Fair Value of Financial Assets and Liabilities

Fair Value Measurements

The accounting guidance for fair value measurements and disclosures provides a single definition of fair value and requires certain disclosures about assets and liabilities measured at fair value. A hierarchical framework for disclosing the observability of the inputs utilized in measuring assets and liabilities at fair value is established by this guidance. The three levels in the hierarchy are as follows:

Level 1 — Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. The types of assets and liabilities included in Level 1 are highly liquid and actively traded instruments with quoted prices.

Level 2 — Pricing inputs are other than quoted prices in active markets, but are either directly or indirectly observable as of the reporting date. The types of assets and liabilities included in Level 2 are typically either comparable to actively traded securities or contracts, or priced with models using highly observable inputs.

Level 3 — Significant inputs to pricing have little or no observability as of the reporting date. The types of assets and liabilities included in Level 3 are those valued with models requiring significant management judgment or estimation.

Specific valuation methods include the following:

Cash equivalents — The fair values of cash equivalents are generally based on cost plus accrued interest; money market funds are measured using quoted net asset values.

Commodity derivatives — The methods used to measure the fair value of commodity derivative forwards and options utilize forward prices and volatilities, as well as pricing adjustments for specific delivery locations, and are generally assigned a Level 2. When contractual settlements extend to periods beyond those readily observable on active exchanges or quoted by brokers, the significance of the use of less observable forecasts of long-term forward prices and volatilities on a valuation is evaluated, and may result in Level 3 classification.

Derivative Instruments Fair Value Measurements

PSCo enters into derivative instruments, including forward contracts, futures, swaps and options, for trading purposes and to manage risk in connection with changes in interest rates, utility commodity prices and vehicle fuel prices.

Interest Rate Derivatives — PSCo enters into various instruments that effectively fix the interest payments on certain floating rate debt obligations or effectively fix the yield or price on a specified benchmark interest rate for an anticipated debt issuance for a specific period. These derivative instruments are generally designated as cash flow hedges for accounting purposes.

At Dec. 31, 2013, accumulated other comprehensive losses related to interest rate derivatives included $0.5 million of net gains expected to be reclassified into earnings during the next 12 months as the related hedged interest rate transactions impact earnings, including forecasted amounts for unsettled hedges, as applicable.

In conjunction with the PSCo debt issuance in September 2012, PSCo settled interest rate hedging instruments with a notional amount of $250 million with cash payments of $44.7 million. This loss is classified as a component of accumulated other comprehensive loss on the consolidated balance sheet, net of tax, and is being reclassified to earnings over the term of the hedged interest payments. See Note 4 for further discussion of long-term borrowings.

Wholesale and Commodity Trading Risk — PSCo conducts various wholesale and commodity trading activities, including the purchase and sale of electric capacity, energy and energy-related instruments. PSCo’s risk management policy allows management to conduct these activities within guidelines and limitations as approved by its risk management committee, which is made up of management personnel not directly involved in the activities governed by this policy.

Commodity Derivatives — PSCo enters into derivative instruments to manage variability of future cash flows from changes in commodity prices in its electric and natural gas operations, as well as for trading purposes. This could include the purchase or sale of energy or energy-related products, natural gas to generate electric energy, natural gas for resale, and vehicle fuel.

At Dec. 31, 2013, PSCo had various vehicle fuel contracts designated as cash flow hedges extending through December 2016. PSCo also enters into derivative instruments that mitigate commodity price risk on behalf of electric and natural gas customers but are not designated as qualifying hedging transactions. Changes in the fair value of non-trading commodity derivative instruments are recorded in OCI or deferred as a regulatory asset or liability. The classification as a regulatory asset or liability is based on commission approved regulatory recovery mechanisms. PSCo recorded immaterial amounts to income related to the ineffectiveness of cash flow hedges for the years ended Dec. 31, 2013 and 2012.

