· | Lower other operation and maintenance primarily due to lower corporate serviceEarnings for the three and six months ended June 30, 2013 increased 49% and 1% compared with the same periods in 2012. See "Results of Operations" below for further discussion of PPL's business segments, details of special items and analysis of the consolidated results of operations.
Economic and Market Conditions
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 and additional renewable energy sources, primarily wind in the western U.S. Unregulated Gross Energy Margins associated with PPL Energy Supply's competitive generation and marketing business are impacted by changes in energy and capacity market prices and demand for electricity and natural gas, power plant availability, competition in the markets for retail customers, fuel costs and availability, transmission constraints that impact the locational pricing of electricity at PPL's power plants, fuel transportation costs and the level and price of hedging activities. As a result of these factors, lower future energy margins are expected when compared to the 2012 energy margins. 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, its hedging strategies and potential plant modifications to burn lower cost fuels.
As previously disclosed, PPL's businesses are subject to extensive federal, state and local environmental laws, rules and regulations, including those surrounding coal combustion residuals, GHG, effluent limitation guidelines and MATS. See "Financial Condition - Environmental Matters" below for additional information on these requirements. These more stringent environmental requirements, combined with low energy margins for competitive generation, have led several energy companies, including PPL, to announce plans to either temporarily or permanently close, or place in long-term reserve status, certain of their coal-fired generating plants.
In 2012, PPL Energy Supply announced its intention, beginning in April 2015, to place its Corette plant in long-term reserve status, suspending the plant's operation due to expected market conditions and the costs to comply with MATS. PPL Energy Supply continues to monitor its Corette plant for potential impairment. The Corette plant asset group's carrying value at June 30, 2013 was $68 million. See Note 10 to the Financial Statements for additional information. PPL Energy Supply believes its remaining competitive generation assets are well positioned to meet the additional environmental requirements based on prior and planned investments and does not currently anticipate the need to temporarily or permanently shut down additional coal-fired plants.
The additional environmental requirements discussed above have also resulted in LKE's projected $2.1 billion in capital investment over the next five years and the anticipated retirement by 2015 of five coal-fired units with a combined summer capacity rating of 726 MW. KU retired the 71 MW unit at the Tyrone plant in February 2013. The retirement of the five coal-fired units is not expected to have a material impact on the financial condition or results of operations of PPL. See Note 8 to the Financial Statements in PPL's 2012 Form 10-K for additional information regarding the anticipated retirement of these units as well as plans to build a combined-cycle natural gas facility in Kentucky.
The KPSC has adopted a series of regulatory mechanisms (ECR, DSM, GLT, fuel adjustment clause, gas supply clause and recovery on certain construction work-in-progress) that provide for recovery of prudently incurred costs. The Kentucky utility businesses are impacted by changes in customer usage levels which can be driven by a number of factors including weather conditions and economic factors that impact the load utilized by industrial and commercial customers.
PPL cannot predict the future impact that economic and market conditions and changes in regulatory requirements may have on its financial condition or results of operations.
Susquehanna Turbine Blade Inspection
In the spring of 2013, PPL Susquehanna made modifications to address the causes of turbine blade cracking at the PPL Susquehanna nuclear plant that was first identified in 2011. The modifications were made during the Unit 2 refueling outage and an additional planned outage for Unit 1. Additional modifications will be made during planned outages in 2014 and 2015. Following completion of these modifications, PPL Susquehanna will continue monitoring the turbine blades using enhanced diagnostic equipment.
Rate Case Proceedings
Pennsylvania
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.
Kentucky
In 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 and an increase in annual base gas rates of $15 million for LG&E using a 10.25% return on equity. The approved rates became effective January 1, 2013.
Ofgem Review of Line Loss Calculation
Ofgem is currently consulting on the methodology to be used by all network operators to calculate the final line loss incentive/penalty for the DPCR4. In April 2013, Ofgem stated that their expectation was to issue a decision in the second half of 2013. In July 2013, Ofgem issued a decision paper on the process to follow for closing out the line loss incentive/penalty. Based on one element of the decision paper, WPD has concluded that certain data, which had previously served to reduce the liability calculation, could not be included. Additional information in the decision paper has increased the level of uncertainty regarding the ultimate settlement of this liability.
WPD currently estimates the potential loss exposure to be in the range of $97 million to $251 million. As a result, during the three and six months ended June 30, 2013, WPD increased the liability by $24 million, to a total of $97 million. PPL cannot predict the outcome of this matter. See Note 6 to the Financial Statements for additional information.
RIIO-ED1
In October 2010, Ofgem announced changes to the regulatory framework that will be effective for the U.K. electricity distribution sector, including WPD, beginning April 2015. The framework, known as RIIO (Revenues = Incentives + Innovation + Outputs), is intended to encourage investment in regulated infrastructure. The next electricity distribution price control review is referred to as RIIO-ED1. Key components of the RIIO-ED1 are: an extension of the price review period to eight years, increased emphasis on outputs and incentives, enhanced stakeholder engagement including network customers, a stronger incentive framework to encourage more efficient investment and innovation, and continued use of a single weighted average cost of capital. Ofgem has also indicated that the depreciation of the RAV, for RAV additions after April 1, 2015, will change from 20 years to 45 years, but that they will consider transition arrangements.
As previously reported, on July 1, 2013, WPD filed its business plan with Ofgem for the RIIO-ED1 period and gave a webcast presentation to highlight the contents of the plan as well as provide potential earnings ranges of the U.K. Regulated segment for the first two years of the RIIO-ED1 period. The ranges provided are subject to certain assumptions including foreign currency exchange rates, interest rates, inflation rates and WPD being "fast-tracked" through the price control review process and therefore earning the fast-track bonus revenue. These assumptions and other future events affecting the potential earnings ranges are subject to significant uncertainties. Although management believes that the business plan submitted by WPD meets the criteria to be fast-tracked, management cannot predict the outcome of the price control review process or the future financial effect on WPD's businesses of the RIIO-ED1 regulatory framework. See "Item 1. Business - Background - U.K. Regulated Segment - Revenue and Regulation" in the 2012 Form 10-K for additional information.
Distribution System Improvement Charge
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. In May 2013, the PUC approved PPL Electric's proposed DSIC, with an initial rate effective July 1, 2013, subject to refund after hearings. See Note 6 to the Financial Statements for additional information.
FERC Formula Rates
PPL Electric must follow FERC's Uniform System of Accounts, which requires subsidiaries to be presented, for FERC reporting purposes, using the equity method of accounting unless a waiver has been granted. The FERC has granted waivers of this requirement to other utilities when alternative accounting would more accurately present the integrated operations of a utility and its subsidiaries. In March 2013, as part of a routine FERC audit of PPL and its subsidiaries, PPL Electric determined that it never obtained a required waiver of the equity method accounting requirement for its subsidiary, PPL Receivables Corporation (PPL Receivables) for FERC Form No. 1 reporting. In March 2013, PPL Electric filed a request for waiver with the 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. If PPL Electric is not successful in obtaining the waiver, its 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. See Note 6 to the Financial Statements for additional information.
Equity Forward Agreements
In the second quarter of 2013, PPL settled forward sale agreements for 10.5 million shares of PPL common stock by issuing 8.4 million shares and cash settling the remaining 2.1 million shares. PPL received net cash proceeds of $201 million, which was used to repay short-term debt obligations and for other general corporate purposes. See Note 7 to the Financial Statements for additional information. Prior to settlement, incremental shares were included within the calculation of diluted EPS using the treasury stock method. See Note 4 to the Financial Statements for the impact on the calculation of diluted EPS.
Equity Units
During 2013, several events occurred related to the components of the 2010 Equity Units. During the first quarter of 2013, financing plans were finalized to remarket the Junior Subordinated Notes component of the 2010 Equity Units and in the second quarter, PPL Capital Funding completed the remarketing of the Junior Subordinated Notes and the simultaneous exchange into Senior Notes. The transaction resulted in a $10 million loss on extinguishment of the Junior Subordinated Notes. Additionally, in July 2013, PPL issued 40 million shares of common stock at $28.73 per share to settle the 2010 Purchase Contracts. PPL received net cash proceeds of $1.150 billion, which will be used to repay short-term and long-term debt obligations and for other general corporate purposes. See Note 7 to the Financial Statements for additional information.
The If-Converted Method of calculating diluted EPS was applied to the Equity Units beginning in the first quarter of 2013. This resulted in $15 million and $30 million of interest charges (after-tax) being added back to income available to PPL common shareowners, and 73 million shares of PPL common stock being treated as outstanding for the three and six months ended June 30, 2013. See Note 4 to the Financial Statements for the impact on the calculation of diluted EPS.
Tax Litigation
In May 2013, the U.S. Supreme Court reversed the December 2011 ruling of the U. S. Court of Appeals for the Third Circuit, on the creditability for U.S. income tax purposes of the U.K. Windfall Profits Tax. As a result of this decision, PPL recorded an income tax benefit of $44 million for the three and six months ended June 30, 2013. See Note 5 to the Financial Statements for additional information.
U.K. Tax Rate Change
In July 2013, the U.K. Finance Act 2013 was enacted, which reduces the U.K.'s statutory income tax rate from 23% to 21%, effective April 1, 2014 and from 21% to 20%, effective April 1, 2015. As a result of these changes, PPL expects to reduce its net deferred tax liabilities and recognize a deferred tax benefit in the range of $90 million to $100 million in the third quarter of 2013.
Results of Operations
The following discussion provides a review of results by reportable segment and a description of key factors by segment expected to impact future earnings. This section ends with "Statement of Income Analysis," which includes explanations of
Kentucky Gross Margins, Pennsylvania Gross Delivery Margins and Unregulated Gross Energy Margins and significant changes in principal line items on PPL's Statements of Income, comparing the three and six months ended June 30, 2013 with the same periods in 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.
Tables analyzing changes in amounts between periods within "Segment Results" and "Statement of Income Analysis" are presented on a constant U.K. foreign currency exchange rate basis, where applicable, in order to isolate the impact of the change in the exchange rate on the item being explained. Results computed on a constant U.K. foreign currency exchange rate basis are calculated by translating current year results at the prior year weighted-average U.K. foreign currency exchange rate.
Segment Results
Kentucky Regulated Segment
The Kentucky Regulated segment consists primarily of LKE's regulated electricity generation, transmission and distribution operations. This segment also includes LKE's regulated distribution and sale of natural gas. In addition, the Kentucky Regulated segment is allocated certain financing costs.
Net Income Attributable to PPL Shareowners for the periods ended June 30 includes the following results:
| | | Three Months | | Six Months | | | | 2013 | | 2012 | | % Change | | 2013 | | 2012 | | % Change | | | | | | | | | | | | | | | | | | Utility revenues | | $ | 682 | | $ | 658 | | 4 | | $ | 1,482 | | $ | 1,363 | | 9 | Fuel | | | 216 | | | 215 | | | | | 447 | | | 428 | | 4 | Energy purchases | | | 37 | | | 34 | | 9 | | | 123 | | | 108 | | 14 | Other operation and maintenance | | | 197 | | | 197 | | | | | 394 | | | 403 | | (2) | Depreciation | | | 83 | | | 86 | | (3) | | | 165 | | | 172 | | (4) | Taxes, other than income | | | 12 | | | 12 | | | | | 24 | | | 23 | | 4 | | Total operating expenses | | | 545 | | | 544 | | | | | 1,153 | | | 1,134 | | 2 | Other Income (Expense) - net | | | | | | (7) | | (100) | | | (2) | | | (10) | | (80) | Interest Expense | | | 61 | | | 54 | | 13 | | | 116 | | | 109 | | 6 | Income Taxes | | | 28 | | | 13 | | 115 | | | 78 | | | 28 | | 179 | Income (Loss) from Discontinued Operations | | | 1 | | | (6) | | (117) | | | 1 | | | (6) | | (117) | Net Income Attributable to PPL Shareowners | | $ | 49 | | $ | 34 | | 44 | | $ | 134 | | $ | 76 | | 76 |
The changes in the components of the Kentucky Regulated segment's results between these periods were due to the following factors, which reflect reclassifications for items included in Kentucky Gross Margins and certain items that management considers special. See additional detail of these special items in the table below.
| | Three Months | | Six Months | | | | | | | | Kentucky Gross Margins | | $ | 32 | | $ | 107 | Other operation and maintenance | | | | | | 10 | Depreciation | | | (8) | | | (17) | Taxes, other than income | | | | | | (1) | Other Income (Expense) - net | | | 7 | | | 7 | Interest Expense | | | (7) | | | (7) | Income Taxes | | | (15) | | | (44) | Special items, after-tax | | | 6 | | | 3 | Total | | $ | 15 | | $ | 58 |
· | See "Statement of Income Analysis - Margins - Changes in Non-GAAP Financial Measures" for an explanation of Kentucky Gross Margins. |
· | Lower other operation and maintenance for the six-month period primarily due to $17 million of lower costs due to the timing and scope of scheduled coal plant maintenance outages. This decrease was partially offset by $4 million of adjustments to regulatory assets and liabilities and increased coal plant operation costs of $3 million. |
· | Higher depreciation for the three and six-month periods 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 and $26 million to depreciation |
that is excluded from Kentucky Gross Margins. This increase was partially offset by lower depreciation of $6 million and $11 million due to revised rates that were effective January 1, 2013. Both events are the result of the 2012 rate case proceedings. · | Higher other income (expense) - net for the three and six-month periods primarily due to losses from the EEI investment recorded in 2012. The EEI investment was fully impaired in the fourth quarter of 2012. |
· | Higher interest expense for the three and six-month periods primarily due to the remarketing of the PPL Capital Funding Junior Subordinated Notes component of the 2010 Equity Units and simultaneous exchange into Senior Notes. Interest expense associated with the 2010 Equity Units is allocated to the Kentucky Regulated segment. |
· | Higher income taxes for the three and six-month periods 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. | The following after-tax gains (losses), which management considers special items, also impacted the Kentucky Regulated segment's results during the periods ended June 30.
| | | Income Statement | | Three Months | | Six Months | | | | Line Item | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | | | LKE acquisition-related adjustments: | | | | | | | | | | | | | | | Income Taxes and Other | | | | | | | | | | | | | | Net operating loss carryforward and other tax-related adjustments | Operation and Maintenance | | | | | | | | | | | $ | 4 | Other: | | | | | | | | | | | | | | | LKE discontinued operations, net of tax of ($1), $4, ($1), $4 (a) | Discontinued Operations | | $ | 1 | | $ | (5) | | $ | 1 | | | (5) | | EEI adjustments, net of tax of $0, $0, $0, $0 | Other Income (Expense)-net | | | | | | | | | 1 | | | | Total | | | $ | 1 | | $ | (5) | | $ | 2 | | $ | (1) |
2013 Outlook
Excluding special items, PPL projects higher segment earnings in 2013 compared with (a) | 2012 primarily driven by higher distribution revenues from a distribution base rate increase and higher transmission margins, partially offset by higher depreciation.includes an adjustment to an indemnification liability. |
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 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 PPL Global which primarily includes WPD's regulated electricity distribution operations and certain costs, such as U.S. income taxes, administrative costs and allocated financing costs.
