Fair Value of Derivative and Other Financial Instruments

Energy Related Derivative Contracts

Overview

The primary objective for the use of derivative instruments, including energy contracts, options, and futures, is to manage price risk associated with forecasted purchases of energy and fuel used to generate electricity, as well as managing anticipated generation capacity in excess of forecasted demand from existing customers. The Company's energy related derivative contracts manage commodity risk. PNM is required to meet the demand and energy needs of its retail and firm-requirements wholesale customers. PNM is exposed to market risk for its share of PVNGS Unit 3 and the needs of its firm-requirements wholesale customers not covered under a FPPAC. PNM’s operations are managed primarily through a net asset-backed strategy, whereby PNM’s aggregate net open forward contract position is covered by its forecasted excess generation capabilities or market purchases. PNM could be exposed to market risk if its generation capabilities were to be disrupted or if its load requirements were to be greater than anticipated, to the extent not covered by the FPPAC. If all or a portion of load requirements were required to be covered as a result of such unexpected situations, commitments would have to be met through market purchases. Additional information concerning the Company's energy related derivative contracts, including how commodity risk is managed, is contained in Note 8 of the Notes to Consolidated Financial Statements in the 2012 Annual Reports on Form 10-K.

Commodity Risk

Marketing and procurement of energy often involve market risks associated with managing energy commodities and establishing open positions in the energy markets, primarily on a short-term basis. PNM routinely enters into various derivative instruments such as forward contracts, option agreements, and price basis swap agreements to economically hedge price and volume risk on power commitments and fuel requirements and to minimize the effect of market fluctuations in wholesale portfolios. PNM monitors the market risk of its commodity contracts using VaR calculations to maintain total exposure within management-prescribed limits in accordance with approved risk and credit policies.

Accounting for Derivatives

Under derivative accounting and related rules for energy contracts, the Company accounts for its various derivative instruments for the purchase and sale of energy based on the Company’s intent. Energy contracts that meet the definition of a derivative under GAAP and do not qualify, or are not designated, for the normal sales and purchases exception are recorded on the balance sheet at fair value at each period end. The changes in fair value are recognized in earnings unless specific hedge accounting criteria are met and elected. Normal sales and purchases are not marked to market and are reflected in results of operations when the underlying transactions settle.

During the three months ended March 31, 2013 and the year ended December 31, 2012, the Company was not hedging its exposure to the variability in future cash flows from commodity derivatives through designated cash flows hedges. The contracts recorded at fair value that do not qualify or are not designated for cash flow hedge accounting are classified as economic hedges. Economic hedges are defined as derivative instruments, including long-term power agreements, used to economically hedge generation assets, purchased power and fuel costs, and customer load requirements. Changes in the fair value of economic hedges are reflected in results of operations and are classified between operating revenues and cost of energy according to the intent of the hedge. The Company has no trading transactions.

Fair value is defined under GAAP as the price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Fair value is based on current market quotes as available and is supplemented by modeling techniques and assumptions made by the Company to the extent quoted market prices or volatilities are not available. External pricing input availability varies based on commodity location, market liquidity, and term of the agreement. Valuations of derivative assets and liabilities take into account nonperformance risk including the effect of counterparties' and the Company’s credit risk. The Company regularly assesses the validity and availability of pricing data for its derivative transactions. Although the Company uses its best judgment in estimating the fair value of these instruments, there are inherent limitations in any estimation technique.

Commodity Derivatives

Commodity derivative instruments are summarized as follows:



	Economic Hedges
	March 31, 2013			December 31, 2012
PNMR and PNM	(In thousands)
Current assets	$	2,114		$	3,785
Deferred charges	—			352
	2,114			4,137

Current liabilities	(4,132		)	(1,000		)
Long-term liabilities	(1,785		)	(1,933		)
	(5,917		)	(2,933		)
Net	$	(3,803	)	$	1,204

Certain of PNM's commodity derivative instruments included in the above table are subject to master netting agreements whereby assets and liabilities could be offset in the settlement process. The Company does not offset fair value, cash collateral, and accrued payable or receivable amounts recognized for derivative instruments under master netting arrangements and the above table reflects the gross amounts of assets and liabilities. The amounts that could be offset under master netting agreements were immaterial at March 31, 2013 and December 31, 2012.

At March 31, 2013 and December 31, 2012, PNMR and PNM had no amounts recognized for the legal right to reclaim cash collateral. In addition, at March 31, 2013 and December 31, 2012, amounts posted as cash collateral under margin arrangements were $1.9 million and $1.9 million for both PNMR and PNM. PNMR and PNM had no obligation to return cash collateral at March 31, 2013 and December 31, 2012. Cash collateral amounts are included in other current assets on the Condensed Consolidated Balance Sheets.

PNM has a NMPRC approved hedging plan to manage fuel and purchased power costs related to customers covered by its FPPAC. The table above includes less than $0.1 million of current assets and current liabilities at March 31, 2013 and December 31, 2012 related to this plan. The offsets to these amounts are recorded as regulatory assets and liabilities on the Condensed Consolidated Balance Sheets.

