Fair Value of Financial Assets and Liabilities

9 Months Ended

Sep. 30, 2019

Fair Value Disclosures [Abstract]

Fair Value of Financial Assets and Liabilities

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, hierarchical framework for measuring assets and liabilities and requires disclosure about assets and liabilities measured at fair value.

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:

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

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 generally utilize observable forward prices and volatilities, as well as observable pricing adjustments for specific delivery locations, and are generally assigned a Level 2 classification. When contractual settlements relate to delivery locations for which pricing is relatively unobservable, or extend to periods beyond those readily observable on active exchanges or quoted by brokers, the significance of the use of less observable inputs on a valuation is evaluated, and may result in Level 3 classification.

Electric commodity derivatives held by SPS include transmission congestion instruments, generally referred to as FTRs, purchased from SPP. FTRs purchased from an RTO are financial instruments that entitle or obligate the holder to monthly revenues or charges based on transmission congestion across a given transmission path. The value of an FTR is derived from, and designed to offset, the cost of transmission congestion. In addition to overall transmission load, congestion is also influenced by the operating schedules of power plants and the consumption of electricity pertinent to a given transmission path. Unplanned plant outages, scheduled plant maintenance, changes in the relative costs of fuels used in generation, weather and overall changes in demand for electricity can each impact the operating schedules of the power plants on the transmission grid and the value of an FTR.

If forecasted costs of electric transmission congestion increase or decrease for a given FTR path, the value of that particular FTR instrument will likewise increase or decrease. Given the limited observability of important inputs to the value of FTRs between auction processes, including expected plant operating schedules and retail and wholesale demand, fair value measurements for FTRs have been assigned a Level 3. Non-trading monthly FTR settlements are expected to be recovered through fuel and purchased energy cost recovery mechanisms, and therefore changes in the fair value of the yet to be settled portions of FTRs are deferred as a regulatory asset or liability. Given this regulatory treatment and the limited magnitude of FTRs relative to the electric utility operations of SPS, the numerous unobservable quantitative inputs pertinent to the value of FTRs are insignificant to the financial statements of SPS.

Derivative Instruments Fair Value Measurements

SPS enters into derivative instruments, including forward contracts, for trading purposes and to manage risk in connection with changes in interest rates and electric utility commodity prices.

Interest Rate Derivatives — SPS may enter into various instruments that 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.

As of Sept. 30, 2019, accumulated other comprehensive loss related to interest rate derivatives included $0.1 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 — SPS conducts various wholesale and commodity trading activities, including the purchase and sale of electric capacity, energy and energy-related instruments, including derivatives. SPS is allowed to conduct these activities within guidelines and limitations as approved by its risk management committee, comprised of management personnel not directly involved in the activities governed by this policy.

Commodity Derivatives — SPS enters into derivative instruments to manage variability of future cash flows from changes in commodity prices in its electric utility operations. This could include the purchase or sale of energy or energy-related products and FTRs.

(Amounts in Millions) (a)	Sept. 30, 2019	Dec. 31, 2018
Mwh of electricity	9.4	5.5

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

Consideration of Credit Risk and Concentrations — SPS continuously monitors the creditworthiness of 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. Impact of credit risk was immaterial to the fair value of unsettled commodity derivatives presented in the balance sheets. SPS’ 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, 2019, one of the six most significant counterparties for these activities, comprising $14.2 million or 31% of this credit exposure, had

investment grade ratings from S&P Global Ratings, Moody’s Investor Services or Fitch Ratings. Five of the six most significant counterparties, comprising $9.7 million or 21% of this credit exposure, were not rated by external rating agencies, but based on SPS’ internal analysis, had credit quality consistent with investment grade. Six of these significant counterparties are municipal or cooperative electric entities, or other utilities.

Impact of Derivative Activities on Income and Accumulated Other Comprehensive Loss — Pre-tax losses related to interest rate derivatives reclassified from accumulated other comprehensive loss into earnings were immaterial for the three and nine months ended Sept. 30, 2019 and 2018.

Changes in the fair value of FTRs resulting in immaterial pre-tax net gains and pre-tax net gains of $4.7 million were recognized for the three and nine months ended Sept. 30, 2019, respectively, were reclassified as regulatory assets and liabilities. For the three and nine months ended Sept. 30, 2018, changes in the fair value of FTRs resulted in pre-tax net losses of $3.3 million and pre-tax net gains of $10.1 million, respectively, and were recognized as regulatory assets and liabilities. The classification as a regulatory asset or liability is based on expected recovery of FTR settlements through fuel and purchased energy cost recovery mechanisms.

