Leases

9 Months Ended

Sep. 30, 2023

We lease certain land, buildings, vehicles, equipment and other property through operating rental agreements with varying terms, provisions, and expiration dates. APS also has certain purchased power and energy storage agreements that qualify as lease arrangements. Our leases have remaining terms that expire in 2023 through 2073. Substantially all of our leasing activities relate to APS.

In 1986, APS entered into agreements with three separate lessor trust entities in order to sell and lease back interests in Palo Verde Unit 2 and related common facilities. These lessor trust entities have been deemed VIEs for which APS is the primary beneficiary. As the primary beneficiary, APS consolidated these lessor trust entities. The impacts of these sale leaseback transactions are excluded from our lease disclosures as lease accounting is eliminated upon consolidation. See Note 6 for a discussion of VIEs.

APS has purchased power lease agreements that allow APS the right to the generation capacity from certain natural-gas fueled generators during certain months of each year throughout the term of the arrangements. As APS only has rights to use the assets during certain periods of each year, the leases have non-consecutive periods of use. APS does not operate or maintain the leased assets. APS controls the dispatch of the leased assets during the months of use and is required to pay a fixed monthly capacity payment during these periods of use. For these types of leased assets, APS has elected to combine both the lease and non-lease payment components and accounts for the entire fixed payment as a lease obligation. In addition to the fixed monthly capacity payments, APS must also pay variable charges based on the actual production volume of the assets. The variable consideration is not included in the measurement of our lease obligation.

In January 2023, APS modified two existing purchase power operating lease agreements. Among other changes, the modifications extend the expiration dates of these contracts from October 2027 to October 2032 for one of the leases, and from September 2026 to October 2034 for the other lease. These lease agreements previously commenced in 2020 and 2021.

APS has executed various energy storage purchased power lease agreements that allow APS the right to charge and discharge energy storage facilities. The first of these energy storage leases commenced in September 2023, and is classified as an operating lease. This agreement provides APS the use of the energy

storage facility through May 2043. APS pays a fixed monthly capacity price for rights to use the leased asset. APS does not operate or maintain the energy storage facility and has no purchase options or residual value guarantees relating to the lease asset. For this class of energy storage lease assets, APS has elected to separate the lease and non-lease components.

The following tables provide information related to our lease costs (dollars in thousands):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2023		2022		2023		2022
Operating Lease Cost - Purchased Power & Energy Storage Lease Contracts	$	81,456	$	68,714	$	117,111	$	97,854
Operating Lease Cost - Land, Property, and Other Equipment	4,820		4,456		14,394		13,597
Total Operating Lease Cost	86,276		73,170		131,505		111,451
Variable lease cost (a)	48,572		42,188		113,296		103,493
Short-term lease cost	9,114		5,065		17,918		8,568
Total lease cost	$	143,962	$	120,423	$	262,719	$	223,512

(a) Primarily relates to purchased power lease contracts.

Lease costs are primarily included as a component of operating expenses on our Condensed Consolidated Statements of Income. Lease costs relating to purchased power and energy storage lease contracts are recorded in fuel and purchased power on the Condensed Consolidated Statements of Income and are subject to recovery under the PSA or RES. See Note 4. The tables above reflect the lease cost amounts before the effect of regulatory deferral under the PSA and RES. Variable lease costs are recognized in the period the costs are incurred, and primarily relate to renewable purchased power lease contracts. Payments under most renewable purchased power lease contracts are dependent upon environmental factors, and due to the inherent uncertainty associated with the reliability of the fuel source, the payments are considered variable and are excluded from the measurement of lease liabilities and right-of-use lease assets. Certain of our lease agreements have lease terms with non-consecutive periods of use. For these agreements, we recognize lease costs during the periods of use. Leases with initial terms of 12 months or less are considered short-term leases and are not recorded on the balance sheet.

The following table provides information related to the maturity of our operating lease liabilities (dollars in thousands):


	September 30, 2023
Year	Purchased Power & Energy Storage Lease Contracts		Land, Property & Equipment Leases		Total
2023 (remaining three months of 2023)	$	30,520	$	4,004	$	34,524
2024	108,201		13,964		122,165
2025	124,968		11,480		136,448
2026	138,692		9,181		147,873
2027	164,613		7,154		171,767
2028	168,410		4,831		173,241
Thereafter	835,813		63,473		899,286
Total lease commitments	1,571,217		114,087		1,685,304
Less imputed interest	347,899		42,188		390,087
Total lease liabilities	$	1,223,318	$	71,899	$	1,295,217

We recognize lease assets and liabilities upon lease commencement. At September 30, 2023, we have lease arrangements that have been executed, but have not yet commenced. We expect the total fixed consideration paid for these arrangements, which includes both lease and non-lease payments, will approximate $7.1 billion over the terms of the arrangements. These arrangements primarily relate to energy storage assets. The lease commencement dates for these arrangements have experienced delays. APS continues to work with the lessors to determine revised commencement dates. We expect lease commencement dates ranging from November 2023 through June 2025, with lease terms expiring through May 2045. As a result of these delays and other events, APS has received cash proceeds from the lessors prior to lease commencement. Proceeds received from lessors relating to energy storage PPA leases are accounted for as lease incentives on our Condensed Consolidated Balance Sheets, and upon lease commencement are amortized over the associated lease term. For regulatory purposes, the proceeds received by APS relating to these PPA leases are treated as a reduction to fuel and purchased power cost through the PSA in the period proceeds are received. See Note 4.

The following tables provide other additional information related to operating lease liabilities (dollars in thousands):


	Nine Months Ended September 30, 2023			Nine Months Ended September 30, 2022
Cash paid for amounts included in the measurement of lease liabilities — operating cash flows:	$	89,304		$	86,323
Right-of-use operating lease assets obtained in exchange for operating lease liabilities	599,281		(a)	14,533


	September 30, 2023		December 31, 2022
Weighted average remaining lease term	10 years		7 years
Weighted average discount rate (b)	4.53	%	2.21	%

(a) Primarily relates to the two purchased power operating lease agreements that were modified in January 2023.

(b) Most of our lease agreements do not contain an implicit rate that is readily determinable. For these agreements, we use our incremental borrowing rate to measure the present value of lease liabilities. We determine our incremental borrowing rate at lease commencement based on the rate of interest that we would have to pay to borrow, on a collateralized basis over a similar term, an amount equal to the lease payments in a similar economic environment. We use the implicit rate when it is readily determinable.