Regulatory Matters

Retail Rate Case Filing with the Arizona Corporation Commission

On June 1, 2016, APS filed an application with the ACC for an annual increase in retail base rates of $165.9 million. This amount excludes amounts that are currently collected on customer bills through adjustor mechanisms. The application requests that some of the balances in these adjustor accounts (aggregating to approximately $267.6 million as of December 31, 2015) be transferred into base rates through the ratemaking process. This transfer would not have an incremental effect on average customer bills. The average annual customer bill impact of APS’s request is an increase of 5.74% (the average annual bill impact for a typical APS residential customer is 7.96%).

The principal provisions of the application are:


•	a test year ended December 31, 2015, adjusted as described below;


•	an original cost rate base of $6.8 billion, which approximates the ACC-jurisdictional portion of the book value of utility assets, net of accumulated depreciation and other credits, as of December 31, 2015;


•	the following proposed capital structure and costs of capital:



	Capital Structure		Cost of Capital
Long-term debt	44.20	%	5.13	%
Common stock equity	55.80	%	10.50	%
Weighted-average cost of capital			8.13	%


•	a 1% return on the increment of fair value rate base above APS’s original cost rate base, as provided for by Arizona law;


•	a base rate for fuel and purchased power costs of $0.029882 per kWh based on estimated 2017 prices (a decrease from the current base fuel rate of $0.03207 per kWh);


•	authorization to defer for potential future recovery its share of the construction costs associated with installing selective catalytic reduction equipment at Four Corners (estimated at approximately $400 million in direct costs). APS proposes that the rates established in this rate case be increased through a step mechanism beginning in 2019 to reflect these deferred costs;


•	authorization to defer for potential future recovery in the Company’s next general rate case the construction costs APS incurs for its Ocotillo power plant modernization project, once the project reaches commercial operation. APS estimates the direct construction costs at approximately $500 million and that the new facility will be fully in service by early 2019;


•	authorization to defer until the Company’s next general rate case the increase or decrease in its Arizona property taxes attributable to tax rate changes after the date the rate application is adjudicated;


•	updates and modifications to four of APS’s adjustor mechanisms - the PSA, the LFCR, the TCA and the Environmental Improvement Surcharge (“EIS”);


•	a number of proposed rate design changes for residential customers, including:


◦	change the on-peak time of use period from 12 p.m. - 7 p.m. to 3 p.m. - 8 p.m. Monday through Friday, excluding holidays;


◦	reduce the difference in the on- and off-peak energy price and lower all energy charges;


◦	offer four rate plan options, three of which have demand charges and a fourth that is available to non-partial requirements customers using less than 600 kWh on average per month; and


◦	modify the current net metering tariff to provide for a credit at the retail rate for the portion of generation by rooftop solar customers that offsets their own load, and for a credit for excess energy delivered to the grid at an export rate.


•	proposed rate design changes for commercial customers, including an aggregation rider that allows certain large customers to qualify for a reduced rate, an extra-high load factor rate schedule for certain customers, and an economic development rate offering for new loads meeting certain criteria.

The Company requested that the increase become effective July 1, 2017. On July 22, 2016, the ALJ set a procedural schedule for the rate proceeding, which supported completing the case within 12 months.

The ACC staff and intervenors began filing their direct testimony in late December 2016 and additional filings of testimony are ongoing. On January 12, 2017, APS began settlement discussions with all parties. On January 13, 2017, the ALJ hearing the case before the ACC issued a procedural order delaying hearings on the case from the originally scheduled March 22, 2017 to April 24, 2017, to allow parties to participate in settlement discussions and prepare testimony on the distributed generation rate design issues addressed in the value and cost of DG decision. According to the procedural order, settlement discussions are to be completed and, if applicable, any related settlement must be filed by March 17, 2017. The procedural order also extended the rate case completion date as calculated by Commission rule for an additional 33 days. APS cannot predict the outcome of this case.

Prior Rate Case Filing

On June 1, 2011, APS filed an application with the ACC for a net retail base rate increase of $95.5 million. APS requested that the increase become effective July 1, 2012. The request would have increased the average retail customer bill by approximately 6.6%. On January 6, 2012, APS and other parties to the general retail rate case entered into the 2012 Settlement Agreement detailing the terms upon which the parties agreed to settle the rate case. On May 15, 2012, the ACC approved the 2012 Settlement Agreement without material modifications.