FTR settlement gains of $1.7 million and $1.5 million were recognized for the three and nine months ended Sept. 30, 2019, respectively, and were recorded to electric fuel and purchased power. There were immaterial FTR settlement losses and $3.4 million of FTR settlement gains recognized for the three and nine months ended Sept. 30, 2018, respectively, and were recorded to electric fuel and purchased power. These derivative settlement gains and losses are shared with electric customers through fuel and purchased energy cost-recovery mechanisms, and reclassified out of income as regulatory assets or liabilities, as appropriate.

SPS had no derivative instruments designated as fair value hedges during the three and nine months ended Sept. 30, 2019 and 2018.

Recurring Fair Value Measurements — SPS’ derivative assets and liabilities measured at fair value on a recurring basis:

	Sept. 30, 2019												Dec. 31, 2018
	Fair Value												Fair Value
(Millions of Dollars)	Level 1		Level 2		Level 3		Fair Value Total		Netting (a)		Total		Level 1		Level 2		Level 3		Fair Value Total		Netting (a)			Total
Current derivative assets
Other derivative instruments:
Electric commodity	$	—	$	—	$	17.3	$	17.3	$	—	$	17.3	$	—	$	—	$	14.9	$	14.9	$	(0.2	)	$	14.7
Total current derivative assets	$	—	$	—	$	17.3	$	17.3	$	—	17.3		$	—	$	—	$	14.9	$	14.9	$	(0.2	)	14.7
PPAs (b)											3.1													3.1
Current derivative instruments											$	20.4												$	17.8
Noncurrent derivative assets
PPAs (b)											13.4													15.8
Noncurrent derivative instruments											$	13.4												$	15.8
Current derivative liabilities
Other derivative instruments:
Electric commodity	$	—	$	—	$	0.2	$	0.2	$	—	$	0.2	$	—	$	—	$	0.2	$	0.2	$	(0.2	)	$	—
Total current derivative liabilities	$	—	$	—	$	0.2	$	0.2	$	—	0.2		$	—	$	—	$	0.2	$	0.2	$	(0.2	)	—
PPAs (b)											3.5								.					3.6
Current derivative instruments											$	3.7												$	3.6
Noncurrent derivative liabilities
PPAs (b)											13.7													16.4
Noncurrent derivative instruments											$	13.7												$	16.4

^(a)  SPS nets derivative instruments and related collateral in its 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, 2019 and Dec. 31, 2018. At both Sept. 30, 2019 and Dec. 31, 2018, derivative assets and liabilities include no obligations to return cash collateral or rights to reclaim cash collateral. The counterparty netting excludes settlement receivables and payables and non-derivative amounts that may be subject to the same master netting agreements.

^(b)  During 2006, SPS 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.

Changes in Level 3 commodity derivatives for the three and nine months ended Sept. 30, 2019 and 2018:

	Three Months Ended Sept. 30,
(Millions of Dollars)	2019			2018
Balance at July 1	$	22.2		$	35.4
Purchases	4.4			3.2
Settlements	(5.2		)	(10.1		)
Net transactions recorded during the period:
Net losses recognized as regulatory assets and liabilities	(4.3		)	(3.2		)
Balance at Sept. 30	$	17.1		$	25.3

	Nine Months Ended Sept. 30,
(Millions of Dollars)	2019			2018
Balance at Jan. 1	$	14.7		$	12.7
Purchases	25.5			22.5
Settlements	(24.9		)	(35.3		)
Net transactions recorded during the period:
Net gains recognized as regulatory assets and liabilities	1.8			25.4
Balance at Sept. 30	$	17.1		$	25.3

SPS recognizes transfers between fair value hierarchy 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, 2019 and 2018.

Fair Value of Long-Term Debt

Other financial instruments for which the carrying amount did not equal fair value:

	Sept. 30, 2019				Dec. 31, 2018
(Millions of Dollars)	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Long-term debt	$	2,419.3	$	2,763.2	$	2,126.1	$	2,139.8

Fair value of SPS’ long-term debt is estimated based on recent trades and observable spreads from benchmark interest rates for similar securities. Fair value estimates are based on information available to management as of Sept. 30, 2019 and Dec. 31, 2018, and given the observability of the inputs, fair values presented for long-term debt were assigned as Level 2.