· | Lower income taxes for the nine-month period, primarily due to lower· | Higher income taxes primarily due to higher pre-tax income. |
· | Lower noncontrolling interests for the three and nine-month periods due to the preference stock redemption in June 2012. |
Outlook
PPL projects lowerThe following after-tax gains (losses), which management considers special items, also impacted the Kentucky Regulated segment's results during the periods ended March 31.
| | | Income Statement | | Three Months | | | | Line Item | | 2013 | | 2012 | | | | | | | | | | | LKE acquisition-related adjustments: | | | | | | | | | Income Taxes and Other Operation | | | | | | | | Net operating loss carryforward and other tax-related adjustments | and Maintenance | | | | | $ | 4 | Other: | | | | | | | | | EEI adjustments, net of tax of $0, $0 | Other Income (Expense)-net | | $ | 1 | | | | Total | | | $ | 1 | | $ | 4 |
2013 Outlook
Excluding special items, PPL projects higher segment earnings in 2013 compared with 2012, primarily driven by electric and gas base rate increases, returns on additional environmental capital investments, and load growth, partially offset by higher operation and maintenance expense.
Earnings in future periods are subject to various risks and uncertainties. See "Forward-Looking Information," the rest of this Item 2, and Notes 6 and 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in PPL's 2012 compared with 2011, primarily driven by higher other operation and maintenance expense, higher depreciation and lower distribution revenue, which are expected to be partially offset by higher transmission revenue, lower financing costs, and lower income taxes.
In March 2012, PPL Electric filed a request with the PUC to increase distribution rates by approximately $105 million effective January 1, 2013. The proposed distribution rate increase would result in a 2.9% increase over PPL Electric's total rates at the time of the request. PPL Electric's application includes a request for an authorized return-on-equity of 11.25%. On October 19, 2012, the presiding Administrative Law Judge (ALJ) issued a decision recommending a rate increase of approximately $64 million, which represents an allowed return on equity of 9.74%. Exceptions to the ALJ's recommendation are due November 8, 2012. PPL Electric expects to file exceptions, together with certain other parties, to the ALJ's recommended decision. The PUC, which is expected to issue its order on the rate request in December 2012, can accept, reject or modify the ALJ's recommendation. PPL cannot predict the outcome of this proceeding.
Earnings in 2012 and future periods are subject to various risks and uncertainties. See "Forward-Looking Information," the rest of this Item 2 and Notes 6 and 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in PPL's 2011 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.
U.K. Regulated Segment
The U.K. Regulated segment consists of WPD's regulated electricity distribution operations and PPL Global. In addition, the U.K. Regulated segment includes certain U.S. income taxes and certain administrative costs, as well as allocated financing costs. Net Income Attributable to PPL Shareowners for the periods ended March 31 includes the following results:
| | | Three Months | | | | 2013 | | 2012 | | % Change | | | | | | | | | | | Utility revenues | | $ | 638 | | $ | 552 | | 16 | Energy-related businesses | | | 10 | | | 10 | | | | Total operating revenues | | | 648 | | | 562 | | 15 | Other operation and maintenance | | | 117 | | | 113 | | 4 | Depreciation | | | 74 | | | 67 | | 10 | Taxes, other than income | | | 37 | | | 36 | | 3 | Energy-related businesses | | | 7 | | | 5 | | 40 | | Total operating expenses | | | 235 | | | 221 | | 6 | Other Income (Expense) - net | | | 120 | | | (20) | | 700 | Interest Expense | | | 107 | | | 103 | | 4 | Income Taxes | | | 113 | | | 53 | | 113 | Net Income Attributable to PPL Shareowners | | $ | 313 | | $ | 165 | | 90 |
The changes in the components of the U.K. Regulated segment's results between these periods were due to the following factors, which reflect reclassifications for certain items that management considers special. See additional detail of these special items in the table below.
| | | | | Three Months | | | | | | | | | U.K. | | | | | | | | Utility revenues | | | | | $ | 75 | | Other operation and maintenance | | | | | | (6) | | Interest expense | | | | | | (3) | | Other | | | | | | (3) | | Income taxes | | | | | | (10) | U.S. | | | | | | | | Income taxes | | | | | | 1 | Foreign currency exchange rates, after-tax (a) | | | | | | 1 | Special items, after-tax | | | | | | 93 | Total | | | | | $ | 148 |
(a) | Includes the effect of realized gains (losses) on foreign currency economic hedges. |
U.K.
· | Higher utility revenues due to the April 1, 2012 price increases that resulted in $57 million of higher utility revenues, $8 million of additional third-party engineering work, $5 million of higher volumes due primarily to weather and a $5 million reduction of regulatory over-recovery in 2013. |
· | Higher other operation and maintenance due to $8 million of additional third-party engineering work and $7 million of higher network maintenance expense, primarily tree trimming, partially offset by $4 million of lower employee-related expenses. |
· | Higher income taxes due to higher pre-tax income, which increased income taxes by $16 million, partially offset by $6 million of lower income taxes due to lower tax rates. |
The following after-tax gains (losses), which management considers special items, also impacted the U.K. Regulated segment's results during the periods ended March 31.
| | | Income Statement | | Three Months | | | | Line Item | | 2013 | | 2012 | | | | | | | | | | | Foreign currency-related economic hedges, net of tax of ($42), $7 (a) | Other Income (Expense)-net | | $ | 78 | | $ | (14) | WPD Midlands acquisition-related adjustments: | | | | | | | | | Separation benefits, net of tax of $1, $2 | Other Operation and Maintenance | | | (1) | | | (4) | | Other acquisition-related adjustments, net of tax of $0, $0 | Other Operation and Maintenance | | | (2) | | | | Total | | | $ | 75 | | $ | (18) |
(a) | Represents unrealized gains (losses) on contracts that economically hedge anticipated earnings denominated in GBP. |
2013 Outlook
Excluding special items, PPL projects higher segment earnings in 2013 compared with 2012, primarily driven by higher electricity delivery revenue and lower income taxes, partially offset by higher operation and maintenance expense, higher depreciation and higher interest expense.
Earnings in future periods are subject to various risks and uncertainties. See "Forward-Looking Information," the rest of this Item 2, and Notes 5, 6 and 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in PPL's 2012 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.
Pennsylvania Regulated Segment
The Pennsylvania Regulated segment includes PPL Electric's regulated electricity transmission and distribution operations. In addition, the Pennsylvania Regulated segment is allocated certain financing costs.
Net Income Attributable to PPL Shareowners for the periods ended March 31 includes the following results: | | | | | | | | | | | | | | Three Months | | | | 2013 | | 2012 | | % Change | Utility revenues | | | | | | | | | | External | | $ | 512 | | $ | 457 | | 12 | | Intersegment | | | 1 | | | 1 | | | | Total utility revenues | | | 513 | | | 458 | | 12 | Energy purchases | | | | | | | | | | External | | | 172 | | | 153 | | 12 | | Intersegment | | | 14 | | | 21 | | (33) | Other operation and maintenance | | | 133 | | | 140 | | (5) | Depreciation | | | 43 | | | 39 | | 10 | Taxes, other than income | | | 30 | | | 26 | | 15 | | Total operating expenses | | | 392 | | | 379 | | 3 | Other Income (Expense) - net | | | 1 | | | 2 | | (50) | Interest Expense | | | 25 | | | 24 | | 4 | Income Taxes | | | 33 | | | 20 | | 65 | Net Income | | | 64 | | | 37 | | 73 | Net Income Attributable to Noncontrolling Interests | | | | | | 4 | | (100) | Net Income Attributable to PPL Shareowners | | $ | 64 | | $ | 33 | | 94 |
The changes in the components of the Pennsylvania Regulated segment's results between these periods were due to the following factors, which reflect reclassifications for items included in Pennsylvania Gross Delivery Margins.
| | | | Three Months | | | | | | | | Pennsylvania Gross Delivery Margins | | | | | $ | 40 | Other operation and maintenance | | | | | | 7 | Depreciation | | | | | | (4) | Other | | | | | | (3) | Income Taxes | | | | | | (13) | Noncontrolling Interests | | | | | | 4 | Total | | | | | $ | 31 |
· | See "Statement of Income Analysis - Margins - Changes in Non-GAAP Financial Measures" for an explanation of Pennsylvania Gross Delivery Margins. |
· | Lower other operation and maintenance primarily due to lower corporate service costs. |
· Higher depreciation due to PP&E additions.
· | Higher income taxes primarily due to the impact of higher pre-tax income. |
· | Lower noncontrolling interests due to PPL Electric's June 2012 redemption of all 2.5 million shares of its preference stock. |
2013 Outlook
Excluding special items, PPL projects higher segment earnings in 2013 compared with 2012, primarily driven by higher distribution revenues from a distribution base rate increase and higher transmission margins, partially offset by higher depreciation.
Earnings in future periods are subject to various risks and uncertainties. See "Forward-Looking Information," the rest of this Item 2, and Notes 6 and 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in PPL's 2012 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.
Supply Segment
The Supply segment primarily consists of thePPL Energy Supply's energy marketing and trading activities, as well as theits competitive generation and development operations of PPL Energy Supply.operations. In addition, the Supply segment is allocated certain financing costs.
Net Income Attributable to PPL Shareowners for the periods ended September 30 includes the following results: | | Net Income Attributable to PPL Shareowners for the periods ended March 31 includes the following results: | | Net Income Attributable to PPL Shareowners for the periods ended March 31 includes the following results: | | | | | | | | �� | | | | | | | | | | | | | | | | | Three Months | | Nine Months | | | Three Months | | | | 2012 | | 2011 | | % Change | | 2012 | | 2011 | | % Change | | | 2013 | | 2012 | | % Change | Energy revenues | Energy revenues | | | | | | | | | | | | | Energy revenues | | | | | | | | External (a) | | $ | 567 | | $ | 1,305 | | (57) | | $ | 3,673 | | $ | 3,437 | | 7 | External (a) | | $ | 381 | | $ | 2,290 | | (83) | | Intersegment | | 23 | | 5 | | 360 | | 61 | | 15 | | 307 | Intersegment | | 14 | | 21 | | (33) | Energy-related businesses | Energy-related businesses | | | 133 | | | 132 | | 1 | | | 346 | | | 360 | | (4) | Energy-related businesses | | | 113 | | | 98 | | 15 | | Total operating revenues | | | 723 | | | 1,442 | | (50) | | | 4,080 | | | 3,812 | | 7 | Total operating revenues | | | 508 | | | 2,409 | | (79) | Fuel (a) | Fuel (a) | | 321 | | 358 | | (10) | | 728 | | 826 | | (12) | Fuel (a) | | 298 | | 211 | | 41 | Energy purchases | Energy purchases | | | | | | | | | | | | | Energy purchases | | | | | | | | External (a) | | (150) | | 335 | | (145) | | 1,288 | | 746 | | 73 | External (a) | | (200) | | 1,247 | | (116) | | Intersegment | | 1 | | 2 | | (50) | | 2 | | 3 | | (33) | Intersegment | | 1 | | 1 | | | Other operation and maintenance | Other operation and maintenance | | 215 | | 191 | | 13 | | 750 | | 707 | | 6 | Other operation and maintenance | | 235 | | 248 | | (5) | Depreciation | Depreciation | | 81 | | 66 | | 23 | | 229 | | 194 | | 18 | Depreciation | | 78 | | 72 | | 8 | Taxes, other than income | Taxes, other than income | | 19 | | 18 | | 6 | | 54 | | 49 | | 10 | Taxes, other than income | | 17 | | 18 | | (6) | Energy-related businesses | Energy-related businesses | | | 129 | | | 131 | | (2) | | | 339 | | | 356 | | (5) | Energy-related businesses | | | 110 | | | 97 | | 13 | | Total operating expenses | | | 616 | | | 1,101 | | (44) | | | 3,390 | | | 2,881 | | 18 | Total operating expenses | | | 539 | | | 1,894 | | (72) | Other Income (Expense) - net | Other Income (Expense) - net | | 6 | | 22 | | (73) | | 15 | | 41 | | (63) | Other Income (Expense) - net | | 4 | | 5 | | (20) | Other-Than-Temporary Impairments | | | | 5 | | (100) | | 1 | | 6 | | (83) | | Interest Expense | Interest Expense | | 62 | | 59 | | 5 | | 163 | | 159 | | 3 | Interest Expense | | 60 | | 48 | | 25 | Income Taxes | Income Taxes | | 3 | | 99 | | (97) | | 180 | | 299 | | (40) | Income Taxes | | | (41) | | | 171 | | (124) | Income (Loss) from Discontinued Operations | | | | | | 1 | | (100) | | | | | | 3 | | (100) | | Net Income | | 48 | | 201 | | (76) | | 361 | | 511 | | (29) | | Net Income Attributable to Noncontrolling Interests | | | | | | 1 | | (100) | | | | | | 1 | | (100) | | Net Income Attributable to PPL Shareowners | | $ | 48 | | $ | 200 | | (76) | | $ | 361 | | $ | 510 | | (29) | | Net Income (Loss) Attributable to PPL Shareowners | | Net Income (Loss) Attributable to PPL Shareowners | | $ | (46) | | $ | 301 | | (115) |
(a) | Includes the impact from energy-related economic activity. See "Commodity Price Risk (Non-trading) - Economic Activity" in Note 14 to the Financial Statements for additional information. |
The changes in the components of the Supply segment's results between these periods were due to the following factors, which reflect reclassifications for items included in unregulated gross energy marginsUnregulated Gross Energy Margins and certain items that management considers special. See additional detail of these special items in the table below.
| | Three Months | | Nine Months | | | | | | | | Unregulated gross energy margins | | $ | (38) | | $ | (125) | Other operation and maintenance | | | (23) | | | (42) | Depreciation | | | (15) | | | (35) | Other Income (Expense) - net | | | (18) | | | (30) | Other | | | 7 | | | 1 | Income Taxes | | | 33 | | | 106 | Discontinued operations, after-tax | | | (1) | | | 2 | Special items, after-tax | | | (97) | | | (26) | Total | | $ | (152) | | $ | (149) |
| | | | Three Months | | | | | | | | Unregulated Gross Energy Margins | | | | | $ | (107) | Other operation and maintenance | | | | | | 6 | Depreciation | | | | | | (6) | Interest expense | | | | | | (12) | Other | | | | | | 2 | Income Taxes | | | | | | 33 | Special items, after-tax | | | | | | (263) | Total | | | | | $ | (347) |
· | See "Statement of Income Analysis - Margins - Changes in Non-GAAP Financial Measures" for an explanation of Unregulated Gross Energy Margins. |
· | HigherLower other operation and maintenance for the three-month periodprimarily due to $8$15 million of higherlower costs at PPL Susquehanna, $7 millioneastern fossil and hydroelectric plants largely due to a planned outage at PPL Brunner Islandoutages in September 2012, and $4partially offset by $3 million of higheradditional costs from Ironwood as a result of the acquisition. |
Higher other operation and maintenance for the nine-month period primarily due to $27 million of higher costs at PPL Susquehanna including refueling outage costs, payroll-related costs and timing of projects and $13 million of higher costs from Ironwood as a result of the acquisition.
· | Higher depreciation for the three and nine-month periods due to the impact of PP&E additions, and $7 million and $11 million due to the Ironwood Acquisition. |
· | Lower other income (expense) - net for the three and nine-month periodsHigher depreciation primarily due to the Ironwood Acquisition. |
· | Higher interest expense primarily due to financings associated with PPL Ironwood, acquired in April 2012, which increased interest expense by $4 million, and $4 million due to the allocation of interest from a $22 million gain on the redemption ofJune 2012 PPL Capital Funding debt in the third quarter of 2011.issuance. |
· | Lower income taxes for the three-month period primarily due to lower pre-tax income.income in 2013, which reduced income taxes by $47 million, partially offset by an $11 million benefit from a state tax rate change recorded in 2012. |
Lower income taxes for the nine-month period due to lower pre-tax income, which reduced income taxes by $73 million, $15 million of net deferred tax benefits from state tax adjustments recorded in 2012 and $11 million of Pennsylvania net operating loss valuation allowance adjustments recorded in 2011, driven primarily by the impact of bonus depreciation.
The following after-tax gains (losses), which management considers special items, also impacted the Supply segment's results during the periods ended September 30.March 31.
| | | Income Statement | | Three Months | | Nine Months | | | Income Statement | | Three Months | | | | Line Item | | 2012 | | 2011 | | 2012 | | 2011 | | | Line Item | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | | | | Adjusted energy-related economic activity, net, net of tax of $63, $8, ($16), ($2) | (a) | | $ | (95) | | $ | (10) | | $ | 23 | | $ | 4 | | Adjusted energy-related economic activity, net, net of tax of $79, ($102) | | Adjusted energy-related economic activity, net, net of tax of $79, ($102) | (a) | | $ | (117) | | $ | 150 | Impairments: | Impairments: | | | | | | | | | | Impairments: | | | | | | | | Emission allowances, net of tax of $0, $0, $0, $1 | Other O&M | | | | | | | | (1) | | | Renewable energy credits, net of tax of $0, $0, $0, $2 | Other O&M | | | | | | | | (3) | | | Adjustments - nuclear decommissioning trust investments, net of tax of $0, $2, ($2), $2 | Other Income-net | | | | (1) | | 1 | | | | LKE acquisition-related adjustments: | | | | | | | | | | | | Sale of certain non-core generation facilities, net of tax of $0, $0, $0, $0 | Disc. Operations | | | | | | | | (2) | Adjustments - nuclear decommissioning trust investments, net of tax of $0, ($1) | Other Income (Expense)-net | | | | | 1 | Other: | Other: | | | | | | | | | | Other: | | | | | | | | Montana hydroelectric litigation, net of tax of $0, $0, $0, $1 | Interest Expense | | | | (1) | | | | (2) | Counterparty bankruptcy, net of tax of $0, $5 (b) | Other Operation and Maintenance | | | | | (6) | | Litigation settlement - spent nuclear fuel storage, net of tax of $0, ($2), $0, ($23) (b) | Fuel | | | | 4 | | | | 33 | Ash basin leak remediation adjustment, net of tax of $0, ($1) | Other Operation and Maintenance | | | | | | 1 | | Counterparty bankruptcy, net of tax of $0, $0, $5, $0 (c) | Other O&M | | | | | | (6) | | | | | Wholesale supply cost reimbursement, net of tax of $0, $0, $0, $0 | (d) | | | | | | 1 | | | | | Ash basin leak remediation adjustment, net of tax of $0, $0, ($1), $0 | Other O&M | | | | | | 1 | | | | | Coal contract modification payments, net of tax of $7, $0, $12, $0 (e) | Fuel | | | (10) | | | | | | (17) | | | | | Total | Total | | | $ | (105) | | $ | (8) | | $ | 3 | | $ | 29 | Total | | | $ | (117) | | $ | 146 |
(a) | See "Reconciliation of Economic Activity" below. |
(b) | In May 2011, PPL Susquehanna entered into a settlement agreement with the U.S. Government relating to PPL Susquehanna's lawsuit, seeking damages for the DOE's failure to accept spent nuclear fuel from the PPL Susquehanna plant. PPL Susquehanna recorded credits to fuel expense to recognize recovery, under the settlement agreement, of certain costs to store spent nuclear fuel at the Susquehanna plant. The amounts recorded through September 2011 cover the costs incurred from 1998 through December 2010. |
(c) | In October 2011, a wholesale customer, SMGT, filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy code. In 2012, PPL EnergyPlus recorded an additional allowance for unpaid amounts under the long-term power contract. In March 2012, the U.S. Bankruptcy Court for the District of Montana approved the request to terminate the contract, effective April 1, 2012. |
(d) | Recorded in "Wholesale energy marketing - Realized" on the Statement of Income. |
(e) | As a result of lower electricity and natural gas prices, coal unit utilization has decreased. Contract modification payments were incurred to reduce 2012 and 2013 contracted coal deliveries. |
Reconciliation of Economic Activity
The following table reconciles unrealized pre-tax gains (losses) for the periods ended September 30,March 31, from the table within "Commodity Price Risk (Non-trading) - Economic Activity" in Note 14 to the Financial Statements to the special item identified as "Adjusted energy-related economic activity, net."
| | | | Three Months | | Nine Months | | | | | 2012 | | 2011 | | 2012 | | 2011 | Operating Revenues | | | | | | | | | | | | | | | Unregulated retail electric and gas | | $ | (13) | | $ | 4 | | $ | (15) | | $ | 9 | | | Wholesale energy marketing | | | (716) | | | 216 | | | (322) | | | 229 | Operating Expenses | | | | | | | | | | | | | | | Fuel | | | 3 | | | (28) | | | (11) | | | (16) | | | Energy Purchases | | | 569 | | | (176) | | | 420 | | | (49) | Energy-related economic activity (a) | | | (157) | | | 16 | | | 72 | | | 173 | Option premiums (b) | | | | | | 6 | | | 1 | | | 17 | Adjusted energy-related economic activity | | | (157) | | | 22 | | | 73 | | | 190 | Less: Economic activity realized, associated with the monetization of | | | | | | | | | | | | | | certain full-requirement sales contracts in 2010 | | | 1 | | | 40 | | | 34 | | | 184 | Adjusted energy-related economic activity, net, pre-tax | | $ | (158) | | $ | (18) | | $ | 39 | | $ | 6 | | | | | | | | | | | | | | | | Adjusted energy-related economic activity, net, after-tax | | $ | (95) | | $ | (10) | | $ | 23 | | $ | 4 |
| | | | Three Months | | | | | 2013 | | 2012 | Operating Revenues | | | | | | | | | Unregulated retail electric and gas | | $ | (8) | | $ | 10 | | | Wholesale energy marketing | | | (822) | | | 852 | Operating Expenses | | | | | | | | | Fuel | | | (1) | | | 2 | | | Energy Purchases | | | 634 | | | (591) | Energy-related economic activity (a) | | | (197) | | | 273 | Option premiums | | | 1 | | | | Adjusted energy-related economic activity | | | (196) | | | 273 | Less: Economic activity realized, associated with the monetization of certain | | | | | | | | full-requirement sales contracts in 2010 | | | | | | 21 | Adjusted energy-related economic activity, net, pre-tax | | $ | (196) | | $ | 252 | | | | | | | | | | Adjusted energy-related economic activity, net, after-tax | | $ | (117) | | $ | 150 |
(a) | See Note 14 to the Financial Statements for additional information. |
(b) | Adjustment for the net deferral and amortization of option premiums over the delivery period of the item that was hedged or upon realization. Option premiums are recorded in "Wholesale energy marketing - Realized" and "Energy purchases - Realized" on the Statements of Income. |
2013 Outlook
Excluding special items, PPL projects lower segment earnings in 20122013 compared with 2011. The decrease is2012, primarily driven by lower energy margins as a result of lower energy and capacity prices, and lower generation volumes, higher otherfuel costs, higher operation and maintenance expense, higher depreciation, and higher depreciation.financing costs, partially offset by higher capacity prices and higher nuclear generation output despite scheduled outages for both Susquehanna units to implement a long-term solution to turbine blade issues.
Earnings in 2012 and future periods are subject to various risks and uncertainties. See "Forward-Looking Information," the rest of this Item 2, and Note 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in PPL's 20112012 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.
Statement of Income Analysis --
Margins
Non-GAAP Financial Measures
The following discussion includes financial information prepared in accordance with GAAP, as well as three non-GAAP financial measures: "Kentucky Gross Margins," "Pennsylvania Gross Delivery Margins" and "Unregulated Gross Energy Margins." These measures are not intended to replace "Operating Income," which is determined in accordance with GAAP, as an indicator of overall operating performance. Other companies may use different measures to analyze and to report on the results of their operations. PPL believes that these measures provide additional criteria to make investment decisions. These performance measures are used, in conjunction with other information, internally by senior management and the Board of Directors to manage the Kentucky Regulated, Pennsylvania Regulated and Supply segment operations, analyze each respective segment's actual results compared with budget and, in certain cases, to measure certain corporate financial goals used in determining variable compensation.
PPL's three non-GAAP financial measures include:
· | "Kentucky Gross Margins" is a single financial performance measure of the Kentucky Regulated segment's electricity generation, transmission and distribution operations as well as its distribution and sale of natural gas. In calculating this measure, fuel and energy purchases are deducted from revenues. In addition, utility revenues and expenses associated with approved cost recovery tracking mechanisms are offset. Certain costs associated with these mechanisms, primarily ECR and DSM, are recorded as "Other operation and maintenance" and "Depreciation." These mechanisms allow for recovery of certain expenses, returns on capital investments and performance incentives. Certain costs associated with these mechanisms, primarily ECR, DSM and GLT, are recorded as "Other operation and maintenance" and "Depreciation." As a result, this measure represents the net revenues from the Kentucky Regulated segment's operations. |
· | "Pennsylvania Gross Delivery Margins" is a single financial performance measure of the Pennsylvania Regulated segment's electric delivery operations, which includes transmission and distribution activities. In calculating this measure, utility revenues and expenses associated with approved recovery mechanisms, including energy provided as a PLR, are offset with minimal impact on earnings. Costs associated with these mechanisms are recorded in "Energy purchases," "Other operation and maintenance," which is primarily Act 129 costs, and "Taxes, other than income," which is primarily gross receipts tax. This performance measure includes PLR energy purchases by PPL Electric from PPL EnergyPlus, which are reflected in "PLR intersegment utility revenue (expense)" in the table below. As a result, this measure represents the net revenues from the Pennsylvania Regulated segment's electric delivery operations. |
EnergyPlus, which are reflected in "PLR intersegment utility revenue (expense)" in the table below. As a result, this measure represents the net revenues from the Pennsylvania Regulated segment's electric delivery operations. · | "Unregulated Gross Energy Margins" is a single financial performance measure of the Supply segment's competitive energy non-trading and trading activities. In calculating this measure, the Supply segment's energy revenues which include operating revenues associated with certain Supply segment businesses that are classified as discontinued operations, are offset by the cost of fuel, energy purchases, certain other operation and maintenance expenses, primarily ancillary charges and gross receipts tax, which is recorded in "Taxes, other than income," and operating expenses associated with certain Supply segment businesses that are classified as discontinued operations.income". This performance measure is relevant to PPL due to the volatility in the individual revenue and expense lines on the Statements of Income that comprise "Unregulated Gross Energy Margins." This volatility stems from a number of factors, including the required netting of certain transactions with ISOs and significant swingsfluctuations in unrealized gains and losses. Such factors could result in gains or losses being recorded in either "Wholesale energy marketing" or "Energy purchases" on the Statements of Income. This performance measure includes PLR revenues from energy sales to PPL Electric by PPL EnergyPlus, which are reflectedrecorded in "PLR intersegment utility revenue (expense)" in the table below. PPL excludes from "Unregulated Gross Energy Margins" the Supply segment's adjusted energy-related economic activity, which includes the changes in fair value of positions used to economically hedge a portion of the economic value of PPL's competitive generation assets, full-requirement sales contracts and retail activities. This economic value is subject to changes in fair value due to market price volatility of the input and output commodities (e.g., fuel and power) prior to the delivery period that was hedged. Also included in adjusted energy-related economic activity is the premium amortization associated with options and for 2012 the ineffective portion of qualifying cash flow hedges and economic activity realized associated with the monetization of certain full-requirementfull requirement sales contracts and premium amortization associated with options.in 2010. This economic activity is deferred, with the exception of the full-requirement sales contracts that were monetized, and included in unregulated gross energy marginsUnregulated Gross Energy Margins over the delivery period that was hedged or upon realization. |
Reconciliation of Non-GAAP Financial Measures |
The following tables reconcile "Operating Income" totable reconciles PPL's three non-GAAP financial measures to "Operating Income" for the periods ended September 30.March 31.
| | | | | | 2012 Three Months | | 2011 Three Months | | | | | | | | | | | Unregulated | | | | | | | | | | | Unregulated | | | | | | | | | | | | | Kentucky | | PA Gross | | Gross | | | | | | | | Kentucky | | PA Gross | | Gross | | | | | | | | | | | | Gross | | Delivery | | Energy | | | | | Operating | | Gross | | Delivery | | Energy | | | | | | | | | | | | | Margins | | Margins | | Margins | | Other (a) | | Income (b) | | Margins | | Margins | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Revenues | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Utility | | $ | 732 | | $ | 443 | | | | | $ | 518 | (c) | | $ | 1,693 | | $ | 734 | | $ | 454 | | | | | $ | 487 | (c) | | $ | 1,675 | | PLR intersegment utility | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | revenue (expense) (d) | | | | | | (23) | | $ | 23 | | | | | | | | | | | | | (5) | | $ | 5 | | | | | | | | | Unregulated retail | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | electric and gas | | | | | | | | | 232 | | | (14) | (g) | | | 218 | | | | | | | | | 186 | | | 3 | (g) | | | 189 | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | | | | | | | | 1,074 | | | 2 | (f) | | | 1,076 | | | | | | | | | 897 | | | 10 | (f) | | | 907 | | | | Unrealized economic | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | activity | | | | | | | | | | | | (716) | (g) | | | (716) | | | | | | | | | | | | 216 | (g) | | | 216 | | Net energy trading margins | | | | | | | | | (11) | | | | | | | (11) | | | | | | | | | (7) | | | | | | | (7) | | Energy-related businesses | | | | | | | | | | | | 143 | | | | 143 | | | | | | | | | | | | 140 | | | | 140 | | | | Total Operating Revenues | | | 732 | | | 420 | | | 1,318 | | | (67) | | | | 2,403 | | | 734 | | | 449 | | | 1,081 | | | 856 | | | | 3,120 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | 2012 Three Months | | 2011 Three Months | | | | | | | | | | | Unregulated | | | | | | | | | | | Unregulated | | | | | | | | | | | | | Kentucky | | PA Gross | | Gross | | | | | | | | Kentucky | | PA Gross | | Gross | | | | | | | | | | | | Gross | | Delivery | | Energy | | | | | Operating | | Gross | | Delivery | | Energy | | | | | | Operating | | | | | | | Margins | | Margins | | Margins | | Other (a) | | Income (b) | | Margins | | Margins | | Margins | | Other (a) | | Income (b) | Operating Expenses | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Fuel | | | 249 | | | | | | 310 | | | 11 | (e) | | | 570 | | | 245 | | | | | | 338 | | | 20 | (e) | | | 603 | | Energy purchases | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | | 27 | | | 137 | | | 418 | | | 1 | (f) | | | 583 | | | 32 | | | 171 | | | 119 | | | 40 | (f) | | | 362 | | | | Unrealized economic | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | activity | | | | | | | | | | | | (569) | (g) | | | (569) | | | | | | | | | | | | 176 | (g) | | | 176 | | Other operation and | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | maintenance | | | 28 | | | 25 | | | 1 | | | 596 | | | | 650 | | | 26 | | | 30 | | | | | | 679 | | | | 735 | | Depreciation | | | 13 | | | | | | | | | 265 | | | | 278 | | | 12 | | | | | | | | | 240 | | | | 252 | | Taxes, other than income | | | | | | 23 | | | 11 | | | 56 | | | | 90 | | | | | | 24 | | | 8 | | | 58 | | | | 90 | | Energy-related businesses | | | | | | | | | | | | 137 | | | | 137 | | | | | | | | | | | | 135 | | | | 135 | | Intercompany eliminations | | | | | | (1) | | | 1 | | | | | | | | | | | | | (1) | | | 1 | | | | | | | | | | | Total Operating Expenses | | | 317 | | | 184 | | | 741 | | | 497 | | | | 1,739 | | | 315 | | | 224 | | | 466 | | | 1,348 | | | | 2,353 | Total | | $ | 415 | | $ | 236 | | $ | 577 | | $ | (564) | | | $ | 664 | | $ | 419 | | $ | 225 | | $ | 615 | | $ | (492) | | | $ | 767 |
| | | | 2012 Nine Months | | 2011 Nine Months | | | | 2013 Three Months | | 2012 Three Months | | | | | | | | Unregulated | | | | | | | | | | Unregulated | | | | | | | | | | | | Unregulated | | | | | | | | | | Unregulated | | | | | | | | | | Kentucky | | PA Gross | | Gross | | | | | | | Kentucky | | PA Gross | | Gross | | | | | | | | | Kentucky | | PA Gross | | Gross | | | | | | | Kentucky | | PA Gross | | Gross | | | | | | | | | | Gross | | Delivery | | Energy | | | | | Operating | | Gross | | Delivery | | Energy | | | | | Operating | | | | Gross | | Delivery | | Energy | | | | | Operating | | Gross | | Delivery | | Energy | | | | | Operating | | | | | Margins | | Margins | | Margins | | Other (a) | | Income (b) | | Margins | | Margins | | Margins | | Other (a) | | Income (b) | | | | Margins | | Margins | | Margins | | Other (a) | | Income (b) | | Margins | | Margins | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Revenues | Operating Revenues | | | | | | | | | | | | | | | | | | | | | | | Operating Revenues | | | | | | | | | | | | | | | | | | | | | | | | Utility | | $ | 2,095 | | $ | 1,303 | | | | $ | 1,614 | (c) | | $ | 5,012 | | $ | 2,139 | | $ | 1,444 | | | | $ | 1,112 | (c) | | $ | 4,695 | Utility | | $ | 800 | | $ | 512 | | | | $ | 638 | (c) | | $ | 1,950 | | $ | 705 | | $ | 457 | | | | $ | 552 | (c) | | $ | 1,714 | | PLR intersegment utility | | | | | | | | | | | | | | | | | | | | | | | PLR intersegment utility | | | | | | | | | | | | | | | | | | | | | | | | | revenue (expense) (d) | | | | (61) | | $ | 61 | | | | | | | | | (15) | | $ | 15 | | | | | | | revenue (expense) (d) | | | | (14) | | $ | 14 | | | | | | | | | (21) | | $ | 21 | | | | | | | Unregulated retail | | | | | | | | | | | | | | | | | | | | | | | Unregulated retail | | | | | | | | | | | | | | | | | | | | | | | | | electric and gas | | | | | | 638 | | (18) | (g) | | 620 | | | | | | 509 | | 8 | (g) | | 517 | | electric and gas | | | | | | 246 | | (9) | (f) | | 237 | | | | | | 214 | | 9 | (f) | | 223 | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | | | | | 3,353 | | 14 | (f) | | 3,367 | | | | | | 2,635 | | 42 | (f) | | 2,677 | | Realized | | | | | | 977 | | (1) | | | 976 | | | | | | 1,204 | | 4 | (e) | | 1,208 | | | Unrealized economic | | | | | | | | | | | | | | | | | | | | | | | | Unrealized economic | | | | | | | | | | | | | | | | | | | | | | | | | activity | | | | | | | | (322) | (g) | | (322) | | | | | | | | 229 | (g) | | 229 | | activity | | | | | | | | (822) | (f) | | (822) | | | | | | | | 852 | (f) | | 852 | | Net energy trading margins | | | | | | 7 | | | | | 7 | | | | | | 14 | | | | | 14 | Net energy trading margins | | | | | | (11) | | | | | (11) | | | | | | 8 | | | | | 8 | | Energy-related businesses | | | | | | | | | | | | 380 | | | | 380 | | | | | | | | | | | | 387 | | | | 387 | Energy-related businesses | | | | | | | | | | | | 127 | | | | 127 | | | | | | | | | | | | 107 | | | | 107 | | | Total Operating Revenues | | | 2,095 | | | 1,242 | | | 4,059 | | | 1,668 | | | | 9,064 | | | 2,139 | | | 1,429 | | | 3,173 | | | 1,778 | | | | 8,519 | | Total Operating Revenues | | | 800 | | | 498 | | | 1,226 | | | (67) | | | | 2,457 | | | 705 | | | 436 | | | 1,447 | | | 1,524 | | | | 4,112 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | Operating Expenses | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | | | | | | | | | | | Fuel | | 677 | | | | 695 | | 33 | (e) | | 1,405 | | 666 | | | | 872 | | (46) | (e) | | 1,492 | Fuel | | 231 | | | | 299 | | (1) | (f) | | 529 | | 213 | | | | 214 | | (3) | (f) | | 424 | | Energy purchases | | | | | | | | | | | | | | | | | | | | | | | Energy purchases | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | 135 | | 410 | | 1,669 | | 39 | (f) | | 2,253 | | 179 | | 591 | | 496 | | 201 | (f) | | 1,467 | | Realized | | 86 | | 172 | | 436 | | (3) | | | 691 | | 74 | | 153 | | 636 | | 20 | (e) | | 883 | | | Unrealized economic | | | | | | | | | | | | | | | | | | | | | | | | Unrealized economic | | | | | | | | | | | | | | | | | | | | | | | | | activity | | | | | | | | (420) | (g) | | (420) | | | | | | | | 49 | (g) | | 49 | | activity | | | | | | | | (634) | (f) | | (634) | | | | | | | | 591 | (f) | | 591 | | Other operation and | | | | | | | | | | | �� | | | | | | | | | | | | Other operation and | | | | | | | | | | | | | | | | | | | | | | | | | maintenance | | 76 | | 74 | | 12 | | 1,933 | | | 2,095 | | 67 | | 77 | | 13 | | 1,884 | | | 2,041 | | maintenance | | 25 | | 22 | | 5 | | 624 | | | 676 | | 22 | | 22 | | 4 | | 658 | | | 706 | | Depreciation | | 39 | | | | | | 774 | | | 813 | | 37 | | | | | | 660 | | | 697 | Depreciation | | | | | | | | 284 | | | 284 | | 13 | | | | | | 251 | | | 264 | | Taxes, other than income | | | | 67 | | 27 | | 174 | | | 268 | | | | 77 | | 22 | | 139 | | | 238 | Taxes, other than income | | | | 28 | | 8 | | 60 | | | 96 | | | | 25 | | 8 | | 58 | | | 91 | | Energy-related businesses | | | | | | | | 363 | | | 363 | | | | | | | | 368 | | | 368 | Energy-related businesses | | | | | | | | 122 | | | 122 | | | | | | | | 102 | | | 102 | | Intercompany eliminations | | | | | | (3) | | | 2 | | | 1 | | | | | | | | | | (9) | | | 3 | | | 6 | | | | | Intercompany eliminations | | | | | | (1) | | | 1 | | | | | | | | | | | | | (1) | | | 1 | | | | | | | | | | Total Operating Expenses | | 927 | | 548 | | 2,405 | | 2,897 | | | 6,777 | | 949 | | 736 | | 1,406 | | 3,261 | | | 6,352 | | Total Operating Expenses | | | 342 | | | 221 | | | 749 | | | 452 | | | | 1,764 | | | 322 | | | 199 | | | 863 | | | 1,677 | | | | 3,061 | | Discontinued operations | | | | | | | | | | | | | | | | | | | | | | | | | 12 | | | (12) | (h) | | | | | Total | Total | | $ | 1,168 | | $ | 694 | | $ | 1,654 | | $ | (1,229) | | | $ | 2,287 | | $ | 1,190 | | $ | 693 | | $ | 1,779 | | $ | (1,495) | | | $ | 2,167 | Total | | $ | 458 | | $ | 277 | | $ | 477 | | $ | (519) | | | $ | 693 | | $ | 383 | | $ | 237 | | $ | 584 | | $ | (153) | | | $ | 1,051 |
(a) | Represents amounts excluded from Margins. |
(b) | As reported on the Statements of Income. |
(c) | Primarily represents WPD's utility revenue. |
(d) | Primarily related to PLR supply sold by PPL EnergyPlus to PPL Electric. |
(e) | Includes economic activity related to fuel as described in "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements. The three and nine months ended September 30, 2012, include pre-tax losses of $17 million and $29 million related to coal contract modification payments. The three and nine months ended September 30, 2011 include pre-tax credits of $6 million and $56 million for the spent nuclear fuel litigation settlement. |
(f)(e) | Represents energy-related economic activity as described in "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements. For the three and nine months ended September 30,March 31, 2012, "Wholesale energy marketing - Realized" and "Energy purchases - Realized" includeincludes a net pre-tax lossesloss of $1 million and $34$21 million related to the monetization of certain full-requirement sales contracts. The three and nine months ended September 30, 2011 include net pre-tax losses of $40 million and $184 million related to the monetization of certain full-requirement sales contracts and net pre-tax gains of $6 million and $17 million related to the amortization of option premiums. |
(g)(f) | Represents energy-related economic activity, which is subject to fluctuations in value due to market price volatility, as described in "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements. |
(h) | Represents the net of certain revenues and expenses associated with certain businesses that are classified as discontinued operations. These revenues and expenses are not reflected in "Operating Income" on the Statements of Income. |
Changes in Non-GAAP Financial Measures
The following table shows PPL's three non-GAAP financial measures for the periods ended September 30March 31 as well as the change between periods. The factors that gave rise to the changes are described below the table.
| | | Three Months | | Nine Months | | | Three Months | | | | 2012 | | 2011 | | Change | | 2012 | | 2011 | | Change | | | 2013 | | 2012 | | Change | | | | | | | | | | | | | | | | | | | | | | Kentucky Gross Margins | Kentucky Gross Margins | | $ | 415 | | $ | 419 | | $ | (4) | | $ | 1,168 | | $ | 1,190 | | $ | (22) | Kentucky Gross Margins | | $ | 458 | | $ | 383 | | $ | 75 | PA Gross Delivery Margins by Component | PA Gross Delivery Margins by Component | | | | | | | | | | | | | PA Gross Delivery Margins by Component | | | | | | | | Distribution | | $ | 185 | | $ | 179 | | $ | 6 | | $ | 544 | | $ | 560 | | $ | (16) | Distribution | | $ | 224 | | $ | 189 | | $ | 35 | | Transmission | | | 51 | | | 46 | | | 5 | | | 150 | | | 133 | | | 17 | Transmission | | | 53 | | | 48 | | | 5 | Total | Total | | $ | 236 | | $ | 225 | | $ | 11 | | $ | 694 | | $ | 693 | | $ | 1 | Total | | $ | 277 | | $ | 237 | | $ | 40 | | | | | | | | | | | | | | | | | | | | | | Unregulated Gross Energy Margins by Region | Unregulated Gross Energy Margins by Region | | | | | | | | | | | | | Unregulated Gross Energy Margins by Region | | | | | | | Non-trading | Non-trading | | | | | | | | | | | | | Non-trading | | | | | | | | Eastern U.S. | | $ | 521 | | $ | 530 | | $ | (9) | | $ | 1,417 | | $ | 1,502 | | $ | (85) | Eastern U.S. | | $ | 430 | | $ | 489 | | $ | (59) | | Western U.S. | | 67 | | 92 | | (25) | | 230 | | 263 | | (33) | Western U.S. | | 58 | | 87 | | (29) | Net energy trading | Net energy trading | | | (11) | | | (7) | | | (4) | | | 7 | | | 14 | | | (7) | Net energy trading | | | (11) | | | 8 | | | (19) | Total | Total | | $ | 577 | | $ | 615 | | $ | (38) | | $ | 1,654 | | $ | 1,779 | | $ | (125) | Total | | $ | 477 | | $ | 584 | | $ | (107) |
Kentucky Gross Margins
Margins decreasedincreased for the ninethree months ended September 30, 2012March 31, 2013 compared with the same period in 2011, primarily2012 due to $16higher base rates of $31 million, higher volumes of lower retail margins, as$19 million, environmental costs added to base rates of $18 million and increased environmental investments of $7 million.
The increase in base rates was the result of new KPSC rates going into effect on January 1, 2013. The increase in volumes were impacted by unseasonably mildwas attributable to colder weather during the first four months of 2012, and $6 million of lower wholesale margins, as volumes were impacted by lower market prices.in 2013 compared with 2012. Total heating degree days decreased 24% comparedincreased 41%. The environmental costs added to base rates was due to the same periodelimination of the 2005 and 2006 ECR plans as a result of the 2012 Kentucky rate case. This elimination results in 2011.depreciation and other operation and maintenance expenses associated with the 2005 and 2006 ECR plans being excluded from Margins in 2013.
Pennsylvania Gross Delivery Margins
Distribution
Margins decreasedincreased for the ninethree months ended September 30, 2012March 31, 2013 compared with the same period in 2011,2012 primarily due to an $18a $13 million unfavorablefavorable effect of mild weather early in 2012. The three2012 and nine-month periods were impacted by a $7$19 million charge recorded in 2011 to reducefavorable effect of price, largely comprised of higher base rates, effective January 1, 2013 as a portionresult of the transmission service charge regulatory asset associated with a 2005 undercollection that was not included in any subsequent2012 rate reconciliations filed with the PUC.case and higher volumes of $3 million.
Transmission
Margins increased for the three and nine-month periodsmonths ended September 30, 2012,March 31, 2013 compared with the same periods in 2011,2012 primarily due to increased investment in plant and the recovery of additional costs through the FERC formula-based rates.
Unregulated Gross Energy Margins
Eastern U.S. | | | | | | | | | | | | | | The changes in non-trading margins for the periods ended September 30, 2012 compared with 2011 were due to: | | | | | | | | | | Three Months | | Nine Months | | | | | | | | Baseload energy prices | | $ | (44) | | $ | (132) | Baseload capacity prices | | | 3 | | | (47) | Intermediate and peaking capacity prices | | | 5 | | | (22) | Impact of non-core generation facilities sold in the first quarter of 2011 | | | | | | (12) | Full-requirement sales contracts | | | 3 | | | (10) | Net economic availability of coal and hydroelectric units | | | (7) | | | 12 | Retail electric | | | 5 | | | 12 | Ironwood acquisition which eliminates tolling expense (a) | | | 14 | | | 27 | Nuclear generation volume (b) | | | 11 | | | 93 | Other | | | 1 | | | (6) | | | $ | (9) | | $ | (85) |
(a)Unregulated Gross Energy Margins | See Note 8 to the Financial Statements for additional information. | | | | | |
(b) | Volumes were higher | | | | | | Eastern U.S. | | | | | | | | | | | | | | The change in non-trading margins for the nine-month period ended March 31, 2013 compared with 2012 was due to a shorter outage period for blade inspections, an unplanned outage in March 2011 and an uprate in the third quarter of 2011. Volumes were higher for the three-month period due to higher availability in 2012.to: | | | | | | | |
| | | | Three Months | | | | | | | | Baseload energy prices | | | | | $ | (125) | Coal prices | | | | | | (10) | Nuclear fuel prices | | | | | | (6) | Full-requirement sales contracts | | | | | | 5 | Intermediate and peaking capacity prices | | | | | | 5 | Baseload capacity prices | | | | | | 6 | Intermediate and peaking Spark Spreads | | | | | | 14 | Ironwood acquisition which eliminated tolling expense | | | | | | 15 | Net economic availability of coal and hydroelectric plants | | | | | | 32 | Other | | | | | | 5 | Total | | | | | $ | (59) |
Western U.S.
Non-trading margins for the three and nine months ended September 30, 2012March 31, 2013 compared with the same periods in 20112012 were lower due to $14 million and $31$43 million of lower wholesale sales, including $10 million and $23 million related to the bankruptcy of SMGT. The three-month period was also lower due to $5prices, partially offset by $12 million of higher fuel costs.wholesale volumes.
Utility Revenues | | | | | | | | | | | | | The increase (decrease) in utility revenues for the periods ended September 30, 2012 compared with 2011 was due to: | | | | | | | | | | | | | | | | | | Three Months | | Nine Months | Domestic: | | | | | | | | PPL Electric (a) | | $ | (11) | | $ | (141) | | LKE (b) | | | (4) | | | (45) | | Total Domestic | | | (15) | | | (186) | | | | | | | | | | | U.K.: | | | | | | | | PPL WW | | | | | | | | | Price (c) | | | 14 | | | 69 | | | Volume (d) | | | (2) | | | (17) | | | Recovery of allowed revenues (e) | | | 3 | | | (8) | | | Foreign currency exchange rates | | | (7) | | | (15) | | | Other | | | 5 | | | 2 | | | Total PPL WW | | | 13 | | | 31 | | WPD Midlands (f) | | | 20 | | | 472 | | Total U.K. | | | 33 | | | 503 | Total | | $ | 18 | | $ | 317 |
Net Energy Trading Margins
Net energy trading margins for the three months ended March 31, 2013 compared with 2012 decreased as a result of lower margins of $16 million on gas positions due to higher prices.
Utility Revenues | | | | | | | | | | | | | The increase (decrease) in utility revenues for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | | | | | | | | | | | Three Months | Domestic: | | | | | | | | PPL Electric (a) | | | | | $ | 55 | | LKE (b) | | | | | | 95 | | Total Domestic | | | | | | 150 | | | | | | | | | | | U.K.: | | | | | | | | Price (c) | | | | | | 57 | | Volume | | | | | | 5 | | Recovery of allowed revenues | | | | | | 5 | | Foreign currency exchange rates | | | | | | 10 | | Other (d) | | | | | | 9 | | Total U.K. | | | | | | 86 | Total | | | | | $ | 236 |
(a) | See "Pennsylvania Gross Delivery Margins" for further information. |
(b) | See "Kentucky Gross Margins" for further information. |
(c) | The three- and nine-month periods were impacted by aDue to price increaseincreases effective April 1, 2012. The nine-month period was also impacted by a price increase effective April 1, 2011. |
(d) | The decrease for the nine-month periodThis increase is primarily due to the downturn in the economy and the unfavorable effect of weather. |
(e) | The decrease for the nine-month period is primarily due to a 2012 charge to income for the over-recovery of revenues from customers. |
(f) | The increase for the three-month period is primarily due to a price increase effective April 1, 2012. The nine-month period ended September 30, 2012 is not comparable to 2011 as 2011 includes only five months of WPD Midlands' results. |
Other Operation and Maintenance
The increase (decrease) in other operation and maintenance expense for the periods ended September 30, 2012 compared with 2011 were due to:
| | | Three Months | | Nine Months | Domestic: | | | | | | | Uncollectible accounts (a) | $ | (5) | | $ | 11 | | LKE coal plant maintenance costs (b) | | 2 | | | 13 | | LKE storm costs (c) | | | | | 6 | | PPL Susquehanna nuclear plant costs (d) | | 8 | | | 27 | | Ironwood Acquisition (e) | | 4 | | | 13 | | PUC-reportable storm costs, net of insurance recoveries | | (3) | | | (18) | | Costs at Western fossil and hydroelectric plants | | (4) | | | (9) | | Costs at Eastern fossil and hydroelectric plants (f) | | 9 | | | (4) | | Payroll-related costs - PPL Electric | | 9 | | | 16 | | Vegetation management | | 3 | | | 12 | | Stock based compensation | | 2 | | | 15 | | Other | | | | | 20 | U.K.: | | | | | | | PPL WW (g) | | 4 | | | 21 | | WPD Midlands (h) | | (114) | | | (69) | Total | $ | (85) | | $ | 54 |
(a) | In October 2011, SMGT filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code. The increase for the nine-month period primarily reflects an $11 million increase to a reserve on SMGT unpaid amounts. |
(b) | The increase for the nine-month period is primarily due to an increased scope of scheduled outages. |
(c) | A credit to establish a regulatory asset was recorded in the first quarter of 2011 related to 2009 storm costs. |
(d) | Primarily due to refueling outage costs, payroll-related costs and timing of projects. |
(e) | There are no comparable amounts in the 2011 periods as the Ironwood Acquisition occurred in April 2012. |
(f) | The increase for the three-month period is primarily due to a planned outage at PPL Brunner Island in September 2012. |
(g) | The increase for the nine-month period includes $15 million of higher pension expense resulting from an increase in amortization of actuarial losses and $8 million of higher network maintenance expense. |
(h) | The decrease for the three-month periodthird-party engineering work, which is primarily due to lower charges recorded as a result of the acquisition, including $85 million for severance compensation, early retirement deficiency costsoffset by expenses in "Other operation and outplacement services for employees separating from WPD Midlands and $5 million of other acquisition-related adjustments, and a decrease in pension costs of $6 million. The nine-month period ended September 30, 2012 is not comparable to 2011 as 2011 includes only five months of WPD Midlands' results. The nine-month period also reflects $81 million of lower charges recorded as a result of the acquisition for severance compensation, early retirement deficiency costs and outplacement services for employees separating from WPD Midlands and $12 million of lower other acquisition-related costs. |
Depreciation | | | | | | | | | | | The increase (decrease) in depreciation expense for the periods ended September 30, 2012 compared with 2011 was due to: | | | | | | | | | | | | Three Months | | Nine Months | | | | | | | | | Additions to PP&E | | $ | 16 | | $ | 52 | WPD Midlands (a) | | | 6 | | | 59 | Ironwood Acquisition (Note 8) | | | 7 | | | 11 | Other | | | (3) | | | (6) | Total | | $ | 26 | | $ | 116 |
(a) | The nine-month period ended September 30, 2012 is not comparable to 2011 as 2011 includes only five months of WPD Midlands' results.maintenance". |
Taxes, Other Than IncomeOperation and Maintenance | | | | | | | | | | | | | | The increase (decrease) in taxes, other than incomeoperation and maintenance for the nine monthsperiod ended September 30, 2012March 31, 2013 compared with 20112012 was due to: | | | | | | | | | | | | Nine | | | | | | | | | | Three Months | Domestic: | | | | | | | Uncollectible accounts (a) | | | | $ | (16) | | LKE coal plant outages (b) | | | | | (14) | | Costs at eastern fossil and hydroelectric plants (c) | | | | | (11) | | Pension and postretirement costs | | | | | 4 | | Other | | | | | 2 | U.K.: | | | | | | | Third-party engineering work (d) | | | | | 8 | | Network maintenance expense (e) | | | | | 7 | | Employee related expenses | | | | | (4) | | Severance compensation | | | | | (4) | | Other | | | | | (2) | Total | | | | $ | (30) |
(a) | The decrease is primarily due to SMGT filing for protection under Chapter 11 of the U.S. Bankruptcy Code in 2011. $11 million of damages billed to SMGT were fully reserved in 2012. |
(b) | The decrease is primarily due to the timing and scope of scheduled outages. |
(c) | The decrease is primarily due to Brunner Island Unit 3 outage costs of $15 million in 2012 compared with no major outage costs in 2013, partially offset by $3 million of additional costs due to the Ironwood Acquisition. |
(d) | These expenses are offset by revenues reflected in "Utility" on the Statements of Income. |
(e) | The increase is primarily due to higher tree trimming expense. |
Depreciation | | | | | | | | | | | The increase (decrease) in depreciation for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | | | | | | | Three Months | | | | | | | | Pennsylvania gross receipts tax (a)Additions to PP&E | | | | | $ | (14)21 | Domestic property taxLKE lower depreciation rates effective January 1, 2013 | | | 7 | WPD Midlands (b) | | | 31(5) | Ironwood Acquisition | | | | | | 6 | Other | | | 6 | | | (2) | Total | | | | | $ | 3020 |
(a) | The decrease for the nine-month period is primarily due to a decrease in taxable electric revenue. This tax is included in "Unregulated Gross Energy Margins" and "Pennsylvania Gross Delivery Margins." |
(b) | The nine-month period ended September 30, 2012 is not comparable to 2011 as 2011 includes only five months of WPD Midlands' results. | Other Income (Expense) - net
Other Income (Expense) - net | | | | | | | | | | | | | | The increase (decrease) in other income (expense) - net for the periods ended September 30, 2012 compared with 2011 was due to: | | | | | | | | | | Three Months | | Nine Months | | | | | | | | Change in the fair value of economic foreign currency exchange contracts (Note 14) | | $ | (58) | | $ | (51) | Net hedge gains associated with the 2011 Bridge Facility (a) | | | | | | (55) | Foreign currency loss on 2011 Bridge Facility (b) | | | | | | 57 | Gain on redemption of debt (c) | | | (22) | | | (22) | WPD Midlands acquisition-related adjustments in 2011 (Note 8) | | | | | | 57 | Earnings (losses) from equity method investments | | | (2) | | | (8) | Other | | | 1 | | | (7) | Total | | $ | (81) | | $ | (29) |
(a) | Represents a gain on foreign currency contracts that hedged the repayment of the 2011 Bridge Facility borrowing. |
(b) | Represents a foreign currency loss related to the repayment of the 2011 Bridge Facility borrowing. |
(c) | In July 2011, as a result of PPL Electric's redemption of 7.125% Senior Secured Bonds due 2013, PPL recorded a gain on the accelerated amortization of the fair value adjustment to the debt recorded in connection with previously settled fair value hedges. | The $139 million increase in other income (expense) - net for the three months ended March 31, 2013 compared with 2012 was primarily due to $119 million of realized and unrealized gains on economic foreign currency contracts compared with losses in 2012 of $18 million.
See Note 12 to the Financial Statements for further details.
Interest Expense | | | | | | | | | | | | The increase (decrease) in interest expense for the periodsperiod ended September 30, 2012March 31, 2013 compared with 20112012 was due to: | | | | | | | | | | | Three Months | | | | | | | | | Long-term debt interest expense (a) | | | | | $ | 14 | Ironwood Acquisition (b) | | | | | | 4 | Other | | | | | | 3 | Total | | | | | $ | 21 |
| | | | | | | | Three Months | | Nine Months | | | | | | | | | 2011 Bridge Facility costs related to financing the acquisition of WPD Midlands | | | | | $ | (43) | 2011 Equity Units (a) | | | | | | 13 | Long-term debt interest expense (b) | | $ | (1) | | | (11) | Short-term debt interest expense (c) | | | (4) | | | (11) | Hedging activity and ineffectiveness | | | 6 | | | 25 | Inflation adjustment on U.K. Index-linked Senior Unsecured Notes | | | (3) | | | (11) | Net amortization of debt discounts, premiums and issuance costs | | | (6) | | | (5) | WPD Midlands (d) | | | 9 | | | 77 | Ironwood Acquisition (Note 8) | | | 4 | | | 8 | Other | | | 3 | | | (6) | Total | | $ | 8 | | $ | 36 |
(a) | Interest relatedThe increase was primarily due to PPL Capital Funding's June 2012 issuance of $400 million, 4.2% Senior Notes due 2022 and October 2012 issuance of $400 million, 3.5% Senior Notes due 2022. Also, contributing to the increase was higher accretion expense on WPD index linked bonds and interest on WPD (East Midlands') April 2012 issuance in April 2011 to support the WPD Midlands acquisition.of £100 million, 5.25% Senior Notes due 2023. |
(b) | The decreaseincrease was primarily due to the redemption of $250 million of 7.0% Senior Notes due 2046 in July 2011 alongfinancings associated with the repayment of $500 million of 6.4% Senior Notes and subsequent issuance of $500 million of 4.6% Senior Notes, both in the fourth quarter of 2011.Ironwood Acquisition. |
(c) | The decrease was primarily due to lower interest rates on 2012 short-term borrowings. |
(d)Income Taxes | | | | | | | | | | | The nine-monthincrease (decrease) in income taxes for the period ended September 30,March 31, 2013 compared with 2012 is not comparable to 2011 as 2011 includes only five months of WPD Midlands' results.was due to: | | | | | | | | | | Three Months | | | | | | | | | Lower pre-tax book income | | | | | $ | (119) | Foreign tax reserve adjustments | | | | | | (3) | Net operating loss carryforward adjustments (a) | | | | | | 6 | State deferred tax rate change (b) | | | | | | 11 | Other | | | | | | (3) | Total | | | | | $ | (108) |
Income Taxes | | | | | | | | | | | The increase (decrease) in income taxes for the periods ended September 30, 2012 compared with 2011 was due to: | | | | | | | | Three Months | | Nine Months | | | | | | | | | Lower pre-tax book income | | $ | (108) | | $ | (131) | State valuation allowance adjustments (a) | | | 2 | | | (9) | Federal and state tax reserve adjustments | | | (6) | | | (8) | Federal and state tax return adjustments | | | | | | 2 | U.S. income tax on foreign earnings net of foreign tax credit (b) | | | 9 | | | 27 | Foreign tax reserve adjustments (c) | | | | | | (5) | Net operating loss carryforward adjustments (d) | | | | | | (9) | Depreciation not normalized (a) | | | (1) | | | 1 | WPD Midlands (e) | | | 25 | | | 86 | State deferred tax rate change (f) | | | (6) | | | (17) | Other | | | (8) | | | (2) | Total | | $ | (93) | | $ | (65) |
(a) | In February 2011, the Pennsylvania Department of Revenue issued interpretive guidance on the treatment of bonus depreciation for Pennsylvania income tax purposes. In accordance with Corporation Tax Bulletin 2011-01, Pennsylvania allows 100% bonus depreciation for qualifying assets in the same year bonus depreciation is allowed for federal income tax purposes. Due to the decrease in projected taxable income related to bonus depreciation, PPL recorded an $11 million state deferred income tax expense during the nine months ended September 30, 2011 related to valuation allowances. |
Additionally, the 100% Pennsylvania bonus depreciation deduction created a current state income tax benefit for the flow-through impact of Pennsylvania regulated state tax depreciation. The federal provision for 100% bonus depreciation generally applies to property placed in service before January 1, 2012. The placed in-service deadline is extended to January 1, 2013 for property that exceeds $1 million, has a production period longer than one year and has a tax life of at least 10 years.