Settlement Agreement

The 2012 Settlement Agreement provides for a zero net change in base rates, consisting of: (1) a non-fuel base rate increase of $116.3 million; (2) a fuel-related base rate decrease of $153.1 million (to be implemented by a change in the Base Fuel Rate from $0.03757 to $0.03207 per kWh); and (3) the transfer of cost recovery for certain renewable energy projects from the RES surcharge to base rates in an estimated amount of $36.8 million.

Other key provisions of the 2012 Settlement Agreement include the following:

•An authorized return on common equity of 10.0%;

•A capital structure comprised of 46.1% debt and 53.9% common equity;


•	A test year ended December 31, 2010, adjusted to include plant that is in service as of March 31, 2012;


•	Deferral for future recovery or refund of property taxes above or below a specified 2010 test year level caused by changes to the Arizona property tax rate as follows:


•	Deferral of increases in property taxes of 25% in 2012, 50% in 2013 and 75% for 2014 and subsequent years if Arizona property tax rates increase; and

•Deferral of 100% in all years if Arizona property tax rates decrease;


•	A procedure to allow APS to request rate adjustments prior to its next general rate case related to APS’s acquisition of additional interests in Units 4 and 5 and the related closure of Units 1-3 of Four Corners (APS made its filing under this provision on December 30, 2013, see "Four Corners" below);


•	Implementation of a “Lost Fixed Cost Recovery” rate mechanism to support energy efficiency and distributed renewable generation;


•	Modifications to the Environmental Improvement Surcharge to allow for the recovery of carrying costs for capital expenditures associated with government-mandated environmental controls, subject to an existing cents per kWh cap on cost recovery that could produce up to approximately $5 million in revenues annually;

•Modifications to the PSA, including the elimination of the 90/10 sharing provision;


•	A limitation on the use of the RES surcharge and the DSMAC to recoup capital expenditures not required under the terms of the settlement agreement for the 2009 retail rate case (the "2009 Settlement Agreement");


•	Allowing a negative credit that existed in the PSA rate to continue until February 2013, rather than being reset on the anticipated July 1, 2012 rate effective date;


•	Modification of the TCA to streamline the process for future transmission-related rate changes; and


•	Implementation of various changes to rate schedules, including the adoption of an experimental “buy-through” rate that could allow certain large commercial and industrial customers to select alternative sources of generation to be supplied by APS.

The 2012 Settlement Agreement was approved by the ACC on May 15, 2012, with new rates effective on July 1, 2012. This accomplished a goal set by the parties to the 2009 Settlement Agreement to process subsequent rate cases within twelve months of sufficiency findings from the ACC staff, which generally occurs within 30 days after the filing of a rate case.

Cost Recovery Mechanisms

APS has received regulatory decisions that allow for more timely recovery of certain costs through the following recovery mechanisms.

Renewable Energy Standard. In 2006, the ACC approved the RES. Under the RES, electric utilities that are regulated by the ACC must supply an increasing percentage of their retail electric energy sales from eligible renewable resources, including solar, wind, biomass, biogas and geothermal technologies. In order to achieve these requirements, the ACC allows APS to include a RES surcharge as part of customer bills to recover the approved amounts for use on renewable energy projects. Each year APS is required to file a five-year implementation plan with the ACC and seek approval for funding the upcoming year’s RES budget.

In December 2014, the ACC voted that it had no objection to APS implementing an APS-owned rooftop solar research and development program aimed at learning how to efficiently enable the integration of rooftop solar and battery storage with the grid. The first stage of the program, called the "Solar Partner Program," placed 8 MW of residential rooftop solar on strategically selected distribution feeders in an effort to maximize potential system benefits, as well as made systems available to limited-income customers who could not easily install solar through transactions with third parties. The second stage of the program, which included an additional 2 MW of rooftop solar and energy storage, placed two energy storage systems sized at 2 MW on two different high solar penetration feeders to test various grid-related operation improvements and system interoperability, and was in operation by the end of 2016. The ACC expressly reserved that any determination of prudency of the residential rooftop solar program for rate making purposes would not be made until the project was fully in service, and APS has requested cost recovery for the project in its currently pending rate case. On September 30, 2016, APS presented its preliminary findings from the residential rooftop solar program in a filing with the ACC.

On July 1, 2015, APS filed its 2016 RES implementation plan and proposed a RES budget of approximately $148 million. On January 12, 2016, the ACC approved APS’s plan and requested budget.