Net Income Attributable to PPL Shareowners for the periods ended June 30 includes the following results:
| | | Three Months | | Six Months | | | | 2013 | | 2012 | | % Change | | 2013 | | 2012 | | % Change | | | | | | | | | | | | | | | | | | | Utility revenues | | $ | 559 | | $ | 543 | | 3 | | $ | 1,197 | | $ | 1,095 | | 9 | Energy-related businesses | | | 13 | | | 14 | | (7) | | | 23 | | | 24 | | (4) | | Total operating revenues | | | 572 | | | 557 | | 3 | | | 1,220 | | | 1,119 | | 9 | Other operation and maintenance | | | 112 | | | 112 | | | | | 229 | | | 225 | | 2 | Depreciation | | | 72 | | | 70 | | 3 | | | 146 | | | 137 | | 7 | Taxes, other than income | | | 36 | | | 36 | | | | | 73 | | | 72 | | 1 | Energy-related businesses | | | 7 | | | 11 | | (36) | | | 14 | | | 16 | | (13) | | Total operating expenses | | | 227 | | | 229 | | (1) | | | 462 | | | 450 | | 3 | Other Income (Expense) - net | | | 4 | | | 31 | | (87) | | | 124 | | | 11 | | 1,027 | Interest Expense | | | 104 | | | 105 | | (1) | | | 211 | | | 208 | | 1 | Income Taxes | | | | | | 58 | | (100) | | | 113 | | | 111 | | 2 | Net Income Attributable to PPL Shareowners | | $ | 245 | | $ | 196 | | 25 | | $ | 558 | | $ | 361 | | 55 |
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 | | Six Months | | | | | | | | | U.K. | | | | | | | | Utility revenues | | $ | 68 | | $ | 143 | | Other operation and maintenance | | | (4) | | | (10) | | Depreciation | | | (6) | | | (11) | | Interest expense | | | (3) | | | (7) | | Other | | | (2) | | | | | Income taxes | | | (11) | | | (21) | U.S. | | | | | | | | Interest expense and other | | | (1) | | | 1 | | Income taxes | | | 9 | | | 9 | Foreign currency exchange rates, after-tax (a) | | | (4) | | | (3) | Special items, after-tax | | | 3 | | | 96 | Total | | $ | 49 | | $ | 197 |
(a) | Includes the effect of realized gains (losses) on foreign currency economic hedges. |
U.K.
· | Higher utility revenues for the three-month period primarily due to the April 1, 2013 and 2012 price increases which resulted in $50 million of higher utility revenues and $23 million of higher volume due primarily to weather, partially offset by $6 million of lower third-party engineering work. |
Higher utility revenues for the six-month period primarily due to the April 1, 2013 and 2012 price increases, which resulted in $113 million of higher utility revenues and $28 million of higher volume due primarily to weather.
· | Higher other operation and maintenance for the three-month period primarily due to $6 million of higher network maintenance expense, partially offset by $3 million of lower third-party engineering costs. |
Higher other operation and maintenance for the six-month period primarily due to $13 million of higher network maintenance expense.
· | Higher depreciation for the three and six-month periods primarily due to PP&E additions. |
· | Higher interest expense for the six-month period primarily due to $4 million of higher interest expense on index-linked notes and $3 million on other long-term debt arising from an April 2012 debt issuance. |
· | Higher income taxes for the three-month period primarily due to higher pre-tax income, which increased income taxes by $14 million, and $9 million from a benefit recorded in 2012 due to the tax deductibility of interest on the acquisition financing for WPD Midlands, partially offset by $5 million of lower effective income tax rates and $5 million of prior year adjustments. |
Higher income taxes for the six-month period primarily due to higher pre-tax income, which increased income taxes by $30 million, and $9 million from a benefit recorded in 2012 due to the tax deductibility of interest on the acquisition financing for WPD Midlands, partially offset by $11 million of lower effective income tax rates and $6 million of prior year adjustments. U.S.
· | Lower income taxes for the three-month period primarily due to a $19 million 2013 adjustment related to a ruling obtained from the IRS regarding 2010 U.K. earnings and profits calculations and $4 million of lower income taxes on intercompany loans, partially offset by a $12 million increase to income tax expense attributable to a revision in the expected taxable amount of cash repatriation in 2013. |
Lower income taxes for the six-month period primarily due to a $19 million 2013 adjustment related to a ruling obtained from the IRS regarding 2010 U.K. earnings and profits calculations and $8 million of lower income taxes on intercompany loans, partially offset by a $15 million increase to income tax expense attributable to a revision in the expected taxable amount of cash repatriation in 2013.
The following after-tax gains (losses), which management considers special items, also impacted the U.K. Regulated segment's results during the periods ended June 30.
| | | Income Statement | | Three Months | | Six Months | | | | Line Item | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | Other Income | | | | | | | | | | | | | Foreign currency-related economic hedges, net of tax of $3, ($8), ($39), ($1) (a) | (Expense)-net | | $ | (5) | | $ | 16 | | $ | 73 | | $ | 2 | WPD Midlands acquisition-related adjustments: | | | | | | | | | | | | | | | | | Other Operation | | | | | | | | | | | | | | Separation benefits, net of tax of $0, $0, $1, $2 | and Maintenance | | | | | | (4) | | | (1) | | | (8) | | | | Other Operation | | | | | | | | | | | | | | Other acquisition-related adjustments, net of tax of $0, ($1), $0, ($1) | and Maintenance | | | | | | 4 | | | (2) | | | 4 | Other: | | | | | | | | | | | | | | | Windfall Profits Tax litigation (b) | Income Taxes | | | 43 | | | | | | 43 | | | | | Change in WPD line loss accrual, net of tax of $5, $0, $5, $0 (c) | Utility | | | (19) | | | | | | (19) | | | | Total | | | $ | 19 | | $ | 16 | | $ | 94 | | $ | (2) |
(a) | Represents unrealized gains (losses) on contracts that economically hedge anticipated earnings denominated in GBP. |
(b) | In May 2013, the U.S. Supreme Court reversed the December 2011 ruling, by the U.S. Court of Appeals for the Third Circuit, on the creditability for income tax purposes of the U.K. Windfall Profits Tax. As a result of the U.S. Supreme Court ruling, PPL recorded an income tax benefit during the three and six months ended June 30, 2013. See Note 5 to the Financial Statements for additional information. |
(c) | WPD Midlands recorded an adjustment to its line loss accrual in June 2013 based on information provided by Ofgem regarding the calculation of line loss incentive/penalty for all network operators related to DPCR4, a price control period that ended prior to PPL's acquisition of WPD Midlands. See Note 6 to the Financial Statements for additional information. |
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 June 30 includes the following results: | | | | | | | | | | | | | | | | | | | | | | Three Months | | Six Months | | | | 2013 | | 2012 | | % Change | | 2013 | | 2012 | | % Change | Utility revenues | | | | | | | | | | | | | | | | | | External | | $ | 413 | | $ | 403 | | 2 | | $ | 925 | | $ | 860 | | 8 | | Intersegment | | | 1 | | | 1 | | | | | 2 | | | 2 | | | | Total utility revenues | | | 414 | | | 404 | | 2 | | | 927 | | | 862 | | 8 | Energy purchases | | | | | | | | | | | | | | | | | | External | | | 120 | | | 120 | | | | | 292 | | | 273 | | 7 | | Intersegment | | | 12 | | | 17 | | (29) | | | 26 | | | 38 | | (32) | Other operation and maintenance | | | 124 | | | 143 | | (13) | | | 257 | | | 283 | | (9) | Depreciation | | | 44 | | | 39 | | 13 | | | 87 | | | 78 | | 12 | Taxes, other than income | | | 22 | | | 22 | | | | | 52 | | | 48 | | 8 | | Total operating expenses | | | 322 | | | 341 | | (6) | | | 714 | | | 720 | | (1) | Other Income (Expense) - net | | | 2 | | | 1 | | 100 | | | 3 | | | 3 | | | Interest Expense | | | 25 | | | 24 | | 4 | | | 50 | | | 48 | | 4 | Income Taxes | | | 24 | | | 11 | | 118 | | | 57 | | | 31 | | 84 | Net Income | | | 45 | | | 29 | | 55 | | | 109 | | | 66 | | 65 | Net Income Attributable to Noncontrolling Interests | | | | | | | | n/a | | | | | | 4 | | (100) | Net Income Attributable to PPL Shareowners | | $ | 45 | | $ | 29 | | 55 | | $ | 109 | | $ | 62 | | 76 |
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 | | Six Months | | | | | | | | Pennsylvania Gross Delivery Margins | | $ | 21 | | $ | 61 | Other operation and maintenance | | | 13 | | | 20 | Depreciation | | | (5) | | | (9) | Interest Expense | | | (1) | | | (2) | Other | | | 1 | | | (1) | Income Taxes | | | (13) | | | (26) | Noncontrolling Interests | | | | | | 4 | Total | | $ | 16 | | $ | 47 |
· | 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 for the three-month period primarily due to lower corporate service costs of $6 million and lower vegetation management of $2 million. |
Lower other operation and maintenance for the six-month period primarily due to lower corporate service costs of $11 million and lower vegetation management of $3 million.
· | Higher depreciation for the three and six-month periods primarily due to the impact of PP&E additions related to the ongoing efforts to ensure the reliability of the delivery system and replace aging infrastructure. |
· | Higher income taxes for the three and six-month periods primarily due to higher pre-tax income. |
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 and 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 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 PPL Energy Supply's energy marketing and trading activities, as well as its competitive generation operations. In addition, the Supply segment is allocated certain financing costs.
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 June 30 includes the following results: | | Net Income Attributable to PPL Shareowners for the periods ended June 30 includes the following results: | | | | | | | | | | | | | | | | | | | | | | | | | Three Months | | | Three Months | | Six Months | | | | 2013 | | 2012 | | % Change | | | 2013 | | 2012 | | % Change | | 2013 | | 2012 | | % Change | Energy revenues | Energy revenues | | | | | | | Energy revenues | | | | | | | | | | | | | | External (a) | | $ | 381 | | $ | 2,290 | | (83) | External (a) | | $ | 1,658 | | $ | 816 | | 103 | | $ | 2,039 | | $ | 3,106 | | (34) | | Intersegment | | 14 | | 21 | | (33) | Intersegment | | 12 | | 17 | | (29) | | 26 | | 38 | | (32) | Energy-related businesses | Energy-related businesses | | | 113 | | | 98 | | 15 | Energy-related businesses | | | 122 | | | 115 | | 6 | | | 235 | | | 213 | | 10 | | Total operating revenues | | | 508 | | | 2,409 | | (79) | Total operating revenues | | | 1,792 | | | 948 | | 89 | | | 2,300 | | | 3,357 | | (31) | Fuel (a) | Fuel (a) | | 298 | | 211 | | 41 | Fuel (a) | | 224 | | 196 | | 14 | | 522 | | 407 | | 28 | Energy purchases | Energy purchases | | | | | | | Energy purchases | | | | | | | | | | | | | | External (a) | | (200) | | 1,247 | | (116) | External (a) | | 897 | | 191 | | 370 | | 697 | | 1,438 | | (52) | | Intersegment | | 1 | | 1 | | | Intersegment | | 1 | | | | n/a | | 2 | | 1 | | 100 | Other operation and maintenance | Other operation and maintenance | | 235 | | 248 | | (5) | Other operation and maintenance | | 270 | | 293 | | (8) | | 505 | | 548 | | (8) | Depreciation | Depreciation | | 78 | | 72 | | 8 | Depreciation | | 79 | | 70 | | 13 | | 157 | | 135 | | 16 | Taxes, other than income | Taxes, other than income | | 17 | | 18 | | (6) | Taxes, other than income | | 16 | | 17 | | (6) | | 33 | | 35 | | (6) | Energy-related businesses | Energy-related businesses | | | 110 | | | 97 | | 13 | Energy-related businesses | | | 118 | | | 113 | | 4 | | | 228 | | | 210 | | 9 | | Total operating expenses | | | 539 | | | 1,894 | | (72) | Total operating expenses | | | 1,605 | | | 880 | | 82 | | | 2,144 | | | 2,774 | | (23) | Other Income (Expense) - net | Other Income (Expense) - net | | 4 | | 5 | | (20) | Other Income (Expense) - net | | 12 | | 4 | | 200 | | 16 | | 9 | | 78 | Other-Than-Temporary Impairments | | Other-Than-Temporary Impairments | | | | 1 | | (100) | | | | 1 | | (100) | Interest Expense | Interest Expense | | 60 | | 48 | | 25 | Interest Expense | | 60 | | 53 | | 13 | | 120 | | 101 | | 19 | Income Taxes | Income Taxes | | | (41) | | | 171 | | (124) | Income Taxes | | | 62 | | | 6 | | 933 | | | 21 | | | 177 | | (88) | Net Income (Loss) Attributable to PPL Shareowners | | $ | (46) | | $ | 301 | | (115) | | Net Income Attributable to PPL Shareowners | | Net Income Attributable to PPL Shareowners | | $ | 77 | | $ | 12 | | 542 | | $ | 31 | | $ | 313 | | (90) |
(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 Margins and certain items that management considers special. See additional detail of these special items in the table below.
| | | | 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) |
| | Three Months | | Six Months | | | | | | | | Unregulated Gross Energy Margins | | $ | (88) | | $ | (195) | Other operation and maintenance | | | 16 | | | 29 | Depreciation | | | (9) | | | (22) | Taxes, other than income | | | 3 | | | 4 | Other Income (Expense) - net | | | 9 | | | 10 | Interest expense | | | (7) | | | (19) | Other | | | 2 | | | 2 | Income Taxes | | | 27 | | | 60 | Special items, after-tax | | | 112 | | | (151) | Total | | $ | 65 | | $ | (282) |
· | See "Statement of Income Analysis - Margins - Changes in Non-GAAP Financial Measures" for an explanation of Unregulated Gross Energy Margins. |
· | Lower other operation and maintenance for the three-month period primarily due to $15$11 million of lower 2013 project and refueling outage costs at eastern fossilPPL Susquehanna and hydroelectric plants largely$4 million of Brunner Island Unit 3 outage costs in 2012 with no comparable outage in 2013. |
Lower other operation and maintenance for the six-month period primarily due to $19 million of Brunner Island Unit 3 outage costs in 2012 with no comparable outage in 2013 and $17 million of lower 2013 project and refueling outage costs at PPL Susquehanna, partially offset by $5 million of Conemaugh Unit 2 outage costs in 2013 with no comparable outage in 2012.
