Accounting for Derivative Instruments and Hedging Activities

15 Months Ended

Jun. 30, 2012

Accounting for Derivative Instruments and Hedging Activities

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 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).

A company’s physical contracts qualify for the 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 June 30, 2012, 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 June 30, 2012 and Dec. 31, 2011:

Total Derivatives (1)
(millions)	June 30, 2012		Dec. 31, 2011
Current assets	$	0.7	$	0.9
Long-term assets		0.1		0.0
Total assets	$	0.8	$	0.9
Current liabilities	$	40.5	$	58.4
Long-term liabilities		3.9		8.6
Total liabilities	$	44.4	$	67.0

(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 contracts at June 30, 2012 and Dec. 31, 2011 to limit the exposure to changes in the market price for diesel fuel used in the production of coal:

Diesel Fuel Derivatives
(millions)	June 30, 2012		Dec. 31, 2011
Current assets	$	0.3	$	0.9
Long-term assets		0.0		0.0
Total assets	$	0.3	$	0.9
Current liabilities	$	1.6	$	0.0
Long-term liabilities		1.3		1.2
Total liabilities	$	2.9	$	1.2

The following table presents the derivative hedges of natural gas contracts at June 30, 2012 and Dec. 31, 2011 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)	June 30, 2012		Dec. 31, 2011
Current assets	$	0.4	$	0.0
Long-term assets		0.1		0.0
Total assets	$	0.5	$	0.0
Current liabilities	$	38.9	$	58.4
Long-term liabilities		2.6		7.4
Total liabilities	$	41.5	$	65.8

The ending balance in AOCI related to the cash flow hedges and previously settled interest rate swaps at June 30, 2012 is a net loss of $10.9 million after tax and accumulated amortization. This compares to a net loss of $5.0 million in AOCI after tax and accumulated amortization at Dec. 31, 2011. The balance at June 30, 2012 is primarily comprised of interest rate swaps settled coincident with debt issued in June of 2008 and 2012 (see Note 7). These amounts will be amortized into earnings over the life of the related debt.

The following table presents the fair values and locations of derivative instruments recorded on the balance sheet at June 30, 2012:

Derivatives Designated As Hedging Instruments
	Asset Derivatives			Liability Derivatives
(millions) at June 30, 2012	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Commodity Contracts:
Diesel fuel derivatives:
Current	Derivative assets	$	0.3	Derivative liabilities	$	1.6
Long-term	Derivative assets		0.0	Derivative liabilities		1.3
Natural gas derivatives:
Current	Derivative assets		0.4	Derivative liabilities		38.9
Long-term	Derivative assets		0.1	Derivative liabilities		2.6
Total derivatives designated as hedging instruments		$	0.8		$	44.4

The following table presents the effect of energy related derivatives on the fuel recovery clause mechanism in the Consolidated Condensed Balance Sheets as of June 30, 2012:

Energy Related Derivatives
	Asset Derivatives			Liability Derivatives
(millions) at June 30, 2012	Balance Sheet Location (1)	Fair Value		Balance Sheet Location (1)	Fair Value
Commodity Contracts:
Natural gas derivatives:
Current	Regulatory liabilities	$	0.4	Regulatory assets	$	38.9
Long-term	Regulatory liabilities		0.1	Regulatory assets		2.6
Total		$	0.5		$	41.5

(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 June 30, 2012, net pretax losses of $38.5 million are expected to be reclassified from regulatory assets or liabilities to the Consolidated Condensed Statements of Income within the next 12 months.