On July 1, 2016, APS filed its 2017 RES Implementation Plan and proposed a budget of approximately $150 million. APS’s budget request included additional funding to process the high volume of residential rooftop solar interconnection requests and also requested a permanent waiver of the residential distributed energy requirement for 2017 contained in the RES rules. The ACC has not yet ruled on the Company’s 2017 RES Implementation Plan.

In September of 2016, the ACC initiated a proceeding which will examine the possible modernization and expansion of the RES. The ACC noted that many of the provisions of the original rule may no longer be appropriate, and the underlying economic assumptions associated with the rule have changed dramatically. The proceeding will review such issues as the rapidly declining cost of solar generation, an increased interest in community solar projects, energy storage options, and the decline in fossil fuel generation due to stringent regulations of the EPA. The proceeding will also examine the feasibility of increasing the standard to 30% of retail sales by 2030, in contrast to the current standard of 15% of retail sales by 2025. APS cannot predict the outcome of this proceeding.

Demand Side Management Adjustor Charge. The ACC Electric Energy Efficiency Standards require APS to submit a Demand Side Management Implementation Plan ("DSM Plan") for review by and approval of the ACC. In March 2014, the ACC approved a Resource Savings Initiative that allows APS to count towards compliance with the ACC Electric Energy Efficiency Standards, savings from improvements to APS’s transmission and delivery system, generation and facilities that have been approved through a DSM Plan.

On March 20, 2015, APS filed an application with the ACC requesting a budget of $68.9 million for 2015 and minor modifications to its DSM portfolio going forward, including for the first time three resource savings projects which reflect energy savings on APS's system. The ACC approved APS’s 2015 DSM budget on November 25, 2015. In its decision, the ACC also approved that verified energy savings from APS's resource savings projects could be counted toward compliance with the Electric Energy Efficiency Standard, however, the ACC ruled that APS was not allowed to count savings from systems savings projects toward determination of its achievement tier level for its performance incentive, nor may APS include savings from conservation voltage reduction in the calculation of its LFCR mechanism.

On June 1, 2015, APS filed its 2016 DSM Plan requesting a budget of $68.9 million and minor modifications to its DSM portfolio to increase energy savings and cost effectiveness of the programs. On April 1, 2016, APS filed an amended 2016 DSM Plan that sought minor modifications to its existing DSM Plan and requested to continue the current DSMAC and current budget of $68.9 million. On July 12, 2016, the ACC approved APS’s amended DSM Plan and directed APS to spend up to an additional $4 million on a new residential demand response or load management program that facilitates energy storage technology. On December 5, 2016, APS filed for ACC approval of a $4 million Residential Demand Response, Energy Storage and Load Management Program.

On June 1, 2016, the Company filed its 2017 DSM Implementation Plan, in which APS proposes programs and measures that specifically focus on reducing peak demand, shifting load to off-peak periods and educating customers about strategies to manage their energy and demand. The requested budget in the 2017 DSM Implementation Plan is $62.6 million. On January 27, 2017, APS filed an updated and modified 2017 DSM Implementation Plan that incorporated the proposed Residential Demand Response, Energy Storage and Load Management Program and the requested budget increased to $66.6 million. The ACC has not yet ruled on the Company’s 2017 DSM Plan.

Electric Energy Efficiency. On June 27, 2013, the ACC voted to open a new docket investigating whether the Electric Energy Efficiency Standards should be modified. The ACC held a series of three workshops in March and April 2014 to investigate methodologies used to determine cost effective energy efficiency programs, cost recovery mechanisms, incentives, and potential changes to the Electric Energy Efficiency and Resource Planning Rules.

On November 4, 2014, the ACC staff issued a request for informal comment on a draft of possible amendments to Arizona’s Electric Energy Efficiency Standards. The draft proposed substantial changes to the rules and energy efficiency standards. The ACC accepted written comments and took public comment regarding the possible amendments on December 19, 2014. On July 12, 2016, the ACC ordered that ACC staff convene a workshop within 120 days to discuss a number of issues related to the Electric Energy Efficiency Standards, including the process of determining the cost effectiveness of DSM programs and the treatment of peak demand and capacity reductions, among others. ACC staff convened the workshop on November 29, 2016 and sought public comment on potential revisions to the Electric Energy Efficiency Standards. APS cannot predict the outcome of this proceeding.