· | Higher depreciation for the three and six-month periods primarily due to outages in 2012, partially offset by $3PP&E additions. The six-month period also includes $6 million of additional costs dueattributable to the Ironwood Acquisition. |
· | Higher depreciation primarilyother income (expense) - net for the three and six-month periods partially due to the Ironwood Acquisition.impact of a worker's compensation adjustment of $4 million. |
· | Higher interest expense primarilyfor the six-month period due to financings associated with$7 million from PPL Ironwood, acquiredCapital Funding's June 2012 $400 million debt issuance, $6 million due to lower capitalized interest in April 2012, which increased interest expense by $4 million,2013 and $4 million due to the allocation of interest from a June 2012financing associated with PPL Ironwood. Interest expense associated with certain PPL Capital Funding debt issuance.issuances is allocated to the Supply segment. |
· | Lower income taxes for the three and six-month periods due to lower pre-tax income in 2013, which reduced income taxes by $47$30 million and $77 million, partially offset for the six-month period 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 Supply segment's results during the periods ended March 31.June 30.
| | | Income Statement | | Three Months | | | Income Statement | | Three Months | | Six Months | | | | Line Item | | 2013 | | 2012 | | | Line Item | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | | | | Adjusted energy-related economic activity, net, net of tax of $79, ($102) | (a) | | $ | (117) | | $ | 150 | | Adjusted energy-related economic activity, net, net of tax of ($51), $23, $28, ($79) | | Adjusted energy-related economic activity, net, net of tax of ($51), $23, $28, ($79) | (a) | | $ | 76 | | $ | (32) | | $ | (41) | | $ | 118 | Impairments: | Impairments: | | | | | | | Impairments: | | | | | | | | | | | Adjustments - nuclear decommissioning trust investments, net of tax of $0, ($1) | Other Income (Expense)-net | | | | | 1 | Adjustments - nuclear decommissioning trust investments, net of tax of $0, ($1), $0, ($2) | Other Income-net | | | | | | | | 1 | Other: | Other: | | | | | | | Other: | | | | | | | | | | | Counterparty bankruptcy, net of tax of $0, $5 (b) | Other Operation and Maintenance | | | | | (6) | Change in tax accounting method related to repairs | Income Taxes | | (3) | | | | (3) | | | | Ash basin leak remediation adjustment, net of tax of $0, ($1) | Other Operation and Maintenance | | | | | | 1 | | Other Operation | | | | | | | | | | | Counterparty bankruptcy, net of tax of ($1), $0, ($1), $5 (b) | and Maintenance | | 1 | | | | 1 | | (6) | | | Wholesale supply cost reimbursement, net of tax of $0, $0, $0, $0 | (c) | | | | 1 | | | | 1 | | | | | Other Operation | | | | | | | | | | | Ash basin leak remediation adjustment, net of tax of $0, $0, $0, ($1) | and Maintenance | | | | | | | | 1 | | | Coal contract modification payments, net of tax of $0, $5, $0, $5 (d) | Fuel | | | | | | (7) | | | | | | (7) | Total | Total | | | $ | (117) | | $ | 146 | Total | | | $ | 74 | | $ | (38) | | $ | (43) | | $ | 108 |
(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. In June 2013, PPL EnergyPlus received an approval for an administrative claim in the amount of $2 million. |
(c) | Recorded in "Wholesale energy marketing - Realized" on the Statement of Income. |
(d) | As a result of lower electricity and natural gas prices, coal-fired generation output decreased during 2012. 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 March 31, from the table within "Commodity Price Risk (Non-trading) - Economic Activity" in Note 14 to the Financial StatementsJune 30, to the special item identified as "Adjusted energy-related economic activity, net."
| | | | Three Months | | | | Three Months | | Six Months | | | | | 2013 | | 2012 | | | | 2013 | | 2012 | | 2013 | | 2012 | Operating Revenues | Operating Revenues | | | | | Operating Revenues | | | | | | | | | | | Unregulated retail electric and gas | | $ | (8) | | $ | 10 | | Unregulated retail electric and gas | | $ | 20 | | $ | (12) | | $ | 12 | | $ | (2) | | | Wholesale energy marketing | | (822) | | 852 | | Wholesale energy marketing | | 590 | | (458) | | (232) | | 394 | Operating Expenses | Operating Expenses | | | | | Operating Expenses | | | | | | | | | | | Fuel | | (1) | | 2 | | Fuel | | (4) | | (16) | | (5) | | (14) | | | Energy Purchases | | | 634 | | | (591) | | Energy Purchases | | | (479) | | | 442 | | | 155 | | | (149) | Energy-related economic activity (a) | Energy-related economic activity (a) | | (197) | | 273 | Energy-related economic activity (a) | | 127 | | (44) | | (70) | | 229 | Option premiums | Option premiums | | | 1 | | | | Option premiums | | | | | | 1 | | | 1 | | | 1 | Adjusted energy-related economic activity | Adjusted energy-related economic activity | | (196) | | 273 | Adjusted energy-related economic activity | | 127 | | (43) | | (69) | | 230 | Less: Economic activity realized, associated with the monetization of certain | | | | | | Less: Economic activity realized, associated with the monetization of | | Less: Economic activity realized, associated with the monetization of | | | | | | | | | | full-requirement sales contracts in 2010 | | | | | | 21 | certain full-requirement sales contracts in 2010 | | | | | | 12 | | | | | | 33 | Adjusted energy-related economic activity, net, pre-tax | Adjusted energy-related economic activity, net, pre-tax | | $ | (196) | | $ | 252 | Adjusted energy-related economic activity, net, pre-tax | | $ | 127 | | $ | (55) | | $ | (69) | | $ | 197 | | | | | | | | | | | | | | | | | | Adjusted energy-related economic activity, net, after-tax | Adjusted energy-related economic activity, net, after-tax | | $ | (117) | | $ | 150 | Adjusted energy-related economic activity, net, after-tax | | $ | 76 | | $ | (32) | | $ | (41) | | $ | 118 |
(a) | See Note 14 to the Financial Statements for additional information. |
2013 Outlook
Excluding special items, PPL projects lower segment 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 lower operation and maintenance expense, 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.output.
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's 2012 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 mechanisms are offset. These mechanisms allow for recovery of certain expenses, returnsreturn 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 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 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 "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 realized economic activity realized associated with the monetization of certain full requirementfull-requirement sales contracts in 2010. This economic activity iswas 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. |
Reconciliation of Non-GAAP Financial Measures |
The following table reconcilestables reconcile PPL's three non-GAAP financial measures to "Operating Income" for the periods ended March 31.June 30.
| | | | | | 2013 Three Months | | 2012 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 Revenues | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Utility | | $ | 800 | | $ | 512 | | | | | $ | 638 | (c) | | $ | 1,950 | | $ | 705 | | $ | 457 | | | | | $ | 552 | (c) | | $ | 1,714 | | PLR intersegment utility | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | revenue (expense) (d) | | | | | | (14) | | $ | 14 | | | | | | | | | | | | | (21) | | $ | 21 | | | | | | | | | Unregulated retail | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | electric and gas | | | | | | | | | 246 | | | (9) | (f) | | | 237 | | | | | | | | | 214 | | | 9 | (f) | | | 223 | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | | | | | | | | 977 | | | (1) | | | | 976 | | | | | | | | | 1,204 | | | 4 | (e) | | | 1,208 | | | | Unrealized economic | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | activity | | | | | | | | | | | | (822) | (f) | | | (822) | | | | | | | | | | | | 852 | (f) | | | 852 | | Net energy trading margins | | | | | | | | | (11) | | | | | | | (11) | | | | | | | | | 8 | | | | | | | 8 | | Energy-related businesses | | | | | | | | | | | | 127 | | | | 127 | | | | | | | | | | | | 107 | | | | 107 | | | | Total Operating Revenues | | | 800 | | | 498 | | | 1,226 | | | (67) | | | | 2,457 | | | 705 | | | 436 | | | 1,447 | | | 1,524 | | | | 4,112 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Fuel | | | 231 | | | | | | 299 | | | (1) | (f) | | | 529 | | | 213 | | | | | | 214 | | | (3) | (f) | | | 424 | | Energy purchases | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | | 86 | | | 172 | | | 436 | | | (3) | | | | 691 | | | 74 | | | 153 | | | 636 | | | 20 | (e) | | | 883 | | | | Unrealized economic | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | activity | | | | | | | | | | | | (634) | (f) | | | (634) | | | | | | | | | | | | 591 | (f) | | | 591 | | Other operation and | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | maintenance | | | 25 | | | 22 | | | 5 | | | 624 | | | | 676 | | | 22 | | | 22 | | | 4 | | | 658 | | | | 706 | | Depreciation | | | | | | | | | | | | 284 | | | | 284 | | | 13 | | | | | | | | | 251 | | | | 264 | | Taxes, other than income | | | | | | 28 | | | 8 | | | 60 | | | | 96 | | | | | | 25 | | | 8 | | | 58 | | | | 91 | | Energy-related businesses | | | | | | | | | | | | 122 | | | | 122 | | | | | | | | | | | | 102 | | | | 102 | | Intercompany eliminations | | | | | | (1) | | | 1 | | | | | | | | | | | | | (1) | | | 1 | | | | | | | | | | | Total Operating Expenses | | | 342 | | | 221 | | | 749 | | | 452 | | | | 1,764 | | | 322 | | | 199 | | | 863 | | | 1,677 | | | | 3,061 | Total | | $ | 458 | | $ | 277 | | $ | 477 | | $ | (519) | | | $ | 693 | | $ | 383 | | $ | 237 | | $ | 584 | | $ | (153) | | | $ | 1,051 |
| | | | | | 2013 Three Months | | 2012 Three Months | | | | | | | | | | | Unregulated | | | | | | | | | | | Unregulated | | | | | | | | | | | | | Kentucky | | PA Gross | | Gross | | | | | Operating | | Kentucky | | PA Gross | | Gross | | | | | Operating | | | | | | | Gross | | Delivery | | Energy | | | | | Income | | Gross | | Delivery | | Energy | | | | | | Income | | | | | | | Margins | | Margins | | Margins | | Other (a) | | (b) | | Margins | | Margins | | Margins | | Other (a) | | (b) | | | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Revenues | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Utility | | $ | 682 | | $ | 413 | | | | | $ | 560 | (c) | | $ | 1,655 | | $ | 658 | | $ | 403 | | | | | $ | 544 | (c) | | $ | 1,605 | | PLR intersegment utility | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | revenue (expense) (d) | | | | | | (12) | | $ | 12 | | | | | | | | | | | | | (17) | | $ | 17 | | | | | | | | | Unregulated retail | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | electric and gas | | | | | | | | | 237 | | | 20 | (f) | | | 257 | | | | | | | | | 192 | | | (13) | (f) | | | 179 | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | | | | | | | | 812 | | | (1) | | | | 811 | | | | | | | | | 1,075 | | | 8 | (e) | | | 1,083 | | | | Unrealized economic | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | activity | | | | | | | | | | | | 590 | (f) | | | 590 | | | | | | | | | | | | (458) | (f) | | | (458) | | Net energy trading margins | | | | | | | | | | | | | | | | | | | | | | | | | 10 | | | | | | | 10 | | Energy-related businesses | | | | | | | | | | | | 137 | | | | 137 | | | | | | | | | | | | 130 | | | | 130 | | | | Total Operating Revenues | | | 682 | | | 401 | | | 1,061 | | | 1,306 | | | | 3,450 | | | 658 | | | 386 | | | 1,294 | | | 211 | | | | 2,549 |
| | | | | | 2013 Three Months | | 2012 Three Months | | | | | | | | | | | Unregulated | | | | | | | | | | | Unregulated | | | | | | | | | | | | | Kentucky | | PA Gross | | Gross | | | | | Operating | | Kentucky | | PA Gross | | Gross | | | | | Operating | | | | | | | Gross | | Delivery | | Energy | | | | | Income | | Gross | | Delivery | | Energy | | | | | | Income | | | | | | | Margins | | Margins | | Margins | | Other (a) | | (b) | | Margins | | Margins | | Margins | | Other (a) | | (b) | | | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Fuel | | | 216 | | | | | | 223 | | | 2 | | | | 441 | | | 215 | | | | | | 170 | | | 26 | (g) | | | 411 | | Energy purchases | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | | 37 | | | 120 | | | 419 | | | (4) | | | | 572 | | | 34 | | | 120 | | | 617 | | | 16 | (e) | | | 787 | | | | Unrealized economic | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | activity | | | | | | | | | | | | 479 | (f) | | | 479 | | | | | | | | | | | | (442) | (f) | | | (442) | | Other operation and | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | maintenance | | | 23 | | | 21 | | | 3 | | | 651 | | | | 698 | | | 24 | | | 26 | | | 7 | | | 682 | | | | 739 | | Depreciation | | | 2 | | | | | | | | | 284 | | | | 286 | | | 13 | | | | | | | | | 258 | | | | 271 | | Taxes, other than income | | | | | | 19 | | | 10 | | | 57 | | | | 86 | | | | | | 20 | | | 7 | | | 60 | | | | 87 | | Energy-related businesses | | | | | | | | | | | | 130 | | | | 130 | | | | | | | | | | | | 124 | | | | 124 | | Intercompany eliminations | | | | | | (1) | | | 1 | | | | | | | | | | | | | (1) | | | | | | 1 | | | | | | | | Total Operating Expenses | | | 278 | | | 159 | | | 656 | | | 1,599 | | | | 2,692 | | | 286 | | | 165 | | | 801 | | | 725 | | | | 1,977 | Total | | $ | 404 | | $ | 242 | | $ | 405 | | $ | (293) | | | $ | 758 | | $ | 372 | | $ | 221 | | $ | 493 | | $ | (514) | | | $ | 572 |
| | | | | | 2013 Six Months | | 2012 Six Months | | | | | | | | | | | Unregulated | | | | | | | | | | | Unregulated | | | | | | | | | | | | | Kentucky | | PA Gross | | Gross | | | | | Operating | | Kentucky | | PA Gross | | Gross | | | | | Operating | | | | | | | Gross | | Delivery | | Energy | | | | | Income | | Gross | | Delivery | | Energy | | | | | | Income | | | | | | | Margins | | Margins | | Margins | | Other (a) | | (b) | | Margins | | Margins | | Margins | | Other (a) | | (b) | | | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Revenues | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Utility | | $ | 1,482 | | $ | 925 | | | | | $ | 1,198 | (c) | | $ | 3,605 | | $ | 1,363 | | $ | 860 | | | | | $ | 1,096 | (c) | | $ | 3,319 | | PLR intersegment utility | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | revenue (expense) (d) | | | | | | (26) | | $ | 26 | | | | | | | | | | | | | (38) | | $ | 38 | | | | | | | | | Unregulated retail | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | electric and gas | | | | | | | | | 483 | | | 11 | (f) | | | 494 | | | | | | | | | 406 | | | (4) | (f) | | | 402 | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | | | | | | | | 1,789 | | | (2) | | | | 1,787 | | | | | | | | | 2,279 | | | 12 | (e) | | | 2,291 | | | | Unrealized economic | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | activity | | | | | | | | | | | | (232) | (f) | | | (232) | | | | | | | | | | | | 394 | (f) | | | 394 | | Net energy trading margins | | | | | | | | | (11) | | | | | | | (11) | | | | | | | | | 18 | | | | | | | 18 | | Energy-related businesses | | | | | | | | | | | | 264 | | | | 264 | | | | | | | | | | | | 237 | | | | 237 | | | | Total Operating Revenues | | | 1,482 | | | 899 | | | 2,287 | | | 1,239 | | | | 5,907 | | | 1,363 | | | 822 | | | 2,741 | | | 1,735 | | | | 6,661 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Fuel | | | 447 | | | | | | 522 | | | 1 | | | | 970 | | | 428 | | | | | | 385 | | | 22 | (g) | | | 835 | | Energy purchases | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | | 123 | | | 292 | | | 855 | | | (7) | | | | 1,263 | | | 108 | | | 273 | | | 1,251 | | | 38 | (e) | | | 1,670 | | | | Unrealized economic | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | activity | | | | | | | | | | | | (155) | (f) | | | (155) | | | | | | | | | | | | 149 | (f) | | | 149 | | Other operation and | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | maintenance | | | 48 | | | 43 | | | 8 | | | 1,275 | | | | 1,374 | | | 46 | | | 49 | | | 11 | | | 1,339 | | | | 1,445 | | Depreciation | | | 2 | | | | | | | | | 568 | | | | 570 | | | 26 | | | | | | | | | 509 | | | | 535 | | Taxes, other than income | | | | | | 47 | | | 18 | | | 117 | | | | 182 | | | | | | 44 | | | 16 | | | 118 | | | | 178 | | Energy-related businesses | | | | | | | | | | | | 252 | | | | 252 | | | | | | | | | | | | 226 | | | | 226 | | Intercompany eliminations | | | | | | (2) | | | 2 | | | | | | | | | | | | | (2) | | | 1 | | | 1 | | | | | | | | Total Operating Expenses | | | 620 | | | 380 | | | 1,405 | | | 2,051 | | | | 4,456 | | | 608 | | | 364 | | | 1,664 | | | 2,402 | | | | 5,038 | Total | | $ | 862 | | $ | 519 | | $ | 882 | | $ | (812) | | | $ | 1,451 | | $ | 755 | | $ | 458 | | $ | 1,077 | | $ | (667) | | | $ | 1,623 |
(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) | 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 six months ended March 31,June 30, 2012, "Wholesale energy marketing - Realized" and "Energy purchases - Realized" includes ainclude net pre-tax losslosses of $21$12 million and $33 million related to the monetization of certain full-requirement sales contracts. |
(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. |
(g) | 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 six months ended June 30, 2012 include a pre-tax loss of $12 million related to coal contract modification payments. |
Changes in Non-GAAP Financial Measures
The following table shows PPL's three non-GAAP financial measures for the periods ended March 31June 30 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 | | | | | | | | | | | | Kentucky Gross Margins | | $ | 458 | | $ | 383 | | $ | 75 | PA Gross Delivery Margins by Component | | | | | | | | | | | Distribution | | $ | 224 | | $ | 189 | | $ | 35 | | Transmission | | | 53 | | | 48 | | | 5 | Total | | $ | 277 | | $ | 237 | | $ | 40 | | | | | | | | | | | | Unregulated Gross Energy Margins by Region | | | | | | | | | | 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 | | Six Months | | | | 2013 | | 2012 | | Change | | 2013 | | 2012 | | Change | | | | | | | | | | | | | | | | | | | | | Kentucky Gross Margins | | $ | 404 | | $ | 372 | | $ | 32 | | $ | 862 | | $ | 755 | | $ | 107 | PA Gross Delivery Margins by Component | | | | | | | | | | | | | | | | | | | | Distribution | | $ | 183 | | $ | 170 | | $ | 13 | | $ | 407 | | $ | 359 | | $ | 48 | | Transmission | | | 59 | | | 51 | | | 8 | | | 112 | | | 99 | | | 13 | Total | | $ | 242 | | $ | 221 | | $ | 21 | | $ | 519 | | $ | 458 | | $ | 61 | | | | | | | | | | | | | | | | | | | | | Unregulated Gross Energy Margins by Region | | | | | | | | | | | | | | | | | | | Non-trading | | | | | | | | | | | | | | | | | | | | Eastern U.S. | | $ | 349 | | $ | 407 | | $ | (58) | | $ | 779 | | $ | 896 | | $ | (117) | | Western U.S. | | | 56 | | | 76 | | | (20) | | | 114 | | | 163 | | | (49) | Net energy trading | | | | | | 10 | | | (10) | | | (11) | | | 18 | | | (29) | Total | | $ | 405 | | $ | 493 | | $ | (88) | | $ | 882 | | $ | 1,077 | | $ | (195) |
Kentucky Gross Margins
Margins increased for the three months ended March 31,June 30, 2013 compared with 2012, primarily due to higher base rates of $31 million, higher volumes of $19$25 million, environmental costscost recoveries added to base rates of $18$14 million and increased environmental investments of $7$3 million, partially offset by lower volumes of $9 million. The change in volumes was partially attributable to weather, as cooling degree days decreased 14% compared to the same period in 2012.