(b) | During the three and nine months ended September 30, 2011, PPL recorded a $7 million and $21 million federal income tax benefit related to U.K. pension contributions. |
(c) | During the nine months ended September 30, 2012, PPL recorded a tax benefit following resolution of a U.K. tax issue related to interest expense. |
(d) | During the nine months ended September 30,March 31, 2012, PPL recorded adjustments to deferred taxes related to net operating loss carryforwards of LKE based on income tax return adjustments. |
(e) | The increase for the three-month period was due to an increase in pre-tax book income, which increased taxes by $30 million, partially offset by an incremental $6 million deferred tax benefit related to the 2012 U.K. Finance Act compared with the 2011 U.K. Finance Act. The nine-month period ended September 30, 2012 is not comparable to 2011 as 2011 includes only five months of WPD Midlands' results. |
(f)(b) | During the three and nine months ended September 30,March 31, 2012, PPL recorded adjustments related to state deferred tax liabilities. |
See Note 5 to the Financial Statements for additional information on income taxes.
Income (Loss) from Discontinued Operations (net of income taxes)Financial Condition | | | | | | | | Liquidity and Capital Resources | | | | | | | | PPL had the following at: |
Loss from discontinued operations increased by $8 million for the nine months ended September 30, 2012, compared with 2011. The increase was primarily related to an adjustment to a liability for indemnifications related to the termination of the WKE lease in 2009.
Noncontrolling Interests
"Net Income Attributable to Noncontrolling Interests" decreased by $5 million and $9 million for the three and nine months ended September 30, 2012 compared with 2011. The decrease is primarily due to PPL Electric's June 2012 redemption of all 2.5 million shares of its preference stock. The price paid was the par value, without premium ($250 million in the aggregate).
Financial Condition | | | | | | | | Liquidity and Capital Resources | | | | | | | | PPL had the following at: | | | | | | | | | | September 30, 2012 | | December 31, 2011 | | | | | | | | Cash and cash equivalents | | $ | 946 | | $ | 1,202 | Short-term investments | | | | | | 16 | | | $ | 946 | | $ | 1,218 | Short-term debt | | $ | 526 | | $ | 578 |
| | March 31, 2013 | | December 31, 2012 | | | | | | | | Cash and cash equivalents | | $ | 853 | | $ | 901 | Short-term debt | | $ | 1,061 | | $ | 652 |
At September 30, 2012, $360March 31, 2013, $335 million of cash and cash equivalents were denominated in GBP. If these amounts would be remitted as dividends, PPL may be subject to additional U.S. taxes, net of allowable foreign tax credits. Historically, dividends paid by foreign subsidiaries have been distributions of the current year's earnings. See Note 5 to the Financial Statements in PPL's 20112012 Form 10-K for additional information on undistributed earnings of WPD.
The $256$48 million decrease in PPL's cash and cash equivalents position was primarily the net result of:
| · | capital expenditures of $2.1 billion;$828 million; |
| · | the payment of $623$210 million of common stock dividends; |
| · | the redemption of preference stock of a subsidiary of $250 million;$52 million net increase in restricted cash and cash equivalents; and |
| · | the retirement$24 million of long-term debt of $105 million;contract adjustment payments; partially offset by |
| · | proceeds of $432 million from the Ironwood Acquisition for $84 million,issuance of long-term debt, net of cash acquired;costs; |
· | net increase in short-term debt of $416 million; and |
· | net cash provided by operating activities of $2.1 billion; and |
| · | proceeds of $824 million from the issuance of long-term debt.$244 million. |
PPL's cash provided by operating activities increaseddecreased by $248$484 million for the ninethree months ended September 30, 2012March 31, 2013 compared with 2011.2012. The increasedecrease was primarily due to:
· | a $336 million increase in cash used by components of working capital (primarily due to changes in accounts receivable of $219 million resulting from higher base rates and favorable effects of weather and counterparty collateral of $129 million); and |
· | ana $221 million increase of $185in defined benefit plans funding; partially offset by |
· | a $72 million increase in net income, when adjusted for non-cash components; andcomponents. |
| · | a decrease of $39 million in defined benefit plan funding. |
Capital expenditures increased by $146 million for the three months ended March 31, 2013 compared with 2012, primarily due to the Susquehanna-Roseland transmission project and environmental projects at Mill Creek and Ghent, and construction of Cane Run Unit 7.
Credit Facilities
PPL maintains credit facilities to provide liquidity and to backstop commercial paper issuances. At September 30, 2012,March 31, 2013, PPL's total committed borrowing capacity under its credit facilities and the use of this borrowing capacity were:
| | | | | | | | Letters of | | | | | | | | | | | | | Credit Issued | | | | | | | | | | | | | and | | | | | | | Committed | | | | Commercial | | Unused | | | | Capacity | | Borrowed | | Paper Backstop | | Capacity | | | | | | | | | | | PPL Energy Supply Credit Facilities | | $ | 3,200 | | | | | $ | 594 | | $ | 2,606 | PPL Electric Credit Facilities (a) | | | 400 | | | | | | 1 | | | 399 | LG&E Credit Facility | | | 400 | | | | | | | | | 400 | KU Credit Facilities (b) | | | 598 | | | | | | 198 | | | 400 | | Total Domestic Credit Facilities (c) (d) | | $ | 4,598 | | | | | $ | 793 | | $ | 3,805 | | | | | | | | | | | | | | | PPL WW Credit Facility (e) | | £ | 150 | | £ | 107 | | | n/a | | £ | 43 | WPD (South West) Credit Facility (f) | | | 245 | | | | | | n/a | | | 245 | WPD (East Midlands) Credit Facility | | | 300 | | | | | | | | | 300 | WPD (West Midlands) Credit Facility | | | 300 | | | | | | | | | 300 | | Total WPD Credit Facilities (g) | | £ | 995 | | £ | 107 | | | | | £ | 888 |
| | | | | | | | | Letters of | | | | | | | | | | | | | Credit Issued | | | | | | | | | | | | | and | | | | | | | Committed | | | | Commercial | | Unused | | | | Capacity | | Borrowed | | Paper Backup | | Capacity | | | | | | | | | | | PPL Energy Supply Credit Facilities (a) | | $ | 3,200 | | | | | $ | 764 | | $ | 2,436 | PPL Electric Credit Facilities (b) | | | 400 | | | | | | 126 | | | 274 | LG&E Syndicated Credit Facility | | | 500 | | | | | | 70 | | | 430 | KU Credit Facilities (c) | | | 598 | | | | | | 313 | | | 285 | | Total Domestic Credit Facilities (d) | | $ | 4,698 | | | | | $ | 1,273 | | $ | 3,425 | | | | | | | | | | | | | | | PPL WW Syndicated Credit Facility (e) | | £ | 210 | | £ | 109 | | | n/a | | £ | 101 | WPD (South West) Syndicated Credit Facility | | | 245 | | | | | | n/a | | | 245 | WPD (East Midlands) Syndicated Credit Facility (f) | | | 300 | | | 65 | | | | | | 235 | WPD (West Midlands) Syndicated Credit Facility | | | 300 | | | | | | | | | 300 | | Total WPD Credit Facilities (g) | | £ | 1,055 | | £ | 174 | | | | | £ | 881 |
(a) | In February 2013, PPL Energy Supply extended a letter of credit facility expiration date from March 2013 and, effective April 2012, PPL Electric increased2013, the capacity of its syndicated credit facility from $200 millionwas reduced to $300$150 million. |
Committed capacity includes a $100 million credit facility related to an asset-backed commercial paper program through which PPL Electric obtains financing by selling and contributing its eligible accounts receivable and unbilled revenue to a special purpose, wholly owned subsidiary on an ongoing basis. The subsidiary pledges these assets to secure loans of up to an aggregate of $100 million from a commercial paper conduit sponsored by a financial institution. At September 30, 2012, based on accounts receivable and unbilled revenue pledged, the amount available for borrowing under the facility was $100 million. In July 2012, PPL Electric and the subsidiary reduced the capacity from $150 million and in September 2012 extended the agreement to September 2013.
(b) | In August 2012, the KU letter ofCommitted capacity includes a $100 million credit facility agreementrelated to an asset-backed commercial paper program through which PPL Electric obtains financing by selling and contributing its eligible accounts receivable and unbilled revenue to a special purpose, wholly owned subsidiary on an ongoing basis. The subsidiary pledges these assets to secure loans of up to an aggregate of $100 million from a commercial paper conduit sponsored by a financial institution. At March 31, 2013, based on accounts receivable and unbilled revenue pledged, the amount available for borrowing under the facility was amended and restated to allow for certain payments under the$100 million. |
(c) | In May 2013, KU extended its $198 million letter of credit facility to be converted to loans rather than requiring immediate payment.May 2016. |
(c)(d) | The commitments under PPL's domestic credit facilities are provided by a diverse bank group, with no one bank and its affiliates providing an aggregate commitment of more than 9% of the total committed capacity. |
(d) | In November 2012, the syndicated credit facilities were amended to extend the expiration dates to November 2017 for PPL Energy Supply, LG&E and KU and to October 2017 for PPL Electric. In addition, LG&E increased the credit facility capacity to $500 million. |
(e) | In December 2012, the PPL WW syndicated credit facility that was set to expire in January 2013 was replaced and the capacity was increased from £150 million. The amount outstandingborrowed at September 30, 2012March 31, 2013 was a USD-denominated borrowing of $171 million, which equated to £107£109 million at the time of borrowing and bore interest at 0.8818%1.9034%. |
(f) | In January 2012, WPD (South West) entered intoThe amount borrowed at March 31, 2013 was a £245GBP-denominated borrowing of £65 million, 5-year syndicated credit facilitywhich equated to replace its previous £210$99 million 3-year syndicated credit facility. Under the facility, WPD (South West) has the ability to make cash borrowings but cannot request the lenders to issue letters of credit. WPD (South West) pays customary commitment fees under this facility and borrowings bearbore interest at LIBOR-based rates plus a margin. The credit facility contains financial covenants that require WPD (South West) to maintain an interest coverage ratio of not less than 3.0 times consolidated earnings before income taxes, depreciation and amortization and total net debt not in excess of 85% of its RAV, in each case calculated in accordance with the credit facility.1.30%. |
(g) | At September 30, 2012,March 31, 2013, the U.S. dollarUSD equivalent of unused capacity under WPD's committed credit facilities was $1.4$1.3 billion. The commitments under WPD's credit facilities are provided by a diverse bank group with no one bank providing more than 16%13% of the total committed capacity. |
See Note 7 to the Financial Statements for further discussion of PPL's credit facilities.
Commercial Paper
In February 2012, LG&E and KU each establishedPPL Energy Supply maintains a commercial paper program for up to $250 million to provide an additional financing source to fund their short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by LG&E's and KU's Syndicated Credit Facilities. LG&E and KU had no commercial paper outstanding at September 30, 2012.
In April 2012, PPL Energy Supply increased the capacity of its commercial paper program from $500 million to $750 million to provide an additional financing source to fund its short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by PPL Energy Supply's Syndicated Credit Facility. At September 30,March 31, 2013 and December 31, 2012, PPL Energy Supply had $355$481 million and $356 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheet,Sheets, at a weighted-average interest raterates of 0.48%0.38% and 0.50%.
In May 2012, PPL Electric increased the capacity of itsmaintains a commercial paper program from $200 millionfor up to $300 million to provide an additional financing source to fund its short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by PPL Electric's Syndicated Credit Facility. At March 31, 2013, PPL Electric had $125 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheet, at a weighted-average interest rate of 0.39%. PPL Electric had no commercial paper outstanding at September 30,December 31, 2012.
In April 2013, LG&E and KU each increased the capacity of their commercial paper programs from $250 million to $350 million to provide an additional financing source to fund their short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by LG&E's and KU's Syndicated Credit Facilities. At March 31, 2013 and December 31, 2012, LG&E had $70 million and $55 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.36% and 0.42%. At March 31, 2013 and December 31, 2012, KU had $115 million and $70 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.36% and 0.42%.
Long-term Debt and Equity Securities
In April 2012, PPL made a registered underwritten public offering of 9.9 million shares of its common stock. In conjunction with that offering,See "Overview" above for information regarding equity forward agreements and the underwriters exercised an option to purchase 591 thousand additional shares of PPL common stock solely to cover over-allotments.
In connection with the registered public offering, PPL entered into forward sale agreements with two counterparties covering the 9.9 million shares of PPL common stock. Settlement of these initial forward sale agreements will occur no later than April 2013. As a result of the underwriters' exercise of the overallotment option, PPL entered into additional forward sale agreements covering the additional 591 thousand shares of PPL common stock. Settlement of the subsequent forward sale agreements will occur in July 2013. Upon any physical settlement of any forward sale agreement, PPL will issue and deliver to the forward counterparties shares of its common stock in exchange for cash proceeds per share equal to the forward sale price. The forward sale price will be calculated based on an initial forward price of $27.02 per share reduced during the period the contracts are outstanding as specified in the forward sale agreements. PPL may, in certain circumstances, elect cash settlement or net share settlement for all or a portion of its rights or obligations under the forward sale agreements.
PPL will not receive any proceeds or issue any shares of common stock until settlement of the forward sale agreements. PPL intends to use any net proceeds that it receives upon settlement to repay short-term debt obligations and for other general corporate purposes.
The forward sale agreements are classified as equity transactions. As a result, no amounts will be recorded in the consolidated financial statements until the settlement of the forward sale agreements. Prior to those settlements, the only impact to the financial statements will be the inclusion of incremental shares within the calculation of diluted EPS using the treasury stock method.2010 Equity Units.
In April 2012, an indirect, wholly owned subsidiary of PPL Energy Supply completed the Ironwood Acquisition. See Note 8 to the Financial Statements for information on the transaction and the long-term debt of PPL Ironwood, LLC assumed through consolidation as part of the acquisition.
In April 2012, WPD (East Midlands) issued £100 million aggregate principal amount of 5.25% Senior Notes due 2023. WPD (East Midlands) received proceeds of approximately £111 million, which equated to $178 million at the time of issuance, net of underwriting fees. The net proceeds were used for general corporate purposes.
In June 2012, LKE completed an exchange of all its outstanding 4.375% Senior Notes due 2021 issued in September 2011 in a transaction not registered under the Securities Act of 1933, for similar securities that were issued in a transaction registered with the SEC. See Note 7 in PPL's and LKE's 2011 Form 10-K for additional information.
In June 2012,March 2013, PPL Capital Funding issued $400$450 million of 4.20% Seniorits 5.90% Junior Subordinated Notes due 2022. The notes may be redeemed at PPL Capital Funding's option any time prior to maturity at make-whole redemption prices.2073. PPL Capital Funding received proceeds of $396$436 million, net of a discount and underwriting fees, which were used for general corporate purposes.
In June 2012, PPL Electric redeemed all 2.5 million shareswill be loaned to or invested in affiliates of its 6.25% Series Preference Stock, par value $100 per share. The price paid for the redemption was the par value, without premium ($250 million in the aggregate). At December 31, 2011, the preference stock was reflected in "Noncontrolling Interests" on PPL's Balance Sheet.
In August 2012, PPL Capital Funding redeemed at par, plus accrued interest, the $99 million outstanding principal amount of its 6.85% Senior Notes due 2047.
In August 2012, PPL Electric issued $250 million of 2.50% First Mortgage Bonds due 2022. The notes may be redeemed at PPL Electric's option any time prior to maturity at make-whole redemption prices. PPL Electric received proceeds of $247 million, net of a discount and underwriting fees. The net proceeds were used to repay short-term indebtedness incurred to fund PPL Electric's redemption of its 6.25% Series Preference Stock in June 2012their capital expenditures and for other general corporate purposes.
In Octoberaddition, PPL has reduced the estimate of its plans to issue new shares of common stock in 2013 by $100 million from the $350 million reported in its 2012 PPL Capital Funding issued $400 million of 3.50% Senior Notes due 2022. The notes may be redeemed at PPL Capital Funding's option any time prior to maturity at make-whole redemption prices. PPL Capital Funding received proceeds of $397 million, net of an underwriting discount and fees, which will be used to repay short-term debt obligations, including commercial paper borrowings and for general corporate purposes.Form 10-K.
See Note 7 in PPL's 2011 Form 10-K for information on the 2010 Equity Units (with respect to which the related $1.150 billion of Notes are expected to be remarketed in 2013), the 2011 Bridge Facility, the 2011 Equity Units and the April 2011 issuance of common stock.
Common Stock Dividends
In August 2012,February 2013, PPL declared its quarterly common stock dividend, payable OctoberApril 1, 2012,2013, at 36.036.75 cents per share (equivalent to $1.44$1.47 per annum). Future dividends, declared at the discretion of the Board of Directors, will be dependent upon future earnings, cash flows, financial and legal requirements and other factors.
Rating Agency Actions
Moody's, S&P and Fitch periodically review the credit ratings on the debt securities of PPL and its subsidiaries. Based on their respective independent reviews, the rating agencies may make certain ratings revisions or ratings affirmations.
A credit rating reflects an assessment by the rating agency of the creditworthiness associated with an issuer and particular securities that it issues. The credit ratings of PPL and its subsidiaries are based on information provided by PPL and other sources. The ratings of Moody's, S&P and Fitch are not a recommendation to buy, sell or hold any securities of PPL or its subsidiaries. Such ratings may be subject to revisions or withdrawal by the agencies at any time and should be evaluated independently of each other and any other rating that may be assigned to the securities.
A downgrade in PPL's or its subsidiaries' credit ratings could result in higher borrowing costs and reduced access to capital markets.
As a result of the passage of the Dodd-Frank Act, PPL is limiting its credit rating disclosure to a description of the actions taken by the rating agencies with respect to PPL's ratings, but without stating what ratings have been assigned to PPL or its subsidiaries, or their securities. The ratings assigned by the rating agencies to PPL and its subsidiaries and their respective securities may be found, without charge, on eachhave no credit rating triggers that would result in the reduction of access to capital markets or the respective rating agencies' websites, which ratings together with all other information contained on such rating agency websites is, hereby, explicitly not incorporated by reference in this report.acceleration of maturity dates of outstanding debt.
The rating agencies took the following actions related to PPL and its subsidiaries:
In January 2012, S&P affirmed its rating and revised its outlook for PPL Montana's Pass Through Certificates due 2020.subsidiaries during 2013:
In February 2012, Fitch assigned ratings2013, Moody's upgraded its rating, from B2 to Ba1, and revised the two newly established commercial paper programsoutlook from under review to stable for LG&E and KU.PPL Ironwood.
In March 2012, Moody's affirmed the following ratings: · | the long-term ratings of the First Mortgage Bonds for LG&E and KU; |
· | the issuer ratings for LG&E and KU; and |
· | the bank loan ratings for LG&E and KU. |
Also in March 2012,2013, S&P, Moody's and S&P each assigned short-term ratings to the two newly established commercial paper programs for LG&E and KU.
In March and May 2012, Moody's, S&P and Fitch affirmed the long-term ratings for LG&E's 2003 Series A and 2007 Series B pollution control bonds.
Following the announcement of the then-pending acquisition of AES Ironwood, L.L.C. in February 2012, the rating agencies took the following actions:
· | In March 2012, Moody's placed AES Ironwood, L.L.C.'s senior secured bonds under review for possible ratings upgrade. |
· | In April 2012, S&P affirmed the rating of AES Ironwood, L.L.C.'s senior secured bonds. |
In May 2012, Fitch downgraded its rating and revised its outlook for PPL Montana's Pass Through Certificates due 2020.
In June 2012, Fitch assigned a ratingratings of BB+, Ba1 and outlookBB+ to PPL Capital Funding's $400$450 million of 4.20% Senior Notes.5.90% Junior Subordinated Notes due 2073. Fitch also assigned a stable outlook to these notes.
In August 2012, Fitch assigned a rating and outlook to PPL Electric's $250 million First Mortgage Bonds.
In August 2012, S&P and Moody's assigned a rating to PPL Electric's $250 million First Mortgage Bonds.
In October 2012,April 2013, Fitch affirmed the long-term issuer defaultBBB- rating and senior unsecured rating ofstable outlook at PPL WW, WPD (South Wales) and WPD (South West).Montana.
In October 2012, Moody's, S&P and Fitch assigned a rating to PPL Capital Funding's $400 million of 3.50% Senior Notes.
In October 2012, S&P affirmed its rating for PPL.
In November 2012, S&P revised its outlook for PPL Montana's Pass Through Certificates due 2020.
Ratings Triggers
PPL and PPL Energy Supply have various derivative and non-derivative contracts, including contracts for the sale and purchase of electricity and fuel, commodity transportation and storage, tolling agreements and interest rate and foreign currency instruments, which contain provisions that require PPL and PPL Energy Supply to post additional collateral or permit the counterparty to terminate the contract, if PPL's or PPL Energy Supply's credit rating were to fall below investment grade. See Note 14 to the Financial Statements for a discussion of "Credit Risk-Related Contingent Features," including a discussion of the potential additional collateral that would have been required for derivative contracts in a net liability position at September 30, 2012. At September 30, 2012, if PPL's and its subsidiaries' credit ratings had been below investment grade, PPL would have been required to prepay or post an additional $486 million of collateral to counterparties for both derivative and non-derivative commodity and commodity-related contracts used in its generation, marketing and trading operations and interest rate and foreign currency contracts.
Capital Expenditures
Capital expenditure plans are revised periodically to reflect changes in operational, market and regulatory conditions. PPL has lowered its projected environmental capital spending for the period 2012 through 2016 by approximately $0.5 billion from the previously disclosed $3.4 billion projection of environmental capital spending included in PPL's 2011 Form 10-K. The lower projected capital spending is based on current project evaluations and pricing contained in contracts executed to date for environmental construction projects. PPL continues to evaluate potential new generation supply sources, including self-build options and power sourced from the market, as an alternative to installing additional emission control equipment at E.W. Brown, which is jointly dispatched for LG&E and KU, and in lieu of the terminated Bluegrass CTs acquisition discussed in Notes 6 and 8 to the Financial Statements. PPL expects to complete its evaluation during the first half ofMarch 31, 2013. The outcome of that evaluation may lead to additional changes in projected capital spending.
For additional information on PPL's liquidity and capital resources, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," in PPL's 20112012 Form 10-K.
Risk Management
Market Risk
See Notes 13 and 14 to the Financial Statements for information about PPL's risk management objectives, valuation techniques and accounting designations.
The forward-looking information presented below provides estimates of what may occur in the future, assuming certain adverse market conditions and model assumptions. Actual future results may differ materially from those presented. These disclosures are not precise indicators of expected future losses, but only indicators of possible losses under normal market conditions at a given confidence level.
Commodity Price Risk (Non-trading)
PPL segregates its non-trading activities into two categories: hedge activity and economic activity. Transactions that are accounted for as hedge activity qualify for hedge accounting treatment. The economic activity category includes transactions that address a specific risk, but were not eligible for hedge accounting or for which hedge accounting was not elected. This activity includes the changes in fair value of positions used to hedge a portion of the economic value of PPL's competitive generation assets and full-requirement sales contracts and retail contracts. This economic activity is subject to changes in fair value due to market price volatility of the input and output commodities (e.g., fuel and power). Although they do not receive hedge accounting treatment, these transactions are considered non-trading activity. The fair value of economic positions at September 30, 2012 and December 31, 2011 was a net asset/(liability) of $491 million and $(63) million. The change in fair value is largely attributable to the dedesignation of cash flow hedges that are now classified as economic hedges. See Note 14 to the Financial Statements for additional information.
To hedge the impact of market price volatility on PPL's energy-related assets, liabilities and other contractual arrangements, PPL both sells and purchases physical energy at the wholesale level under FERC market-based tariffs throughout the U.S. and enters into financial exchange-traded and over-the-counter contracts. PPL's non-trading commodity derivative contracts range in maturity through 2019.
The following table sets forth the changes in the net fair value of non-trading commodity derivative contracts for the periods ended September 30.March 31. See Notes 13 and 14 to the Financial Statements for additional information.
| | Gains (Losses) | | | Three Months | | Nine Months | | | 2012 | | 2011 | | 2012 | | 2011 | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | $ | 961 | | $ | 894 | | $ | 1,082 | | $ | 956 | Contracts realized or otherwise settled during the period | | | (224) | | | (100) | | | (764) | | | (237) | Fair value of new contracts entered into during the period (a) | | | (11) | | | 4 | | | 1 | | | 19 | Other changes in fair value | | | (101) | | | 46 | | | 306 | | | 106 | Fair value of contracts outstanding at the end of the period | | $ | 625 | | $ | 844 | | $ | 625 | | $ | 844 |
| | | | | | | | Gains (Losses) | | | | | Three Months | | | | | | | 2013 | | 2012 | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | | | | | | | $ | 473 | | $ | 1,082 | Contracts realized or otherwise settled during the period | | | | | | | | | (137) | | | (279) | Fair value of new contracts entered into during the period (a) | | | | | | | | | 9 | | | (1) | Other changes in fair value | | | | | | | | | (116) | | | 413 | Fair value of contracts outstanding at the end of the period | | | | | | | | $ | 229 | | $ | 1,215 |
(a) | Represents the fair value of contracts at the end of the quarter of their inception. |
The following table segregates the net fair value of non-trading commodity derivative contracts at September 30, 2012,March 31, 2013, based on the level of observability of the information used to determine the fair value.
| | | Net Asset (Liability) | | | Net Asset (Liability) | | | | Maturity | | | | | | Maturity | | | | | Maturity | | | | | | Maturity | | | | | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | Source of Fair Value | Source of Fair Value | | | | | | | | | | | Source of Fair Value | | | | | | | | | | | Prices based on significant observable inputs (Level 2) | Prices based on significant observable inputs (Level 2) | | $ | 520 | | $ | 94 | | $ | (19) | | $ | 7 | | $ | 602 | Prices based on significant observable inputs (Level 2) | | $ | 238 | | $ | (21) | | $ | (8) | | $ | 6 | | $ | 215 | Prices based on significant unobservable inputs (Level 3) | Prices based on significant unobservable inputs (Level 3) | | | 11 | | | 8 | | | 4 | | | | | | 23 | Prices based on significant unobservable inputs (Level 3) | | | (1) | | | 12 | | | 3 | | | | | | 14 | Fair value of contracts outstanding at the end of the period | Fair value of contracts outstanding at the end of the period | | $ | 531 | | $ | 102 | | $ | (15) | | $ | 7 | | $ | 625 | Fair value of contracts outstanding at the end of the period | | $ | 237 | | $ | (9) | | $ | (5) | | $ | 6 | | $ | 229 |
PPL sells electricity, capacity and related services and buys fuel on a forward basis to hedge the value of energy from its generation assets. If PPL were unable to deliver firm capacity and energy or to accept the delivery of fuel under its agreements, under certain circumstances it could be required to pay liquidating damages. These damages couldwould be based on the difference between the market price and the contract price of the commodity. Depending on price changes in the wholesale energy markets, such damages could be significant. Extreme weather conditions, unplanned power plant outages, transmission disruptions, nonperformance by counterparties (or their own counterparties) with which it has energy contracts and other factors could affect PPL's ability to meet its obligations, or cause significant increases in the market price of replacement energy. Although PPL attempts to mitigate these risks, there can be no assurance that it will be able to fully meet its firm obligations, that it will not be required to pay damages for failure to perform, or that it will not experience counterparty nonperformance in the future. In connection with its bankruptcy proceedings, a significant counterparty, SMGT, had been purchasing lower volumes of electricity than prescribed in the contract and effective April 1, 2012 the contract was terminated. PPL Energy Supply cannot predict the prices or other terms on which it will be able to market to third parties the power that SMGT will not purchase from PPL EnergyPlus due to the termination of this contract. See Note 10 to the Financial Statements for additional information.
Commodity Price Risk (Trading)
PPL's trading commodity derivative contracts range in maturity through 2017. The following table sets forth changes in the net fair value of trading commodity derivative contracts for the periods ended September 30.March 31. See Notes 13 and 14 to the Financial Statements for additional information.
| | Gains (Losses) | | | | | | Gains (Losses) | | | Three Months | | Nine Months | | | | Three Months | | | 2012 | | 2011 | | 2012 | | 2011 | | | | | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | $ | 17 | | $ | 15 | | $ | (4) | | $ | 4 | | | | | | $ | 29 | | $ | (4) | Contracts realized or otherwise settled during the period | | 17 | | (10) | | 16 | | (7) | | | | | | (2) | | | Fair value of new contracts entered into during the period (a) | | 13 | | (2) | | 18 | | 6 | | | | | | | (12) | | | 6 | Other changes in fair value | | | (15) | | | 4 | | | 2 | | | 4 | | Fair value of contracts outstanding at the end of the period | | $ | 32 | | $ | 7 | | $ | 32 | | $ | 7 | | | | | | $ | 15 | | $ | 2 |
(a) | Represents the fair value of contracts at the end of the quarter of their inception. |
Unrealized gains of approximately $4 million will be reversed over the next three months as the transactions are realized.
The following table segregates the net fair value of trading commodity derivative contracts at September 30, 2012,March 31, 2013, based on the level of observability of the information used to determine the fair value.
| | Net Asset (Liability) | | Net Asset (Liability) | | | Maturity | | | | | | Maturity | | | | Maturity | | | | | | Maturity | | | | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | Source of Fair Value | | | | | | | | | | | | | | | | | | | | | Prices quoted in active markets for identical instruments (Level 1) | | | $ | 1 | | | | | | | | $ | 1 | Prices based on significant observable inputs (Level 2) | | $ | 18 | | $ | 11 | | $ | 1 | | | | $ | 30 | | | 5 | | $ | 9 | | | | | | | | | 14 | Prices based on significant unobservable inputs (Level 3) | | | 2 | | | | | | | | | | | | 2 | | Fair value of contracts outstanding at the end of the period | | $ | 20 | | $ | 11 | | $ | 1 | | | | | $ | 32 | | $ | 6 | | $ | 9 | | | | | | | | $ | 15 |
VaR Models
A VaR model is utilized to measure commodity price risk in domesticunregulated gross energy margins for the non-trading and trading portfolios. VaR is a statistical model that attempts to estimate the value of potential loss over a given holding period under normal market conditions at a given confidence level. VaR is calculated using a Monte Carlo simulation technique based on a five-day holding period at a 95% confidence level. Given the company's conservativedisciplined hedging program, the non-trading VaR exposure is expected to be limited in the short-term. The VaR for portfolios using end-of-month results for the periodperiods was as follows.
| | | Trading VaR | | Non-Trading VaR | | | | Nine Months | | Twelve Months | | Nine Months | | Twelve Months | | | | Ended | | Ended | | Ended | | Ended | | | | September 30, | | December 31, | | September 30, | | December 31, | | | | 2012 | | 2011 | | 2012 | | 2011 | 95% Confidence Level, Five-Day Holding Period | | | | | | | | | | | | | | Period End | | $ | 6 | | $ | 1 | | $ | 10 | | $ | 6 | | Average for the Period | | | 3 | | | 3 | | | 9 | | | 5 | | High | | | 8 | | | 6 | | | 11 | | | 7 | | Low | | | 1 | | | 1 | | | 7 | | | 4 |
| | | Trading VaR | | Non-Trading VaR | | | | Three Months | | Three Months | | | | Ended | | Ended | | | | March 31, | | March 31, | | | | 2013 | | 2013 | 95% Confidence Level, Five-Day Holding Period | | | | | | | | Period End | | $ | 6 | | $ | 8 | | Average for the Period | | | 5 | | | 9 | | High | | | 6 | | | 9 | | Low | | | 3 | | | 8 |
The trading portfolio includes all speculativeproprietary trading positions, regardless of the delivery period. All positions not considered speculativeproprietary trading are considered non-trading. The non-trading portfolio includes the entire portfolio, including generation, with delivery periods through the next 12 months. Both the trading and non-trading VaR computations exclude FTRs due to the absence of reliable spot and forward markets. The fair value of the non-trading and trading FTR positions was insignificant at September 30, 2012.March 31, 2013.
Interest Rate Risk
PPL and its subsidiaries issue debt to finance their operations, which exposes them to interest rate risk. PPL utilizes various financial derivative instruments to adjust the mix of fixed and floating interest rates in its debt portfolio, adjust the duration of its debt portfolio and lock in benchmark interest rates in anticipation of future financing, when appropriate. Risk limits under the risk management program are designed to balance risk exposure to volatility in interest expense and changes in the fair value of PPL's debt portfolio due to changes in the absolute level of interest rates.
At September 30, 2012,March 31, 2013, PPL's potential annual exposure to increased interest expense, based on a 10% increase in interest rates, was not significant.
PPL is also exposed to changes in the fair value of its domestic and international debt portfolios. PPL estimated that a 10% decrease in interest rates at September 30, 2012March 31, 2013 would increase the fair value of its debt portfolio by $609$563 million.
At September 30, 2012,March 31, 2013, PPL had the following interest rate hedges outstanding:
| | | | | | | Effect of a | | | | | | | Effect of a | | | | | | Fair Value, | | 10% Adverse | | | | | Fair Value, | | 10% Adverse | | | | Exposure | | Net - Asset | | Movement | | | Exposure | | Net - Asset | | Movement | | | | Hedged | | (Liability) (a) | | in Rates (b) | | | Hedged | | (Liability) (a) | | in Rates (b) | Cash flow hedges | Cash flow hedges | | | | | | | Cash flow hedges | | | | | | | | Interest rate swaps (c) | | $ | 618 | | $ | (21) | | $ | (14) | Interest rate swaps (c) | | $ | 1,148 | | $ | 12 | | $ | (35) | | Cross-currency swaps (d) | | 1,262 | | 20 | | (180) | Cross-currency swaps (d) | | 1,262 | | 82 | | (171) | Economic hedges | | | | | | | | Economic activity | | Economic activity | | | | | | | | Interest rate swaps (e) | | 179 | | (62) | | (3) | Interest rate swaps (e) | | 179 | | (55) | | (3) |
(a) | Includes accrued interest, if applicable. |
(b) | Effects of adverse movements decrease assets or increase liabilities, as applicable, which could result in an asset becoming a liability. Sensitivities represent a 10% adverse movement in interest rates, except for cross-currency swaps which also includes foreign currency exchange rates. |
(c) | PPL utilizes various risk management instruments to reduce its exposure to the expected future cash flow variability of its debt instruments. These risks include exposure to adverse interest rate movements for outstanding variable rate debt and for future anticipated financing. While PPL is exposed to changes in the fair value of these instruments, any changes in the fair value of such cash flow hedges are recorded in equity.equity or as regulatory assets or liabilities, if recoverable through regulated rates. The changes in fair value of these instruments are then reclassified into earnings in the same period during which the item being hedged affects earnings. Sensitivities represent a 10% adverse movement in interest rates. The positions outstanding at September 30, 2012March 31, 2013 mature through 2024.2043. |
(d) | PPL utilizes cross-currency swaps to hedge the interest payments and principal of WPD's U.S. dollar-denominated senior notes. While PPL is exposed to changes in the fair value of these instruments, any change in the fair value of these instruments is recorded in equity and reclassified into earnings in the same period during which the item being hedged affects earnings. Sensitivities represent a 10% adverse movement in both interest rates and foreign currency exchange rates. The positions outstanding at September 30, 2012March 31, 2013 mature through 2028. |
(e) | PPL utilizes various risk management instruments to reduce its exposure to the expected future cash flow variability of its debt instruments. These risks include exposure to adverse interest rate movements for outstanding variable rate debt and for future anticipated financing. While PPL is exposed to changes in the fair value of these instruments, any realized changes in the fair value of such economic hedgespositions are recoverable through regulated rates and any subsequent changes in fair value of these derivatives are included in regulatory assets or liabilities. Sensitivities represent a 10% adverse movement in interest rates. The positions outstanding at September 30, 2012March 31, 2013 mature through 2033. |
Foreign Currency Risk
PPL is exposed to foreign currency risk, primarily through investments in U.K. affiliates. In addition, PPL's domestic operations may make purchases of equipment in currencies other than U.S. dollars.
PPL has adopted a foreign currency risk management program designed to hedge certain foreign currency exposures, including firm commitments, recognized assets or liabilities, anticipated transactions and net investments. In addition, PPL enters into financial instruments to protect against foreign currency translation risk of expected earnings.
At September 30, 2012, PPL had the following foreign currency hedges outstanding:
outstanding March 31, 2013:
| | | | | | | Effect of a | | | | | | | Effect of a | | | | | | | | 10% | | | | | | | 10% | | | | | | | | Adverse | | | | | | | Adverse | | | | | | | | Movement | | | | | | | Movement | | | | | | | | in Foreign | | | | | | | in Foreign | | | | | | Fair Value, | | Currency | | | | | Fair Value, | | Currency | | | | Exposure | | Net - Asset | | Exchange | | | Exposure | | Net - Asset | | Exchange | | | | Hedged | | (Liability) | | Rates (a) | | | Hedged | | (Liability) | | Rates (a) | | | | | | | | | | | | | | | | Net investment hedges (b) | Net investment hedges (b) | | £ | 163 | | $ | (1) | | $ | (26) | Net investment hedges (b) | | £ | 162 | | $ | 15 | | $ | (25) | Economic hedges (c) | | 1,199 | | (35) | | (185) | | Economic activity (c) | | Economic activity (c) | | 1,175 | | 78 | | (167) |
(a) | Effects of adverse movements decrease assets or increase liabilities, as applicable, which could result in an asset becoming a liability. |
(b) | To protect the value of a portion of its net investment in WPD, PPL executes forward contracts to sell GBP. The positions outstanding at September 30, 2012March 31, 2013 mature through 2013. Excludes the amount of an intercompany loan classified as a net investment hedge. See Note 14 to the Financial Statements for additional information. |
(c) | To economically hedge the translation of expected income denominated in GBP to U.S. dollars, PPL enters into a combination of average rate forwards and average rate options to sell GBP. The positionsforwards and options outstanding at September 30, 2012March 31, 2013 mature through 2014.2015. |
NDT Funds - Securities Price Risk
In connection with certain NRC requirements, PPL Susquehanna maintains trust funds to fund certain costs of decommissioning the PPL Susquehanna nuclear plant (Susquehanna). At September 30, 2012,March 31, 2013, these funds were invested primarily in domestic equity securities and fixed-rate, fixed-income securities and are reflected at fair value on the Balance Sheet. The mix of securities is designed to provide returns sufficient to fund Susquehanna's decommissioning and to compensate for inflationary increases in decommissioning costs. However, the equity securities included in the trusts are exposed to price fluctuation in equity markets, and the values of fixed-rate, fixed-income securities are primarily exposed to changes in interest rates. PPL actively monitors the investment performance and periodically reviews asset allocation in accordance with its NDTnuclear decommissioning trust policy statement. At September 30, 2012,March 31, 2013, a hypothetical 10% increase in interest rates and a 10% decrease in equity prices would have resulted in an estimated $49$55 million reduction in the fair value of the trust assets. See Notes 13 and 17 to the Financial Statements for additional information regarding the NDT funds.
Credit Risk
See Notes 13 and 14 to the Financial Statements in this Form 10-Q and "Risk Management - Energy Marketing & Trading and Other - Credit Risk" in PPL's 20112012 Form 10-K for additional information.
Foreign Currency Translation
The value of the British pound sterling fluctuates in relation to the U.S. dollar. Changes in thesethis exchange ratesrate resulted in a foreign currency translation loss of $256 million for the three months ended March 31, 2013, which primarily reflected a $696 million decrease to PP&E and goodwill offset by a decrease of $440 million to net liabilities. Changes in this exchange rate resulted in a foreign currency translation gain of $53$76 million for the ninethree months ended September 30,March 31, 2012, which primarily reflected a $93$188 million increase to PP&E and goodwill offset by an increase of $40 million to net liabilities. Changes in these exchange rates resulted in a foreign currency translation gain of $154 million for the nine months ended September 30, 2011, which primarily reflected a $242 million increase to PP&E offset by an increase of $88$112 million to net liabilities. The impact of foreign currency translation is recorded in AOCI.
Related Party Transactions
PPL is not aware of any material ownership interests or operating responsibility by senior management of PPL, PPL Energy Supply, PPL Electric, LKE, LG&E or KU in outside partnerships, including leasing transactions with variable interest entities or other entities doing business with PPL. See Note 11 to the Financial Statements for additional information on related party transactions.
Acquisitions, Development and Divestitures
See Note 8PPL from time to the Financial Statementstime evaluates opportunities for information on the April 2012 Ironwood Acquisitionpotential acquisitions, divestitures and LG&E's and KU's June 2012 termination of the asset purchase agreement for the Bluegrass CTs.
See Note 8 to the Financial Statements in this Form 10-Q and Note 10 to the Financial Statements in PPL's 2011 Form 10-K for information on PPL's April 2011 acquisition of WPD Midlands.
development projects. Development projects are continuously reexamined based on market conditions and other factors to determine whether to proceed with the projects, sell, cancel or expand them, execute tolling agreements or pursue other options. See Note 8 to the Financial Statements for additional information on the more significant activities.
Environmental Matters
Extensive federal, state and local environmental laws and regulations are applicable to PPL's air emissions, water discharges and the management of hazardous and solid waste, amongas well as other areas; and theaspects of PPL's business. The cost of compliance or alleged non-compliance cannot be predicted with certainty but could be material. In addition, costs may increase significantly if the requirements or scope of environmental laws or regulations, or similar rules, are expanded or changed by the relevant regulatory agencies. Costs may take the form of increased capital expenditures or operating and maintenance expenses;expenses, monetary fines, penalties or other restrictions. Many of these environmental law considerations are also applicable to the operations of key suppliers, or customers, such as coal producers and industrial power users, and may impact the cost ofcosts for their products or their demand for PPL's services.
Physical effects associated with climate change could include the impact of changes in weather patterns, such as storm frequency and intensity, and the resultant potential damage to PPL's generation assets, electricity transmission and distribution systems, as well as impacts on customers. In addition, changed weather patterns could potentially reduce annual rainfall in areas where PPL has hydro generating facilities or where river water is used to cool its fossil and nuclear powered generators. PPL cannot currently predict whether its businesses will experience these potential climate change-related risks or estimate the potential cost of their related consequences.
The following is a discussion of the more significant environmental matters.
Coal Combustion Residuals (CCRs) In June 2010, the EPA proposed two approaches to regulating the disposal and management of CCRs (as either hazardous or non-hazardous) under existing solid waste regulations. A final rulemaking is currently expected before the end of 2015. However, the timing of the final regulations could be accelerated by certain litigation that could require the EPA to issue its regulations sooner. Regulations could impact handling, disposal and/or beneficial use of CCRs. The financial impact could be material if CCRs are regulated as hazardous waste, and significant if regulated as non-hazardous, in accordance with the proposed rule.
Effluent Limitation Guidelines On April 19, 2013, the EPA issued proposed regulations to revise discharge limitations for steam electric generation wastewater permits. The proposed limitations are based on the EPA review of available treatment technologies and their capacity for reducing pollutants and include new requirements for fly ash and bottom ash handling and metal cleaning wastes, as well as new limits for scrubber wastewater, gasification wastewater and landfill leachate. The proposal contains several alternative approaches, some of which could significantly impact PPL's coal-fired plants. PPL will work with industry groups to comment on the proposed regulation. The final regulation is expected in May 2014. At the present time, PPL is unable to predict the outcome of this matter or estimate a range of reasonably possible costs, but the costs could be significant.
316(b) Cooling Water Intake Structure Rule In April 2011, the EPA published a draft regulation under Section 316(b) of the Clean Water Act, which regulates cooling water intakes for power plants. The draft rule has two provisions: one requires installation of Best Technology Available (BTA) to reduce mortality of aquatic organisms that are pulled into the plant cooling water system (entrainment), and the second imposes standards for reduction of mortality of aquatic organisms trapped on water intake screens (impingement). A final rule is expected in June 2013. The proposed regulation would apply to nearly all PPL-owned steam electric plants in Pennsylvania, Kentucky, and Montana, potentially even including those equipped with closed-cycle cooling systems. PPL's compliance costs could be significant, especially if the final rule requires closed-cycle systems at plants that do not currently have them or conversions of once-through systems to closed-cycle. GHG Regulations In 2013, the EPA is expected to finalize limits on GHG emissions from new power plants and to begin working on a proposal for such emissions from existing power plants. The EPA's proposal on GHG emissions from new power plants would effectively preclude construction of any coal-fired plants and could even be difficult for new gas-fired plants to meet. With respect to existing power plants, the impact could be significant, depending on the structure and stringency of the final rule. PPL, along with others in the industry, filed comments on the EPA's proposal related to GHG emissions from new plants.
MATS The EPA finalized MATS requiring fossil-fuel fired plants to reduce emissions of mercury and other hazardous air pollutants by April 16, 2015. The rule is being challenged by industry groups and states. The EPA has subsequently proposed changes to the rule with respect to new sources to address the concern that the rule effectively precludes construction of any new coal-fired plants. PPL is generally well-positioned to comply with MATS, primarily due to recent investments in environmental controls and approved ECR plans to install additional controls at some of its Kentucky plants. Additionally, PPL is evaluating chemical additive systems for mercury control at Brunner Island, and modifications to existing controls at Colstrip for improved particulate matter reductions. In September 2012, PPL announced its intention to place its Corette plant in long-term reserve status beginning in April 2015 due to expected market conditions and costs to comply with MATS. The anticipated retirements of certain coal-fired electric generating units are in response to this and other environmental regulations.
CSAPR and CAIR In 2011, the EPA finalized its CSAPR regulating emissions of nitrous oxide and sulfur dioxide through new allowance trading programs which were to be implemented in two phases (2012 and 2014). Like its predecessor, the CAIR, CSAPR targeted sources in the eastern United States. In December 2011, the U.S. Court of Appeals for the District of Columbia Circuit (the Court) stayed implementation of CSAPR, leaving CAIR in place. Subsequently, in August 2012, the Court vacated and remanded CSAPR back to the EPA for further rulemaking, again leaving CAIR in place. PPL plants in Pennsylvania and Kentucky will continue to comply with CAIR through optimization of existing controls, balanced with emission allowance purchases. The Court's August decision leaves plants in CSAPR-affected states potentially exposed to more stringent emission reductions due to regional haze implementation (it was previously determined that CSAPR or CAIR participation satisfies regional haze requirements), and/or petitions to the EPA by downwind states under Section 126 of the Clean Air Act requesting the EPA to require plants that allegedly contribute to downwind non-attainment to take action to reduce emissions.
Regional Haze - Montana The EPA signed its final Federal Implementation Plan of the Regional Haze Rules for Montana in September 2012, with tighter emissions limits for Colstrip Units 1 & 2 based on the installation of new controls (no limits or additional controls were specified for Colstrip Units 3 & 4), and tighter emission limits for Corette (which are not based on additional controls). The cost of the potential additional controls for Colstrip Units 1 & 2, if required, could be significant. PPL expects to meet the tighter permit limits at Corette without any significant changes to operations, although other requirements have led to the planned suspension of operations at Corette beginning in April 2015 (see "MATS" discussion above).
See Note 10 to the Financial Statements in this Form 10-Q and "Item 1. Business - Environmental Matters" in PPL's 20112012 Form 10-K for a discussion of environmental matters.
New Accounting Guidance
See Notes 2 and 1819 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.
Application of Critical Accounting Policies
Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies. The following accounting policies are particularly important to the financial condition or results of operations, and require estimates or other judgments of matters inherently uncertain: price risk management, defined benefits, asset impairment (excluding investments), loss accruals, AROs, income taxes, and regulatory assets and liabilities and business combinations - purchase price allocation.liabilities. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in PPL's 20112012 Form 10-K for a discussion of each critical accounting policy.
PPL ENERGY SUPPLY, LLC AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following should be read in conjunction with PPL Energy Supply's Condensed Consolidated Financial Statements and the accompanying Notes and with PPL Energy Supply's 20112012 Form 10-K. Capitalized terms and abbreviations are defined in the glossary. Dollars are in millions, unless otherwise noted.
"Management's Discussion and Analysis of Financial Condition and Results of Operations" includes the following information:
· | "Overview" provides a description of PPL Energy Supply and its business strategy, a summary of Net Income Attributable to PPL Energy Supply Member and a discussion of certain events related to PPL Energy Supply's results of operations and financial condition. |
· | "Results of Operations" provides a summary of PPL Energy Supply's earnings and a description of key factors expected to impact future earnings. This section ends with explanations of significant changes in principal line items on PPL Energy Supply's Statements of Income, comparing the three and nine months ended September 30, 2012March 31, 2013 with the same periods in 2011.2012. |
· | "Financial Condition - Liquidity and Capital Resources" provides an analysis of PPL Energy Supply's liquidity position and credit profile. This section also includes a discussion of rating agency actions. |
· | "Financial Condition - Risk Management" provides an explanation of PPL Energy Supply's risk management programs relating to market and credit risk. |
Overview
Introduction
PPL Energy Supply is an energy company with headquarters in Allentown, Pennsylvania. Through its subsidiaries, PPL Energy Supply is primarily engaged in the competitive generation and marketing of electricity in two key markets - the northeastern and northwestern U.S.
Business Strategy
PPL Energy Supply's overall strategy is to achieve disciplined optimization of energy supply margins while mitigating volatility in both cash flows and earnings. More specifically, PPL Energy Supply's strategy is to optimize the value from its competitive generation and marketing portfolios. PPL Energy Supply endeavors to do this by matching energy supply with load, or customer demand, under contracts of varying durations with creditworthy counterparties to capture profits while effectively managing exposure to energy and fuel price risk,volatility, counterparty credit risk and operational risk. PPL Energy Supply is focused on maintaining profitability during the current and projected period of low commodity prices by controlling its capital and operation and maintenance expenditures.
To manage financing costs and access to credit markets, a key objective offor PPL Energy Supply's business strategySupply is to maintain a strong credit profile. PPL Energy Supply continually focuses on maintaining an appropriate capital structureprofile and liquidity position. In addition, PPL Energy Supply has financial and operational risk management programs that, among other things, are designed to monitor and manage its exposure to earnings and cash flow volatility related to changes in energy and fuel prices, interest rates, counterparty credit quality and the operating performance of its generating units.
Financial and Operational Developments
Net Income (Loss) Attributable to PPL Energy Supply Member
Net Income (Loss) Attributable to PPL Energy Supply Member for the three and nine months ended September 30, 2012March 31, 2013 was $54 million and $382$(38) million compared to $169$309 million and $472 million for the same periods in 2011,2012, representing decreases of 68% and 19% from the same periods in 2011.a 112% decrease.
See "Results of Operations" below for details of special itemsfurther discussion and analysis of the consolidated results of operations.
Economic and Market Conditions
Unregulated gross energy marginsGross Energy Margins associated with PPL Energy Supply's competitive generation and marketing business are impacted by changes in market prices and demand for electricity and natural gas, power plant availability, competition in the markets for retail customers, fuel costs and availability, fuel transportation costs and other costs. Current depressed wholesale market prices for electricity and natural gas have resulted from general weak economic conditions and other factors, including the impact of expanded domestic shale gas development. As a result of these factors, PPL Energy Supply has experienced a shift in the dispatching of its competitive generation from coal-fired to combined-cycle gas-fired generation as illustrated in the following table:
| | | Average Utilization Factors (a) | | | | 2009 - 2011 | | | YTD 2012 | Pennsylvania coal plants | | | 89% | | | 70% | Montana coal plants | | | 87% | | | 59% | Combined-cycle gas plants | | | 70% | | | 96% |
(a) | All periods reflect the nine months ending September 30. |
This reduction in coal-fired generation output had resulted in a surplus of coal inventory at certain of PPL Energy Supply's Pennsylvania coal plants. To mitigate the risk of exceeding available coal storage, PPL Energy Supply incurred pre-tax charges of $17 million and $29 million during the three and nine months ended September 30, 2012 to reduce its 2012 and 2013 contracted coal deliveries. PPL Energy Supply will continue to manage its coal inventory to mitigate the financial impact and physical implications of an oversupply.
In addition, current economic and commodity market conditions indicated a lower value of unhedged future energy margins (primarily in 2014 and forward years)are expected to continue compared to the hedged energy margins in 2012. As has been PPL Energy Supply's practice in periods of changing business conditions, PPL Energy Supply continues to review its future business and operational plans, including capital and operation and maintenance expenditures, as well as its hedging strategies.
PPL Energy Supply's businesses are also subject to extensive federal, state and local environmental laws, rules and regulations. PPL Energy Supply's competitive generation assets are well positioned to meet these requirements. See Note 10 to the Financial Statements in this Form 10-Q and Note 15 to the Financial Statements in PPL Energy Supply's 2011 Form 10-K for additional information on these requirements. As a result of these requirements, PPL Energy Supply announced in September 2012 its intention, beginning in April 2015,continues to placemonitor its Corette plant (which as previously announced will be placed in long-term reserve status, suspending the plant's operation due to expected market conditions and the costs to comply with the Mercury and Air Toxics Standards.MATS beginning in April 2015) for impairment. The Corette plant'splant asset group's carrying value at September 30, 2012March 31, 2013 was approximately $67$65 million. Although the Corette plant was not determined to be impaired at September 30, 2012,March 31, 2013, it is reasonably possible that an impairment charge could be recorded in the fourth quarter of 2012 oroccur in future periods, as higher priced sales contracts settle, adversely impacting projected cash flows.
In light of these economic and market conditions, as well as current and projected environmental regulatory requirements, PPL Energy Supply considered whether certain of its other generating assets were impaired, and determined that no impairment charges were required at September 30, 2012. PPL Energy Supply is unable to predict whether future environmental requirements or market conditions will result in impairment charges for other generating assets or additional retirements.
PPL Energy Supply and its subsidiaries may also be impacted in future periods by the uncertainty in the worldwide financial and credit markets partially caused by the European sovereign debt crisis. In addition, PPL Energy Supply may be impacted by reductions in the credit ratings of financial institutions and evolving regulations in the financial sector. Collectively, these factors could reduce availability or restrict PPL Energy Supply and its subsidiaries' ability to maintain sufficient levels of liquidity, reduce capital market activities, change collateral posting requirements and increase the associated costs to PPL Energy Supply and its subsidiaries.
PPL Energy Supply cannot predict the future impact that these economic and market conditions and regulatory requirements may have on its financial condition or results of operations.
Susquehanna Turbine Blade Inspection
In the spring of 2013, PPL Energy Supply previously announced that a shutdown of Unit 1 of its Susquehanna nuclear power plant in October 2012 will include an inspection of that unit's turbine blades that could leadbegin making modifications to address the finalization of a plan to resolve the issuecauses of turbine blade cracking at the Susquehanna nuclear plant that was first identified in 2011. The modifications will be made during the Unit 1 is expected to resume operations by November 8, 2012.2 refueling outage and an additional planned outage for Unit 1. Following completion of the modifications, PPL Energy Supply plans to take an inspection outage for Unit 2. The projected pre-tax earnings impact of these inspections, including reduced energy-sales margins and possible repair expenses, is estimated incontinue monitoring the range of $43 million to $58 million ($26 million to $35 million, after-tax), and the ultimate financial impact will depend on the duration of the Unit 2 outage. Ironwood Acquisition
In April 2012, an indirect, wholly owned subsidiary of PPL Energy Supply completed the acquisition of the equity interests in the owner and operator of the Ironwood Facility. The Ironwood Facility began operation in 2001 and, since 2008, PPL EnergyPlus has supplied natural gas for the operation of the facility and received the facility's full electricity output and capacity value pursuant to a tolling agreement that expires in 2021. The acquisition provides PPL Energy Supply, through its subsidiaries, operational control of additional combined-cycle gas generation in PJM. See Note 8 to the Financial Statements for additional information.
Bankruptcy of SMGT
In October 2011, SMGT, a Montana cooperative and purchaser of electricity under a long-term supply contract with PPL EnergyPlus expiring in June 2019 (SMGT Contract), filed for protection under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the District of Montana. At the time of the bankruptcy filing, SMGT was PPL EnergyPlus' largest unsecured credit exposure.
The SMGT Contract provided for fixed volume purchases on a monthly basis at established prices. Pursuant to a court order and subsequent stipulations entered into between the SMGT bankruptcy trustee and PPL EnergyPlus, since the date of its Chapter 11 filing through January 2012, SMGT continued to purchase electricity from PPL EnergyPlus at the price specified in the SMGT Contract, and made timely payments for such purchases, but at lower volumes than as prescribed in the SMGT Contract. In January 2012, the trustee notified PPL EnergyPlus that SMGT would not purchase electricity under the SMGT Contract for the month of February. In March 2012, the U.S. Bankruptcy Court for the District of Montana issued an order approving the request of the SMGT bankruptcy trustee and PPL EnergyPlus to terminate the SMGT Contract. As a result, the SMGT Contract was terminated effective April 1, 2012, allowing PPL EnergyPlus to resell the electricity previously contracted to SMGT under the SMGT Contract to other customers.
PPL EnergyPlus' receivable under the SMGT Contract totaled approximately $21 million at September 30, 2012, which has been fully reserved.
In July 2012, PPL EnergyPlus filed its proof of claim in the SMGT bankruptcy proceeding. The total claim is approximately $375 million, predominantly an unsecured claim representing the value for energy sales that will not occur as a result of the termination of the SMGT Contract. No assurance can be given as to the collectability of the claim.
PPL Energy Supply cannot predict any amounts that it may recover in connection with the SMGT bankruptcy or the prices and other terms on which it will be able to market to third parties the power that SMGT will not purchase from PPL EnergyPlus due to the termination of the SMGT Contract.turbine blades using enhanced diagnostic equipment.
Results of Operations
The following discussion provides a summary of PPL Energy Supply's earnings and a description of key factors that are expected to impact future earnings. This section ends with "Statement of Income Analysis," which includes explanations of significant changes in Unregulated Gross Energy Margins by region and principal line items on PPL Energy Supply's Statements of Income, comparing the three and nine months ended September 30, 2012March 31, 2013 with the same periods in 2011.2012.
The results for interim periods can be disproportionately influenced by numerous factors and developments and by seasonal variations. As such, the results of operations for interim periods do not necessarily indicate results or trends for the year or future periods.
