12. Accounting for Derivative Instruments and Hedging Activities

From time to time, TECO Energy and its affiliates enter into futures, forwards, swaps and option contracts for the following purposes:

•

To limit the exposure to price fluctuations for physical purchases and sales of natural gas in the course of normal operations at Tampa Electric and PGS;

•

To limit the exposure to interest rate fluctuations on debt securities at TECO Energy and its affiliates; and

•

To limit the exposure to price fluctuations for physical purchases of diesel fuel at TECO Coal.

TECO Energy and its affiliates use derivatives only to reduce normal operating and market risks, not for speculative purposes. The company's primary objective in using derivative instruments for regulated operations is to reduce the impact of market price volatility on ratepayers.

The risk management policies adopted by TECO Energy provide a framework through which management monitors various risk exposures. Daily and periodic reporting of positions and other relevant metrics are performed by a centralized risk management group which is independent of all operating companies.

The company applies the accounting standards for derivative instruments and hedging activities. These standards require companies to recognize derivatives as either assets or liabilities in the financial statements, to measure those instruments at fair value, and to reflect the changes in the fair value of those instruments as either components of OCI or in net income, depending on the designation of those instruments. The changes in fair value that are recorded in OCI are not immediately recognized in current net income. As the underlying hedged transaction matures or the physical commodity is delivered, the deferred gain or loss on the related hedging instrument must be reclassified from OCI to earnings based on its value at the time of the instrument's settlement. For effective hedge transactions, the amount reclassified from OCI to earnings is offset in net income by the market change of the amount paid or received on the underlying physical transaction.

The company applies the accounting standards for regulated operations to financial instruments used to hedge the purchase of natural gas for its regulated companies. These standards, in accordance with the FPSC, permit the changes in fair value of natural gas derivatives to be recorded as regulatory assets or liabilities reflecting the impact of hedging activities on the fuel recovery clause. As a result, these changes are not recorded in OCI (see Note 3).

The company's physical contracts qualify for the normal purchase/normal sale (NPNS) exception to derivative accounting rules, provided they meet certain criteria. Generally, NPNS applies if the company deems the counterparty creditworthy, if the counterparty owns or controls resources within the proximity to allow for physical delivery of the commodity, if the company intends to receive physical delivery and if the transaction is reasonable in relation to the company's business needs. As of Sep. 30, 2011, all of the company's physical contracts qualify for the NPNS exception.

The following table presents the derivatives that are designated as cash flow hedges at Sep. 30, 2011 and Dec. 31, 2010:

Total Derivatives⁽¹⁾


(millions)	Sep. 30, 2011		Dec. 31, 2010
Current assets	$	1.3	$	2.7
Long-term assets		0.2		0.2

Total assets	$	1.5	$	2.9

Current liabilities	$	29.5	$	27.2
Long-term liabilities		6.0		2.6

Total liabilities	$	35.5	$	29.8

(1)	Amounts presented above are on a gross basis, with asset and liability positions netted by counterparty in accordance with accounting standards for derivatives and hedging.

The following table presents the derivative hedges of diesel fuel swaps and option contracts at Sep. 30, 2011 and Dec. 31, 2010 to limit the exposure to changes in the market price for diesel fuel used in the production of coal:

Diesel Fuel Derivatives


(millions)	Sep. 30, 2011		Dec. 31, 2010
Current assets	$	1.3	$	1.6
Long-term assets		0.2		0.2

Total assets	$	1.5	$	1.8

Current liabilities	$	0.0	$	0.0
Long-term liabilities		1.5		0.0

Total liabilities	$	1.5	$	0.0

The following table presents the derivative hedges of natural gas contracts at Sep. 30, 2011 and Dec. 31, 2010 to limit the exposure to changes in market price for natural gas used to produce energy and natural gas purchased for resale to customers:

Natural Gas Derivatives


(millions)	Sep. 30, 2011		Dec. 31, 2010
Current assets	$	0.0	$	1.1
Long-term assets		0.0		0.0

Total assets	$	0.0	$	1.1

Current liabilities	$	29.5	$	27.2
Long-term liabilities		4.5		2.6

Total liabilities	$	34.0	$	29.8

The ending balance in accumulated other comprehensive income (AOCI) related to the cash flow hedges and previously settled interest rate swaps at Sep. 30, 2011 is a net loss of $5.1 million after tax and accumulated amortization. This compares to a net loss of $4.2 million in AOCI after tax and accumulated amortization at Dec. 31, 2010.