Margins increased for the six months ended June 30, 2013 compared with 2012, primarily due to higher base rates of $56 million, environmental cost recoveries added to base rates of $32 million, increased environmental investments of $10 million and higher volumes of $10 million. The change in volumes was attributable to weather, as heating degree days increased 40% compared to the same period in 2012, offsetting the lower cooling degree days for the three-month period.
The increase in base rates was the result of new KPSC rates going into effect oneffective January 1, 2013. The increase in volumes was attributable to colder weather in 2013 compared with 2012. Total heating degree days increased 41%. The environmental costscost recoveries added to base rates waswere due to the elimination of the 2005 and 2006 ECR plans as a result of the 2012 Kentucky rate case.cases. This elimination results in depreciation and other operation and maintenance expenses associated with the 2005 and 2006 ECR plans being excluded from Margins in 2013.2013, while the recovery of such costs remain in Margins through base rates.
Pennsylvania Gross Delivery Margins
Distribution
Margins increased for the three months ended March 31,June 30, 2013 compared with 2012, primarily due to an $11 million favorable effect of price as a result of higher base rates, effective January 1, 2013.
Margins increased for the six months ended June 30, 2013 compared with 2012, primarily due to a $13 million favorableadverse effect of mild weather in 2012 and a $19$32 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$4 million.
Transmission
Margins increased for the three and six months ended March 31,June 30, 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: | | | | | | | |
Unregulated Gross Energy Margins | | | | 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 increase (decrease) in non-trading margins for the periods ended June 30, 2013 compared with 2012 were due to: | | | | | | | | | | Three Months | | Six Months | | | | | | | | Baseload energy prices | | $ | (121) | | $ | (246) | Nuclear fuel prices | | | (4) | | | (10) | Coal prices | | | 1 | | | (9) | Intermediate and peaking Spark Spreads | | | (7) | | | 7 | Nuclear generation volume | | | 9 | | | 9 | Full-requirement sales contracts | | | 5 | | | 10 | Gas optimization and storage | | | 10 | | | 11 | Ironwood Acquisition which eliminated tolling expense | | | 2 | | | 17 | Net economic availability of coal and hydroelectric plants | | | 7 | | | 39 | Capacity prices | | | 36 | | | 47 | Other | | | 4 | | | 8 | Total | | $ | (58) | | $ | (117) |
Western U.S.
Non-trading margins for the three and six months ended March 31,June 30, 2013 compared with the same periods in 2012 were lower due to $43$20 million and $59 million of lower wholesale prices,prices. The six-month period was partially offset by $12$7 million of higher wholesale volumes.
Net Energy Trading Margins
Net energy trading margins for the three months ended March 31,June 30, 2013 compared with the same period in 2012 decreased as a result of lower margins of $16$5 million on power positions and $3 million on FTRs.
Net energy trading margins for the six months ended June 30, 2013 compared with the same period in 2012 decreased as a result of lower margins of $15 million on gas positions due to higher prices.and $7 million on power positions.
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 |
Utility Revenues | | | | | | | | | | | | | The increase (decrease) in utility revenues for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | | | | | | | | | | | Three Months | | Six Months | Domestic: | | | | | | | | PPL Electric (a) | | $ | 10 | | $ | 65 | | LKE (b) | | | 24 | | | 119 | | Total Domestic | | | 34 | | | 184 | | | | | | | | | | | U.K.: | | | | | | | | Price (c) | | | 50 | | | 113 | | Volume (d) | | | 23 | | | 28 | | DPCR4 accrual adjustments (e) | | | (24) | | | (24) | | Foreign currency exchange rates | | | (26) | | | (16) | | Other (f) | | | (7) | | | 1 | | Total U.K. | | | 16 | | | 102 | Total | | $ | 50 | | $ | 286 |
(a) | See "Pennsylvania Gross Delivery Margins" for further information. |
(b) | See "Kentucky Gross Margins" for further information. |
(c) | DueThe increase for the three and six-month periods is primarily due to price increases effective April 1, 2013 and April 1, 2012. |
(d) | ThisThe increase for the three and six-month periods is primarily due to $8the favorable effect of weather. |
(e) | The decrease for the three and six-month periods is due to a $24 million reduction in revenue based on information provided by Ofgem regarding the calculation of line loss incentive/penalty for all network operators related to DPCR4. See Note 6 to the Financial Statements for additional information. |
(f) | The decrease for the three month period is primarily related to a $6 million reduction in third-party engineering work,revenue, which is partially offset by expensesa reduction in costs in "Other operation and maintenance". on the Statements of Income. |
Other Operation and Maintenance | | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance for the periodperiods ended March 31,June 30, 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) |
| | | Three Months | | Six Months | Domestic: | | | | | | | Uncollectible accounts (a) | $ | (4) | | $ | (20) | | LKE coal plant outages (b) | | (4) | | | (17) | | Brunner Island Unit 3 outage in 2012 | | (4) | | | (19) | | PPL Susquehanna projects | | (6) | | | (9) | | PPL Susquehanna refueling outage | | (5) | | | (8) | | Act 129 (c) | | (7) | | | (7) | | Conemaugh Unit 2 outage in 2013 | | 3 | | | 5 | | Other generation plant costs | | (7) | | | (1) | | Other | | (7) | | | 1 | U.K.: | | | | | | | Third-party engineering (d) | | (3) | | | 2 | | Network maintenance (e) | | 6 | | | 13 | | Insurance claim provision release | | 6 | | | 6 | | Severance compensation (f) | | (4) | | | (8) | | Pension | | (2) | | | (4) | | Foreign currency exchange rates | | (5) | | | (3) | | Other | | 2 | | | (2) | Total | $ | (41) | | $ | (71) |
(a) | The decrease for the six-month period 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 for the three and six month periods is primarily due to the timing and scope of scheduled outages. |
(c) | The decrease for the three and six month periods is primarily due to Brunner Island Unit 3 outagea reduction in Act 129 energy efficiency and conservation plan 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.for Phase 1 programs. Phase 1 ended May 31, 2013. |
(d) | These expensescosts are offset by revenues reflected in "Utility" on the StatementsStatement of Income. |
(e) | The increase for the three and six month periods is primarily due to higher tree trimming expense.vegetation management costs. |
(f) | The decrease for the three and six month periods is primarily due to costs incurred in 2012 related to the WPD Midlands reorganization. |
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 |
Depreciation | | | | | | | | | | | The increase (decrease) in depreciation for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | | | | | Three Months | | Six Months | | | | | | | | | Additions to PP&E | | $ | 23 | | $ | 44 | LKE lower depreciation rates effective January 1, 2013 | | | (6) | | | (11) | Ironwood Acquisition | | | | | | 6 | Other | | | (2) | | | (4) | Total | | $ | 15 | | $ | 35 |
Other Income (Expense) - net
The $139$17 million increasedecrease in other income (expense) - net for the three months ended March 31,June 30, 2013 compared with 2012 was primarily due to $119a decrease of $21 million offrom realized and unrealized gains on economic foreign currency contractscontracts.
The $122 million increase in other income (expense) - net for the six months ended June 30, 2013 compared with losses in 2012 was primarily due to an increase of $18 million.$116 million from realized and unrealized gains on foreign currency contracts.
See Note 12 to the Financial Statements for further details.additional information on other income (expense) - net.
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 |
Interest Expense | | | | | | | | | | | | The increase (decrease) in interest expense for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | | Three Months | | Six Months | | | | | | | | | Long-term debt interest expense (a) | | $ | 8 | | $ | 22 | Loss on extinguishment of debt (b) | | | 10 | | | 10 | Ironwood Acquisition financing | | | | | | 4 | Capitalized interest | | | 3 | | | 4 | Other | | | 1 | | | 3 | Total | | $ | 22 | | $ | 43 |
(a) | The increase for the three-month period was primarily due to PPL Capital Funding's debt issuances in March 2013, 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, contributing2012. See Note 7 to the Financial Statements in this Form 10-Q and in PPL's 2012 Form 10-K for additional information. |
| The increase for the six-month period was primarily due to PPL Capital Funding's debt issuances as discussed above as well as higher accretion expense on WPD index linked bondsnotes and interest on WPD (East Midlands') April 2012 issuance of £100 million, 5.25% Senior Notes due 2023. |
(b) | The increase was dueIn May 2013, PPL Capital Funding remarketed and exchanged junior subordinated notes that were originally issued in June 2010 as a component of PPL's 2010 Equity Units. See Note 7 to financings associated with the Ironwood Acquisition. Financial Statements for additional information. |
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) |
Income Taxes | | | | | | | | | | | The increase (decrease) in income taxes for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | Three Months | | Six Months | | | | | | | | | Higher (lower) pre-tax income | | $ | 52 | | $ | (67) | Federal and state tax reserve adjustments (a) | | | (35) | | | (35) | U.S. income tax on foreign earnings net of foreign tax credit (b) | | | (6) | | | (6) | Foreign tax reserve adjustments (c) | | | 8 | | | 5 | Foreign tax return adjustments | | | (4) | | | (4) | Net operating loss carryforward adjustments (d) | | | 3 | | | 9 | State deferred tax rate change (e) | | | | | | 11 | Other | | | 3 | | | | Total | | $ | 21 | | $ | (87) |
(a) | In May 2013, the U.S. Supreme Court reversed the December 2011 ruling of the U.S. Court of Appeals for the Third Circuit on the creditability of U.K. Windfall Profits Tax for tax purposes. As a result of this decision, PPL recorded a tax benefit of $44 million during the three and six months ended June 30, 2013. See Note 5 to the Financial Statements for additional information. |
(b) | During the three and six months ended March 31,June 30, 2013, PPL recorded a $14 million increase to income tax expense primarily attributable to a revision in the expected taxable amount of cash repatriation in 2013 and recorded a tax benefit of $19 million associated with a ruling obtained from the IRS impacting the recalculation of 2010 U.K. earnings and profits that will be reflected on an amended 2010 U.S. tax return. |
(c) | During the three and six months ended June 30, 2012, PPL recorded a tax benefit following resolution of a U.K. tax issue related to the tax deductibility of interest expense. |
(d) | During the three and six months ended June 30, 2012, PPL recorded adjustments to deferred taxes related to net operating loss carryforwards of LKE based on income tax return adjustments. |
(b)(e) | During the threesix months ended March 31,June 30, 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: |
Financial Condition | | Financial Condition | | | | | | | Liquidity and Capital Resources | | Liquidity and Capital Resources | | | | | | | PPL had the following at: | | PPL had the following at: | | | | | | | | | March 31, 2013 | | December 31, 2012 | | June 30, 2013 | | December 31, 2012 | | | | | | | | | | Cash and cash equivalents | | $ | 853 | | $ | 901 | | $ | 711 | | $ | 901 | Short-term debt | | $ | 1,061 | | $ | 652 | | $ | 1,206 | | $ | 652 |
At March 31,June 30, 2013, $335$178 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. income taxes, net of allowable foreign income 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$190 million decrease in PPL's cash and cash equivalents position was primarily the net result of:
· | capital expenditures of $828 million;$1.8 billion; |
· | the payment of $210$426 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.$947 million; |
· | net increase in short-term debt of $563 million; and |
· | proceeds of $450 million from the issuance of long-term debt. |
PPL's cash provided by operating activities decreased by $484 millionhad no net change for the threesix months ended March 31,June 30, 2013 compared with 2012. The decreaseresult was primarily due to:the net effect of:
· | a $336$219 million increase in net income, when adjusted for non-cash components; and |
· | a $25 million decrease in defined benefit plan funding, offset by |
· | a $245 million increase in cash used by components of working capital (primarily due to changes in accounts receivable of $219$210 million resulting from higher base rates and favorable effects of weather andin counterparty collateral of $129 million); and |
· | a $221$118 million, increase in defined benefit plans funding; partially offset by |
· | a $72$95 million increasechange in net income, when adjusted for non-cash components.fuel, materials and supplies). |
Capital expenditures increased by $146$488 million for the threesix months ended March 31,June 30, 2013 compared with 2012, primarily due to thePPL Electric's Susquehanna-Roseland transmission project and projects to enhance system reliability, and LKE's environmental projects at Mill Creek and Ghent and construction of Cane Run Unit 7.
