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 value (NAV).

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 classification. 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 Sept. 30, 2017, accumulated other comprehensive losses related to interest rate derivatives included $1.0 million of net losses 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.

Wholesale and Commodity Trading Risk — PSCo conducts various wholesale and commodity trading activities, including the purchase and sale of electric capacity, energy, energy-related instruments and natural gas related instruments, including derivatives. 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.

PSCo enters into derivative instruments that mitigate commodity price risk on behalf of electric and natural gas customers but may not be 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 nine months ended Sept. 30, 2017 and 2016.

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 Sept. 30, 2017 and Dec. 31, 2016:


^(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 months ended Sept. 30, 2017 and 2016, on accumulated other comprehensive loss, regulatory assets and liabilities, and income:



	Three Months Ended Sept. 30, 2017
	Pre-Tax Fair Value Losses Recognized During the Period in:					Pre-Tax 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	$	—	$	—		$	407	^(a)	$	—	$	—
Total	$	—	$	—		$	407		$	—	$	—
Other derivative instruments
Commodity trading	$	—	$	—		$	—		$	—	$	(211	)	^(c)
Natural gas commodity	—		(1,635		)	—			—		—
Total	$	—	$	(1,635	)	$	—		$	—	$	(211	)




	Nine Months Ended Sept. 30, 2017
	Pre-Tax Fair Value Losses Recognized During the Period in:					Pre-Tax Losses Reclassified into Income During the Period from:						Pre-Tax Losses Recognized During the Period in Income
(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	$	—	$	—		$	1,208	^(a)	$	—		$	—
Total	$	—	$	—		$	1,208		$	—		$	—
Other derivative instruments
Commodity trading	$	—	$	—		$	—		$	—		$	(23	)	^(c)
Natural gas commodity	—		(8,643		)	—			282		^(d)	(2,990		)	^(d)
Total	$	—	$	(8,643	)	$	—		$	282		$	(3,013	)





	Three Months Ended Sept. 30, 2016
	Pre-Tax Fair Value Losses Recognized During the Period in:						Pre-Tax 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 Recognized During the Period in Income
Derivatives designated as cash flow hedges
Interest rate	$	—		$	—		$	407	^(a)	$	—	$	—
Vehicle fuel and other commodity	(2		)	—			21		^(b)	—		—
Total	$	(2	)	$	—		$	428		$	—	$	—
Other derivative instruments
Commodity trading	$	—		$	—		$	—		$	—	$	(28	)	^(c)
Natural gas commodity	—			(4,848		)	—			—		(6		)	^(d)
Total	$	—		$	(4,848	)	$	—		$	—	$	(34	)




	Nine Months Ended Sept. 30, 2016
	Pre-Tax Fair Value Gains (Losses) Recognized During the Period in:					Pre-Tax 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	$	—	$	—		$	1,211	^(a)	$	—		$	—
Vehicle fuel and other commodity	2		—			67		^(b)	—			—
Total	$	2	$	—		$	1,278		$	—		$	—
Other derivative instruments
Commodity trading	$	—	$	—		$	—		$	—		$	200		^(c)
Natural gas commodity	—		(1,172		)	—			7,736		^(d)	(3,242		)	^(d)
Total	$	—	$	(1,172	)	$	—		$	7,736		$	(3,042	)


^(a)	Recorded to interest charges.


^(b)	Recorded to operating and maintenance (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)

Certain derivatives are utilized to mitigate natural gas price risk for electric generation and are recorded to electric fuel and purchased power, subject to cost-recovery mechanisms and reclassified to a regulatory asset, as appropriate. Amounts for the three and nine months ended Sept. 30, 2017 included no settlement gains or losses and $0.9 million of settlement gains, respectively. Amounts for the three and nine months ended Sept. 30, 2016 included no settlement gains or losses. The remaining derivative settlement gains and losses for the nine months ended Sept. 30, 2017 and 2016 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 nine months ended Sept. 30, 2017 and 2016. 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 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 Sept. 30, 2017, five of PSCo’s 10 most significant counterparties for these activities, comprising $4.5 million or 10 percent of this credit exposure, had investment grade credit ratings from Standard & Poor’s, Moody’s or Fitch Ratings. Four of the 10 most significant counterparties, comprising $17.3 million or 39 percent of this credit exposure, were not rated by these external agencies, but based on PSCo’s internal analysis, had credit quality consistent with investment grade. The one remaining significant counterparty, comprising $8.1 million or 18 percent of this credit exposure, had credit quality less than investment grade, based on ratings from external analysis. Nine 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 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’s credit ratings are downgraded below its investment grade credit rating by any of the major credit rating agencies or for cross-default contractual provisions that could result in the settlement of such contracts if there was a failure under other financing arrangements related to payment terms or other covenants. At Sept. 30, 2017 and Dec. 31, 2016, there were no derivative instruments in a material liability position with such underlying contract provisions.