Earnings | | | | | | | | | | | | | | | Net Income Attributable to PPL Energy Supply Member for the periods ended September 30 was: | | | | | | | | | | | | | | | | | | Three Months | | Nine Months | | | | 2012 | | 2011 | | 2012 | | 2011 | | | | | | | | | | | | | | | Net Income Attributable to PPL Energy Supply Member | | $ | 54 | | $ | 169 | | $ | 382 | | $ | 472 |
Earnings | | | | | | | | | | | | | | | Net Income (Loss) Attributable to PPL Energy Supply Member for the periods ended March 31 was: | | | | | | | | | | | | | | | | | | | | | | | | Three Months | | | | | | | | | | 2013 | | 2012 | | | | | | | | | | | | | | | Net Income (Loss) Attributable to PPL Energy Supply Member | | | | | | | | $ | (38) | | $ | 309 |
The changes in the components of Net Income (Loss) Attributable to PPL Energy Supply Member between these periods were due to the following factors, which reflect reclassifications for items included in unregulated gross energy marginsUnregulated Gross Energy Margins and certain items that management considers special. See additional detail of these special items in the tables below.
| | Three Months | | Nine Months | | | | | | | | Unregulated gross energy margins | | $ | (38) | | $ | (125) | Other operation and maintenance | | | (11) | | | (27) | Depreciation | | | (11) | | | (25) | Other Income (Expense) - net | | | | | | (10) | Interest Expense | | | 8 | | | 24 | Other | | | 9 | | | 6 | Income Taxes | | | 25 | | | 90 | Discontinued operations, after-tax | | | | | | 3 | Special items, after-tax | | | (97) | | | (26) | Total | | $ | (115) | | $ | (90) |
| | | | Three Months | | | | | | | | Unregulated Gross Energy Margins | | | | | $ | (107) | Other operation and maintenance | | | | | | 13 | Depreciation | | | | | | (14) | Interest Expense | | | | | | (9) | Income Taxes | | | | | | 33 | Special items, after-tax | | | | | | (263) | Total | | | | | $ | (347) |
· | See "Statement of Income Analysis - Unregulated Gross Energy Margins - Changes in Non-GAAP Financial Measures" for an explanation of Unregulated Gross Energy Margins. |
· | HigherLower other operation and maintenance for the three-month period primarily due to $8$15 million of higherlower costs at PPL Susquehanna, $7 millioneastern fossil and hydroelectric plants largely due to a planned outage at PPL Brunner Islandoutages in September 2012, and $4 million of higher costs from Ironwood as a result of the acquisition, partially offset by $9$3 million of trademark royalties with an affiliate in 2011 for which the agreement was terminated December 31, 2011. |
| Higher other operation and maintenance for the nine-month period primarily due to $27 million of higheradditional costs at PPL Susquehanna including refueling outage costs, payroll-related costs and timing of projects, $17 million from higher systems-related costs and timing of projects and $13 million of higher costs from Ironwood as a result of the acquisition, partially offset by $26 million of trademark royalties with an affiliate in 2011 for which the agreement was terminated December 31, 2011. |
· | Higher depreciation for the three and nine-month periods due to the impact of PP&E additions, including $7 million and $11 million due to the Ironwood Acquisition. |
· | Lower other income (expense) - net for the nine-month period partlyHigher depreciation primarily due to lower earnings on securities in the NDT funds. |
· | Lower interest expense for the three and nine-month periods due to 2011 including the acceleration of deferred financing fees of $7 million related to the July 2011 redemption of $250 million of 7.00% Senior Notes. In addition, the nine-month period was lower due to a $10 million impact of not replacing the $250 million of debt, a $7 million impact from $500 million in debt that matured in 2011 being replaced with debt at a lower interest rate, and a $10 million impact from less short-term debt in 2012, partially offset by an $8 million increase related to the debt assumed through consolidation as a result of the Ironwood Acquisition. |
· | Lower income taxes for the three-month periodHigher interest expense primarily due to financings associated with PPL Ironwood, acquired in April 2012, which increased interest expense by $4 million and $3 million due to lower pre-tax income.capitalized interest. |
· | Lower income taxes for the nine-month period due to lower pre-tax income in 2013, which reduced income taxes by $67$47 million, $15partially offset by an $11 million of net deferred tax benefitsbenefit from a state tax adjustmentsrate change recorded in 2012 and $6 million of Pennsylvania net operating loss valuation allowance adjustments recorded in 2011, driven primarily by the impact of bonus depreciation.2012. |
The following after-tax gains (losses), which management considers special items, also impacted the results during the periods ended September 30.March 31.
| | | Income Statement | | Three Months | | Nine Months | | | Income Statement | | Three Months | | | | Line Item | | 2012 | | 2011 | | 2012 | | 2011 | | | Line Item | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | | | | Adjusted energy-related economic activity, net, net of tax of $63, $8, ($16), ($2) | (a) | | $ | (95) | | $ | (10) | | $ | 23 | | $ | 4 | | Adjusted energy-related economic activity, net, net of tax of $79, ($102) | | Adjusted energy-related economic activity, net, net of tax of $79, ($102) | (a) | | $ | (117) | | $ | 150 | Impairments: | Impairments: | | | | | | | | | | Impairments: | | | | | | | | Emission allowances, net of tax of $0, $0, $0, $1 | Other O&M | | | | | | | | (1) | | | Renewable energy credits, net of tax of $0, $0, $0, $2 | Other O&M | | | | | | | | (3) | | | Adjustments - nuclear decommissioning trust investments, net of tax of $0, $2, ($2), $2 | Other Income-net | | | | (1) | | 1 | | | | LKE acquisition-related adjustments: | | | | | | | | | | | | Sale of certain non-core generation facilities, net of tax of $0, $0, $0, $0 | Disc. Operations | | | | | | | | (2) | Adjustments - nuclear decommissioning trust investments, net of tax of $0, ($1) | Other Income (Expense)-net | | | | | 1 | Other: | Other: | | | | | | | | | | Other: | | | | | | | | Montana hydroelectric litigation, net of tax of $0, $0, $0, $1 | Interest Expense | | | | (1) | | | | (2) | Counterparty bankruptcy, net of tax of $0, $5 (b) | Other Operation and Maintenance | | | | | (6) | | Litigation settlement - spent nuclear fuel storage, net of tax of $0, ($2), $0, ($23) (b) | Fuel | | | | 4 | | | | 33 | Ash basin leak remediation adjustment, net of tax of $0, ($1) | Other Operation and Maintenance | | | | | | 1 | | Counterparty bankruptcy, net of tax of $0, $0, $5, $0 (c) | Other O&M | | | | | | (6) | | | | | Wholesale supply cost reimbursement, net of tax of $0, $0, $0, $0 | (d) | | | | | | 1 | | | | | Ash basin leak remediation adjustment, net of tax of $0, $0, ($1), $0 | Other O&M | | | | | | 1 | | | | | Coal contract modification payments, net of tax of $7, $0, $12, $0 (e) | Fuel | | | (10) | | | | | | (17) | | | | | Total | Total | | | $ | (105) | | $ | (8) | | $ | 3 | | $ | 29 | Total | | | $ | (117) | | $ | 146 |
(a) | See "Reconciliation of Economic Activity" below. |
(b) | In May 2011, PPL Susquehanna entered into a settlement agreement with the U.S. Government relating to PPL Susquehanna's lawsuit, seeking damages for the DOE's failure to accept spent nuclear fuel from the PPL Susquehanna plant. PPL Susquehanna recorded credits to fuel expense to recognize recovery, under the settlement agreement, of certain costs to store spent nuclear fuel at the Susquehanna plant. The amounts recorded through September 2011 cover the costs incurred from 1998 through December 2010. |
(c) | In October 2011, a wholesale customer, SMGT, filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy code. In 2012, PPL EnergyPlus recorded an additional allowance for unpaid amounts under the long-term power contract. In March 2012, the U.S. Bankruptcy Court for the District of Montana approved the request to terminate the contract, effective April 1, 2012. |
(d) | Recorded in "Wholesale energy marketing - Realized" on the Statement of Income. |
(e) | As a result of lower electricity and natural gas prices, coal unit utilization has decreased. Contract modification payments were incurred to reduce 2012 and 2013 contracted coal deliveries. |
Reconciliation of Economic Activity
The following table reconciles unrealized pre-tax gains (losses) for the periods ended September 30,March 31, from the table within "Commodity Price Risk (Non-trading) - Economic Activity" in Note 14 to the Financial Statements to the special item identified as "Adjusted energy-related economic activity, net."
| | | | Three Months | | Nine Months | | | | Three Months | | | | | 2012 | | 2011 | | 2012 | | 2011 | | | | 2013 | | 2012 | Operating Revenues | Operating Revenues | | | | | | | | | Operating Revenues | | | | | | | Unregulated retail electric and gas | | $ | (13) | | $ | 4 | | $ | (15) | | $ | 9 | | Unregulated retail electric and gas | | $ | (8) | | $ | 10 | | | Wholesale energy marketing | | (716) | | 216 | | (322) | | 229 | | Wholesale energy marketing | | (822) | | 852 | Operating Expenses | Operating Expenses | | | | | | | | | Operating Expenses | | | | | | | Fuel | | 3 | | (28) | | (11) | | (16) | | Fuel | | (1) | | 2 | | | Energy Purchases | | | 569 | | | (176) | | | 420 | | | (49) | | Energy Purchases | | | 634 | | | (591) | Energy-related economic activity (a) | Energy-related economic activity (a) | | (157) | | 16 | | 72 | | 173 | Energy-related economic activity (a) | | (197) | | 273 | Option premiums (b) | Option premiums (b) | | | | | | 6 | | | 1 | | | 17 | Option premiums (b) | | | 1 | | | | Adjusted energy-related economic activity | Adjusted energy-related economic activity | | (157) | | 22 | | 73 | | 190 | Adjusted energy-related economic activity | | (196) | | 273 | Less: Economic activity realized, associated with the monetization of | | | | | | | | | | Less: Economic activity realized, associated with the monetization of certain | | Less: Economic activity realized, associated with the monetization of certain | | | | | | certain full-requirement sales contracts in 2010 | | | 1 | | | 40 | | | 34 | | | 184 | full-requirement sales contracts in 2010 | | | | | | 21 | Adjusted energy-related economic activity, net, pre-tax | Adjusted energy-related economic activity, net, pre-tax | | $ | (158) | | $ | (18) | | $ | 39 | | $ | 6 | Adjusted energy-related economic activity, net, pre-tax | | $ | (196) | | $ | 252 | | | | | | | | | | | | | | | | | | Adjusted energy-related economic activity, net, after-tax | Adjusted energy-related economic activity, net, after-tax | | $ | (95) | | $ | (10) | | $ | 23 | | $ | 4 | Adjusted energy-related economic activity, net, after-tax | | $ | (117) | | $ | 150 |
(a) | See Note 14 to the Financial Statements for additional information. |
(b) | Adjustment for the net deferral and amortization of option premiums over the delivery period of the item that was hedged or upon realization. Option premiums are recorded in "Wholesale energy marketing - Realized" and "Energy purchases - Realized" on the Statements of Income. |
2013 Outlook
Excluding special items, PPL Energy Supply projects lower earnings in 20122013 compared with 2011. The decrease is2012, primarily driven by lower energy margins as a result of lower energy and capacity prices, and lower generation volumes, higher otherfuel costs, higher operation and maintenance expense, higher depreciation, and higher depreciation.financing costs, partially offset by higher capacity prices and higher nuclear generation output despite scheduled outages for both Susquehanna units to implement a long-term solution to turbine blade issues.
Earnings in 2012future periods are subject to various risks and uncertainties. See "Forward-Looking Information," the rest of this Item 2, and Note 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in PPL Energy Supply's 20112012 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings. Statement of Income Analysis --
Unregulated Gross Energy Margins
Non-GAAP Financial Measure
The following discussion includes financial information prepared in accordance with GAAP, as well as a non-GAAP financial measure, "Unregulated Gross Energy Margins." "Unregulated Gross Energy Margins" is a single financial performance measure of PPL Energy Supply's competitive energy non-trading and trading activities. In calculating this measure, PPL Energy Supply's energy revenues which include operating revenues associated with certain PPL Energy Supply businesses that are classified as discontinued operations, are offset by the cost of fuel, energy purchases, certain other operation and maintenance expenses, primarily ancillary charges, and gross receipts tax, which is recorded in "Taxes, other than income," and operating expenses associated with certain PPL Energy Supply businesses that are classified as discontinued operations.income". This performance measure is relevant to PPL Energy Supply due to the volatility in the individual revenue and expense lines on the Statements of Income that comprise "Unregulated Gross Energy Margins." This volatility stems from a number of factors, including the required netting of certain transactions with ISOs and significant swingsfluctuations in unrealized gains and losses. Such factors could result in gains or losses being recorded in either "Wholesale energy marketing" or "Energy purchases" on the Statements of Income. This performance measure includes PLR revenues from energy sales to PPL Electric by PPL EnergyPlus, which are recorded in "Wholesale energy marketing to affiliate" revenue. PPL Energy Supply excludes from "Unregulated Gross Energy Margins" adjusted energy-related economic activity, which includes the changes in fair value of positions used to economically hedge a portion of the economic value of PPL Energy Supply's competitive generation assets, full-requirement sales contracts and retail activities. This economic value is subject to changes in fair value due to market price volatility of the input and output commodities (e.g., fuel and power) prior to the delivery period that was hedged. Also included in adjusted energy-related economic activity is the premium amortization associated with options and for 2012 the ineffective portion of qualifying cash flow hedges and economic activity realized associated with the monetization of certain full-requirement sales contracts and premium amortization associated with options.in 2010. This economic activity is deferred, with the exception of the full-requirement sales contracts that were monetized, and included in "Unregulated Gross Energy Margins" over the delivery period that was hedged or upon realization. This measure is not intended to replace "Operating Income," which is determined in accordance with GAAP, as an indicator of overall operating performance. Other companies may use different measures to analyze and to report on the results of their operations. PPL Energy Supply believes that "Unregulated Gross Energy Margins" provides another criterion to make investment decisions. This performance measure is used, in conjunction with other information, internally by senior management to manage PPL Energy Supply's operations, analyze actual results compared with budget and measure certain corporate financial goals used in determining variable compensation.
Reconciliation of Non-GAAP Financial Measures
The following tables reconcile "Operating Income" totable reconciles "Unregulated Gross Energy Margins" as defined by PPL Energy Supply to "Operating Income" for the periods ended September 30.March 31.
| | | | | 2012 Three Months | | 2011 Three Months | | | | | | Unregulated | | | | | | | | Unregulated | | | | | | | | | | | | Gross Energy | | | | | Operating | | Gross Energy | | | | | | Operating | | | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | Operating Revenues | | | | | | | | | | | | | | | | | | | | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | | | Realized | $ | 1,074 | | $ | 2 | (c) | | $ | 1,076 | | $ | 897 | | $ | 10 | (c) | | $ | 907 | | | | | Unrealized economic activity | | | | | (716) | (d) | | | (716) | | | | | | 216 | (d) | | | 216 | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | to affiliate | | 23 | | | | | | | 23 | | | 5 | | | | | | | 5 | | Unregulated retail electric and gas | | 232 | | | (13) | (d) | | | 219 | | | 186 | | | 4 | (d) | | | 190 | | Net energy trading margins | | (11) | | | | | | | (11) | | | (7) | | | | | | | (7) | | Energy-related businesses | | | | | 128 | | | | 128 | | | | | | 130 | | | | 130 | | | | Total Operating Revenues | | 1,318 | | | (599) | | | | 719 | | | 1,081 | | | 360 | | | | 1,441 | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | 2013 Three Months | | 2012 Three Months | | | | | | | Unregulated | | | | | | | | Unregulated | | | | | | | | | | | | | Gross Energy | | | | | Operating | | Gross Energy | | | | | | Operating | | | | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | | Operating Revenues | | | | | | | | | | | | | | | | | | | | | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | $ | 977 | | $ | (1) | | | $ | 976 | | $ | 1,204 | | $ | 4 | (c) | | $ | 1,208 | | | | | Unrealized economic activity | | | | | | (822) | (d) | | | (822) | | | | | | 852 | (d) | | | 852 | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | | to affiliate | | | 14 | | | | | | | 14 | | | 21 | | | | | | | 21 | | Unregulated retail electric and gas | | | 246 | | | (8) | (d) | | | 238 | | | 214 | | | 10 | (d) | | | 224 | | Net energy trading margins | | | (11) | | | | | | | (11) | | | 8 | | | | | | | 8 | | Energy-related businesses | | | | | | 113 | | | | 113 | | | | | | 96 | | | | 96 | | | | Total Operating Revenues | | | 1,226 | | | (718) | | | | 508 | | | 1,447 | | | 962 | | | | 2,409 | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | | | | | | | | | Fuel | | | 299 | | | (1) | (d) | | | 298 | | | 214 | | | (3) | (d) | | | 211 | | Energy purchases | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | | 436 | | | (2) | | | | 434 | | | 636 | | | 23 | (c) | | | 659 | | | | | Unrealized economic activity | | | | | | (634) | (d) | | | (634) | | | | | | 591 | (d) | | | 591 | | Energy purchases from affiliate | | | 1 | | | | | | | 1 | | | 1 | | | | | | | 1 | | Other operation and maintenance | | | 5 | | | 230 | | | | 235 | | | 4 | | | 251 | | | | 255 | | Depreciation | | | | | | 78 | | | | 78 | | | | | | 64 | | | | 64 | | Taxes, other than income | | | 8 | | | 9 | | | | 17 | | | 8 | | | 10 | | | | 18 | | Energy-related businesses | | | | | | 110 | | | | 110 | | | | | | 92 | | | | 92 | | | | Total Operating Expenses | | | 749 | | | (210) | | | | 539 | | | 863 | | | 1,028 | | | | 1,891 | Total | | $ | 477 | | $ | (508) | | | $ | (31) | | $ | 584 | | $ | (66) | | | $ | 518 |
| | | | | 2012 Three Months | | 2011 Three Months | | | | | | Unregulated | | | | | | | | Unregulated | | | | | | | | | | | | Gross Energy | | | | | Operating | | Gross Energy | | | | | | Operating | | | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | Operating Expenses | | | | | | | | | | | | | | | | | | | | | Fuel | | 310 | | | 11 | (e) | | | 321 | | | 338 | | | 20 | (e) | | | 358 | | Energy purchases | | | | | | | | | | | | | | | | | | | | | | | | Realized | | 418 | | | 3 | (c) | | | 421 | | | 119 | | | 42 | (c) | | | 161 | | | | | Unrealized economic activity | | | | | (569) | (d) | | | (569) | | | | | | 176 | (d) | | | 176 | | Energy purchases from affiliate | | 1 | | | | | | | 1 | | | 1 | | | | | | | 1 | | Other operation and maintenance | | 1 | | | 219 | | | | 220 | | | | | | 208 | | | | 208 | | Depreciation | | | | | 73 | | | | 73 | | | | | | 62 | | | | 62 | | Taxes, other than income | | 11 | | | 7 | | | | 18 | | | 8 | | | 10 | | | | 18 | | Energy-related businesses | | | | | 125 | | | | 125 | | | | | | 130 | | | | 130 | | | | Total Operating Expenses | | 741 | | | (131) | | | | 610 | | | 466 | | | 648 | | | | 1,114 | Total | $ | 577 | | $ | (468) | | | $ | 109 | | $ | 615 | | $ | (288) | | | $ | 327 |
| | | | | | 2012 Nine Months | | 2011 Nine Months | | | | | | | Unregulated | | | | | | | | Unregulated | | | | | | | | | | | | | Gross Energy | | | | | Operating | | Gross Energy | | | | | | Operating | | | | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | | Operating Revenues | | | | | | | | | | | | | | | | | | | | | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | $ | 3,353 | | $ | 14 | (c) | | $ | 3,367 | | $ | 2,635 | | $ | 42 | (c) | | $ | 2,677 | | | | | Unrealized economic activity | | | | | | (322) | (d) | | | (322) | | | | | | 229 | (d) | | | 229 | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | | to affiliate | | | 61 | | | | | | | 61 | | | 15 | | | | | | | 15 | | Unregulated retail electric and gas | | | 638 | | | (15) | (d) | | | 623 | | | 509 | | | 9 | (d) | | | 518 | | Net energy trading margins | | | 7 | | | | | | | 7 | | | 14 | | | | | | | 14 | | Energy-related businesses | | | | | | 336 | | | | 336 | | | | | | 354 | | | | 354 | | | | Total Operating Revenues | | | 4,059 | | | 13 | | | | 4,072 | | | 3,173 | | | 634 | | | | 3,807 | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | | | | | | | | | Fuel | | | 695 | | | 33 | (e) | | | 728 | | | 872 | | | (46) | (e) | | | 826 | | Energy purchases | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | | 1,669 | | | 46 | (c) | | | 1,715 | | | 496 | | | 205 | (c) | | | 701 | | | | | Unrealized economic activity | | | | | | (420) | (d) | | | (420) | | | | | | 49 | (d) | | | 49 | | Energy purchases from affiliate | | | 2 | | | | | | | 2 | | | 3 | | | | | | | 3 | | Other operation and maintenance | | | 12 | | | 757 | | | | 769 | | | 13 | | | 728 | | | | 741 | | Depreciation | | | | | | 206 | | | | 206 | | | | | | 181 | | | | 181 | | Taxes, other than income | | | 27 | | | 26 | | | | 53 | | | 22 | | | 28 | | | | 50 | | Energy-related businesses | | | | | | 326 | | | | 326 | | | | | | 350 | | | | 350 | | | | Total Operating Expenses | | | 2,405 | | | 974 | | | | 3,379 | | | 1,406 | | | 1,495 | | | | 2,901 | | Discontinued Operations | | | | | | | | | | | | | 12 | | | (12) | (f) | | | | Total | | $ | 1,654 | | $ | (961) | | | $ | 693 | | $ | 1,779 | | $ | (873) | | | $ | 906 |
(a) | Represents amounts excluded from Margins. |
(b) | As reported on the Statements of Income. |
(c) | Represents energy-related economic activity as described in "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements. For the three and nine months ended September 30,March 31, 2012, "Wholesale energy marketing - Realized" and "Energy purchases - Realized" includeincludes a net pre-tax lossesloss of $1 million and $34$21 million related to the monetization of certain full-requirement sales contracts. The three and nine months ended September 30, 2011 include net pre-tax losses of $40 million and $184 million related to the monetization of certain full-requirement sales contracts and net pre-tax gains of $6 million and $17 million related to the amortization of option premiums. |
(d) | Represents energy-related economic activity, which is subject to fluctuations in value due to market price volatility, as described in "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements. |
(e) | Includes economic activity related to fuel as described in "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements. The three and nine months ended September 30, 2012 include pre-tax losses of $17 million and $29 million related to coal contract modification payments. The three and nine months ended September 30, 2011 include pre-tax credits of $6 million and $56 million for the spent nuclear fuel litigation settlement. |
(f) | Represents the net of certain revenues and expenses associated with certain businesses that are classified as discontinued operations. These revenues and expenses are not reflected in "Operating Income" on the Statements of Income. |
Changes in Non-GAAP Financial Measures
Unregulated Gross Energy Margins are generated through PPL Energy Supply's competitive non-trading and trading activities. PPL Energy Supply's non-trading energy business is managed on a geographic basis that is aligned with its generation fleet. The following table shows PPL Energy Supply's non-GAAP financial measure, Unregulated Gross Energy Margins, for the periods ended September 30,March 31, as well as the change between periods. The factors that gave rise to the changes are described below the table.
| | | | | Three Months | | | | | | | | | | 2013 | | 2012 | | Change | | | | | | | | | | | | | | | | | | | | | Non-trading | | | | | | | | | | | | | | | | | | | | Eastern U.S. | | | | | | | | | | | $ | 430 | | $ | 489 | | $ | (59) | | Western U.S. | | | | | | | | | | | | 58 | | | 87 | | | (29) | Net energy trading | | | | | | | | | | | | (11) | | | 8 | | | (19) | Total | | | | | | | | | | | $ | 477 | | $ | 584 | | $ | (107) |
| | | Three Months | | Nine Months | | | | 2012 | | 2011 | | Change | | 2012 | | 2011 | | Change | | | | | | | | | | | | | | | | | | | | | Non-trading | | | | | | | | | | | | | | | | | | | | Eastern U.S. | | $ | 521 | | $ | 530 | | $ | (9) | | $ | 1,417 | | $ | 1,502 | | $ | (85) | | Western U.S. | | | 67 | | | 92 | | | (25) | | | 230 | | | 263 | | | (33) | Net energy trading | | | (11) | | | (7) | | | (4) | | | 7 | | | 14 | | | (7) | Total | | $ | 577 | | $ | 615 | | $ | (38) | | $ | 1,654 | | $ | 1,779 | | $ | (125) |
Unregulated Gross Energy Margins | | | | | | | | | | | | | | Eastern U.S. | | | | | | | | | | | | | | The change in non-trading margins for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | | | | | Three Months | | | | | | | | Baseload energy prices | | | | | $ | (125) | Coal prices | | | | | | (10) | Nuclear fuel prices | | | | | | (6) | Full-requirement sales contracts | | | | | | 5 | Intermediate and peaking capacity prices | | | | | | 5 | Baseload capacity prices | | | | | | 6 | Intermediate and peaking Spark Spreads | | | | | | 14 | Ironwood acquisition which eliminated tolling expense | | | | | | 15 | Net economic availability of coal and hydroelectric plants | | | | | | 32 | Other | | | | | | 5 | Total | | | | | $ | (59) |
Eastern U.S. | | | | | | | | | | | | | | The changes in non-trading margins for the periods ended September 30, 2012 compared with 2011 were due to: | | | | | | | | | | Three Months | | Nine Months | | | | | | | | Baseload energy prices | | $ | (44) | | $ | (132) | Baseload capacity prices | | | 3 | | | (47) | Intermediate and peaking capacity prices | | | 5 | | | (22) | Impact of non-core generation facilities sold in the first quarter of 2011 | | | | | | (12) | Full-requirement sales contracts | | | 3 | | | (10) | Net economic availability of coal and hydroelectric units | | | (7) | | | 12 | Retail electric | | | 5 | | | 12 | Ironwood acquisition which eliminates tolling expense (a) | | | 14 | | | 27 | Nuclear generation volume (b) | | | 11 | | | 93 | Other | | | 1 | | | (6) | Total | | $ | (9) | | $ | (85) |
(a) | See Note 8 to the Financial Statements for additional information. |
(b) | Volumes were higher for the nine-month period due to a shorter outage period for blade inspections, an unplanned outage in March 2011 and an uprate in the third quarter of 2011. Volumes were higher for the three-month period due to higher availability in 2012. |
Western U.S.
Non-trading margins for the three and nine months ended September 30, 2012March 31, 2013 compared with the same periods in 20112012 were lower due to $14 million and $31$43 million of lower wholesale sales, including $10 million and $23 million related to the bankruptcy of SMGT. The three-month period was also lower due to $5prices, partially offset by $12 million of higher fuel costs.wholesale volumes.
Other Operation and Maintenance | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance expense for the periods ended September 30, 2012 compared with 2011 was due to: | | | | | | Three Months | | Nine Months | | | | | | | | Susquehanna nuclear plant costs (a) | $ | 8 | | $ | 27 | Uncollectible accounts (b) | | (2) | | | 9 | Ironwood acquisition (c) | | 4 | | | 13 | Costs at Western fossil and hydroelectric plants | | (4) | | | (9) | Costs at Eastern fossil and hydroelectric plants (d) | | 9 | | | (4) | Gain on disposition of RECs | | (2) | | | (8) | Trademark royalties (e) | | (9) | | | (26) | Corporate service costs (f) | | 5 | | | 19 | Other | | 3 | | | 7 | Total | $ | 12 | | $ | 28 |
Net Energy Trading Margins
Net energy trading margins for the three months ended March 31, 2013 compared with 2012 decreased as a result of lower margins of $16 million on gas positions due to higher prices.
Other Operation and Maintenance | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | Three Months | | | | | | | | Uncollectible accounts (a) | Primarily | | | $ | (11) | Costs at eastern fossil and hydroelectric plants (b) | | | | | (11) | Other | | | | | 2 | Total | | | | $ | (20) |
(a) | The decrease is primarily due to refueling outage costs, payroll-related costs and timing of projects. |
(b) | In October 2011, SMGT filedfiling for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code. The increase for the nine-month period primarily reflects anCode in 2011. $11 million increaseof damages billed to a reserve on SMGT unpaid amounts. |
(c) | There are no comparable amountswere fully reserved in the 2011 periods as the Ironwood Acquisition occurred in April 2012. |
(d) | Increase for the three-month period primarily due to a planned outage at PPL Brunner Island in September 2012. |
(e) | In 2011, PPL Energy Supply was charged trademark royalties by an affiliate. The agreement was terminated December 31, 2011. |
(f) | Primarily due to systems-related costs and timing of projects. |
Depreciation | | | | | | | | | | | | | | The increase (decrease) in depreciation expense for the periods ended September 30, 2012 compared with 2011 was due to: | | | | | | | | | | Three Months | | Nine Months | | | | | | | | Additions to PP&E | | $ | 4 | | $ | 14 | Ironwood Acquisition (Note 8) | | | 7 | | | 11 | Total | | $ | 11 | | $ | 25 |
Other Income (Expense) - net
See Note 12 to the Financial Statements for details.
Interest Expense | | | | | | | | | | | | | | | The increase (decrease) in interest expense for the periods ended September 30, 2012 compared with 2011 was due to: | | | | | | | | | | | | | | | | | | | | | | | | | | Three Months | | Nine Months | | | | | | | | | Long-term debt interest expense (a) | | $ | (3) | | $ | (13) | Short-term debt interest expense (b) | | | (3) | | | (10) | Ironwood Acquisition (Note 8) | | | 4 | | | 8 | Net amortization of debt discounts, premiums and issuance costs (c) | | | (8) | | | (9) | Other | | | 1 | | | (3) | Total | | $ | (9) | | $ | (27) |
(a) | The decrease was primarily due to the redemption of $250 million of 7.0% Senior Notes due 2046 in July 2011 along with the repayment of $500 million of 6.4% Senior Notes and subsequent issuance of $500 million of 4.6% Senior Notes, both in the fourth quarter of 2011. |
(b) | The decrease wasis primarily due to lower interest rates on 2012 short-term borrowings. |
(c) | The three and nine-month periods include the impactBrunner Island Unit 3 outage costs of accelerating the amortization of deferred financing fees of $7$15 million in 2011,2012 compared with no major outage costs in 2013, partially offset by $3 million of additional costs due to the July 2011 redemption.Ironwood Acquisition. |
Income Taxes | | | | | | | | | | | | | | The increase (decrease) in income taxes for the periods ended September 30, 2012 compared with 2011 was due to: | | | | | | | | | | | | | | Three Months | | Nine Months | | | | | | | | Lower pre-tax book income | | $ | (82) | | $ | (80) | State valuation allowance adjustments (a) | | | 2 | | | (4) | State deferred tax rate change (b) | | | (6) | | | (17) | Other | | | (2) | | | (2) | Total | | $ | (88) | | $ | (103) |
Depreciation
Depreciation increased by $14 million for the three months ended March 31, 2013 compared with 2012, primarily due to $10 million related to PP&E additions and $6 million attributable to the Ironwood Acquisition.
Interest Expense | | | | | | | | | | | | | | | The increase (decrease) in interest expense for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | | | | | | Three Months | | | | | | | | | Ironwood Acquisition (a) | | | | | $ | 4 | Capitalized interest | | | | | | 3 | Other | | | | | | 2 | Total | | | | | $ | 9 |
(a) | In February 2011,The increase was due to financings associated with the Pennsylvania Department of Revenue issued interpretive guidance on the treatment of bonus depreciation for Pennsylvania income tax purposes. In accordance with Corporation Tax Bulletin 2011-01, Pennsylvania allows 100% bonus depreciation for qualifying assets in the same year bonus depreciation is allowed for federal tax purposes. Due to the decrease in projected taxable income related to bonus depreciation, PPL Energy Supply recorded $6 million of state deferred income tax expense during the nine months ended September 30, 2011 related to valuation allowances on state net operating loss carryforwards.Ironwood Acquisition. |
(b)Income Taxes | | | | | | | | | | | | | | The increase (decrease) in income taxes for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | | | | | | | | | Three Months | | | | | | | | Lower pre-tax book income | | | | | $ | (225) | State deferred tax rate change (a) | | | | | | 11 | Other | | | | | | 2 | Total | | | | | $ | (212) |
(a) | During the three and nine months ended September 30,March 31, 2012, PPL Energy Supply recorded adjustments related to state deferred tax liabilities. |
See Note 5 to the Financial Statements for additional information on income taxes.
Financial Condition | | | | | | | | | | Liquidity and Capital Resources | | | | | | | | | | PPL Energy Supply had the following at: | | | | | | | | | | | | September 30, 2012 | | December 31, 2011 | | March 31, 2013 | | December 31, 2012 | | | | | | | | | | Cash and cash equivalents | | $ | 432 | | $ | 379 | | $ | 147 | | $ | 413 | Short-term debt | | $ | 355 | | $ | 400 | | $ | 481 | | $ | 356 |
The $53$266 million increasedecrease in PPL Energy Supply's cash and cash equivalents position was primarily the net result of:
· | net cash provided by operating activities of $674 million; |
· contributions from Member of $472 million;
· | a net decrease in notes receivable from affiliate of $198 million; |
· | distributions to Membermember of $733$313 million; |
· | capital expenditures of $460$124 million; |
· | a net increase in restricted cash and cash equivalents of $59 million; |
· | net cash provided by operating activities of $125 million; and |
· | the Ironwood Acquisition for $84 million,a net increase in short-term debt of cash acquired.$125 million. |
PPL Energy Supply's cash provided by operating activities increaseddecreased by $234$129 million for the ninethree months ended September 30, 2012,March 31, 2013, compared with 2011.2012. This was primarily due to a $177$45 million increase in cash fromused by working capital components, a decrease in net income when adjusted for non-cash components of working capital (primarily due to changes in counterparty collateral, partially offset by changes in unbilled revenues and accrued taxes)$31 million and a $66$36 million decreaseincrease in defined benefit planplans funding. Credit Facilities
PPL Energy Supply maintains credit facilities to provide liquidity and to backstop commercial paper issuances. At September 30, 2012,March 31, 2013, PPL Energy Supply's total committed borrowing capacity under its credit facilities and the use of this borrowing capacity were:
| | | | | | | Letters of | | | | | | | | | Letters of | | | | | | | | | | Credit Issued | | | | | | | | | Credit Issued | | | | | | | | | | and | | | | | | | | | and | | | | | | Committed | | | | Commercial | | Unused | | | Committed | | | | Commercial | | Unused | | | | Capacity | | Borrowed | | Paper Backstop | | Capacity | | | Capacity | | Borrowed | | Paper Backup | | Capacity | | | | | | | | | | | | | | | | | | | | Syndicated Credit Facility (a) | Syndicated Credit Facility (a) | | $ | 3,000 | | | | $ | 468 | | $ | 2,532 | Syndicated Credit Facility (a) | | $ | 3,000 | | | | $ | 641 | | $ | 2,359 | Letter of Credit Facility(a) | Letter of Credit Facility(a) | | | 200 | | | n/a | | | 126 | | | 74 | Letter of Credit Facility(a) | | | 200 | | | n/a | | | 123 | | | 77 | Total PPL Energy Supply Credit Facilities (b) | Total PPL Energy Supply Credit Facilities (b) | | $ | 3,200 | | | | | $ | 594 | | $ | 2,606 | Total PPL Energy Supply Credit Facilities (b) | | $ | 3,200 | | | | | $ | 764 | | $ | 2,436 |
(a) | In November 2012,February 2013, PPL Energy Supply amended its syndicated credit facility to extendextended the expiration date from March 2013 and, effective April 2013, the capacity was reduced to November 2017.$150 million. |
(b) | The commitments under PPL Energy Supply's credit facilities are provided by a diverse bank group, with no one bank and its affiliates providing an aggregate commitment of more than 11% of the total committed capacity. |
See Note 7 to the Financial Statements for further discussion of PPL Energy Supply's credit facilities.
Commercial Paper
In April 2012, PPL Energy Supply increased the capacity of itsmaintains a commercial paper program from $500 millionup to $750 million to provide an additional financing source to fund its short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by PPL Energy Supply's Syndicated Credit Facility. At September 30,March 31, 2013 and December 31, 2012, PPL Energy Supply had $355$481 million and $356 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheet,Sheets, at a weighted-average interest raterates of 0.48%.
Long-term Debt Securities
In April 2012, an indirect, wholly owned subsidiary of PPL Energy Supply completed the Ironwood Acquisition. See Note 8 to the Financial Statements for information on the transaction0.38% and the debt of PPL Ironwood, LLC assumed through consolidation as part of the acquisition.0.50%.
Rating Agency Actions
Moody's, S&P and Fitch periodically review the credit ratings on the debt securities of PPL Energy Supply and its subsidiaries. Based on their respective independent reviews, the rating agencies may make certain ratings revisions or ratings affirmations.
A credit rating reflects an assessment by the rating agency of the creditworthiness associated with an issuer and particular securities that it issues. The credit ratings of PPL Energy Supply and its subsidiaries are based on information provided by PPL Energy Supply and other sources. The ratings of Moody's, S&P and Fitch are not a recommendation to buy, sell or hold any securities of PPL Energy Supply or its subsidiaries. Such ratings may be subject to revisions or withdrawal by the agencies at any time and should be evaluated independently of each other and any other rating that may be assigned to the securities.
A downgrade in PPL Energy Supply's or its subsidiaries' credit ratings could result in higher borrowing costs and reduced access to capital markets.
As a result of the passage of the Dodd-Frank Act, PPL Energy Supply is limiting its credit rating disclosure to a description of the actions taken by the rating agencies with respect to PPL Energy Supply's ratings, but without stating what ratings have been assigned to PPL Energy Supply or its subsidiaries, or their securities. The ratings assigned by the rating agencies to PPL Energy Supply and its subsidiaries and their respective securities may be found, without charge, on eachhave no credit rating triggers that would result in the reduction of access to capital markets or the respective rating agencies' websites, which ratings together with all other information contained on such rating agency websites is, hereby, explicitly not incorporated by reference in this report.acceleration of maturity dates of outstanding debt.
The rating agencies took the following actions related to PPL Energy Supply and its subsidiaries:subsidiaries in 2013:
In January 2012, S&P affirmedFebruary 2013, Moody's upgraded its rating, from B2 to Ba1, and revised itsthe outlook from under review to stable for PPL Montana's Pass Through Certificates due 2020.Ironwood.
FollowingIn April 2013, Fitch affirmed the announcement of the then-pending acquisition of AES Ironwood, L.L.C. in February 2012, theBBB- rating agencies took the following actions:and stable outlook at PPL Montana.
· | In March 2012, Moody's placed AES Ironwood, L.L.C.'s senior secured bonds under review for possible ratings upgrade. |
· | In April 2012, S&P affirmed the rating of AES Ironwood, L.L.C.'s senior secured bonds. |
· | In May 2012, Fitch downgraded its rating and revised its outlook for PPL Montana's Pass Through Certificates due 2020. |
· | In November 2012, S&P revised its outlook for PPL Montana's Pass Through Certificates due 2020. |
Ratings Triggers
PPL Energy Supply has various derivative and non-derivative contracts, including contracts for the sale and purchase of electricity and fuel, commodity transportation and storage, tolling agreements and interest rate instruments, which contain provisions that require PPL Energy Supply to post additional collateral or permit the counterparty to terminate the contract if PPL Energy Supply's credit rating were to fall below investment grade. See Note 14 to the Financial Statements for a discussion of "Credit Risk-Related Contingent Features," including a discussion of the potential additional collateral that would have been required for derivative contracts in a net liability position at September 30, 2012. At September 30, 2012, if PPL Energy Supply's credit rating had been below investment grade, PPL Energy Supply would have been required to prepay or post an additional $341 million of collateral to counterparties for both derivative and non-derivative commodity and commodity-related contracts used in its generation, marketing and trading operations and interest rate contracts.March 31, 2013. For additional information on PPL Energy Supply's liquidity and capital resources, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," in PPL Energy Supply's 20112012 Form 10-K.
Risk Management
Market Risk
See Notes 13 and 14 to the Financial Statements for information about PPL Energy Supply's risk management objectives, valuation techniques and accounting designations.
The forward-looking information presented below provides estimates of what may occur in the future, assuming certain adverse market conditions and model assumptions. Actual future results may differ materially from those presented. These disclosures are not precise indicators of expected future losses, but only indicators of possible losses under normal market conditions at a given confidence level.
Commodity Price Risk (Non-trading)
PPL Energy Supply segregates its non-trading activities into two categories: hedge activity and economic activity. Transactions that are accounted for as hedge activity qualify for hedge accounting treatment. The economic activity category includes transactions that address a specific risk, but were not eligible for hedge accounting or for which hedge accounting was not elected. This activity includes the changes in fair value of positions used to hedge a portion of the economic value of PPL Energy Supply's competitive generation assets and full-requirement sales contracts and retail contracts. This economic activity is subject to changes in fair value due to market price volatility of the input and output commodities (e.g., fuel and power). Although they do not receive hedge accounting treatment, these transactions are considered non-trading activity. The fair value of economic positions at September 30, 2012 and December 31, 2011 was a net asset/(liability) of $491 million and $(63) million. The change in fair value is largely attributable to the dedesignation of cash flow hedges that are now classified as economic hedges. See Note 14 to the Financial Statements for additional information.
To hedge the impact of market price volatility on PPL Energy Supply's energy-related assets, liabilities and other contractual arrangements, PPL Energy Supply both sells and purchases physical energy at the wholesale level under FERC market-based tariffs throughout the U.S. and enters into financial exchange-traded and over-the-counter contracts. PPL Energy Supply's non-trading commodity derivative contracts range in maturity through 2019.
The following table sets forth the changes in the net fair value of non-trading commodity derivative contracts for the periodsperiod ended September 30.March 31. See Notes 13 and 14 to the Financial Statements for additional information.
| | Gains (Losses) | | | | | | Gains (Losses) | | | Three Months | | Nine Months | | | | Three Months | | | 2012 | | 2011 | | 2012 | | 2011 | | | | | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | $ | 961 | | $ | 896 | | $ | 1,082 | | $ | 958 | | | | | | $ | 473 | | $ | 1,082 | Contracts realized or otherwise settled during the period | | (224) | | (99) | | (764) | | (234) | | | | | | (137) | | (279) | Fair value of new contracts entered into during the period (a) | | (11) | | 4 | | 1 | | 19 | | | | | | 9 | | (1) | Other changes in fair value | | | (101) | | | 43 | | | 306 | | | 101 | | | | | | | (116) | | | 413 | Fair value of contracts outstanding at the end of the period | | $ | 625 | | $ | 844 | | $ | 625 | | $ | 844 | | | | | | $ | 229 | | $ | 1,215 |
(a) | Represents the fair value of contracts at the end of the quarter of their inception. |
The following table segregates the net fair value of non-trading commodity derivative contracts at September 30, 2012,March 31, 2013, based on the level of observability of the information used to determine the fair value.
| | | Net Asset (Liability) | | | Net Asset (Liability) | | | | Maturity | | | | | | Maturity | | | | | Maturity | | | | | | Maturity | | | | | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | Source of Fair Value | Source of Fair Value | | | | | | | | | | | Source of Fair Value | | | | | | | | | | | Prices based on significant observable inputs (Level 2) | Prices based on significant observable inputs (Level 2) | | $ | 520 | | $ | 94 | | $ | (19) | | $ | 7 | | $ | 602 | Prices based on significant observable inputs (Level 2) | | $ | 238 | | $ | (21) | | $ | (8) | | $ | 6 | | $ | 215 | Prices based on significant unobservable inputs (Level 3) | Prices based on significant unobservable inputs (Level 3) | | | 11 | | | 8 | | | 4 | | | | | | 23 | Prices based on significant unobservable inputs (Level 3) | | | (1) | | | 12 | | | 3 | | | | | | 14 | Fair value of contracts outstanding at the end of the period | Fair value of contracts outstanding at the end of the period | | $ | 531 | | $ | 102 | | $ | (15) | | $ | 7 | | $ | 625 | Fair value of contracts outstanding at the end of the period | | $ | 237 | | $ | (9) | | $ | (5) | | $ | 6 | | $ | 229 |
PPL Energy Supply sells electricity, capacity and related services and buys fuel on a forward basis to hedge the value of energy from its generation assets. If PPL Energy Supply were unable to deliver firm capacity and energy or to accept the delivery of fuel under its agreements, under certain circumstances it could be required to pay liquidating damages. These damages couldwould be based on the difference between the market price and the contract price of the commodity. Depending on price changes in the wholesale energy markets, such damages could be significant. Extreme weather conditions, unplanned power plant outages, transmission disruptions, nonperformance by counterparties (or their own counterparties) with which it has energy contracts and other factors could affect PPL Energy Supply's ability to meet its obligations, or cause significant increases in the market price of replacement energy. Although PPL Energy Supply attempts to mitigate these risks, there can be no assurance that it will be able to fully meet its firm obligations, that it will not be required to pay damages for failure to perform, or that it will not experience counterparty nonperformance in the future. In connection with its bankruptcy proceedings, a significant counterparty, SMGT, had been purchasing lower volumes of electricity than prescribed in the contract and effective April 1, 2012 the contract was terminated. PPL Energy Supply cannot predict the prices or other terms on which it will be able to market to third parties the power that SMGT will not purchase from PPL EnergyPlus due to the termination of this contract. See Note 10 to the Financial Statements for additional information.
Commodity Price Risk (Trading)
PPL Energy Supply's trading commodity derivative contracts range in maturity through 2017. The following table sets forth changes in the net fair value of PPL Energy Supply's trading commodity derivative contracts for the periodsperiod ended September 30.March 31. See Notes 13 and 14 to the Financial Statements for additional information.
| | Gains (Losses) | | | | Three Months | | Nine Months | | | | Three Months | | | 2012 | | 2011 | | 2012 | | 2011 | | | | | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | $ | 17 | | $ | 15 | | $ | (4) | | $ | 4 | | | | | | $ | 29 | | $ | (4) | Contracts realized or otherwise settled during the period | | 17 | | (10) | | 16 | | (7) | | | | | | (2) | | | Fair value of new contracts entered into during the period (a) | | 13 | | (2) | | 18 | | 6 | | | | | | | (12) | | | 6 | Other changes in fair value | | | (15) | | | 4 | | | 2 | | | 4 | | Fair value of contracts outstanding at the end of the period | | $ | 32 | | $ | 7 | | $ | 32 | | $ | 7 | | | | | | $ | 15 | | $ | 2 |
(a) | Represents the fair value of contracts at the end of the quarter of their inception. |
Unrealized gains of approximately $4 million will be reversed over the next three months as the transactions are realized.
The following table segregates the net fair value of trading commodity derivative contracts at September 30, 2012,March 31, 2013, based on the level of observability of the information used to determine the fair value.
| | Net Asset (Liability) | | Net Asset (Liability) | | | Maturity | | | | | | Maturity | | | | Maturity | | | | | | Maturity | | | | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | Source of Fair Value | | | | | | | | | | | | | | | | | | | | | Prices quoted in active markets for identical instruments (Level 1) | | | $ | 1 | | | | | | | | $ | 1 | Prices based on significant observable inputs (Level 2) | | $ | 18 | | $ | 11 | | $ | 1 | | | | $ | 30 | | | 5 | | $ | 9 | | | | | | | | | 14 | Prices based on significant unobservable inputs (Level 3) | | | 2 | | | | | | | | | | | | 2 | | Fair value of contracts outstanding at the end of the period | | $ | 20 | | $ | 11 | | $ | 1 | | | | �� | $ | 32 | | $ | 6 | | $ | 9 | | | | | | | | $ | 15 |
VaR Models
A VaR model is utilized to measure commodity price risk in domesticunregulated gross energy margins for the non-trading and trading portfolios. VaR is a statistical model that attempts to estimate the value of potential loss over a given holding period under normal market conditions at a given confidence level. VaR is calculated using a Monte Carlo simulation technique based on a five-day holding period at a 95% confidence level. Given the company's conservativedisciplined hedging program, the non-trading VaR exposure is expected to be limited in the short-term. The VaR for portfolios using end-of-month results for the periodperiods was as follows.
| | | Trading VaR | | Non-Trading VaR | | | | Nine Months | | Twelve Months | | Nine Months | | Twelve Months | | | | Ended | | Ended | | Ended | | Ended | | | | September 30, | | December 31, | | September 30, | | December 31, | | | | 2012 | | 2011 | | 2012 | | 2011 | 95% Confidence Level, Five-Day Holding Period | | | | | | | | | | | | | | Period End | | $ | 6 | | $ | 1 | | $ | 10 | | $ | 6 | | Average for the Period | | | 3 | | | 3 | | | 9 | | | 5 | | High | | | 8 | | | 6 | | | 11 | | | 7 | | Low | | | 1 | | | 1 | | | 7 | | | 4 |
| | | Trading VaR | | Non-Trading VaR | | | | Three Months | | Three Months | | | | Ended | | Ended | | | | March 31, | | March 31, | | | | 2013 | | 2013 | 95% Confidence Level, Five-Day Holding Period | | | | | | | | Period End | | $ | 6 | | $ | 8 | | Average for the Period | | | 5 | | | 9 | | High | | | 6 | | | 9 | | Low | | | 3 | | | 8 |
The trading portfolio includes all speculativeproprietary trading positions, regardless of the delivery period. All positions not considered speculativeproprietary trading are considered non-trading. The non-trading portfolio includes the entire portfolio, including generation, with delivery periods through the next 12 months. Both the trading and non-trading VaR computations exclude FTRs due to the absence of reliable spot and forward markets. The fair value of the non-trading and trading FTR positions was insignificant at September 30, 2012.March 31, 2013. Interest Rate Risk
PPL Energy Supply and its subsidiaries issue debt to finance their operations, which exposes them to interest rate risk. PPL and PPL Energy Supply utilize various financial derivative instruments to adjust the mix of fixed and floating interest rates in PPL Energy Supply's debt portfolio, adjust the duration of its debt portfolio and lock in benchmark interest rates in anticipation of future financing, when appropriate. Risk limits under the risk management program are designed to balance risk exposure to volatility in interest expense and changes in the fair value of PPL Energy Supply's debt portfolio due to changes in the absolute level of interest rates. PPL Energy Supply had no interest rate hedges outstanding at September 30, 2012.March 31, 2013.
At September 30, 2012,March 31, 2013, PPL Energy Supply's potential annual exposure to increased interest expense, based on a 10% increase in interest rates, was not significant.
PPL Energy Supply is also exposed to changes in the fair value of its debt portfolio. PPL Energy Supply estimated that a 10% decrease in interest rates at September 30, 2012March 31, 2013 would increase the fair value of its debt portfolio by $56$47 million.
NDT Funds - Securities Price Risk
In connection with certain NRC requirements, PPL Susquehanna maintains trust funds to fund certain costs of decommissioning the PPL Susquehanna nuclear plant (Susquehanna). At September 30, 2012,March 31, 2013, these funds were invested primarily in domestic equity securities and fixed-rate, fixed-income securities and are reflected at fair value on the Balance Sheet. The mix of securities is designed to provide returns sufficient to fund Susquehanna's decommissioning and to compensate for inflationary increases in decommissioning costs. However, the equity securities included in the trusts are exposed to price fluctuation in equity markets, and the values of fixed-rate, fixed-income securities are primarily exposed to changes in interest rates. PPL actively monitors the investment performance and periodically reviews asset allocation in accordance with its NDTnuclear decommissioning trust policy statement. At September 30, 2012,March 31, 2013, a hypothetical 10% increase in interest rates and a 10% decrease in equity prices would have resulted in an estimated $49$55 million reduction in the fair value of the trust assets. See Notes 13 and 17 to the Financial Statements for additional information regarding the NDT funds.
Credit Risk
See Notes 11, 13 and 14 to the Financial Statements in this Form 10-Q and "Risk Management - Energy Marketing & Trading and Other - Credit Risk" in PPL Energy Supply's 20112012 Form 10-K for additional information.
Related Party Transactions
PPL Energy Supply is not aware of any material ownership interests or operating responsibility by senior management of PPL Energy Supply in outside partnerships, including leasing transactions with variable interest entities or other entities doing business with PPL Energy Supply. See Note 11 to the Financial Statements for additional information on related party transactions.
Acquisitions, Development and Divestitures
PPL Energy Supply from time to time evaluates opportunities for potential acquisitions, divestitures and development projects. Development projects are continuously reexamined based on market conditions and other factors to determine whether to proceed with the projects, sell, cancel or expand them, execute tolling agreements or pursue other options. See Note 8 to the Financial Statements for information on the more significant activities, including the April 2012 Ironwood Acquisition.activities.
Environmental Matters
Extensive federal, state and local environmental laws and regulations are applicable to PPL Energy Supply's air emissions, water discharges and the management of hazardous and solid waste, amongas well as other areas; and the costsaspects of PPL Energy Supply's business. The cost of compliance or alleged non-compliance cannot be predicted with certainty but could be material. In addition, costcosts may increase significantly if the requirements or scope of environmental laws or regulations, or similar rules, are expanded or changed by the relevant regulatory agencies. Costs may take the form of increased capital expenditures or operating and maintenance expenses;expenses, monetary fines, penalties or other restrictions. Many of these environmental law considerations are also applicable to the operations of key suppliers, or customers, such as coal producers and industrial power users, and may impact the costs of their products or their demand for PPL Energy Supply's services. Physical effects associated with climate change could include the impact of changes in weather patterns, such as storm frequency and intensity, and the resultant potential damage to PPL Energy Supply's generation assets as well as impacts on customers. In addition, changed weather patterns could potentially reduce annual rainfall in areas where PPL Energy Supply has hydro generating facilities or where river water is used to cool its fossil and nuclear powered generators. PPL Energy Supply cannot currently predict whether its businesses will experience these potential climate change-related risks or estimate the potential cost of their related consequences.
The following is a discussion of the more significant environmental matters.
Coal Combustion Residuals (CCRs) In June 2010, the EPA proposed two approaches to regulating the disposal and management of CCRs (as either hazardous or non-hazardous) under existing solid waste regulations. A final rulemaking is currently expected before the end of 2015. However, the timing of the final regulations could be accelerated by certain litigation that could require the EPA to issue its regulations sooner. Regulations could impact handling, disposal and/or beneficial use of CCRs. The financial impact could be material if CCRs are regulated as hazardous waste, and significant if regulated as non-hazardous, in accordance with the proposed rule.
Effluent Limitation Guidelines On April 19, 2013, the EPA issued proposed regulations to revise discharge limitations for steam electric generation wastewater permits. The proposed limitations are based on the EPA review of available treatment technologies and their capacity for reducing pollutants and include new requirements for fly ash and bottom ash handling and metal cleaning wastes, as well as new limits for scrubber wastewater, gasification wastewater and landfill leachate. The proposal contains several alternative approaches, some of which could significantly impact PPL Energy Supply's coal-fired plants. PPL Energy Supply will work with industry groups to comment on the proposed regulation. A final regulation is expected in May 2014. At the present time, PPL Energy Supply is unable to predict the outcome of this matter or estimate a range of reasonably possible costs, but the costs could be significant.
316(b) Cooling Water Intake Structures Rule In April 2011, the EPA published a draft regulation under Section 316(b) of the Clean Water Act, which regulates cooling water intakes for power plants. The draft rule has two provisions: one requires installation of Best Technology Available (BTA) to reduce mortality of aquatic organisms that are pulled into the plants cooling water system (entrainment), and the second imposes standards for reduction of mortality of aquatic organisms trapped on water intake screens (impingement). A final rule is expected in June 2013. The proposed regulation would apply to nearly all PPL Energy Supply-owned steam electric plants in Pennsylvania and Montana, potentially even including those equipped with closed-cycle cooling systems. PPL Energy Supply's compliance costs could be significant, especially if the final rule requires closed-cycle systems at plants that do not currently have them or conversions of once-through systems to closed-cycle.
GHG Regulations In 2013, the EPA is expected to finalize limits on GHG emissions from new power plants and to begin working on a proposal for such emissions from existing power plants. The EPA's proposal on GHG emissions from new power plants would effectively preclude construction on any coal-fired plants and could even be difficult for new gas-fired plants to meet. With respect to existing power plants, the impact could be significant, depending on the structure and stringency of the final rule. PPL Energy Supply, along with others in the industry, filed comments on the EPA's proposal related to GHG emissions from new plants.
MATS The EPA finalized MATS requiring fossil-fuel fired plants to reduce emissions of mercury and other hazardous air pollutants by April 16, 2015. The rule is being challenged by industry groups and states. The EPA has subsequently proposed changes to the rule with respect to new sources to address the concern that the rule effectively precludes construction of any new coal-fired plants. PPL Energy Supply is generally well-positioned to comply with MATS due to its recent investment in, and installation of, environmental controls such as wet flue gas desulfurization systems. PPL Energy Supply is evaluating chemical additive systems for mercury control at Brunner Island, and modifications to existing controls at Colstrip for improved particulate matter reductions. In September 2012, PPL Energy Supply announced its intention to place its Corette plant in long-term reserve status beginning in April 2015 due to expected market conditions and costs to comply with MATS.
CSAPR and CAIR In 2011, the EPA finalized its CSAPR regulating emissions of nitrous oxide and sulfur dioxide through new allowance trading programs which were to be implemented in two phases (2012 and 2014). Like its predecessor, the CAIR, CSAPR targeted sources in the eastern United States. In December 2011, the U.S. Court of Appeals for the District of Columbia. Circuit (the Court) stayed implementation of CSAPR, leaving CAIR in place. Subsequently, in August 2012, the Court vacated and remanded CSAPR back to the EPA for further rulemaking, again leaving CAIR in place. PPL Energy Supply
plants in Pennsylvania will continue to comply with CAIR through optimization of existing controls, balanced with emission allowance purchases. The Court's August decision leaves plants in CSAPR-affected states potentially exposed to more stringent emission reductions due to regional haze implementation (it was previously determined that CSAPR or CAIR participation satisfies regional haze requirements), and/or petitions to the EPA by downwind states under Section 126 of the Clean Air Act requesting the EPA to require plants that allegedly contribute to downwind non-attainment to take action to reduce emissions.
Regional Haze - Montana The EPA signed its final Federal Implementation Plan of the Regional Haze Rules for Montana in September 2012, with tighter emissions limits for Colstrip Units 1 & 2 based on the installation of new controls (no limits or additional controls were specified for Colstrip Units 3 & 4), and tighter emission limits for Corette (which are not based on additional controls). The cost of the potential additional controls for Colstrip Units 1 & 2, if required, could be significant. PPL Energy Supply expects to meet the tighter permit limits at Corette without any significant changes to operations, although other requirements have led to the planned suspension of operations at Corette beginning in April 2015 (see "MATS" discussion above).
See Note 10 to the Financial Statements in this Form 10-Q and "Item 1. Business - Environmental Matters" in PPL Energy Supply's 20112012 Form 10-K for a discussion of environmental matters.
New Accounting Guidance
See Notes 2 and 1819 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.
Application of Critical Accounting Policies
Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies. The following accounting policies are particularly important to the financial condition or results of operations, and require estimates or other judgments of matters inherently uncertain: price risk management, defined benefits, asset impairment (excluding investments), loss accruals, AROs and income taxes. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in PPL Energy Supply's 20112012 Form 10-K for a discussion of each critical accounting policy.
PPL ELECTRIC UTILITIES CORPORATION AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following should be read in conjunction with PPL Electric's Condensed Consolidated Financial Statements and the accompanying Notes and with PPL Electric's 20112012 Form 10-K. Capitalized terms and abbreviations are defined in the glossary. Dollars are in millions, unless otherwise noted.
"Management's Discussion and Analysis of Financial Condition and Results of Operations" includes the following information:
· | "Overview" provides a description of PPL Electric and its business strategy, a summary of Net Income Available to PPL and a discussion of certain events related to PPL Electric's results of operations and financial condition. |
· | "Results of Operations" provides a summary of PPL Electric's earnings and a description of key factors expected to impact future earnings. This section ends with explanations of significant changes in principal line items on PPL Electric's Statements of Income, comparing the three and nine months ended September 30, 2012March 31, 2013 with the same periods in 2011.2012. |
· | "Financial Condition - Liquidity and Capital Resources" provides an analysis of PPL Electric's liquidity position and credit profile. This section also includes a discussion of rating agency actions. |
· | "Financial Condition - Risk Management" provides an explanation of PPL Electric's risk management programs relating to market and credit risk. |
Overview
Introduction
PPL Electric is an electricity transmission and distribution service provider in eastern and central Pennsylvania with headquarters in Allentown, Pennsylvania. PPL Electric is subject to regulation as a public utility by the PUC, and certain of its transmission activities are subject to the jurisdiction of FERC under the Federal Power Act. PPL Electric delivers electricity in its Pennsylvania service area and provides electricity supply to retail customers in that area as a PLR under the Customer Choice Act.