PPL maintains credit facilities to provide liquidity and to backstop commercial paper issuances. At March 31,June 30, 2013, PPL'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 Backup | | Capacity | | | Capacity | | Borrowed | | Paper Backup | | Capacity | | | | | | | | | | | | | | | | | | | | PPL Energy Supply Credit Facilities (a) | PPL Energy Supply Credit Facilities (a) | | $ | 3,200 | | | | $ | 764 | | $ | 2,436 | PPL Energy Supply Credit Facilities (a) | | $ | 3,150 | | | | $ | 785 | | $ | 2,365 | PPL Electric Credit Facilities (b) | PPL Electric Credit Facilities (b) | | 400 | | | | 126 | | 274 | PPL Electric Credit Facilities (b) | | 400 | | | | 86 | | 314 | LG&E Syndicated Credit Facility | LG&E Syndicated Credit Facility | | 500 | | | | | | 70 | | | 430 | LG&E Syndicated Credit Facility | | 500 | | | | | | 80 | | | 420 | KU Credit Facilities (c) | KU Credit Facilities (c) | | | 598 | | | | | | 313 | | | 285 | KU Credit Facilities (c) | | | 598 | | | | | | 370 | | | 228 | | Total Domestic Credit Facilities (d) | | $ | 4,698 | | | | | $ | 1,273 | | $ | 3,425 | Total Domestic Credit Facilities (a) | | $ | 4,648 | | | | | $ | 1,321 | | $ | 3,327 | | | | | | | | | | | | | | | | | | | | 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 | | Total WPD Credit Facilities (b) | | Total WPD Credit Facilities (b) | | £ | 1,055 | | £ | 193 | | | | | £ | 862 |
(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%8% 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)(b) | At March 31,June 30, 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,June 30, 2013 and December 31, 2012, PPL Energy Supply had $481$575 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%0.29% 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,June 30, 2013, PPL Electric had $125$85 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheet, at a weighted-average interest rate of 0.39%0.34%. 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,June 30, 2013 and December 31, 2012, LG&E had $70$80 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%0.32% and 0.42%. At March 31,June 30, 2013 and December 31, 2012, KU had $115$172 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%0.33% and 0.42%.
Long-term Debt and Equity Securities
See "Overview""Overview - Financial and Operational Developments" above for information regarding equity forward agreements and the 2010 Equity Units. PPL has no plans to issue new shares of common stock for the remainder of 2013.
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 bewas loaned to or invested in affiliates of PPL Capital Funding and used to fund their capital expenditures and other general corporate purposes.
In July 2013, PPL Electric issued $350 million of 4.75% First Mortgage Bonds due 2043. PPL Electric received proceeds of $345 million, net of a discount and underwriting fees, which will be used for capital expenditures, to fund pension obligations and for other general corporate purposes.
In addition, PPL has reducedSee Note 7 to the estimateFinancial Statements for further discussion 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.Long-term Debt and Equity Securities.
Common Stock Dividends
In FebruaryMay 2013, PPL declared its quarterly common stock dividend, payable AprilJuly 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
Fitch, Moody's and 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 Fitch, Moody's and 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,Fitch, Moody's and FitchS&P 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 aton PPL Montana.Montana's pass-through trust certificates due 2020.
In May 2013, Fitch, Moody's and S&P assigned ratings of BBB, Baa3 and BBB- to PPL Capital Funding's $250 million 1.90% Senior Notes due 2018, $600 million 3.40% Senior Notes due 2023 and $300 million 4.70% Senior Notes due 2043. Fitch also assigned a stable outlook to these notes.
In July 2013, Fitch, Moody's and S&P assigned ratings of A-, A3 and A- to PPL Electric's $350 million 4.75% First Mortgage Bonds due 2043. Fitch also assigned a stable outlook to these notes and S&P assigned a recovery rating of 1+.
In July 2013, S&P confirmed the AA+ ratings for KU's 2000 Series A Solid Waste Disposal Facility Revenue Bonds and KU's 2004 Series A, 2006 Series B and 2008 Series A Environmental Facilities Revenue Bonds. S&P also confirmed the A-1+ short term rating on these Bonds.
In July 2013, Moody's withdrew its rating and outlook for PPL Ironwood.
In July 2013, S&P lowered its rating, from BBB- to BB+, and retained the negative outlook for PPL Montana's pass-through trust certificates due 2020.
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,June 30, 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.June 30. See Notes 13 and 14 to the Financial Statements for additional information.
| | | | | | Gains (Losses) | | Gains (Losses) | | | | | Three Months | | Three Months | | Six Months | | | | | | | 2013 | | 2012 | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | | | | | $ | 473 | | $ | 1,082 | | $ | 229 | | $ | 1,215 | | $ | 473 | | $ | 1,082 | Contracts realized or otherwise settled during the period | | | | | | (137) | | (279) | | (100) | | (261) | | (237) | | (540) | Fair value of new contracts entered into during the period (a) | | | | | | 9 | | (1) | | 37 | | 13 | | 46 | | 12 | Other changes in fair value | | | | | | | (116) | | | 413 | | | 119 | | | (6) | | | 3 | | | 407 | Fair value of contracts outstanding at the end of the period | | | | | | $ | 229 | | $ | 1,215 | | $ | 285 | | $ | 961 | | $ | 285 | | $ | 961 |
(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,June 30, 2013, based on the 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) | | $ | 238 | | $ | (21) | | $ | (8) | | $ | 6 | | $ | 215 | Prices based on significant observable inputs (Level 2) | | $ | 226 | | $ | 32 | | $ | (10) | | $ | 5 | | $ | 253 | Prices based on significant unobservable inputs (Level 3) | Prices based on significant unobservable inputs (Level 3) | | | (1) | | | 12 | | | 3 | | | | | | 14 | Prices based on significant unobservable inputs (Level 3) | | | 10 | | | 18 | | | 4 | | | | | | 32 | Fair value of contracts outstanding at the end of the period | Fair value of contracts outstanding at the end of the period | | $ | 237 | | $ | (9) | | $ | (5) | | $ | 6 | | $ | 229 | Fair value of contracts outstanding at the end of the period | | $ | 236 | | $ | 50 | | $ | (6) | | $ | 5 | | $ | 285 |
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 2017.2018. The following table sets forth changes in the net fair value of trading commodity derivative contracts for the periods ended March 31.June 30. See Notes 13 and 14 to the Financial Statements for additional information.
| | | | | | Gains (Losses) | | Gains (Losses) | | | | | Three Months | | Three Months | | Six Months | | | | | | | 2013 | | 2012 | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | | | | | $ | 29 | | $ | (4) | | $ | 15 | | $ | 2 | | $ | 29 | | $ | (4) | Contracts realized or otherwise settled during the period | | | | | | (2) | | | | | | (1) | | (2) | | (1) | Fair value of new contracts entered into during the period (a) | | | | | | | (12) | | | 6 | | (4) | | (1) | | (16) | | 5 | Other changes in fair value | | | | 7 | | | 17 | | | 7 | | | 17 | Fair value of contracts outstanding at the end of the period | | | | | | $ | 15 | | $ | 2 | | $ | 18 | | $ | 17 | | $ | 18 | | $ | 17 |
(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,June 30, 2013, based on the 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) | | | 5 | | $ | 9 | | | | | | | | | 14 | | $ | 4 | | $ | 6 | | | | | | | $ | 10 | Prices based on significant unobservable inputs (Level 3) | | | | 6 | | | 2 | | | | | | | | | 8 | Fair value of contracts outstanding at the end of the period | | $ | 6 | | $ | 9 | | | | | | | | $ | 15 | | $ | 10 | | $ | 8 | | | | | | | | $ | 18 |
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 periodssix months ended June 30, 2013 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 |
| | | | | | Non-Trading | | | | Trading VaR | | VaR | 95% Confidence Level, Five-Day Holding Period | | | | | | | | Period End | | $ | 2 | | $ | 8 | | Average for the Period | | | 4 | | | 9 | | High | | | 6 | | | 10 | | Low | | | 2 | | | 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,June 30, 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,June 30, 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,June 30, 2013 would increase the fair value of its debt portfolio by $563$631 million.
At March 31,June 30, 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) | | $ | 1,148 | | $ | 12 | | $ | (35) | Interest rate swaps (c) | | $ | 1,930 | | $ | 129 | | $ | (74) | | Cross-currency swaps (d) | | 1,262 | | 82 | | (171) | Cross-currency swaps (d) | | 1,262 | | 61 | | (171) | Economic activity | Economic activity | | | | | | | Economic activity | | | | | | | | Interest rate swaps (e) | | 179 | | (55) | | (3) | Interest rate swaps (e) | | 179 | | (44) | | (4) |
(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,June 30, 2013 mature through 2043.2044. |
(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,June 30, 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,June 30, 2013 mature through 2033. |
Foreign CurrencyUnregulated Gross Energy Margins
Eastern U.S. | | | | | | | | | | | | | | The increase (decrease) in non-trading margins for the periods ended June 30, 2013 compared with 2012 were due to: | | | | | | | | | | Three Months | | Six Months | | | | | | | | Baseload energy prices | | $ | (121) | | $ | (246) | Nuclear fuel prices | | | (4) | | | (10) | Coal prices | | | 1 | | | (9) | Intermediate and peaking Spark Spreads | | | (7) | | | 7 | Nuclear generation volume | | | 9 | | | 9 | Full-requirement sales contracts | | | 5 | | | 10 | Gas optimization and storage | | | 10 | | | 11 | Ironwood Acquisition which eliminated tolling expense | | | 2 | | | 17 | Net economic availability of coal and hydroelectric plants | | | 7 | | | 39 | Capacity prices | | | 36 | | | 47 | Other | | | 4 | | | 8 | Total | | $ | (58) | | $ | (117) |
Western U.S.
Non-trading margins for the three and six months ended June 30, 2013 compared with the same periods in 2012 were lower due to $20 million and $59 million of lower wholesale prices. The six-month period was partially offset by $7 million of higher wholesale volumes.
Net Energy Trading Margins
Net energy trading margins for the three months ended June 30, 2013 compared with the same period in 2012 decreased as a result of lower margins of $5 million on power positions and $3 million on FTRs.
Net energy trading margins for the six months ended June 30, 2013 compared with the same period in 2012 decreased as a result of lower margins of $15 million on gas positions and $7 million on power positions.
Utility Revenues | | | | | | | | | | | | | The increase (decrease) in utility revenues for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | | | | | | | | | | | Three Months | | Six Months | Domestic: | | | | | | | | PPL Electric (a) | | $ | 10 | | $ | 65 | | LKE (b) | | | 24 | | | 119 | | Total Domestic | | | 34 | | | 184 | | | | | | | | | | | U.K.: | | | | | | | | Price (c) | | | 50 | | | 113 | | Volume (d) | | | 23 | | | 28 | | DPCR4 accrual adjustments (e) | | | (24) | | | (24) | | Foreign currency exchange rates | | | (26) | | | (16) | | Other (f) | | | (7) | | | 1 | | Total U.K. | | | 16 | | | 102 | Total | | $ | 50 | | $ | 286 |
(a) | See "Pennsylvania Gross Delivery Margins" for further information. |
(b) | See "Kentucky Gross Margins" for further information. |
(c) | The increase for the three and six-month periods is primarily due to price increases effective April 1, 2013 and April 1, 2012. |
(d) | The increase for the three and six-month periods is primarily due to the favorable effect of weather. |
(e) | The decrease for the three and six-month periods is due to a $24 million reduction in revenue based on information provided by Ofgem regarding the calculation of line loss incentive/penalty for all network operators related to DPCR4. See Note 6 to the Financial Statements for additional information. |
(f) | The decrease for the three month period is primarily related to a $6 million reduction in third-party engineering revenue, which is partially offset by a reduction in costs in "Other operation and maintenance" on the Statements of Income. |
Other Operation and Maintenance | | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance for the periods ended June 30, 2013 compared with 2012 was due to: |
| | | Three Months | | Six Months | Domestic: | | | | | | | Uncollectible accounts (a) | $ | (4) | | $ | (20) | | LKE coal plant outages (b) | | (4) | | | (17) | | Brunner Island Unit 3 outage in 2012 | | (4) | | | (19) | | PPL Susquehanna projects | | (6) | | | (9) | | PPL Susquehanna refueling outage | | (5) | | | (8) | | Act 129 (c) | | (7) | | | (7) | | Conemaugh Unit 2 outage in 2013 | | 3 | | | 5 | | Other generation plant costs | | (7) | | | (1) | | Other | | (7) | | | 1 | U.K.: | | | | | | | Third-party engineering (d) | | (3) | | | 2 | | Network maintenance (e) | | 6 | | | 13 | | Insurance claim provision release | | 6 | | | 6 | | Severance compensation (f) | | (4) | | | (8) | | Pension | | (2) | | | (4) | | Foreign currency exchange rates | | (5) | | | (3) | | Other | | 2 | | | (2) | Total | $ | (41) | | $ | (71) |
(a) | The decrease for the six-month period 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 for the three and six month periods is due to the timing and scope of scheduled outages. |
(c) | The decrease for the three and six month periods is due to a reduction in Act 129 energy efficiency and conservation plan costs for Phase 1 programs. Phase 1 ended May 31, 2013. |
(d) | These costs are offset by revenues reflected in "Utility" on the Statement of Income. |
(e) | The increase for the three and six month periods is primarily due to higher vegetation management costs. |
(f) | The decrease for the three and six month periods is primarily due to costs incurred in 2012 related to the WPD Midlands reorganization. |
Depreciation | | | | | | | | | | | The increase (decrease) in depreciation for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | | | | | Three Months | | Six Months | | | | | | | | | Additions to PP&E | | $ | 23 | | $ | 44 | LKE lower depreciation rates effective January 1, 2013 | | | (6) | | | (11) | Ironwood Acquisition | | | | | | 6 | Other | | | (2) | | | (4) | Total | | $ | 15 | | $ | 35 |
Other Income (Expense) - net
The $17 million decrease in other income (expense) - net for the three months ended June 30, 2013 compared with 2012 was primarily due to a decrease of $21 million from realized and unrealized gains on foreign currency contracts.
The $122 million increase in other income (expense) - net for the six months ended June 30, 2013 compared with 2012 was primarily due to an increase of $116 million from realized and unrealized gains on foreign currency contracts.