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 Sept. 30, 2017 and Dec. 31, 2016.

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 Sept. 30, 2017:



	Sept. 30, 2017
	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
Other derivative instruments:
Commodity trading	$	116	$	3,238	$	5	$	3,359	$	(2,652	)	$	707
Natural gas commodity	—		1,394		—		1,394		(135		)	1,259
Total current derivative assets	$	116	$	4,632	$	5	$	4,753	$	(2,787	)	1,966
PPAs ^(a)												1,715
Current derivative instruments												$	3,681
Noncurrent derivative assets
Other derivative instruments:
Commodity trading	$	—	$	511	$	—	$	511	$	(109	)	$	402
Total noncurrent derivative assets	$	—	$	511	$	—	$	511	$	(109	)	402
PPAs ^(a)												459
Noncurrent derivative instruments												$	861
Current derivative liabilities
Other derivative instruments:
Commodity trading	$	144	$	3,104	$	3	$	3,251	$	(3,188	)	$	63
Natural gas commodity	—		962		—		962		(135		)	827
Total current derivative liabilities	$	144	$	4,066	$	3	$	4,213	$	(3,323	)	890
PPAs ^(a)												5,159
Current derivative instruments												$	6,049
Noncurrent derivative liabilities
Other derivative instruments:
Commodity trading	$	—	$	406	$	—	$	406	$	(109	)	$	297
Total noncurrent derivative liabilities	$	—	$	406	$	—	$	406	$	(109	)	297
PPAs ^(a)												3,958
Noncurrent derivative instruments												$	4,255


^(a)	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 Sept. 30, 2017. At Sept. 30, 2017, derivative assets and liabilities include no obligations to return cash collateral and rights to reclaim cash collateral of $0.5 million. 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, 2016:



	Dec. 31, 2016
	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
Other derivative instruments:
Commodity trading	$	1,124	$	5,453	$	—	$	6,577	$	(5,137	)	$	1,440
Natural gas commodity	—		7,778		—		7,778		—			7,778
Total current derivative assets	$	1,124	$	13,231	$	—	$	14,355	$	(5,137	)	9,218
PPAs ^(a)												1,716
Current derivative instruments												$	10,934
Noncurrent derivative assets
Other derivative instruments:
Natural gas commodity	$	—	$	1,652	$	—	$	1,652	$	—		$	1,652
Total noncurrent derivative assets	$	—	$	1,652	$	—	$	1,652	$	—		1,652
PPAs ^(a)												1,746
Noncurrent derivative instruments												$	3,398
Current derivative liabilities
Other derivative instruments:
Commodity trading	$	1,386	$	5,357	$	22	$	6,765	$	(5,137	)	$	1,628
Total current derivative liabilities	$	1,386	$	5,357	$	22	$	6,765	$	(5,137	)	1,628
PPAs ^(a)												5,160
Current derivative instruments												$	6,788
Noncurrent derivative liabilities
PPAs ^(a)												$	7,828
Noncurrent derivative instruments												$	7,828


^(a)	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, 2016. At Dec. 31, 2016, derivative assets and liabilities include no obligations to return cash collateral or 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 immaterial gains and losses recognized in earnings for Level 3 commodity trading derivatives in the three and nine months ended Sept. 30, 2017 and 2016.

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 nine months ended Sept. 30, 2017 and 2016.

Fair Value of Long-Term Debt

As of Sept. 30, 2017 and Dec. 31, 2016, other financial instruments for which the carrying amount did not equal fair value were as follows:



	Sept. 30, 2017				Dec. 31, 2016
(Thousands of Dollars)	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Long-term debt, including current portion	$	4,608,666	$	4,958,850	$	4,216,206	$	4,491,570

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 Sept. 30, 2017 and Dec. 31, 2016, 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)

Sept. 30, 2017

Dec. 31, 2016

Megawatt hours of electricity

Million British thermal units of natural gas