At Dec. 31, 2013, net gains related to commodity derivative cash flow hedges recorded as a component of accumulated other comprehensive losses included an immaterial amount of net gains expected to be reclassified into earnings during the next 12 months as the hedged transactions occur.

Additionally, PSCo enters into commodity derivative instruments for trading purposes not directly related to commodity price risks associated with serving its electric and natural gas customers. Changes in the fair value of these commodity derivatives are recorded in electric operating revenues, net of amounts credited to customers under margin-sharing mechanisms.

The following table details the gross notional amounts of commodity forwards and options at Dec. 31, 2013 and 2012:


^(a)	Amounts are not reflective of net positions in the underlying commodities.


^(b)	Notional amounts for options are included on a gross basis, but are weighted for the probability of exercise.

Consideration of Credit Risk and Concentrations — PSCo continuously monitors the creditworthiness of the counterparties to its interest rate derivatives and commodity derivative contracts prior to settlement, and assesses each counterparty’s ability to perform on the transactions set forth in the contracts. Given this assessment, as well as an assessment of the impact of PSCo’s own credit risk when determining the fair value of derivative liabilities, the impact of considering credit risk was immaterial to the fair value of unsettled commodity derivatives presented in the consolidated balance sheets.

PSCo employs additional credit risk control mechanisms when appropriate, such as letters of credit, parental guarantees, standardized master netting agreements and termination provisions that allow for offsetting of positive and negative exposures. Credit exposure is monitored and, when necessary, the activity with a specific counterparty is limited until credit enhancement is provided.

PSCo’s most significant concentrations of credit risk with particular entities or industries are contracts with counterparties to its wholesale, trading and non-trading commodity activities. At Dec. 31, 2013, five of PSCo’s 10 most significant counterparties for these activities, comprising $35.2 million or 36 percent of this credit exposure, had investment grade credit ratings from Standard & Poor’s, Moody’s or Fitch Ratings. The remaining five significant counterparties, comprising $35.9 million or 36 percent of this credit exposure at Dec. 31, 2013, were not rated by these agencies, but based on PSCo’s internal analysis, had credit quality consistent with investment grade. All 10 of these significant counterparties are municipal or cooperative electric entities, or other utilities.

Financial Impact of Qualifying Cash Flow Hedges — The impact of qualifying interest rate and vehicle fuel cash flow hedges on PSCo’s accumulated other comprehensive loss, included in the consolidated statements of common stockholder’s equity and in the consolidated statements of comprehensive income, is detailed in the following table:



(Thousands of Dollars)	2013			2012			2011
Accumulated other comprehensive (loss) income related to cash flow hedges at Jan. 1	$	(22,871	)	$	(12,377	)	$	7,457
After-tax net unrealized gains (losses) related to derivatives accounted for as hedges	9			(9,311		)	(18,328		)
After-tax net realized gains on derivative transactions reclassified into earnings	(476		)	(1,183		)	(1,506		)
Accumulated other comprehensive loss related to cash flow hedges at Dec. 31	$	(23,338	)	$	(22,871	)	$	(12,377	)

The following tables detail the impact of derivative activity during the years ended Dec. 31, 2013, 2012 and 2011, on accumulated other comprehensive loss, regulatory assets and liabilities, and income:



	Year Ended Dec. 31, 2013
	Pre-Tax Fair Value Gains (Losses) Recognized During the Period in:					Pre-Tax (Gains) Losses Reclassified into Income During the Period from:
(Thousands of Dollars)	Accumulated Other Comprehensive Loss		Regulatory (Assets) and Liabilities			Accumulated Other Comprehensive Loss				Regulatory Assets and (Liabilities)			Pre-Tax Losses Recognized During the Period in Income
Derivatives designated as cash flow hedges
Interest rate	$	—	$	—		$	(730	)	^(a)	$	—		$	—
Vehicle fuel and other commodity	14		—			(40		)	^(b)	—			—
Total	$	14	$	—		$	(770	)		$	—		$	—
Other derivative instruments
Natural gas commodity	$	—	$	(4,001	)	$	—			$	4,340	^(e)	$	(5,850	)	^(d)
Total	$	—	$	(4,001	)	$	—			$	4,340		$	(5,850	)