See Note 12 to the Financial Statements for additional information on other income (expense) - net. Interest Expense | | | | | | | | | | | | The increase (decrease) in interest expense for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | | Three Months | | Six Months | | | | | | | | | Long-term debt interest expense (a) | | $ | 8 | | $ | 22 | Loss on extinguishment of debt (b) | | | 10 | | | 10 | Ironwood Acquisition financing | | | | | | 4 | Capitalized interest | | | 3 | | | 4 | Other | | | 1 | | | 3 | Total | | $ | 22 | | $ | 43 |
(a) | The increase for the three-month period was primarily due to PPL Capital Funding's debt issuances in March 2013, June 2012 and October 2012. See Note 7 to the Financial Statements in this Form 10-Q and in PPL's 2012 Form 10-K for additional information. |
| The increase for the six-month period was primarily due to PPL Capital Funding's debt issuances as discussed above as well as higher accretion expense on WPD index linked notes and interest on WPD (East Midlands') April 2012 issuance of £100 million, 5.25% Senior Notes due 2023. |
(b) | In May 2013, PPL Capital Funding remarketed and exchanged junior subordinated notes that were originally issued in June 2010 as a component of PPL's 2010 Equity Units. See Note 7 to the Financial Statements for additional information. |
Income Taxes | | | | | | | | | | | The increase (decrease) in income taxes for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | Three Months | | Six Months | | | | | | | | | Higher (lower) pre-tax income | | $ | 52 | | $ | (67) | Federal and state tax reserve adjustments (a) | | | (35) | | | (35) | U.S. income tax on foreign earnings net of foreign tax credit (b) | | | (6) | | | (6) | Foreign tax reserve adjustments (c) | | | 8 | | | 5 | Foreign tax return adjustments | | | (4) | | | (4) | Net operating loss carryforward adjustments (d) | | | 3 | | | 9 | State deferred tax rate change (e) | | | | | | 11 | Other | | | 3 | | | | Total | | $ | 21 | | $ | (87) |
(a) | In May 2013, the U.S. Supreme Court reversed the December 2011 ruling of the U.S. Court of Appeals for the Third Circuit on the creditability of U.K. Windfall Profits Tax for tax purposes. As a result of this decision, PPL recorded a tax benefit of $44 million during the three and six months ended June 30, 2013. See Note 5 to the Financial Statements for additional information. |
(b) | During the three and six months ended June 30, 2013, PPL recorded a $14 million increase to income tax expense primarily attributable to a revision in the expected taxable amount of cash repatriation in 2013 and recorded a tax benefit of $19 million associated with a ruling obtained from the IRS impacting the recalculation of 2010 U.K. earnings and profits that will be reflected on an amended 2010 U.S. tax return. |
(c) | During the three and six months ended June 30, 2012, PPL recorded a tax benefit following resolution of a U.K. tax issue related to the tax deductibility of interest expense. |
(d) | During the three and six months ended June 30, 2012, PPL recorded adjustments to deferred taxes related to net operating loss carryforwards of LKE based on income tax return adjustments. |
(e) | During the six months ended June 30, 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: | | | | | | | | | | June 30, 2013 | | December 31, 2012 | | | | | | | | Cash and cash equivalents | | $ | 711 | | $ | 901 | Short-term debt | | $ | 1,206 | | $ | 652 |
At June 30, 2013, $178 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. income taxes, net of allowable foreign income 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 $190 million decrease in PPL's cash and cash equivalents position was primarily the net result of:
· | capital expenditures of $1.8 billion; |
· | the payment of $426 million of common stock dividends; |
· | net cash provided by operating activities of $947 million; |
· | net increase in short-term debt of $563 million; and |
· | proceeds of $450 million from the issuance of long-term debt. |
PPL's cash provided by operating activities had no net change for the six months ended June 30, 2013 compared with 2012. The result was the net effect of:
· | a $219 million increase in net income, when adjusted for non-cash components; and |
· | a $25 million decrease in defined benefit plan funding, offset by |
· | a $245 million increase in cash used by components of working capital (primarily due to changes in accounts receivable of $210 million and in counterparty collateral of $118 million, partially offset by a $95 million change in fuel, materials and supplies). |
Capital expenditures increased by $488 million for the six months ended June 30, 2013 compared with 2012, primarily due to PPL Electric's Susquehanna-Roseland transmission project and projects to enhance system reliability, and LKE's environmental projects at Mill Creek and Ghent and construction of Cane Run Unit 7.
PPL maintains credit facilities to provide liquidity and to backstop commercial paper issuances. At June 30, 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 | | $ | 3,150 | | | | | $ | 785 | | $ | 2,365 | PPL Electric Credit Facilities | | | 400 | | | | | | 86 | | | 314 | LG&E Syndicated Credit Facility | | | 500 | | | | | | 80 | | | 420 | KU Credit Facilities | | | 598 | | | | | | 370 | | | 228 | | Total Domestic Credit Facilities (a) | | $ | 4,648 | | | | | $ | 1,321 | | $ | 3,327 | | | | | | | | | | | | | | | Total WPD Credit Facilities (b) | | £ | 1,055 | | £ | 193 | | | | | £ | 862 |
(a) | 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 8% of the total committed capacity. |
(b) | At June 30, 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 June 30, 2013 and December 31, 2012, PPL Energy Supply had $575 million and $356 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.29% 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 June 30, 2013, PPL Electric had $85 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheet, at a weighted-average interest rate of 0.34%. 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 June 30, 2013 and December 31, 2012, LG&E had $80 million and $55 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.32% and 0.42%. At June 30, 2013 and December 31, 2012, KU had $172 million and $70 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.33% and 0.42%.
Long-term Debt and Equity Securities
See "Overview - Financial and Operational Developments" above for information regarding equity forward agreements and the 2010 Equity Units. PPL has no plans to issue new shares of common stock for the remainder of 2013.
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 was loaned to or invested in affiliates of PPL Capital Funding and used to fund their capital expenditures and other general corporate purposes.
In July 2013, PPL Electric issued $350 million of 4.75% First Mortgage Bonds due 2043. PPL Electric received proceeds of $345 million, net of a discount and underwriting fees, which will be used for capital expenditures, to fund pension obligations and for other general corporate purposes.
See Note 7 to the Financial Statements for further discussion of Long-term Debt and Equity Securities.
Common Stock Dividends
In May 2013, PPL declared its quarterly common stock dividend, payable July 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
Fitch, Moody's and S&P 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 Fitch, Moody's and S&P 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, Fitch, Moody's and S&P 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 on PPL Montana's pass-through trust certificates due 2020.
In May 2013, Fitch, Moody's and S&P assigned ratings of BBB, Baa3 and BBB- to PPL Capital Funding's $250 million 1.90% Senior Notes due 2018, $600 million 3.40% Senior Notes due 2023 and $300 million 4.70% Senior Notes due 2043. Fitch also assigned a stable outlook to these notes.
In July 2013, Fitch, Moody's and S&P assigned ratings of A-, A3 and A- to PPL Electric's $350 million 4.75% First Mortgage Bonds due 2043. Fitch also assigned a stable outlook to these notes and S&P assigned a recovery rating of 1+.
In July 2013, S&P confirmed the AA+ ratings for KU's 2000 Series A Solid Waste Disposal Facility Revenue Bonds and KU's 2004 Series A, 2006 Series B and 2008 Series A Environmental Facilities Revenue Bonds. S&P also confirmed the A-1+ short term rating on these Bonds.
In July 2013, Moody's withdrew its rating and outlook for PPL Ironwood.
In July 2013, S&P lowered its rating, from BBB- to BB+, and retained the negative outlook for PPL Montana's pass-through trust certificates due 2020.
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 June 30, 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 June 30. See Notes 13 and 14 to the Financial Statements for additional information.
| | Gains (Losses) | | | Three Months | | Six Months | | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | $ | 229 | | $ | 1,215 | | $ | 473 | | $ | 1,082 | Contracts realized or otherwise settled during the period | | | (100) | | | (261) | | | (237) | | | (540) | Fair value of new contracts entered into during the period (a) | | | 37 | | | 13 | | | 46 | | | 12 | Other changes in fair value | | | 119 | | | (6) | | | 3 | | | 407 | Fair value of contracts outstanding at the end of the period | | $ | 285 | | $ | 961 | | $ | 285 | | $ | 961 |
(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 June 30, 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) | | $ | 226 | | $ | 32 | | $ | (10) | | $ | 5 | | $ | 253 | Prices based on significant unobservable inputs (Level 3) | | | 10 | | | 18 | | | 4 | | | | | | 32 | Fair value of contracts outstanding at the end of the period | | $ | 236 | | $ | 50 | | $ | (6) | | $ | 5 | | $ | 285 |
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 2018. The following table sets forth changes in the net fair value of trading commodity derivative contracts for the periods ended June 30. See Notes 13 and 14 to the Financial Statements for additional information.
| | Gains (Losses) | | | Three Months | | Six Months | | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | $ | 15 | | $ | 2 | | $ | 29 | | $ | (4) | Contracts realized or otherwise settled during the period | | | | | | (1) | | | (2) | | | (1) | Fair value of new contracts entered into during the period (a) | | | (4) | | | (1) | | | (16) | | | 5 | Other changes in fair value | | | 7 | | | 17 | | | 7 | | | 17 | Fair value of contracts outstanding at the end of the period | | $ | 18 | | $ | 17 | | $ | 18 | | $ | 17 |
(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 June 30, 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) | | $ | 4 | | $ | 6 | | | | | | | | $ | 10 | Prices based on significant unobservable inputs (Level 3) | | | 6 | | | 2 | | | | | | | | | 8 | Fair value of contracts outstanding at the end of the period | | $ | 10 | | $ | 8 | | | | | | | | $ | 18 |
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 six months ended June 30, 2013 was as follows.
| | | | | | Non-Trading | | | | Trading VaR | | VaR | 95% Confidence Level, Five-Day Holding Period | | | | | | | | Period End | | $ | 2 | | $ | 8 | | Average for the Period | | | 4 | | | 9 | | High | | | 6 | | | 10 | | Low | | | 2 | | | 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 June 30, 2013.
Interest Rate Risk
PPL is exposedand its subsidiaries issue debt to foreign currencyfinance 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 primarily through investmentsmanagement program are designed to balance risk exposure to volatility in U.K. affiliates. In addition,interest expense and changes in the fair value of PPL's domestic operations may make purchasesdebt portfolio due to changes in the absolute level of equipmentinterest rates.
At June 30, 2013, PPL's potential annual exposure to increased interest expense, based on a 10% increase in currencies other than U.S. dollars.interest rates, was not significant.
PPL has adoptedis also exposed to changes in the fair value of its domestic and international debt portfolios. PPL estimated that 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 risk10% decrease in interest rates at June 30, 2013 would increase the fair value of expected earnings.its debt portfolio by $631 million.
At June 30, 2013, PPL had the following foreign currencyinterest rate hedges outstanding March 31, 2013:outstanding:
| | | | | | | 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) |
| | | | | | | Effect of a | | | | | | Fair Value, | | 10% Adverse | | | | Exposure | | Net - Asset | | Movement | | | | Hedged | | (Liability) (a) | | in Rates (b) | Cash flow hedges | | | | | | | | | | | Interest rate swaps (c) | | $ | 1,930 | | $ | 129 | | $ | (74) | | Cross-currency swaps (d) | | | 1,262 | | | 61 | | | (171) | Economic activity | | | | | | | | | | | Interest rate swaps (e) | | | 179 | | | (44) | | | (4) |
(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. |
(b) | To protect the value of Sensitivities represent a portion of its net investment10% adverse movement 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 Statementsinterest rates, except for additional information.cross-currency swaps which also includes foreign currency exchange rates. |
(c) | To economically hedgePPL utilizes various risk management instruments to reduce its exposure to the translationexpected future cash flow variability of expected income denominatedits 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 GBP to U.S. dollars, PPL entersthe 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 rates. The changes in fair value of these instruments are then reclassified into a combination of average rate forwards and average rate options to sell GBP.earnings in the same period during which the item being hedged affects earnings. The forwards and optionspositions outstanding at March 31,June 30, 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.2044. |
(b)(d) | In October 2011, a wholesale customer, SMGT, filedPPL 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 June 30, 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 bankruptcy protection under Chapter 11outstanding 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 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 Districtfair value of Montana approved the request to terminate the contract, effective April 1, 2012.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 June 30, 2013 mature through 2033. |
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
Eastern U.S. | | | | | | | | | | | | | | The increase (decrease) in non-trading margins for the periods ended June 30, 2013 compared with 2012 were due to: | | | | | | | | | | Three Months | | Six Months | | | | | | | | Baseload energy prices | | $ | (121) | | $ | (246) | Nuclear fuel prices | | | (4) | | | (10) | Coal prices | | | 1 | | | (9) | Intermediate and peaking Spark Spreads | | | (7) | | | 7 | Nuclear generation volume | | | 9 | | | 9 | Full-requirement sales contracts | | | 5 | | | 10 | Gas optimization and storage | | | 10 | | | 11 | Ironwood Acquisition which eliminated tolling expense | | | 2 | | | 17 | Net economic availability of coal and hydroelectric plants | | | 7 | | | 39 | Capacity prices | | | 36 | | | 47 | Other | | | 4 | | | 8 | Total | | $ | (58) | | $ | (117) |
Western U.S.
Non-trading margins for the three and six months ended June 30, 2013 compared with the same periods in 2012 were lower due to $20 million and $59 million of lower wholesale prices. The six-month period was partially offset by $7 million of higher wholesale volumes.
Net Energy Trading Margins
Net energy trading margins for the three months ended June 30, 2013 compared with the same period in 2012 decreased as a result of lower margins of $5 million on power positions and $3 million on FTRs.
Net energy trading margins for the six months ended June 30, 2013 compared with the same period in 2012 decreased as a result of lower margins of $15 million on gas positions and $7 million on power positions.
Utility Revenues | | | | | | | | | | | | | The increase (decrease) in utility revenues for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | | | | | | | | | | | Three Months | | Six Months | Domestic: | | | | | | | | PPL Electric (a) | | $ | 10 | | $ | 65 | | LKE (b) | | | 24 | | | 119 | | Total Domestic | | | 34 | | | 184 | | | | | | | | | | | U.K.: | | | | | | | | Price (c) | | | 50 | | | 113 | | Volume (d) | | | 23 | | | 28 | | DPCR4 accrual adjustments (e) | | | (24) | | | (24) | | Foreign currency exchange rates | | | (26) | | | (16) | | Other (f) | | | (7) | | | 1 | | Total U.K. | | | 16 | | | 102 | Total | | $ | 50 | | $ | 286 |
(a) | See "Pennsylvania Gross Delivery Margins" for further information. |
(b) | See "Kentucky Gross Margins" for further information. |
(c) | The increase for the three and six-month periods is primarily due to price increases effective April 1, 2013 and April 1, 2012. |
(d) | The increase for the three and six-month periods is primarily due to the favorable effect of weather. |
(e) | The decrease for the three and six-month periods is due to a $24 million reduction in revenue based on information provided by Ofgem regarding the calculation of line loss incentive/penalty for all network operators related to DPCR4. See Note 6 to the Financial Statements for additional information. |
(f) | The decrease for the three month period is primarily related to a $6 million reduction in third-party engineering revenue, which is partially offset by a reduction in costs in "Other operation and maintenance" on the Statements of Income. |
Other Operation and Maintenance | | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance for the periods ended June 30, 2013 compared with 2012 was due to: |
| | | Three Months | | Six Months | Domestic: | | | | | | | Uncollectible accounts (a) | $ | (4) | | $ | (20) | | LKE coal plant outages (b) | | (4) | | | (17) | | Brunner Island Unit 3 outage in 2012 | | (4) | | | (19) | | PPL Susquehanna projects | | (6) | | | (9) | | PPL Susquehanna refueling outage | | (5) | | | (8) | | Act 129 (c) | | (7) | | | (7) | | Conemaugh Unit 2 outage in 2013 | | 3 | | | 5 | | Other generation plant costs | | (7) | | | (1) | | Other | | (7) | | | 1 | U.K.: | | | | | | | Third-party engineering (d) | | (3) | | | 2 | | Network maintenance (e) | | 6 | | | 13 | | Insurance claim provision release | | 6 | | | 6 | | Severance compensation (f) | | (4) | | | (8) | | Pension | | (2) | | | (4) | | Foreign currency exchange rates | | (5) | | | (3) | | Other | | 2 | | | (2) | Total | $ | (41) | | $ | (71) |
(a) | The decrease for the six-month period 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 for the three and six month periods is due to the timing and scope of scheduled outages. |
(c) | The decrease for the three and six month periods is due to a reduction in Act 129 energy efficiency and conservation plan costs for Phase 1 programs. Phase 1 ended May 31, 2013. |
(d) | These costs are offset by revenues reflected in "Utility" on the Statement of Income. |
(e) | The increase for the three and six month periods is primarily due to higher vegetation management costs. |
(f) | The decrease for the three and six month periods is primarily due to costs incurred in 2012 related to the WPD Midlands reorganization. |
Depreciation | | | | | | | | | | | The increase (decrease) in depreciation for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | | | | | Three Months | | Six Months | | | | | | | | | Additions to PP&E | | $ | 23 | | $ | 44 | LKE lower depreciation rates effective January 1, 2013 | | | (6) | | | (11) | Ironwood Acquisition | | | | | | 6 | Other | | | (2) | | | (4) | Total | | $ | 15 | | $ | 35 |
Other Income (Expense) - net
The $17 million decrease in other income (expense) - net for the three months ended June 30, 2013 compared with 2012 was primarily due to a decrease of $21 million from realized and unrealized gains on foreign currency contracts.