The following table presents the fair values and locations of derivative instruments recorded on the balance sheet at Sep. 30, 2011:

Derivatives Designated As Hedging Instruments

Asset Derivatives

Liability Derivatives

(millions)
at Sep. 30, 2011

Balance Sheet
Location

Fair
Value

Balance Sheet
Location

Fair
Value

Commodity Contracts:

Diesel fuel derivatives:

Current

Derivative assets

1.3

Derivative liabilities

0.0

Long-term

Derivative assets

0.2

Derivative liabilities

1.5

Natural gas derivatives:

Current

Derivative assets

0.0

Derivative liabilities

29.5

Long-term

Derivative assets

0.0

Derivative liabilities

4.5

Total derivatives designated as hedging instruments

1.5

35.5

The following table presents the effect of energy related derivatives on the fuel recovery clause mechanism in the Consolidated Condensed Balance Sheet as of Sep. 30, 2011:

Energy Related Derivatives

Asset Derivatives

Liability Derivatives

(millions)
at Sep. 30, 2011

Balance Sheet
Location⁽¹⁾

Fair
Value

Balance Sheet
Location⁽¹⁾

Fair
Value

Commodity Contracts:

Natural gas derivatives:

Current

Regulatory liabilities

0.0

Regulatory assets

29.5

Long-term

Regulatory liabilities

0.0

Regulatory assets

4.5

Total

0.0

34.0

(1)

Natural gas derivatives are deferred in accordance with accounting standards for regulated operations and all increases and decreases in the cost of natural gas supply are passed on to customers with the fuel recovery clause mechanism. As gains and losses are realized in future periods, they will be recorded as fuel costs in the Consolidated Condensed Statements of Income.

Based on the fair value of the instruments at Sep. 30, 2011, net pretax losses of $29.5 million are expected to be reclassified from regulatory assets or liabilities to the Consolidated Condensed Statements of Income within the next twelve months.

The following tables present the effect of hedging instruments on OCI and income for the three months and nine months ended Sep. 30:

For the three months ended Sep. 30:


(millions)	Amount of Gain/(Loss) on Derivatives Recognized in OCI			Location of Gain/(Loss) Reclassified From AOCI Into Income	Amount of Gain/(Loss) Reclassified From AOCI Into Income
Derivatives in Cash Flow Hedging Relationships	Effective Portion⁽¹⁾				Effective Portion⁽¹⁾
2011
Interest rate contracts:	$	0.0		Interest expense	($	0.2	)
Commodity contracts:
Diesel fuel derivatives		(1.3	)	Mining related costs		0.7

Total	$	(1.3	)		$	0.5

2010
Interest rate contracts:	$	0.0		Interest expense	($	0.4	)
Commodity contracts:
Diesel fuel derivatives		0.7		Mining related costs		(0.3	)

Total	$	0.7			$	(0.7	)

(1)	Changes in OCI and AOCI are reported in after-tax dollars.

For the nine months ended Sep. 30:


(millions)	Amount of Gain/(Loss) on Derivatives Recognized in OCI			Location of Gain/(Loss) Reclassified From AOCI Into Income	Amount of Gain/(Loss) Reclassified From AOCI Into Income
Derivatives in Cash Flow Hedging Relationships	Effective Portion⁽¹⁾				Effective Portion⁽¹⁾
2011
Interest rate contracts:	$	0.0		Interest expense	$	(0.5	)
Commodity contracts:
Diesel fuel derivatives		0.6		Mining related costs		2.0

Total	$	0.6			$	1.5

2010
Interest rate contracts:	$	(0.1	)	Interest expense	$	(1.2	)
Commodity contracts:
Diesel fuel derivatives		(0.2	)	Mining related costs		(0.9	)

Total	$	(0.3	)		$	(2.1	)

(1)	Changes in OCI and AOCI are reported in after-tax dollars.

For derivative instruments that meet cash flow hedge criteria, the effective portion of the gain or loss on the derivative is reported as a component of OCI and reclassified into earnings in the same period or period during which the hedged transaction affects earnings. Gains and losses on the derivatives representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings. For the three and nine months ended Sep. 30, 2011 and 2010, all hedges were effective.