The following table presents the effect of commodity derivative instruments on earnings, excluding income tax effects. Commodity derivatives had no impact on OCI for the periods presented.



	Economic Hedges
	Three Months Ended
	March 31,
	2013			2012
PNMR and PNM	(In thousands)
Electric operating revenues	$	(4,603	)	$	5,218
Cost of energy	756			(604		)
Total gain (loss)	$	(3,847	)	$	4,614

Commodity contract volume positions are presented in MMBTU for gas related contracts and in MWh for power related contracts. The table below presents PNMR’s and PNM’s net buy (sell) volume positions:



	Economic Hedges
	MMBTU	MWh
March 31, 2013
PNMR and PNM	1,425,000	(2,042,657	)
December 31, 2012
PNMR and PNM	1,127,500	(2,477,520	)

In connection with managing its commodity risks, the Company enters into master agreements with certain counterparties. If the Company is in a net liability position under an agreement, some agreements provide that the counterparties can request collateral from the Company if the Company’s credit rating is downgraded; other agreements provide that the counterparty may request collateral to provide it with “adequate assurance” that the Company will perform; and others have no provision for collateral.

The table below presents information about the Company’s contingent requirements to provide collateral under commodity contracts having an objectively determinable collateral provision that are in net liability positions and are not fully collateralized with cash. Contractual liability represents commodity derivative contracts recorded at fair value on the balance sheet, determined on an individual contract basis without offsetting amounts for individual contracts that are in an asset position and could be offset under master netting agreements with the same counterparty. The table only reflects cash collateral that has been posted under the existing contracts and does not reflect letters of credit under the Company’s revolving credit facilities that have been issued as collateral. Net exposure is the net contractual liability for all contracts, including those designated as normal purchases and sales, offset by existing cash collateral and by any offsets available under master netting agreements, including both asset and liability positions.



Contingent Feature – Credit Rating Downgrade	Contractual Liability		Existing Cash Collateral		Net Exposure
	(In thousands)
March 31, 2013
PNMR and PNM	$	3,935	$	—	$	3,854
December 31, 2012
PNMR and PNM	$	2,933	$	—	$	2,777

Sale of Power from PVNGS Unit 3

Since January 1, 2011, PNM has been selling power from its interest in PVNGS Unit 3 daily at market prices. PNM has established fixed rates for all of these sales through the end of 2013 through hedging arrangements that are accounted for as economic hedges. PNM is also partially hedged for 2014.

Non-Derivative Financial Instruments

The carrying amounts reflected on the Condensed Consolidated Balance Sheets approximate fair value for cash, receivables, and payables due to the short period of maturity. Available-for-sale securities are carried at fair value, which include unrealized gains on securities which have not been recognized in net earnings. Available-for-sale securities for PNMR and PNM consist of PNM assets held in the NDT for its share of decommissioning costs of PVNGS and a trust for PNM's share of post-term reclamation

costs related to the coal mines serving SJGS , which investments are included in "other investments" on the Condensed Consolidated Balance Sheet. PNMR and PNM do not have any unrecognized losses on available-for-sale securities. The fair value and gross unrealized gains of investments in available-for-sale securities are presented in the following table.



	March 31, 2013				December 31, 2012
	Unrealized Gains		Fair Value		Unrealized Gains		Fair Value
			(In thousands)
Cash and cash equivalents	$	—	$	3,877	$	—	$	4,628
Equity securities:
Domestic value	8,782		34,410		5,223		30,044
Domestic growth	18,184		55,435		15,212		51,650
International and other	803		15,420		247		14,868
Fixed income securities:
U.S. Government	1,077		33,721		1,305		32,592
Municipals	3,845		43,459		4,069		43,861
Corporate and other	989		15,085		1,100		14,868
	$	33,680	$	201,407	$	27,156	$	192,511

The proceeds and gross realized gains and losses on the disposition of available-for-sale securities for PNMR and PNM are shown in the following table. Realized gains and losses are determined by specific identification of costs of securities sold.



	Three Months Ended
	March 31,
	2013			2012
	(In thousands)
Proceeds from sales	$	14,284		$	26,760
Gross realized gains	$	1,391		$	2,332
Gross realized (losses)	$	(407	)	$	(738	)

Held-to-maturity securities are those investments in debt securities that the Company has the ability and intent to hold until maturity. Held-to-maturity securities consist of the investment in PVNGS lessor notes and certain items within other investments.

The Company has no available-for-sale or held-to-maturity securities for which carrying value exceeds fair value. There are no impairments considered to be “other than temporary” that are included in AOCI and not recognized in earnings.

