8. 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 discounted cash flow or option pricing 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.

PSCo continuously monitors the creditworthiness of the counterparties to its interest rate derivatives and commodity derivatives 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.

Derivative Instruments Fair Value Measurements

PSCo enters into derivative instruments, including forward contracts, futures, swaps and options, for trading purposes and to reduce 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, 2012, 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.

In conjunction with the PSCo debt issuance in September 2012, PSCo settled interest rate hedging instruments with a notional amount of $250 million during the three months ended Sept. 30, 2012 with cash payments of $44.7 million. These losses are classified as a component of accumulated other comprehensive loss on the consolidated balance sheet, net of tax, and will be reclassified to earnings over the term of the hedged interest payments. See Note 7 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 Sept. 30, 2012, PSCo had various vehicle fuel related 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 three and nine months ended Sept. 30, 2012 and 2011.

At Sept. 30, 2012, 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 any amounts credited to customers under margin-sharing mechanisms.

The following table details the gross notional amounts of commodity forwards and options at Sept. 30, 2012 and Dec. 31, 2011:

(Amounts in Thousands) (a)(b)	Sept. 30, 2012		Dec. 31, 2011
Megawatt hours (MWh) of electricity		973		1,299
MMBtu of natural gas		6,932		32,053
Gallons of vehicle fuel		329		270

(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.

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 as a component of common stockholder's equity and in the consolidated statement of comprehensive income, is detailed in the following table:

	Three Months Ended Sept. 30
(Thousands of Dollars)	2012			2011
Accumulated other comprehensive (loss) income related to cash flow hedges at July 1	$	(18,865	)	$	6,793
After-tax net unrealized losses related to derivatives accounted for as hedges		(3,574	)		(14,428	)
After-tax net realized gains on derivative transactions reclassified into earnings		(304	)		(381	)
Accumulated other comprehensive loss related to cash flow hedges at Sept. 30	$	(22,743	)	$	(8,016	)

	Nine Months Ended Sept. 30
(Thousands of Dollars)	2012			2011
Accumulated other comprehensive (loss) income related to cash flow hedges at Jan. 1	$	(12,377	)	$	7,457
After-tax net unrealized losses related to derivatives accounted for as hedges		(9,311	)		(14,346	)
After-tax net realized gains on derivative transactions reclassified into earnings		(1,055	)		(1,127	)
Accumulated other comprehensive loss related to cash flow hedges at Sept. 30	$	(22,743	)	$	(8,016	)

The following tables detail the impact of derivative activity during the three and nine months ended Sept. 30, 2012 and 2011, on accumulated other comprehensive loss, regulatory assets and liabilities, and income:

	Three Months Ended Sept. 30, 2012
	Fair Value Gains (Losses)					Pre-Tax (Gains) Losses Reclassified
	Recognized During the Period in					into Income During the Period from
	Accumulated					Accumulated						Pre-Tax Gains
	Other			Regulatory		Other				Regulatory		Recognized
	Comprehensive			(Assets) and		Comprehensive				Assets and		During the Period
(Thousands of Dollars)	Loss			Liabilities		Loss				(Liabilities)		in Income
Derivatives designated as cash flow hedges
Interest rate	$	(5,836	)	$	-	$	(470	)	(a)	$	-	$	-
Vehicle fuel and other commodity		65			-		(20	)	(e)		-		-
Total	$	(5,771	)	$	-	$	(490	)		$	-	$	-

Other derivative instruments
Trading commodity	$	-		$	-	$	-			$	-	$	1	(b)
Natural gas commodity		-			1,109		-				-		-
Total	$	-		$	1,109	$	-			$	-	$	1

	Nine Months Ended Sept. 30, 2012
	Fair Value Gains (Losses)						Pre-Tax (Gains) Losses Reclassified
	Recognized During the Period in:						into Income During the Period from:
	Accumulated						Accumulated							Pre-Tax Gains
	Other			Regulatory			Other				Regulatory			(Losses) Recognized
	Comprehensive			(Assets) and			Comprehensive				Assets and			During the Period
(Thousands of Dollars)	Loss			Liabilities			Loss				(Liabilities)			in Income
Derivatives designated as cash flow hedges
Interest rate	$	(15,082	)	$	-		$	(1,635	)	(a)	$	-		$	-
Vehicle fuel and other commodity		61			-			(66	)	(e)		-			-
Total	$	(15,021	)	$	-		$	(1,701	)		$	-		$	-

Other derivative instruments
Trading commodity	$	-		$	-		$	-			$	-		$	2		(b)
Natural gas commodity		-			(5,837	)		-				61,858	(d)		(109	)	(c)
Total	$	-		$	(5,837	)	$	-			$	61,858		$	(107	)