The following tables present the effect of hedging instruments on OCI and income for the three and six months ended June 30:

For the three months ended June 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)
2012
Interest rate contracts	($	4.9	)	Interest expense	($	0.2	)
Commodity contracts:
Diesel fuel derivatives		(2.7	)	Mining related costs		0.0
Total	($	7.6	)		($	0.2	)
2011
Interest rate contracts	$	0.0		Interest expense	($	0.2	)
Commodity contracts:
Diesel fuel derivatives		(0.8	)	Mining related costs		0.8
Total	($	0.8	)		$	0.6

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

For the six months ended June 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)
2012
Interest rate contracts	($	4.9	)	Interest expense	($	0.4	)
Commodity contracts:
Diesel fuel derivatives		(1.2	)	Mining related costs		0.2
Total	($	6.1	)		($	0.2	)
2011
Interest rate contracts	$	0.0		Interest expense	($	0.3	)
Commodity contracts:
Diesel fuel derivatives		1.8		Mining related costs		1.2
Total	$	1.8			$	0.9

(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 six months ended June 30, 2012 and 2011, all hedges were effective.

The following table presents the derivative activity for instruments classified as qualifying cash flow hedges and their effect on OCI and AOCI for the six months ended June 30:

For the six months ended June 30: (millions)	Fair Value Asset/(Liability)			Amount of Gain/(Loss) Recognized in OCI (1)			Amount of Gain/(Loss) Reclassified From AOCI Into Income
2012
Interest rate swaps	$	0.0		($	4.9	)	($	0.4	)
Diesel fuel derivatives		(2.6	)		(1.2	)		0.2
Total	($	2.6	)	($	6.1	)	($	0.2	)
2011
Interest rate swaps	$	0.0		$	0.0		($	0.3	)
Diesel fuel derivatives		3.1			1.8			1.2
Total	$	3.1		$	1.8		$	0.9

(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 June 30, 2012, are expected to settle during the 2012, 2013 and 2014 fiscal years:

	Diesel Fuel Contracts				Natural Gas Contracts
(millions)	(Gallons)				(MMBTUs)
Year	Physical		Financial		Physical		Financial
2012		0.0		4.9		0.0		20.1
2013		0.0		2.7		0.0		13.4
2014		0.0		1.5		0.0		2.1
Total		0.0		9.1		0.0		35.6

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 June 30, 2012, substantially 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) EEI agreements - standardized power sales contracts in the electric industry; (2) ISDA agreements - standardized financial gas and electric contracts; and (3) NAESB agreements - 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 standings, 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. As of June 30, 2012, all positions with counterparties are net liabilities.

Certain TECO Energy derivative instruments contain provisions that require the company’s debt, or in the case of derivative instruments where TEC is the counterparty, TEC’s debt, to maintain an investment grade credit rating from any or all of the major credit rating agencies. If debt ratings, including TEC’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 June 30, 2012:

Contingent Features
(millions) At June 30, 2012	Fair Value Asset/ (Liability)			Derivative Exposure Asset/ (Liability)			Posted Collateral
Credit Rating	($	44.0	)	($	44.0	)	$	0.0

Tampa Electric Co [Member]

Accounting for Derivative Instruments and Hedging Activities

10. Accounting for Derivative Instruments and Hedging Activities

From time to time, TEC enters 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, and

• to limit the exposure to interest rate fluctuations on debt securities.

TEC uses derivatives only to reduce normal operating and market risks, not for speculative purposes. TEC’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 TEC 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.

TEC applies the accounting standards for derivatives and hedging. 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.

TEC applies accounting standards for regulated operations to financial instruments used to hedge the purchase of natural gas for the 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).

A company’s physical contracts qualify for the 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 June 30, 2012, all of TEC’s physical contracts qualify for the NPNS exception.

The following table presents the derivative hedges of natural gas contracts at June 30, 2012 and Dec. 31, 2011 to limit the exposure to changes in the market price for natural gas used to produce energy and natural gas purchased for resale to customers:

Natural Gas Derivatives
(millions)	June 30, 2012		Dec. 31, 2011
Current assets	$	0.4	$	0.0
Long-term assets		0.1		0.0
Total assets	$	0.5	$	0.0
Current liabilities (1)	$	38.9	$	58.4
Long-term liabilities		2.6		7.4
Total liabilities	$	41.5	$	65.8

(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 ending balance in AOCI related to previously settled interest rate swaps at June 30, 2012 is a net loss of $9.1 million after tax and accumulated amortization. This compares to a net loss of $4.6 million in AOCI after tax and accumulated amortization at Dec. 31, 2011. The balance at June 30, 2012 is comprised of interest rate swaps settled coincident with debt issued in June of 2008 and 2012 (see Note 7). These amounts will be amortized into earnings over the life of the related debt.