Business Strategy
PPL Electric's strategy and principal challenge is to own and operatefor its regulated electricity delivery business is to provide safe, reliable service to its customers and achieve stable, long-term growth in earnings and rate base. Rate base is expected to grow as a result of significant capital expenditure programs aimed at the mostmaintaining existing assets and improving system reliability. PPL Electric is focused on timely recovery of costs, efficient cost while maintaining high qualityoperations, strong customer service and reliability. PPL Electric anticipates that it will have significant capital expenditure requirements for at least the next five years. In order toconstructive regulatory relationships.
To manage financing costs and access to credit markets and to fund its capital expenditure program, a key objective for PPL Electric's business strategyElectric is to maintain a strong credit profile. PPL Electric continually focuses on maintaining an appropriate capital structureprofile and strong liquidity position.
Timely recovery of costs to maintain and enhance the reliability of its delivery system, including the replacement of aging distribution assets, is required in order to maintain strong cash flows and a strong credit profile. Traditionally, such cost recovery would be pursued through periodic base rate case proceedings with the PUC. As such costs continue to increase, more frequent rate case proceedings may be required or an alternative rate making process would need to be implemented in order to achieve more timely recovery. See "Regulatory Matters - Pennsylvania Activities - Legislation"Legislation - Regulatory Procedures and Mechanisms" in Note 6 to the Financial Statementsbelow for information on Pennsylvania's new alternative rate-making mechanism.
Transmission costs are recovered through a FERC Formula Rate mechanism, which is updated annually for costs incurred and assets placed in service. Accordingly, increased costs, including those related to the replacement of aging transmission assets and the PJM-approved Regional Transmission Line Expansion Plan, are recovered on a timely basis.
Financial and Operational Developments
Pennsylvania Gross Delivery Margins
Distribution
Margins increased for the three months ended March 31, 2013 compared with 2012 primarily due to a $13 million favorable effect of mild weather in 2012 and a $19 million favorable effect of price, largely comprised of higher base rates, effective January 1, 2013 as a result of the 2012 rate case and higher volumes of $3 million.
Transmission
Margins increased for the three months ended March 31, 2013 compared with 2012 primarily due to increased investment in plant and the recovery of additional costs through the FERC formula-based rates.
Unregulated Gross Energy Margins | | | | | | | | | | | | | | Eastern U.S. | | | | | | | | | | | | | | The change in non-trading margins for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | |
| | | | Three Months | | | | | | | | Baseload energy prices | | | | | $ | (125) | Coal prices | | | | | | (10) | Nuclear fuel prices | | | | | | (6) | Full-requirement sales contracts | | | | | | 5 | Intermediate and peaking capacity prices | | | | | | 5 | Baseload capacity prices | | | | | | 6 | Intermediate and peaking Spark Spreads | | | | | | 14 | Ironwood acquisition which eliminated tolling expense | | | | | | 15 | Net economic availability of coal and hydroelectric plants | | | | | | 32 | Other | | | | | | 5 | Total | | | | | $ | (59) |
Western U.S.
Non-trading margins for the three months ended March 31, 2013 compared with 2012 were lower due to $43 million of lower wholesale prices, partially offset by $12 million of higher wholesale volumes.
Net Energy Trading Margins
Net energy trading margins for the three months ended March 31, 2013 compared with 2012 decreased as a result of lower margins of $16 million on gas positions due to higher prices.
Utility Revenues | | | | | | | | | | | | | The increase (decrease) in utility revenues for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | | | | | | | | | | | Three Months | Domestic: | | | | | | | | PPL Electric (a) | | | | | $ | 55 | | LKE (b) | | | | | | 95 | | Total Domestic | | | | | | 150 | | | | | | | | | | | U.K.: | | | | | | | | Price (c) | | | | | | 57 | | Volume | | | | | | 5 | | Recovery of allowed revenues | | | | | | 5 | | Foreign currency exchange rates | | | | | | 10 | | Other (d) | | | | | | 9 | | Total U.K. | | | | | | 86 | Total | | | | | $ | 236 |
(a) | See "Pennsylvania Gross Delivery Margins" for further information. |
(b) | See "Kentucky Gross Margins" for further information. |
(c) | Due to price increases effective April 1, 2012. |
(d) | This increase is primarily due to $8 million of third-party engineering work, which is offset by expenses in "Other operation and maintenance". |
Other Operation and Maintenance | | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | | | | | | | | | | | | | | | Three Months | Domestic: | | | | | | | Uncollectible accounts (a) | | | | $ | (16) | | LKE coal plant outages (b) | | | | | (14) | | Costs at eastern fossil and hydroelectric plants (c) | | | | | (11) | | Pension and postretirement costs | | | | | 4 | | Other | | | | | 2 | U.K.: | | | | | | | Third-party engineering work (d) | | | | | 8 | | Network maintenance expense (e) | | | | | 7 | | Employee related expenses | | | | | (4) | | Severance compensation | | | | | (4) | | Other | | | | | (2) | Total | | | | $ | (30) |
(a) | The decrease is primarily due to SMGT filing for protection under Chapter 11 of the U.S. Bankruptcy Code in 2011. $11 million of damages billed to SMGT were fully reserved in 2012. |
(b) | The decrease is primarily due to the timing and scope of scheduled outages. |
(c) | The decrease is primarily due to Brunner Island Unit 3 outage costs of $15 million in 2012 compared with no major outage costs in 2013, partially offset by $3 million of additional costs due to the Ironwood Acquisition. |
(d) | These expenses are offset by revenues reflected in "Utility" on the Statements of Income. |
(e) | The increase is primarily due to higher tree trimming expense. |
Depreciation | | | | | | | | | | | The increase (decrease) in depreciation for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | | | | | | | Three Months | | | | | | | | Additions to PP&E | | | | | $ | 21 | LKE lower depreciation rates effective January 1, 2013 | | | | | | (5) | Ironwood Acquisition | | | | | | 6 | Other | | | | | | (2) | Total | | | | | $ | 20 |
Other Income Available(Expense) - net
The $139 million increase in other income (expense) - net for the three months ended March 31, 2013 compared with 2012 was primarily due to $119 million of realized and unrealized gains on economic foreign currency contracts compared with losses in 2012 of $18 million.
See Note 12 to the Financial Statements for further details.
Interest Expense | | | | | | | | | | | | The increase (decrease) in interest expense for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | | | | Three Months | | | | | | | | | Long-term debt interest expense (a) | | | | | $ | 14 | Ironwood Acquisition (b) | | | | | | 4 | Other | | | | | | 3 | Total | | | | | $ | 21 |
(a) | The increase was primarily due to PPL Capital Funding's June 2012 issuance of $400 million, 4.2% Senior Notes due 2022 and October 2012 issuance of $400 million, 3.5% Senior Notes due 2022. Also, contributing to the increase was higher accretion expense on WPD index linked bonds and interest on WPD (East Midlands') April 2012 issuance of £100 million, 5.25% Senior Notes due 2023. |
(b) | The increase was due to financings associated with the Ironwood Acquisition. |
Income Taxes | | | | | | | | | | | The increase (decrease) in income taxes for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | | | Three Months | | | | | | | | | Lower pre-tax book income | | | | | $ | (119) | Foreign tax reserve adjustments | | | | | | (3) | Net operating loss carryforward adjustments (a) | | | | | | 6 | State deferred tax rate change (b) | | | | | | 11 | Other | | | | | | (3) | Total | | | | | $ | (108) |
(a) | During the three months ended March 31, 2012, PPL recorded adjustments to deferred taxes related to net operating loss carryforwards of LKE based on income tax return adjustments. |
(b) | During the three months ended March 31, 2012, PPL recorded adjustments related to state deferred tax liabilities. |
See Note 5 to the Financial Statements for additional information on income taxes.
Financial Condition | | | | | | | | Liquidity and Capital Resources | | | | | | | | PPL had the following at: |
| | March 31, 2013 | | December 31, 2012 | | | | | | | | Cash and cash equivalents | | $ | 853 | | $ | 901 | Short-term debt | | $ | 1,061 | | $ | 652 |
At March 31, 2013, $335 million of cash and cash equivalents were denominated in GBP. If these amounts would be remitted as dividends, PPL may be subject to additional U.S. taxes, net of allowable foreign tax credits. Historically, dividends paid by foreign subsidiaries have been distributions of the current year's earnings. See Note 5 to the Financial Statements in PPL's 2012 Form 10-K for additional information on undistributed earnings of WPD.
The $48 million decrease in PPL's cash and cash equivalents position was primarily the net result of:
· | capital expenditures of $828 million; |
· | the payment of $210 million of common stock dividends; |
· | a $52 million net increase in restricted cash and cash equivalents; and |
· | $24 million of contract adjustment payments; partially offset by |
· | proceeds of $432 million from the issuance of long-term debt, net of costs; |
· | net increase in short-term debt of $416 million; and |
· | net cash provided by operating activities of $244 million. |
PPL's cash provided by operating activities decreased by $484 million for the three months ended March 31, 2013 compared with 2012. The decrease was primarily due to:
· | a $336 million increase in cash used by components of working capital (primarily due to changes in accounts receivable of $219 million resulting from higher base rates and favorable effects of weather and counterparty collateral of $129 million); and |
· | a $221 million increase in defined benefit plans funding; partially offset by |
· | a $72 million increase in net income, when adjusted for non-cash components. |
Capital expenditures increased by $146 million for the three months ended March 31, 2013 compared with 2012, primarily due to the Susquehanna-Roseland transmission project and environmental projects at Mill Creek and Ghent, and construction of Cane Run Unit 7.
Credit Facilities
PPL maintains credit facilities to provide liquidity and to backstop commercial paper issuances. At March 31, 2013, PPL's total committed borrowing capacity under its credit facilities and the use of this borrowing capacity were:
| | | | | | | | | Letters of | | | | | | | | | | | | | Credit Issued | | | | | | | | | | | | | and | | | | | | | Committed | | | | Commercial | | Unused | | | | Capacity | | Borrowed | | Paper Backup | | Capacity | | | | | | | | | | | PPL Energy Supply Credit Facilities (a) | | $ | 3,200 | | | | | $ | 764 | | $ | 2,436 | PPL Electric Credit Facilities (b) | | | 400 | | | | | | 126 | | | 274 | LG&E Syndicated Credit Facility | | | 500 | | | | | | 70 | | | 430 | KU Credit Facilities (c) | | | 598 | | | | | | 313 | | | 285 | | Total Domestic Credit Facilities (d) | | $ | 4,698 | | | | | $ | 1,273 | | $ | 3,425 | | | | | | | | | | | | | | | PPL WW Syndicated Credit Facility (e) | | £ | 210 | | £ | 109 | | | n/a | | £ | 101 | WPD (South West) Syndicated Credit Facility | | | 245 | | | | | | n/a | | | 245 | WPD (East Midlands) Syndicated Credit Facility (f) | | | 300 | | | 65 | | | | | | 235 | WPD (West Midlands) Syndicated Credit Facility | | | 300 | | | | | | | | | 300 | | Total WPD Credit Facilities (g) | | £ | 1,055 | | £ | 174 | | | | | £ | 881 |
(a) | In February 2013, PPL Energy Supply extended a letter of credit facility expiration date from March 2013 and, effective April 2013, the capacity was reduced to $150 million. |
(b) | Committed capacity includes a $100 million credit facility related to an asset-backed commercial paper program through which PPL Electric obtains financing by selling and contributing its eligible accounts receivable and unbilled revenue to a special purpose, wholly owned subsidiary on an ongoing basis. The subsidiary pledges these assets to secure loans of up to an aggregate of $100 million from a commercial paper conduit sponsored by a financial institution. At March 31, 2013, based on accounts receivable and unbilled revenue pledged, the amount available for borrowing under the facility was $100 million. |
(c) | In May 2013, KU extended its $198 million letter of credit facility to May 2016. |
(d) | The commitments under PPL's domestic credit facilities are provided by a diverse bank group, with no one bank and its affiliates providing an aggregate commitment of more than 9% of the total committed capacity. |
(e) | In December 2012, the PPL WW syndicated credit facility that was set to expire in January 2013 was replaced and the capacity was increased from £150 million. The amount borrowed at March 31, 2013 was a USD-denominated borrowing of $171 million, which equated to £109 million at the time of borrowing and bore interest at 1.9034%. |
(f) | The amount borrowed at March 31, 2013 was a GBP-denominated borrowing of £65 million, which equated to $99 million and bore interest at 1.30%. |
(g) | At March 31, 2013, the USD equivalent of unused capacity under WPD's committed credit facilities was $1.3 billion. The commitments under WPD's credit facilities are provided by a diverse bank group with no one bank providing more than 13% of the total committed capacity. |
See Note 7 to the Financial Statements for further discussion of PPL's credit facilities.
Commercial Paper
PPL Energy Supply maintains a commercial paper program for up to $750 million to provide an additional financing source to fund its short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by PPL Energy Supply's Syndicated Credit Facility. At March 31, 2013 and December 31, 2012, PPL Energy Supply had $481 million and $356 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.38% and 0.50%.
PPL Electric maintains a commercial paper program for up to $300 million to provide an additional financing source to fund its short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by PPL Electric's Syndicated Credit Facility. At March 31, 2013, PPL Electric had $125 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheet, at a weighted-average interest rate of 0.39%. PPL Electric had no commercial paper outstanding at December 31, 2012.
In April 2013, LG&E and KU each increased the capacity of their commercial paper programs from $250 million to $350 million to provide an additional financing source to fund their short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by LG&E's and KU's Syndicated Credit Facilities. At March 31, 2013 and December 31, 2012, LG&E had $70 million and $55 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.36% and 0.42%. At March 31, 2013 and December 31, 2012, KU had $115 million and $70 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.36% and 0.42%.
Long-term Debt and Equity Securities
See "Overview" above for information regarding equity forward agreements and the 2010 Equity Units.
In March 2013, PPL Capital Funding issued $450 million of its 5.90% Junior Subordinated Notes due 2073. PPL Capital Funding received proceeds of $436 million, net of underwriting fees, which will be loaned to or invested in affiliates of PPL Capital Funding and used to fund their capital expenditures and other general corporate purposes.
In addition, PPL has reduced the estimate of its plans to issue new shares of common stock in 2013 by $100 million from the $350 million reported in its 2012 Form 10-K.
Common Stock Dividends
In February 2013, PPL declared its quarterly common stock dividend, payable April 1, 2013, at 36.75 cents per share (equivalent to $1.47 per annum). Future dividends, declared at the discretion of the Board of Directors, will be dependent upon future earnings, cash flows, financial and legal requirements and other factors.
Rating Agency Actions
Moody's, S&P and Fitch periodically review the credit ratings on the debt securities of PPL and its subsidiaries. Based on their respective independent reviews, the rating agencies may make certain ratings revisions or ratings affirmations.
A credit rating reflects an assessment by the rating agency of the creditworthiness associated with an issuer and particular securities that it issues. The credit ratings of PPL and its subsidiaries are based on information provided by PPL and other sources. The ratings of Moody's, S&P and Fitch are not a recommendation to buy, sell or hold any securities of PPL or its subsidiaries. Such ratings may be subject to revisions or withdrawal by the agencies at any time and should be evaluated independently of each other and any other rating that may be assigned to the securities.
A downgrade in PPL's or its subsidiaries' credit ratings could result in higher borrowing costs and reduced access to capital markets. PPL and its subsidiaries have no credit rating triggers that would result in the reduction of access to capital markets or the acceleration of maturity dates of outstanding debt.
The rating agencies took the following actions related to PPL and its subsidiaries during 2013:
In February 2013, Moody's upgraded its rating, from B2 to Ba1, and revised the outlook from under review to stable for PPL Ironwood.
In March 2013, S&P, Moody's and Fitch assigned ratings of BB+, Ba1 and BB+ to PPL Capital Funding's $450 million 5.90% Junior Subordinated Notes due 2073. Fitch also assigned a stable outlook to these notes.
In April 2013, Fitch affirmed the BBB- rating and stable outlook at PPL Montana.
Ratings Triggers
PPL and PPL Energy Supply have various contracts, including contracts for the sale and purchase of electricity and fuel, commodity transportation and storage, tolling agreements and interest rate and foreign currency instruments, which contain provisions that require PPL and PPL Energy Supply to post additional collateral or permit the counterparty to terminate the contract, if PPL's or PPL Energy Supply's credit rating were to fall below investment grade. See Note 14 to the Financial Statements for a discussion of "Credit Risk-Related Contingent Features," including a discussion of the potential additional collateral that would have been required for derivative contracts in a net liability position at March 31, 2013.
For additional information on PPL's liquidity and capital resources, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," in PPL's 2012 Form 10-K.
Risk Management
Market Risk
See Notes 13 and 14 to the Financial Statements for information about PPL's risk management objectives, valuation techniques and accounting designations.
The forward-looking information presented below provides estimates of what may occur in the future, assuming certain adverse market conditions and model assumptions. Actual future results may differ materially from those presented. These disclosures are not precise indicators of expected future losses, but only indicators of possible losses under normal market conditions at a given confidence level.
Commodity Price Risk (Non-trading)
PPL segregates its non-trading activities into two categories: hedge activity and economic activity. Transactions that are accounted for as hedge activity qualify for hedge accounting treatment. The economic activity category includes transactions that address a specific risk, but were not eligible for hedge accounting or for which hedge accounting was not elected. This activity includes the changes in fair value of positions used to hedge a portion of the economic value of PPL's competitive generation assets and full-requirement sales and retail contracts. This economic activity is subject to changes in fair value due to market price volatility of the input and output commodities (e.g., fuel and power). Although they do not receive hedge accounting treatment, these transactions are considered non-trading activity. See Note 14 to the Financial Statements for additional information.
To hedge the impact of market price volatility on PPL's energy-related assets, liabilities and other contractual arrangements, PPL both sells and purchases physical energy at the wholesale level under FERC market-based tariffs throughout the U.S. and enters into financial exchange-traded and over-the-counter contracts. PPL's non-trading commodity derivative contracts range in maturity through 2019.
The following table sets forth the changes in the net fair value of non-trading commodity derivative contracts for the periods ended March 31. See Notes 13 and 14 to the Financial Statements for additional information.
| | | | | | | | Gains (Losses) | | | | | Three Months | | | | | | | 2013 | | 2012 | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | | | | | | | $ | 473 | | $ | 1,082 | Contracts realized or otherwise settled during the period | | | | | | | | | (137) | | | (279) | Fair value of new contracts entered into during the period (a) | | | | | | | | | 9 | | | (1) | Other changes in fair value | | | | | | | | | (116) | | | 413 | Fair value of contracts outstanding at the end of the period | | | | | | | | $ | 229 | | $ | 1,215 |
(a) | Represents the fair value of contracts at the end of the quarter of their inception. |
The following table segregates the net fair value of non-trading commodity derivative contracts at March 31, 2013, based on the observability of the information used to determine the fair value.
| | | Net Asset (Liability) | | | | Maturity | | | | | | | | Maturity | | | | | | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | Source of Fair Value | | | | | | | | | | | | | | | | Prices based on significant observable inputs (Level 2) | | $ | 238 | | $ | (21) | | $ | (8) | | $ | 6 | | $ | 215 | Prices based on significant unobservable inputs (Level 3) | | | (1) | | | 12 | | | 3 | | | | | | 14 | Fair value of contracts outstanding at the end of the period | | $ | 237 | | $ | (9) | | $ | (5) | | $ | 6 | | $ | 229 |
PPL sells electricity, capacity and related services and buys fuel on a forward basis to hedge the value of energy from its generation assets. If PPL were unable to deliver firm capacity and energy or to accept the delivery of fuel under its agreements, under certain circumstances it could be required to pay liquidating damages. These damages would be based on the difference between the market price and the contract price of the commodity. Depending on price changes in the wholesale energy markets, such damages could be significant. Extreme weather conditions, unplanned power plant outages, transmission disruptions, nonperformance by counterparties (or their counterparties) with which it has energy contracts and other factors could affect PPL's ability to meet its obligations, or cause significant increases in the market price of replacement energy. Although PPL attempts to mitigate these risks, there can be no assurance that it will be able to fully meet its firm obligations, that it will not be required to pay damages for failure to perform, or that it will not experience counterparty nonperformance in the future.
Commodity Price Risk (Trading)
PPL's trading commodity derivative contracts range in maturity through 2017. The following table sets forth changes in the net fair value of trading commodity derivative contracts for the periods ended March 31. See Notes 13 and 14 to the Financial Statements for additional information.
| | | | | | | | Gains (Losses) | | | | | Three Months | | | | | | | 2013 | | 2012 | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | | | | | | | $ | 29 | | $ | (4) | Contracts realized or otherwise settled during the period | | | | | | | | | (2) | | | | Fair value of new contracts entered into during the period (a) | | | | | | | | | (12) | | | 6 | Fair value of contracts outstanding at the end of the period | | | | | | | | $ | 15 | | $ | 2 |
(a) | Represents the fair value of contracts at the end of the quarter of their inception. |
The following table segregates the net fair value of trading commodity derivative contracts at March 31, 2013, based on the observability of the information used to determine the fair value.
| | Net Asset (Liability) | | | Maturity | | | | | | | Maturity | | | | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | Source of Fair Value | | | | | | | | | | | | | | | | Prices quoted in active markets for identical instruments (Level 1) | | $ | 1 | | | | | | | | | | | $ | 1 | Prices based on significant observable inputs (Level 2) | | | 5 | | $ | 9 | | | | | | | | | 14 | Fair value of contracts outstanding at the end of the period | | $ | 6 | | $ | 9 | | | | | | | | $ | 15 |
VaR Models
A VaR model is utilized to measure commodity price risk in unregulated gross energy margins for the non-trading and trading portfolios. VaR is a statistical model that attempts to estimate the value of potential loss over a given holding period under normal market conditions at a given confidence level. VaR is calculated using a Monte Carlo simulation technique based on a five-day holding period at a 95% confidence level. Given the company's disciplined hedging program, the non-trading VaR exposure is expected to be limited in the short-term. The VaR for portfolios using end-of-month results for the periods was as follows.
| | | Trading VaR | | Non-Trading VaR | | | | Three Months | | Three Months | | | | Ended | | Ended | | | | March 31, | | March 31, | | | | 2013 | | 2013 | 95% Confidence Level, Five-Day Holding Period | | | | | | | | Period End | | $ | 6 | | $ | 8 | | Average for the Period | | | 5 | | | 9 | | High | | | 6 | | | 9 | | Low | | | 3 | | | 8 |
The trading portfolio includes all proprietary trading positions, regardless of the delivery period. All positions not considered proprietary trading are considered non-trading. The non-trading portfolio includes the entire portfolio, including generation, with delivery periods through the next 12 months. Both the trading and non-trading VaR computations exclude FTRs due to the absence of reliable spot and forward markets. The fair value of the non-trading and trading FTR positions was insignificant at March 31, 2013.
Interest Rate Risk
PPL and its subsidiaries issue debt to finance their operations, which exposes them to interest rate risk. PPL utilizes various financial derivative instruments to adjust the mix of fixed and floating interest rates in its debt portfolio, adjust the duration of its debt portfolio and lock in benchmark interest rates in anticipation of future financing, when appropriate. Risk limits under the risk management program are designed to balance risk exposure to volatility in interest expense and changes in the fair value of PPL's debt portfolio due to changes in the absolute level of interest rates.
At March 31, 2013, PPL's potential annual exposure to increased interest expense, based on a 10% increase in interest rates, was not significant.
PPL is also exposed to changes in the fair value of its domestic and international debt portfolios. PPL estimated that a 10% decrease in interest rates at March 31, 2013 would increase the fair value of its debt portfolio by $563 million.
At March 31, 2013, PPL had the following interest rate hedges outstanding:
| | | | | | | | | Effect of a | | | | | | | Fair Value, | | 10% Adverse | | | | Exposure | | Net - Asset | | Movement | | | | Hedged | | (Liability) (a) | | in Rates (b) | Cash flow hedges | | | | | | | | | | | Interest rate swaps (c) | | $ | 1,148 | | $ | 12 | | $ | (35) | | Cross-currency swaps (d) | | | 1,262 | | | 82 | | | (171) | Economic activity | | | | | | | | | | | Interest rate swaps (e) | | | 179 | | | (55) | | | (3) |
(a) | Includes accrued interest, if applicable. |
(b) | Effects of adverse movements decrease assets or increase liabilities, as applicable, which could result in an asset becoming a liability. Sensitivities represent a 10% adverse movement in interest rates, except for cross-currency swaps which also includes foreign currency exchange rates. |
(c) | PPL utilizes various risk management instruments to reduce its exposure to the expected future cash flow variability of its debt instruments. These risks include exposure to adverse interest rate movements for outstanding variable rate debt and for future anticipated financing. While PPL is exposed to changes in the fair value of these instruments, any changes in the fair value of such cash flow hedges are recorded in equity or as regulatory assets or liabilities, if recoverable through regulated rates. The changes in fair value of these instruments are then reclassified into earnings in the same period during which the item being hedged affects earnings. The positions outstanding at March 31, 2013 mature through 2043. |
(d) | PPL utilizes cross-currency swaps to hedge the interest payments and principal of WPD's U.S. dollar-denominated senior notes. While PPL is exposed to changes in the fair value of these instruments, any change in the fair value of these instruments is recorded in equity and reclassified into earnings in the same period during which the item being hedged affects earnings. The positions outstanding at March 31, 2013 mature through 2028. |
(e) | PPL utilizes various risk management instruments to reduce its exposure to the expected future cash flow variability of its debt instruments. These risks include exposure to adverse interest rate movements for outstanding variable rate debt and for future anticipated financing. While PPL is exposed to changes in the fair value of these instruments, any realized changes in the fair value of such economic positions are recoverable through regulated rates and any subsequent changes in fair value of these derivatives are included in regulatory assets or liabilities. The positions outstanding at March 31, 2013 mature through 2033. |
Foreign Currency Risk
PPL is exposed to foreign currency risk, primarily through investments in U.K. affiliates. In addition, PPL's domestic operations may make purchases of equipment in currencies other than U.S. dollars.
PPL has adopted a foreign currency risk management program designed to hedge certain foreign currency exposures, including firm commitments, recognized assets or liabilities, anticipated transactions and net investments. In addition, PPL enters into financial instruments to protect against foreign currency translation risk of expected earnings.
PPL had the following foreign currency hedges outstanding March 31, 2013:
| | | | | | | Effect of a | | | | | | | | 10% | | | | | | | | Adverse | | | | | | | | Movement | | | | | | | | in Foreign | | | | | | Fair Value, | | Currency | | | | Exposure | | Net - Asset | | Exchange | | | | Hedged | | (Liability) | | Rates (a) | | | | | | | | | | | | Net investment hedges (b) | | £ | 162 | | $ | 15 | | $ | (25) | Economic activity (c) | | | 1,175 | | | 78 | | | (167) |
(a) | Effects of adverse movements decrease assets or increase liabilities, as applicable, which could result in an asset becoming a liability. |
(b) | To protect the value of a portion of its net investment in WPD, PPL executes forward contracts to sell GBP. The positions outstanding at March 31, 2013 mature through 2013. Excludes the amount of an intercompany loan classified as a net investment hedge. See Note 14 to the Financial Statements for additional information. |
(c) | To economically hedge the translation of expected income denominated in GBP to U.S. dollars, PPL enters into a combination of average rate forwards and average rate options to sell GBP. The forwards and options outstanding at March 31, 2013 mature through 2015. |
NDT Funds - Securities Price Risk
In connection with certain NRC requirements, PPL Susquehanna maintains trust funds to fund certain costs of decommissioning the PPL Susquehanna nuclear plant (Susquehanna). At March 31, 2013, these funds were invested primarily in domestic equity securities and fixed-rate, fixed-income securities and are reflected at fair value on the Balance Sheet. The mix of securities is designed to provide returns sufficient to fund Susquehanna's decommissioning and to compensate for inflationary increases in decommissioning costs. However, the equity securities included in the trusts are exposed to price fluctuation in equity markets, and the values of fixed-rate, fixed-income securities are primarily exposed to changes in interest rates. PPL actively monitors the investment performance and periodically reviews asset allocation in accordance with its nuclear decommissioning trust policy statement. At March 31, 2013, a hypothetical 10% increase in interest rates and a 10% decrease in equity prices would have resulted in an estimated $55 million reduction in the fair value of the trust assets. See Notes 13 and 17 to the Financial Statements for additional information regarding the NDT funds.
Credit Risk
See Notes 13 and 14 to the Financial Statements in this Form 10-Q and "Risk Management - Energy Marketing & Trading and Other - Credit Risk" in PPL's 2012 Form 10-K for additional information.
Foreign Currency Translation
The value of the British pound sterling fluctuates in relation to the U.S. dollar. Changes in this exchange rate resulted in a foreign currency translation loss of $256 million for the three months ended March 31, 2013, which primarily reflected a $696 million decrease to PP&E and goodwill offset by a decrease of $440 million to net liabilities. Changes in this exchange rate resulted in a foreign currency translation gain of $76 million for the three months ended March 31, 2012, which primarily reflected a $188 million increase to PP&E and goodwill offset by an increase of $112 million to net liabilities. The impact of foreign currency translation is recorded in AOCI.
Related Party Transactions
PPL is not aware of any material ownership interests or operating responsibility by senior management of PPL, PPL Energy Supply, PPL Electric, LKE, LG&E or KU in outside partnerships, including leasing transactions with variable interest entities or other entities doing business with PPL.
Acquisitions, Development and Divestitures
PPL from time to time evaluates opportunities for potential acquisitions, divestitures and development projects. Development projects are reexamined based on market conditions and other factors to determine whether to proceed with the projects, sell, cancel or expand them, execute tolling agreements or pursue other options. See Note 8 to the Financial Statements for information on the more significant activities.
Environmental Matters
Extensive federal, state and local environmental laws and regulations are applicable to PPL's air emissions, water discharges and the management of hazardous and solid waste, as well as other aspects of PPL's business. The cost of compliance or alleged non-compliance cannot be predicted with certainty but could be material. In addition, costs may increase significantly if the requirements or scope of environmental laws or regulations, or similar rules, are expanded or changed by the relevant agencies. Costs may take the form of increased capital expenditures or operating and maintenance expenses, monetary fines, penalties or other restrictions. Many of these environmental law considerations are also applicable to the operations of key suppliers, or customers, such as coal producers and industrial power users, and may impact the costs for their products or their demand for PPL's services.
Physical effects associated with climate change could include the impact of changes in weather patterns, such as storm frequency and intensity, and the resultant potential damage to PPL's generation assets, electricity transmission and distribution systems, as well as impacts on customers. In addition, changed weather patterns could potentially reduce annual rainfall in areas where PPL has hydro generating facilities or where river water is used to cool its fossil and nuclear powered generators. PPL cannot currently predict whether its businesses will experience these potential climate change-related risks or estimate the potential cost of their related consequences.
The following is a discussion of the more significant environmental matters.
Coal Combustion Residuals (CCRs) In June 2010, the EPA proposed two approaches to regulating the disposal and management of CCRs (as either hazardous or non-hazardous) under existing solid waste regulations. A final rulemaking is currently expected before the end of 2015. However, the timing of the final regulations could be accelerated by certain litigation that could require the EPA to issue its regulations sooner. Regulations could impact handling, disposal and/or beneficial use of CCRs. The financial impact could be material if CCRs are regulated as hazardous waste, and significant if regulated as non-hazardous, in accordance with the proposed rule.
Effluent Limitation Guidelines On April 19, 2013, the EPA issued proposed regulations to revise discharge limitations for steam electric generation wastewater permits. The proposed limitations are based on the EPA review of available treatment technologies and their capacity for reducing pollutants and include new requirements for fly ash and bottom ash handling and metal cleaning wastes, as well as new limits for scrubber wastewater, gasification wastewater and landfill leachate. The proposal contains several alternative approaches, some of which could significantly impact PPL's coal-fired plants. PPL will work with industry groups to comment on the proposed regulation. The final regulation is expected in May 2014. At the present time, PPL is unable to predict the outcome of this matter or estimate a range of reasonably possible costs, but the costs could be significant.
316(b) Cooling Water Intake Structure Rule In April 2011, the EPA published a draft regulation under Section 316(b) of the Clean Water Act, which regulates cooling water intakes for power plants. The draft rule has two provisions: one requires installation of Best Technology Available (BTA) to reduce mortality of aquatic organisms that are pulled into the plant cooling water system (entrainment), and the second imposes standards for reduction of mortality of aquatic organisms trapped on water intake screens (impingement). A final rule is expected in June 2013. The proposed regulation would apply to nearly all PPL-owned steam electric plants in Pennsylvania, Kentucky, and Montana, potentially even including those equipped with closed-cycle cooling systems. PPL's compliance costs could be significant, especially if the final rule requires closed-cycle systems at plants that do not currently have them or conversions of once-through systems to closed-cycle. GHG Regulations In 2013, the EPA is expected to finalize limits on GHG emissions from new power plants and to begin working on a proposal for such emissions from existing power plants. The EPA's proposal on GHG emissions from new power plants would effectively preclude construction of any coal-fired plants and could even be difficult for new gas-fired plants to meet. With respect to existing power plants, the impact could be significant, depending on the structure and stringency of the final rule. PPL, along with others in the industry, filed comments on the EPA's proposal related to GHG emissions from new plants.
MATS The EPA finalized MATS requiring fossil-fuel fired plants to reduce emissions of mercury and other hazardous air pollutants by April 16, 2015. The rule is being challenged by industry groups and states. The EPA has subsequently proposed changes to the rule with respect to new sources to address the concern that the rule effectively precludes construction of any new coal-fired plants. PPL is generally well-positioned to comply with MATS, primarily due to recent investments in environmental controls and approved ECR plans to install additional controls at some of its Kentucky plants. Additionally, PPL is evaluating chemical additive systems for mercury control at Brunner Island, and modifications to existing controls at Colstrip for improved particulate matter reductions. In September 2012, PPL announced its intention to place its Corette plant in long-term reserve status beginning in April 2015 due to expected market conditions and costs to comply with MATS. The anticipated retirements of certain coal-fired electric generating units are in response to this and other environmental regulations.
CSAPR and CAIR In 2011, the EPA finalized its CSAPR regulating emissions of nitrous oxide and sulfur dioxide through new allowance trading programs which were to be implemented in two phases (2012 and 2014). Like its predecessor, the CAIR, CSAPR targeted sources in the eastern United States. In December 2011, the U.S. Court of Appeals for the District of Columbia Circuit (the Court) stayed implementation of CSAPR, leaving CAIR in place. Subsequently, in August 2012, the Court vacated and remanded CSAPR back to the EPA for further rulemaking, again leaving CAIR in place. PPL plants in Pennsylvania and Kentucky will continue to comply with CAIR through optimization of existing controls, balanced with emission allowance purchases. The Court's August decision leaves plants in CSAPR-affected states potentially exposed to more stringent emission reductions due to regional haze implementation (it was previously determined that CSAPR or CAIR participation satisfies regional haze requirements), and/or petitions to the EPA by downwind states under Section 126 of the Clean Air Act requesting the EPA to require plants that allegedly contribute to downwind non-attainment to take action to reduce emissions.
Regional Haze - Montana The EPA signed its final Federal Implementation Plan of the Regional Haze Rules for Montana in September 2012, with tighter emissions limits for Colstrip Units 1 & 2 based on the installation of new controls (no limits or additional controls were specified for Colstrip Units 3 & 4), and tighter emission limits for Corette (which are not based on additional controls). The cost of the potential additional controls for Colstrip Units 1 & 2, if required, could be significant. PPL expects to meet the tighter permit limits at Corette without any significant changes to operations, although other requirements have led to the planned suspension of operations at Corette beginning in April 2015 (see "MATS" discussion above).
See Note 10 to the Financial Statements in this Form 10-Q and "Item 1. Business - Environmental Matters" in PPL's 2012 Form 10-K for a discussion of environmental matters.
New Accounting Guidance
See Notes 2 and 19 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.
Application of Critical Accounting Policies
Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies. The following accounting policies are particularly important to the financial condition or results of operations, and require estimates or other judgments of matters inherently uncertain: price risk management, defined benefits, asset impairment (excluding investments), loss accruals, AROs, income taxes, and regulatory assets and liabilities. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in PPL's 2012 Form 10-K for a discussion of each critical accounting policy.
PPL ENERGY SUPPLY, LLC AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following should be read in conjunction with PPL Energy Supply's Condensed Consolidated Financial Statements and the accompanying Notes and with PPL Energy Supply's 2012 Form 10-K. Capitalized terms and abbreviations are defined in the glossary. Dollars are in millions, unless otherwise noted.
"Management's Discussion and Analysis of Financial Condition and Results of Operations" includes the following information:
· | "Overview" provides a description of PPL Energy Supply and its business strategy, a summary of Net Income Attributable to PPL Energy Supply Member and a discussion of certain events related to PPL Energy Supply's results of operations and financial condition. |
· | "Results of Operations" provides a summary of PPL Energy Supply's earnings and a description of key factors expected to impact future earnings. This section ends with explanations of significant changes in principal line items on PPL Energy Supply's Statements of Income, comparing the three months ended March 31, 2013 with 2012. |
· | "Financial Condition - Liquidity and Capital Resources" provides an analysis of PPL Energy Supply's liquidity position and credit profile. This section also includes a discussion of rating agency actions. |
· | "Financial Condition - Risk Management" provides an explanation of PPL Energy Supply's risk management programs relating to market and credit risk. |
Overview
Introduction
PPL Energy Supply is an energy company with headquarters in Allentown, Pennsylvania. Through its subsidiaries, PPL Energy Supply is primarily engaged in the competitive generation and marketing of electricity in two key markets - the northeastern and northwestern U.S.
Business Strategy
PPL Energy Supply's strategy is to achieve disciplined optimization of energy supply margins while mitigating volatility in both cash flows and earnings. More specifically, PPL Energy Supply's strategy is to optimize the value from its competitive generation and marketing portfolios. PPL Energy Supply endeavors to do this by matching energy supply with load, or customer demand, under contracts of varying durations with creditworthy counterparties to capture profits while effectively managing exposure to energy and fuel price volatility, counterparty credit risk and operational risk. PPL Energy Supply is focused on maintaining profitability during the current and projected period of low commodity prices by controlling its capital and operation and maintenance expenditures.
To manage financing costs and access to credit markets, a key objective for PPL Energy Supply is to maintain a strong credit profile and liquidity position. In addition, PPL Energy Supply has financial and operational risk management programs that, among other things, are designed to monitor and manage exposure to earnings and cash flow volatility related to changes in energy and fuel prices, interest rates, counterparty credit quality and the operating performance of its generating units.
Financial and Operational Developments
Net Income Available(Loss) Attributable to PPL Energy Supply Member
Net Income (Loss) Attributable to PPL Energy Supply Member for the three and nine months ended September 30, 2012March 31, 2013 was $33 million and $95$(38) million compared to $28$309 million and $116 million for the same periods in 2011,2012, representing an 18% increase over and an 18% decrease from the same periods in 2011.a 112% decrease.
See "Results of Operations" below for afurther discussion and analysis of PPL Electric's earnings.the consolidated results of operations.
Redemption of Preference Stock
In June 2012, PPL Electric redeemed all 2.5 million shares of its 6.25% Series Preference Stock, par value $100 per share. The price paid for the redemption was the par value, without premium ($250 million in the aggregate). At December 31, 2011, the preference stock was reflected on PPL Electric's Balance Sheets in "Preference stock."
Hurricane Sandy
In late October 2012, PPL Electric experienced widespread significant damage to its transmission and distribution network from Hurricane Sandy. The total costs associated with the restoration efforts are still being finalized but are estimated to be in excess of $60 million. PPL Electric has insurance coverage that could cover a portion of the costs incurred from Hurricane Sandy. PPL Electric will have the ability to file a request with the PUC for permission to defer for future recovery certain of the costs incurred to repair the distribution network in excess of the insurance coverage. Costs incurred to repair the transmission network are recoverable through the FERC Formula Rate mechanism which is updated annually.
Regional Transmission Line Expansion Plan
On October 1, 2012, the National Park Service (NPS) issued its Record of Decision (ROD) on the proposed Susquehanna-Roseland transmission line affirming the route chosen by PPL Electric and Public Service Electric & Gas as the preferred alternative under the NPS's National Environmental Policy Act review. On October 15, 2012, a complaint was filed in the United States District Court for the District of Columbia by various environmental groups, including the Sierra Club, challenging the ROD and seeking to prohibit its implementation. Construction activities have begun on portions of the 101-mile route in Pennsylvania. The line is expected to be in service before the peak summer demand period of 2015. The chosen route had previously been approved by the PUC and New Jersey Board of Public Utilities. An appeal of the New Jersey Board of Public Utilities approval is pending before the New Jersey Superior Court Appellate Division. PPL Electric cannot predict the ultimate outcome or timing of any further legal challenges to the project. PJM has developed a strategy to manage potential reliability problems until the line is built. PPL Electric cannot predict what additional actions, if any, PJM might take in the event of a further delay to its scheduled in-service date for the new line.
At September 30, 2012, PPL Electric's estimated share of the project cost was $560 million, an increase from approximately $500 million at December 31, 2011, due primarily to increased material costs. See Note 8 in PPL Electric's 2011 Form 10-K for additional information.
On October 9, 2012, the FERC issued an order in response to PPL Electric's December 2011 request for ratemaking incentives for the Northeast/Pocono Reliability project (a new 58-mile 230 kV transmission line, three new substations and upgrades to adjacent facilities). The incentives were specifically tailored to address the risks and challenges PPL Electric will face in building the project. The FERC granted the incentive for inclusion of 100% of prudently incurred construction work in progress (CWIP) costs in rate base and denied the request for a 100 basis point adder to the return on equity incentive. The order requires a follow-up compliance filing from PPL Electric to ensure proper accounting treatment of AFUDC and CWIP for the project. PPL Electric estimates the project costs to be approximately $180 million.
Legislation - Regulatory Procedures and Mechanisms
In June 2011, the Pennsylvania House Consumer Affairs Committee approved legislation authorizing the PUC to approve regulatory procedures and mechanisms to provide more timely recovery of a utility's costs. In the first quarter of 2012, the Governor signed an amended version of the legislation (Act 11 of 2012), which became effective April 14, 2012. The legislation authorizes the PUC to approve two specific ratemaking mechanisms - a fully projected future test year and, subject to certain conditions, a distribution system improvements charge (DSIC). Such alternative ratemaking procedures and mechanisms are important to PPL Electric as it begins a period of significant capital investment to maintain and enhance the reliability of its delivery system, including the replacement of aging distribution assets. In August 2012, the PUC issued a Final Implementation Order adopting procedures, guidelines and a model tariff for the implementation of Act 11 of 2012.
Economic and Market Conditions
In September 2012,Unregulated Gross Energy Margins associated with PPL Electric filed its Long Term Infrastructure Improvement Plan (LTIIP) describing projects eligibleEnergy Supply's competitive generation and marketing business are impacted by changes in market prices and demand for inclusionelectricity and natural gas, power plant availability, competition in the DSIC. In October 2012, several parties filed commentsmarkets for retail customers, fuel costs and availability, fuel transportation costs and other costs. Current depressed wholesale market prices for electricity and natural gas have resulted from general weak economic conditions and other factors, including the impact of expanded domestic shale gas development. As a result of these factors, lower future energy margins are expected to continue compared to the LTIIP but noneenergy margins in 2012. As has been PPL Energy Supply's practice in periods of changing business conditions, PPL Energy Supply continues to review its future business and operational plans, including capital and operation and maintenance expenditures, as well as its hedging strategies.
PPL Energy Supply continues to monitor its Corette plant (which as previously announced will be placed in long-term reserve status, suspending the comments requested evidentiary hearings onplant's operation due to expected market conditions and the LTIIP. A decision oncosts to comply with the LTIIP is expected in January 2013. PPL Electric expects to file a petition requesting permission to establish a DSIC in January 2013 with rates proposed to be effectiveMATS beginning in April 2013.2015) for impairment. The Corette plant asset group's carrying value at March 31, 2013 was $65 million. Although the Corette plant was not impaired at March 31, 2013, it is reasonably possible that an impairment could occur in future periods, as higher priced sales contracts settle, adversely impacting projected cash flows.
FERC Formula RatesPPL Energy Supply cannot predict the future impact that economic and market conditions and regulatory requirements may have on its financial condition or results of operations.
Susquehanna Turbine Blade Inspection
In March 2012,the spring of 2013, PPL Electric filed a request withEnergy Supply will begin making modifications to address the FERC seeking recovery, over a 34-year period beginning in June 2012,causes of its unrecovered regulatory asset related to the deferred state tax liability that existedturbine blade cracking at the timeSusquehanna nuclear plant that was first identified in 2011. The modifications will be made during the Unit 2 refueling outage and an additional planned outage for Unit 1. Following completion of the transition frommodifications, PPL Energy Supply plans to continue monitoring the flow-through treatment of state income taxes to full normalization. This change in tax treatment occurred in 2008 as a result of prior FERC initiatives that transferred regulatory jurisdiction of certain transmission assets from the PUC to FERC. A regulatory asset of approximately $50 million related to this transition, classified as taxes recoverable through future rates, is included in "Other Noncurrent Assets - Regulatory assets" on the Balance Sheets at September 30, 2012 and December 31, 2011. In May 2012, the FERC issued an order approving PPL Electric's request effective June 1, 2012.turbine blades using enhanced diagnostic equipment.
Results of Operations
The following discussion provides a summary of PPL Electric'sEnergy Supply's earnings and a description of key factors that management expects mayare expected to impact future earnings. This section ends with "Statement of Income Analysis," which includes explanations of significant changes in Unregulated Gross Energy Margins by region and principal line items on PPL Electric'sEnergy Supply's Statements of Income, comparing the three and nine months ended September 30, 2012March 31, 2013 with the same periods in 2011.2012.
The results for interim periods can be disproportionately influenced by numerous factors and developments and by seasonal variations. As such, the results of operations for interim periods do not necessarily indicate results or trends for the year or future periods.
Earnings | | | | | | | | | | | | | | | | | | | | | | | | | | | Net Income Available to PPL for the periods ended September 30 was: | | | | | | | | | | | | | | | | | | Three Months | | Nine Months | | | | 2012 | | 2011 | | 2012 | | 2011 | | | | | | | | | | | | | | | Net Income Available to PPL | | $ | 33 | | $ | 28 | | $ | 95 | | $ | 116 |
Earnings | | | | | | | | | | | | | | | Net Income (Loss) Attributable to PPL Energy Supply Member for the periods ended March 31 was: | | | | | | | | | | | | | | | | | | | | | | | | Three Months | | | | | | | | | | 2013 | | 2012 | | | | | | | | | | | | | | | Net Income (Loss) Attributable to PPL Energy Supply Member | | | | | | | | $ | (38) | | $ | 309 |
The changes in the components of Net Income Available(Loss) Attributable to PPL Energy Supply Member between these periods were due to the following factors, which reflect reclassifications for items included in gross delivery margins.Unregulated Gross Energy Margins and certain items that management considers special. See additional detail of these special items in the tables below.
| | Three Months | | Nine Months | | | | | | | | Pennsylvania gross delivery margins | | $ | 11 | | $ | 1 | Other operation and maintenance | | | (7) | | | (32) | Depreciation | | | (3) | | | (11) | Other | | | 2 | | | 4 | Income Taxes | | | (2) | | | 9 | Distributions on preference stock | | | 4 | | | 8 | Total | | $ | 5 | | $ | (21) |
| | | | Three Months | | | | | | | | Unregulated Gross Energy Margins | | | | | $ | (107) | Other operation and maintenance | | | | | | 13 | Depreciation | | | | | | (14) | Interest Expense | | | | | | (9) | Income Taxes | | | | | | 33 | Special items, after-tax | | | | | | (263) | Total | | | | | $ | (347) |
· | See "Statement of Income Analysis - PennsylvaniaUnregulated Gross DeliveryEnergy Margins - Changes in Non-GAAP Financial Measures" for an explanation of PennsylvaniaUnregulated Gross DeliveryEnergy Margins. |
· | Lower other operation and maintenance primarily due to $15 million of lower costs at eastern fossil and hydroelectric plants largely due to outages in 2012, partially offset by $3 million of additional costs due to the Ironwood Acquisition. |
· | Higher other operation and maintenance for the three-month period,depreciation primarily due to $9 million of higher payroll-related costs, $2 million of higher vegetation management costs and $2 million of higher corporate service costs, partially offset by $6 million of lower PUC-reportable storm costs.the Ironwood Acquisition. |
Higher other operation and maintenance for the nine-month period, primarily due to $16 million of higher payroll-related costs, $10 million of higher vegetation management costs, $7 million of higher corporate service costs and $4 million of higher contractor costs, partially offset by $13 million of lower PUC-reportable storm costs.
· | Higher depreciation for the nine-month period,interest expense primarily due to the impact of PP&E additions relatedfinancings associated with PPL Ironwood, acquired in April 2012, which increased interest expense by $4 million and $3 million due to the ongoing efforts to ensure the reliability of the delivery system and replace aging infrastructure.lower capitalized interest. |
· | Lower income taxes for the nine-month period, primarily due to lower pre-tax income. |
· | Lower distributions on preference stock for the three and nine month periods due to the preference stock redemptionincome in June2013, which reduced income taxes by $47 million, partially offset by an $11 million benefit from a state tax rate change recorded in 2012. |
The following after-tax gains (losses), which management considers special items, also impacted the results during the periods ended March 31.
| | | Income Statement | | Three Months | | | | Line Item | | 2013 | | 2012 | | | | | | | | | | | Adjusted energy-related economic activity, net, net of tax of $79, ($102) | (a) | | $ | (117) | | $ | 150 | Impairments: | | | | | | | | | Adjustments - nuclear decommissioning trust investments, net of tax of $0, ($1) | Other Income (Expense)-net | | | | | | 1 | Other: | | | | | | | | | Counterparty bankruptcy, net of tax of $0, $5 (b) | Other Operation and Maintenance | | | | | | (6) | | Ash basin leak remediation adjustment, net of tax of $0, ($1) | Other Operation and Maintenance | | | | | | 1 | Total | | | $ | (117) | | $ | 146 |
(a) | See "Reconciliation of Economic Activity" below. |
(b) | In October 2011, a wholesale customer, SMGT, filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy code. In 2012, PPL EnergyPlus recorded an additional allowance for unpaid amounts under the long-term power contract. In March 2012, the U.S. Bankruptcy Court for the District of Montana approved the request to terminate the contract, effective April 1, 2012. |
Reconciliation of Economic Activity
The following table reconciles unrealized pre-tax gains (losses) for the periods ended March 31, from the table within "Commodity Price Risk (Non-trading) - Economic Activity" in Note 14 to the Financial Statements to the special item identified as "Adjusted energy-related economic activity, net."
| | | | Three Months | | | | | 2013 | | 2012 | Operating Revenues | | | | | | | | | Unregulated retail electric and gas | | $ | (8) | | $ | 10 | | | Wholesale energy marketing | | | (822) | | | 852 | Operating Expenses | | | | | | | | | Fuel | | | (1) | | | 2 | | | Energy Purchases | | | 634 | | | (591) | Energy-related economic activity (a) | | | (197) | | | 273 | Option premiums | | | 1 | | | | Adjusted energy-related economic activity | | | (196) | | | 273 | Less: Economic activity realized, associated with the monetization of certain | | | | | | | | full-requirement sales contracts in 2010 | | | | | | 21 | Adjusted energy-related economic activity, net, pre-tax | | $ | (196) | | $ | 252 | | | | | | | | | | Adjusted energy-related economic activity, net, after-tax | | $ | (117) | | $ | 150 |
(a) | See Note 14 to the Financial Statements for additional information. |
2013 Outlook
Excluding special items, PPL ElectricEnergy Supply projects lower earnings in 20122013 compared with 2011,2012, primarily driven by lower energy prices, higher otherfuel costs, higher operation and maintenance expense, higher depreciation, and lower distribution revenue, which are expected to behigher financing costs, partially offset by higher transmission revenue, lower financing costs,capacity prices and lower income taxes.higher nuclear generation output despite scheduled outages for both Susquehanna units to implement a long-term solution to turbine blade issues.
In March 2012, PPL Electric filed a request with the PUC to increase distribution rates by approximately $105 million effective January 1, 2013. The proposed distribution rate increase would result in a 2.9% increase over PPL Electric's total rates at the time of the request. PPL Electric's application includes a request for an authorized return-on-equity of 11.25%. On October 19, 2012, the presiding Administrative Law Judge (ALJ) issued a decision recommending a rate increase of approximately $64 million, which represents an allowed return on equity of 9.74%. Exceptions to the ALJ's recommendation are due November 8, 2012. PPL Electric expects to file exceptions, together with certain other parties, to the ALJ's recommended decision. The PUC, which is expected to issue its order on the rate request in December 2012, can accept, reject or modify the ALJ's recommendation. PPL Electric cannot predict the outcome of this proceeding.
Earnings in 2012 and future periods are subject to various risks and uncertainties. See "Forward-Looking Information," the rest of this Item 2, and Notes 6 andNote 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in PPL Electric's 2011Energy Supply's 2012 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings. Statement of Income Analysis --
Unregulated Gross Energy Margins
Non-GAAP Financial Measure
The following discussion includes financial information prepared in accordance with GAAP, as well as a non-GAAP financial measure, "Unregulated Gross Energy Margins." "Unregulated Gross Energy Margins" is a single financial performance measure of PPL Energy Supply's competitive energy non-trading and trading activities. In calculating this measure, PPL Energy Supply's energy revenues are offset by the cost of fuel, energy purchases, certain other operation and maintenance expenses, primarily ancillary charges, and gross receipts tax, which is recorded in "Taxes, other than income". This performance measure is relevant to PPL Energy Supply due to the volatility in the individual revenue and expense lines on the Statements of Income that comprise "Unregulated Gross Energy Margins." This volatility stems from a number of factors, including the required netting of certain transactions with ISOs and significant fluctuations in unrealized gains and losses. Such factors could result in gains or losses being recorded in either "Wholesale energy marketing" or "Energy purchases" on the Statements of Income. This performance measure includes PLR revenues from energy sales to PPL Electric by PPL EnergyPlus, which are recorded in "Wholesale energy marketing to affiliate" revenue. PPL Energy Supply excludes from "Unregulated Gross Energy Margins" adjusted energy-related economic activity, which includes the changes in fair value of positions used to economically hedge a portion of the economic value of PPL Energy Supply's competitive generation assets, full-requirement sales contracts and retail activities. This economic value is subject to changes in fair value due to market price volatility of the input and output commodities (e.g., fuel and power) prior to the delivery period that was hedged. Also included in adjusted energy-related economic activity is the premium amortization associated with options and for 2012 the ineffective portion of qualifying cash flow hedges and economic activity realized associated with the monetization of certain full-requirement sales contracts in 2010. This economic activity is deferred, with the exception of the full-requirement sales contracts that were monetized, and included in "Unregulated Gross Energy Margins" over the delivery period that was hedged or upon realization. This measure is not intended to replace "Operating Income," which is determined in accordance with GAAP, as an indicator of overall operating performance. Other companies may use different measures to analyze and to report on the results of their operations. PPL Energy Supply believes that "Unregulated Gross Energy Margins" provides another criterion to make investment decisions. This performance measure is used, in conjunction with other information, internally by senior management to manage PPL Energy Supply's operations, analyze actual results compared with budget and measure certain corporate financial goals used in determining variable compensation.
Reconciliation of Non-GAAP Financial Measures
The following table reconciles "Unregulated Gross Energy Margins" as defined by PPL Energy Supply to "Operating Income" for the periods ended March 31.
| | | | | | 2013 Three Months | | 2012 Three Months | | | | | | | Unregulated | | | | | | | | Unregulated | | | | | | | | | | | | | Gross Energy | | | | | Operating | | Gross Energy | | | | | | Operating | | | | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | | Operating Revenues | | | | | | | | | | | | | | | | | | | | | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | $ | 977 | | $ | (1) | | | $ | 976 | | $ | 1,204 | | $ | 4 | (c) | | $ | 1,208 | | | | | Unrealized economic activity | | | | | | (822) | (d) | | | (822) | | | | | | 852 | (d) | | | 852 | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | | to affiliate | | | 14 | | | | | | | 14 | | | 21 | | | | | | | 21 | | Unregulated retail electric and gas | | | 246 | | | (8) | (d) | | | 238 | | | 214 | | | 10 | (d) | | | 224 | | Net energy trading margins | | | (11) | | | | | | | (11) | | | 8 | | | | | | | 8 | | Energy-related businesses | | | | | | 113 | | | | 113 | | | | | | 96 | | | | 96 | | | | Total Operating Revenues | | | 1,226 | | | (718) | | | | 508 | | | 1,447 | | | 962 | | | | 2,409 | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | | | | | | | | | Fuel | | | 299 | | | (1) | (d) | | | 298 | | | 214 | | | (3) | (d) | | | 211 | | Energy purchases | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | | 436 | | | (2) | | | | 434 | | | 636 | | | 23 | (c) | | | 659 | | | | | Unrealized economic activity | | | | | | (634) | (d) | | | (634) | | | | | | 591 | (d) | | | 591 | | Energy purchases from affiliate | | | 1 | | | | | | | 1 | | | 1 | | | | | | | 1 | | Other operation and maintenance | | | 5 | | | 230 | | | | 235 | | | 4 | | | 251 | | | | 255 | | Depreciation | | | | | | 78 | | | | 78 | | | | | | 64 | | | | 64 | | Taxes, other than income | | | 8 | | | 9 | | | | 17 | | | 8 | | | 10 | | | | 18 | | Energy-related businesses | | | | | | 110 | | | | 110 | | | | | | 92 | | | | 92 | | | | Total Operating Expenses | | | 749 | | | (210) | | | | 539 | | | 863 | | | 1,028 | | | | 1,891 | Total | | $ | 477 | | $ | (508) | | | $ | (31) | | $ | 584 | | $ | (66) | | | $ | 518 |
(a) | Represents amounts excluded from Margins. |
(b) | As reported on the Statements of Income. |
(c) | Represents energy-related economic activity as described in "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements. For the three months ended March 31, 2012, "Wholesale energy marketing - Realized" and "Energy purchases - Realized" includes a net pre-tax loss of $21 million related to the monetization of certain full-requirement sales contracts. |
(d) | Represents energy-related economic activity, which is subject to fluctuations in value due to market price volatility, as described in "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements. |
Changes in Non-GAAP Financial Measures
Unregulated Gross Energy Margins are generated through PPL Energy Supply's competitive non-trading and trading activities. PPL Energy Supply's non-trading energy business is managed on a geographic basis that is aligned with its generation fleet. The following table shows PPL Energy Supply's non-GAAP financial measure, Unregulated Gross Energy Margins, for the periods ended March 31, as well as the change between periods. The factors that gave rise to the changes are described below the table.
| | | | | Three Months | | | | | | | | | | 2013 | | 2012 | | Change | | | | | | | | | | | | | | | | | | | | | Non-trading | | | | | | | | | | | | | | | | | | | | Eastern U.S. | | | | | | | | | | | $ | 430 | | $ | 489 | | $ | (59) | | Western U.S. | | | | | | | | | | | | 58 | | | 87 | | | (29) | Net energy trading | | | | | | | | | | | | (11) | | | 8 | | | (19) | Total | | | | | | | | | | | $ | 477 | | $ | 584 | | $ | (107) |
Unregulated Gross Energy Margins | | | | | | | | | | | | | | Eastern U.S. | | | | | | | | | | | | | | The change in non-trading margins for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | | | | | Three Months | | | | | | | | Baseload energy prices | | | | | $ | (125) | Coal prices | | | | | | (10) | Nuclear fuel prices | | | | | | (6) | Full-requirement sales contracts | | | | | | 5 | Intermediate and peaking capacity prices | | | | | | 5 | Baseload capacity prices | | | | | | 6 | Intermediate and peaking Spark Spreads | | | | | | 14 | Ironwood acquisition which eliminated tolling expense | | | | | | 15 | Net economic availability of coal and hydroelectric plants | | | | | | 32 | Other | | | | | | 5 | Total | | | | | $ | (59) |
Western U.S.