	Year Ended Dec. 31, 2012
	Pre-Tax Fair Value Gains (Losses) Recognized During the Period in:					Pre-Tax (Gains) Losses Reclassified into Income During the Period from:
(Thousands of Dollars)	Accumulated Other Comprehensive Loss			Regulatory (Assets) and Liabilities		Accumulated Other Comprehensive Loss				Regulatory Assets and (Liabilities)			Pre-Tax Gains (Losses) Recognized During the Period in Income
Derivatives designated as cash flow hedges
Interest rate	$	(15,082	)	$	—	$	(1,819	)	^(a)	$	—		$	—
Vehicle fuel and other commodity	63			—		(89		)	^(b)	—			—
Total	$	(15,019	)	$	—	$	(1,908	)		$	—		$	—
Other derivative instruments
Commodity trading	$	—		$	—	$	—			$	—		$	2		^(c)
Natural gas commodity	—			7,727		—				61,820		^(e)	(137		)	^(d)
Total	$	—		$	7,727	$	—			$	61,820		$	(135	)



	Year Ended Dec. 31, 2011
	Pre-Tax Fair Value Gains (Losses) Recognized During the Period in:						Pre-Tax (Gains) Losses Reclassified into Income During the Period from:
(Thousands of Dollars)	Accumulated Other Comprehensive Loss			Regulatory (Assets) and Liabilities			Accumulated Other Comprehensive Loss				Regulatory Assets and (Liabilities)			Pre-Tax Gains (Losses) Recognized During the Period in Income
Derivatives designated as cash flow hedges
Interest rate	$	(29,630	)	$	—		$	(2,337	)	^(a)	$	—		$	—
Vehicle fuel and other commodity	76			—			(92		)	^(b)	—			—
Total	$	(29,554	)	$	—		$	(2,429	)		$	—		$	—
Other derivative instruments
Commodity trading	$	—		$	—		$	—			$	—		$	88		^(c)
Natural gas commodity	—			(85,357		)	—				70,811		^(e)	(382		)	^(d)
Total	$	—		$	(85,357	)	$	—			$	70,811		$	(294	)


^(a)	Amounts are recorded to interest charges.


^(b)	Amounts are recorded to O&M expenses.


^(c)	Amounts are recorded to electric operating revenues. Portions of these gains and losses are subject to sharing with electric customers through margin-sharing mechanisms and deducted from gross revenue, as appropriate.


^(d)	Amounts are recorded to electric fuel and purchased power.

^(e)

Amounts for the years ended Dec. 31, 2012 and 2011 included $5.0 million and $12.7 million, respectively, of settlement losses on derivatives entered to mitigate natural gas price risk for electric generation, recorded to electric fuel and purchased power, subject to cost-recovery mechanisms and reclassified to a regulatory asset, as appropriate. Such losses for the year ended Dec. 31, 2013 were immaterial. The remaining settlement losses for the years ended Dec. 31, 2013, 2012 and 2011 relate to natural gas operations and are recorded to cost of natural gas sold and transported. These losses are subject to cost-recovery mechanisms and reclassified out of income to a regulatory asset, as appropriate.

PSCo had no derivative instruments designated as fair value hedges during the years ended Dec. 31, 2013, 2012 and 2011. Therefore, no gains or losses from fair value hedges or related hedged transactions were recognized for these periods.