The $122 million increase in other income (expense) - net for the six months ended June 30, 2013 compared with 2012 was primarily due to an increase of $116 million from realized and unrealized gains on foreign currency contracts.
See Note 12 to the Financial Statements for additional information on other income (expense) - net. Interest Expense | | | | | | | | | | | | The increase (decrease) in interest expense for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | | Three Months | | Six Months | | | | | | | | | Long-term debt interest expense (a) | | $ | 8 | | $ | 22 | Loss on extinguishment of debt (b) | | | 10 | | | 10 | Ironwood Acquisition financing | | | | | | 4 | Capitalized interest | | | 3 | | | 4 | Other | | | 1 | | | 3 | Total | | $ | 22 | | $ | 43 |
(a) | The increase for the three-month period was primarily due to PPL Capital Funding's debt issuances in March 2013, June 2012 and October 2012. See Note 7 to the Financial Statements in this Form 10-Q and in PPL's 2012 Form 10-K for additional information. |
| The increase for the six-month period was primarily due to PPL Capital Funding's debt issuances as discussed above as well as higher accretion expense on WPD index linked notes and interest on WPD (East Midlands') April 2012 issuance of £100 million, 5.25% Senior Notes due 2023. |
(b) | In May 2013, PPL Capital Funding remarketed and exchanged junior subordinated notes that were originally issued in June 2010 as a component of PPL's 2010 Equity Units. See Note 7 to the Financial Statements for additional information. |
Income Taxes | | | | | | | | | | | The increase (decrease) in income taxes for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | Three Months | | Six Months | | | | | | | | | Higher (lower) pre-tax income | | $ | 52 | | $ | (67) | Federal and state tax reserve adjustments (a) | | | (35) | | | (35) | U.S. income tax on foreign earnings net of foreign tax credit (b) | | | (6) | | | (6) | Foreign tax reserve adjustments (c) | | | 8 | | | 5 | Foreign tax return adjustments | | | (4) | | | (4) | Net operating loss carryforward adjustments (d) | | | 3 | | | 9 | State deferred tax rate change (e) | | | | | | 11 | Other | | | 3 | | | | Total | | $ | 21 | | $ | (87) |
(a) | In May 2013, the U.S. Supreme Court reversed the December 2011 ruling of the U.S. Court of Appeals for the Third Circuit on the creditability of U.K. Windfall Profits Tax for tax purposes. As a result of this decision, PPL recorded a tax benefit of $44 million during the three and six months ended June 30, 2013. See Note 5 to the Financial Statements for additional information. |
(b) | During the three and six months ended June 30, 2013, PPL recorded a $14 million increase to income tax expense primarily attributable to a revision in the expected taxable amount of cash repatriation in 2013 and recorded a tax benefit of $19 million associated with a ruling obtained from the IRS impacting the recalculation of 2010 U.K. earnings and profits that will be reflected on an amended 2010 U.S. tax return. |
(c) | During the three and six months ended June 30, 2012, PPL recorded a tax benefit following resolution of a U.K. tax issue related to the tax deductibility of interest expense. |
(d) | During the three and six months ended June 30, 2012, PPL recorded adjustments to deferred taxes related to net operating loss carryforwards of LKE based on income tax return adjustments. |
(e) | During the six months ended June 30, 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: | | | | | | | | | | June 30, 2013 | | December 31, 2012 | | | | | | | | Cash and cash equivalents | | $ | 711 | | $ | 901 | Short-term debt | | $ | 1,206 | | $ | 652 |
At June 30, 2013, $178 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. income taxes, net of allowable foreign income 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 $190 million decrease in PPL's cash and cash equivalents position was primarily the net result of:
· | capital expenditures of $1.8 billion; |
· | the payment of $426 million of common stock dividends; |
· | net cash provided by operating activities of $947 million; |
· | net increase in short-term debt of $563 million; and |
· | proceeds of $450 million from the issuance of long-term debt. |
PPL's cash provided by operating activities had no net change for the six months ended June 30, 2013 compared with 2012. The result was the net effect of:
· | a $219 million increase in net income, when adjusted for non-cash components; and |
· | a $25 million decrease in defined benefit plan funding, offset by |
· | a $245 million increase in cash used by components of working capital (primarily due to changes in accounts receivable of $210 million and in counterparty collateral of $118 million, partially offset by a $95 million change in fuel, materials and supplies). |
Capital expenditures increased by $488 million for the six months ended June 30, 2013 compared with 2012, primarily due to PPL Electric's Susquehanna-Roseland transmission project and projects to enhance system reliability, and LKE's environmental projects at Mill Creek and Ghent and construction of Cane Run Unit 7.
PPL maintains credit facilities to provide liquidity and to backstop commercial paper issuances. At June 30, 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 | | $ | 3,150 | | | | | $ | 785 | | $ | 2,365 | PPL Electric Credit Facilities | | | 400 | | | | | | 86 | | | 314 | LG&E Syndicated Credit Facility | | | 500 | | | | | | 80 | | | 420 | KU Credit Facilities | | | 598 | | | | | | 370 | | | 228 | | Total Domestic Credit Facilities (a) | | $ | 4,648 | | | | | $ | 1,321 | | $ | 3,327 | | | | | | | | | | | | | | | Total WPD Credit Facilities (b) | | £ | 1,055 | | £ | 193 | | | | | £ | 862 |
(a) | 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 8% of the total committed capacity. |
(b) | At June 30, 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 June 30, 2013 and December 31, 2012, PPL Energy Supply had $575 million and $356 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.29% 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 June 30, 2013, PPL Electric had $85 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheet, at a weighted-average interest rate of 0.34%. 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 June 30, 2013 and December 31, 2012, LG&E had $80 million and $55 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.32% and 0.42%. At June 30, 2013 and December 31, 2012, KU had $172 million and $70 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.33% and 0.42%.
Long-term Debt and Equity Securities
See "Overview - Financial and Operational Developments" above for information regarding equity forward agreements and the 2010 Equity Units. PPL has no plans to issue new shares of common stock for the remainder of 2013.
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 was loaned to or invested in affiliates of PPL Capital Funding and used to fund their capital expenditures and other general corporate purposes.
In July 2013, PPL Electric issued $350 million of 4.75% First Mortgage Bonds due 2043. PPL Electric received proceeds of $345 million, net of a discount and underwriting fees, which will be used for capital expenditures, to fund pension obligations and for other general corporate purposes.
See Note 7 to the Financial Statements for further discussion of Long-term Debt and Equity Securities.
Common Stock Dividends
In May 2013, PPL declared its quarterly common stock dividend, payable July 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
Fitch, Moody's and S&P 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 Fitch, Moody's and S&P 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, Fitch, Moody's and S&P 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 on PPL Montana's pass-through trust certificates due 2020.
In May 2013, Fitch, Moody's and S&P assigned ratings of BBB, Baa3 and BBB- to PPL Capital Funding's $250 million 1.90% Senior Notes due 2018, $600 million 3.40% Senior Notes due 2023 and $300 million 4.70% Senior Notes due 2043. Fitch also assigned a stable outlook to these notes.
In July 2013, Fitch, Moody's and S&P assigned ratings of A-, A3 and A- to PPL Electric's $350 million 4.75% First Mortgage Bonds due 2043. Fitch also assigned a stable outlook to these notes and S&P assigned a recovery rating of 1+.
In July 2013, S&P confirmed the AA+ ratings for KU's 2000 Series A Solid Waste Disposal Facility Revenue Bonds and KU's 2004 Series A, 2006 Series B and 2008 Series A Environmental Facilities Revenue Bonds. S&P also confirmed the A-1+ short term rating on these Bonds.
In July 2013, Moody's withdrew its rating and outlook for PPL Ironwood.
In July 2013, S&P lowered its rating, from BBB- to BB+, and retained the negative outlook for PPL Montana's pass-through trust certificates due 2020.
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 June 30, 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 June 30. See Notes 13 and 14 to the Financial Statements for additional information.
| | Gains (Losses) | | | Three Months | | Six Months | | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | $ | 229 | | $ | 1,215 | | $ | 473 | | $ | 1,082 | Contracts realized or otherwise settled during the period | | | (100) | | | (261) | | | (237) | | | (540) | Fair value of new contracts entered into during the period (a) | | | 37 | | | 13 | | | 46 | | | 12 | Other changes in fair value | | | 119 | | | (6) | | | 3 | | | 407 | Fair value of contracts outstanding at the end of the period | | $ | 285 | | $ | 961 | | $ | 285 | | $ | 961 |
(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 June 30, 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) | | $ | 226 | | $ | 32 | | $ | (10) | | $ | 5 | | $ | 253 | Prices based on significant unobservable inputs (Level 3) | | | 10 | | | 18 | | | 4 | | | | | | 32 | Fair value of contracts outstanding at the end of the period | | $ | 236 | | $ | 50 | | $ | (6) | | $ | 5 | | $ | 285 |
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 2018. The following table sets forth changes in the net fair value of trading commodity derivative contracts for the periods ended June 30. See Notes 13 and 14 to the Financial Statements for additional information.
| | Gains (Losses) | | | Three Months | | Six Months | | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | $ | 15 | | $ | 2 | | $ | 29 | | $ | (4) | Contracts realized or otherwise settled during the period | | | | | | (1) | | | (2) | | | (1) | Fair value of new contracts entered into during the period (a) | | | (4) | | | (1) | | | (16) | | | 5 | Other changes in fair value | | | 7 | | | 17 | | | 7 | | | 17 | Fair value of contracts outstanding at the end of the period | | $ | 18 | | $ | 17 | | $ | 18 | | $ | 17 |
(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 June 30, 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) | | $ | 4 | | $ | 6 | | | | | | | | $ | 10 | Prices based on significant unobservable inputs (Level 3) | | | 6 | | | 2 | | | | | | | | | 8 | Fair value of contracts outstanding at the end of the period | | $ | 10 | | $ | 8 | | | | | | | | $ | 18 |
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 six months ended June 30, 2013 was as follows.
| | | | | | Non-Trading | | | | Trading VaR | | VaR | 95% Confidence Level, Five-Day Holding Period | | | | | | | | Period End | | $ | 2 | | $ | 8 | | Average for the Period | | | 4 | | | 9 | | High | | | 6 | | | 10 | | Low | | | 2 | | | 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 June 30, 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 June 30, 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 June 30, 2013 would increase the fair value of its debt portfolio by $631 million.
At June 30, 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) | | $ | 1,930 | | $ | 129 | | $ | (74) | | Cross-currency swaps (d) | | | 1,262 | | | 61 | | | (171) | Economic activity | | | | | | | | | | | Interest rate swaps (e) | | | 179 | | | (44) | | | (4) |
(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 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 June 30, 2013 mature through 2044. |
(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 June 30, 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 June 30, 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 June 30, 2013, PPL had the following foreign currency hedges outstanding:
| | | | | | | Effect of a | | | | | | | | 10% | | | | | | | | Adverse | | | | | | | | Movement | | | | | | | | in Foreign | | | | | | Fair Value, | | Currency | | | | Exposure | | Net - Asset | | Exchange | | | | Hedged | | (Liability) | | Rates (a) | | | | | | | | | | | | Net investment hedges (b) | | £ | 166 | | $ | 11 | | $ | (25) | Economic activity (c) | | | 1,185 | | | 71 | | | (171) |
(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 June 30, 2013 mature through 2014. Excludes the amount of intercompany loans classified as net investment hedges. 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 June 30, 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 June 30, 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 June 30, 2013, a hypothetical 10% increase in interest rates and a 10% decrease in equity prices would have resulted in an estimated $57 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 $269 million for the six months ended June 30, 2013, which primarily reflected a $714 million reduction to PP&E and goodwill offset by a reduction of $445 million to net liabilities. Changes in this exchange rate resulted in a foreign currency translation loss of $104 million for the six months ended June 30, 2012, which primarily reflected a $259 million reduction to PP&E and goodwill offset by a reduction of $155 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 possible 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 hydroelectric 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 waste) 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. On July 25, 2013, the U.S. House of Representatives passed House Bill H.R. 2218, the Coal Residuals and Reuse Management Act of 2013, which would preempt the EPA from regulating CCRs under RCRA and sets rules governing state programs. Prospects remain uncertain for similar legislation to pass in the U.S. Senate.
Effluent Limitation Guidelines (ELGs) In June 2013, the EPA published 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 transport water and metal cleaning waste waters, as well as new limits for scrubber wastewater and landfill leachate. The EPA's proposed ELG regulations also contain some requirements that would affect the inspection and operation of CCR facilities, if finalized. 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: requiring installation of Best Technology Available (BTA) to reduce mortality of aquatic organisms that are pulled into the plant cooling water system (entrainment); and imposing standards for reduction of mortality of aquatic organisms trapped on water intake screens (impingement). A final rule is expected to be issued in November 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 June 2013, President Obama released his Climate Action Plan which reiterates the goal of reducing greenhouse gas emissions in the U.S. "in the range of" 17% below 2005 levels by 2020 through such actions as regulating power plant emissions, promoting increased use of renewables and clean energy technology, and establishing tighter energy efficiency standards. Also, by Presidential Memorandum the EPA was directed to issue a new proposal for new power plants by September 20, 2013, with a final rule to be issued in a timely fashion thereafter, and to issue proposed standards for existing power plants by June 1, 2014 with a final rule by June 1, 2015. The EPA was further directed to require that states develop implementation plans for existing plants by June 2016. Regulation of existing plants could have a significant industry-wide impact depending on the structure and stringency of the final rule and state implementation plans. The Administration's recent increase in its estimate of the "social cost of carbon" (which is used to calculate benefits associated with proposed regulations) from $23.80 to $38 per metric ton in 2015 may lead to more costly regulatory requirements. Additionally, the Climate Action Plan requirements related to preparing the U.S. for the impacts of climate change could affect PPL and others in the industry as transmission system modifications to improve the ability to withstand major storms may be needed in order to meet those requirements.
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.
Regional Haze Under the EPA's regional haze programs (developed to eliminate man-made visibility degradation by 2064), states are required to make reasonable progress every decade, including the application of Best Available Retrofit Technology (BART) on power plants commissioned between 1962 and 1977. For the eastern U.S., the EPA had determined that region-wide reductions under the CAIR or CSAPR trading program could be utilized by state programs to satisfy BART requirements. However, the August 2012 decision by the U.S. Court of Appeals for the District of Columbia Circuit (Circuit Court) to vacate and remand CSAPR exposes power plants located in the eastern U.S., including PPL's plants in Pennsylvania and Kentucky, to reductions in sulfur dioxide and nitrogen oxides as required by BART.
