2. Fair Value:

Authoritative guidance regarding fair value measurements for financial and non-financial assets and liabilities defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements.

The guidance establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value as follows:

•: Level 1. Quoted prices from active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis. Quoted prices in active markets provide the most reliable evidence of fair value and are used to measure fair value whenever available. Level 1 primarily consists of financial instruments that are exchange-traded.
•: Level 2. Pricing inputs 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 financial instruments that are valued using models or other valuation methodologies. These models are primarily industry-standard models that consider various assumptions, including quoted forward prices for commodities, time value, volatility factors, and current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Level 2 primarily consists of financial instruments that are non-exchange-traded but have significant observable inputs.
•: Level 3. Pricing inputs that include significant inputs which are generally less observable from objective sources. These inputs may include internally developed methodologies that result in management's best estimate of fair value. Level 3 financial instruments are those whose fair value is based on significant unobservable inputs.

Assets and liabilities measured at fair value are based on one or more of the following three valuation techniques:

(1)

Market approach.  The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business) and deriving fair value based on these inputs.

(2)

Income approach.  The income approach uses valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present amount (discounted). The measurement is based on the value indicated by current market expectations about those future amounts.

(3)

Cost approach.  The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (often referred to as current replacement cost). This approach assumes that the fair value would not exceed what it would cost a market participant to acquire or construct a substitute asset or comparable utility adjusted for obsolescence.

The table below details assets and liabilities measured at fair value on a recurring basis for the periods ended December 31, 2013 and 2012, respectively.



	Fair Value Measurements at Reporting Date Using
		December 31, 2013			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)	Valuation Technique

		(dollars in thousands)
Nuclear decommissioning trust funds:
Domestic equity	$	143,929		$	143,929	$	–	$	–	(1	)
International equity trust		72,466			–		72,466		–	(1	)
Corporate bonds		39,863			–		39,863		–	(1	)
U.S. Treasury and government agency securities		44,846			44,846		–		–	(1	)
Agency mortgage and asset backed securities		30,133			–		30,133		–	(1	)
Municipal Bonds		641			–		641		–	(1	)
Other		11,820			11,820		–		–	(1	)
Long-term investments:
Corporate bonds		6,487			–		6,487		–	(1	)
U.S. Treasury and government agency securities		8,563			8,563		–		–	(1	)
Agency mortgage and asset backed securities		3,679			–		3,679		–	(1	)
International equity trust		11,148			–		11,148		–	(1	)
Mutual funds		51,559			51,559		–		–	(1	)
Other		284			284		–		–	(1	)
Interest rate options		63,471	⁽¹⁾		–		–		63,471	(3	)
Natural gas swaps		1,011			–		1,011		–	(1	)



	Fair Value Measurements at Reporting Date Using
		December 31, 2012			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)	Valuation Technique

		(dollars in thousands)
Nuclear Decommissioning trust funds:
Domestic equity	$	118,329		$	118,329	$	–		$	–	(1	)
International equity		48,105			48,105						(1	)
Corporate bonds		53,172			–		53,172			–	(1	)
U.S. Treasury and government agency securities		46,626			46,626		–			–	(1	)
Agency mortgage and asset backed securities		21,273			–		21,273			–	(1	)
Other		13,280			13,280		–			–	(1	)
Long-term investments:
Corporate bonds		5,762			–		5,762			–	(1	)
U.S. Treasury and government agency securities		7,387			7,387		–			–	(1	)
Agency mortgage and asset backed securities		2,526			–		2,526			–	(1	)
Mutual funds		60,972			60,972		–			–	(1	)
Other		375			375		–			–	(1	)
Interest rate options		25,783	⁽¹⁾		–		–			25,783	(3	)
Natural gas swaps		(1,085	)		–		(1,085	)		–	(1	)

(1): Interest rate options as reflected on the Consolidated Balance Sheet includes the fair value of the interest rate options offset by $34,970,000 and $8,950,000 of collateral received by the counterparties at December 31, 2013 and 2012, respectively.

The Level 2 investments above in corporate bonds and agency mortgage and asset backed securities may not be exchanged traded. The fair value measurements for these investments are based on a market approach, including the use of observable inputs. Common inputs include reported trades and broker/dealer bid/ask prices.