Credit Related Contingent Features — Contract provisions for derivative instruments that PSCo enters into, including those recorded to the consolidated balance sheet at fair value, as well as those accounted for as normal purchase-normal sale contracts and therefore not reflected on the balance sheet, may require the posting of collateral or settlement of the contracts for various reasons, including if PSCo is unable to maintain its credit ratings. If the credit ratings of PSCo were downgraded below investment grade, derivative instruments reflected in a $1.4 million and $4.6 million gross liability position on the consolidated balance sheets at Dec. 31, 2013 and 2012, respectively, would have required PSCo to post collateral or settle outstanding contracts, including other contracts subject to master netting agreements, which would have resulted in payments of $1.4 million and $4.6 million at Dec. 31, 2013 and 2012, respectively. At Dec. 31, 2013 and 2012, there was no collateral posted on these specific contracts.

Certain derivative instruments are also subject to contract provisions that contain adequate assurance clauses. These provisions allow counterparties to seek performance assurance, including cash collateral, in the event that PSCo’s ability to fulfill its contractual obligations is reasonably expected to be impaired. PSCo had no collateral posted related to adequate assurance clauses in derivative contracts as of Dec. 31, 2013 and 2012.

Recurring Fair Value Measurements — The following table presents, for each of the fair value hierarchy levels, PSCo’s derivative assets and liabilities measured at fair value on a recurring basis at Dec. 31, 2013:



	Dec. 31, 2013
	Fair Value
(Thousands of Dollars)	Level 1		Level 2		Level 3		Fair Value Total		Counterparty Netting ^(b)			Total
Current derivative assets
Derivatives designated as cash flow hedges:
Vehicle fuel and other commodity	$	—	$	40	$	—	$	40	$	—		$	40
Other derivative instruments:
Commodity trading	—		2,756		—		2,756		(1,276		)	1,480
Natural gas commodity	—		3,341		—		3,341		—			3,341
Total current derivative assets	$	—	$	6,137	$	—	$	6,137	$	(1,276	)	4,861
PPAs ^(a)												1,715
Current derivative instruments												$	6,576
Noncurrent derivative assets
Derivatives designated as cash flow hedges:
Vehicle fuel and other commodity	$	—	$	13	$	—	$	13	$	—		$	13
Total noncurrent derivative assets	$	—	$	13	$	—	$	13	$	—		13
PPAs ^(a)												6,892
Noncurrent derivative instruments												$	6,905
Current derivative liabilities
Derivatives designated as cash flow hedges:
Other derivative instruments:
Commodity trading	$	—	$	2,438	$	—	$	2,438	$	(1,039	)	$	1,399
Total current derivative liabilities	$	—	$	2,438	$	—	$	2,438	$	(1,039	)	1,399
PPAs ^(a)												5,335
Current derivative instruments												$	6,734
Noncurrent derivative liabilities
PPAs ^(a)												23,366
Noncurrent derivative instruments												$	23,366

^(a)

In 2003, as a result of implementing new guidance on the normal purchase exception for derivative accounting, PSCo began recording several long-term PPAs at fair value due to accounting requirements related to underlying price adjustments. As these purchases are recovered through normal regulatory recovery mechanisms, the changes in fair value for these contracts were offset by regulatory assets and liabilities. During 2006, PSCo qualified these contracts under the normal purchase exception. Based onthis qualification, the contracts are no longer adjusted to fair value and the previous carrying value of these contracts will be amortized over the remaining contract lives along with the offsetting regulatory assets and liabilities.

^(b)

PSCo nets derivative instruments and related collateral in its consolidated balance sheet when supported by a legally enforceable master netting agreement, and all derivative instruments and related collateral amounts were subject to master netting agreements at Dec. 31, 2013. At Dec. 31, 2013, derivative assets and liabilities include obligations to return cash collateral of $0.2 million and no rights to reclaim cash collateral. The counterparty netting amounts presented exclude settlement receivables and payables and non-derivative amounts that may be subject to the same master netting agreements.