Non-trading margins for the three months ended March 31, 2013 compared with 2012 were lower due to $43 million of lower wholesale prices, partially offset by $12 million of higher wholesale volumes.
Net Energy Trading Margins
Net energy trading margins for the three months ended March 31, 2013 compared with 2012 decreased as a result of lower margins of $16 million on gas positions due to higher prices.
Other Operation and Maintenance | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | Three Months | | | | | | | | Uncollectible accounts (a) | | | | $ | (11) | Costs at eastern fossil and hydroelectric plants (b) | | | | | (11) | Other | | | | | 2 | Total | | | | $ | (20) |
(a) | The decrease is primarily due to SMGT filing for protection under Chapter 11 of the U.S. Bankruptcy Code in 2011. $11 million of damages billed to SMGT were fully reserved in 2012. |
(b) | The decrease is primarily due to Brunner Island Unit 3 outage costs of $15 million in 2012 compared with no major outage costs in 2013, partially offset by $3 million of additional costs due to the Ironwood Acquisition. |
Depreciation
Depreciation increased by $14 million for the three months ended March 31, 2013 compared with 2012, primarily due to $10 million related to PP&E additions and $6 million attributable to the Ironwood Acquisition.
Interest Expense | | | | | | | | | | | | | | | The increase (decrease) in interest expense for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | | | | | | Three Months | | | | | | | | | Ironwood Acquisition (a) | | | | | $ | 4 | Capitalized interest | | | | | | 3 | Other | | | | | | 2 | Total | | | | | $ | 9 |
(a) | The increase was due to financings associated with the Ironwood Acquisition. |
Income Taxes | | | | | | | | | | | | | | The increase (decrease) in income taxes for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | | | | | | | | | Three Months | | | | | | | | Lower pre-tax book income | | | | | $ | (225) | State deferred tax rate change (a) | | | | | | 11 | Other | | | | | | 2 | Total | | | | | $ | (212) |
(a) | During the three months ended March 31, 2012, PPL Energy Supply recorded adjustments related to state deferred tax liabilities. |
See Note 5 to the Financial Statements for additional information on income taxes.
Financial Condition | | | | | | | | Liquidity and Capital Resources | | | | | | | | PPL Energy Supply had the following at: | | | | | | | | | | March 31, 2013 | | December 31, 2012 | | | | | | | | Cash and cash equivalents | | $ | 147 | | $ | 413 | Short-term debt | | $ | 481 | | $ | 356 |
The $266 million decrease in PPL Energy Supply's cash and cash equivalents position was primarily the net result of:
· | distributions to member of $313 million; |
· | capital expenditures of $124 million; |
· | a net increase in restricted cash and cash equivalents of $59 million; |
· | net cash provided by operating activities of $125 million; and |
· | a net increase in short-term debt of $125 million. |
PPL Energy Supply's cash provided by operating activities decreased by $129 million for the three months ended March 31, 2013, compared with 2012. This was primarily due to a $45 million increase in cash used by working capital components, a decrease in net income when adjusted for non-cash components of $31 million and a $36 million increase in defined benefit plans funding. Credit Facilities
PPL Energy Supply maintains credit facilities to provide liquidity and to backstop commercial paper issuances. At March 31, 2013, PPL Energy Supply's total committed borrowing capacity under its credit facilities and the use of this borrowing capacity were:
| | | | | | | | | Letters of | | | | | | | | | | | | | Credit Issued | | | | | | | | | | | and | | | | | | Committed | | | | Commercial | | Unused | | | | Capacity | | Borrowed | | Paper Backup | | Capacity | | | | | | | | | | | | | | | Syndicated Credit Facility | | $ | 3,000 | | | | | $ | 641 | | $ | 2,359 | Letter of Credit Facility (a) | | | 200 | | | n/a | | | 123 | | | 77 | Total PPL Energy Supply Credit Facilities (b) | | $ | 3,200 | | | | | $ | 764 | | $ | 2,436 |
(a) | In February 2013, PPL Energy Supply extended the expiration date from March 2013 and, effective April 2013, the capacity was reduced to $150 million. |
(b) | The commitments under PPL Energy Supply's credit facilities are provided by a diverse bank group, with no one bank and its affiliates providing an aggregate commitment of more than 11% of the total committed capacity. |
See Note 7 to the Financial Statements for further discussion of PPL Energy Supply's credit facilities.
Commercial Paper
PPL Energy Supply maintains a commercial paper program up to $750 million to provide an additional financing source to fund its short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by PPL Energy Supply's Syndicated Credit Facility. At March 31, 2013 and December 31, 2012, PPL Energy Supply had $481 million and $356 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.38% and 0.50%.
Rating Agency Actions
Moody's, S&P and Fitch periodically review the credit ratings on the debt securities of PPL Energy Supply and its subsidiaries. Based on their respective independent reviews, the rating agencies may make certain ratings revisions or ratings affirmations.
A credit rating reflects an assessment by the rating agency of the creditworthiness associated with an issuer and particular securities that it issues. The credit ratings of PPL Energy Supply and its subsidiaries are based on information provided by PPL Energy Supply and other sources. The ratings of Moody's, S&P and Fitch are not a recommendation to buy, sell or hold any securities of PPL Energy Supply or its subsidiaries. Such ratings may be subject to revisions or withdrawal by the agencies at any time and should be evaluated independently of each other and any other rating that may be assigned to the securities.
A downgrade in PPL Energy Supply's or its subsidiaries' credit ratings could result in higher borrowing costs and reduced access to capital markets. PPL Energy Supply and its subsidiaries have no credit rating triggers that would result in the reduction of access to capital markets or the acceleration of maturity dates of outstanding debt.
The rating agencies took the following actions related to PPL Energy Supply and its subsidiaries in 2013:
In February 2013, Moody's upgraded its rating, from B2 to Ba1, and revised the outlook from under review to stable for PPL Ironwood.
In April 2013, Fitch affirmed the BBB- rating and stable outlook at PPL Montana.
Ratings Triggers
PPL Energy Supply has various contracts, including contracts for the sale and purchase of electricity and fuel, commodity transportation and storage, tolling agreements and interest rate instruments, which contain provisions that require PPL Energy Supply to post additional collateral or permit the counterparty to terminate the contract if PPL Energy Supply's credit rating were to fall below investment grade. See Note 14 to the Financial Statements for a discussion of "Credit Risk-Related Contingent Features," including a discussion of the potential additional collateral that would have been required for derivative contracts in a net liability position at March 31, 2013. For additional information on PPL Energy Supply's liquidity and capital resources, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," in PPL Energy Supply's 2012 Form 10-K.
Risk Management
Market Risk
See Notes 13 and 14 to the Financial Statements for information about PPL Energy Supply's risk management objectives, valuation techniques and accounting designations.
The forward-looking information presented below provides estimates of what may occur in the future, assuming certain adverse market conditions and model assumptions. Actual future results may differ materially from those presented. These disclosures are not precise indicators of expected future losses, but only indicators of possible losses under normal market conditions at a given confidence level.
Commodity Price Risk (Non-trading)
PPL Energy Supply segregates its non-trading activities into two categories: hedge activity and economic activity. Transactions that are accounted for as hedge activity qualify for hedge accounting treatment. The economic activity category includes transactions that address a specific risk, but were not eligible for hedge accounting or for which hedge accounting was not elected. This activity includes the changes in fair value of positions used to hedge a portion of the economic value of PPL Energy Supply's competitive generation assets and full-requirement sales and retail contracts. This economic activity is subject to changes in fair value due to market price volatility of the input and output commodities (e.g., fuel and power). Although they do not receive hedge accounting treatment, these transactions are considered non-trading activity. See Note 14 to the Financial Statements for additional information.
To hedge the impact of market price volatility on PPL Energy Supply's energy-related assets, liabilities and other contractual arrangements, PPL Energy Supply both sells and purchases physical energy at the wholesale level under FERC market-based tariffs throughout the U.S. and enters into financial exchange-traded and over-the-counter contracts. PPL Energy Supply's non-trading commodity derivative contracts range in maturity through 2019.
The following table sets forth the changes in the net fair value of non-trading commodity derivative contracts for the period ended March 31. See Notes 13 and 14 to the Financial Statements for additional information.
| | | | | | | | Gains (Losses) | | | | | Three Months | | | | | | | 2013 | | 2012 | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | | | | | | | $ | 473 | | $ | 1,082 | Contracts realized or otherwise settled during the period | | | | | | | | | (137) | | | (279) | Fair value of new contracts entered into during the period (a) | | | | | | | | | 9 | | | (1) | Other changes in fair value | | | | | | | | | (116) | | | 413 | Fair value of contracts outstanding at the end of the period | | | | | | | | $ | 229 | | $ | 1,215 |
(a) | Represents the fair value of contracts at the end of the quarter of their inception. |
The following table segregates the net fair value of non-trading commodity derivative contracts at March 31, 2013, based on the observability of the information used to determine the fair value.
| | | Net Asset (Liability) | | | | Maturity | | | | | | | | Maturity | | | | | | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | Source of Fair Value | | | | | | | | | | | | | | | | Prices based on significant observable inputs (Level 2) | | $ | 238 | | $ | (21) | | $ | (8) | | $ | 6 | | $ | 215 | Prices based on significant unobservable inputs (Level 3) | | | (1) | | | 12 | | | 3 | | | | | | 14 | Fair value of contracts outstanding at the end of the period | | $ | 237 | | $ | (9) | | $ | (5) | | $ | 6 | | $ | 229 |
PPL Energy Supply sells electricity, capacity and related services and buys fuel on a forward basis to hedge the value of energy from its generation assets. If PPL Energy Supply were unable to deliver firm capacity and energy or to accept the delivery of fuel under its agreements, under certain circumstances it could be required to pay liquidating damages. These damages would be based on the difference between the market price and the contract price of the commodity. Depending on price changes in the wholesale energy markets, such damages could be significant. Extreme weather conditions, unplanned power plant outages, transmission disruptions, nonperformance by counterparties (or their counterparties) with which it has energy contracts and other factors could affect PPL Energy Supply's ability to meet its obligations, or cause significant increases in the market price of replacement energy. Although PPL Energy Supply attempts to mitigate these risks, there can be no assurance that it will be able to fully meet its firm obligations, that it will not be required to pay damages for failure to perform, or that it will not experience counterparty nonperformance in the future.
Commodity Price Risk (Trading)
PPL Energy Supply's trading commodity derivative contracts range in maturity through 2017. The following table sets forth changes in the net fair value of trading commodity derivative contracts for the period ended March 31. See Notes 13 and 14 to the Financial Statements for additional information.
| | | | Three Months | | | | | | | 2013 | | 2012 | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | | | | | | | $ | 29 | | $ | (4) | Contracts realized or otherwise settled during the period | | | | | | | | | (2) | | | | Fair value of new contracts entered into during the period (a) | | | | | | | | | (12) | | | 6 | Fair value of contracts outstanding at the end of the period | | | | | | | | $ | 15 | | $ | 2 |
(a) | Represents the fair value of contracts at the end of the quarter of their inception. |
The following table segregates the net fair value of trading commodity derivative contracts at March 31, 2013, based on the observability of the information used to determine the fair value.
| | Net Asset (Liability) | | | Maturity | | | | | | | Maturity | | | | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | Source of Fair Value | | | | | | | | | | | | | | | | Prices quoted in active markets for identical instruments (Level 1) | | $ | 1 | | | | | | | | | | | $ | 1 | Prices based on significant observable inputs (Level 2) | | | 5 | | $ | 9 | | | | | | | | | 14 | Fair value of contracts outstanding at the end of the period | | $ | 6 | | $ | 9 | | | | | | | | $ | 15 |
VaR Models
A VaR model is utilized to measure commodity price risk in unregulated gross energy margins for the non-trading and trading portfolios. VaR is a statistical model that attempts to estimate the value of potential loss over a given holding period under normal market conditions at a given confidence level. VaR is calculated using a Monte Carlo simulation technique based on a five-day holding period at a 95% confidence level. Given the company's disciplined hedging program, the non-trading VaR exposure is expected to be limited in the short-term. The VaR for portfolios using end-of-month results for the periods was as follows.
| | | Trading VaR | | Non-Trading VaR | | | | Three Months | | Three Months | | | | Ended | | Ended | | | | March 31, | | March 31, | | | | 2013 | | 2013 | 95% Confidence Level, Five-Day Holding Period | | | | | | | | Period End | | $ | 6 | | $ | 8 | | Average for the Period | | | 5 | | | 9 | | High | | | 6 | | | 9 | | Low | | | 3 | | | 8 |
The trading portfolio includes all proprietary trading positions, regardless of the delivery period. All positions not considered proprietary trading are considered non-trading. The non-trading portfolio includes the entire portfolio, including generation, with delivery periods through the next 12 months. Both the trading and non-trading VaR computations exclude FTRs due to the absence of reliable spot and forward markets. The fair value of the non-trading and trading FTR positions was insignificant at March 31, 2013. Interest Rate Risk
PPL Energy Supply and its subsidiaries issue debt to finance their operations, which exposes them to interest rate risk. PPL and PPL Energy Supply utilize various financial derivative instruments to adjust the mix of fixed and floating interest rates in PPL Energy Supply's debt portfolio, adjust the duration of its debt portfolio and lock in benchmark interest rates in anticipation of future financing, when appropriate. Risk limits under the risk management program are designed to balance risk exposure to volatility in interest expense and changes in the fair value of PPL Energy Supply's debt portfolio due to changes in the absolute level of interest rates. PPL Energy Supply had no interest rate hedges outstanding at March 31, 2013.
At March 31, 2013, PPL Energy Supply's potential annual exposure to increased interest expense, based on a 10% increase in interest rates, was not significant.
PPL Energy Supply is also exposed to changes in the fair value of its debt portfolio. PPL Energy Supply estimated that a 10% decrease in interest rates at March 31, 2013 would increase the fair value of its debt portfolio by $47 million.
NDT Funds - Securities Price Risk
In connection with certain NRC requirements, PPL Susquehanna maintains trust funds to fund certain costs of decommissioning the PPL Susquehanna nuclear plant (Susquehanna). At March 31, 2013, these funds were invested primarily in domestic equity securities and fixed-rate, fixed-income securities and are reflected at fair value on the Balance Sheet. The mix of securities is designed to provide returns sufficient to fund Susquehanna's decommissioning and to compensate for inflationary increases in decommissioning costs. However, the equity securities included in the trusts are exposed to price fluctuation in equity markets, and the values of fixed-rate, fixed-income securities are primarily exposed to changes in interest rates. PPL actively monitors the investment performance and periodically reviews asset allocation in accordance with its nuclear decommissioning trust policy statement. At March 31, 2013, a hypothetical 10% increase in interest rates and a 10% decrease in equity prices would have resulted in an estimated $55 million reduction in the fair value of the trust assets. See Notes 13 and 17 to the Financial Statements for additional information regarding the NDT funds.
Credit Risk
See Notes 11, 13 and 14 to the Financial Statements in this Form 10-Q and "Risk Management - Energy Marketing & Trading and Other - Credit Risk" in PPL Energy Supply's 2012 Form 10-K for additional information.
Related Party Transactions
PPL Energy Supply is not aware of any material ownership interests or operating responsibility by senior management of PPL Energy Supply in outside partnerships, including leasing transactions with variable interest entities or other entities doing business with PPL Energy Supply. See Note 11 to the Financial Statements for additional information on related party transactions.
Acquisitions, Development and Divestitures
PPL Energy Supply from time to time evaluates opportunities for potential acquisitions, divestitures and development projects. Development projects are reexamined based on market conditions and other factors to determine whether to proceed with the projects, sell, cancel or expand them, execute tolling agreements or pursue other options. See Note 8 to the Financial Statements for information on the more significant activities.
Environmental Matters
Extensive federal, state and local environmental laws and regulations are applicable to PPL Energy Supply's air emissions, water discharges and the management of hazardous and solid waste, as well as other aspects of PPL Energy Supply's business. The cost of compliance or alleged non-compliance cannot be predicted with certainty but could be material. In addition, costs may increase significantly if the requirements or scope of environmental laws or regulations, or similar rules, are expanded or changed by the relevant agencies. Costs may take the form of increased capital expenditures or operating and maintenance expenses, monetary fines, penalties or other restrictions. Many of these environmental law considerations are also applicable to the operations of key suppliers, or customers, such as coal producers and industrial power users, and may impact the costs of their products or their demand for PPL Energy Supply's services. Physical effects associated with climate change could include the impact of changes in weather patterns, such as storm frequency and intensity, and the resultant potential damage to PPL Energy Supply's generation assets as well as impacts on customers. In addition, changed weather patterns could potentially reduce annual rainfall in areas where PPL Energy Supply has hydro generating facilities or where river water is used to cool its fossil and nuclear powered generators. PPL Energy Supply cannot currently predict whether its businesses will experience these potential climate change-related risks or estimate the potential cost of their related consequences.
The following is a discussion of the more significant environmental matters.
Coal Combustion Residuals (CCRs) In June 2010, the EPA proposed two approaches to regulating the disposal and management of CCRs (as either hazardous or non-hazardous) under existing solid waste regulations. A final rulemaking is currently expected before the end of 2015. However, the timing of the final regulations could be accelerated by certain litigation that could require the EPA to issue its regulations sooner. Regulations could impact handling, disposal and/or beneficial use of CCRs. The financial impact could be material if CCRs are regulated as hazardous waste, and significant if regulated as non-hazardous, in accordance with the proposed rule.
Effluent Limitation Guidelines On April 19, 2013, the EPA issued proposed regulations to revise discharge limitations for steam electric generation wastewater permits. The proposed limitations are based on the EPA review of available treatment technologies and their capacity for reducing pollutants and include new requirements for fly ash and bottom ash handling and metal cleaning wastes, as well as new limits for scrubber wastewater, gasification wastewater and landfill leachate. The proposal contains several alternative approaches, some of which could significantly impact PPL Energy Supply's coal-fired plants. PPL Energy Supply will work with industry groups to comment on the proposed regulation. A final regulation is expected in May 2014. At the present time, PPL Energy Supply is unable to predict the outcome of this matter or estimate a range of reasonably possible costs, but the costs could be significant.
316(b) Cooling Water Intake Structures Rule In April 2011, the EPA published a draft regulation under Section 316(b) of the Clean Water Act, which regulates cooling water intakes for power plants. The draft rule has two provisions: one requires installation of Best Technology Available (BTA) to reduce mortality of aquatic organisms that are pulled into the plants cooling water system (entrainment), and the second imposes standards for reduction of mortality of aquatic organisms trapped on water intake screens (impingement). A final rule is expected in June 2013. The proposed regulation would apply to nearly all PPL Energy Supply-owned steam electric plants in Pennsylvania and Montana, potentially even including those equipped with closed-cycle cooling systems. PPL Energy Supply's compliance costs could be significant, especially if the final rule requires closed-cycle systems at plants that do not currently have them or conversions of once-through systems to closed-cycle.
GHG Regulations In 2013, the EPA is expected to finalize limits on GHG emissions from new power plants and to begin working on a proposal for such emissions from existing power plants. The EPA's proposal on GHG emissions from new power plants would effectively preclude construction on any coal-fired plants and could even be difficult for new gas-fired plants to meet. With respect to existing power plants, the impact could be significant, depending on the structure and stringency of the final rule. PPL Energy Supply, along with others in the industry, filed comments on the EPA's proposal related to GHG emissions from new plants.
MATS The EPA finalized MATS requiring fossil-fuel fired plants to reduce emissions of mercury and other hazardous air pollutants by April 16, 2015. The rule is being challenged by industry groups and states. The EPA has subsequently proposed changes to the rule with respect to new sources to address the concern that the rule effectively precludes construction of any new coal-fired plants. PPL Energy Supply is generally well-positioned to comply with MATS due to its recent investment in, and installation of, environmental controls such as wet flue gas desulfurization systems. PPL Energy Supply is evaluating chemical additive systems for mercury control at Brunner Island, and modifications to existing controls at Colstrip for improved particulate matter reductions. In September 2012, PPL Energy Supply announced its intention to place its Corette plant in long-term reserve status beginning in April 2015 due to expected market conditions and costs to comply with MATS.
CSAPR and CAIR In 2011, the EPA finalized its CSAPR regulating emissions of nitrous oxide and sulfur dioxide through new allowance trading programs which were to be implemented in two phases (2012 and 2014). Like its predecessor, the CAIR, CSAPR targeted sources in the eastern United States. In December 2011, the U.S. Court of Appeals for the District of Columbia. Circuit (the Court) stayed implementation of CSAPR, leaving CAIR in place. Subsequently, in August 2012, the Court vacated and remanded CSAPR back to the EPA for further rulemaking, again leaving CAIR in place. PPL Energy Supply
plants in Pennsylvania will continue to comply with CAIR through optimization of existing controls, balanced with emission allowance purchases. The Court's August decision leaves plants in CSAPR-affected states potentially exposed to more stringent emission reductions due to regional haze implementation (it was previously determined that CSAPR or CAIR participation satisfies regional haze requirements), and/or petitions to the EPA by downwind states under Section 126 of the Clean Air Act requesting the EPA to require plants that allegedly contribute to downwind non-attainment to take action to reduce emissions.
Regional Haze - Montana The EPA signed its final Federal Implementation Plan of the Regional Haze Rules for Montana in September 2012, with tighter emissions limits for Colstrip Units 1 & 2 based on the installation of new controls (no limits or additional controls were specified for Colstrip Units 3 & 4), and tighter emission limits for Corette (which are not based on additional controls). The cost of the potential additional controls for Colstrip Units 1 & 2, if required, could be significant. PPL Energy Supply expects to meet the tighter permit limits at Corette without any significant changes to operations, although other requirements have led to the planned suspension of operations at Corette beginning in April 2015 (see "MATS" discussion above).
See Note 10 to the Financial Statements in this Form 10-Q and "Item 1. Business - Environmental Matters" in PPL Energy Supply's 2012 Form 10-K for a discussion of environmental matters.
New Accounting Guidance
See Notes 2 and 19 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.
Application of Critical Accounting Policies
Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies. The following accounting policies are particularly important to the financial condition or results of operations, and require estimates or other judgments of matters inherently uncertain: price risk management, defined benefits, asset impairment (excluding investments), loss accruals, AROs and income taxes. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in PPL Energy Supply's 2012 Form 10-K for a discussion of each critical accounting policy.
PPL ELECTRIC UTILITIES CORPORATION AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following should be read in conjunction with PPL Electric's Condensed Consolidated Financial Statements and the accompanying Notes and with PPL Electric's 2012 Form 10-K. Capitalized terms and abbreviations are defined in the glossary. Dollars are in millions, unless otherwise noted.
"Management's Discussion and Analysis of Financial Condition and Results of Operations" includes the following information:
· | "Overview" provides a description of PPL Electric and its business strategy, a summary of Net Income Available to PPL and a discussion of certain events related to PPL Electric's results of operations and financial condition. |
· | "Results of Operations" provides a summary of PPL Electric's earnings and a description of key factors expected to impact future earnings. This section ends with explanations of significant changes in principal line items on PPL Electric's Statements of Income, comparing the three months ended March 31, 2013 with 2012. |
· | "Financial Condition - Liquidity and Capital Resources" provides an analysis of PPL Electric's liquidity position and credit profile. This section also includes a discussion of rating agency actions. |
· | "Financial Condition - Risk Management" provides an explanation of PPL Electric's risk management programs relating to market and credit risk. |
Overview
Introduction
PPL Electric is an electricity transmission and distribution service provider in eastern and central Pennsylvania with headquarters in Allentown, Pennsylvania. PPL Electric is subject to regulation as a public utility by the PUC, and certain of its transmission activities are subject to the jurisdiction of FERC under the Federal Power Act. PPL Electric delivers electricity in its Pennsylvania service area and provides electricity supply to retail customers in that area as a PLR under the Customer Choice Act.
Business Strategy
PPL Electric's strategy for its regulated electricity delivery business is to provide safe, reliable service to its customers and achieve stable, long-term growth in earnings and rate base. Rate base is expected to grow as a result of significant capital expenditure programs aimed at maintaining existing assets and improving system reliability. PPL Electric is focused on timely recovery of costs, efficient operations, strong customer service and constructive regulatory relationships.
To manage financing costs and access to credit markets and to fund its capital expenditure program, a key objective for PPL Electric is to maintain a strong credit profile and strong liquidity position.
Timely recovery of costs to maintain and enhance the reliability of its delivery system, including the replacement of aging distribution assets, is required in order to maintain strong cash flows and a strong credit profile. Traditionally, such cost recovery would be pursued through periodic base rate case proceedings with the PUC. As such costs continue to increase, more frequent rate case proceedings may be required or an alternative rate making process would need to be implemented in order to achieve more timely recovery. See "Legislation - Regulatory Procedures and Mechanisms" below for information on Pennsylvania's new alternative rate-making mechanism.
Transmission costs are recovered through a FERC Formula Rate mechanism, which is updated annually for costs incurred and assets placed in service. Accordingly, increased costs, including those related to the replacement of aging transmission assets and the PJM-approved Regional Transmission Line Expansion Plan, are recovered on a timely basis. Financial and Operational Developments
Pennsylvania Gross Delivery Margins
Distribution
Margins increased for the three months ended March 31, 2013 compared with 2012 primarily due to a $13 million favorable effect of mild weather in 2012 and a $19 million favorable effect of price, largely comprised of higher base rates, effective January 1, 2013 as a result of the 2012 rate case and higher volumes of $3 million.
Transmission
Margins increased for the three months ended March 31, 2013 compared with 2012 primarily due to increased investment in plant and the recovery of additional costs through the FERC formula-based rates.
Unregulated Gross Energy Margins | | | | | | | | | | | | | | Eastern U.S. | | | | | | | | | | | | | | The change in non-trading margins for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | |
| | | | Three Months | | | | | | | | Baseload energy prices | | | | | $ | (125) | Coal prices | | | | | | (10) | Nuclear fuel prices | | | | | | (6) | Full-requirement sales contracts | | | | | | 5 | Intermediate and peaking capacity prices | | | | | | 5 | Baseload capacity prices | | | | | | 6 | Intermediate and peaking Spark Spreads | | | | | | 14 | Ironwood acquisition which eliminated tolling expense | | | | | | 15 | Net economic availability of coal and hydroelectric plants | | | | | | 32 | Other | | | | | | 5 | Total | | | | | $ | (59) |
Western U.S.
Non-trading margins for the three months ended March 31, 2013 compared with 2012 were lower due to $43 million of lower wholesale prices, partially offset by $12 million of higher wholesale volumes.
Net Energy Trading Margins
Net energy trading margins for the three months ended March 31, 2013 compared with 2012 decreased as a result of lower margins of $16 million on gas positions due to higher prices.
Utility Revenues | | | | | | | | | | | | | The increase (decrease) in utility revenues for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | | | | | | | | | | | Three Months | Domestic: | | | | | | | | PPL Electric (a) | | | | | $ | 55 | | LKE (b) | | | | | | 95 | | Total Domestic | | | | | | 150 | | | | | | | | | | | U.K.: | | | | | | | | Price (c) | | | | | | 57 | | Volume | | | | | | 5 | | Recovery of allowed revenues | | | | | | 5 | | Foreign currency exchange rates | | | | | | 10 | | Other (d) | | | | | | 9 | | Total U.K. | | | | | | 86 | Total | | | | | $ | 236 |
(a) | See "Pennsylvania Gross Delivery Margins" for further information. |
(b) | See "Kentucky Gross Margins" for further information. |
(c) | Due to price increases effective April 1, 2012. |
(d) | This increase is primarily due to $8 million of third-party engineering work, which is offset by expenses in "Other operation and maintenance". |
Other Operation and Maintenance | | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | | | | | | | | | | | | | | | Three Months | Domestic: | | | | | | | Uncollectible accounts (a) | | | | $ | (16) | | LKE coal plant outages (b) | | | | | (14) | | Costs at eastern fossil and hydroelectric plants (c) | | | | | (11) | | Pension and postretirement costs | | | | | 4 | | Other | | | | | 2 | U.K.: | | | | | | | Third-party engineering work (d) | | | | | 8 | | Network maintenance expense (e) | | | | | 7 | | Employee related expenses | | | | | (4) | | Severance compensation | | | | | (4) | | Other | | | | | (2) | Total | | | | $ | (30) |
(a) | The decrease is primarily due to SMGT filing for protection under Chapter 11 of the U.S. Bankruptcy Code in 2011. $11 million of damages billed to SMGT were fully reserved in 2012. |
(b) | The decrease is primarily due to the timing and scope of scheduled outages. |
(c) | The decrease is primarily due to Brunner Island Unit 3 outage costs of $15 million in 2012 compared with no major outage costs in 2013, partially offset by $3 million of additional costs due to the Ironwood Acquisition. |
(d) | These expenses are offset by revenues reflected in "Utility" on the Statements of Income. |
(e) | The increase is primarily due to higher tree trimming expense. |
Depreciation | | | | | | | | | | | The increase (decrease) in depreciation for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | | | | | | | Three Months | | | | | | | | Additions to PP&E | | | | | $ | 21 | LKE lower depreciation rates effective January 1, 2013 | | | | | | (5) | Ironwood Acquisition | | | | | | 6 | Other | | | | | | (2) | Total | | | | | $ | 20 |
Other Income (Expense) - net
The $139 million increase in other income (expense) - net for the three months ended March 31, 2013 compared with 2012 was primarily due to $119 million of realized and unrealized gains on economic foreign currency contracts compared with losses in 2012 of $18 million.
See Note 12 to the Financial Statements for further details.
Interest Expense | | | | | | | | | | | | The increase (decrease) in interest expense for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | | | | Three Months | | | | | | | | | Long-term debt interest expense (a) | | | | | $ | 14 | Ironwood Acquisition (b) | | | | | | 4 | Other | | | | | | 3 | Total | | | | | $ | 21 |
(a) | The increase was primarily due to PPL Capital Funding's June 2012 issuance of $400 million, 4.2% Senior Notes due 2022 and October 2012 issuance of $400 million, 3.5% Senior Notes due 2022. Also, contributing to the increase was higher accretion expense on WPD index linked bonds and interest on WPD (East Midlands') April 2012 issuance of £100 million, 5.25% Senior Notes due 2023. |
(b) | The increase was due to financings associated with the Ironwood Acquisition. |
Income Taxes | | | | | | | | | | | The increase (decrease) in income taxes for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | | | Three Months | | | | | | | | | Lower pre-tax book income | | | | | $ | (119) | Foreign tax reserve adjustments | | | | | | (3) | Net operating loss carryforward adjustments (a) | | | | | | 6 | State deferred tax rate change (b) | | | | | | 11 | Other | | | | | | (3) | Total | | | | | $ | (108) |
(a) | During the three months ended March 31, 2012, PPL recorded adjustments to deferred taxes related to net operating loss carryforwards of LKE based on income tax return adjustments. |
(b) | During the three months ended March 31, 2012, PPL recorded adjustments related to state deferred tax liabilities. |
See Note 5 to the Financial Statements for additional information on income taxes.
Financial Condition | | | | | | | | Liquidity and Capital Resources | | | | | | | | PPL had the following at: |
| | March 31, 2013 | | December 31, 2012 | | | | | | | | Cash and cash equivalents | | $ | 853 | | $ | 901 | Short-term debt | | $ | 1,061 | | $ | 652 |
At March 31, 2013, $335 million of cash and cash equivalents were denominated in GBP. If these amounts would be remitted as dividends, PPL may be subject to additional U.S. taxes, net of allowable foreign tax credits. Historically, dividends paid by foreign subsidiaries have been distributions of the current year's earnings. See Note 5 to the Financial Statements in PPL's 2012 Form 10-K for additional information on undistributed earnings of WPD.
The $48 million decrease in PPL's cash and cash equivalents position was primarily the net result of:
· | capital expenditures of $828 million; |
· | the payment of $210 million of common stock dividends; |
· | a $52 million net increase in restricted cash and cash equivalents; and |
· | $24 million of contract adjustment payments; partially offset by |
· | proceeds of $432 million from the issuance of long-term debt, net of costs; |
· | net increase in short-term debt of $416 million; and |
· | net cash provided by operating activities of $244 million. |
PPL's cash provided by operating activities decreased by $484 million for the three months ended March 31, 2013 compared with 2012. The decrease was primarily due to:
· | a $336 million increase in cash used by components of working capital (primarily due to changes in accounts receivable of $219 million resulting from higher base rates and favorable effects of weather and counterparty collateral of $129 million); and |
· | a $221 million increase in defined benefit plans funding; partially offset by |
· | a $72 million increase in net income, when adjusted for non-cash components. |
Capital expenditures increased by $146 million for the three months ended March 31, 2013 compared with 2012, primarily due to the Susquehanna-Roseland transmission project and environmental projects at Mill Creek and Ghent, and construction of Cane Run Unit 7.
Credit Facilities
PPL maintains credit facilities to provide liquidity and to backstop commercial paper issuances. At March 31, 2013, PPL's total committed borrowing capacity under its credit facilities and the use of this borrowing capacity were:
| | | | | | | | | Letters of | | | | | | | | | | | | | Credit Issued | | | | | | | | | | | | | and | | | | | | | Committed | | | | Commercial | | Unused | | | | Capacity | | Borrowed | | Paper Backup | | Capacity | | | | | | | | | | | PPL Energy Supply Credit Facilities (a) | | $ | 3,200 | | | | | $ | 764 | | $ | 2,436 | PPL Electric Credit Facilities (b) | | | 400 | | | | | | 126 | | | 274 | LG&E Syndicated Credit Facility | | | 500 | | | | | | 70 | | | 430 | KU Credit Facilities (c) | | | 598 | | | | | | 313 | | | 285 | | Total Domestic Credit Facilities (d) | | $ | 4,698 | | | | | $ | 1,273 | | $ | 3,425 | | | | | | | | | | | | | | | PPL WW Syndicated Credit Facility (e) | | £ | 210 | | £ | 109 | | | n/a | | £ | 101 | WPD (South West) Syndicated Credit Facility | | | 245 | | | | | | n/a | | | 245 | WPD (East Midlands) Syndicated Credit Facility (f) | | | 300 | | | 65 | | | | | | 235 | WPD (West Midlands) Syndicated Credit Facility | | | 300 | | | | | | | | | 300 | | Total WPD Credit Facilities (g) | | £ | 1,055 | | £ | 174 | | | | | £ | 881 |
(a) | In February 2013, PPL Energy Supply extended a letter of credit facility expiration date from March 2013 and, effective April 2013, the capacity was reduced to $150 million. |
(b) | Committed capacity includes a $100 million credit facility related to an asset-backed commercial paper program through which PPL Electric obtains financing by selling and contributing its eligible accounts receivable and unbilled revenue to a special purpose, wholly owned subsidiary on an ongoing basis. The subsidiary pledges these assets to secure loans of up to an aggregate of $100 million from a commercial paper conduit sponsored by a financial institution. At March 31, 2013, based on accounts receivable and unbilled revenue pledged, the amount available for borrowing under the facility was $100 million. |
(c) | In May 2013, KU extended its $198 million letter of credit facility to May 2016. |
(d) | The commitments under PPL's domestic credit facilities are provided by a diverse bank group, with no one bank and its affiliates providing an aggregate commitment of more than 9% of the total committed capacity. |
(e) | In December 2012, the PPL WW syndicated credit facility that was set to expire in January 2013 was replaced and the capacity was increased from £150 million. The amount borrowed at March 31, 2013 was a USD-denominated borrowing of $171 million, which equated to £109 million at the time of borrowing and bore interest at 1.9034%. |
(f) | The amount borrowed at March 31, 2013 was a GBP-denominated borrowing of £65 million, which equated to $99 million and bore interest at 1.30%. |
(g) | At March 31, 2013, the USD equivalent of unused capacity under WPD's committed credit facilities was $1.3 billion. The commitments under WPD's credit facilities are provided by a diverse bank group with no one bank providing more than 13% of the total committed capacity. |
See Note 7 to the Financial Statements for further discussion of PPL's credit facilities.
Commercial Paper
PPL Energy Supply maintains a commercial paper program for up to $750 million to provide an additional financing source to fund its short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by PPL Energy Supply's Syndicated Credit Facility. At March 31, 2013 and December 31, 2012, PPL Energy Supply had $481 million and $356 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.38% and 0.50%.
PPL Electric maintains a commercial paper program for up to $300 million to provide an additional financing source to fund its short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by PPL Electric's Syndicated Credit Facility. At March 31, 2013, PPL Electric had $125 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheet, at a weighted-average interest rate of 0.39%. PPL Electric had no commercial paper outstanding at December 31, 2012.
In April 2013, LG&E and KU each increased the capacity of their commercial paper programs from $250 million to $350 million to provide an additional financing source to fund their short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by LG&E's and KU's Syndicated Credit Facilities. At March 31, 2013 and December 31, 2012, LG&E had $70 million and $55 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.36% and 0.42%. At March 31, 2013 and December 31, 2012, KU had $115 million and $70 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.36% and 0.42%.
Long-term Debt and Equity Securities
See "Overview" above for information regarding equity forward agreements and the 2010 Equity Units.
In March 2013, PPL Capital Funding issued $450 million of its 5.90% Junior Subordinated Notes due 2073. PPL Capital Funding received proceeds of $436 million, net of underwriting fees, which will be loaned to or invested in affiliates of PPL Capital Funding and used to fund their capital expenditures and other general corporate purposes.
In addition, PPL has reduced the estimate of its plans to issue new shares of common stock in 2013 by $100 million from the $350 million reported in its 2012 Form 10-K.
Common Stock Dividends
In February 2013, PPL declared its quarterly common stock dividend, payable April 1, 2013, at 36.75 cents per share (equivalent to $1.47 per annum). Future dividends, declared at the discretion of the Board of Directors, will be dependent upon future earnings, cash flows, financial and legal requirements and other factors.
Rating Agency Actions
Moody's, S&P and Fitch periodically review the credit ratings on the debt securities of PPL and its subsidiaries. Based on their respective independent reviews, the rating agencies may make certain ratings revisions or ratings affirmations.
A credit rating reflects an assessment by the rating agency of the creditworthiness associated with an issuer and particular securities that it issues. The credit ratings of PPL and its subsidiaries are based on information provided by PPL and other sources. The ratings of Moody's, S&P and Fitch are not a recommendation to buy, sell or hold any securities of PPL or its subsidiaries. Such ratings may be subject to revisions or withdrawal by the agencies at any time and should be evaluated independently of each other and any other rating that may be assigned to the securities.
A downgrade in PPL's or its subsidiaries' credit ratings could result in higher borrowing costs and reduced access to capital markets. PPL and its subsidiaries have no credit rating triggers that would result in the reduction of access to capital markets or the acceleration of maturity dates of outstanding debt.
The rating agencies took the following actions related to PPL and its subsidiaries during 2013:
In February 2013, Moody's upgraded its rating, from B2 to Ba1, and revised the outlook from under review to stable for PPL Ironwood.
In March 2013, S&P, Moody's and Fitch assigned ratings of BB+, Ba1 and BB+ to PPL Capital Funding's $450 million 5.90% Junior Subordinated Notes due 2073. Fitch also assigned a stable outlook to these notes.
In April 2013, Fitch affirmed the BBB- rating and stable outlook at PPL Montana.
Ratings Triggers
PPL and PPL Energy Supply have various contracts, including contracts for the sale and purchase of electricity and fuel, commodity transportation and storage, tolling agreements and interest rate and foreign currency instruments, which contain provisions that require PPL and PPL Energy Supply to post additional collateral or permit the counterparty to terminate the contract, if PPL's or PPL Energy Supply's credit rating were to fall below investment grade. See Note 14 to the Financial Statements for a discussion of "Credit Risk-Related Contingent Features," including a discussion of the potential additional collateral that would have been required for derivative contracts in a net liability position at March 31, 2013.
For additional information on PPL's liquidity and capital resources, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," in PPL's 2012 Form 10-K.
Risk Management
Market Risk
See Notes 13 and 14 to the Financial Statements for information about PPL's risk management objectives, valuation techniques and accounting designations.
The forward-looking information presented below provides estimates of what may occur in the future, assuming certain adverse market conditions and model assumptions. Actual future results may differ materially from those presented. These disclosures are not precise indicators of expected future losses, but only indicators of possible losses under normal market conditions at a given confidence level.
Commodity Price Risk (Non-trading)
PPL segregates its non-trading activities into two categories: hedge activity and economic activity. Transactions that are accounted for as hedge activity qualify for hedge accounting treatment. The economic activity category includes transactions that address a specific risk, but were not eligible for hedge accounting or for which hedge accounting was not elected. This activity includes the changes in fair value of positions used to hedge a portion of the economic value of PPL's competitive generation assets and full-requirement sales and retail contracts. This economic activity is subject to changes in fair value due to market price volatility of the input and output commodities (e.g., fuel and power). Although they do not receive hedge accounting treatment, these transactions are considered non-trading activity. See Note 14 to the Financial Statements for additional information.
To hedge the impact of market price volatility on PPL's energy-related assets, liabilities and other contractual arrangements, PPL both sells and purchases physical energy at the wholesale level under FERC market-based tariffs throughout the U.S. and enters into financial exchange-traded and over-the-counter contracts. PPL's non-trading commodity derivative contracts range in maturity through 2019.
The following table sets forth the changes in the net fair value of non-trading commodity derivative contracts for the periods ended March 31. See Notes 13 and 14 to the Financial Statements for additional information.
| | | | | | | | Gains (Losses) | | | | | Three Months | | | | | | | 2013 | | 2012 | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | | | | | | | $ | 473 | | $ | 1,082 | Contracts realized or otherwise settled during the period | | | | | | | | | (137) | | | (279) | Fair value of new contracts entered into during the period (a) | | | | | | | | | 9 | | | (1) | Other changes in fair value | | | | | | | | | (116) | | | 413 | Fair value of contracts outstanding at the end of the period | | | | | | | | $ | 229 | | $ | 1,215 |
(a) | Represents the fair value of contracts at the end of the quarter of their inception. |
The following table segregates the net fair value of non-trading commodity derivative contracts at March 31, 2013, based on the observability of the information used to determine the fair value.
| | | Net Asset (Liability) | | | | Maturity | | | | | | | | Maturity | | | | | | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | Source of Fair Value | | | | | | | | | | | | | | | | Prices based on significant observable inputs (Level 2) | | $ | 238 | | $ | (21) | | $ | (8) | | $ | 6 | | $ | 215 | Prices based on significant unobservable inputs (Level 3) | | | (1) | | | 12 | | | 3 | | | | | | 14 | Fair value of contracts outstanding at the end of the period | | $ | 237 | | $ | (9) | | $ | (5) | | $ | 6 | | $ | 229 |
PPL sells electricity, capacity and related services and buys fuel on a forward basis to hedge the value of energy from its generation assets. If PPL were unable to deliver firm capacity and energy or to accept the delivery of fuel under its agreements, under certain circumstances it could be required to pay liquidating damages. These damages would be based on the difference between the market price and the contract price of the commodity. Depending on price changes in the wholesale energy markets, such damages could be significant. Extreme weather conditions, unplanned power plant outages, transmission disruptions, nonperformance by counterparties (or their counterparties) with which it has energy contracts and other factors could affect PPL's ability to meet its obligations, or cause significant increases in the market price of replacement energy. Although PPL attempts to mitigate these risks, there can be no assurance that it will be able to fully meet its firm obligations, that it will not be required to pay damages for failure to perform, or that it will not experience counterparty nonperformance in the future.
Commodity Price Risk (Trading)
PPL's trading commodity derivative contracts range in maturity through 2017. The following table sets forth changes in the net fair value of trading commodity derivative contracts for the periods ended March 31. See Notes 13 and 14 to the Financial Statements for additional information.
| | | | | | | | Gains (Losses) | | | | | Three Months | | | | | | | 2013 | | 2012 | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | | | | | | | $ | 29 | | $ | (4) | Contracts realized or otherwise settled during the period | | | | | | | | | (2) | | | | Fair value of new contracts entered into during the period (a) | | | | | | | | | (12) | | | 6 | Fair value of contracts outstanding at the end of the period | | | | | | | | $ | 15 | | $ | 2 |
(a) | Represents the fair value of contracts at the end of the quarter of their inception. |
The following table segregates the net fair value of trading commodity derivative contracts at March 31, 2013, based on the observability of the information used to determine the fair value.
| | Net Asset (Liability) | | | Maturity | | | | | | | Maturity | | | | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | Source of Fair Value | | | | | | | | | | | | | | | | Prices quoted in active markets for identical instruments (Level 1) | | $ | 1 | | | | | | | | | | | $ | 1 | Prices based on significant observable inputs (Level 2) | | | 5 | | $ | 9 | | | | | | | | | 14 | Fair value of contracts outstanding at the end of the period | | $ | 6 | | $ | 9 | | | | | | | | $ | 15 |
VaR Models
A VaR model is utilized to measure commodity price risk in unregulated gross energy margins for the non-trading and trading portfolios. VaR is a statistical model that attempts to estimate the value of potential loss over a given holding period under normal market conditions at a given confidence level. VaR is calculated using a Monte Carlo simulation technique based on a five-day holding period at a 95% confidence level. Given the company's disciplined hedging program, the non-trading VaR exposure is expected to be limited in the short-term. The VaR for portfolios using end-of-month results for the periods was as follows.
| | | Trading VaR | | Non-Trading VaR | | | | Three Months | | Three Months | | | | Ended | | Ended | | | | March 31, | | March 31, | | | | 2013 | | 2013 | 95% Confidence Level, Five-Day Holding Period | | | | | | | | Period End | | $ | 6 | | $ | 8 | | Average for the Period | | | 5 | | | 9 | | High | | | 6 | | | 9 | | Low | | | 3 | | | 8 |
The trading portfolio includes all proprietary trading positions, regardless of the delivery period. All positions not considered proprietary trading are considered non-trading. The non-trading portfolio includes the entire portfolio, including generation, with delivery periods through the next 12 months. Both the trading and non-trading VaR computations exclude FTRs due to the absence of reliable spot and forward markets. The fair value of the non-trading and trading FTR positions was insignificant at March 31, 2013.
Interest Rate Risk
PPL and its subsidiaries issue debt to finance their operations, which exposes them to interest rate risk. PPL utilizes various financial derivative instruments to adjust the mix of fixed and floating interest rates in its debt portfolio, adjust the duration of its debt portfolio and lock in benchmark interest rates in anticipation of future financing, when appropriate. Risk limits under the risk management program are designed to balance risk exposure to volatility in interest expense and changes in the fair value of PPL's debt portfolio due to changes in the absolute level of interest rates.
At March 31, 2013, PPL's potential annual exposure to increased interest expense, based on a 10% increase in interest rates, was not significant.
PPL is also exposed to changes in the fair value of its domestic and international debt portfolios. PPL estimated that a 10% decrease in interest rates at March 31, 2013 would increase the fair value of its debt portfolio by $563 million.
At March 31, 2013, PPL had the following interest rate hedges outstanding:
| | | | | | | | | Effect of a | | | | | | | Fair Value, | | 10% Adverse | | | | Exposure | | Net - Asset | | Movement | | | | Hedged | | (Liability) (a) | | in Rates (b) | Cash flow hedges | | | | | | | | | | | Interest rate swaps (c) | | $ | 1,148 | | $ | 12 | | $ | (35) | | Cross-currency swaps (d) | | | 1,262 | | | 82 | | | (171) | Economic activity | | | | | | | | | | | Interest rate swaps (e) | | | 179 | | | (55) | | | (3) |
(a) | Includes accrued interest, if applicable. |
(b) | Effects of adverse movements decrease assets or increase liabilities, as applicable, which could result in an asset becoming a liability. Sensitivities represent a 10% adverse movement in interest rates, except for cross-currency swaps which also includes foreign currency exchange rates. |
(c) | PPL utilizes various risk management instruments to reduce its exposure to the expected future cash flow variability of its debt instruments. These risks include exposure to adverse interest rate movements for outstanding variable rate debt and for future anticipated financing. While PPL is exposed to changes in the fair value of these instruments, any changes in the fair value of such cash flow hedges are recorded in equity or as regulatory assets or liabilities, if recoverable through regulated rates. The changes in fair value of these instruments are then reclassified into earnings in the same period during which the item being hedged affects earnings. The positions outstanding at March 31, 2013 mature through 2043. |
(d) | PPL utilizes cross-currency swaps to hedge the interest payments and principal of WPD's U.S. dollar-denominated senior notes. While PPL is exposed to changes in the fair value of these instruments, any change in the fair value of these instruments is recorded in equity and reclassified into earnings in the same period during which the item being hedged affects earnings. The positions outstanding at March 31, 2013 mature through 2028. |
(e) | PPL utilizes various risk management instruments to reduce its exposure to the expected future cash flow variability of its debt instruments. These risks include exposure to adverse interest rate movements for outstanding variable rate debt and for future anticipated financing. While PPL is exposed to changes in the fair value of these instruments, any realized changes in the fair value of such economic positions are recoverable through regulated rates and any subsequent changes in fair value of these derivatives are included in regulatory assets or liabilities. The positions outstanding at March 31, 2013 mature through 2033. |
Foreign Currency Risk
PPL is exposed to foreign currency risk, primarily through investments in U.K. affiliates. In addition, PPL's domestic operations may make purchases of equipment in currencies other than U.S. dollars.
PPL has adopted a foreign currency risk management program designed to hedge certain foreign currency exposures, including firm commitments, recognized assets or liabilities, anticipated transactions and net investments. In addition, PPL enters into financial instruments to protect against foreign currency translation risk of expected earnings.
PPL had the following foreign currency hedges outstanding March 31, 2013:
| | | | | | | Effect of a | | | | | | | | 10% | | | | | | | | Adverse | | | | | | | | Movement | | | | | | | | in Foreign | | | | | | Fair Value, | | Currency | | | | Exposure | | Net - Asset | | Exchange | | | | Hedged | | (Liability) | | Rates (a) | | | | | | | | | | | | Net investment hedges (b) | | £ | 162 | | $ | 15 | | $ | (25) | Economic activity (c) | | | 1,175 | | | 78 | | | (167) |
(a) | Effects of adverse movements decrease assets or increase liabilities, as applicable, which could result in an asset becoming a liability. |
(b) | To protect the value of a portion of its net investment in WPD, PPL executes forward contracts to sell GBP. The positions outstanding at March 31, 2013 mature through 2013. Excludes the amount of an intercompany loan classified as a net investment hedge. See Note 14 to the Financial Statements for additional information. |
(c) | To economically hedge the translation of expected income denominated in GBP to U.S. dollars, PPL enters into a combination of average rate forwards and average rate options to sell GBP. The forwards and options outstanding at March 31, 2013 mature through 2015. |
NDT Funds - Securities Price Risk
In connection with certain NRC requirements, PPL Susquehanna maintains trust funds to fund certain costs of decommissioning the PPL Susquehanna nuclear plant (Susquehanna). At March 31, 2013, these funds were invested primarily in domestic equity securities and fixed-rate, fixed-income securities and are reflected at fair value on the Balance Sheet. The mix of securities is designed to provide returns sufficient to fund Susquehanna's decommissioning and to compensate for inflationary increases in decommissioning costs. However, the equity securities included in the trusts are exposed to price fluctuation in equity markets, and the values of fixed-rate, fixed-income securities are primarily exposed to changes in interest rates. PPL actively monitors the investment performance and periodically reviews asset allocation in accordance with its nuclear decommissioning trust policy statement. At March 31, 2013, a hypothetical 10% increase in interest rates and a 10% decrease in equity prices would have resulted in an estimated $55 million reduction in the fair value of the trust assets. See Notes 13 and 17 to the Financial Statements for additional information regarding the NDT funds.
Credit Risk
See Notes 13 and 14 to the Financial Statements in this Form 10-Q and "Risk Management - Energy Marketing & Trading and Other - Credit Risk" in PPL's 2012 Form 10-K for additional information.
Foreign Currency Translation
The value of the British pound sterling fluctuates in relation to the U.S. dollar. Changes in this exchange rate resulted in a foreign currency translation loss of $256 million for the three months ended March 31, 2013, which primarily reflected a $696 million decrease to PP&E and goodwill offset by a decrease of $440 million to net liabilities. Changes in this exchange rate resulted in a foreign currency translation gain of $76 million for the three months ended March 31, 2012, which primarily reflected a $188 million increase to PP&E and goodwill offset by an increase of $112 million to net liabilities. The impact of foreign currency translation is recorded in AOCI.
Related Party Transactions
PPL is not aware of any material ownership interests or operating responsibility by senior management of PPL, PPL Energy Supply, PPL Electric, LKE, LG&E or KU in outside partnerships, including leasing transactions with variable interest entities or other entities doing business with PPL.
Acquisitions, Development and Divestitures
PPL from time to time evaluates opportunities for potential acquisitions, divestitures and development projects. Development projects are reexamined based on market conditions and other factors to determine whether to proceed with the projects, sell, cancel or expand them, execute tolling agreements or pursue other options. See Note 8 to the Financial Statements for information on the more significant activities.
Environmental Matters
Extensive federal, state and local environmental laws and regulations are applicable to PPL's air emissions, water discharges and the management of hazardous and solid waste, as well as other aspects of PPL's business. The cost of compliance or alleged non-compliance cannot be predicted with certainty but could be material. In addition, costs may increase significantly if the requirements or scope of environmental laws or regulations, or similar rules, are expanded or changed by the relevant agencies. Costs may take the form of increased capital expenditures or operating and maintenance expenses, monetary fines, penalties or other restrictions. Many of these environmental law considerations are also applicable to the operations of key suppliers, or customers, such as coal producers and industrial power users, and may impact the costs for their products or their demand for PPL's services.
Physical effects associated with climate change could include the impact of changes in weather patterns, such as storm frequency and intensity, and the resultant potential damage to PPL's generation assets, electricity transmission and distribution systems, as well as impacts on customers. In addition, changed weather patterns could potentially reduce annual rainfall in areas where PPL has hydro generating facilities or where river water is used to cool its fossil and nuclear powered generators. PPL cannot currently predict whether its businesses will experience these potential climate change-related risks or estimate the potential cost of their related consequences.
The following is a discussion of the more significant environmental matters.
Coal Combustion Residuals (CCRs) In June 2010, the EPA proposed two approaches to regulating the disposal and management of CCRs (as either hazardous or non-hazardous) under existing solid waste regulations. A final rulemaking is currently expected before the end of 2015. However, the timing of the final regulations could be accelerated by certain litigation that could require the EPA to issue its regulations sooner. Regulations could impact handling, disposal and/or beneficial use of CCRs. The financial impact could be material if CCRs are regulated as hazardous waste, and significant if regulated as non-hazardous, in accordance with the proposed rule.
Effluent Limitation Guidelines On April 19, 2013, the EPA issued proposed regulations to revise discharge limitations for steam electric generation wastewater permits. The proposed limitations are based on the EPA review of available treatment technologies and their capacity for reducing pollutants and include new requirements for fly ash and bottom ash handling and metal cleaning wastes, as well as new limits for scrubber wastewater, gasification wastewater and landfill leachate. The proposal contains several alternative approaches, some of which could significantly impact PPL's coal-fired plants. PPL will work with industry groups to comment on the proposed regulation. The final regulation is expected in May 2014. At the present time, PPL is unable to predict the outcome of this matter or estimate a range of reasonably possible costs, but the costs could be significant.
316(b) Cooling Water Intake Structure Rule In April 2011, the EPA published a draft regulation under Section 316(b) of the Clean Water Act, which regulates cooling water intakes for power plants. The draft rule has two provisions: one requires installation of Best Technology Available (BTA) to reduce mortality of aquatic organisms that are pulled into the plant cooling water system (entrainment), and the second imposes standards for reduction of mortality of aquatic organisms trapped on water intake screens (impingement). A final rule is expected in June 2013. The proposed regulation would apply to nearly all PPL-owned steam electric plants in Pennsylvania, Kentucky, and Montana, potentially even including those equipped with closed-cycle cooling systems. PPL's compliance costs could be significant, especially if the final rule requires closed-cycle systems at plants that do not currently have them or conversions of once-through systems to closed-cycle. GHG Regulations In 2013, the EPA is expected to finalize limits on GHG emissions from new power plants and to begin working on a proposal for such emissions from existing power plants. The EPA's proposal on GHG emissions from new power plants would effectively preclude construction of any coal-fired plants and could even be difficult for new gas-fired plants to meet. With respect to existing power plants, the impact could be significant, depending on the structure and stringency of the final rule. PPL, along with others in the industry, filed comments on the EPA's proposal related to GHG emissions from new plants.
MATS The EPA finalized MATS requiring fossil-fuel fired plants to reduce emissions of mercury and other hazardous air pollutants by April 16, 2015. The rule is being challenged by industry groups and states. The EPA has subsequently proposed changes to the rule with respect to new sources to address the concern that the rule effectively precludes construction of any new coal-fired plants. PPL is generally well-positioned to comply with MATS, primarily due to recent investments in environmental controls and approved ECR plans to install additional controls at some of its Kentucky plants. Additionally, PPL is evaluating chemical additive systems for mercury control at Brunner Island, and modifications to existing controls at Colstrip for improved particulate matter reductions. In September 2012, PPL announced its intention to place its Corette plant in long-term reserve status beginning in April 2015 due to expected market conditions and costs to comply with MATS. The anticipated retirements of certain coal-fired electric generating units are in response to this and other environmental regulations.
CSAPR and CAIR In 2011, the EPA finalized its CSAPR regulating emissions of nitrous oxide and sulfur dioxide through new allowance trading programs which were to be implemented in two phases (2012 and 2014). Like its predecessor, the CAIR, CSAPR targeted sources in the eastern United States. In December 2011, the U.S. Court of Appeals for the District of Columbia Circuit (the Court) stayed implementation of CSAPR, leaving CAIR in place. Subsequently, in August 2012, the Court vacated and remanded CSAPR back to the EPA for further rulemaking, again leaving CAIR in place. PPL plants in Pennsylvania and Kentucky will continue to comply with CAIR through optimization of existing controls, balanced with emission allowance purchases. The Court's August decision leaves plants in CSAPR-affected states potentially exposed to more stringent emission reductions due to regional haze implementation (it was previously determined that CSAPR or CAIR participation satisfies regional haze requirements), and/or petitions to the EPA by downwind states under Section 126 of the Clean Air Act requesting the EPA to require plants that allegedly contribute to downwind non-attainment to take action to reduce emissions.
Regional Haze - Montana The EPA signed its final Federal Implementation Plan of the Regional Haze Rules for Montana in September 2012, with tighter emissions limits for Colstrip Units 1 & 2 based on the installation of new controls (no limits or additional controls were specified for Colstrip Units 3 & 4), and tighter emission limits for Corette (which are not based on additional controls). The cost of the potential additional controls for Colstrip Units 1 & 2, if required, could be significant. PPL expects to meet the tighter permit limits at Corette without any significant changes to operations, although other requirements have led to the planned suspension of operations at Corette beginning in April 2015 (see "MATS" discussion above).
See Note 10 to the Financial Statements in this Form 10-Q and "Item 1. Business - Environmental Matters" in PPL's 2012 Form 10-K for a discussion of environmental matters.
New Accounting Guidance
See Notes 2 and 19 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.