The following table presents the effect of energy related derivatives on the fuel recovery clause mechanism in the Consolidated Condensed Balance Sheets as of June 30, 2012:

Energy Related Derivatives
	Asset Derivatives			Liability Derivatives
(millions) at June 30, 2012	Balance Sheet Location (1)	Fair Value		Balance Sheet Location (1)	Fair Value
Commodity Contracts:
Natural gas derivatives:
Current	Regulatory liabilities	$	0.4	Regulatory assets	$	38.9
Long-term	Regulatory liabilities		0.1	Regulatory assets		2.6
Total		$	0.5		$	41.5

(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 June 30, 2012, net pretax losses of $38.5 million are expected to be reclassified from regulatory assets to the Consolidated Condensed Statements of Income within the next 12 months.

The following table presents the effect of hedging instruments on OCI and income for the three and six months ended June 30:

(millions)	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)	Three months ended June  30:			Six months ended June 30:
2012
Interest rate contracts:	Interest expense	($	0.2	)	($	0.4	)
Total		($	0.2	)	($	0.4	)
2011
Interest rate contracts:	Interest expense	($	0.2	)	($	0.3	)
Total		($	0.2	)	($	0.3	)

(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 six months ended June 30, 2012 and 2011, all hedges were effective.

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

(millions)	Natural Gas Contracts (MMBTUs)
Year	Physical		Financial
2012		0.0		20.1
2013		0.0		13.4
2014		0.0		2.1
Total		0.0		35.6

TEC is exposed to credit risk primarily through entering into derivative instruments with counterparties to limit its exposure to the commodity price fluctuations associated with natural gas. Credit risk is the potential loss resulting from a counterparty’s nonperformance under an agreement. TEC 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 TEC to have material credit risk exposures with one or more counterparties. If such counterparties fail to perform their obligations under one or more agreements, TEC could suffer a material financial loss. However, as of June 30, 2012, substantially all of the counterparties with transaction amounts outstanding in TEC’s energy portfolio are rated investment grade by the major rating agencies. TEC assesses credit risk internally for counterparties that are not rated.

TEC has entered into commodity master arrangements with its counterparties to mitigate credit exposure to those counterparties. TEC generally enters into the following master arrangements: (1) EEI agreements - standardized power sales contracts in the electric industry; (2) ISDA agreements - standardized financial gas and electric contracts; and (3) NAESB agreements - standardized physical gas contracts. TEC believes that entering into such agreements reduces the risk from default by creating contractual rights relating to creditworthiness, collateral and termination.

TEC has implemented procedures to monitor the creditworthiness of its counterparties and to consider nonperformance in valuing counterparty positions. TEC monitors counterparties’ credit standings, 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 TEC 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, TEC 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. As of June 30, 2012, all positions with counterparties are net liabilities.

Certain TEC derivative instruments contain provisions that require TEC’s debt to maintain an investment grade credit rating from any or all of the major credit rating agencies. If debt ratings 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. TEC 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 TEC’s derivative activity at June 30, 2012:

Contingent Features
(millions) At June 30, 2012	Fair Value Asset/ (Liability)			Derivative Exposure Asset/ (Liability)			Posted Collateral
Credit Rating	($	41.2	)	($	41.2	)	$	0.0

Tampa Electric Co [Member] | Energy Related Derivatives [Member]

Accounting for Derivative Instruments and Hedging Activities

Energy Related Derivatives
	Asset Derivatives			Liability Derivatives
(millions) at June 30, 2012	Balance Sheet Location (1)	Fair Value		Balance Sheet Location (1)	Fair Value
Commodity Contracts:
Natural gas derivatives:
Current	Regulatory liabilities	$	0.4	Regulatory assets	$	38.9
Long-term	Regulatory liabilities		0.1	Regulatory assets		2.6
Total		$	0.5		$	41.5

(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.