PSA Mechanism and Balance. The PSA provides for the adjustment of retail rates to reflect variations in retail fuel and purchased power costs. The PSA is subject to specified parameters and procedures, including the following:


•	APS records deferrals for recovery or refund to the extent actual retail fuel and purchased power costs vary from the Base Fuel Rate;


•	An adjustment to the PSA rate is made annually each February 1 (unless otherwise approved by the ACC) and goes into effect automatically unless suspended by the ACC;


•	The PSA uses a forward-looking estimate of fuel and purchased power costs to set the annual PSA rate, which is reconciled to actual costs experienced for each PSA Year (February 1 through January 31) (see the following bullet point);

•

The PSA rate includes (a) a “Forward Component,” under which APS recovers or refunds differences between expected fuel and purchased power costs for the upcoming calendar year and those embedded in the Base Fuel Rate; (b) a “Historical Component,” under which differences between actual fuel and purchased power costs and those recovered through the combination of the Base Fuel Rate and the Forward Component are recovered during the next PSA Year; and (c) a “Transition Component,” under which APS may seek mid-year PSA changes due to large variances between actual fuel and purchased power costs and the combination of the Base Fuel Rate and the Forward Component; and


•	The PSA rate may not be increased or decreased more than $0.004 per kWh in a year without permission of the ACC.

The following table shows the changes in the deferred fuel and purchased power regulatory asset (liability) for 2016 and 2015 (dollars in thousands):



	Year Ended December 31,
	2016			2015
Beginning balance	$	(9,688	)	$	6,926
Deferred fuel and purchased power costs - current period	60,303			(14,997		)
Amounts charged to customers	(38,150		)	(1,617		)
Ending balance	$	12,465		$	(9,688	)

The PSA rate for the PSA year beginning February 1, 2017 is $(0.001348) per kWh, as compared to $0.001678 per kWh for the prior year. This new rate is comprised of a forward component of $(0.001027) per kWh and a historical component of $(0.000321) per kWh.

Transmission Rates, Transmission Cost Adjustor and Other Transmission Matters. In July 2008, FERC approved an Open Access Transmission Tariff for APS to move from fixed rates to a formula rate-setting methodology in order to more accurately reflect and recover the costs that APS incurs in providing transmission services. A large portion of the rate represents charges for transmission services to serve APS’s retail customers ("Retail Transmission Charges"). In order to recover the Retail Transmission Charges, APS was previously required to file an application with, and obtain approval from, the ACC to reflect changes in Retail Transmission Charges through the TCA. Under the terms of the 2012 Settlement Agreement, however, an adjustment to rates to recover the Retail Transmission Charges will be made annually each June 1 and will go into effect automatically unless suspended by the ACC.

The formula rate is updated each year effective June 1 on the basis of APS’s actual cost of service, as disclosed in APS’s FERC Form 1 report for the previous fiscal year. Items to be updated include actual capital expenditures made as compared with previous projections, transmission revenue credits and other items. The resolution of proposed adjustments can result in significant volatility in the revenues to be collected. APS reviews the proposed formula rate filing amounts with the ACC staff. Any items or adjustments which are not agreed to by APS and the ACC staff can remain in dispute until settled or litigated at FERC. Settlement or litigated resolution of disputed issues could require an extended period of time and could have a significant effect on the Retail Transmission Charges because any adjustment, though applied prospectively, may be calculated to account for previously over- or under-collected amounts.

Effective June 1, 2015, APS’s annual wholesale transmission rates for all users of its transmission system decreased by approximately $17.6 million for the twelve-month period beginning June 1, 2015 in accordance with the FERC-approved formula. An adjustment to APS’s retail rates to recover FERC-approved transmission charges went into effect automatically on June 1, 2015.

Effective June 1, 2016, APS's annual wholesale transmission rates for all users of its transmission system increased by approximately $24.9 million for the twelve-month period beginning June 1, 2016 in accordance with the FERC-approved formula. An adjustment to APS’s retail rates to recover FERC approved transmission charges went into effect automatically on June 1, 2016.

APS's formula rate protocols have been in effect since 2008. Recent FERC orders suggest that FERC is examining the structure of formula rate protocols and may require companies to make changes to their protocols in the future. As a result, APS is evaluating how its formula rate protocols compare with more recently approved formula rate protocols and anticipates that it will make a filing to update its formula rate protocols in the first quarter of 2017.