Application of Critical Accounting Policies
Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies. The following accounting policies are particularly important to the financial condition or results of operations, and require estimates or other judgments of matters inherently uncertain: price risk management, defined benefits, asset impairment (excluding investments), loss accruals, AROs, income taxes, and regulatory assets and liabilities. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in PPL's 2012 Form 10-K for a discussion of each critical accounting policy.
PPL ENERGY SUPPLY, LLC AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following should be read in conjunction with PPL Energy Supply's Condensed Consolidated Financial Statements and the accompanying Notes and with PPL Energy Supply's 2012 Form 10-K. Capitalized terms and abbreviations are defined in the glossary. Dollars are in millions, unless otherwise noted.
"Management's Discussion and Analysis of Financial Condition and Results of Operations" includes the following information:
· | "Overview" provides a description of PPL Energy Supply and its business strategy, a summary of Net Income Attributable to PPL Energy Supply Member and a discussion of certain events related to PPL Energy Supply's results of operations and financial condition. |
· | "Results of Operations" provides a summary of PPL Energy Supply's earnings and a description of key factors expected to impact future earnings. This section ends with explanations of significant changes in principal line items on PPL Energy Supply's Statements of Income, comparing the three months ended March 31, 2013 with 2012. |
· | "Financial Condition - Liquidity and Capital Resources" provides an analysis of PPL Energy Supply's liquidity position and credit profile. This section also includes a discussion of rating agency actions. |
· | "Financial Condition - Risk Management" provides an explanation of PPL Energy Supply's risk management programs relating to market and credit risk. |
Overview
Introduction
PPL Energy Supply is an energy company with headquarters in Allentown, Pennsylvania. Through its subsidiaries, PPL Energy Supply is primarily engaged in the competitive generation and marketing of electricity in two key markets - the northeastern and northwestern U.S.
Business Strategy
PPL Energy Supply's strategy is to achieve disciplined optimization of energy supply margins while mitigating volatility in both cash flows and earnings. More specifically, PPL Energy Supply's strategy is to optimize the value from its competitive generation and marketing portfolios. PPL Energy Supply endeavors to do this by matching energy supply with load, or customer demand, under contracts of varying durations with creditworthy counterparties to capture profits while effectively managing exposure to energy and fuel price volatility, counterparty credit risk and operational risk. PPL Energy Supply is focused on maintaining profitability during the current and projected period of low commodity prices by controlling its capital and operation and maintenance expenditures.
To manage financing costs and access to credit markets, a key objective for PPL Energy Supply is to maintain a strong credit profile and liquidity position. In addition, PPL Energy Supply has financial and operational risk management programs that, among other things, are designed to monitor and manage exposure to earnings and cash flow volatility related to changes in energy and fuel prices, interest rates, counterparty credit quality and the operating performance of its generating units.
Financial and Operational Developments
Net Income (Loss) Attributable to PPL Energy Supply Member
Net Income (Loss) Attributable to PPL Energy Supply Member for the three months ended March 31, 2013 was $(38) million compared to $309 million in 2012, representing a 112% decrease.
See "Results of Operations" below for further discussion and analysis of the consolidated results of operations. Economic and Market Conditions
Unregulated Gross Energy Margins associated with PPL Energy Supply's competitive generation and marketing business are impacted by changes in market prices and demand for electricity and natural gas, power plant availability, competition in the markets for retail customers, fuel costs and availability, fuel transportation costs and other costs. Current depressed wholesale market prices for electricity and natural gas have resulted from general weak economic conditions and other factors, including the impact of expanded domestic shale gas development. As a result of these factors, lower future energy margins are expected to continue compared to the energy margins in 2012. As has been PPL Energy Supply's practice in periods of changing business conditions, PPL Energy Supply continues to review its future business and operational plans, including capital and operation and maintenance expenditures, as well as its hedging strategies.
PPL Energy Supply continues to monitor its Corette plant (which as previously announced will be placed in long-term reserve status, suspending the plant's operation due to expected market conditions and the costs to comply with the MATS beginning in April 2015) for impairment. The Corette plant asset group's carrying value at March 31, 2013 was $65 million. Although the Corette plant was not impaired at March 31, 2013, it is reasonably possible that an impairment could occur in future periods, as higher priced sales contracts settle, adversely impacting projected cash flows.
PPL Energy Supply cannot predict the future impact that economic and market conditions and regulatory requirements may have on its financial condition or results of operations.
Susquehanna Turbine Blade Inspection
In the spring of 2013, PPL Energy Supply will begin making modifications to address the causes of turbine blade cracking at the Susquehanna nuclear plant that was first identified in 2011. The modifications will be made during the Unit 2 refueling outage and an additional planned outage for Unit 1. Following completion of the modifications, PPL Energy Supply plans to continue monitoring the turbine blades using enhanced diagnostic equipment.
Results of Operations
The following discussion provides a summary of PPL Energy Supply's earnings and a description of key factors that are expected to impact future earnings. This section ends with "Statement of Income Analysis," which includes explanations of significant changes in Unregulated Gross Energy Margins by region and principal line items on PPL Energy Supply's Statements of Income, comparing the three months ended March 31, 2013 with 2012.
The results for interim periods can be disproportionately influenced by numerous factors and developments and by seasonal variations. As such, the results of operations for interim periods do not necessarily indicate results or trends for the year or future periods.
Earnings | | | | | | | | | | | | | | | Net Income (Loss) Attributable to PPL Energy Supply Member for the periods ended March 31 was: | | | | | | | | | | | | | | | | | | | | | | | | Three Months | | | | | | | | | | 2013 | | 2012 | | | | | | | | | | | | | | | Net Income (Loss) Attributable to PPL Energy Supply Member | | | | | | | | $ | (38) | | $ | 309 |
The changes in the components of Net Income (Loss) Attributable to PPL Energy Supply Member between these periods were due to the following factors, which reflect reclassifications for items included in Unregulated Gross Energy Margins and certain items that management considers special. See additional detail of these special items in the tables below.
| | | | Three Months | | | | | | | | Unregulated Gross Energy Margins | | | | | $ | (107) | Other operation and maintenance | | | | | | 13 | Depreciation | | | | | | (14) | Interest Expense | | | | | | (9) | Income Taxes | | | | | | 33 | Special items, after-tax | | | | | | (263) | Total | | | | | $ | (347) |
· | See "Statement of Income Analysis - Unregulated Gross Energy Margins - Changes in Non-GAAP Financial Measures" for an explanation of Unregulated Gross Energy Margins. |
· | Lower other operation and maintenance primarily due to $15 million of lower costs at eastern fossil and hydroelectric plants largely due to outages in 2012, partially offset by $3 million of additional costs due to the Ironwood Acquisition. |
· | Higher depreciation primarily due to the Ironwood Acquisition. |
· | Higher interest expense primarily due to financings associated with PPL Ironwood, acquired in April 2012, which increased interest expense by $4 million and $3 million due to lower capitalized interest. |
· | Lower income taxes due to lower pre-tax income in 2013, which reduced income taxes by $47 million, partially offset by an $11 million benefit from a state tax rate change recorded in 2012. |
The following after-tax gains (losses), which management considers special items, also impacted the results during the periods ended March 31.
| | | Income Statement | | Three Months | | | | Line Item | | 2013 | | 2012 | | | | | | | | | | | Adjusted energy-related economic activity, net, net of tax of $79, ($102) | (a) | | $ | (117) | | $ | 150 | Impairments: | | | | | | | | | Adjustments - nuclear decommissioning trust investments, net of tax of $0, ($1) | Other Income (Expense)-net | | | | | | 1 | Other: | | | | | | | | | Counterparty bankruptcy, net of tax of $0, $5 (b) | Other Operation and Maintenance | | | | | | (6) | | Ash basin leak remediation adjustment, net of tax of $0, ($1) | Other Operation and Maintenance | | | | | | 1 | Total | | | $ | (117) | | $ | 146 |
(a) | See "Reconciliation of Economic Activity" below. |
(b) | In October 2011, a wholesale customer, SMGT, filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy code. In 2012, PPL EnergyPlus recorded an additional allowance for unpaid amounts under the long-term power contract. In March 2012, the U.S. Bankruptcy Court for the District of Montana approved the request to terminate the contract, effective April 1, 2012. |
Reconciliation of Economic Activity
The following table reconciles unrealized pre-tax gains (losses) for the periods ended March 31, from the table within "Commodity Price Risk (Non-trading) - Economic Activity" in Note 14 to the Financial Statements to the special item identified as "Adjusted energy-related economic activity, net."
| | | | Three Months | | | | | 2013 | | 2012 | Operating Revenues | | | | | | | | | Unregulated retail electric and gas | | $ | (8) | | $ | 10 | | | Wholesale energy marketing | | | (822) | | | 852 | Operating Expenses | | | | | | | | | Fuel | | | (1) | | | 2 | | | Energy Purchases | | | 634 | | | (591) | Energy-related economic activity (a) | | | (197) | | | 273 | Option premiums | | | 1 | | | | Adjusted energy-related economic activity | | | (196) | | | 273 | Less: Economic activity realized, associated with the monetization of certain | | | | | | | | full-requirement sales contracts in 2010 | | | | | | 21 | Adjusted energy-related economic activity, net, pre-tax | | $ | (196) | | $ | 252 | | | | | | | | | | Adjusted energy-related economic activity, net, after-tax | | $ | (117) | | $ | 150 |
(a) | See Note 14 to the Financial Statements for additional information. |
2013 Outlook
Excluding special items, PPL Energy Supply projects lower earnings in 2013 compared with 2012, primarily driven by lower energy prices, higher fuel costs, higher operation and maintenance expense, higher depreciation, and higher financing costs, partially offset by higher capacity prices and higher nuclear generation output despite scheduled outages for both Susquehanna units to implement a long-term solution to turbine blade issues.
Earnings in future periods are subject to various risks and uncertainties. See "Forward-Looking Information," the rest of this Item 2, and Note 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in PPL Energy Supply's 2012 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings. Statement of Income Analysis --
Unregulated Gross Energy Margins
Non-GAAP Financial Measure
The following discussion includes financial information prepared in accordance with GAAP, as well as a non-GAAP financial measure, "Unregulated Gross Energy Margins." "Unregulated Gross Energy Margins" is a single financial performance measure of PPL Energy Supply's competitive energy non-trading and trading activities. In calculating this measure, PPL Energy Supply's energy revenues are offset by the cost of fuel, energy purchases, certain other operation and maintenance expenses, primarily ancillary charges, and gross receipts tax, which is recorded in "Taxes, other than income". This performance measure is relevant to PPL Energy Supply due to the volatility in the individual revenue and expense lines on the Statements of Income that comprise "Unregulated Gross Energy Margins." This volatility stems from a number of factors, including the required netting of certain transactions with ISOs and significant fluctuations in unrealized gains and losses. Such factors could result in gains or losses being recorded in either "Wholesale energy marketing" or "Energy purchases" on the Statements of Income. This performance measure includes PLR revenues from energy sales to PPL Electric by PPL EnergyPlus, which are recorded in "Wholesale energy marketing to affiliate" revenue. PPL Energy Supply excludes from "Unregulated Gross Energy Margins" adjusted energy-related economic activity, which includes the changes in fair value of positions used to economically hedge a portion of the economic value of PPL Energy Supply's competitive generation assets, full-requirement sales contracts and retail activities. This economic value is subject to changes in fair value due to market price volatility of the input and output commodities (e.g., fuel and power) prior to the delivery period that was hedged. Also included in adjusted energy-related economic activity is the premium amortization associated with options and for 2012 the ineffective portion of qualifying cash flow hedges and economic activity realized associated with the monetization of certain full-requirement sales contracts in 2010. This economic activity is deferred, with the exception of the full-requirement sales contracts that were monetized, and included in "Unregulated Gross Energy Margins" over the delivery period that was hedged or upon realization. This measure is not intended to replace "Operating Income," which is determined in accordance with GAAP, as an indicator of overall operating performance. Other companies may use different measures to analyze and to report on the results of their operations. PPL Energy Supply believes that "Unregulated Gross Energy Margins" provides another criterion to make investment decisions. This performance measure is used, in conjunction with other information, internally by senior management to manage PPL Energy Supply's operations, analyze actual results compared with budget and measure certain corporate financial goals used in determining variable compensation.
Reconciliation of Non-GAAP Financial Measures
The following table reconciles "Unregulated Gross Energy Margins" as defined by PPL Energy Supply to "Operating Income" for the periods ended March 31.
| | | | | | 2013 Three Months | | 2012 Three Months | | | | | | | Unregulated | | | | | | | | Unregulated | | | | | | | | | | | | | Gross Energy | | | | | Operating | | Gross Energy | | | | | | Operating | | | | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | | Operating Revenues | | | | | | | | | | | | | | | | | | | | | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | $ | 977 | | $ | (1) | | | $ | 976 | | $ | 1,204 | | $ | 4 | (c) | | $ | 1,208 | | | | | Unrealized economic activity | | | | | | (822) | (d) | | | (822) | | | | | | 852 | (d) | | | 852 | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | | to affiliate | | | 14 | | | | | | | 14 | | | 21 | | | | | | | 21 | | Unregulated retail electric and gas | | | 246 | | | (8) | (d) | | | 238 | | | 214 | | | 10 | (d) | | | 224 | | Net energy trading margins | | | (11) | | | | | | | (11) | | | 8 | | | | | | | 8 | | Energy-related businesses | | | | | | 113 | | | | 113 | | | | | | 96 | | | | 96 | | | | Total Operating Revenues | | | 1,226 | | | (718) | | | | 508 | | | 1,447 | | | 962 | | | | 2,409 | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | | | | | | | | | Fuel | | | 299 | | | (1) | (d) | | | 298 | | | 214 | | | (3) | (d) | | | 211 | | Energy purchases | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | | 436 | | | (2) | | | | 434 | | | 636 | | | 23 | (c) | | | 659 | | | | | Unrealized economic activity | | | | | | (634) | (d) | | | (634) | | | | | | 591 | (d) | | | 591 | | Energy purchases from affiliate | | | 1 | | | | | | | 1 | | | 1 | | | | | | | 1 | | Other operation and maintenance | | | 5 | | | 230 | | | | 235 | | | 4 | | | 251 | | | | 255 | | Depreciation | | | | | | 78 | | | | 78 | | | | | | 64 | | | | 64 | | Taxes, other than income | | | 8 | | | 9 | | | | 17 | | | 8 | | | 10 | | | | 18 | | Energy-related businesses | | | | | | 110 | | | | 110 | | | | | | 92 | | | | 92 | | | | Total Operating Expenses | | | 749 | | | (210) | | | | 539 | | | 863 | | | 1,028 | | | | 1,891 | Total | | $ | 477 | | $ | (508) | | | $ | (31) | | $ | 584 | | $ | (66) | | | $ | 518 |
(a) | Represents amounts excluded from Margins. |
(b) | As reported on the Statements of Income. |
(c) | Represents energy-related economic activity as described in "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements. For the three months ended March 31, 2012, "Wholesale energy marketing - Realized" and "Energy purchases - Realized" includes a net pre-tax loss of $21 million related to the monetization of certain full-requirement sales contracts. |
(d) | Represents energy-related economic activity, which is subject to fluctuations in value due to market price volatility, as described in "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements. |
Changes in Non-GAAP Financial Measures
Unregulated Gross Energy Margins are generated through PPL Energy Supply's competitive non-trading and trading activities. PPL Energy Supply's non-trading energy business is managed on a geographic basis that is aligned with its generation fleet. The following table shows PPL Energy Supply's non-GAAP financial measure, Unregulated Gross Energy Margins, for the periods ended March 31, as well as the change between periods. The factors that gave rise to the changes are described below the table.
| | | | | Three Months | | | | | | | | | | 2013 | | 2012 | | Change | | | | | | | | | | | | | | | | | | | | | Non-trading | | | | | | | | | | | | | | | | | | | | Eastern U.S. | | | | | | | | | | | $ | 430 | | $ | 489 | | $ | (59) | | Western U.S. | | | | | | | | | | | | 58 | | | 87 | | | (29) | Net energy trading | | | | | | | | | | | | (11) | | | 8 | | | (19) | Total | | | | | | | | | | | $ | 477 | | $ | 584 | | $ | (107) |
Unregulated Gross Energy Margins | | | | | | | | | | | | | | Eastern U.S. | | | | | | | | | | | | | | The change in non-trading margins for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | | | | | Three Months | | | | | | | | Baseload energy prices | | | | | $ | (125) | Coal prices | | | | | | (10) | Nuclear fuel prices | | | | | | (6) | Full-requirement sales contracts | | | | | | 5 | Intermediate and peaking capacity prices | | | | | | 5 | Baseload capacity prices | | | | | | 6 | Intermediate and peaking Spark Spreads | | | | | | 14 | Ironwood acquisition which eliminated tolling expense | | | | | | 15 | Net economic availability of coal and hydroelectric plants | | | | | | 32 | Other | | | | | | 5 | Total | | | | | $ | (59) |
Western U.S.
Non-trading margins for the three months ended March 31, 2013 compared with 2012 were lower due to $43 million of lower wholesale prices, partially offset by $12 million of higher wholesale volumes.
Net Energy Trading Margins
Net energy trading margins for the three months ended March 31, 2013 compared with 2012 decreased as a result of lower margins of $16 million on gas positions due to higher prices.
Other Operation and Maintenance | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | Three Months | | | | | | | | Uncollectible accounts (a) | | | | $ | (11) | Costs at eastern fossil and hydroelectric plants (b) | | | | | (11) | Other | | | | | 2 | Total | | | | $ | (20) |
(a) | The decrease is primarily due to SMGT filing for protection under Chapter 11 of the U.S. Bankruptcy Code in 2011. $11 million of damages billed to SMGT were fully reserved in 2012. |
(b) | The decrease is primarily due to Brunner Island Unit 3 outage costs of $15 million in 2012 compared with no major outage costs in 2013, partially offset by $3 million of additional costs due to the Ironwood Acquisition. |
Depreciation
Depreciation increased by $14 million for the three months ended March 31, 2013 compared with 2012, primarily due to $10 million related to PP&E additions and $6 million attributable to the Ironwood Acquisition.
Interest Expense | | | | | | | | | | | | | | | The increase (decrease) in interest expense for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | | | | | | Three Months | | | | | | | | | Ironwood Acquisition (a) | | | | | $ | 4 | Capitalized interest | | | | | | 3 | Other | | | | | | 2 | Total | | | | | $ | 9 |
(a) | The increase was due to financings associated with the Ironwood Acquisition. |
Income Taxes | | | | | | | | | | | | | | The increase (decrease) in income taxes for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | | | | | | | | | Three Months | | | | | | | | Lower pre-tax book income | | | | | $ | (225) | State deferred tax rate change (a) | | | | | | 11 | Other | | | | | | 2 | Total | | | | | $ | (212) |
(a) | During the three months ended March 31, 2012, PPL Energy Supply recorded adjustments related to state deferred tax liabilities. |
See Note 5 to the Financial Statements for additional information on income taxes.
Financial Condition | | | | | | | | Liquidity and Capital Resources | | | | | | | | PPL Energy Supply had the following at: | | | | | | | | | | March 31, 2013 | | December 31, 2012 | | | | | | | | Cash and cash equivalents | | $ | 147 | | $ | 413 | Short-term debt | | $ | 481 | | $ | 356 |
The $266 million decrease in PPL Energy Supply's cash and cash equivalents position was primarily the net result of:
· | distributions to member of $313 million; |
· | capital expenditures of $124 million; |
· | a net increase in restricted cash and cash equivalents of $59 million; |
· | net cash provided by operating activities of $125 million; and |
· | a net increase in short-term debt of $125 million. |
PPL Energy Supply's cash provided by operating activities decreased by $129 million for the three months ended March 31, 2013, compared with 2012. This was primarily due to a $45 million increase in cash used by working capital components, a decrease in net income when adjusted for non-cash components of $31 million and a $36 million increase in defined benefit plans funding. Credit Facilities
PPL Energy Supply maintains credit facilities to provide liquidity and to backstop commercial paper issuances. At March 31, 2013, PPL Energy Supply's total committed borrowing capacity under its credit facilities and the use of this borrowing capacity were:
| | | | | | | | | Letters of | | | | | | | | | | | | | Credit Issued | | | | | | | | | | | and | | | | | | Committed | | | | Commercial | | Unused | | | | Capacity | | Borrowed | | Paper Backup | | Capacity | | | | | | | | | | | | | | | Syndicated Credit Facility | | $ | 3,000 | | | | | $ | 641 | | $ | 2,359 | Letter of Credit Facility (a) | | | 200 | | | n/a | | | 123 | | | 77 | Total PPL Energy Supply Credit Facilities (b) | | $ | 3,200 | | | | | $ | 764 | | $ | 2,436 |
(a) | In February 2013, PPL Energy Supply extended the expiration date from March 2013 and, effective April 2013, the capacity was reduced to $150 million. |
(b) | The commitments under PPL Energy Supply's credit facilities are provided by a diverse bank group, with no one bank and its affiliates providing an aggregate commitment of more than 11% of the total committed capacity. |
See Note 7 to the Financial Statements for further discussion of PPL Energy Supply's credit facilities.
Commercial Paper
PPL Energy Supply maintains a commercial paper program up to $750 million to provide an additional financing source to fund its short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by PPL Energy Supply's Syndicated Credit Facility. At March 31, 2013 and December 31, 2012, PPL Energy Supply had $481 million and $356 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.38% and 0.50%.
Rating Agency Actions
Moody's, S&P and Fitch periodically review the credit ratings on the debt securities of PPL Energy Supply and its subsidiaries. Based on their respective independent reviews, the rating agencies may make certain ratings revisions or ratings affirmations.
A credit rating reflects an assessment by the rating agency of the creditworthiness associated with an issuer and particular securities that it issues. The credit ratings of PPL Energy Supply and its subsidiaries are based on information provided by PPL Energy Supply and other sources. The ratings of Moody's, S&P and Fitch are not a recommendation to buy, sell or hold any securities of PPL Energy Supply or its subsidiaries. Such ratings may be subject to revisions or withdrawal by the agencies at any time and should be evaluated independently of each other and any other rating that may be assigned to the securities.
A downgrade in PPL Energy Supply's or its subsidiaries' credit ratings could result in higher borrowing costs and reduced access to capital markets. PPL Energy Supply and its subsidiaries have no credit rating triggers that would result in the reduction of access to capital markets or the acceleration of maturity dates of outstanding debt.
The rating agencies took the following actions related to PPL Energy Supply and its subsidiaries in 2013:
In February 2013, Moody's upgraded its rating, from B2 to Ba1, and revised the outlook from under review to stable for PPL Ironwood.
In April 2013, Fitch affirmed the BBB- rating and stable outlook at PPL Montana.
Ratings Triggers
PPL Energy Supply has various contracts, including contracts for the sale and purchase of electricity and fuel, commodity transportation and storage, tolling agreements and interest rate instruments, which contain provisions that require PPL Energy Supply to post additional collateral or permit the counterparty to terminate the contract if PPL Energy Supply's credit rating were to fall below investment grade. See Note 14 to the Financial Statements for a discussion of "Credit Risk-Related Contingent Features," including a discussion of the potential additional collateral that would have been required for derivative contracts in a net liability position at March 31, 2013. For additional information on PPL Energy Supply's liquidity and capital resources, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," in PPL Energy Supply's 2012 Form 10-K.
Risk Management
Market Risk
See Notes 13 and 14 to the Financial Statements for information about PPL Energy Supply's risk management objectives, valuation techniques and accounting designations.
The forward-looking information presented below provides estimates of what may occur in the future, assuming certain adverse market conditions and model assumptions. Actual future results may differ materially from those presented. These disclosures are not precise indicators of expected future losses, but only indicators of possible losses under normal market conditions at a given confidence level.
Commodity Price Risk (Non-trading)
PPL Energy Supply segregates its non-trading activities into two categories: hedge activity and economic activity. Transactions that are accounted for as hedge activity qualify for hedge accounting treatment. The economic activity category includes transactions that address a specific risk, but were not eligible for hedge accounting or for which hedge accounting was not elected. This activity includes the changes in fair value of positions used to hedge a portion of the economic value of PPL Energy Supply's competitive generation assets and full-requirement sales and retail contracts. This economic activity is subject to changes in fair value due to market price volatility of the input and output commodities (e.g., fuel and power). Although they do not receive hedge accounting treatment, these transactions are considered non-trading activity. See Note 14 to the Financial Statements for additional information.
To hedge the impact of market price volatility on PPL Energy Supply's energy-related assets, liabilities and other contractual arrangements, PPL Energy Supply both sells and purchases physical energy at the wholesale level under FERC market-based tariffs throughout the U.S. and enters into financial exchange-traded and over-the-counter contracts. PPL Energy Supply's non-trading commodity derivative contracts range in maturity through 2019.
The following table sets forth the changes in the net fair value of non-trading commodity derivative contracts for the period ended March 31. See Notes 13 and 14 to the Financial Statements for additional information.
| | | | | | | | Gains (Losses) | | | | | Three Months | | | | | | | 2013 | | 2012 | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | | | | | | | $ | 473 | | $ | 1,082 | Contracts realized or otherwise settled during the period | | | | | | | | | (137) | | | (279) | Fair value of new contracts entered into during the period (a) | | | | | | | | | 9 | | | (1) | Other changes in fair value | | | | | | | | | (116) | | | 413 | Fair value of contracts outstanding at the end of the period | | | | | | | | $ | 229 | | $ | 1,215 |
(a) | Represents the fair value of contracts at the end of the quarter of their inception. |
The following table segregates the net fair value of non-trading commodity derivative contracts at March 31, 2013, based on the observability of the information used to determine the fair value.
| | | Net Asset (Liability) | | | | Maturity | | | | | | | | Maturity | | | | | | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | Source of Fair Value | | | | | | | | | | | | | | | | Prices based on significant observable inputs (Level 2) | | $ | 238 | | $ | (21) | | $ | (8) | | $ | 6 | | $ | 215 | Prices based on significant unobservable inputs (Level 3) | | | (1) | | | 12 | | | 3 | | | | | | 14 | Fair value of contracts outstanding at the end of the period | | $ | 237 | | $ | (9) | | $ | (5) | | $ | 6 | | $ | 229 |
PPL Energy Supply sells electricity, capacity and related services and buys fuel on a forward basis to hedge the value of energy from its generation assets. If PPL Energy Supply were unable to deliver firm capacity and energy or to accept the delivery of fuel under its agreements, under certain circumstances it could be required to pay liquidating damages. These damages would be based on the difference between the market price and the contract price of the commodity. Depending on price changes in the wholesale energy markets, such damages could be significant. Extreme weather conditions, unplanned power plant outages, transmission disruptions, nonperformance by counterparties (or their counterparties) with which it has energy contracts and other factors could affect PPL Energy Supply's ability to meet its obligations, or cause significant increases in the market price of replacement energy. Although PPL Energy Supply attempts to mitigate these risks, there can be no assurance that it will be able to fully meet its firm obligations, that it will not be required to pay damages for failure to perform, or that it will not experience counterparty nonperformance in the future.
Commodity Price Risk (Trading)
PPL Energy Supply's trading commodity derivative contracts range in maturity through 2017. The following table sets forth changes in the net fair value of trading commodity derivative contracts for the period ended March 31. See Notes 13 and 14 to the Financial Statements for additional information.
| | | | Three Months | | | | | | | 2013 | | 2012 | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | | | | | | | $ | 29 | | $ | (4) | Contracts realized or otherwise settled during the period | | | | | | | | | (2) | | | | Fair value of new contracts entered into during the period (a) | | | | | | | | | (12) | | | 6 | Fair value of contracts outstanding at the end of the period | | | | | | | | $ | 15 | | $ | 2 |
(a) | Represents the fair value of contracts at the end of the quarter of their inception. |
The following table segregates the net fair value of trading commodity derivative contracts at March 31, 2013, based on the observability of the information used to determine the fair value.
| | Net Asset (Liability) | | | Maturity | | | | | | | Maturity | | | | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | Source of Fair Value | | | | | | | | | | | | | | | | Prices quoted in active markets for identical instruments (Level 1) | | $ | 1 | | | | | | | | | | | $ | 1 | Prices based on significant observable inputs (Level 2) | | | 5 | | $ | 9 | | | | | | | | | 14 | Fair value of contracts outstanding at the end of the period | | $ | 6 | | $ | 9 | | | | | | | | $ | 15 |
VaR Models
A VaR model is utilized to measure commodity price risk in unregulated gross energy margins for the non-trading and trading portfolios. VaR is a statistical model that attempts to estimate the value of potential loss over a given holding period under normal market conditions at a given confidence level. VaR is calculated using a Monte Carlo simulation technique based on a five-day holding period at a 95% confidence level. Given the company's disciplined hedging program, the non-trading VaR exposure is expected to be limited in the short-term. The VaR for portfolios using end-of-month results for the periods was as follows.
| | | Trading VaR | | Non-Trading VaR | | | | Three Months | | Three Months | | | | Ended | | Ended | | | | March 31, | | March 31, | | | | 2013 | | 2013 | 95% Confidence Level, Five-Day Holding Period | | | | | | | | Period End | | $ | 6 | | $ | 8 | | Average for the Period | | | 5 | | | 9 | | High | | | 6 | | | 9 | | Low | | | 3 | | | 8 |
The trading portfolio includes all proprietary trading positions, regardless of the delivery period. All positions not considered proprietary trading are considered non-trading. The non-trading portfolio includes the entire portfolio, including generation, with delivery periods through the next 12 months. Both the trading and non-trading VaR computations exclude FTRs due to the absence of reliable spot and forward markets. The fair value of the non-trading and trading FTR positions was insignificant at March 31, 2013. Interest Rate Risk
PPL Energy Supply and its subsidiaries issue debt to finance their operations, which exposes them to interest rate risk. PPL and PPL Energy Supply utilize various financial derivative instruments to adjust the mix of fixed and floating interest rates in PPL Energy Supply's debt portfolio, adjust the duration of its debt portfolio and lock in benchmark interest rates in anticipation of future financing, when appropriate. Risk limits under the risk management program are designed to balance risk exposure to volatility in interest expense and changes in the fair value of PPL Energy Supply's debt portfolio due to changes in the absolute level of interest rates. PPL Energy Supply had no interest rate hedges outstanding at March 31, 2013.
At March 31, 2013, PPL Energy Supply's potential annual exposure to increased interest expense, based on a 10% increase in interest rates, was not significant.
PPL Energy Supply is also exposed to changes in the fair value of its debt portfolio. PPL Energy Supply estimated that a 10% decrease in interest rates at March 31, 2013 would increase the fair value of its debt portfolio by $47 million.
NDT Funds - Securities Price Risk
In connection with certain NRC requirements, PPL Susquehanna maintains trust funds to fund certain costs of decommissioning the PPL Susquehanna nuclear plant (Susquehanna). At March 31, 2013, these funds were invested primarily in domestic equity securities and fixed-rate, fixed-income securities and are reflected at fair value on the Balance Sheet. The mix of securities is designed to provide returns sufficient to fund Susquehanna's decommissioning and to compensate for inflationary increases in decommissioning costs. However, the equity securities included in the trusts are exposed to price fluctuation in equity markets, and the values of fixed-rate, fixed-income securities are primarily exposed to changes in interest rates. PPL actively monitors the investment performance and periodically reviews asset allocation in accordance with its nuclear decommissioning trust policy statement. At March 31, 2013, a hypothetical 10% increase in interest rates and a 10% decrease in equity prices would have resulted in an estimated $55 million reduction in the fair value of the trust assets. See Notes 13 and 17 to the Financial Statements for additional information regarding the NDT funds.
Credit Risk
See Notes 11, 13 and 14 to the Financial Statements in this Form 10-Q and "Risk Management - Energy Marketing & Trading and Other - Credit Risk" in PPL Energy Supply's 2012 Form 10-K for additional information.
Related Party Transactions
PPL Energy Supply is not aware of any material ownership interests or operating responsibility by senior management of PPL Energy Supply in outside partnerships, including leasing transactions with variable interest entities or other entities doing business with PPL Energy Supply. See Note 11 to the Financial Statements for additional information on related party transactions.
Acquisitions, Development and Divestitures
PPL Energy Supply from time to time evaluates opportunities for potential acquisitions, divestitures and development projects. Development projects are reexamined based on market conditions and other factors to determine whether to proceed with the projects, sell, cancel or expand them, execute tolling agreements or pursue other options. See Note 8 to the Financial Statements for information on the more significant activities.
Environmental Matters
Extensive federal, state and local environmental laws and regulations are applicable to PPL Energy Supply's air emissions, water discharges and the management of hazardous and solid waste, as well as other aspects of PPL Energy Supply's business. The cost of compliance or alleged non-compliance cannot be predicted with certainty but could be material. In addition, costs may increase significantly if the requirements or scope of environmental laws or regulations, or similar rules, are expanded or changed by the relevant agencies. Costs may take the form of increased capital expenditures or operating and maintenance expenses, monetary fines, penalties or other restrictions. Many of these environmental law considerations are also applicable to the operations of key suppliers, or customers, such as coal producers and industrial power users, and may impact the costs of their products or their demand for PPL Energy Supply's services. Physical effects associated with climate change could include the impact of changes in weather patterns, such as storm frequency and intensity, and the resultant potential damage to PPL Energy Supply's generation assets as well as impacts on customers. In addition, changed weather patterns could potentially reduce annual rainfall in areas where PPL Energy Supply has hydro generating facilities or where river water is used to cool its fossil and nuclear powered generators. PPL Energy Supply cannot currently predict whether its businesses will experience these potential climate change-related risks or estimate the potential cost of their related consequences.
The following is a discussion of the more significant environmental matters.
Coal Combustion Residuals (CCRs) In June 2010, the EPA proposed two approaches to regulating the disposal and management of CCRs (as either hazardous or non-hazardous) under existing solid waste regulations. A final rulemaking is currently expected before the end of 2015. However, the timing of the final regulations could be accelerated by certain litigation that could require the EPA to issue its regulations sooner. Regulations could impact handling, disposal and/or beneficial use of CCRs. The financial impact could be material if CCRs are regulated as hazardous waste, and significant if regulated as non-hazardous, in accordance with the proposed rule.
Effluent Limitation Guidelines On April 19, 2013, the EPA issued proposed regulations to revise discharge limitations for steam electric generation wastewater permits. The proposed limitations are based on the EPA review of available treatment technologies and their capacity for reducing pollutants and include new requirements for fly ash and bottom ash handling and metal cleaning wastes, as well as new limits for scrubber wastewater, gasification wastewater and landfill leachate. The proposal contains several alternative approaches, some of which could significantly impact PPL Energy Supply's coal-fired plants. PPL Energy Supply will work with industry groups to comment on the proposed regulation. A final regulation is expected in May 2014. At the present time, PPL Energy Supply is unable to predict the outcome of this matter or estimate a range of reasonably possible costs, but the costs could be significant.
316(b) Cooling Water Intake Structures Rule In April 2011, the EPA published a draft regulation under Section 316(b) of the Clean Water Act, which regulates cooling water intakes for power plants. The draft rule has two provisions: one requires installation of Best Technology Available (BTA) to reduce mortality of aquatic organisms that are pulled into the plants cooling water system (entrainment), and the second imposes standards for reduction of mortality of aquatic organisms trapped on water intake screens (impingement). A final rule is expected in June 2013. The proposed regulation would apply to nearly all PPL Energy Supply-owned steam electric plants in Pennsylvania and Montana, potentially even including those equipped with closed-cycle cooling systems. PPL Energy Supply's compliance costs could be significant, especially if the final rule requires closed-cycle systems at plants that do not currently have them or conversions of once-through systems to closed-cycle.
GHG Regulations In 2013, the EPA is expected to finalize limits on GHG emissions from new power plants and to begin working on a proposal for such emissions from existing power plants. The EPA's proposal on GHG emissions from new power plants would effectively preclude construction on any coal-fired plants and could even be difficult for new gas-fired plants to meet. With respect to existing power plants, the impact could be significant, depending on the structure and stringency of the final rule. PPL Energy Supply, along with others in the industry, filed comments on the EPA's proposal related to GHG emissions from new plants.
MATS The EPA finalized MATS requiring fossil-fuel fired plants to reduce emissions of mercury and other hazardous air pollutants by April 16, 2015. The rule is being challenged by industry groups and states. The EPA has subsequently proposed changes to the rule with respect to new sources to address the concern that the rule effectively precludes construction of any new coal-fired plants. PPL Energy Supply is generally well-positioned to comply with MATS due to its recent investment in, and installation of, environmental controls such as wet flue gas desulfurization systems. PPL Energy Supply is evaluating chemical additive systems for mercury control at Brunner Island, and modifications to existing controls at Colstrip for improved particulate matter reductions. In September 2012, PPL Energy Supply announced its intention to place its Corette plant in long-term reserve status beginning in April 2015 due to expected market conditions and costs to comply with MATS.
CSAPR and CAIR In 2011, the EPA finalized its CSAPR regulating emissions of nitrous oxide and sulfur dioxide through new allowance trading programs which were to be implemented in two phases (2012 and 2014). Like its predecessor, the CAIR, CSAPR targeted sources in the eastern United States. In December 2011, the U.S. Court of Appeals for the District of Columbia. Circuit (the Court) stayed implementation of CSAPR, leaving CAIR in place. Subsequently, in August 2012, the Court vacated and remanded CSAPR back to the EPA for further rulemaking, again leaving CAIR in place. PPL Energy Supply
plants in Pennsylvania will continue to comply with CAIR through optimization of existing controls, balanced with emission allowance purchases. The Court's August decision leaves plants in CSAPR-affected states potentially exposed to more stringent emission reductions due to regional haze implementation (it was previously determined that CSAPR or CAIR participation satisfies regional haze requirements), and/or petitions to the EPA by downwind states under Section 126 of the Clean Air Act requesting the EPA to require plants that allegedly contribute to downwind non-attainment to take action to reduce emissions.
Regional Haze - Montana The EPA signed its final Federal Implementation Plan of the Regional Haze Rules for Montana in September 2012, with tighter emissions limits for Colstrip Units 1 & 2 based on the installation of new controls (no limits or additional controls were specified for Colstrip Units 3 & 4), and tighter emission limits for Corette (which are not based on additional controls). The cost of the potential additional controls for Colstrip Units 1 & 2, if required, could be significant. PPL Energy Supply expects to meet the tighter permit limits at Corette without any significant changes to operations, although other requirements have led to the planned suspension of operations at Corette beginning in April 2015 (see "MATS" discussion above).
See Note 10 to the Financial Statements in this Form 10-Q and "Item 1. Business - Environmental Matters" in PPL Energy Supply's 2012 Form 10-K for a discussion of environmental matters.
New Accounting Guidance
See Notes 2 and 19 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.
Application of Critical Accounting Policies
Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies. The following accounting policies are particularly important to the financial condition or results of operations, and require estimates or other judgments of matters inherently uncertain: price risk management, defined benefits, asset impairment (excluding investments), loss accruals, AROs and income taxes. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in PPL Energy Supply's 2012 Form 10-K for a discussion of each critical accounting policy.
PPL ELECTRIC UTILITIES CORPORATION AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following should be read in conjunction with PPL Electric's Condensed Consolidated Financial Statements and the accompanying Notes and with PPL Electric's 2012 Form 10-K. Capitalized terms and abbreviations are defined in the glossary. Dollars are in millions, unless otherwise noted.
"Management's Discussion and Analysis of Financial Condition and Results of Operations" includes the following information:
· | "Overview" provides a description of PPL Electric and its business strategy, a summary of Net Income Available to PPL and a discussion of certain events related to PPL Electric's results of operations and financial condition. |
· | "Results of Operations" provides a summary of PPL Electric's earnings and a description of key factors expected to impact future earnings. This section ends with explanations of significant changes in principal line items on PPL Electric's Statements of Income, comparing the three months ended March 31, 2013 with 2012. |
· | "Financial Condition - Liquidity and Capital Resources" provides an analysis of PPL Electric's liquidity position and credit profile. This section also includes a discussion of rating agency actions. |
· | "Financial Condition - Risk Management" provides an explanation of PPL Electric's risk management programs relating to market and credit risk. |
Overview
Introduction
PPL Electric is an electricity transmission and distribution service provider in eastern and central Pennsylvania with headquarters in Allentown, Pennsylvania. PPL Electric is subject to regulation as a public utility by the PUC, and certain of its transmission activities are subject to the jurisdiction of FERC under the Federal Power Act. PPL Electric delivers electricity in its Pennsylvania service area and provides electricity supply to retail customers in that area as a PLR under the Customer Choice Act.
Business Strategy
PPL Electric's strategy for its regulated electricity delivery business is to provide safe, reliable service to its customers and achieve stable, long-term growth in earnings and rate base. Rate base is expected to grow as a result of significant capital expenditure programs aimed at maintaining existing assets and improving system reliability. PPL Electric is focused on timely recovery of costs, efficient operations, strong customer service and constructive regulatory relationships.
To manage financing costs and access to credit markets and to fund its capital expenditure program, a key objective for PPL Electric is to maintain a strong credit profile and strong liquidity position.
Timely recovery of costs to maintain and enhance the reliability of its delivery system, including the replacement of aging distribution assets, is required in order to maintain strong cash flows and a strong credit profile. Traditionally, such cost recovery would be pursued through periodic base rate case proceedings with the PUC. As such costs continue to increase, more frequent rate case proceedings may be required or an alternative rate making process would need to be implemented in order to achieve more timely recovery. See "Legislation - Regulatory Procedures and Mechanisms" below for information on Pennsylvania's new alternative rate-making mechanism.
Transmission costs are recovered through a FERC Formula Rate mechanism, which is updated annually for costs incurred and assets placed in service. Accordingly, increased costs, including those related to the replacement of aging transmission assets and the PJM-approved Regional Transmission Line Expansion Plan, are recovered on a timely basis. Financial and Operational Developments
Net Income Available to PPL
Net Income Available to PPL for the three months ended March 31, 2013 was $64 million compared to $33 million in 2012, representing a 94% increase.
See "Results of Operations" below for further discussion and analysis of PPL Electric's earnings.
Rate Case Proceeding
In December 2012, the PUC approved a total distribution revenue increase of about $71 million, using a 10.4% return on equity. The approved rates became effective January 1, 2013.
Legislation - Regulatory Procedures and Mechanisms
Act 11 authorizes the PUC to approve two specific ratemaking mechanisms - the use of a fully projected future test year in base rate proceedings and, subject to certain conditions, the use of a DSIC. Such alternative ratemaking procedures and mechanisms provide opportunity for accelerated cost-recovery and, therefore, are important to PPL Electric as it begins a period of significant capital investment to maintain and enhance the reliability of its delivery system, including the replacement of aging distribution assets. In August 2012, the PUC issued a final implementation order adopting procedures, guidelines and a model tariff for the implementation of Act 11. Act 11 requires utilities to file an LTIIP as a prerequisite to filing for recovery through the DSIC. The LTIIP is mandated to be a five- to ten-year plan describing projects eligible for inclusion in the DSIC. In September 2012, PPL Electric filed its LTIIP describing projects eligible for inclusion in the DSIC.
The PUC approved the LTIIP on January 10, 2013 and, on January 15, 2013, PPL Electric filed a petition requesting permission to establish a DSIC. Several parties have filed responses to PPL Electric's petition. The case remains pending before the PUC. PPL Electric does not expect any new rates to be effective before the third quarter of 2013.
FERC Formula Rates
Transmission rates are regulated by the FERC. PPL Electric's transmission revenues are billed in accordance with a FERC-approved PJM open access transmission tariff that utilizes a formula-based rate recovery mechanism. The formula rate is calculated, in part, based on financial results as reported in PPL Electric's annual FERC Form No. 1, filed under FERC's Uniform System of Accounts (USOA). PPL Electric must follow FERC's USOA, which requires subsidiaries to be presented, for FERC reporting purposes, using the equity method of accounting unless a waiver has been issued. The FERC has granted waivers of this requirement to other utilities when such waiver would more accurately present the integrated operations of the utilities and their subsidiaries. In March 2013, as part of a routine FERC audit of PPL and its subsidiaries, PPL Electric determined that it never obtained a waiver of the use of the equity method of accounting for PPL Receivables Corporation (PPL Receivables). PPL Receivables is a wholly owned subsidiary of PPL Electric, formed in 2004 to purchase eligible accounts receivable and unbilled revenue of PPL Electric to collateralize commercial paper issuances to reduce borrowing costs. In March 2013, PPL Electric filed a request for waiver with FERC that, if approved, would allow it to continue to consolidate the results of PPL Receivables with the results of PPL Electric, as it has done since 2004. While PPL Electric may ultimately be successful in obtaining a waiver from FERC, FERC may require PPL Electric to re-issue one or more of its prior FERC Form No. 1 filings in either the audit proceeding or the waiver proceeding. If re-issuance of FERC Form No. 1 filings were required by FERC, PPL Electric's revenue requirement calculated under the formula rate could be negatively impacted. The impact, if any, is not known at this time but could range between $0 and $40 million, pre-tax. PPL Electric cannot predict the outcome of the waiver or audit proceedings, which remain pending before the FERC. Results of Operations
The following discussion provides a summary of PPL Electric's earnings and a description of key factors that are expected to impact future earnings. This section ends with "Statement of Income Analysis," which includes explanations of significant changes in Pennsylvania Gross Delivery Margins by component and principal line items on PPL Electric's Statements of Income, comparing the three months ended March 31, 2013 with 2012.
The results for interim periods can be disproportionately influenced by numerous factors and developments and by seasonal variations. As such, the results of operations for interim periods do not necessarily indicate results or trends for the year or future periods.
Earnings | | | | | | | | | | | | | | | | | | | | | | | | | | | Net Income Available to PPL for the periods ended March 31 was: | | | | | | | | | | | | | | | | | | | | Three Months | | | | | | | | 2013 | | 2012 | | | | | | | | | | | | | | | Net Income Available to PPL | | | | | | | | $ | 64 | | $ | 33 |
The changes in the components of Net Income Available to PPL between these periods were due to the following factors which reflect reclassifications for items included in Pennsylvania Gross Delivery Margins.
| | | | Three Months | | | | | | | | Pennsylvania Gross Delivery Margins | | | | | $ | 40 | Other operation and maintenance | | | | | | 7 | Depreciation | | | | | | (4) | Other | | | | | | (3) | Income Taxes | | | | | | (13) | Distributions on Preference Stock | | | | | | 4 | Total | | | | | $ | 31 |
· | See "Statement of Income Analysis - Pennsylvania Gross Delivery Margins - Changes in Non-GAAP Financial Measures" for an explanation of Pennsylvania Gross Delivery Margins. |
· | Lower other operation and maintenance primarily due to lower corporate service costs. |
· Higher depreciation due to PP&E additions.
· | Higher income taxes primarily due to the impact of higher pre-tax income. |
· | Lower distributions on preference stock due to the June 2012 redemption of all 2.5 million shares of preference stock. |
2013 Outlook
Excluding special items, PPL Electric projects higher earnings in 2013 compared with 2012, primarily driven by higher distribution revenues from a distribution base rate increase and higher transmission margins, partially offset by higher depreciation.
Earnings in future periods are subject to various risks and uncertainties. See "Forward-Looking Information," the rest of this Item 2, and Notes 6 and 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in PPL Electric's 2012 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.
Statement of Income Analysis --
Pennsylvania Gross Delivery Margins
Non-GAAP Financial Measure
The following discussion includes financial information prepared in accordance with GAAP, as well as a non-GAAP financial measure, "Pennsylvania Gross Delivery Margins." "Pennsylvania Gross Delivery Margins" is a single financial performance measure of PPL Electric's Pennsylvania regulated electric delivery operations, which includes transmission and distribution activities. In calculating this measure, utility revenues and expenses associated with approved recovery mechanisms, including energy provided as a PLR, are offset with minimal impact on earnings. Costs associated with these mechanisms are recorded in "Energy purchases," "Energy purchases from affiliate," "Other operation and maintenance," which is primarily Act 129 costs, and "Taxes, other than income" which is primarily gross receipts tax. As a result, this measure represents the net revenues from PPL Electric's Pennsylvania regulated electric delivery operations. This measure is not intended to replace "Operating Income," which is determined in accordance with GAAP, as an indicator of overall operating performance. Other companies may use different measures to analyze and to report on the results of their operations. PPL Electric believes that "Pennsylvania Gross Delivery Margins" provides another criterion to make investment decisions. This performance measure is used, in conjunction with other information, internally by senior management to manage PPL Electric's operations and analyze actual results to budget.
Reconciliation of Non-GAAP Financial Measures
The following tables reconcile "Operating Income" totable reconciles "Pennsylvania Gross Delivery Margins" as defined by PPL Electric to "Operating Income" for the periods ended September 30.March 31.
| | | | | 2012 Three Months | | 2011 Three Months | | | | | | PA Gross | | | | | | | PA Gross | | | | | | | | | | | Delivery | | | | Operating | | Delivery | | | | | Operating | | | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | Operating Revenues | | | | | | | | | | | | | | | | | | | Retail electric | $ | 443 | | | | | $ | 443 | | $ | 454 | | | | | $ | 454 | | Electric revenue from affiliate | | 1 | | | | | | 1 | | | 1 | | | | | | 1 | | | | Total Operating Revenues | | 444 | | | | | | 444 | | | 455 | | | | | | 455 |
| | | | | 2013 Three Months | | 2012 Three Months | | | | | | PA Gross | | | | | | PA Gross | | | | | | | | | | Delivery | | | | Operating | | Delivery | | | | Operating | | | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | Operating Revenues | | Operating Revenues | | | | | | | | | | | | | | | | 2012 Three Months | | 2011 Three Months | Retail electric | | $ | 512 | | | | $ | 512 | | $ | 457 | | | | $ | 457 | | | | PA Gross | | | | | | PA Gross | | | | | Electric revenue from affiliate | | | 1 | | | | | | 1 | | | 1 | | | | | | 1 | | | | Delivery | | | | Operating | | Delivery | | | | Operating | | Total Operating Revenues | | | 513 | | | | | | 513 | | | 458 | | | | | | 458 | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | Operating Expenses | Operating Expenses | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | Energy purchases | | 137 | | | | 137 | | 171 | | | | 171 | Energy purchases | | 172 | | | | 172 | | 153 | | | | 153 | | Energy purchases from affiliate | | 23 | | | | 23 | | 5 | | | | 5 | Energy purchases from affiliate | | 14 | | | | 14 | | 21 | | | | 21 | | Other operation and maintenance | | 25 | | $ | 123 | | 148 | | 30 | | $ | 116 | | 146 | Other operation and maintenance | | 22 | | $ | 111 | | 133 | | 22 | | $ | 118 | | 140 | | Depreciation | | | | 41 | | 41 | | | | 38 | | 38 | Depreciation | | | | 43 | | 43 | | | | 39 | | 39 | | Taxes, other than income | | 23 | | | 1 | | | 24 | | | 24 | | | 2 | | | 26 | Taxes, other than income | | | 28 | | | 2 | | | 30 | | | 25 | | | 1 | | | 26 | | | Total Operating Expenses | | 208 | | | 165 | | | 373 | | | 230 | | | 156 | | | 386 | | Total Operating Expenses | | | 236 | | | 156 | | | 392 | | | 221 | | | 158 | | | 379 | Total | Total | $ | 236 | | $ | (165) | | $ | 71 | | $ | 225 | | $ | (156) | | $ | 69 | Total | | $ | 277 | | $ | (156) | | $ | 121 | | $ | 237 | | $ | (158) | | $ | 79 |
| | | | | | 2012 Nine Months | | 2011 Nine Months | | | | | | | PA Gross | | | | | | | PA Gross | | | | | | | | | | | | Delivery | | | | Operating | | Delivery | | | | | Operating | | | | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | Operating Revenues | | | | | | | | | | | | | | | | | | | | Retail electric | | $ | 1,303 | | | | | $ | 1,303 | | $ | 1,444 | | | | | $ | 1,444 | | Electric revenue from affiliate | | | 3 | | | | | | 3 | | | 9 | | | | | | 9 | | | | Total Operating Revenues | | | 1,306 | | | | | | 1,306 | | | 1,453 | | | | | | 1,453 | | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | | | | | | | Energy purchases | | | 410 | | | | | | 410 | | | 591 | | | | | | 591 | | Energy purchases from affiliate | | | 61 | | | | | | 61 | | | 15 | | | | | | 15 | | Other operation and maintenance | | | 74 | | $ | 357 | | | 431 | | | 77 | | $ | 325 | | | 402 | | Depreciation | | | | | | 119 | | | 119 | | | | | | 108 | | | 108 | | Taxes, other than income | | | 67 | | | 5 | | | 72 | | | 77 | | | 6 | | | 83 | | | | Total Operating Expenses | | | 612 | | | 481 | | | 1,093 | | | 760 | | | 439 | | | 1,199 | Total | | $ | 694 | | $ | (481) | | $ | 213 | | $ | 693 | | $ | (439) | | $ | 254 |
(a) | Represents amounts excluded from Margins. |
(b) | As reported on the Statements of Income. |
Changes in Non-GAAP Financial Measures
The following table shows PPL Electric's non-GAAP financial measure, "Pennsylvania Gross Delivery Margins" for the periods ended September 30,March 31, as well as the change between periods. The factors that gave rise to the change are described below the table. | | | Three Months | | Nine Months | | | | 2012 | | 2011 | | Change | | 2012 | | 2011 | | Change | | | | | | | | | | | | | | | | | | | | | PA Gross Delivery Margins by Component | | | | | | | | | | | | | | | | | | | | Distribution | | $ | 185 | | $ | 179 | | $ | 6 | | $ | 544 | | $ | 560 | | $ | (16) | | Transmission | | | 51 | | | 46 | | | 5 | | | 150 | | | 133 | | | 17 | | Total | | $ | 236 | | $ | 225 | | $ | 11 | | $ | 694 | | $ | 693 | | $ | 1 |
| | | | | | | | | | | | Three Months | | | | | | | | | | | | | 2013 | | 2012 | | Change | PA Gross Delivery Margins by Component | | | | | | | | | | | | | | | | | | | | Distribution | | | | | | | | | | | $ | 224 | | $ | 189 | | $ | 35 | | Transmission | | | | | | | | | | | | 53 | | | 48 | | | 5 | | Total | | | | | | | | | | | $ | 277 | | $ | 237 | | $ | 40 |
Distribution
Margins decreasedincreased for the ninethree months ended September 30, 2012March 31, 2013 compared with the same period in 2011,2012 primarily due to an $18a $13 million unfavorablefavorable effect of mild weather early in 2012. The three2012 and nine-month periods were impacted by a $7$19 million charge recorded in 2011 to reducefavorable effect of price, largely comprised of higher base rates, effective January 1, 2013 as a portionresult of the transmission service charge regulatory asset associated with a 2005 undercollection that was not included in any subsequent2012 rate reconciliations filed with the PUC.case and higher volumes of $3 million.
Transmission
Margins increased for the three and nine-month periodsmonths ended September 30, 2012,March 31, 2013 compared with the same periods in 2011,2012 primarily due to increased investment in plant and the recovery of additional costs through the FERC formula-based rates.
Other Operation and Maintenance | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | Three Months | | | | | | | | | | | | | | Uncollectible accounts | | | | $ | (2) | Corporate service costs (a) | | | | | (5) | Total | | | | $ | (7) |
(a) | The decrease is partially due to $2 million of storm insurance policy premiums for coverage that was in place in 2012 but was not renewed in 2013. |
Other Operation and Maintenance | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance expense for the periods ended September 30, 2012 compared with 2011 was due to: | | | | | | Three Months | | Nine Months | | | | | | | | | | | | | | Payroll-related costs | $ | 9 | | $ | 16 | Contractor-related expenses | | 1 | | | 4 | Vegetation management | | 2 | | | 10 | PUC-reportable storm costs, net of insurance recovery | | (6) | | | (13) | Act 129 costs | | (5) | | | (6) | Uncollectible accounts | | (1) | | | 3 | Allocation of certain corporate support group costs | | 2 | | | 7 | Other | | | | | 8 | Total | $ | 2 | | $ | 29 |
Depreciation
Depreciation expense increased by $11$4 million for the ninethree months ended September 30, 2012March 31, 2013 compared with 2011,2012, primarily due to PP&E additions relatedas part of ongoing investments to PPL Electric's ongoing efforts to ensure the reliability of its deliveryenhance system and replace aging infrastructure.reliability.
Taxes, Other Than Income
Taxes, other than income decreasedincreased by $11$4 million for the ninethree months ended September 30, 2012March 31, 2013 compared with 2011,2012, primarily due to lowerhigher Pennsylvania gross receipts tax expense due to a decrease in taxable electrichigher retail electricity revenue. This tax is included in "Pennsylvania Gross Delivery Margins."
Financing Costs | | | | | | | | | | | | | | The increase (decrease) in financing costs for the periods ended September 30, 2012 compared with 2011 was due to: | | | | | | | | | | Three Months | | Nine Months | | | | | | | | Long-term debt interest expense | | $ | 1 | | $ | (1) | Distributions on preference stock (a) | | | (4) | | | (8) | Amortization of debt issuance costs | | | (2) | | | 1 | Other | | | | | | (1) | Total | | $ | (5) | | $ | (9) |
Financing Costs
Financing costs, which consist of "Interest Expense" and "Distributions on Preference Stock," decreased by $3 million for the three months ended March 31, 2013, compared with 2012. The decrease was primarily due to the June 2012 redemption of all 2.5 million shares of preference stock.
(a)Income Taxes | Decreases | | �� | | | | | | | | | | | The increase (decrease) in income taxes for both periods arethe period ended March 31, 2013 compared with 2012 was due to the June 2012 redemption of all 2.5 million shares of preference stock.to: | | | | | | | | | | | | | | | | Three Months | | | | | | | | Higher pre-tax book income | | | | | $ | 16 | Depreciation not normalized | | | | | | (2) | Other | | | | | | (1) | Total | | | | | $ | 13 |
Income Taxes | | | | | | | | | | | | | | The increase (decrease) in income taxes for the periods ended September 30, 2012 compared with 2011 was due to: | | | | | | | | | | | | | | Three Months | | Nine Months | | | | | | | | Higher (lower) pre-tax book income | | $ | 1 | | $ | (15) | Federal and state tax reserve adjustments | | | | | | 1 | Federal and state tax return adjustments (a) | | | | | | 2 | Depreciation not normalized (a) | | | | | | 1 | Other | | | 1 | | | 2 | Total | | $ | 2 | | $ | (9) |
(a) | In February 2011, the Pennsylvania Department of Revenue issued interpretive guidance on the treatment of bonus depreciation for Pennsylvania income tax purposes. In accordance with Corporation Tax Bulletin 2011-01, Pennsylvania allows 100% bonus depreciation for qualifying assets in the same year bonus depreciation is allowed for federal income tax purposes. The 100% Pennsylvania bonus depreciation deduction created a current state income tax benefit for the flow-through impact of Pennsylvania regulated state tax depreciation. The federal provision for 100% bonus depreciation generally applies to property placed in service before January 1, 2012. |
See Note 5 to the Financial Statements for additional information on income taxes.