	Three Months Ended Sept. 30, 2011
	Fair Value Gains (Losses)						Pre-Tax (Gains) Losses Reclassified
	Recognized During the Period in:						into Income During the Period from:
	Accumulated						Accumulated							Pre-Tax Losses
	Other			Regulatory			Other				Regulatory			Recognized
	Comprehensive			(Assets) and			Comprehensive				Assets and			During the Period
(Thousands of Dollars)	Income			Liabilities			Income				(Liabilities)			in Income
Derivatives designated as cash flow hedges
Interest rate	$	(23,178	)	$	-		$	(589	)	(a)	$	-		$	-
Vehicle fuel and other commodity		(89	)		-			(25	)	(e)		-			-
Total	$	(23,267	)	$	-		$	(614	)		$	-		$	-

Other derivative instruments
Trading commodity	$	-		$	-		$	-			$	-		$	(12	)	(b)
Natural gas commodity		-			(31,802	)		-				308	(d)		(126	)	(c)
Total	$	-		$	(31,802	)	$	-			$	308		$	(138	)

	Nine Months Ended Sept. 30, 2011
	Fair Value Gains (Losses)						Pre-Tax (Gains) Losses Reclassified
	Recognized During the Period in:						into Income During the Period from:
	Accumulated						Accumulated							Pre-Tax Gains
	Other			Regulatory			Other				Regulatory			Recognized
	Comprehensive			(Assets) and			Comprehensive				Assets and			During the Period
(Thousands of Dollars)	Income			Liabilities			Income				(Liabilities)			in Income
Derivatives designated as cash flow hedges
Interest rate	$	(23,178	)	$	-		$	(1,748	)	(a)	$	-		$	-
Vehicle fuel and other commodity		44			-			(70	)	(e)		-			-
Total	$	(23,134	)	$	-		$	(1,818	)		$	-		$	-

Other derivative instruments
Trading commodity	$	-		$	-		$	-			$	-		$	83		(b)
Natural gas commodity		-			(44,948	)		-				45,527	(d)		(126	)	(c)
Total	$	-		$	(44,948	)	$	-			$	45,527		$	(43	)

(a)	Amounts are recorded to interest charges.

(b)	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.

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

(d)

Amounts for the nine months ended Sept. 30, 2012 and 2011 include $5.0 million and $9.9 million of settlement losses, respectively, on derivatives utilized 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 settlement losses for the nine months ended Sept. 30, 2012 and 2011, and all settlement losses for the three months ended Sept. 30, 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 to a regulatory asset, as appropriate.

(e)	Amounts are recorded to operating and maintenance (O&M) expenses.

PSCo had no derivative instruments designated as fair value hedges during the three and nine months ended Sept. 30, 2012 and Sept. 30, 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 of the 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 (NPNS) 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 $5.4 million and $6.9 million gross liability position on the consolidated balance sheets at Sept. 30, 2012 and Dec. 31, 2011, respectively, would have required PSCo to post collateral or settle outstanding contracts, including NPNS contracts, which would have resulted in payments of $5.4 million and $9.2 million at Sept. 30. 2012 and Dec. 31, 2011, respectively, inclusive of the impacts of offsetting asset positions with the applicable counterparties. At Sept. 30 2012 and Dec. 31, 2011, 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 Sept. 30, 2012 and Dec. 31, 2011.

Recurring Fair Value Measurements— The following table presents for each of the hierarchy levels, PSCo's assets and liabilities that are measured at fair value on a recurring basis at Sept. 30, 2012:

	Sept. 30, 2012
	Fair Value
							Fair Value		Counterparty
(Thousands of Dollars)	Level 1		Level 2		Level 3		Total		Netting (b)			Total
Current derivative assets
Derivatives designated as cash flow hedges:
Vehicle fuel and other commodity	$	-	$	60	$	-	$	60	$	-		$	60
Other derivative instruments:
Trading commodity		-		5,899		-		5,899		(3,150	)		2,749
Natural gas commodity		-		1,878		-		1,878		-			1,878
Total current derivative assets	$	-	$	7,837	$	-	$	7,837	$	(3,150	)		4,687
Purchased power agreements (a)													1,716
Current derivative instruments												$	6,403
Noncurrent derivative assets
Derivatives designated as cash flow hedges:
Vehicle fuel and other commodity	$	-	$	62	$	-	$	62	$	-		$	62
Other derivative instruments:
Trading commodity		-		4,710		-		4,710		(1,852	)		2,858
Total noncurrent derivative assets	$	-	$	4,772	$	-	$	4,772	$	(1,852	)		2,920
Purchased power agreements (a)													9,037
Noncurrent derivative instruments												$	11,957
Current derivative liabilities
Derivatives designated as cash flow hedges:
Other derivative instruments:
Trading commodity	$	-	$	5,425	$	-	$	5,425	$	(2,445	)	$	2,980
Total current derivative liabilities	$	-	$	5,425	$	-	$	5,425	$	(2,445	)		2,980
Purchased power agreements (a)													5,428
Current derivative instruments												$	8,408
Noncurrent derivative liabilities
Other derivative instruments:
Trading commodity	$	-	$	4,237	$	-	$	4,237	$	(1,852	)	$	2,385
Total noncurrent derivative liabilities	$	-	$	4,237	$	-	$	4,237	$	(1,852	)		2,385
Purchased power agreements (a)													30,058
Noncurrent derivative instruments												$	32,443