The following table presents, for each of the fair value hierarchy levels, PSCo’s derivative assets and liabilities measured at fair value on a recurring basis at Dec. 31, 2012:



	Dec. 31, 2012
	Fair Value
(Thousands of Dollars)	Level 1		Level 2		Level 3		Fair Value Total		Counterparty Netting ^(b)			Total
Current derivative assets
Derivatives designated as cash flow hedges:
Vehicle fuel and other commodity	$	—	$	43	$	—	$	43	$	—		$	43
Other derivative instruments:
Commodity trading	—		6,432		—		6,432		(3,301		)	3,131
Natural gas commodity	—		7		—		7		(7		)	—
Total current derivative assets	$	—	$	6,482	$	—	$	6,482	$	(3,308	)	3,174
PPAs ^(a)												1,715
Current derivative instruments												$	4,889
Noncurrent derivative assets
Derivatives designated as cash flow hedges:
Vehicle fuel and other commodity	$	—	$	39	$	—	$	39	$	—		$	39
Other derivative instruments:
Commodity trading	—		3,768		—		3,768		(1,546		)	2,222
Total noncurrent derivative assets	$	—	$	3,807	$	—	$	3,807	$	(1,546	)	2,261
PPAs ^(a)												8,607
Noncurrent derivative instruments												$	10,868
Current derivative liabilities
Other derivative instruments:
Commodity trading	$	—	$	5,958	$	—	$	5,958	$	(2,712	)	$	3,246
Natural gas commodity	—		85		—		85		(7		)	78
Total current derivative liabilities	$	—	$	6,043	$	—	$	6,043	$	(2,719	)	3,324
PPAs ^(a)												5,429
Current derivative instruments												$	8,753
Noncurrent derivative liabilities
Other derivative instruments:
Commodity trading	$	—	$	3,450	$	—	$	3,450	$	(1,546	)	$	1,904
Total noncurrent derivative liabilities	$	—	$	3,450	$	—	$	3,450	$	(1,546	)	1,904
PPAs ^(a)												28,701
Noncurrent derivative instruments												$	30,605

^(a)

In 2003, as a result of implementing new guidance on the normal purchase exception for derivative accounting, PSCo began recording several long-term PPAs at fair value due to accounting requirements related to underlying price adjustments. As these purchases are recovered through normal regulatory recovery mechanisms, the changes in fair value for these contracts were offset by regulatory assets and liabilities. During 2006, PSCo qualified these contracts under the normal purchase exception. Based on this qualification, the contracts are no longer adjusted to fair value and the previous carrying value of these contracts will be amortized over the remaining contract lives along with the offsetting regulatory assets and liabilities.

^(b)

PSCo nets derivative instruments and related collateral in its consolidated balance sheet when supported by a legally enforceable master netting agreement, and all derivative instruments and related collateral amounts were subject to master netting agreements at Dec. 31, 2012. At Dec. 31, 2012, derivative assets and liabilities include obligations to return cash collateral of $0.6 million and no rights to reclaim cash collateral. The counterparty netting amounts presented exclude settlement receivables and payables and non-derivative amounts that may be subject to the same master netting agreements.

There were no changes in Level 3 recurring fair value measurements for the years ended Dec. 31, 2013, 2012 and 2011.

PSCo recognizes transfers between levels as of the beginning of each period. There were no transfers of amounts between levels for derivative instruments for the years ended Dec. 31, 2013, 2012 and 2011.

Fair Value of Long-Term Debt

As of Dec. 31, 2013 and 2012, other financial instruments for which the carrying amount did not equal fair value were as follows:



	2013				2012
(Thousands of Dollars)	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Long-term debt, including current portion	$	3,872,643	$	4,059,661	$	3,630,773	$	4,131,866

The fair value of PSCo’s long-term debt is estimated based on recent trades and observable spreads from benchmark interest rates for similar securities. The fair value estimates are based on information available to management as of Dec. 31, 2013 and 2012, and given the observability of the inputs to these estimates, the fair values presented for long-term debt have been assigned a Level 2.

(Amounts in Thousands) ^(a)(b)

Dec. 31, 2013

Dec. 31, 2012

MWh of electricity

MMBtu of natural gas

Gallons of vehicle fuel