Financial Condition | | | | | | | | | | Liquidity and Capital Resources | | | | | | | | | | PPL Electric had the following at: | | | | | | | | | | | | September 30, 2012 | | December 31, 2011 | | March 31, 2013 | | December 31, 2012 | | | | | | | | | | Cash and cash equivalents | | $ | 31 | | $ | 320 | | $ | 31 | | $ | 140 | Short-term debt | | | $ | 125 | | | |
The $289$109 million decrease in PPL Electric's cash and cash equivalents position was primarily the net result of:
· | capital expenditures of $407$189 million; |
· | redemptionnet cash used in operating activities of preference$77 million; |
· | the payment of $25 million of common stock of $250 million;dividends to parent; partially offset by |
· | a net increase in notes receivable from affiliateshort-term debt of $210 million; |
· | the payment of $75 million of common stock dividends to parent; |
· | net cash provided by operating activities of $261 million; |
· | long-term debt issuance of $249$125 million; and |
· | contributions from parent of $150$60 million. |
PPL Electric's cash used in operating activities increased by $67 million for the three months ended March 31, 2013 compared with 2012. The increase was a net effect of:
· | a $77 million increase in cash used by components of working capital (primarily due to a $76 million change in accounts receivable resulting from higher base rates and favorable effects of weather); and |
· | a $34 million increase in defined benefit plan funding; partially offset by |
· | a $27 million increase in net income. |
Credit Facilities
PPL Electric maintains credit facilities to provide liquidity and to backstop commercial paper issuances. At September 30, 2012,March 31, 2013, PPL Electric's total committed borrowing capacity under its credit facilities and the use of this borrowing capacity were:
| | | | | | | Letters of | | | | | | | | | Letters of | | | | | | | | | | Credit Issued | | | | | | | | | Credit Issued | | | | | | | | | | and | | | | | | | | | and | | | | | | Committed | | | | Commercial | | Unused | | | Committed | | | | Commercial | | Unused | | | | Capacity | | Borrowed | | Paper Backstop | | Capacity | | | Capacity | | Borrowed | | Paper Backup | | Capacity | | | | | | | | | | | | | | | | | | | | Syndicated Credit Facility (a) (b) | | $ | 300 | | | | $ | 1 | | $ | 299 | | Syndicated Credit Facility (a) | | Syndicated Credit Facility (a) | | $ | 300 | | | | $ | 126 | | $ | 174 | Asset-backed Credit Facility (c)(b) | Asset-backed Credit Facility (c)(b) | | | 100 | | | | | | n/a | | | 100 | Asset-backed Credit Facility (c)(b) | | | 100 | | | | | | n/a | | | 100 | Total PPL Electric Credit Facilities | Total PPL Electric Credit Facilities | | $ | 400 | | | | | $ | 1 | | $ | 399 | Total PPL Electric Credit Facilities | | $ | 400 | | | | | $ | 126 | | $ | 274 |
(a) | The commitments under this credit facility are provided by a diverse bank group, with no one bank and its affiliates providing an aggregate commitment of more than 7%5% of the total committed capacity. |
(b) | In November 2012, PPL Electric amended its syndicated credit facility to extend the expiration date to October 2017. |
(c) | PPL Electric obtains financing by selling and contributing its eligible accounts receivable and unbilled revenue to a special purpose, wholly owned subsidiary on an ongoing basis. The subsidiary pledges these assets to secure loans of up to an aggregate of $100 million from a commercial paper conduit sponsored by a financial institution. At September 30, 2012,March 31, 2013, based on accounts receivable and unbilled revenue pledged, the amount available for borrowing under the facility was $100 million. In July 2012, PPL Electric and the subsidiary extended this agreement to September 2012 and reduced the capacity from $150 million. In September 2012, the agreement was extended to September 2013. |
See Note 7 to the Financial Statements for further discussion of PPL Electric's credit facilities.
Commercial Paper
In May 2012, PPL Electric increased the capacity of itsmaintains a commercial paper program from $200 millionfor up to $300 million to provide an additional financing source to fund its short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by PPL Electric's Syndicated Credit Facility. At March 31, 2013, PPL Electric had $125 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheet, at a weighted-average interest rate of 0.39%. PPL Electric had no commercial paper outstanding at September 30, 2012.
Long-term Debt and Equity Securities
In June 2012, PPL Electric redeemed all 2.5 million shares of its 6.25% Series Preference Stock, par value $100 per share. The price paid for the redemption was the par value, without premium ($250 million in the aggregate). At December 31, 2011, the preference stock was reflected in "Preference stock" on PPL Electric's Balance Sheet.
In August 2012, PPL Electric issued $250 million of 2.50% First Mortgage Bonds due 2022. The notes may be redeemed at PPL Electric's option any time prior to maturity at make-whole redemption prices. PPL Electric received proceeds of $247 million, net of a discount and underwriting fees. The net proceeds were used to repay short-term indebtedness incurred to fund PPL Electric's redemption of its 6.25% Series Preference Stock in June 2012 and for other general corporate purposes.
Rating Agency Actions
Moody's, S&P and Fitch periodically review the credit ratings on the debt securities of PPL Electric. Based on their respective independent reviews, the rating agencies may make certain ratings revisions or ratings affirmations.
A credit rating reflects an assessment by the rating agency of the creditworthiness associated with an issuer and particular securities that it issues. The credit ratings of PPL Electric are based on information provided by PPL Electric and other sources. The ratings of Moody's, S&P and Fitch are not a recommendation to buy, sell or hold any securities of PPL Electric. Such ratings may be subject to revisions or withdrawal by the agencies at any time and should be evaluated independently of each other and any other rating that may be assigned to the securities.
A downgrade in PPL Electric's credit ratings could result in higher borrowing costs and reduced access to capital markets.
As a result of the passage of the Dodd-Frank Act, PPL Electric is limiting itsdoes not have credit rating disclosuretriggers that would result in the reduction of access to a descriptioncapital markets or the acceleration of the actions taken by the rating agencies with respect to PPL Electric's ratings, but without stating what ratings have been assigned to PPL Electric or its securities. The ratings assigned by the rating agencies to PPL Electric and its respective securities may be found, without charge, on eachmaturity dates of the respective rating agencies' websites, which ratings together with all other information contained on such rating agency websites is, hereby, explicitly not incorporated by reference in this report.outstanding debt.
The rating agencies took the followingdid not take any actions related to PPL Electric:
In August 2012, Fitch assigned a rating and outlook to PPL Electric's $250 million First Mortgage Bonds.
In August 2012, S&P and Moody's assigned a rating to PPL Electric's $250 million First Mortgage Bonds.Electric in 2013.
For additional information on PPL Electric's liquidity and capital resources, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," in PPL Electric's 20112012 Form 10-K.
Risk Management
Market Risk and Credit Risk
PPL Electric issues debt to finance its operations, which exposes it to interest rate risk. At September 30, 2012,March 31, 2013, PPL Electric had noElectric's potential annual exposure to increased interest expense, based on its current debt portfolio.a 10% increase in interest rates, was not significant.
PPL Electric is also exposed to changes in the fair value of its debt portfolio. PPL Electric estimated that a 10% decrease in interest rates at September 30, 2012March 31, 2013 would increase the fair value of its debt portfolio by $97$71 million.
See Notes 13 and 14 to the Financial Statements in this Form 10-Q and "Risk Management" in PPL Electric's 20112012 Form 10-K for additional information on market and credit risk.
Related Party Transactions
PPL Electric is not aware of any material ownership interests or operating responsibility by senior management of PPL Electric in outside partnerships, including leasing transactions with variable interest entities or other entities doing business with PPL Electric. See Note 11 to the Financial Statements for additional information on related party transactions.
Environmental Matters
Physical effects associated with climate change could include the impact of changes in weather patterns, such as storm frequency and intensity, and the resultant potential damage to PPL Electric's electricity transmission and distribution systems, as well as impacts on customers. PPL Electric cannot currently predict whether its businesses will experience these potential climate change-related risks or estimate the potential cost of their related consequences.
See Note 10 to the Financial Statements in this Form 10-Q and "Item 1. Business - Environmental Matters" in PPL Electric's 20112012 Form 10-K for a discussion of environmental matters.
New Accounting Guidance
See Notes 2 and 1819 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.
Application of Critical Accounting Policies
Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies. The following accounting policies are particularly important to the financial condition or results of operations, and require estimates or other judgments of matters inherently uncertain: defined benefits, loss accruals, income taxes, regulatory assets and liabilities, and revenue recognition - unbilled revenue. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in PPL Electric's 20112012 Form 10-K for a discussion of each critical accounting policy.
LG&E AND KU ENERGY LLC AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following should be read in conjunction with LKE's Condensed Consolidated Financial Statements and the accompanying Notes and with LKE's 20112012 Form 10-K. Capitalized terms and abbreviations are defined in the glossary. Dollars are in millions, unless otherwise noted.
"Management's Discussion and Analysis of Financial Condition and Results of Operations" includes the following information:
| · | "Overview" provides a description of LKE and its business strategy, a summary of Net Income and a discussion of certain events related to LKE's results of operations and financial condition. |
| · | "Results of Operations" provides a summary of LKE's earnings and a description of key factors expected to impact future earnings. This section ends with explanations of significant changes in principal line items on LKE's Statements of Income, comparing the three and nine months ended September 30, 2012March 31, 2013 with the same periods in 2011.2012. |
| · | "Financial Condition - Liquidity and Capital Resources" provides an analysis of LKE's liquidity position and credit profile. This section also includes a discussion of rating agency actions. |
| · | "Financial Condition - Risk Management" provides an explanation of LKE's risk management programs relating to market and credit risk. |
Overview
Introduction
LKE, headquartered in Louisville, Kentucky, is a holding company withand a wholly owned subsidiary of PPL. LKE has regulated utility operations through its subsidiaries, LG&E and KU. LG&E and KU, which constitute substantially all of LKE's operations,assets. LG&E and KU are regulated utilities engaged in the generation, transmission, distribution and sale of electricity, in Kentucky, Virginia and Tennessee.electric energy. LG&E also engages in the distribution and sale of natural gasgas. LG&E and KU maintain their separate identities and serve customers in Kentucky.Kentucky under their respective names. KU also serves customers in Virginia under the Old Dominion Power name and in Tennessee under the KU name.
Business Strategy
LKE's overall strategy is to provide reliable, safe, and competitively priced energy to its customers.customers and reasonable returns on regulated investments to its member.
A key objective for LKE is to maintain a strong credit profile through managing financing costs and access to credit markets. LKE continually focuses on maintaining an appropriate capital structure and liquidity position.
Financial and Operational Developments
Net Income Net Income for the three and nine months ended September 30, 2012March 31, 2013 was $83 million and $180$96 million compared to $89$53 million and $217 million for the same periods in 20112012 representing decreases of 7% and 17% from the same periods in 2011.an 81% increase over 2012.
See "Results of Operations" for a discussion and analysis of LKE's earnings.
Terminated Bluegrass CTs AcquisitionRate Case Proceedings
In September 2011,December 2012, the KPSC approved a rate case settlement agreement providing for increases in annual base electricity rates of $34 million for LG&E and $51 million for KU entered intoand an asset purchase agreement with Bluegrass Generationincrease in annual base gas rates of $15 million for the purchase of the Bluegrass CTs, aggregating approximately 495 MW, plus limited associated contractual arrangements required for operation of the units, for a purchase price of $110 million, pending receipt of applicable regulatory approvals. In May 2012, the KPSC issued an order approving the request to purchase the Bluegrass CTs. Also in May 2012, the FERC issued an order conditionally authorizing the acquisition of the Bluegrass CTs, subject to approval by the FERC of satisfactory mitigation measures to address market-power concerns. After a review of potentially available mitigation options, LG&E and KU determined that the options were not commercially justifiable. In June 2012, LG&E and KU terminated the asset purchase agreement for the Bluegrass CTs in accordance with its terms and made applicable filings withusing a 10.25% return on equity. The approved rates became effective January 1, 2013.
the KPSC and FERC. LG&E and KU are currently assessing the impact of the asset purchase agreement termination and potential future generation capacity options.
NGCC Construction
In September 2011, LG&E and KU filed a CPCN with the KPSC requesting approval to build a 640 MW NGCC at the existing Cane Run plant site in Kentucky. In May 2012, the KPSC issued an order approving the request. LG&E will own a 22% undivided interest and KU will own a 78% undivided interest in the new NGCC. LG&E and KU commenced preliminary construction activities in the third quarter of 2012 and project construction is expected to be completed by May 2015. The project, which includes building a natural gas supply pipeline and related transmission projects, has an estimated cost of approximately $600 million.
In conjunction with this construction and to meet new, more stringent federal EPA regulations with a 2015 compliance date, LG&E and KU anticipate retiring six older coal-fired electric generating units at the Cane Run, Green River and Tyrone plants, which have a combined summer capacity rating of 797 MW.
Capital Expenditures
Capital expenditure plans are revised periodically to reflect changes in operational, market and regulatory conditions. LKE has lowered its projected environmental capital spending for the period 2012 through 2016 by approximately $0.5 billion from the previously disclosed $3.1 billion projection included in LKE's 2011 Form 10-K. The lower projected capital spending is based on current project evaluations and pricing contained in contracts executed to date for environmental construction projects. LKE continues to evaluate potential new generation supply sources, including self-build options and power sourced from the market, as alternatives to installing additional emission control equipment at E.W. Brown, which is jointly dispatched for LG&E and KU, and in lieu of the terminated Bluegrass CTs acquisition discussed in Notes 6 and 8 to the Financial Statements. LKE expects to complete its evaluation during the first half of 2013. The outcome of that evaluation may lead to additional changes in projected capital spending.
Registered Debt Exchange Offer by LKE
In June 2012, LKE completed an exchange of all its outstanding 4.375% Senior Notes due 2021 issued in September 2011 in a transaction not registered under the Securities Act of 1933, for similar securities that were issued in a transaction registered with the SEC. See Note 7 in LKE's 2011 Form 10-K for additional information.
Commercial Paper
In February 2012, LG&E and KU each established a commercial paper program for up to $250 million to provide an additional financing source to fund their short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by LG&E's and KU's Syndicated Credit Facilities. LG&E and KU had no commercial paper outstanding at September 30, 2012.
Results of Operations
The following discussion provides a summary of LKE's earnings and a description of key factors that management expects mayexpected to impact future earnings. This section ends with "Statement of Income Analysis," which includes explanations of significant changes in Margins and principal line items on LKE's Statements of Income, comparing the three and nine months ended September 30, 2012March 31, 2013 with the same periods in 2011.2012.
The results for interim periods can be disproportionately influenced by numerous factors and developments and by seasonal variations. As such, the results of operations for interim periods do not necessarily indicate results or trends for the year or for future periods.
Earnings | | | | | | | | | | | | | | | | | | | | Net Income for the periods ended September 30 was: | | | | | | | | | | Net Income for the period ended March 31 was: | | Net Income for the period ended March 31 was: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Three Months | | Nine Months | | | | | Three Months | | | | 2012 | | 2011 | | 2012 | | 2011 | | | | | | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | | | Net Income | Net Income | | $ | 83 | | $ | 89 | | $ | 180 | | $ | 217 | Net Income | | | | | | $ | 96 | | $ | 53 |
The changes in the components of Net Income between these periods were due to the following factors, which reflect reclassifications for items included in marginsMargins and certain items that management considers special. See additional detail of these special items in the table below.
| | Three Months | | Nine Months | | | | | | | | Margins | | $ | (4) | | $ | (22) | Other operation and maintenance | | | 3 | | | (12) | Depreciation | | | (2) | | | (8) | Taxes, other than income | | | (1) | | | (6) | Other | | | (2) | | | (5) | Other Income (Expense) - net | | | (4) | | | (13) | Income Taxes | | | 4 | | | 30 | Special items | | | | | | (1) | Total | | $ | (6) | | $ | (37) |
| | | | Three Months | | | | | | | | Margins | | | | | $ | 75 | Other operation and maintenance | | | | | | 10 | Depreciation | | | | | | (9) | Taxes, other than income | | | | | | (1) | Interest Expense | | | | | | 1 | Income Taxes | | | | | | (30) | Special items, after-tax | | | | | | (3) | Total | | | | | $ | 43 |
· | See "Statement of Income Analysis - Margins - Changes in Non-GAAP Financial Measures" for an explanation of margins.Margins. |
· | HigherLower other operation and maintenance for the nine-month period, primarily due to $12$14 million of higherlower costs due to the timing and scope of scheduled coal plant maintenance costs resulting from an increased scopeoutages, partially offset by $4 million of scheduled plant outages.adjustments to regulatory assets and liabilities. |
· | Higher depreciation for the nine-month period, primarily due to PP&E additions.environmental costs related to the elimination of the 2005 and 2006 ECR plans now being included in base rates, which added $13 million to depreciation that is excluded from Margins, partially offset by lower depreciation of $5 million due to revised rates that were effective January 1, 2013. Both of these events are the result of the 2012 Kentucky rate case proceedings. |
· | Higher taxes, other than income for the nine-month period,taxes primarily due to an increase in property taxes resulting from property additions, higher assessed values, and changes in property classifications to categories with higher tax rates. |
· | Lower other income (expense) - net for the nine-month period, primarily due to losses from an equity method investment. |
· | Lower income taxes for the nine-month period, primarily due to lower pre-tax income. |
The following after-tax gains (losses), which management considers special items, also impacted earnings during the periods ended September 30.March 31.
| | Income Statement | | Three Months | | Nine Months | | | Line Item | | 2012 | | 2011 | | 2012 | | 2011 | | | | | | | | | | | | | | | | Acquisition-related adjustments: | | | | | | | | | | | | | | | Net operating loss carryforward and other tax related adjustments | Income Taxes and Other O&M | | | | | | | | $ | 4 | | | | Other: | | | | | | | | | | | | | | | Discontinued Operations, net of tax of $0, $1, $4, $1 (a) | Discontinued Operations | | | | | $ | (1) | | | (5) | | $ | (1) | | Energy-related economic activity, net of tax of $0, ($1), $0, $0 | Operating Revenues | | | | | | 1 | | | | | | 1 | Total | | | | | | | | | $ | (1) | | | |
| | Income Statement | | | Three Months | | | Line Item | | | 2013 | | 2012 | | | | | | | | | | | EEI adjustments | Other Income (Expense) - net | | | $ | 1 | | | | Net operating loss carryforward and other tax-related adjustments | Income Taxes and Other O&M | | | | | | $ | 4 | Total | | | | $ | 1 | | $ | 4 |
(a) | The nine months ended September 30, 2012 includes an adjustment to an indemnification liability. |
2013 Outlook
Excluding special items, LKE projects lowerhigher earnings in 20122013 compared with 2011 as a result of2012, primarily driven by electric and gas base rate increases, returns on additional environmental capital investments and load growth, partially offset by higher other operation and maintenance expense, higher depreciation, higher property taxes and losses from an equity method investment. expense.
In June 2012, LG&E and KU filed requests with the KPSC for increases in annual base electric rates of approximately $62 million at LG&E and approximately $82 million at KU and an increase in annual base gas rates of approximately $17 million at LG&E. The proposed base rate increases would result in electric rate increases of 6.9% at LG&E and 6.5% at KU and a gas rate increase of 7.0% at LG&E and would be effective in January 2013. LG&E's and KU's applications include requests for authorized returns-on-equity at LG&E and KU of 11% each. In November 2012, the KPSC issued an order for a settlement conference to begin on November 13, 2012. A hearing on the original application and subsequent testimony is scheduled to begin on November 27, 2012. LG&E and KU cannot predict the outcome of these proceedings, including the possibility of any agreed stipulations or settlement, which would remain subject to KPSC approval. A final order may be issued in December 2012 or January 2013.Earnings in 2012 and future periods are subject to various risks and uncertainties. See "Forward-Looking Information," the rest of this Item 2, Notes 6 and 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in LKE's 20112012 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.
Statement of Income Analysis --
Margins
Non-GAAP Financial Measure
The following discussion includes financial information prepared in accordance with GAAP, as well as a non-GAAP financial measure, "Margins." Margins is not intended to replace "Operating Income," which is determined in accordance with GAAP as an indicator of overall operating performance. Other companies may use different measures to analyze and to report on the results of their operations. Margins is a single financial performance measure of LKE's operations.electricity generation, transmission and distribution operations as well as its distribution and sale of natural gas. In calculating this measure, fuel and energy purchases are deducted from revenues. In addition, utility revenues and expenses associated with approved cost recovery tracking mechanisms are offset. These mechanisms allow for recovery of certain expenses, returns on capital investments associated with environmental regulations and performance incentives. Certain costs associated with these mechanisms, primarily ECR, DSM and DSM,GLT, are recorded as "Other operation and maintenance" and "Depreciation." As a result, this measure represents the net revenues from LKE's operations. This performance measure is used, in conjunction with other information, internally by senior management to manage operations and analyze actual results compared towith budget.
Reconciliation of Non-GAAP Financial Measures
The following tables reconciletable reconciles "Margins" to "Operating Income" to "Margins" as defined by LKE for the periods ended September 30.March 31.
| | | | 2012 Three Months | | 2011 Three Months | | | | 2013 Three Months | | 2012 Three Months | | | | | | | | | Operating | | | | | | Operating | | | | | | | | Operating | | | | | | Operating | | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Revenues | Operating Revenues | | $ | 732 | | | | $ | 732 | | $ | 734 | | $ | 2 | | $ | 736 | Operating Revenues | | $ | 800 | | | | $ | 800 | | $ | 705 | | | | $ | 705 | Operating Expenses | Operating Expenses | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | Fuel | | 249 | | | | 249 | | 245 | | | | 245 | Fuel | | 231 | | | | 231 | | 213 | | | | 213 | | Energy purchases | | 27 | | | | 27 | | 32 | | | | 32 | Energy purchases | | 86 | | | | 86 | | 74 | | | | 74 | | Other operation and maintenance | | 28 | | $ | 158 | | 186 | | 26 | | 161 | | 187 | Other operation and maintenance | | 25 | | $ | 172 | | 197 | | 22 | | $ | 184 | | 206 | | Depreciation | | 13 | | 74 | | 87 | | 12 | | 72 | | 84 | Depreciation | | | | 82 | | 82 | | 13 | | 73 | | 86 | | Taxes, other than income | | | | | | 11 | | | 11 | | | | | | 10 | | | 10 | Taxes, other than income | | | | | | 12 | | | 12 | | | | | | 11 | | | 11 | | | Total Operating Expenses | | | 317 | | | 243 | | | 560 | | | 315 | | | 243 | | | 558 | | Total Operating Expenses | | | 342 | | | 266 | | | 608 | | | 322 | | | 268 | | | 590 | Total | Total | | $ | 415 | | $ | (243) | | $ | 172 | | $ | 419 | | $ | (241) | | $ | 178 | Total | | $ | 458 | | $ | (266) | | $ | 192 | | $ | 383 | | $ | (268) | | $ | 115 |
| | | | | | 2012 Nine Months | | | 2011 Nine Months | | | | | | | | | | | Operating | | | | | | | | Operating | | | | | | | Margins | | Other (a) | | Income (b) | | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | Operating Revenues | | $ | 2,095 | | | | | $ | 2,095 | | | $ | 2,139 | | $ | 1 | | $ | 2,140 | Operating Expenses | | | | | | | | | | | | | | | | | | | | | Fuel | | | 677 | | | | | | 677 | | | | 666 | | | | | | 666 | | Energy purchases | | | 135 | | | | | | 135 | | | | 179 | | | | | | 179 | | Other operation and maintenance | | | 76 | | $ | 513 | | | 589 | | | | 67 | | | 499 | | | 566 | | Depreciation | | | 39 | | | 220 | | | 259 | | | | 37 | | | 212 | | | 249 | | Taxes, other than income | | | | | | 34 | | | 34 | | | | | | | 28 | | | 28 | | | | Total Operating Expenses | | | 927 | | | 767 | | | 1,694 | | | | 949 | | | 739 | | | 1,688 | Total | | $ | 1,168 | | $ | (767) | | $ | 401 | | | $ | 1,190 | | $ | (738) | | $ | 452 |
(a) | Represents amounts excluded from Margins. |
(b) | As reported on the Statements of Income. |
Changes in Non-GAAP Financial Measures
Margins decreasedincreased by $22$75 million for the ninethree months ended September 30, 2012March 31, 2013 compared with the same period in 2011, primarily2012 due to $16higher base rates of $31 million, higher volumes of lower retail margins, as$19 million, environmental costs added to base rates of $18 million and increased environmental investments of $7 million.
The increase in base rates was the result of new KPSC rates going into effect on January 1, 2013. The increase in volumes were impacted by unseasonably mildwas attributable to colder weather during the first four months of 2012, and $6 million of lower wholesale margins, as volumes were impacted by lower market prices.in 2013 compared with 2012. Total heating degree days decreased 24% comparedincreased 41%. The environmental costs added to base rates was due to the same periodelimination of the 2005 and 2006 ECR plans as a result of the 2012 Kentucky rate case. This elimination results in 2011.depreciation and other operation and maintenance expenses associated with the 2005 and 2006 ECR plans being excluded from Margins in 2013.
Other Operation and Maintenance | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance expense for the period ended March 31, 2013 compared with 2012 was due to: | | | |
Other Operation and Maintenance | | | Three Months | | | | | | | | Coal plant outages (a) | | | | $ | (14) | Bad debt expense | | | | | (3) | Adjustments to regulatory assets and liabilities | | | | | 4 | Other | | | | | 4 | Total | | | | $ | (9) |
Other operation and maintenance increased by $23 million for the nine months ended September 30, 2012 compared with 2011, primarily due to:
·(a) | a $13 million increase in coal plant maintenance costs, including certain amounts included in margins,Decrease is primarily resulting from an increaseddue to the timing and scope of scheduled outages;outages. |
· | a $6 million credit to establish a regulatory asset was recorded in the first quarter of 2011 related to 2009 storm costs; and |
·Depreciation | a $3 million | | | | | | | | The increase (decrease) in restricted stock awards.depreciation for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | | | | | Three Months | | | | | | | | Lower depreciation rates effective January 1, 2013 | | | | $ | (5) | Additions to PP&E | | | | | 2 | Other | | | | | (1) | Total | | | | $ | (4) |
Depreciation
Depreciation increased by $3 million and $10 million for the three and nine months ended September 30, 2012 compared with 2011, primarily due to PP&E additions.
Taxes, Other Than Income
Taxes, other than income increased by $6 million for the nine months ended September 30, 2012 compared with 2011, primarily due to an increase in property taxes resulting from property additions, higher assessed values, and changes in property classifications to categories with higher tax rates.
Other Income (Expense) - net
Other income (expense) - net decreased by $13 million for the nine months ended September 30, 2012, compared with 2011, primarily due to $8 million in losses from an equity method investment.
Income Taxes
Income taxes decreasedincreased by $36 million for the ninethree months ended September 30, 2012,March 31, 2013 compared with 2011,2012 primarily due to a $68 million decrease inhigher pre-tax income and $9 million of adjustments to deferred taxes related to net operating loss carryforwards based on income tax return adjustments.income.
See Note 5 to the Financial Statements for additional information on income taxes.
Income (Loss) from Discontinued Operations (net of income taxes)Financial Condition | | | | | | | | Liquidity and Capital Resources | | | | | | | | LKE had the following at: | | | | | | | | | | March 31, 2013 | | December 31, 2012 | | | | | | | | Cash and cash equivalents | | $ | 52 | | $ | 43 | | | | | | | | Short-term debt (a) | | $ | 185 | | $ | 125 | | | | | | | | Notes payable with affiliates | | $ | 85 | | $ | 25 |
Loss from discontinued operations increased by $5 million for the nine months ended September 30, 2012, compared with 2011. The increase was primarily related to an adjustment to the estimated liability for indemnifications related to the termination of the WKE lease in 2009.
Financial Condition | | | | | | | | Liquidity and Capital Resources | | | | | | | | LKE had the following at: | | | | | | | | | | September 30, 2012 | | December 31, 2011 | | | | | | | | Cash and cash equivalents | | $ | 90 | | $ | 59 |
(a) | Represents borrowings under LG&E's and KU's commercial paper programs. See Note 7 to the Financial Statements for additional information. |
The $31$9 million increase in LKE's cash and cash equivalents position was primarily the net result of:
· | cash provided by operating activities of $646$85 million; |
· | an increase in short term debt of $60 million; |
· | an increase in notes payable with affiliates of $60 million; and |
· | capital contributions from member of $75 million; offset by |
· | capital expenditures of $525 million; and |
· | distributions to member of $95$271 million. |
LKE's cash provided by operating activities decreased by $37$147 million for the ninethree months ended September 30, 2012,March 31, 2013, compared with 2011,2012, primarily due to:
159
· | an increase in cash outflows from other operating activities of $110 million driven by a $96 million increase in discretionary defined benefit plan contributions; and |
· | a decreasedecline in working capital cash flow changes of $98 million driven primarily by changes in accounts receivable and unbilled revenues due to higher sales volumes, higher rates and extended payment terms, offset by lower inventory levels in 2013 compared with 2012 driven by increased generation; offset by |
· | an increase in net income of $37 million due to unseasonably mild weather during the first four months of 2012 and higher operation and maintenance expenses, adjusted for non-cash effectsitems of $103$61 million (deferred income taxes and investment tax credits of $114$13 million, and defined benefit plans - expense of $8$7 million partiallyand other non-cash items of $2 million, offset by depreciation of $10 million and other noncash items of $9$4 million); and. |
· | a decrease in cash inflows related to income tax receivable of $37 million due to fewer income tax payments received from member; partially offset by |
· | a decrease in cash outflows related to accrued taxes of $49 million primarily due to the timing of property and income tax payments; and |
· | a decrease in cash outflows of $93 million due to a reduction in discretionary defined benefit plan contributions. |
LKE's cash used in investing activities137
Capital expenditures increased by $383$97 million forduring the ninethree months ended September 30, 2012,March 31, 2013 compared with 2011,2012 primarily due to proceeds from the saleenvironmental air projects at Mill Creek and Ghent, and construction of other investments of $163 million in 2011 and an increase in capital expenditures of $229 million as a result of increased environmental spending, primarily related to landfills; and infrastructure improvements at generation, distribution and transmission facilities.
LKE's cash used in financing activities decreased by $292 million for the nine months ended September 30, 2012, compared with 2011, primarily due to the issuance of long-term debt of $250 million and a repayment on a revolving line of credit of $163 million in 2011 and lower distributions to member of $374 million in 2012.Cane Run Unit 7.
Credit Facilities
At September 30, 2012,March 31, 2013, LKE's total committed borrowing capacity under its credit facilities and the use of this borrowing capacity were: | | | Committed | | | | Letters of | | Unused | | | | | | | Letters of | | | | | | Capacity | | Borrowed | | Credit Issued | | Capacity | | | | | | | Credit Issued | | | | | | | | | | | | | | | | | | | and | | | LKE Credit Facility with a subsidiary of PPL Energy Supply | | $ | 300 | | | | | | $ | 300 | | | | | | Committed | | | | Commercial | | Unused | | | | | Capacity | | Borrowed | | Paper Backup | | Capacity | | | | | | | | | | | | LKE Credit Facility with a subsidiary of PPL Energy Funding Corporation | | LKE Credit Facility with a subsidiary of PPL Energy Funding Corporation | | $ | 300 | | $ | 85 | | | | $ | 215 | LG&E Credit Facility (a) | LG&E Credit Facility (a) | | 400 | | | | | | | | | 400 | LG&E Credit Facility (a) | | 500 | | | | | $ | 70 | | | 430 | KU Credit Facilities (a) (b) | KU Credit Facilities (a) (b) | | | 598 | | | | | $ | 198 | | | 400 | KU Credit Facilities (a) (b) | | | 598 | | | | | | 313 | | | 285 | | Total Credit Facilities (c) | | $ | 1,298 | | | | | $ | 198 | | $ | 1,100 | Total Credit Facilities (c) | | $ | 1,398 | | $ | 85 | | $ | 383 | | $ | 930 |
(a) | In November 2012, LG&E and KU amended theEach company pays customary fees under their respective syndicated credit facility to extend the expiration dates to November 2017. In addition, LG&E increased thefacilities, as well as KU's letter of credit facility, capacity to $500 million.and borrowings generally bear interest at LIBOR-based rates plus an applicable margin. |
(b) | In August 2012, theMay 2013, KU letter of credit facility agreement was amended and restated to allow for certain payments under theextended its $198 million letter of credit facility to be converted to loans rather than requiring immediate payment.May 2016. |
(c) | The $1.098 billion of commitments under LKE'sLG&E's and KU's domestic credit facilities are provided by a diverse bank group, with no one bank and its affiliates providing an aggregate commitment of more than 10%11% of the total committed capacity; however, the PPL affiliate providesprovided a commitment of approximately 23%21% of the total facilities listed above. The syndicated credit facilities, as well as KU's letter of credit facility, each contain a financial covenant requiring debt to total capitalization not to exceed 70% for LG&E or KU, as calculated in accordance with the facility, and other customary covenants. |
See Note 7 to the Financial Statements for further discussion of LKE's credit facilities.
Long-term Debt Securities
LKE's long-term debt securities activity through September 30, 2012 was: | | | | | | | | | | | | | | Debt | | | | | Issuances | | Retirement | | | | | | | | | | Non-cash Exchanges (a) | | | | | | | | LKE Senior Unsecured Notes | | $ | 250 | | $ | (250) |
(a) | In June 2012, LKE completed an exchange of all of its outstanding 4.375% Senior Notes due 2021 issued in September 2011, in a transaction not registered under the Securities Act of 1933, for similar securities that were issued in a transaction registered with the SEC. | LG&E and KU currently plan to issue, subject to market conditions, up to $350 million for LG&E and $300 million for KU, of first mortgage bond indebtedness in 2013, the proceeds of which will be used to fund capital expenditures and for other general corporate purposes.
See Note 7 to the Financial Statements for additional information about long-term debt securities.
Rating Agency Actions
Moody's, S&P and Fitch periodically review the credit ratings on the debt securities of LKE and its subsidiaries. Based on their respective independent reviews, the rating agencies may make certain ratings revisions or ratings affirmations.
A credit rating reflects an assessment by the rating agency of the creditworthiness associated with an issuer and particular securities that it issues. The credit ratings of LKE and its subsidiaries are based on information provided by LKE and other sources. The ratings of Moody's, S&P and Fitch are not a recommendation to buy, sell or hold any securities of LKE or its subsidiaries. Such ratings may be subject to revisions or withdrawal by the agencies at any time and should be evaluated independently of each other and any other rating that may be assigned to the securities. A downgrade in LKE's or its subsidiaries'The credit ratings could result in higher borrowing costs and reduced access to capital markets.
As a result of the passage of the Dodd-Frank Act and the attendant uncertainties relating to the extent to which issuers of non-asset backed securities may disclose credit ratings without being required to obtain rating agency consent to the inclusion of such disclosure, or incorporation by reference of such disclosure, in a registrant's registration statement or section 10(a) prospectus, LKE is limiting its credit rating disclosure to a description of the actions taken by the rating agencies with respect to LKE's ratings, but without stating what ratings have been assigned to LKE or its subsidiaries, or their securities. The ratings assigned by the rating agencies to LKE and its subsidiaries affect its liquidity, access to capital markets and their respective securities may be found, without charge, on eachcost of the respective rating agencies' websites, which ratings together with all other information contained on such rating agency websites is, hereby, explicitly not incorporated by reference in this report.borrowing under its credit facilities.
The rating agencies took the followingdid not take any actions related to LKE and its subsidiaries:
In February 2012, Fitch assigned ratings tosubsidiaries during the two newly established commercial paper programs for LG&E and KU.
In March 2012, Moody's affirmed the following ratings:
· | the long-term ratings of the First Mortgage Bonds for LG&E and KU; |
· | the issuer ratings for LG&E and KU; and |
· | the bank loan ratings for LG&E and KU. |
Also in March 2012, Moody's and S&P each assigned short-term ratings to the two newly established commercial paper programs for LG&E and KU.
In March and May 2012, Moody's, S&P and Fitch affirmed the long-term ratings for LG&E's 2003 Series A and 2007 Series B pollution control bonds.first quarter of 2013.
Ratings Triggers
LKE and its subsidiaries have various derivative and non-derivative contracts, including contracts for the sale and purchase of electricity, fuel, commodity transportation and storage and interest rate instruments, which contain provisions requiring LKE and its subsidiaries to post additional collateral, or permitting the counterparty to terminate the contract, if LKE's or its subsidiaries' credit ratings were to fall below investment grade. See Note 14 to the Financial Statements for a discussion of "Credit Risk-Related Contingent Features," including a discussion of the potential additional collateral that would have been required for derivative contracts in a net liability position at September 30, 2012. At September 30, 2012, if LKE and its subsidiaries' credit ratings had been below investment grade, the maximum amount that LKE would have been required to post as additional collateral to counterparties was $87 million for both derivative and non-derivative commodity and commodity-related contracts used in its generation and marketing operations, gas supply and interest rate contracts.March 31, 2013. Risk Management
Market Risk
See Notes 13 and 14 to the Financial Statements for information about LKE's risk management objectives, valuation techniques and accounting designations.
The forward-looking information presented below provides estimates of what may occur in the future, assuming certain adverse market conditions and model assumptions. Actual future results may differ materially from those presented. These disclosures are not precise indicators of expected future losses, but only indicators of possible losses under normal market conditions at a given confidence level.
Commodity Price Risk (Non-trading)
LG&E's and KU's rates are set by regulatory commissions and the fuel costs incurred are directly recoverable from customers. As a result, LG&E and KU are subject to commodity price risk for only a small portion of on-going business operations. LKE conducts energy trading and risk management activitiessells excess economic generation to maximize the value of the physical assets at times when the assets are not required to serve LG&E's andor KU's customers. See Note 14 to the Financial Statements for additional disclosures.
Interest Rate Risk
LKE and its subsidiaries issue debt to finance their operations, which exposes them to interest rate risk. LKE utilizes various financial derivative instruments to adjust the mix of fixed and floating interest rates in its debt portfolio when appropriate. Risk limits under LKE's risk management program are designed to balance risk, exposure to volatility in interest expense and changes in the fair value of LKE's debt portfolio due to changes in the absolute level of interest rates.
At September 30, 2012,March 31, 2013, LKE's potential annual exposure to increased interest expense, based on a 10% increase in interest rates, was not significant.
LKE is also exposed to changes in the fair value of its debt portfolio. LKE estimated that a 10% decrease in interest rates at September 30, 2012,March 31, 2013, would increase the fair value of its debt portfolio by $117$111 million.
At September 30, 2012, LKE had the following interest rate hedges outstanding: | | | | | | | | | | | | | | | | | | | Effect of a | | | | | | Fair Value, | | 10% Adverse | | | | Exposure | | Net - Asset | | Movement | | | | Hedged | | (Liability) (a) | | in Rates | Economic hedges | | | | | | | | | | | Interest rate swaps (b) | | $ | 179 | | $ | (62) | | $ | (3) |
At March 31, 2013, LKE had the following interest rate hedges outstanding: | | | | | | | | | | | | | | | | | | | Effect of a | | | | | | | | | 10% Adverse | | | | | | | Fair Value, | | Movement | | | | Exposure | | Net - Asset | | in Interest | | | | Hedged | | (Liability) (a) | | Rates | Economic activity | | | | | | | | | | | Interest rate swaps (b) | | $ | 179 | | $ | (55) | | $ | (3) | Cash flow hedges | | | | | | | | | | | Interest rate swaps (b) | | | 300 | | | 24 | | | (17) |
(a) | Includes accrued interest. |
(b) | LKE utilizes various risk management instruments to reduce its exposure to the expected future cash flow variability of its debt instruments. These risks include exposure to adverse interest rate movements for outstanding variable rate debt and for future anticipated financing. While LKE is exposed to changes in the fair value of these instruments, any realized changes in the fair value of such economic positions and cash flow hedges are recoverable through regulated rates and any subsequent changes in fair value of these derivatives are included in regulatory assets or liabilities. Sensitivities represent a 10% adverse movement in interest rates. The positions outstanding at September 30, 2012March 31, 2013 mature through 2033.2043. |
Credit Risk
See Notes 13 and 14 to the Financial Statements in this Form 10-Q and "Risk Management - Energy Marketing & Trading and Other - Credit Risk" in LKE's 20112012 Form 10-K for additional information.
Related Party Transactions
LKE is not aware of any material ownership interest or operating responsibility by senior management of LKE, LG&E or KU in outside partnerships, including leasing transactions with variable interest entities, or other entities doing business with LKE. See Note 11 to the Financial Statements for additional information on related party transactions. Environmental Matters
Protection of the environment is a major priority for LKE and a significant element of its business activities. Extensive federal, state and local environmental laws and regulations are applicable to LKE'sLG&E's and KU's air emissions, water discharges and the management of hazardous and solid waste, amongas well as other areas, and the costsaspects of LKE's business. The cost of compliance or alleged non-compliance cannot be predicted with certainty but could be material. In addition, costs may increase significantly if the requirements or scope of environmental laws or regulations, or similar rules, are expanded or changed from prior versions by the relevant agencies. Costs may take the form of increased capital expenditures or operating and maintenance expenses;expenses, monetary fines, penalties or forfeitures; or other restrictions. Many of these environmental law considerations are also applicable to the operations of key suppliers, or customers, such as coal producers and industrial power users, etc. and may impact the costscost for their products or their demand for LKE'sLG&E's and KU's services.
Physical effects associated with climate change could include the impact of changes in weather patterns, such as storm frequency and intensity, and the resultant potential damage to LG&E's and KU's generation assets, electricity transmission and distribution systems, as well as impacts on customers. In addition, changed weather patterns could potentially reduce annual rainfall in areas where LG&E and KU have hydro generating facilities or where river water is used to cool its fossil-powered generators. LKE cannot currently predict whether its businesses will experience these potential climate change-related risks or estimate the potential costs of their related consequences.
The following is a discussion of the more significant environmental matters.
Coal Combustion Residuals (CCRs) In June 2010, the EPA proposed two approaches to regulating the disposal and management of CCRs (as either hazardous or non-hazardous) under existing solid waste regulations. A final rulemaking is currently expected before the end of 2015. However, the timing of the final regulations could be accelerated by certain litigation that could require the EPA to issue its regulations sooner. Regulations could impact handling, disposal and/or beneficial use of CCRs. The financial impact could be material if CCRs are regulated as hazardous waste, and significant if regulated as non-hazardous, in accordance with the proposed rule.
Effluent Limitation Guidelines On April 19, 2013, the EPA issued proposed regulations to revise discharge limitations for steam electric generation wastewater permits. The proposed limitations are based on the EPA review of available treatment technologies and their capacity for reducing pollutants and include new requirements for fly ash and bottom ash handling and metal cleaning wastes as well as new limits for scrubber wastewater, gasification wastewater and landfill leachate. The proposal contains several alternative approaches, some of which could significantly impact LG&E's and KU's coal-fired plants. LG&E and KU will comment on the proposed regulation. The final regulation is expected in May 2014. At the present time, LKE is unable to predict the outcome of this matter or estimate a range of reasonably possible costs, but the costs could be significant.
316(b) Cooling Water Intake Structure Rule In April 2011, the EPA published a draft regulation under Section 316(b) of the Clean Water Act, which regulates cooling water intakes for power plants. The draft rule has two provisions: one requires installation of Best Technology Available (BTA) to reduce mortality of aquatic organisms that are pulled into the plant cooling water system (entrainment), and the second imposes standards for reduction of mortality of aquatic organisms trapped on water intake screens (impingement). A final rule is expected in June 2013. The proposed regulation would apply to nearly all LG&E and KU-owned steam electric plants in Kentucky, potentially even including those equipped with closed-cycle cooling systems.
GHG Regulations In 2013, the EPA is expected to finalize limits on GHG emissions from new power plants and to begin working on a proposal for such emissions from existing power plants. The EPA's proposal on GHG emissions from new power plants would effectively preclude construction of any coal-fired plants and could even be difficult for new gas-fired plants to meet. With respect to existing power plants, the impact could be very significant, depending on the structure and stringency of the final rule. On behalf of LG&E and KU, PPL, along with others in the industry, filed comments on the EPA's proposal related to GHG emissions from new plants. MATS The EPA finalized MATS requiring fossil-fuel fired plants to reduce emissions of mercury and other hazardous air pollutants by April 16, 2015. The rule is being challenged by industry groups and states. The EPA has subsequently proposed changes to the rule with respect to new sources to address the concern that the rule effectively precludes construction of any new coal-fired plants. LG&E and KU are generally well-positioned to comply with MATS, primarily due to recent investments in environmental controls and approved ECR plans to install additional controls at some of their Kentucky plants. LG&E and KU are evaluating, among other measures, chemical additive systems for mercury control at Trimble County and Brown plants. The anticipated retirements of certain coal-fired electric generating units is in response to this and other environmental regulations.
CSAPR and CAIR In 2011, the EPA finalized its CSAPR regulating emissions of nitrous oxide and sulfur dioxide through new allowance trading programs which were to be implemented in two phases (2012 and 2014). Like its predecessor, the CAIR, CSAPR targeted sources in the eastern United States. In December 2011, the U.S. Court of Appeals for the District of Columbia Circuit (the Court) stayed implementation of CSAPR, leaving CAIR in place. Subsequently, in August 2012, the Court vacated and remanded CSAPR back to the EPA for further rulemaking, again leaving CAIR in place. LG&E and KU plants in Kentucky will continue to comply with CAIR through optimization of existing controls, balanced with emission allowance purchases. The Court's August decision leaves plants in CSAPR-affected states potentially exposed to more stringent emission reductions due to regional haze implementation (it was previously determined that CSAPR or CAIR participation satisfies regional haze requirements), and/or petitions to the EPA by downwind states under Section 126 of the Clean Air Act requesting the EPA to require plants that allegedly contribute to downwind non-attainment to take action to reduce emissions.
National Ambient Air Quality Standards During 2010 and 2012, the EPA issued new ambient air standards for sulfur dioxide and particulates, respectively. In 2013, the EPA preliminarily designated Jefferson County, Kentucky, as a partial non-attainment area for sulfur dioxide. Final designations of non-attainment areas may occur in 2013 and 2014, respectively. Existing environmental plans for LG&E's and KU's Kentucky plants, including announced retirements of certain plants and ECR-approved new or upgraded scrubbers or baghouses at other plants, may aid in achievement of eventual ambient air requirements. However, depending upon the specifics of final non-attainment designations and consequent compliance plans, additional controls may be required, the financial impact of which could be significant.
See Note 10 to the Financial Statements in this Form 10-Q report and "Item 1. Business - Environmental Matters" in LKE's 20112012 Form 10-K and Note 10 to the Financial Statements for a discussion of environmental matters.
New Accounting Guidance
See Notes 2 and 1819 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.
Application of Critical Accounting Policies
Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies. The following accounting policies are particularly important to the financial condition or results of operations and require estimates or other judgments of matters inherently uncertain: revenue recognition - unbilled revenue, price risk management, defined benefits, asset impairment (excluding investments), loss accruals, AROs, income taxes, and regulatory assets and liabilities. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in LKE's 20112012 Form 10-K for a discussion of each critical accounting policy.
LOUISVILLE GAS AND ELECTRIC COMPANY
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following should be read in conjunction with LG&E's Condensed Financial Statements and the accompanying Notes and with LG&E's 20112012 Form 10-K. Capitalized terms and abbreviations are defined in the glossary. Dollars are in millions, unless otherwise noted.
"Management's Discussion and Analysis of Financial Condition and Results of Operations" includes the following information:
| · | "Overview" provides a description of LG&E and its business strategy, a summary of Net Income and a discussion of certain events related to LG&E's results of operations and financial condition. |
| · | "Results of Operations" provides a summary of LG&E's earnings and a description of key factors expected to impact future earnings. This section ends with explanations of significant changes in principal line items on LG&E's Statements of Income, comparing the three and nine months ended September 30, 2012March 31, 2013 with the same periods in 2011.2012. |
| · | "Financial Condition - Liquidity and Capital Resources" provides an analysis of LG&E's liquidity position and credit profile. This section also includes a discussion of rating agency actions. |
| · | "Financial Condition - Risk Management" provides an explanation of LG&E's risk management programs relating to market and credit risk. |
Overview
Introduction
LG&E, headquartered in Louisville, Kentucky, is a regulated utility engaged in the generation, transmission, distribution and sale of electricityelectric energy and the distribution and sale of natural gas in Kentucky. LG&E and its affiliate, KU, are wholly owned subsidiaries of LKE. LKE is an intermediary holding company in PPL's group of companies.
Business Strategy
LG&E's overall strategy is to provide reliable, safe, and competitively priced energy to its customers.customers and reasonable returns on regulated investments to its shareowner.
A key objective for LG&E is to maintain a strong credit profile through managing financing costs and access to credit markets. LG&E continually focuses on maintaining an appropriate capital structure and liquidity position.
Financial and Operational Developments
Net Income Net Income for the three and nine months ended September 30, 2012March 31, 2013 was $43 million and $94$44 million compared to $43$25 million and $102 million for the same periods in 20112012 representing an 8% decrease from the nine-month period in 2011.a 76% increase over 2012.
See "Results of Operations" for a discussion and analysis of LG&E's earnings.
Terminated Bluegrass CTs AcquisitionRate Case Proceedings
In September 2011, LG&E and KU entered into an asset purchase agreement with Bluegrass Generation for the purchase of the Bluegrass CTs, aggregating approximately 495 MW, plus limited associated contractual arrangements required for operation of the units, for a purchase price of $110 million, pending receipt of applicable regulatory approvals. In MayDecember 2012, the KPSC issuedapproved a rate case settlement agreement providing for increases in annual base electricity rates of $34 million and an order approving the request to purchase the Bluegrass CTs. Alsoincrease in May 2012, the FERC issued an order conditionally authorizing the acquisitionannual base gas rates of the Bluegrass CTs, subject to approval by the FERC of satisfactory mitigation measures to address market-power concerns. After$15 million using a review of potentially available mitigation options, LG&E and KU determined that the options were not commercially justifiable. In June 2012, LG&E and KU terminated the asset purchase agreement for the Bluegrass CTs in accordance with its terms and made applicable filings with the KPSC and FERC. LG&E and KU are currently assessing the impact of the asset purchase agreement termination and potential future generation capacity options.10.25% return on equity. The approved rates became effective January 1, 2013.
NGCC Construction
In September 2011, LG&E and KU filed a CPCN with the KPSC requesting approval to build a 640 MW NGCC at the existing Cane Run plant site in Kentucky. In May 2012, the KPSC issued an order approving the request. LG&E will own a 22% undivided interest and KU will own a 78% undivided interest in the new NGCC. LG&E and KU commenced preliminary construction activities in the third quarter of 2012 and project construction is expected to be completed by May 2015. The project, which includes building a natural gas supply pipeline and related transmission projects, has an estimated cost of approximately $600 million.
In conjunction with this construction and to meet new, more stringent federal EPA regulations with a 2015 compliance date, LG&E and KU anticipate retiring six older coal-fired electric generating units at the Cane Run, Green River and Tyrone plants, which have a combined summer capacity rating of 797 MW.
Capital Expenditures
Capital expenditure plans are revised periodically to reflect changes in operational, market and regulatory conditions. LG&E has lowered its projected environmental capital spending for the period 2012 through 2016 by approximately $0.4 billion from the previously disclosed $1.6 billion projection included in LG&E's 2011 Form 10-K. The lower projected capital spending is based on current project evaluations and pricing contained in contracts executed to date for environmental construction projects. LG&E continues to evaluate potential new generation supply sources, including self-build options and power sourced from the market, as alternatives to installing additional emission control equipment at E.W. Brown, which is jointly dispatched for LG&E and KU, and in lieu of the terminated Bluegrass CTs acquisition discussed in Notes 6 and 8 to the Financial Statements. LG&E expects to complete its evaluation during the first half of 2013. The outcome of that evaluation may lead to additional changes in projected capital spending.
Commercial Paper
In February 2012, LG&E established a commercial paper program for up to $250 million to provide an additional financing source to fund its short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by LG&E's Syndicated Credit Facility. LG&E had no commercial paper outstanding at September 30, 2012.
Results of Operations
The following discussion provides a summary of LG&E's earnings and a description of key factors that management expects mayexpected to impact future earnings. This section ends with "Statement of Income Analysis," which includes explanations of significant changes in Margins and principal line items on LG&E's Statements of Income, comparing the three and nine months ended September 30, 2012March 31, 2013 with the same periods in 2011.2012.
The results for interim periods can be disproportionately influenced by numerous factors and developments and by seasonal variations. As such, the results of operations for interim periods do not necessarily indicate results or trends for the year or for future periods.
Earnings | | | | | | | | | | | | | | | | | | | | Net Income for the periods ended September 30 was: | | Net Income for the periods ended March 31 was: | | Net Income for the periods ended March 31 was: | | | | | | | | | | | | | | | | | | | | | | | Three Months | | Nine Months | | | | | Three Months | | | | 2012 | | 2011 | | 2012 | | 2011 | | | | | | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | | | Net Income | Net Income | | $ | 43 | | $ | 43 | | $ | 94 | | $ | 102 | Net Income | | | | | | $ | 44 | | $ | 25 |
The changes in the components of Net Income between these periods were due to the following factors, which reflect reclassifications for items included in margins.Margins.
| | Three Months | | Nine Months | | | | | | | | Margin | | $ | (1) | | $ | (5) | Other operation and maintenance | | | 7 | | | 1 | Depreciation | | | (1) | | | (4) | Taxes, other than income | | | (1) | | | (3) | Other | | | (4) | | | 3 | Total | | $ | | | $ | (8) |
| | | | Three Months | | | | | | | | Margins | | | | | $ | 22 | Other operation and maintenance | | | | | | 8 | Depreciation | | | | | | 1 | Taxes, other than income | | | | | | (1) | Other Income (Expense) - net | | | | | | (2) | Interest Expense | | | | | | 1 | Income Taxes | | | | | | (10) | Total | | | | | $ | 19 |
· | See "Statement of Income Analysis - Margins - Changes in Non-GAAP Financial Measures" for an explanation of margins.Margins. |
| · | Lower other operation and maintenance for the three-month period,primarily due to less storm restorationthe timing and tree trimming costs, less gas operation andscope of scheduled coal plant maintenance costs, lower bad debt expenses as a result of milder weather and improving economy and lower pension expenses.outages. |
· | Higher income taxes primarily due to higher pre-tax income. |
2013 Outlook
LG&E projects lowerhigher earnings in 20122013 compared with 2011 as a result of2012, primarily driven by electric and gas base rate increases, returns on additional environmental capital investments and retail load growth, partially offset by higher other operation and maintenance expense, higher depreciation and higher property taxes.
In June 2012, LG&E filed a request with the KPSC for an increase in annual base electric rates of approximately $62 million and an increase in annual base gas rates of approximately $17 million. The proposed request would result in a 6.9% increase in the base electric rates and a 7.0% increase in the base gas rates, and would be effective in January 2013. LG&E's application includes a request for authorized return-on-equity of 11%. In November 2012, the KPSC issued an order for a settlement conference to begin on November 13, 2012. A hearing on the original application and subsequent testimony is scheduled to begin on November 27, 2012. LG&E cannot predict the outcome of these proceedings, including the possibility of any agreed stipulations or settlement, which would remain subject to KPSC approval. A final order may be issued in December 2012 or January 2013.expense.
Earnings in 2012 and future periods are subject to various risks and uncertainties. See "Forward-Looking Information," the rest of this Item 2, Notes 6 and 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in LG&E's 20112012 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.
Statement of Income Analysis --
Margins
Non-GAAP Financial Measure
The following discussion includes financial information prepared in accordance with GAAP, as well as a non-GAAP financial measure, "Margins." Margins is not intended to replace "Operating Income," which is determined in accordance with GAAP as an indicator of overall operating performance. Other companies may use different measures to analyze and to report on the results of their operations. Margins is a single financial performance measure of LG&E's operations.electricity generation, transmission and distribution operations as well as its distribution and sale of natural gas. In calculating this measure, fuel and energy purchases are deducted from revenues. In addition, utility revenues and expenses associated with approved cost recovery tracking mechanisms are offset. These mechanisms allow for recovery of certain expenses, returns on capital investments associated with environmental regulations and performance incentives. Certain costs associated with these mechanisms, primarily ECR, DSM and DSM,GLT, are recorded as "Other operation and maintenance" and "Depreciation." As a result, this measure represents the net revenues from LG&E's operations. This performance measure is used, in conjunction with other information, internally by senior management to manage operations and analyze actual results compared towith budget.
Reconciliation of Non-GAAP Financial Measures
The following tables reconciletable reconciles "Margins" to "Operating Income" to "Margins" as defined by LG&E for the periods ended September 30.March 31.
| | | | | | 2012 Three Months | | | 2011 Three Months | | | | | | | | | | | Operating | | | | | | | | Operating | | | | | | | Margins | | Other (a) | | Income (b) | | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | Operating Revenues | | $ | 333 | | | | | $ | 333 | | | $ | 339 | | $ | 1 | | $ | 340 | Operating Expenses | | | | | | | | | | | | | | | | | | | | | Fuel | | | 100 | | | | | | 100 | | | | 98 | | | | | | 98 | | Energy purchases | | | 21 | | | | | | 21 | | | | 31 | | | | | | 31 | | Other operation and maintenance | | | 13 | | $ | 74 | | | 87 | | | | 10 | | | 81 | | | 91 | | Depreciation | | | 1 | | | 37 | | | 38 | | | | 1 | | | 36 | | | 37 | | Taxes, other than income | | | | | | 6 | | | 6 | | | | | | | 5 | | | 5 | | | | Total Operating Expenses | | | 135 | | | 117 | | | 252 | | | | 140 | | | 122 | | | 262 | Total | | $ | 198 | | $ | (117) | | $ | 81 | | | $ | 199 | | $ | (121) | | $ | 78 |
| | | | 2012 Nine Months | | 2011 Nine Months | | | | | | | | | | Operating | | | | | | Operating | | | | 2013 Three Months | | 2012 Three Months | | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | | | | | Operating | | | | | | Operating | | | | | | | | | | | | | | | | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Revenues | Operating Revenues | | $ | 990 | | | | $ | 990 | | $ | 1,034 | | $ | 1 | | $ | 1,035 | Operating Revenues | | $ | 390 | | | | $ | 390 | | $ | 353 | | | | $ | 353 | Operating Expenses | Operating Expenses | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | Fuel | | 281 | | | | 281 | | 265 | | | | 265 | Fuel | | 96 | | | | 96 | | 89 | | | | 89 | | Energy purchases | | 119 | | | | 119 | | 180 | | | | 180 | Energy purchases | | 81 | | | | 81 | | 73 | | | | 73 | | Other operation and maintenance | | 36 | | $ | 241 | | 277 | | 30 | | 242 | | 272 | Other operation and maintenance | | 11 | | $ | 80 | | 91 | | 10 | | $ | 88 | | 98 | | Depreciation | | 2 | | 112 | | 114 | | 2 | | 108 | | 110 | Depreciation | | | | 36 | | 36 | | 1 | | 37 | | 38 | | Taxes, other than income | | | | | | 17 | | | 17 | | | | | | 14 | | | 14 | Taxes, other than income | | | | | | 6 | | | 6 | | | | | | 5 | | | 5 | | | Total Operating Expenses | | | 438 | | | 370 | | | 808 | | | 477 | | | 364 | | | 841 | | Total Operating Expenses | | | 188 | | | 122 | | | 310 | | | 173 | | | 130 | | | 303 | Total | Total | | $ | 552 | | $ | (370) | | $ | 182 | | $ | 557 | | $ | (363) | | $ | 194 | Total | | $ | 202 | | $ | (122) | | $ | 80 | | $ | 180 | | $ | (130) | | $ | 50 |
(a) | Represents amounts excluded from Margins. |
(b) | As reported on the Statements of Income. |
Changes in Non-GAAP Financial Measures
Margins decreasedincreased by $5$22 million duringfor the ninethree months ended September 30, 2012March 31, 2013 compared with the same period in 2011, primarily2012 due to $4higher base rates of $13 million, higher volumes of lower wholesale margins, as$6 million, increased environmental investments of $2 million and environmental costs added to base rates of $1 million.
The increase in base rates was the result of new KPSC rates going into effect on January 1, 2013. The increase in volumes were impacted by lower market prices. Retail margins were consistentwas attributable to colder weather in 2013 compared with the prior year as increased industrial sales offset declines associated with unseasonably mild weather during the first four months of 2012. Total heating degree days decreased 28% comparedincreased 48%. The environmental costs added to base rates was due to the same periodelimination of the 2005 and 2006 ECR plans as a result of the 2012 Kentucky rate case. This elimination results in 2011. Other Operationdepreciation and Maintenance
Otherother operation and maintenance expenses associated with the 2005 and 2006 ECR plans being excluded from Margins in 2013.