At March 31, 2013, the available-for-sale and held-to-maturity debt securities had the following final maturities:



	Fair Value
	Available-for-Sale		Held-to-Maturity
	PNMR and PNM		PNMR		PNM
	(In thousands)
Within 1 year	$	1,792	$	7,478	$	3,780
After 1 year through 5 years	30,751		66,708		66,375
After 5 years through 10 years	17,244		—		—
After 10 years through 15 years	8,637		—		—
After 15 years through 20 years	11,060		—		—
After 20 years	22,781		—		—
	$	92,265	$	74,186	$	70,155

Fair Value Disclosures

The Company determines the fair values of its derivative and other instruments based on the hierarchy established in GAAP, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. GAAP describes three levels of inputs that may be used to measure fair value. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability. Level 3 inputs used in determining fair values for the Company consist of internal valuation models.

For the NDT and reclamation trust investments, Level 2 fair values are provided by the trustee utilizing a pricing service. The pricing provider predominantly uses the market approach using bid side market value based upon a hierarchy of information for specific securities or securities with similar characteristics. For commodity derivatives, Level 2 fair values are determined based on market observable inputs, which are validated using multiple broker quotes, including forward price, volatility, and interest rate curves to establish expectations of future prices. Credit valuation adjustments are made for estimated credit losses based on the overall exposure to each counterparty. For long-term debt, Level 2 fair values are provided by an external pricing service. The pricing service primarily utilizes quoted prices for similar debt in active markets when determining fair value. For investments categorized as Level 3, primarily the PVNGS lessor notes and other investments, fair values were determined by discounted cash flow models that take into consideration discount rates that are observable for similar type assets and liabilities. Management of the Company independently verifies the information provided by pricing services.

The Company records any transfers between fair value hierarchy levels as of the end of each calendar quarter. There were no transfers between levels during the three months ended March 31, 2013 and 2012.

Items recorded at fair value on the Condensed Consolidated Balance Sheets are presented below:



				GAAP Fair Value Hierarchy
	Total			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)
March 31, 2013				(In thousands)
PNMR and PNM
Decommissioning and reclamation investments:
Cash and cash equivalents	$	3,877		$	3,877	$	—
Equity securities:
Domestic value	34,410			34,410		—
Domestic growth	55,435			55,435		—
International and other	15,420			15,420		—
Fixed income securities:
U.S. government	33,721			30,193		3,528
Municipals	43,459			—		43,459
Corporate and other	15,085			—		15,085
	$	201,407		$	139,335	$	62,072

Commodity derivative assets	$	2,114		$	—	$	2,114
Commodity derivative liabilities	(5,917		)	—		(5,917		)
Net	$	(3,803	)	$	—	$	(3,803	)

December 31, 2012
PNMR and PNM
Decommissioning and reclamation investments:
Cash and cash equivalents	$	4,628		$	4,628	$	—
Equity securities:
Domestic value	30,044			30,044		—
Domestic growth	51,650			51,650		—
International and other	14,868			14,868		—
Fixed income securities:
U.S. government	32,592			27,737		4,855
Municipals	43,861			—		43,861
Corporate and other	14,868			—		14,868
	$	192,511		$	128,927	$	63,584

Commodity derivative assets	$	4,137		$	—	$	4,137
Commodity derivative liabilities	(2,933		)	—		(2,933		)
Net	$	1,204		$	—	$	1,204

There were no Level 3 fair value measurements at March 31, 2013 or December 31, 2012.

The carrying amounts and fair values of investments in PVNGS lessor notes, other investments, and long-term debt, which are not recorded at fair value on the Condensed Consolidated Balance Sheets are presented below:



					GAAP Fair Value Hierarchy
	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
March 31, 2013	(In thousands)
PNMR
Long-term debt	$	1,672,456	$	1,977,199	$	—	$	1,974,550	$	2,649
Investment in PVNGS lessor notes	$	66,375	$	69,155	$	—	$	—	$	69,155
Other investments	$	4,647	$	6,939	$	761	$	—	$	6,178
PNM
Long-term debt	$	1,215,589	$	1,391,714	$	—	$	1,391,714	$	—
Investment in PVNGS lessor notes	$	66,375	$	69,155	$	—	$	—	$	69,155
Other investments	$	480	$	480	$	480	$	—	$	—
TNMP
Long-term debt	$	311,745	$	418,912	$	—	$	418,912	$	—
Other investments	$	281	$	281	$	281	$	—	$	—

December 31, 2012
PNMR
Long-term debt	$	1,672,290	$	1,969,362	$	—	$	1,966,725	$	2,637
Investment in PVNGS lessor notes	$	77,682	$	84,198	$	—	$	—	$	84,198
Other investments	$	5,599	$	6,965	$	774	$	—	$	6,191
PNM
Long-term debt	$	1,215,579	$	1,385,433	$	—	$	1,385,433	$	—
Investment in PVNGS lessor notes	$	77,682	$	84,198	$	—	$	—	$	84,198
Other investments	$	494	$	494	$	494	$	—	$	—
TNMP
Long-term debt	$	311,589	$	418,166	$	—	$	418,166	$	—
Other investments	$	281	$	281	$	281	$	—	$	—