Lost Fixed Cost Recovery Mechanism. The LFCR mechanism permits APS to recover on an after-the-fact basis a portion of its fixed costs that would otherwise have been collected by APS in the kWh sales lost due to APS energy efficiency programs and to distributed generation such as rooftop solar arrays. The fixed costs recoverable by the LFCR mechanism were established in the 2012 Settlement Agreement and amount to approximately 3.1 cents per residential kWh lost and 2.3 cents per non-residential kWh lost. The LFCR adjustment has a year-over-year cap of 1% of retail revenues. Any amounts left unrecovered in a particular year because of this cap can be carried over for recovery in a future year. The kWh’s lost from energy efficiency are based on a third-party evaluation of APS’s energy efficiency programs. Distributed generation sales losses are determined from the metered output from the distributed generation units.

APS files for a LFCR adjustment every January. APS filed its 2015 annual LFCR adjustment on January 15, 2015, requesting an LFCR adjustment of $38.5 million, which was approved on March 2, 2015, effective for the first billing cycle of March. APS filed its 2016 annual LFCR adjustment on January 15, 2016, requesting an LFCR adjustment of $46.4 million (a $7.9 million annual increase), to be effective for the first billing cycle of March 2016. The ACC approved the 2016 annual LFCR to be effective in May 2016. Because the LFCR mechanism has a balancing account that trues up any under or over recoveries, the two month delay in implementation did not have an adverse effect on APS. APS filed its 2017 LFCR adjustment on January 13, 2017. APS requested an adjustment of $63.7 million (a $17.3 million per year increase over 2016 levels), to be effective the first billing cycle of March 2017.

Net Metering

In 2015, the ACC voted to conduct a generic evidentiary hearing on the value and cost of distributed generation to gather information that will inform the ACC on net metering issues and cost of service studies in upcoming utility rate cases. A hearing was held in April 2016. On October 7, 2016, the ALJ issued a recommendation in the docket concerning the value and cost of DG solar installations. On December 20, 2016, the ACC completed its open meeting to consider the recommended decision by the ALJ. After making several amendments, the ACC approved the recommended decision by a 4-1 vote. As a result of the ACC’s action, effective following APS’s pending rate case, the current net metering tariff that governs payments for energy exported to the grid from rooftop solar systems will be replaced by a more formula-driven approach that will utilize inputs from historical wholesale solar power costs and eventually an avoided cost methodology.

As amended, the decision provides that payments by utilities for energy exported to the grid from DG solar facilities will be determined using a resource comparison proxy methodology, a method that is based on the price that APS pays for utility-scale solar projects on a five year rolling average, while a forecasted avoided cost methodology is being developed. The price established by this resource comparison proxy method will be updated annually (between rate cases) but will not be decreased by more than 10% per year. Once the avoided cost methodology is developed, the ACC will determine in APS's subsequent rate cases which method (or a combination of methods) is appropriate to determine the actual price to be paid by that utility for exported distributed energy.

In addition, the ACC made the following determinations:


•	Customers who have interconnected a DG system or submitted an application for interconnection for DG systems prior to the date new rates are effective based on APS' pending rate case will be grandfathered for a period of 20 years from the date of interconnection;


•	Customers with DG solar systems are to be considered a separate class of customers for ratemaking purposes; and


•	Once an export price is set for APS, no netting or banking of retail credits will be available for new DG customers, and the then-applicable export price will be guaranteed for new customers for a period of 10 years.

This decision of the ACC addresses policy determinations only. The decision states that its principles will be applied in future rate cases, and the policy determinations themselves may be subject to future change as are all ACC policies. The determination of the initial export energy price to be paid by APS will be made in APS’s currently pending rate case, which is scheduled for hearing by the ACC in April 2017. APS cannot predict the outcome of this determination.

The ACC’s decision did not make any policy determinations as to any specific costs to be charged to DG solar system customers for their use of the grid. The determination of any such costs will be made in APS's future rate cases.

On January 23, 2017, The Alliance for Solar Choice ("TASC") sought rehearing of the ACC's decision regarding the value and cost of DG. TASC asserts that the ACC improperly ignored the Administrative Procedure Act, failed to give adequate notice regarding the scope of the proceedings, and relied on information that was not submitted as evidence, among other alleged defects. TASC's request for rehearing is required for TASC to challenge this decision in court. To date, the ACC has taken no action on the rehearing request. The ACC's decision is expected to remain in effect during any legal challenge.