Other Operation and Maintenance | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance expense for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | Three Months | | | | | | | | Coal plant outages (a) | | | | $ | (8) | Other | | | | | 1 | Total | | | | $ | (7) |
(a) | Decrease is due to the timing and scope of scheduled outages. |
Income Taxes
Income taxes increased by $5$10 million for the ninethree months ended September 30, 2012March 31, 2013 compared with 2011,2012 primarily due to an $8 million increase in coal plant maintenance costs, primarily resulting from an increased scope of scheduled outages. This increase was offset by a $2 million decrease in pension expense.higher pre-tax income.
Financial Condition | | | | | | | | Liquidity and Capital Resources | | | | | | | | LG&E had the following at: | | | | | | | | | | September 30, 2012 | | December 31, 2011 | | | | | | | | Cash and cash equivalents | | $ | 48 | | $ | 25 |
See Note 5 to the Financial Statements for additional information on income taxes.
Financial Condition | | | | | | | | Liquidity and Capital Resources | | | | | | | | LG&E had the following at: | | | | | | | | | | March 31, 2013 | | December 31, 2012 | | | | | | | | Cash and cash equivalents | | $ | 34 | | $ | 22 | | | | | | | | Short-term debt (a) | | $ | 70 | | $ | 55 |
(a) | Represents borrowings under LG&E's commercial paper program. See Note 7 to the Financial Statements for additional information. |
The $23$12 million increase in LG&E's cash and cash equivalents position was primarily the net result of:
· | cash provided by operating activities of $267 million,$85 million; |
· | capital contributions from parent of $25 million; and |
· | an increase in short term debt of $15 million; partially offset by |
· | capital expenditures of $193$98 million; and |
· | the payment of common stock dividends to parent of $47$19 million. |
LG&E's cash provided by operating activities decreased by $12$17 million for the ninethree months ended September 30, 2012,March 31, 2013, compared with 2011,2012, primarily due to:
· | a decreasean increase in cash inflowsoutflows from accounts receivableother operating activities of $26$18 million which is primarily the result ofdriven by a decrease$19 million increase in accounts receivable from affiliates of $20 million for receivables from KU for TC2 coal inventory and other shared costs and from LKE for income tax settlements;discretionary defined benefit plan contributions; and |
· | a decreasedecline in coal consumption resultingworking capital cash flow changes of $12 million driven primarily from lower coal-fired generationby changes in accounts receivable and unbilled revenues due to the mild winter weatherhigher sales volume, higher rates and an increase in combustion turbine generation that led to an increase of $34 million in coal inventory,extended payment terms, partially offset by lower fuel levels in 2013 compared with 2012 driven by increased generation and a $7 million greater declinehigher federal income tax accrual in gas storage in comparison to 2011; partially2013; offset by |
· | a decreasean increase in cash outflowsnet income adjusted for non-cash items of $42$13 million due to a reduction in discretionary(amortization of $3 million and defined benefit plan contributions.plans - expense of $2 million partially offset by deferred income taxes and investment tax credits of $5 million, other non-cash items of $4 million and depreciation of $2 million). |
LG&E's cash used in investing activitiesCapital expenditures increased by $221$38 million forduring the ninethree months ended September 30, 2012,March 31, 2013 compared with 2011,2012 primarily due to proceeds from the saleenvironmental air projects at Mill Creek, and construction of other investments of $163 million in 2011 and an increase in capital expenditures of $66 million as a result of increased environmental spending, primarily related to landfills; and infrastructure improvements at generation, distribution and transmission facilities.
LG&E's cash used in financing activities decreased by $183 million for the nine months ended September 30, 2012, compared with 2011, primarily due to a repayment on a revolving line of credit of $163 million and a net decrease in notes payable with affiliates of $12 million in 2011, along with lower common stock dividends paid to LKE of $8 million in 2012.Cane Run Unit 7.
Credit Facilities
At September 30, 2012,March 31, 2013, LG&E's committed borrowing capacity under its credit facilities and the use of this borrowing capacity were: | | | Committed | | | | Letters of | | Unused | | | | Capacity | | Borrowed | | Credit Issued | | Capacity | | | | | | | | | | | Syndicated Credit Facility (a) (b) | | $ | 400 | | | | | | | | $ | 400 |
| | | | | | | | | Letters of | | | | | | | | | | | | | Credit Issued | | | | | | | | | | | | and | | | | | | | Committed | | | | Commercial | | Unused | | | | Capacity | | Borrowed | | Paper Backup | | Capacity | | | | | | | | | | | Syndicated Credit Facility (a) (b) | | $ | 500 | | | | | $ | 70 | | $ | 430 |
(a) | The commitments under LG&E's Syndicated Credit Facility are provided by a diverse bank group, with no one bank and its affiliates providing an aggregate commitment of more than 6% of the total committed capacity available to LG&E. |
(b) | In November 2012, LG&E amended thepays customary fees under its syndicated credit facility, to extend the expiration date to November 2017. In addition, LG&E increased the credit facility capacity to $500 million.and borrowings generally bear interest at LIBOR-based rates plus an applicable margin. |
LG&E participates in an intercompany money pool agreement whereby LKE and/or KU make available to LG&E funds up to $500 million at an interest rate based on a market index of commercial paper issues. At September 30, 2012March 31, 2013 and December 31, 2011,2012, there was no balance outstanding.
See Note 7 to the Financial Statements for further discussion of LG&E's credit facilities. Long-term Debt Securities
LG&E currently plans to issue, subject to market conditions, up to $350 million of first mortgage bond indebtedness in 2013, the proceeds of which will be used to fund capital expenditures and for other general corporate purposes.
See Note 7 to the Financial Statements for additional information about long-term debt securities.
Rating Agency Actions
Moody's, S&P and Fitch periodically review the credit ratings on the debt securities of LG&E. Based on their respective independent reviews, the rating agencies may make certain ratings revisions or ratings affirmations.
A credit rating reflects an assessment by the rating agency of the creditworthiness associated with an issuer and particular securities that it issues. The credit ratings of LG&E are based on information provided by LG&E and other sources. The ratings of Moody's, S&P and Fitch are not a recommendation to buy, sell or hold any securities of LG&E. Such ratings may be subject to revisions or withdrawal by the agencies at any time and should be evaluated independently of each other and any other rating that may be assigned to the securities. A downgrade in LG&E'sThe credit ratings could result in higher borrowing costs and reducedof LG&E affect its liquidity, access to capital markets.
As a resultmarkets and cost of the passage of the Dodd-Frank Act and the attendant uncertainties relating to the extent to which issuers of non-asset backed securities may disclose credit ratings without being required to obtain rating agency consent to the inclusion of such disclosure, or incorporation by reference of such disclosure, in a registrant's registration statement or section 10(a) prospectus, LG&E is limitingborrowing under its credit rating disclosure to a description of the actions taken by the rating agencies with respect to LG&E's ratings, but without stating what ratings have been assigned to LG&E's securities. The ratings assigned by the rating agencies to LG&E and its securities may be found, without charge, on each of the respective rating agencies' websites, which ratings together with all other information contained on such rating agency websites is, hereby, explicitly not incorporated by reference in this report.facilities.
The rating agencies took the followingdid not take any actions related to LG&E:&E during the first quarter of 2013.
In February 2012, Fitch assigned ratings to LG&E's newly established commercial paper program.
In March 2012, Moody's affirmed the following ratings:
· | the long-term ratings of the First Mortgage Bonds for LG&E; |
· | the issuer ratings for LG&E; and |
· | the bank loan ratings for LG&E. |
Also in March 2012, Moody's and S&P each assigned short-term ratings to LG&E's newly established commercial paper program.
In March and May 2012, Moody's, S&P and Fitch affirmed the long-term ratings for LG&E's 2003 Series A and 2007 Series B pollution control bonds.
Ratings Triggers
LG&E has various derivative and non-derivative contracts, including contracts for the sale and purchase of electricity, fuel, commodity transportation and storage and interest rate instruments, which contain provisions requiring LG&E to post additional collateral, or permitting the counterparty to terminate the contract, if LG&E's credit rating were to fall below investment grade. See Note 14 to the Financial Statements for a discussion of "Credit Risk-Related Contingent Features," including a discussion of the potential additional collateral that would have been required for derivative contracts in a net liability position at September 30, 2012. At September 30, 2012, if LG&E's credit ratings had been below investment grade, the maximum amount that LG&E would have been required to post as additional collateral to counterparties was $62 million for both derivative and non-derivative commodity and commodity-related contracts used in its generation and marketing operations, gas supply and interest rate contracts.March 31, 2013.
Risk Management
Market Risk
See Notes 13 and 14 to the Financial Statements for information about LG&E's risk management objectives, valuation techniques and accounting designations.
The forward-looking information presented below provides estimates of what may occur in the future, assuming certain adverse market conditions and model assumptions. Actual future results may differ materially from those presented. These disclosures are not precise indicators of expected future losses, but only indicators of possible losses under normal market conditions at a given confidence level.
Commodity Price Risk (Non-trading)
LG&E's rates are set by a regulatory commissioncommissions and the fuel costs incurred are directly recoverable from customers. As a result, LG&E is subject to commodity price risk for only a small portion of on-going business operations. LG&E conducts energy trading and risk management activitiessells excess economic generation to maximize the value of the physical assets at times when the assets are not required to serve LG&E's or KU's customers. See Note 14 to the Financial Statements for additional disclosures.
Interest Rate Risk
LG&E issues debt to finance its operations, which exposes it to interest rate risk. LG&E utilizes various financial derivative instruments to adjust the mix of fixed and floating interest rates in its debt portfolio when appropriate. Risk limits under LG&E's risk management program are designed to balance risk, exposure to volatility in interest expense and changes in the fair value of LG&E's debt portfolio due to changes in the absolute level of interest rates.
At September 30, 2012,March 31, 2013, LG&E's potential annual exposure to increased interest expense, based on a 10% increase in interest rates, was not significant.
LG&E is also exposed to changes in the fair value of its debt portfolio. LG&E estimated that a 10% decrease in interest rates at September 30, 2012,March 31, 2013, would increase the fair value of its debt portfolio by $27 million.
At September 30, 2012, LG&E had the following interest rate hedges outstanding: | | | | | | | | | | | | | | | | | | | Effect of a | | | | | | Fair Value, | | 10% Adverse | | | | Exposure | | Net - Asset | | Movement | | | | Hedged | | (Liability) (a) | | in Rates | Economic hedges | | | | | | | | | | | Interest rate swaps (b) | | $ | 179 | | $ | (62) | | $ | (3) |
At March 31, 2013, LG&E had the following interest rate hedges outstanding: | | | | | | | | | | | | | | | | | | | Effect of a | | | | | | | | | 10% Adverse | | | | | | | Fair Value, | | Movement | | | | Exposure | | Net - Asset | | in Interest | | | | Hedged | | (Liability) (a) | | Rates | Economic activity | | | | | | | | | | | Interest rate swaps (b) | | $ | 179 | | $ | (55) | | $ | (3) | Cash flow hedges | | | | | | | | | | | Interest rate swaps (b) | | | 150 | | | 12 | | | (8) |
(a) | Includes accrued interest. |
(b) | LG&E utilizes various risk management instruments to reduce its exposure to the expected future cash flow variability of its debt instruments. These risks include exposure to adverse interest rate movements for outstanding variable rate debt and for future anticipated financing. While LG&E is exposed to changes in the fair value of these instruments, any realized changes in the fair value of such economic positions and cash flow hedges are recoverable through regulated rates and any subsequent changes in fair value of these derivatives are included in regulatory assets or liabilities. Sensitivities represent a 10% adverse movement in interest rates. The positions outstanding at September 30, 2012March 31, 2013 mature through 2033.2043. |
Credit Risk
See Notes 13 and 14 to the Financial Statements in this Form 10-Q and "Risk Management - Energy Marketing & Trading and Other - Credit Risk" in LG&E's 20112012 Form 10-K for additional information.
Related Party Transactions
LG&E is not aware of any material ownership interest or operating responsibility by senior management of LG&E in outside partnerships, including leasing transactions with variable interest entities, or other entities doing business with LG&E. See Note 11 to the Financial Statements for additional information on related party transactions.
Environmental Matters
Protection of the environment is a major priority for LG&E and a significant element of its business activities. Extensive federal, state and local environmental laws and regulations are applicable to LG&E's air emissions, water discharges and the management of hazardous and solid waste, amongas well as other areas, and the costsaspects of LG&E's business. The cost of compliance or alleged non-compliance cannot be predicted with certainty but could be material. In addition, costs may increase significantly if the requirements or scope of environmental laws or regulations, or similar rules, are expanded or changed from prior versions by the relevant agencies. Costs may take the form of increased capital expenditures or operating and maintenance expenses;expenses, monetary fines, penalties or forfeitures; or other restrictions. Many of these environmental law considerations are also applicable to the operations of key suppliers, or customers, such as coal producers and industrial power users, etc. and may impact the costscost for their products or their demand for LG&E's services.
Physical effects associated with climate change could include the impact of changes in weather patterns, such as storm frequency and intensity, and the resultant potential damage to LG&E's generation assets, electricity transmission and distribution systems, as well as impacts on customers. In addition, changed weather patterns could potentially reduce annual rainfall in areas where LG&E has hydro generating facilities or where river water is used to cool its fossil-powered generators. LG&E cannot currently predict whether its businesses will experience these potential climate change-related risks or estimate the potential costs of their related consequences.
The following is a discussion of the more significant environmental matters.
Coal Combustion Residuals (CCRs) In June 2010, the EPA proposed two approaches to regulating the disposal and management of CCRs (as either hazardous or non-hazardous) under existing solid waste regulations. A final rulemaking is currently expected before the end of 2015. However, the timing of the final regulations could be accelerated by certain litigation that could require the EPA to issue its regulations sooner. Regulations could impact handling, disposal and/or beneficial use of CCRs. The financial impact could be material if CCRs are regulated as hazardous waste, and significant if regulated as non-hazardous, in accordance with the proposed rule. Effluent Limitation Guidelines On April 19, 2013, the EPA issued proposed regulations to revise discharge limitations for steam electric generation wastewater permits. The proposed limitations are based on the EPA review of available treatment technologies and their capacity for reducing pollutants and include new requirements for fly ash and bottom ash handling and metal cleaning wastes as well as new limits for scrubber wastewater, gasification wastewater and landfill leachate. The proposal contains several alternative approaches, some of which could significantly impact LG&E's coal-fired plants. LG&E will comment on the proposed regulation. The final regulation is expected in May 2014. At the present time, LG&E is unable to predict the outcome of this matter or estimate a range of reasonably possible costs, but the costs could be significant.
316(b) Cooling Water Intake Structure Rule In April 2011, the EPA published a draft regulation under Section 316(b) of the Clean Water Act, which regulates cooling water intakes for power plants. The draft rule has two provisions: one requires installation of Best Technology Available (BTA) to reduce mortality of aquatic organisms that are pulled into the plant cooling water system (entrainment), and the second imposes standards for reduction of mortality of aquatic organisms trapped on water intake screens (impingement). A final rule is expected in June 2013. The proposed regulation would apply to nearly all LG&E-owned steam electric plants in Kentucky, potentially even including those equipped with closed-cycle cooling systems.
GHG Regulations In 2013, the EPA is expected to finalize limits on GHG emissions from new power plants and to begin working on a proposal for such emissions from existing power plants. The EPA's proposal on GHG emissions from new power plants would effectively preclude construction of any coal-fired plants and could even be difficult for new gas-fired plants to meet. With respect to existing power plants, the impact could be very significant, depending on the structure and stringency of the final rule. On behalf of LG&E, PPL, along with others in the industry, filed comments on the EPA's proposal related to GHG emissions from new plants.
MATS The EPA finalized MATS requiring fossil-fuel fired plants to reduce emissions of mercury and other hazardous air pollutants by April 16, 2015. The rule is being challenged by industry groups and states. The EPA has subsequently proposed changes to the rule with respect to new sources to address the concern that the rule effectively precludes construction of any new coal-fired plants. LG&E is generally well-positioned to comply with MATS, primarily due to recent investments in environmental controls and approved ECR plans to install additional controls at some of its Kentucky plants. LG&E is evaluating, among other measures, chemical additive systems for mercury control at Trimble County plant. The anticipated retirements of certain coal-fired electric generating units is in response to this and other environmental regulations.
CSAPR and CAIR In 2011, the EPA finalized its CSAPR regulating emissions of nitrous oxide and sulfur dioxide through new allowance trading programs which were to be implemented in two phases (2012 and 2014). Like its predecessor, the CAIR, CSAPR targeted sources in the eastern United States. In December 2011, the U.S. Court of Appeals for the District of Columbia Circuit (the Court) stayed implementation of CSAPR, leaving CAIR in place. Subsequently, in August 2012, the Court vacated and remanded CSAPR back to the EPA for further rulemaking, again leaving CAIR in place. LG&E plants in Kentucky will continue to comply with CAIR through optimization of existing controls, balanced with emission allowance purchases. The Court's August decision leaves plants in CSAPR-affected states potentially exposed to more stringent emission reductions due to regional haze implementation (it was previously determined that CSAPR or CAIR participation satisfies regional haze requirements), and/or petitions to the EPA by downwind states under Section 126 of the Clean Air Act requesting the EPA to require plants that allegedly contribute to downwind non-attainment to take action to reduce emissions.
National Ambient Air Quality Standards During 2010 and 2012, the EPA issued new ambient air standards for sulfur dioxide and particulates, respectively. In 2013, the EPA preliminarily designated Jefferson County, Kentucky, as a partial non-attainment area for sulfur dioxide. Final designations of non-attainment areas may occur in 2013 and 2014, respectively. Existing environmental plans for LG&E's Kentucky plants, including announced retirements of certain plants and ECR-approved new or upgraded scrubbers or baghouses at other plants, may aid in achievement of eventual ambient air requirements. However, depending upon the specifics of final non-attainment designations and consequent compliance plans, additional controls may be required, the financial impact of which could be significant.
See Note 10 to the Financial Statements in this Form 10-Q report and "Item 1. Business - Environmental Matters" in LG&E's 20112012 Form 10-K and Note 10 to the Financial Statements for a discussion of environmental matters. New Accounting Guidance
See Notes 2 and 1819 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.
Application of Critical Accounting Policies
Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies. The following accounting policies are particularly important to the financial condition or results of operations and require estimates or other judgments of matters inherently uncertain: revenue recognition - unbilled revenue, price risk management, defined benefits, asset impairment (excluding investments), loss accruals, AROs, income taxes, and regulatory assets and liabilities. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in LG&E's 20112012 Form 10-K for a discussion of each critical accounting policy.
KENTUCKY UTILITIES COMPANY
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following should be read in conjunction with KU's Condensed Financial Statements and the accompanying Notes and with KU's 20112012 Form 10-K. Capitalized terms and abbreviations are defined in the glossary. Dollars are in millions, unless otherwise noted.
"Management's Discussion and Analysis of Financial Condition and Results of Operations" includes the following information:
| · | "Overview" provides a description of KU and its business strategy, a summary of Net Income and a discussion of certain events related to KU's results of operations and financial condition. |
| · | "Results of Operations" provides a summary of KU's earnings and a description of key factors expected to impact future earnings. This section ends with explanations of significant changes in principal line items on KU's Statements of Income, comparing the three and nine months ended September 30, 2012March 31, 2013 with the same periods in 2011.2012. |
| · | "Financial Condition - Liquidity and Capital Resources" provides an analysis of KU's liquidity position and credit profile. This section also includes a discussion of rating agency actions. |
| · | "Financial Condition - Risk Management" provides an explanation of KU's risk management programs relating to market and credit risk. |
Overview
Introduction
KU, headquartered in Lexington, Kentucky, is a regulated utility engaged in the generation, transmission, distribution and sale of electricity,electric energy in Kentucky, Virginia and Tennessee. KU and its affiliate, LG&E, are wholly owned subsidiaries of LKE. LKE is an intermediary holding company in PPL's group of companies.
Business Strategy
KU's overall strategy is to provide reliable, safe, and competitively priced energy to its customers.customers and reasonable returns on regulated investments to its shareowner.
A key objective for KU is to maintain a strong credit profile through managing financing costs and access to credit markets. KU continually focuses on maintaining an appropriate capital structure and liquidity position.
Financial and Operational Developments
Net Income Net Income for the three and nine months ended September 30, 2012March 31, 2013 was $50 million and $118$64 million compared to $56$38 million and $144 million for the same periods in 20112012 representing decreases of 11% and 18% from the same periods in 2011.a 68% increase over 2012.
See "Results of Operations" for a discussion and analysis of KU's earnings.
Terminated Bluegrass CTs AcquisitionRate Case Proceedings
In September 2011, KU and LG&E entered into an asset purchase agreement with Bluegrass Generation for the purchase of the Bluegrass CTs, aggregating approximately 495 MW, plus limited associated contractual arrangements required for operation of the units, for a purchase price of $110 million, pending receipt of applicable regulatory approvals. In MayDecember 2012, the KPSC issued an order approving the request to purchase the Bluegrass CTs. Alsoapproved a rate case settlement agreement providing for increases in May 2012, the FERC issued an order conditionally authorizing the acquisitionannual base electricity rates of the Bluegrass CTs, subject to approval by the FERC of satisfactory mitigation measures to address market-power concerns. After$51 million using a review of potentially available mitigation options, KU and LG&E determined that the options were not commercially justifiable. In June 2012, KU and LG&E terminated the asset purchase agreement for the Bluegrass CTs in accordance with its terms and made applicable filings with the KPSC and FERC. KU and LG&E are currently assessing the impact of the asset purchase agreement termination and potential future generation capacity options.
NGCC Construction
In September 2011, KU and LG&E filed a CPCN with the KPSC requesting approval to build a 640 MW NGCC at the existing Cane Run plant site in Kentucky. In May 2012, the KPSC issued an order approving the request. KU will own a 78% undivided interest and LG&E will own a 22% undivided interest in the new NGCC. KU and LG&E commenced preliminary construction activities in the third quarter of 2012 and project construction is expected to be completed by May 2015.10.25% return on equity. The project, which includes building a natural gas supply pipeline and related transmission projects, has an estimated cost of approximately $600 million.
In conjunction with this construction and to meet new, more stringent federal EPA regulations with a 2015 compliance date, KU and LG&E anticipate retiring six older coal-fired electric generating units at the Cane Run, Green River and Tyrone plants, which have a combined summer capacity rating of 797 MW.
Capital Expenditures
Capital expenditure plans are revised periodically to reflect changes in operational, market and regulatory conditions. KU has lowered its projected environmental capital spending for the period 2012 through 2016 by approximately $0.1 billion from the previously disclosed $1.5 billion projection included in KU's 2011 Form 10-K. The lower projected capital spending is based on current project evaluations and pricing contained in contracts executed to date for environmental construction projects. KU continues to evaluate potential new generation supply sources, including self-build options and power sourced from the market, as alternatives to installing additional emission control equipment at E.W. Brown, which is jointly dispatched for KU and LG&E, and in lieu of the terminated Bluegrass CTs acquisition discussed in Notes 6 and 8 to the Financial Statements. KU expects to complete its evaluation during the first half ofapproved rates became effective January 1, 2013. The outcome of that evaluation may lead to additional changes in projected capital spending.
Commercial Paper
In February 2012, KU established a commercial paper program for up to $250 million to provide an additional financing source to fund its short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by KU's Syndicated Credit Facility. KU had no commercial paper outstanding at September 30, 2012.
Results of Operations
The following discussion provides a summary of KU's earnings and a description of key factors that management expects mayexpected to impact future earnings. This section ends with "Statement of Income Analysis," which includes explanations of significant changes in Margins and principal line items on KU's Statements of Income, comparing the three and nine months ended September 30, 2012March 31, 2013 with the same periods in 2011.2012.
The results for interim periods can be disproportionately influenced by numerous factors and developments and by seasonal variations. As such, the results of operations for interim periods do not necessarily indicate results or trends for the year or for future periods.
Earnings | | | | | | | | | | | | | | | | | | | | Net Income for the periods ended September 30 was: | | Net Income for the periods ended March 31 was: | | Net Income for the periods ended March 31 was: | | | | | | | | | | | | | | | | | | | | | | | Three Months | | Nine Months | | | | | Three Months | | | | 2012 | | 2011 | | 2012 | | 2011 | | | | | | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | | | Net Income | Net Income | | $ | 50 | | $ | 56 | | $ | 118 | | $ | 144 | Net Income | | | | | | $ | 64 | | $ | 38 |
The changes in the components of Net Income between these periods were due to the following factors, which reflect reclassifications for items included in margins.
| | Three Months | | Nine Months | | | | | | | | Margin | | $ | (5) | | $ | (17) | Other operation and maintenance | | | (1) | | | (8) | Depreciation | | | (2) | | | (5) | Other | | | (1) | | | (2) | Other Income (Expense) - net | | | 1 | | | (6) | Income Taxes | | | 2 | | | 12 | Total | | $ | (6) | | $ | (26) |
Margins.
| | | | Three Months | | | | | | | | Margins | | | | | $ | 53 | Depreciation | | | | | | (10) | Other Income (Expense) - net | | | | | | (1) | Income Taxes | | | | | | (17) | Special item - EEI adjustments, after-tax | | | | �� | | 1 | Total | | | | | $ | 26 |
· | See "Statement of Income Analysis - Margins - Changes in Non-GAAP Financial Measures" for an explanation of margins.Margins. |
| · | Higher other operation and maintenance for the nine-month period primarilydepreciation due to a $6 million credit recorded in 2011 to establish a regulatory assetenvironmental costs related to 2009 storm costs.the elimination of the 2005 and 2006 ECR plans now being included in base rates, which added $12 million to depreciation that is excluded from Margins, partially offset by lower depreciation of $3 million due to revised rates that were effective January 1, 2013. Both of these events are the result of the 2012 Kentucky rate case proceedings. |
| · | Higher depreciation for the three and nine-month periodsincome taxes primarily due to PP&E additions. |
| · | Lower other income (expense) - net for the nine-month period primarily due to losses from an equity method investment. |
| · | Lower income taxes for the nine-month period primarily due to lowerhigher pre-tax income. |
2013 Outlook
Excluding special items, KU projects lowerhigher earnings in 20122013 compared with 2011 as a result of2012, primarily driven by electric base rate increases, returns on additional environmental capital investments and load growth, partially offset by higher other operation and maintenance expense, higher depreciation, higher property taxes and losses from an equity method investment.
In June 2012, KU filed a request with the KPSC for an increase in annual base electric rates of approximately $82 million. The proposed base electric rate increase would result in a 6.5% increase over KU's present rate and would be effective in January 2013. KU's application includes a request for authorized return-on-equity of 11%. In November 2012, the KPSC issued an order for a settlement conference to begin on November 13, 2012. A hearing on the original application and subsequent testimony is scheduled to begin on November 27, 2012. KU cannot predict the outcome of these proceedings, including the possibility of any agreed stipulations or settlement, which would remain subject to KPSC approval. A final order may be issued in December 2012 or January 2013.expense.
Earnings in 2012 and future periods are subject to various risks and uncertainties. See "Forward-Looking Information," the rest of this Item 2, Notes 6 and 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in KU's 20112012 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.
Statement of Income Analysis --
Margins
Non-GAAP Financial Measure
The following discussion includes financial information prepared in accordance with GAAP, as well as a non-GAAP financial measure, "Margins." Margins is not intended to replace "Operating Income," which is determined in accordance with GAAP as an indicator of overall operating performance. Other companies may use different measures to analyze and to report on the results of their operations. Margins is a single financial performance measure of KU's electricity generation, transmission and distribution operations. In calculating this measure, fuel and energy purchases are deducted from revenues. In addition, utility revenues and expenses associated with approved cost recovery tracking mechanisms are offset. These mechanisms allow for recovery of certain expenses, returns on capital investments associated with environmental regulations and performance incentives. Certain costs associated with these mechanisms, primarily ECR and DSM, are recorded as "Other operation and maintenance" and "Depreciation." As a result, this measure represents the net revenues from KU's operations. This performance measure is used, in conjunction with other information, internally by senior management to manage operations and analyze actual results compared towith budget.
Reconciliation of Non-GAAP Financial Measures
The following tables reconciletable reconciles "Margins" to "Operating Income" to "Margins" as defined by KU for the periods ended September 30.March 31.
| | | | | | 2012 Three Months | | | 2011 Three Months | | | | | | | | | | | Operating | | | | | | | | Operating | | | | | | | Margins | | Other (a) | | Income (b) | | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | Operating Revenues | | $ | 411 | | | | | $ | 411 | | | $ | 419 | | $ | 1 | | $ | 420 | Operating Expenses | | | | | | | | | | | | | | | | | | | | | Fuel | | | 149 | | | | | | 149 | | | | 147 | | | | | | 147 | | Energy purchases | | | 18 | | | | | | 18 | | | | 25 | | | | | | 25 | | Other operation and maintenance | | | 16 | | $ | 77 | | | 93 | | | | 14 | | | 76 | | | 90 | | Depreciation | | | 12 | | | 37 | | | 49 | | | | 12 | | | 35 | | | 47 | | Taxes, other than income | | | | | | 5 | | | 5 | | | | | | | 5 | | | 5 | | | | Total Operating Expenses | | | 195 | | | 119 | | | 314 | | | | 198 | | | 116 | | | 314 | Total | | $ | 216 | | $ | (119) | | $ | 97 | | | $ | 221 | | $ | (115) | | $ | 106 |
| | | | 2012 Nine Months | | 2011 Nine Months | | | | 2013 Three Months | | 2012 Three Months | | | | | | | | | Operating | | | | | | Operating | | | | | | | | Operating | | | | | | Operating | | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Revenues | Operating Revenues | | $ | 1,165 | | | | $ | 1,165 | | $ | 1,191 | | | | $ | 1,191 | Operating Revenues | | $ | 432 | | | | $ | 432 | | $ | 380 | | | | $ | 380 | Operating Expenses | Operating Expenses | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | Fuel | | 396 | | | | 396 | | 401 | | | | 401 | Fuel | | 135 | | | | 135 | | 124 | | | | 124 | | Energy purchases | | 76 | | | | 76 | | 85 | | | | 85 | Energy purchases | | 27 | | | | 27 | | 29 | | | | 29 | | Other operation and maintenance | | 41 | | $ | 245 | | 286 | | 37 | | $ | 237 | | 274 | Other operation and maintenance | | 14 | | $ | 83 | | 97 | | 12 | | $ | 83 | | 95 | | Depreciation | | 36 | | 109 | | 145 | | 35 | | 104 | | 139 | Depreciation | | | | 46 | | 46 | | 12 | | 36 | | 48 | | Taxes, other than income | | | | | | 17 | | | 17 | | | | | | 14 | | | 14 | Taxes, other than income | | | | | | 6 | | | 6 | | | | | | 6 | | | 6 | | | Total Operating Expenses | | | 549 | | | 371 | | | 920 | | | 558 | | | 355 | | | 913 | | Total Operating Expenses | | | 176 | | | 135 | | | 311 | | | 177 | | | 125 | | | 302 | Total | Total | | $ | 616 | | $ | (371) | | $ | 245 | | $ | 633 | | $ | (355) | | $ | 278 | Total | | $ | 256 | | $ | (135) | | $ | 121 | | $ | 203 | | $ | (125) | | $ | 78 |
(a) | Represents amounts excluded from Margins. |
(b) | As reported on the Statements of Income. |
Changes in Non-GAAP Financial Measures
Margins decreasedincreased by $5$53 million for the three months ended September 30, 2012March 31, 2013 compared with the same period in 2011, primarily2012, due to $4higher base rates of $18 million, environmental costs added to base rates of lower retail margins.$16 million, higher volumes of $13 million and increased environmental investments of $5 million.
Margins decreased by $17 million forThe increase in base rates was the nine months ended September 30, 2012result of new KPSC rates going into effect on January 1, 2013. The increase in volumes was attributable to colder weather in 2013 compared with the same period in 2011, primarily due to $16 million of lower retail margins, as volumes were impacted by unseasonably mild weather during the first four months of 2012. Total heating degree days decreased 21% as comparedincreased 35%. The environmental costs added to base rates was due to the same periodelimination of the 2005 and 2006 ECR plans as a result of the 2012 Kentucky rate case. This elimination results in 2011.
Other Operationdepreciation and Maintenance
Otherother operation and maintenance increased by $12 million forexpenses associated with the nine months ended September 30, 2012 compared with 2011, primarily due to a $6 million credit to establish a regulatory asset was recorded2005 and 2006 ECR plans being excluded from Margins in the first quarter of 2011 related to 2009 storm costs, and a $5 million increase in coal plant maintenance costs, primarily resulting from an increased scope of scheduled outages.
Depreciation2013.
Depreciation increased by $2 million and $6 million for the three and nine months ended September 30, 2012 compared with 2011, primarily due to PP&E additions.Other Operation and Maintenance | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance expense for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | Three Months | | | | | | | | Coal plant outages (a) | | | | $ | (5) | Adjustments to regulatory assets and liabilities | | | | | 4 | Other | | | | | 3 | Total | | | | $ | 2 |
Other Income (Expense) - net
Other income (expense) - net decreased by $6 million for the nine months ended September 30, 2012, compared with 2011, primarily due to losses from an equity method investment.(a) | Decrease is due to the timing and scope of scheduled outages. |
Income Taxes
Income taxes decreasedincreased by $12$17 million for the ninethree months ended September 30, 2012,March 31, 2013 compared with 2011,2012 primarily due to a $38 million decrease inhigher pre-tax income.
See Note 5 to the Financial Statements for additional information on income taxes.
Financial Condition | | | | | | | | | | Liquidity and Capital Resources | | | | | | | | | | KU had the following at: | | | | | | | | | | | | September 30, 2012 | | December 31, 2011 | | March 31, 2013 | | December 31, 2012 | | | | | | | | | | Cash and cash equivalents | | $ | 42 | | $ | 31 | | $ | 16 | | $ | 21 | | | | | | | Short-term debt (a) | | | $ | 115 | | $ | 70 |
(a) | Represents borrowings made under KU's commercial paper program. See Note 7 to the Financial Statements for additional information. |
The $11$5 million increasedecrease in KU's cash and cash equivalents position was the net result of:
· | capital expenditures of $172 million; and |
· | the payment of common stock dividends to parent of $13 million; partially offset by |
· | cash provided by operating activities of $410$85 million; partially offset by |
· | capital expenditurescontributions from parent of $331$50 million; and |
· | common stock dividendsan increase in short term debt of $68$45 million. |
KU's cash provided by operating activities increaseddecreased by $51$67 million for the ninethree months ended September 30, 2012,March 31, 2013, compared with 2011,2012, primarily due to:
· | a decreasean increase in cash outflows for accounts payable to affiliatesfrom other operating activities of $17$61 million primarily as a result of payables to LG&E for TC2 coal inventory and other shared costs, partially offsetdriven by a decrease in income tax settlements with LKE in 2011; |
· | a decrease in cash outflows of $26$43 million due to a reductionincrease in discretionary defined benefit plan contributions; and |
· | a decreasedecline in working capital cash flow changes of $49 million driven primarily by changes in accounts receivable and unbilled revenues due to higher sales volumes, higher rates and extended payment terms and a lower federal income tax accrual in 2013 as a result of federal settlement payment, offset by an increase in cash outflows related to accrued taxes of $31 millionfrom accounts payable primarily due to the timing of propertyfuel purchase commitments and income tax payments; partially offset by |
· | a decrease in cash inflows for accounts receivable of $42 million due to an increase in customer receivables in 2012 resulting from increased revenues in 2012 following unseasonably mild weather in December 2011net income adjusted for non-cash items of $43 million (deferred income taxes and the timinginvestment tax credits of cash receipts$10 million, amortization of $4 million, other non-cash items of $3 million and payments, and an increase in accounts receivable from affiliates balance for income tax settlements with LKE in 2012.defined benefit plans - expense of $2 million offset by depreciation of $2 million) |
KU's cash used in investing activities increased by $163 million for the nine months ended September 30, 2012, compared with 2011, due to an increase in capital expenditures of $163 million as a result of increased environmental spending, primarily related to landfills; and infrastructure improvements at generation, distribution and transmission facilities.
KU's cash used in financing activities decreasedCapital expenditures increased by $32$59 million forduring the ninethree months ended September 30, 2012,March 31, 2013 compared with 2011,2012 primarily due to lower common stock dividends paid to LKEenvironmental air projects at Ghent and construction of $20 million in 2012.Cane Run Unit 7.
Credit Facilities
At September 30, 2012,March 31, 2013, KU's committed borrowing capacity under its credit facilities and the use of this borrowing capacity were: | | | | | | | | Letters of | | | | | | | | | | | Credit Issued | | | | | | | | | | | and | | | | | | Committed | | | | Letters of | | Unused | | | Committed | | | | Commercial | | Unused | | | | Capacity | | Borrowed | | Credit Issued | | Capacity | | | Capacity | | Borrowed | | Paper Backup | | Capacity | | | | | | | | | | | | | | | | | | | | Syndicated Credit Facility (a) | Syndicated Credit Facility (a) | | $ | 400 | | | | | | | | $ | 400 | Syndicated Credit Facility (a) | | $ | 400 | | | | | $ | 115 | | $ | 285 | Letter of Credit Facility (b) | | | 198 | | | | | $ | 198 | | | | | Letter of Credit Facility (a) (b) | | Letter of Credit Facility (a) (b) | | | 198 | | | | | | 198 | | | | | Total Credit Facilities (c) | | $ | 598 | | | | | $ | 198 | | $ | 400 | Total Credit Facilities (c) | | $ | 598 | | | | | $ | 313 | | $ | 285 |
(a) | In November 2012, KU amended thepays customary fees under its syndicated credit facility to extend the expiration date to November 2017.as well as its letter of credit facility, and borrowings generally bear interest at LIBOR-based rates plus an applicable margin. |
(b) | In August 2012, theMay 2013, KU letter of credit facility agreement was amended and restated to allow for certain payments under theextended its $198 million letter of credit facility to be converted to loans rather than requiring immediate payment.May 2016. |
(c) | The commitments under KU's credit facilities are provided by a diverse bank group, with no one bank and its affiliates providing an aggregate commitment of more than 19% of the total committed capacity available to KU. |
KU participates in an intercompany money pool agreement whereby LKE and/or LG&E make available to KU funds up to $500 million at an interest rate based on a market index of commercial paper issues. At September 30, 2012March 31, 2013 and December 31, 2011,2012, there was no balance outstanding.
See NotesNote 7 and 11 to the Financial Statements for further discussion of KU's credit facilities.
Long-term Debt Securities
KU currently plans to issue, subject to market conditions, up to $300 million of first mortgage bond indebtedness in 2013, the proceeds of which will be used to fund capital expenditures and for other general corporate purposes.
See Note 7 to the Financial Statements for additional information about long-term debt securities. Rating Agency Actions
Moody's, S&P and Fitch periodically review the credit ratings on the debt securities of KU. Based on their respective independent reviews, the rating agencies may make certain ratings revisions or ratings affirmations.
A credit rating reflects an assessment by the rating agency of the creditworthiness associated with an issuer and particular securities that it issues. The credit ratings of KU are based on information provided by KU and other sources. The ratings of Moody's, S&P and Fitch are not a recommendation to buy, sell or hold any securities of KU. Such ratings may be subject to revisions or withdrawal by the agencies at any time and should be evaluated independently of each other and any other rating that may be assigned to the securities. A downgrade in KU'sThe credit ratings could result in higher borrowing costs and reducedof KU affect its liquidity, access to capital markets.
As a resultmarkets and cost of the passage of the Dodd-Frank Act and the attendant uncertainties relating to the extent to which issuers of non-asset backed securities may disclose credit ratings without being required to obtain rating agency consent to the inclusion of such disclosure, or incorporation by reference of such disclosure, in a registrant's registration statement or section 10(a) prospectus, KU is limitingborrowing under its credit rating disclosure to a description of the actions taken by the rating agencies with respect to KU's ratings, but without stating what ratings have been assigned to KU's securities. The ratings assigned by the rating agencies to KU and its securities may be found, without charge, on each of the respective rating agencies' websites, which ratings together with all other information contained on such rating agency websites is, hereby, explicitly not incorporated by reference in this report.facilities.
The rating agencies took the followingdid not take any actions related to KU:
In February 2012, Fitch assigned ratings to KU's newly established commercial paper program.
In March 2012, Moody's affirmedKU during the following ratings:
· | the long-term ratings of the First Mortgage Bonds for KU; |
· | the issuer ratings for KU; and |
· | the bank loan ratings for KU. |
Also in March 2012, Moody's and S&P each assigned short-term ratings to KU's newly established commercial paper program.first quarter of 2013.
Ratings Triggers
KU has various derivative and non-derivative contracts, including contracts for the sale and purchase of electricity, fuel, and commodity transportation and storage, which contain provisions requiring KU to post additional collateral, or permitting the counterparty to terminate the contract, if KU's credit rating were to fall below investment grade. See Note 14 to the Financial Statements for a discussion of "Credit Risk-Related Contingent Features," including a discussion of the potential additional collateral that would have been required for derivative contracts in a net liability position at September 30, 2012. At September 30, 2012, if KU's credit ratings had been below investment grade, the maximum amount that KU would have been required to post as additional collateral to counterparties was $25 million for both derivative and non-derivative commodity and commodity-related contracts used in its generation and marketing operations.March 31, 2013.
Risk Management
Market Risk
See Notes 13 and 14 to the Financial Statements for information about KU's risk management objectives, valuation techniques and accounting designations.
The forward-looking information presented below provides estimates of what may occur in the future, assuming certain adverse market conditions and model assumptions. Actual future results may differ materially from those presented. These disclosures are not precise indicators of expected future losses, but only indicators of possible losses under normal market conditions at a given confidence level.
Commodity Price Risk (Non-trading)
KU's rates are set by regulatory commissions and the fuel costs incurred are directly recoverable from customers. As a result, KU is subject to commodity price risk for only a small portion of on-going business operations. KU conducts energy trading and risk management activitiessells excess economic generation to maximize the value of the physical assets at times when the assets are not required to serve KU'sLG&E's or LG&E'sKU's customers. See Note 14 to the Financial Statements for additional disclosures.
Interest Rate Risk
KU issues debt to finance its operations, which exposes it to interest rate risk. KU utilizes various financial derivative instruments to adjust the mix of fixed and floating interest rates in its debt portfolio when appropriate. Risk limits under KU's risk management program are designed to balance risk, exposure to volatility in interest expense and changes in the fair value of KU's debt portfolio due to changes in the absolute level of interest rates.
At September 30, 2012,March 31, 2013, KU's potential annual exposure to increased interest expense, based on a 10% increase in interest rates, was not significant.
KU is also exposed to changes in the fair value of its debt portfolio. KU estimated that a 10% decrease in interest rates at September 30, 2012,March 31, 2013, would increase the fair value of its debt portfolio by $70$68 million.
At March 31, 2013, KU had the following interest rate hedges outstanding: | | | | | | | | | | | | | | | | | | | Effect of a | | | | | | | | | 10% Adverse | | | | | | | Fair Value, | | Movement | | | | Exposure | | Net - Asset | | in Interest | | | | Hedged | | (Liability) | | Rates | Cash flow hedges | | | | | | | | | | | Interest rate swaps (a) | | $ | 150 | | $ | 12 | | $ | (8) |
(a) | KU utilizes various risk management instruments to reduce its exposure to the expected future cash flow variability of its debt instruments. These risks include exposure to adverse interest rate movements for outstanding variable rate debt and for future anticipated financing. While KU is exposed to changes in the fair value of these instruments, any realized changes in the fair value of such cash flow hedges are recoverable through regulated rates and any subsequent changes in fair value of these derivatives are included in regulatory assets or liabilities. The positions outstanding at March 31, 2013 mature through 2043. |
Credit Risk
See Notes 13 and 14 to the Financial Statements in this Form 10-Q and "Risk Management - Energy Marketing & Trading and Other - Credit Risk" in KU's 20112012 Form 10-K for additional information.
Related Party Transactions
KU is not aware of any material ownership interest or operating responsibility by senior management of KU in outside partnerships, including leasing transactions with variable interest entities, or other entities doing business with KU. See Note 11 to the Financial Statements for additional information on related party transactions.
Environmental Matters
Protection of the environment is a major priority for KU and a significant element of its business activities. Extensive federal, state and local environmental laws and regulations are applicable to KU's air emissions, water discharges and the management of hazardous and solid waste, amongas well as other areas, and the costsaspects of KU's business. The cost of compliance or alleged non-compliance cannot be predicted with certainty but could be material. In addition, costs may increase significantly if the requirements or scope of environmental laws or regulations, or similar rules, are expanded or changed from prior versions by the relevant agencies. Costs may take the form of increased capital expenditures or operating and maintenance expenses;expenses, monetary fines, penalties or forfeitures; or other restrictions. Many of these environmental law considerations are also applicable to the operations of key suppliers, or customers, such as coal producers and industrial power users, etc. and may impact the costscost for their products or their demand for KU's services.
Physical effects associated with climate change could include the impact of changes in weather patterns, such as storm frequency and intensity, and the resultant potential damage to KU's generation assets, electricity transmission and distribution systems, as well as impacts on customers. In addition, changed weather patterns could potentially reduce annual rainfall in areas where KU has hydro generating facilities or where river water is used to cool its fossil-powered generators. KU cannot currently predict whether its businesses will experience these potential climate change-related risks or estimate the potential costs of their related consequences.
The following is a discussion of the more significant environmental matters.
Coal Combustion Residuals (CCRs) In June 2010, the EPA proposed two approaches to regulating the disposal and management of CCRs (as either hazardous or non-hazardous) under existing solid waste regulations. A final rulemaking is currently expected before the end of 2015. However, the timing of the final regulations could be accelerated by certain litigation that could require the EPA to issue its regulations sooner. Regulations could impact handling, disposal and/or beneficial use of CCRs. The financial impact could be material if CCRs are regulated as hazardous waste, and significant if regulated as non-hazardous, in accordance with the proposed rule.
Effluent Limitation Guidelines On April 19, 2013, the EPA issued proposed regulations to revise discharge limitations for steam electric generation wastewater permits. The proposed limitations are based on the EPA review of available treatment technologies and their capacity for reducing pollutants and include new requirements for fly ash and bottom ash handling and metal cleaning wastes as well as new limits for scrubber wastewater, gasification wastewater and landfill leachate. The proposal contains several alternative approaches, some of which could significantly impact KU's coal-fired plants. KU will comment on the proposed regulation. The final regulation is expected in May 2014. At the present time, KU is unable to predict the outcome of this matter or estimate a range of reasonably possible costs, but the costs could be significant.
316(b) Cooling Water Intake Structure Rule In April 2011, the EPA published a draft regulation under Section 316(b) of the Clean Water Act, which regulates cooling water intakes for power plants. The draft rule has two provisions: one requires installation of Best Technology Available (BTA) to reduce mortality of aquatic organisms that are pulled into the plant cooling water system (entrainment), and the second imposes standards for reduction of mortality of aquatic organisms trapped on water intake screens (impingement). A final rule is expected in June 2013. The proposed regulation would apply to nearly all KU-owned steam electric plants in Kentucky, potentially even including those equipped with closed-cycle cooling systems.
GHG Regulations In 2013, the EPA is expected to finalize limits on GHG emissions from new power plants and to begin working on a proposal for such emissions from existing power plants. The EPA's proposal on GHG emissions from new power plants would effectively preclude construction of any coal-fired plants and could even be difficult for new gas-fired plants to meet. With respect to existing power plants, the impact could be very significant, depending on the structure and stringency of the final rule. On behalf of KU, PPL, along with others in the industry, filed comments on the EPA's proposal related to GHG emissions from new plants.
MATS The EPA finalized MATS requiring fossil-fuel fired plants to reduce emissions of mercury and other hazardous air pollutants by April 16, 2015. The rule is being challenged by industry groups and states. The EPA has subsequently proposed changes to the rule with respect to new sources to address the concern that the rule effectively precludes construction of any new coal-fired plants. KU is generally well-positioned to comply with MATS, primarily due to recent investments in environmental controls and approved ECR plans to install additional controls at some of its Kentucky plants. KU is evaluating, among other measures, chemical additive systems for mercury control at Trimble County and Brown plants. The anticipated retirements of certain coal-fired electric generating units is in response to this and other environmental regulations.
CSAPR and CAIR In 2011, the EPA finalized its CSAPR regulating emissions of nitrous oxide and sulfur dioxide through new allowance trading programs which were to be implemented in two phases (2012 and 2014). Like its predecessor, the CAIR, CSAPR targeted sources in the eastern United States. In December 2011, the U.S. Court of Appeals for the District of Columbia Circuit (the Court) stayed implementation of CSAPR, leaving CAIR in place. Subsequently, in August 2012, the Court vacated and remanded CSAPR back to the EPA for further rulemaking, again leaving CAIR in place. KU plants in Kentucky will continue to comply with CAIR through optimization of existing controls, balanced with emission allowance purchases. The Court's August decision leaves plants in CSAPR-affected states potentially exposed to more stringent emission reductions due to regional haze implementation (it was previously determined that CSAPR or CAIR participation satisfies regional haze requirements), and/or petitions to the EPA by downwind states under Section 126 of the Clean Air Act requesting the EPA to require plants that allegedly contribute to downwind non-attainment to take action to reduce emissions.
National Ambient Air Quality Standards During 2010 and 2012, the EPA issued new ambient air standards for sulfur dioxide and particulates, respectively. In 2013, the EPA preliminarily designated Jefferson County, Kentucky, as a partial non-attainment area for sulfur dioxide. Final designations of non-attainment areas may occur in 2013 and 2014, respectively. Existing environmental plans for KU's Kentucky plants, including announced retirements of certain plants and ECR-approved new or upgraded scrubbers or baghouses at other plants, may aid in achievement of eventual ambient air requirements. However, depending upon the specifics of final non-attainment designations and consequent compliance plans, additional controls may be required, the financial impact of which could be significant.
See Note 10 to the Financial Statements in this Form 10-Q report and "Item 1. Business - Environmental Matters" in KU's 20112012 Form 10-K and Note 10 to the Financial Statements for a discussion of environmental matters.
New Accounting Guidance
See Notes 2 and 1819 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.
Application of Critical Accounting Policies
Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies. The following accounting policies are particularly important to the financial condition or results of operations and require estimates or other judgments of matters inherently uncertain: revenue recognition - unbilled revenue, price risk management, defined benefits, asset impairment (excluding investments), loss accruals, AROs, income taxes, and regulatory assets and liabilities. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in KU's 20112012 Form 10-K for a discussion of each critical accounting policy.
PPL Corporation PPL Energy Supply, LLC PPL Electric Utilities Corporation LG&E and KU Energy LLC Louisville Gas and Electric Company Kentucky Utilities Company
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Reference is made to "Risk Management" in each Registrant's "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations."
Item 4. Controls and Procedures
(a) Evaluation of disclosure controls and procedures.
PPL Corporation, PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company, and Kentucky Utilities Company
The registrants' principal executive officers and principal financial officers, based on their evaluation of the registrants' disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934) have concluded that, as of September 30, 2012,March 31, 2013, the registrants' disclosure controls and procedures are effective to ensure that material information relating to the registrants and their consolidated subsidiaries is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms, particularly during the period for which this quarterly report has been prepared. The aforementioned principal officers have concluded that the disclosure controls and procedures are also effective to ensure that information required to be disclosed in reports filed under the Exchange Act is accumulated and communicated to management, including the principal executive and principal financial officers, to allow for timely decisions regarding required disclosure.
(b) Change in internal controls over financial reporting.
PPL Corporation,
The registrant's principal executive officer and principal financial officer have concluded that there were no changes in the registrant's internal control over financial reporting during the registrant's third fiscal quarter that have materially affected, or are reasonably likely to materially affect, the registrant's internal control over financial reporting.
As reported in the 2011 Form 10-K, PPL's principal executive officer and principal financial officer concluded that a systems migration related to the WPD Midlands acquisition created a material change to its internal control over financial reporting. Specifically, on December 1, 2011, the use of legacy information technology systems at WPD Midlands was discontinued and the related data, processes and internal controls were migrated to the systems, processes and controls currently in place at PPL WW.
Risks related to the systems migration were partially mitigated by PPL's expanded internal control over financial reporting that were implemented subsequent to the acquisition and PPL's existing policy of consolidating foreign subsidiaries on a one-month lag, which provided management additional time for review and analysis of WPD Midlands' results and their incorporation into PPL's consolidated financial statements.
PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company, and Kentucky Utilities Company
The registrants' principal executive officers and principal financial officers have concluded that there were no changes in the registrants' internal control over financial reporting during the registrants' thirdfirst fiscal quarter that have materially affected, or are reasonably likely to materially affect, the registrants' internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
For additional information regarding various pending administrative and judicial proceedings involving regulatory, environmental and other matters, which information is incorporated by reference into this Part II, see:
| · | | "Item 3. Legal Proceedings" in each Registrant's 20112012 Form 10-K; and | | · | | Notes 5, 6 and 10 to the Financial Statements. |
There have been no material changes in the Registrant's risk factors from those disclosed in "Item 1A. Risk Factors" of the 20112012 Form 10-K.
Item 4. Mine Safety Disclosures
Not applicable.
The following Exhibits indicated by an asterisk preceding the Exhibit number are filed herewith. The balance of the Exhibits have heretofore been filed with the Commission and pursuant to Rule 12(b)-32 are incorporated herein by reference. Exhibits indicated by a [_] are filed or listed pursuant to Item 601(b)(10)(iii) of Regulation S-K.
4(a) | - | Supplemental Indenture No. 14,4, dated as of August 1, 2012, made and entered into by and between PPL Electric Utilities Corporation and The Bank of New York Mellon, as Trustee, under the Indenture dated as of August 1, 2001 (Exhibit 4(a) to PPL Corporation Form 8-K Report (File No. 1-11459) dated August 24, 2012) | 4(b) | - | Supplemental Indenture No. 9, dated as of OctoberMarch 15, 2012,2013, among PPL Capital Funding, Inc., PPL Corporation and The Bank of New York Mellon (as successor to JPMorgan Chase Bank, N. A. (formerly known as The Chase Manhattan Bank))Bank of New York), as Trustee (Exhibit 4(b) to PPL Corporation Form 8-K Report (File No. 1-11459) dated OctoberMarch 15, 2012)2013) | | - | Amendment No. 6 to Credit and Security Agreement,1, dated as of July 24, 2012, byMay 1, 2013, to $198,309,583.05 Amended and among PPL Receivables Corporation, as Borrower, PPL Electric Utilities Corporation, as Servicer, Victory Receivables Corporation, as a Lender, and The BankRestated Letter of Tokyo-Mitsubishi UFJ, Ltd., New York Branch, as Liquidity Bank and as Agent | | - | Amendment No. 7 to Credit and Security Agreement, dated as of September 24, 2012, by and among PPL Receivables Corporation, as Borrower, PPL Electric Utilities Corporation, as Servicer, Victory Receivables Corporation, as a Lender, and The Bank of Tokyo-Mitsubishi UFJ, Ltd., New York Branch, as Liquidity Bank and as Agent | | - | Amendment and Restatement Agreement dated as of August 16, 2012 to Letter of Credit Agreement, dated as of April 29, 2011, as amended, among Kentucky Utilities Company, the Borrower; the Lenders from time to time party thereto, the Lenders;and Banco Bilbao Vizcaya Argentaria, S.A., New York Branch, theas Administrative Agent and Sumitomo Mitsui Banking Corporation, New York Branch theas Issuing Lender and Lender | | - | Amendment No. 2, dated as of May 1, 2013, to $198,309,583.05 Amended and Restated Letter of Credit Agreement dated as of August 16, 2012 among Kentucky Utilities Company, the Lenders from time to time party thereto, Sumitomo Mitsui Banking Corporation, New York Branch, as successor Administrative Agent and Sumitomo Mitsui Banking Corporation, New York Branch as Issuing Lender | | - | PPL Corporation and Subsidiaries Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends | | - | PPL Energy Supply, LLC and Subsidiaries Computation of Ratio of Earnings to Fixed Charges | | - | PPL Electric Utilities Corporation and Subsidiaries Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends | | - | LG&E and KU Energy LLC and Subsidiaries Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends | | - | Louisville Gas and Electric Company Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends | | - | Kentucky Utilities Company Computation of Ratio of Earnings to Fixed Charges | | | | Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, for the quarterly period ended September 30, 2012,March 31, 2013, filed by the following officers for the following companies: | | | | | - | PPL Corporation's principal executive officer | | - | PPL Corporation's principal financial officer | | - | PPL Energy Supply, LLC's principal executive officer | | - | PPL Energy Supply, LLC's principal financial officer | | - | PPL Electric Utilities Corporation's principal executive officer | | - | PPL Electric Utilities Corporation's principal financial officer | | - | LG&E and KU Energy LLC's principal executive officer | | - | LG&E and KU Energy LLC's principal financial officer | | - | Louisville Gas and Electric Company's principal executive officer | | - | Louisville Gas and Electric Company's principal financial officer |
| - | Kentucky Utilities Company's principal executive officer | | - | Kentucky Utilities Company's principal financial officer | |
Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, for the quarterly period ended September 30, 2012,March 31, 2013, furnished by the following officers for the following companies: | | | | | - | PPL Corporation's principal executive officer and principal financial officer | | - | PPL Energy Supply, LLC's principal executive officer and principal financial officer | | - | PPL Electric Utilities Corporation's principal executive officer and principal financial officer | | - | LG&E and KU Energy LLC's principal executive officer and principal financial officer | | - | Louisville Gas and Electric Company's principal executive officer and principal financial officer | | - | Kentucky Utilities Company's principal executive officer and principal financial officer | | | | 101.INS | - | XBRL Instance Document for PPL Corporation, PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company and Kentucky Utilities Company | 101.SCH | - | XBRL Taxonomy Extension Schema for PPL Corporation, PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company and Kentucky Utilities Company | 101.CAL | - | XBRL Taxonomy Extension Calculation Linkbase for PPL Corporation, PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company and Kentucky Utilities Company | 101.DEF | - | XBRL Taxonomy Extension Definition Linkbase for PPL Corporation, PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company and Kentucky Utilities Company | 101.LAB | - | XBRL Taxonomy Extension Label Linkbase for PPL Corporation, PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company and Kentucky Utilities Company | 101.PRE | - | XBRL Taxonomy Extension Presentation Linkbase for PPL Corporation, PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company and Kentucky Utilities Company |
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrants have duly caused this report to be signed on their behalf by the undersigned thereunto duly authorized. The signature for each undersigned company shall be deemed to relate only to matters having reference to such company or its subsidiaries.
| PPL Corporation | | (Registrant) | | | | | | PPL Energy Supply, LLC | | (Registrant) | | | | | | | | | | | Date: November 8, 2012May 3, 2013 | /s/ Vincent Sorgi | | | Vincent Sorgi | | | Vice President and Controller | | | (Principal Accounting Officer) | | | | | | | | | | | | PPL Electric Utilities Corporation | | (Registrant) | | | | | | | | | | | Date: November 8, 2012May 3, 2013 | /s/ Vincent Sorgi | | | Vincent Sorgi | | | Vice President and | | | Chief Accounting Officer | | | (Principal Financial and Accounting Officer) | |
| LG&E and KU Energy LLC | | (Registrant) | | | | | | Louisville Gas and Electric Company | | (Registrant) | | | | | | Kentucky Utilities Company | | (Registrant) | | | | | | | | | | | Date: November 8, 2012May 3, 2013 | /s/ Kent W. Blake | | | Kent W. Blake Chief Financial Officer | | | (Principal Financial Officer and Principal Accounting Officer) | |
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