The following tables present the changes in Level 3 assets measured at fair value on a recurring basis during the years ended December 31, 2013 and 2012, respectively.



	Year Ended December 31, 2013
		Interest rate options

		(dollars in thousands)
Assets:
Balance at December 31, 2012	$	25,783
Total gains or losses (realized/unrealized):
Included in earnings (or changes in net assets)		37,688

Balance at December 31, 2013	$	63,471



	Year Ended December 31, 2012
		Nuclear decommissioning trust funds			Long-term investments			Interest rate options

		(dollars in thousands)
Assets:
Balance at December 31, 2011	$	(982	)	$	7,713		$	69,446
Total gains or losses (realized/unrealized):
Included in earnings (or changes in net assets)		982			887			(43,663	)
Purchases, issuances, liquidations		–			(8,600	)		–

Balance at December 31, 2012	$	–		$	–		$	25,783

We estimate the value of the interest rate options as the sum of time value and any intrinsic value minus a counterparty credit adjustment. Intrinsic value is the value of the underlying swap, which we are able to calculate based on the forward LIBOR swap rates, the fixed rate on the underlying swap, the time to expiration, the term of the underlying swap and discount rates, all of which we are able to effectively observe. Time value is the additional value of the swaption due to the fact that it is an option. We estimate the time value using an option pricing model which, in addition to the factors used to calculate intrinsic value, also takes into account option volatility, which we estimate based on option valuations we obtain from various sources. We estimate the counterparty credit adjustment by observing credit attributes, including the credit default swap spread of entities similar to the counterparty and the amount of credit support that is available for each swaption. Since the primary component of the LIBOR swaptions' value is time value, which is based on estimated option volatility derived from valuations of comparable instruments that are generally not publicly available, we have categorized these LIBOR swaptions as Level 3. We believe the estimated fair values for the LIBOR swaptions we hold are based on the most accurate information available for these types of derivative contracts. For additional information regarding our interest rate options, see Note 3.

The Level 3 long-term investments in the above table for the year ended December 31, 2012 represent auction rate securities. On February 15, 2012, we sold our remaining $8,600,000 of auction rate securities, which resulted in a loss of $1,075,000. The loss was recorded as a regulatory asset and is being charged to income over a period of four years. As a result of market conditions, including the failure of auctions for the auction rate securities in which we had invested, the fair value of these auction rate securities in prior periods were determined using an income approach based on a discounted cash flow model. The discounted cash flow model utilized projected cash flows at current rates, which was adjusted for illiquidity premiums based on discussions with market participants.

The estimated fair values of our long-term debt, including current maturities at December 31, 2013 and 2012 were as follows (in thousands):



		2013				2012
		Carrying Value		Fair Value		Carrying Value		Fair Value

Long-term debt	$	6,954,293	$	7,317,476	$	5,930,449	$	7,213,365

Long-term debt is classified as Level 2 and is estimated based on observed or quoted market prices for the same or similar issues or on current rates offered to us for debt of similar maturities. The primary sources of our long-term debt consist of first mortgage bonds, pollution control revenue bonds and long-term debt issued by the Federal Financing Bank. We also have small amounts of long-term debt provided by National Rural Utilities Cooperative Finance Corporation (CFC) and by CoBank, ACB in addition to a multi-year term loan with Bank of Tokyo. The valuations for the first mortgage bonds and the pollution control revenue bonds were obtained from third party investment banking firms and a third party subscription service, and are based on secondary market trading of our debt. Valuations for debt issued by the Federal Financing Bank are based on U.S. Treasury rates as of December 31, 2013 plus ¹/8 percent, which reflects our borrowing rate for new loans of this type from the Federal Financing Bank. We use an interest rate quote sheet provided by CoBank for valuation of the CoBank debt, which reflects current rates for a similar loan. The rates on the CFC debt are fixed and the valuation is based on rate quotes provided by CFC. The rate in effect at December 31, 2013 for our term loan, which resets each month and is based on a 1.25% spread to LIBOR, was used for valuation of the term loan.

For cash and cash equivalents, restricted cash and receivables, the carrying amount approximates fair value because of the short-term maturity of those instruments.