Appellate Review of Third-Party Regulatory Decision ("System Improvement Benefits" or "SIB")

In a recent appellate challenge to an ACC rate decision involving a water company, the Arizona Court of Appeals considered the question of how the ACC should determine the “fair value” of a utility’s property, as specified in the Arizona Constitution, in connection with authorizing the recovery of costs through rate adjustors outside of a rate case. The Court of Appeals reversed the ACC’s method of finding fair value in that case, and raised questions concerning the relationship between the need for fair value findings and the recovery of capital and certain other utility costs through adjustors. The ACC sought review by the Arizona Supreme Court of this decision, and APS filed a brief supporting the ACC’s petition to the Arizona Supreme Court for review of the Court of Appeals’ decision. On February 9, 2016, the Arizona Supreme Court granted review of the decision and on August 8, 2016, the Arizona Supreme Court vacated the Court of Appeals opinion and affirmed the ACC’s orders approving the water company’s SIB adjustor.

System Benefits Charge

The 2012 Settlement Agreement provided that once APS achieved full funding of its decommissioning obligation under the sale leaseback agreements covering Unit 2 of Palo Verde, APS was required to implement a reduced System Benefits charge effective January 1, 2016. Beginning on January 1, 2016, APS began implementing a reduced System Benefits charge. The impact on APS retail revenues from the new System Benefits charge is an overall reduction of approximately $14.6 million per year with a corresponding reduction in depreciation and amortization expense.

Subpoena from Arizona Corporation Commissioner Robert Burns

On August 25, 2016, Commissioner Burns, individually and not by action of the ACC as a whole, filed subpoenas in APS’s current retail rate proceeding to APS and Pinnacle West for the production of records and information relating to a range of expenditures from 2011 through 2016. The subpoenas requested information concerning marketing and advertising expenditures, charitable donations, lobbying expenses, contributions to 501(c)(3) and (c)(4) nonprofits and political contributions. The return date for the production of information was set as September 15, 2016. The subpoenas also sought testimony from Company personnel having knowledge of the material, including the Chief Executive Officer.

On September 9, 2016, APS filed with the ACC a motion to quash the subpoenas or, alternatively to stay APS's obligations to comply with the subpoenas and decline to decide APS's motion pending court proceedings. Contemporaneously with the filing of this motion, APS and Pinnacle West filed a complaint for special action and declaratory judgment in the Superior Court of Arizona for Maricopa County, seeking a declaratory judgment that Commissioner Burns’ subpoenas are contrary to law. On September 15, 2016, APS produced all non-confidential and responsive documents and offered to produce any remaining responsive documents that are confidential after an appropriate confidentiality agreement is signed.

On February 7, 2017, Commissioner Burns opened a new ACC docket and indicated that its purpose is to study and rectify problems with transparency and disclosure regarding financial contributions from regulated monopolies or other stakeholders who may appear before the ACC that may directly or indirectly benefit an ACC Commissioner, a candidate for ACC Commissioner, or key ACC staff. As part of this docket, Commissioner Burns set March 24, 2017 as a deadline for APS to produce all information previously requested through the subpoenas. Commissioner Burns has also scheduled a workshop in this matter for March 17, 2017. APS and Pinnacle West cannot predict the outcome of this matter.

Four Corners

On December 30, 2013, APS purchased SCE’s 48% ownership interest in each of Units 4 and 5 of Four Corners. The 2012 Settlement Agreement includes a procedure to allow APS to request rate adjustments prior to its next general rate case related to APS’s acquisition of the additional interests in Units 4 and 5 and the related closure of Units 1-3 of Four Corners. APS made its filing under this provision on December 30, 2013. On December 23, 2014, the ACC approved rate adjustments resulting in a revenue increase of $57.1 million on an annual basis. This includes the deferral for future recovery of all non-fuel operating costs for the acquired SCE interest in Four Corners, net of the non-fuel operating costs savings resulting from the closure of Units 1-3 from the date of closing of the purchase through its inclusion in rates. The 2012 Settlement Agreement also provides for deferral for future recovery of all unrecovered costs incurred in connection with the closure of Units 1-3. The deferral balance related to the acquisition of SCE’s interest in Units 4 and 5 and the closure of Units 1-3 was $64 million as of December 31, 2016 and is being amortized in rates over a total of 10 years. On February 23, 2015, the Arizona School Boards Association and the Association of Business Officials filed a notice of appeal in Division 1 of the Arizona Court of Appeals of the ACC decision approving the rate adjustments. APS has intervened and is actively participating in the proceeding. The Arizona Court of Appeals suspended the appeal pending the Arizona Supreme Court's decision in the SIB matter discussed above. On August 8, 2016, the Arizona Supreme Court issued its opinion in the SIB matter, and the Arizona Court of Appeals has now ordered supplemental briefing on how that SIB decision should affect the challenge to the Four Corners rate adjustment. We cannot predict when or how this matter will be resolved.

