emissions that affect electric utilities. Under EPA regulations finalized in May 2010 (referred to as the “Tailoring Rule”), the EPA began regulating GHG emissions from certain stationary sources in January 2011. The regulations are being implemented pursuant to two CAA programs: the Title V Operating Permit program and the program requiring a permit if undergoing construction or major modifications (referred to as the “PSD” program). Obligations relating to Title V permits will include recordkeeping and monitoring requirements. With respect to PSD permits, projects that cause a significant increase in GHG emissions (currently defined to be more than 75,000 tons or 100,000 tons per year, depending on various factors), will be required to implement “best available control technology,” or “BACT”. The EPA has issued guidance on what BACT entails for the control of GHGs, and individual states are now required to determine what controls are required for facilities within their jurisdiction on a case-by-case basis. The ultimate impact of these new regulations on the Company’s operations cannot be determined at this time, but the cost of compliance with new regulations could be material. Also, on December 23, 2010, the EPA announced a settlement agreement with states and environmental groups regarding setting new source performance standards for GHG emissions from new and existing coal-, gas- and oil-based power plants. Pursuant to this agreement, the EPA was to propose standards for both new and modified boilers and for existing facilities in September 2011, and finalize those standards by May 26, 2012. However, on September 15, 2011, the EPA again postponed a proposed rule and stated a new schedule would be proposed "soon". The impact of these rules on the Company is unknown at this time, but they could result in significant costs.

In addition, almost half of the states, either individually or through multi state regional initiatives, have begun to consider how to address GHG emissions and are actively considering the development of emission inventories or regional GHG cap and trade programs. The State of New Mexico, where the Company operates one facility and has an interest in another facility, has joined with California and several other states in the Western Climate Initiative and is pursuing initiatives to reduce GHG emissions in the state. The New Mexico Environmental Improvement Board approved two separate rulemakings in November and December 2010 to limit GHG emissions from certain stationary sources. Under the November 2010 regulation, stationary sources that emit 25,000 metric tons or more of carbon dioxide a year would be required to reduce their GHG emissions by 2% per year from 2012 through 2020. The December 2010 regulation establishes a cap-and-trade system which would require certain industrial and electric generating facilities with carbon dioxide emissions in excess of 25,000 metric tons per year to reduce their emissions by 3% per year below 2010 levels. There are various uncertainties relating to these regulations, including whether current legal challenges to them will be successful, but as drafted, the Company does not expect these regulations to result in significant costs to the Company.

It is not currently possible to predict with confidence how any pending, proposed or future GHG legislation by Congress, the states, or multi-state regions or regulations adopted by EPA or the state environmental agencies will impact the Company’s business. However, any such legislation or regulation of GHG emissions or any future related litigation could result in increased compliance costs or additional operating restrictions or reduced demand for the power the Company generates, could require the Company to purchase rights to emit GHG, and could have a material adverse effect on the Company’s business, financial condition, reputation or results of operations.

Climate change also has potential physical effects that could be relevant to the Company’s business. In particular, some studies suggest that climate change could affect our service area by causing higher temperatures, less winter precipitation and less spring runoff, as well as by causing more extreme weather events. Such developments could change the demand for power in the region and could also impact the price or ready availability of water supplies or affect maintenance needs and the reliability of Company equipment.

The Company believes that material effects on the Company’s business or operations may result from the physical consequences of climate change, the regulatory approach to climate change ultimately selected and implemented by governmental authorities, or both. Substantial expenditures may be required for the Company to comply with such regulations in the future and, in some instances, those expenditures may be material. Given the very significant remaining uncertainties regarding whether and how these issues will be regulated, as well as the timing and severity of any physical effects of climate change, the Company believes it is impossible at present to meaningfully quantify the costs of these potential impacts.

Contamination Matters. The Company has a provision for environmental remediation obligations of approximately $0.4 million at September 30, 2011, related to compliance with federal and state environmental standards. However, unforeseen expenses associated with environmental compliance or remediation may occur and could have a material adverse effect on the future operations and financial condition of the Company.

The Company incurred the following expenditures during the three, nine and twelve months ended September 30, 2011 and 2010 to comply with federal environmental statutes (in thousands):



	Three Months Ended				Nine Months Ended				Twelve Months Ended
	September 30,				September 30,				September 30,
	2011		2010		2011		2010		2011		2010
Clean Air Act	$	164	$	88	$	457	$	376	$	696	$	523
Clean Water Act	63		51		172		154		196		305

The EPA has investigated releases or potential releases of hazardous substances, pollutants or contaminants at the Gila River Boundary Site, on the Gila River Indian Community reservation in Arizona and designated it as a Superfund site. The Company currently owns 16.29% of the site and will share in the cost of cleanup of this site. The Company has an agreement with the EPA and a former property owner to resolve this matter and on June 30, 2011 the Company entered into a consent decree with the EPA at a cost to the Company of less than $0.1 million (which amount is included in the $0.4 million accrued at September 30, 2011).

Environmental Litigation and Investigations. On April 6, 2009, APS received a request from the EPA under Section 114 of the CAA seeking detailed information regarding projects and operations at Four Corners. APS has responded to this request. The Company is unable to predict the timing or content of the EPA’s response or any resulting actions.

On February 16, 2010, a group of environmental organizations filed a petition with the United States Departments of Interior and Agriculture requesting that the agencies certify to the EPA that emissions from Four Corners are causing “reasonably attributable visibility impairment” under the CAA. If the agencies certify impairment, the EPA is required to evaluate and, if necessary, determine “best available retrofit technology" (“BART”) for Four Corners. On January 19, 2011, a similar group of environmental organizations filed a lawsuit against the Departments of Interior and Agriculture, alleging, among other things, that the agencies failed to act on the February 2010 petition “without unreasonable delay” and requesting the court to order the agencies to act on the petition within 30 days. The Company cannot predict the outcome of the petition or whether any resulting actions could have an adverse effect on its capital or operating costs.

On May 7, 2010, APS, on behalf of the Four Corners co-owners (the "Project Participants"), received Notice of Intent to Sue Four Corners Power Plant for Violations of the Clean Air Act (the "Notice"). EarthJustice sent the Notice on behalf of Dine CARE (Citizens Against Ruining our Environment), to Nizhoni Ani, National Parks Conservation Association, and the Sierra Club. The Notice alleges two Clean Air Act violations: (i) Prevention of Significant Deterioration violations, and (ii) New Source Performance Standards violations. The alleged violations concern pulverizer projects on Units 4-5 in the 1980's and boiler, turbine, generator and other projects on Units 4-5 commencing in 2007. The Company recently received word that EarthJustice filed a lawsuit in the United States District Court for New Mexico on October 4, 2011 regarding these alleged Clean Air Act violations. The Company has not yet been served with the lawsuit, and the Company is unable to predict the outcome of these alleged violations.