The following table presents the derivative activity for instruments classified as qualifying cash flow hedges for the nine months ended Sep. 30:

For the nine months ended Sep. 30:


(millions)	Fair Value Asset/(Liability)			Amount of Gain/(Loss) Recognized in OCI⁽¹⁾			Amount of Gain/(Loss) Reclassified From AOCI Into Income⁽¹⁾
2011
Interest rate swaps	$	0.0		$	0.0		$	(0.5	)
Diesel fuel derivatives		0.0			0.6			2.0

Total	$	0.0		$	0.6		$	1.5

2010
Interest rate swaps	$	(0.3	)	$	(0.1	)	$	(1.2	)
Diesel fuel derivatives		0.3			(0.2	)		(0.9	)

Total	$	0.0		$	(0.3	)	$	(2.1	)

(1)	Changes in OCI and AOCI are reported in after-tax dollars.

The maximum length of time over which the company is hedging its exposure to the variability in future cash flows extends to Dec. 31, 2014 for both financial natural gas and financial diesel fuel contracts. The following table presents by commodity type the company's derivative volumes that, as of Sep. 30, 2011, are expected to settle during the 2011, 2012, 2013 and 2014 fiscal years:


(millions) Year	Diesel Fuel Contracts (Gallons)				Natural Gas Contracts (MMBTUs)
(millions) Year	Physical		Financial		Physical		Financial
2011		0.0		2.4		0.0		11.6
2012		0.0		2.6		0.0		35.0
2013		0.0		1.8		0.0		5.0
2014		0.0		1.0		0.0		0.0

Total		0.0		7.8		0.0		51.6

The company is exposed to credit risk primarily through entering into derivative instruments with counterparties to limit its exposure to the commodity price fluctuations associated with diesel fuel and natural gas. Credit risk is the potential loss resulting from a counterparty's nonperformance under an agreement. The company manages credit risk with policies and procedures for, among other things, counterparty analysis, exposure measurement, and exposure monitoring and mitigation.

It is possible that volatility in commodity prices could cause the company to have material credit risk exposures with one or more counterparties. If such counterparties fail to perform their obligations under one or more agreements, the company could suffer a material financial loss. However, as of Sep. 30, 2011, all of the counterparties with transaction amounts outstanding in the company's energy portfolio are rated investment grade by the major rating agencies. The company assesses credit risk internally for counterparties that are not rated.

The company has entered into commodity master arrangements with its counterparties to mitigate credit exposure to those counterparties. The company generally enters into the following master arrangements: (1) Edison Electric Institute agreements (EEI)—standardized power sales contracts in the electric industry; (2) International Swaps and Derivatives Association agreements (ISDA)—standardized financial gas and electric contracts; and (3) North American Energy Standards Board agreements (NAESB)—standardized physical gas contracts. The company believes that entering into such agreements reduces the risk from default by creating contractual rights relating to creditworthiness, collateral and termination.

The company has implemented procedures to monitor the creditworthiness of its counterparties and to consider nonperformance in valuing counterparty positions. The company monitors counterparties' credit standing, including those that are experiencing financial problems, have significant swings in credit default swap rates, have credit rating changes by external rating agencies or have changes in ownership. Net liability positions are generally not adjusted as the company uses derivative transactions as hedges and has the ability and intent to perform under each of these contracts. In the instance of net asset positions, the company considers general market conditions and the observable financial health and outlook of specific counterparties, forward looking data such as credit default swaps, when available, and historical default probabilities from credit rating agencies in evaluating the potential impact of nonperformance risk to derivative positions.

Certain TECO Energy derivative instruments contain provisions that require the company's debt, or in the case of derivative instruments where Tampa Electric Company is the counterparty, Tampa Electric Company's debt, to maintain an investment grade credit rating from any or all of the major credit rating agencies. If debt ratings, including Tampa Electric Company's, were to fall below investment grade, it could trigger these provisions, and the counterparties to the derivative instruments could request immediate payment or demand immediate and ongoing full overnight collateralization on derivative instruments in net liability positions. The company has no other contingent risk features associated with any derivative instruments.

The table below presents the fair value of the overall contractual contingent liability positions for the company's derivative activity at Sep. 30, 2011:

Contingent Features

(millions)

At Sep. 30, 2011

Fair Value
Asset/
(Liability)

Derivative
Exposure
Asset/
(Liability)

Posted
Collateral

Credit Rating

(35.1

)

(35.1

)

0.0