As part of APS’s acquisition of SCE’s interest in Units 4 and 5, APS and SCE agreed, via a “Transmission Termination Agreement” that, upon closing of the acquisition, the companies would terminate an existing transmission agreement (“Transmission Agreement”) between the parties that provides transmission capacity on a system (the “Arizona Transmission System”) for SCE to transmit its portion of the output from Four Corners to California. APS previously submitted a request to FERC related to this termination, which resulted in a FERC order denying rate recovery of $40 million that APS agreed to pay SCE associated with the termination. On December 22, 2015, APS and SCE agreed to terminate the Transmission Termination Agreement and allow for the Transmission Agreement to expire according to its terms, which includes settling obligations in accordance with the terms of the Transmission Agreement. APS established a regulatory asset of $12 million in 2015 in connection with the payment required under the terms of the Transmission Agreement. On July 1, 2016, FERC issued an order denying APS’s request to recover the regulatory asset through its FERC-jurisdictional rates. APS and SCE completed the termination of the Transmission Agreement on July 6, 2016. APS made the required payment to SCE and wrote-off the $12 million regulatory asset and charged operating revenues to reflect the effects of this order in the second quarter of 2016. On July 29, 2016, APS filed a request for rehearing with FERC. In its order denying recovery, FERC also referred to its enforcement division a question of whether the agreement between APS and SCE relating to the settlement of obligations under the Transmission Agreement was a jurisdictional contract that should have been filed with FERC. APS cannot predict the outcome of either matter.

Cholla

On September 11, 2014, APS announced that it would close Cholla Unit 2 and cease burning coal at the other APS-owned units (Units 1 and 3) at the plant by the mid-2020s, if EPA approves a compromise proposal offered by APS to meet required environmental and emissions standards and rules. On April 14, 2015, the ACC approved APS's plan to retire Unit 2, without expressing any view on the future recoverability of APS's remaining investment in the Unit. APS closed Unit 2 on October 1, 2015. On January 13, 2017, EPA approved a final rule incorporating APS's compromise proposal. Once the final rule is published in the Federal Register, parties have 60 days to file a petition for review in the Ninth Circuit Court of Appeals. APS cannot predict at this time whether such petitions will be filed or if they will be successful. In addition, under the terms of an executive memorandum issued on January 20, 2017, this final rule will not be published in the Federal Register until after it has been reviewed by an appointee of the President. We cannot predict when such review will occur and what may result from the additional review.

Previously, APS estimated Cholla Unit 2’s end of life to be 2033. APS is currently recovering a return on and of the net book value of the unit in base rates and is seeking recovery of the unit’s decommissioning and other retirement-related costs over the previously estimated remaining life of the plant in its current retail rate case. APS believes it will be allowed recovery of the remaining net book value of Unit 2 ($116 million as of December 31, 2016), in addition to a return on its investment. In accordance with GAAP, in the third quarter of 2014, Unit 2’s remaining net book value was reclassified from property, plant and equipment to a regulatory asset. If the ACC does not allow full recovery of the remaining net book value of Cholla Unit 2, all or a portion of the regulatory asset will be written off and APS’s net income, cash flows, and financial position will be negatively impacted.

Navajo Plant

On February 13, 2017, the co-owners of the Navajo Plant voted not to pursue continued operation of the plant beyond December 2019, the expiration of the current lease term, and to pursue a new lease or lease extension with the Navajo Nation that would allow decommissioning activities to begin after December 2019 instead of later this year. Various stakeholders including regulators, tribal representatives and others interested in the continued operation of the plant intend to meet to determine if an alternate solution can be reached that would permit continued operation of the plant beyond 2019. We cannot predict whether any alternate solutions will be found that would be acceptable to all of the stakeholders and feasible to implement. APS is currently recovering depreciation and a return on the net book value of its interest in the Navajo Plant. APS will seek continued recovery in rates for the book value of its remaining investment in the plant ($108 million as of December 31, 2016, see Note 9 for additional details) plus a return on the net book value as well as other costs related to retirement and closure, which are still being assessed and which may be material. We cannot predict whether APS would obtain such recovery.