(a)

In 2003, as a result of implementing new guidance on the normal purchase exception for derivative accounting, PSCo began recording several long-term purchased power agreements 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)

The accounting guidance for derivatives and hedging permits the netting of receivables and payables for derivatives and related collateral amounts when a legally enforceable master netting agreement exists between PSCo and a counterparty. A master netting agreement is an agreement between two parties who have multiple contracts with each other that provides for the net settlement of all contracts in the event of default on or termination of any one contract.

The following table presents for each of the hierarchy levels, PSCo's assets and liabilities that are measured at fair value on a recurring basis at Dec. 31, 2011:

	Dec. 31, 2011
	Fair Value
							Fair Value		Counterparty
(Thousands of Dollars)	Level 1		Level 2		Level 3		Total		Netting (b)			Total
Current derivative assets
Derivatives designated as cash flow hedges:
Vehicle fuel and other commodity	$	-	$	76	$	-	$	76	$	(76	)	$	-
Other derivative instruments:
Trading commodity		-		6,550		-		6,550		(3,712	)		2,838
Total current derivative assets	$	-	$	6,626	$	-	$	6,626	$	(3,788	)		2,838
Purchased power agreements (a)													2,092
Current derivative instruments												$	4,930
Noncurrent derivative assets
Derivatives designated as cash flow hedges:
Vehicle fuel and other commodity	$	-	$	48	$	-	$	48	$	-		$	48
Other derivative instruments:
Trading commodity		-		8,292		-		8,292		(3,305	)		4,987
Total noncurrent derivative assets	$	-	$	8,340	$	-	$	8,340	$	(3,305	)		5,035
Purchased power agreements (a)													10,322
Noncurrent derivative instruments												$	15,357
Current derivative liabilities
Derivatives designated as cash flow hedges:
Interest rate	$	-	$	29,630	$	-	$	29,630	$	-		$	29,630
Other derivative instruments:
Trading commodity		-		6,076		-		6,076		(2,846	)		3,230
Natural gas commodity		-		54,525		-		54,525		(7,410	)		47,115
Total current derivative liabilities	$	-	$	90,231	$	-	$	90,231	$	(10,256	)		79,975
Purchased power agreements (a)													5,543
Current derivative instruments												$	85,518
Noncurrent derivative liabilities
Other derivative instruments:
Trading commodity	$	-	$	7,502	$	-	$	7,502	$	(3,305	)	$	4,197
Total noncurrent derivative liabilities	$	-	$	7,502	$	-	$	7,502	$	(3,305	)		4,197
Purchased power agreements (a)													34,128
Noncurrent derivative instruments												$	38,325

(a)

(b)

There were no changes in Level 3 recurring fair value measurements for the three and nine months ended Sept. 30, 2012 and 2011.

PSCo recognizes transfers between levels as of the beginning of each period. There were no transfers of amounts between levels for the three and nine months ended Sept. 30, 2012 and 2011.

Fair Value of Long-Term Debt

As of Sept. 30, 2012 and Dec. 31, 2011, other financial instruments for which the carrying amount did not equal fair value were as follows:

	Sept. 30, 2012				Dec. 31, 2011
	Carrying				Carrying
(Thousands of Dollars)	Amount		Fair Value		Amount		Fair Value
Long-term debt, including current portion	$	4,280,745	$	4,825,506	$	3,486,275	$	4,020,083

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, 2012 and Dec. 31, 2011, and given the observability of the inputs to these estimates, the fair values presented for long-term debt have been assigned a Level 2. These fair value estimates have not been comprehensively revalued for purposes of these consolidated financial statements since those dates and current estimates of fair values may differ significantly.