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.

Interest rate derivatives — The fair values of interest rate derivatives are based on broker quotes that utilize current market interest rate forecasts.

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 June 30, 2014, 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 any unsettled hedges.

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 June 30, 2014, 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 other comprehensive income 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 three and six months ended June 30, 2014 and 2013.

At June 30, 2014, 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 June 30, 2014 and Dec. 31, 2013:


^(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.

The following tables detail the impact of derivative activity during the three and six months ended June 30, 2014 and 2013, on accumulated other comprehensive loss, regulatory assets and liabilities, and income:



	Three Months Ended June 30, 2014
	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	$	—	$	—		$	(182	)	^(a)	$	—	$	—
Vehicle fuel and other commodity	8		—			(7		)	^(b)	—		—
Total	$	8	$	—		$	(189	)		$	—	$	—
Other derivative instruments
Natural gas commodity	$	—	$	(1,916	)	$	—			$	—	$	(65	)	^(c)
Total	$	—	$	(1,916	)	$	—			$	—	$	(65	)



	Six Months Ended June 30, 2014
	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	$	—	$	—	$	(362	)	^(a)	$	—			$	—
Vehicle fuel and other commodity	3		—		(20		)	^(b)	—				—
Total	$	3	$	—	$	(382	)		$	—			$	—
Other derivative instruments
Natural gas commodity	$	—	$	7,910	$	—			$	(8,579	)	^(d)	$	(4,381	)	^(d)
Total	$	—	$	7,910	$	—			$	(8,579	)		$	(4,381	)



	Three Months Ended June 30, 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	$	—		$	—		$	(182	)	^(a)	$	—	$	—
Vehicle fuel and other commodity	(31		)	—			(7		)	^(b)	—		—
Total	$	(31	)	$	—		$	(189	)		$	—	$	—
Other derivative instruments
Natural gas commodity	$	—		$	(3,211	)	$	—			$	—	$	(244	)	^(c)
Total	$	—		$	(3,211	)	$	—			$	—	$	(244	)



	Six Months Ended June 30, 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	$	—		$	—		$	(362	)	^(a)	$	—		$	—
Vehicle fuel and other commodity	(20		)	—			(19		)	^(b)	—			—
Total	$	(20	)	$	—		$	(381	)		$	—		$	—
Other derivative instruments
Natural gas commodity	$	—		$	(3,169	)	$	—			$	7	^(d)	$	(228	)	^(c)
Total	$	—		$	(3,169	)	$	—			$	7		$	(228	)


^(a)	Recorded to interest charges.


^(b)	Recorded to O&M expenses.


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

^(d)

Amounts for the six months ended June 30, 2014 and 2013 included immaterial 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. The remaining derivative settlement gains and losses for the six months ended June 30, 2014 and 2013 relate to natural gas operations and are recorded to cost of natural gas sold and transported. These gains and losses are subject to cost-recovery mechanisms and reclassified out of income to a regulatory asset or liability, as appropriate.

PSCo had no derivative instruments designated as fair value hedges during the three and six months ended June 30, 2014 and 2013. Therefore, no gains or losses from fair value hedges or related hedged transactions were recognized for these periods.

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 June 30, 2014, five of PSCo’s 10 most significant counterparties, comprising $28.0 million or 38 percent of this credit exposure, had investment grade credit ratings from Standard & Poor’s Ratings Services, Moody’s Investor Services or Fitch Ratings. The remaining five significant counterparties, comprising $25.5 million or 34 percent of this credit exposure, 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.

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. At June 30, 2014, there were no derivative instruments in a liability position that would have required the posting of collateral or settlement of applicable outstanding contracts if the credit ratings of PSCo were downgraded below investment grade. If the credit ratings of PSCo were downgraded below investment grade at Dec. 31, 2013, derivative instruments reflected in a $1.4 million gross liability position on the consolidated balance sheets 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. At June 30, 2014 and Dec. 31, 2013, 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 June 30, 2014 and Dec. 31, 2013.

Recurring Fair Value Measurements — The following table presents, for each of the fair value hierarchy levels, PSCo’s assets and liabilities measured at fair value on a recurring basis at June 30, 2014:



	June 30, 2014
	Fair Value						Fair Value Total		Counterparty Netting ^(b)
(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	$	—	$	27	$	—	$	27	$	—		$	27
Other derivative instruments:
Natural gas commodity	—		3,715		—		3,715		(9		)	3,706
Total current derivative assets	$	—	$	3,742	$	—	$	3,742	$	(9	)	3,733
PPAs ^(a)												1,715
Current derivative instruments												$	5,448
Noncurrent derivative assets
Derivatives designated as cash flow hedges:
Vehicle fuel and other commodity	$	—	$	15	$	—	$	15	$	—		$	15
Total noncurrent derivative assets	$	—	$	15	$	—	$	15	$	—		15
PPAs ^(a)												6,034
Noncurrent derivative instruments												$	6,049
Current derivative liabilities
Other derivative instruments:
Natural gas commodity	$	—	$	63	$	—	$	63	$	(9	)	$	54
Total current derivative liabilities	$	—	$	63	$	—	$	63	$	(9	)	54
PPAs ^(a)												5,216
Current derivative instruments												$	5,270
Noncurrent derivative liabilities
Other derivative instruments:
Natural gas commodity	$	—	$	27	$	—	$	27	$	—		$	27
Total noncurrent derivative liabilities	$	—	$	27	$	—	$	27	$	—		27
PPAs ^(a)												20,771
Noncurrent derivative instruments												$	20,798

^(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 June 30, 2014. At June 30, 2014, derivative assets and liabilities include no obligations to return cash collateral 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 assets and liabilities measured at fair value on a recurring basis at Dec. 31, 2013:



	Dec. 31, 2013
	Fair Value						Fair Value Total		Counterparty Netting ^(b)
(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
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 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, 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.

There were no changes in Level 3 recurring fair value measurements for the three and six months ended June 30, 2014 and 2013.

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 three and six months ended June 30, 2014 and 2013.

Fair Value of Long-Term Debt

As of June 30, 2014 and Dec. 31, 2013, other financial instruments for which the carrying amount did not equal fair value were as follows:



	June 30, 2014				Dec. 31, 2013
(Thousands of Dollars)	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Long-term debt, including current portion	$	3,893,570	$	4,216,091	$	3,872,643	$	4,059,661

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 June 30, 2014 and Dec. 31, 2013, 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)

June 30, 2014

Dec. 31, 2013

Megawatt hours of electricity

Million British thermal units of natural gas

Gallons of vehicle fuel