On February 14, 2017, the ACC opened a docket titled "ACC Investigation Concerning the Future of the Navajo Generating Station" with the stated goal of engaging stakeholders and negotiating a sustainable pathway for the Navajo Plant to continue operating in some form after December 2019. APS cannot predict the outcome of this proceeding.

Regulatory Assets and Liabilities

The detail of regulatory assets is as follows (dollars in thousands):



S	Amortization Through	December 31, 2016				December 31, 2015
		Current		Non-Current		Current		Non-Current
Pension	(a)	$	—	$	711,059	$	—	$	619,223
Retired power plant costs	2033	9,913		117,591		9,913		127,518
Income taxes - AFUDC equity	2046	6,305		152,118		5,495		133,712
Deferred fuel and purchased power — mark-to-market (Note 16)	2020	—		42,963		71,852		69,697
Four Corners cost deferral	2024	6,689		56,894		6,689		63,582
Income taxes — investment tax credit basis adjustment	2046	2,120		54,356		1,766		48,462
Lost fixed cost recovery	2017	61,307		—		45,507		—
Palo Verde VIEs (Note 18)	2046	—		18,775		—		18,143
Deferred compensation	2036	—		35,595		—		34,751
Deferred property taxes	(d)	—		73,200		—		50,453
Loss on reacquired debt	2038	1,637		16,942		1,515		16,375
AG-1 deferral	2018	—		5,868		—		—
Demand side management (b)	2017	3,744		—		—		—
Tax expense of Medicare subsidy	2024	1,513		10,589		1,520		12,163
Transmission vegetation management	2016	—		—		4,543		—
Mead-Phoenix transmission line CIAC	2050	332		10,708		332		11,040
Deferred fuel and purchased power (b) (c)	2017	12,465		—		—		—
Coal reclamation	2026	418		5,182		418		6,085
Other	Various	432		1,588		5		2,942
Total regulatory assets (e)		$	106,875	$	1,313,428	$	149,555	$	1,214,146


(a)	This asset represents the future recovery of pension benefit obligations through retail rates. If these costs are disallowed by the ACC, this regulatory asset would be charged to OCI and result in lower future revenues. See Note 7 for further discussion.


(b)	See “Cost Recovery Mechanisms” discussion above.


(c)	Subject to a carrying charge.


(d)	Per the provision of the 2012 Settlement Agreement.


(e)	There are no regulatory assets for which the ACC has allowed recovery of costs, but not allowed a return by exclusion from rate base. FERC rates are set using a formula rate as described in “Transmission Rates, Transmission Cost Adjustor and Other Transmission Matters.”

The detail of regulatory liabilities is as follows (dollars in thousands):



	Amortization Through	December 31, 2016				December 31, 2015
		Current		Non-Current		Current		Non-Current
Asset retirement obligations	2057	$	—	$	279,976	$	—	$	277,554
Removal costs	(a)	29,899		223,145		39,746		240,367
Other postretirement benefits	(d)	32,662		123,913		34,100		179,521
Income taxes — deferred investment tax credit	2046	4,368		108,827		3,604		97,175
Income taxes - change in rates	2045	1,771		70,898		1,113		72,454
Spent nuclear fuel	2047	—		71,726		3,051		67,437
Renewable energy standard (b)	2017	26,809		—		43,773		4,365
Demand side management (b)	2019	—		20,472		6,079		19,115
Sundance maintenance	2030	—		15,287		—		13,678
Deferred fuel and purchased power (b) (c)	2016	—		—		9,688		—
Deferred gains on utility property	2018	2,063		8,895		2,062		6,001
Four Corners coal reclamation	2031	—		18,248		—		8,920
Other	Various	2,327		7,529		2,550		7,565
Total regulatory liabilities		$	99,899	$	948,916	$	145,766	$	994,152


(a)	In accordance with regulatory accounting guidance, APS accrues for removal costs for its regulated assets, even if there is no legal obligation for removal (see Note 11).


(b)	See “Cost Recovery Mechanisms” discussion above.


(c)	Subject to a carrying charge.


(d)	See Note 7.