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).
CSAPR and CAIR In 2011, the EPA finalized its CSAPR regulating emissions of nitrogen 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 U.S. In December 2011, the Circuit Court stayed implementation of CSAPR, leaving CAIR in place. Subsequently, in August 2012, the Circuit Court vacated and remanded CSAPR back to the EPA for further rulemaking, again leaving CAIR in place in the interim, and on June 24, 2013 the U.S. Supreme Court granted the EPA's petition for review of the Circuit Court's decision.
PPL plants in Pennsylvania and Kentucky will continue to comply with CAIR through optimization of existing controls, balanced with emission allowance purchases. The Circuit Court's August 2012 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.
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 additional information on 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 and six months ended June 30, 2013 with the same periods in 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.
The capacity (summer rating) of PPL Energy Supply's competitive electricity generation facilities at June 30, 2013 was:
| | | Ownership or | | | | | Lease Interest | | Primary Fuel | | in MW (a) | | | | | | | Coal (b) (c) | | 4,146 | | Natural Gas/Oil | | 3,316 | | Nuclear (c) | | 2,275 | | Hydro | | 807 | | Other (d) | | 70 | | | | | | | Total | | 10,614 | |
(a) | The capacity of generation units is based on a number of factors, including the operating experience and physical conditions of the units, and may be revised periodically to reflect changed circumstances. See "Item 2. Properties" in PPL Energy Supply's 2012 Form 10-K for additional information on ownership percentages. |
(b) | Includes a leasehold interest held by PPL Montana. See Note 11 to the Financial Statements in PPL Energy Supply's 2012 Form 10-K for additional information. |
(c) | Includes units that are jointly owned. Each owner is entitled to its proportionate share of the unit's total output and funds its proportionate share of fuel and other operating costs. See Note 14 to the Financial Statements in PPL Energy Supply's 2012 Form 10-K for additional information. |
(d) | Includes facilities owned, controlled or for which PPL Energy Supply has the rights to the output. |
Business Strategy
PPL Energy Supply's strategy is to achieve disciplined optimization of energy supply margins while mitigating near-term 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 managing profitability during the current and projected period of low commodity prices. See "Financial and Operational Developments - Economic and Market Conditions" below.
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 Attributable to PPL Energy Supply Member
Net Income Attributable to PPL Energy Supply Member for the three and six months ended June 30, 2013 was $86 million and $48 million compared to $19 million and $328 million for the same periods in 2012.
See "Results of Operations" below for further discussion and analysis of the consolidated results of operations.
Economic and Market Conditions
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 and additional renewable energy sources, primarily wind in the western U.S. Unregulated Gross Energy Margins associated with PPL Energy Supply's competitive generation and marketing business are impacted by changes in energy and capacity market prices and demand for electricity and natural gas, power plant availability, competition in the markets for retail customers, fuel costs and availability, transmission constraints that impact the locational pricing of electricity at PPL Energy Supply's power plants, fuel transportation costs and the level and price of hedging activities. As a result of these factors, lower energy margins are expected when compared to the 2012 energy margins. 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, its hedging strategies, and potential plant modifications to burn lower cost fuels.
As previously disclosed, PPL Energy Supply's businesses are subject to extensive federal, state and local environmental laws, rules and regulations, including those surrounding coal combustion residuals, GHG, effluent limitation guidelines and MATS. See "Financial Condition - Environmental Matters" below for additional information on these requirements. These more stringent environmental requirements, combined with low energy margins for competitive generation, have led several energy companies, including PPL Energy Supply, to announce plans to either temporarily or permanently close, or place in long-term reserve status, certain of their coal-fired generating plants.
In 2012, PPL Energy Supply announced its intention, beginning in April 2015, to place its Corette plant in long-term reserve status, suspending the plant's operation due to expected market conditions and the costs to comply with MATS. PPL Energy Supply continues to monitor its Corette plant for potential impairment. The Corette plant asset group's carrying value at June 30, 2013 was $68 million. See Note 10 to the Financial Statements for additional information. PPL Energy Supply believes its remaining competitive generation assets are well positioned to meet the additional environmental requirements based on prior and planned investments and does not currently anticipate the need to temporarily or permanently shut down additional coal-fired plants. PPL Energy Supply cannot predict the future impact that economic and market conditions and changes in regulatory requirements may have on its financial condition or results of operations.
Susquehanna Turbine Blade Inspection
In the spring of 2013, PPL Susquehanna made modifications to address the causes of turbine blade cracking at the PPL Susquehanna nuclear plant that was first identified in 2011. The modifications were made during the Unit 2 refueling outage and an additional planned outage for Unit 1. Additional modifications will be made during the planned outages in 2014 and 2015. Following completion of these modifications, PPL Susquehanna will continue monitoring the turbine blades using enhanced diagnostic equipment.
Colstrip Unit 4 Outage
On July 1, 2013, Colstrip Unit 4 tripped off line as a result of damage that occurred in the unit's generator. The cost to repair Unit 4 is estimated to be between $30 million to $40 million and is expected to take at least six months to complete. Property damage insurance for Unit 4 is subject to a $2.5 million self-insured retention. PPL Montana operates Unit 4 pursuant to an agreement with the owners and, pursuant to a separate agreement with NorthWestern, is entitled to receive 15% of Unit 4's
electricity output and is responsible for 15% of the capital, operating, maintenance and repair costs associated with Unit 4. PPL Montana's estimated pre-tax loss of earnings attributable to the Unit 4 outage is between $5 million and $10 million.
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 six months ended June 30, 2013 with the same periods in 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 June 30 was: | | | | | | | | | | | | | | | | | | Three Months | | Six Months | | | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | Net Income Attributable to PPL Energy Supply Member | | $ | 86 | | $ | 19 | | $ | 48 | | $ | 328 |
The changes in the components of Net Income 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 | | Six Months | | | | | | | | Unregulated Gross Energy Margins | | $ | (88) | | $ | (195) | Other operation and maintenance | | | 17 | | | 30 | Depreciation | | | (10) | | | (24) | Taxes, other than income | | | 3 | | | 4 | Other Income (Expense) - net | | | 7 | | | 8 | Interest Expense | | | (3) | | | (12) | Other | | | 4 | | | 2 | Income Taxes | | | 25 | | | 58 | Special items, after-tax | | | 112 | | | (151) | Total | | $ | 67 | | $ | (280) |
· | 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 for the three-month period primarily due to $11 million of lower 2013 project and refueling outage costs at PPL Susquehanna and $4 million of Brunner Island Unit 3 outage costs in 2012 with no comparable outage in 2013. |
Lower other operation and maintenance for the six-month period primarily due to $19 million of Brunner Island Unit 3 outage costs in 2012 with no comparable outage in 2013 and $17 million of lower 2013 project and refueling outage costs at PPL Susquehanna, partially offset by $5 million of Conemaugh Unit 2 outage costs in 2013 with no comparable outage in 2012.
· | Higher depreciation for the three and six-month periods primarily due to PP&E additions. The six-month period also includes $6 million attributable to the Ironwood Acquisition. |
· | Higher other income (expense) - net for the three and six-month periods partially due to the impact of a worker's compensation adjustment of $4 million. |
· | Higher interest expense for the six-month period primarily due to $6 million of lower capitalized interest in 2013 and $4 million due to financings associated with PPL Ironwood. |
· | Lower income taxes for the three and six-month periods due to lower pre-tax income in 2013, which reduced income taxes by $30 million and $77 million, partially offset for the six-month period 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 June 30.
| | | Income Statement | | Three Months | | Six Months | | | | Line Item | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | | | Adjusted energy-related economic activity, net, net of tax of ($51), $23, $28, ($79) | (a) | | $ | 76 | | $ | (32) | | $ | (41) | | $ | 118 | Impairments: | | | | | | | | | | | | | | | Adjustments - nuclear decommissioning trust investments, net of tax of $0, ($1), $0, ($2) | Other Income-net | | | | | | | | | | | | 1 | Other: | | | | | | | | | | | | | | | Change in tax accounting method related to repairs | Income Taxes | | | (3) | | | | | | (3) | | | | | | Other Operation | | | | | | | | | | | | | | Counterparty bankruptcy, net of tax of ($1), $0, ($1), $5 (b) | and Maintenance | | | 1 | | | | | | 1 | | | (6) | | Wholesale supply cost reimbursement, net of tax of $0, $0, $0, $0 | (c) | | | | | | 1 | | | | | | 1 | | | | Other Operation | | | | | | | | | | | | | | Ash basin leak remediation adjustment, net of tax of $0, $0, $0, ($1) | and Maintenance | | | | | | | | | | | | 1 | | Coal contract modification payments, net of tax of $0, $5, $0, $5 (d) | Fuel | | | | | | (7) | | | | | | (7) | Total | | | $ | 74 | | $ | (38) | | $ | (43) | | $ | 108 |
(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. In June 2013, PPL EnergyPlus received an approval for an administrative claim in the amount of $2 million. |
(c) | Recorded in "Wholesale energy marketing - Realized" on the Statement of Income. |
(d) | As a result of lower electricity and natural gas prices, coal-fired generation output decreased during 2012. 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 June 30, to the special item identified as "Adjusted energy-related economic activity, net."
| | | | Three Months | | Six Months | | | | | 2013 | | 2012 | | 2013 | | 2012 | Operating Revenues | | | | | | | | | | | | | | | Unregulated retail electric and gas | | $ | 20 | | $ | (12) | | $ | 12 | | $ | (2) | | | Wholesale energy marketing | | | 590 | | | (458) | | | (232) | | | 394 | Operating Expenses | | | | | | | | | | | | | | | Fuel | | | (4) | | | (16) | | | (5) | | | (14) | | | Energy Purchases | | | (479) | | | 442 | | | 155 | | | (149) | Energy-related economic activity (a) | | | 127 | | | (44) | | | (70) | | | 229 | Option premiums | | | | | | 1 | | | 1 | | | 1 | Adjusted energy-related economic activity | | | 127 | | | (43) | | | (69) | | | 230 | Less: Economic activity realized, associated with the monetization of | | | | | | | | | | | | | | certain full-requirement sales contracts in 2010 | | | | | | 12 | | | | | | 33 | Adjusted energy-related economic activity, net, pre-tax | | $ | 127 | | $ | (55) | | $ | (69) | | $ | 197 | | | | | | | | | | | | | | | | Adjusted energy-related economic activity, net, after-tax | | $ | 76 | | $ | (32) | | $ | (41) | | $ | 118 |
(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 depreciation and higher financing costs, partially offset by lower operation and maintenance expense, higher capacity prices and higher nuclear generation output.
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 realized economic activity realized associated with the monetization of certain full-requirement sales contracts in 2010. This economic activity iswas 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 reconcilestables reconcile "Unregulated Gross Energy Margins" as defined by PPL Energy Supply to "Operating Income" for the periods ended March 31.June 30.
| | | | 2013 Three Months | | 2012 Three Months | | | 2013 Three Months | | 2012 Three Months | | | | | Unregulated | | | | | | | Unregulated | | | | | | | | Unregulated | | | | | | | Unregulated | | | | | | | | | | Gross Energy | | | | | Operating | | Gross Energy | | | | | Operating | | | Gross Energy | | | | | Operating | | Gross Energy | | | | | 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 | | | | | | | | | | | | | | | Operating Revenues | | | | | | | | | | | | | | | | Wholesale energy marketing | | | | | | | | | | | | | | | Wholesale energy marketing | | | | | | | | | | | | | | | | | Realized | | $ | 977 | | $ | (1) | | | $ | 976 | | $ | 1,204 | | $ | 4 | (c) | | $ | 1,208 | | Realized | $ | 812 | | $ | (1) | | | $ | 811 | | $ | 1,075 | | $ | 8 | (c) | | $ | 1,083 | | | Unrealized economic activity | | | | (822) | (d) | | (822) | | | | 852 | (d) | | 852 | | Unrealized economic activity | | | | 590 | (d) | | 590 | | | | (458) | (d) | | (458) | | Wholesale energy marketing | | | | | | | | | | | | | | | Wholesale energy marketing | | | | | | | | | | | | | | | | | to affiliate | | 14 | | | | | 14 | | 21 | | | | | 21 | | to affiliate | | 12 | | | | | 12 | | 17 | | | | | 17 | | Unregulated retail electric and gas | | 246 | | (8) | (d) | | 238 | | 214 | | 10 | (d) | | 224 | Unregulated retail electric and gas | | 237 | | 20 | (d) | | 257 | | 192 | | (12) | (d) | | 180 | | Net energy trading margins | | (11) | | | | | (11) | | 8 | | | | | 8 | Net energy trading margins | | | | | | | | | 10 | | | | | 10 | | Energy-related businesses | | | | | | 113 | | | | 113 | | | | | | 96 | | | | 96 | Energy-related businesses | | | | | 122 | | | | 122 | | | | | | 112 | | | | 112 | | | Total Operating Revenues | | | 1,226 | | | (718) | | | | 508 | | | 1,447 | | | 962 | | | | 2,409 | | Total Operating Revenues | | 1,061 | | | 731 | | | | 1,792 | | | 1,294 | | | (350) | | | | 944 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | Operating Expenses | | | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | | | Fuel | | 299 | | (1) | (d) | | 298 | | 214 | | (3) | (d) | | 211 | Fuel | | 223 | | 1 | | | 224 | | 170 | | 26 | (e) | | 196 | | Energy purchases | | | | | | | | | | | | | | | Energy purchases | | | | | | | | | | | | | | | | | Realized | | 436 | | (2) | | | 434 | | 636 | | 23 | (c) | | 659 | | Realized | | 419 | | (1) | | | 418 | | 617 | | 18 | (c) | | 635 | | | Unrealized economic activity | | | | (634) | (d) | | (634) | | | | 591 | (d) | | 591 | | Unrealized economic activity | | | | 479 | (d) | | 479 | | | | (442) | (d) | | (442) | | Energy purchases from affiliate | | 1 | | | | | 1 | | 1 | | | | | 1 | Energy purchases from affiliate | | 1 | | | | | 1 | | | | | | | | | Other operation and maintenance | | 5 | | 230 | | | 235 | | 4 | | 251 | | | 255 | Other operation and maintenance | | 3 | | 267 | | | 270 | | 7 | | 287 | | | 294 | | Depreciation | | | | 78 | | | 78 | | | | 64 | | | 64 | Depreciation | | | | 79 | | | 79 | | | | 69 | | | 69 | | Taxes, other than income | | 8 | | 9 | | | 17 | | 8 | | 10 | | | 18 | Taxes, other than income | | 10 | | 6 | | | 16 | | 7 | | 10 | | | 17 | | Energy-related businesses | | | | | | 110 | | | | 110 | | | | | | 92 | | | | 92 | Energy-related businesses | | | | | 118 | | | | 118 | | | | | | 109 | | | | 109 | | | Total Operating Expenses | | | 749 | | | (210) | | | | 539 | | | 863 | | | 1,028 | | | | 1,891 | | Total Operating Expenses | | 656 | | 949 | | | 1,605 | | 801 | | 77 | | | 878 | Total | Total | | $ | 477 | | $ | (508) | | | $ | (31) | | $ | 584 | | $ | (66) | | | $ | 518 | Total | $ | 405 | | $ | (218) | | | $ | 187 | | $ | 493 | | $ | (427) | | | $ | 66 |
| | | | | | 2013 Six Months | | 2012 Six 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 | | $ | 1,789 | | $ | (2) | | | $ | 1,787 | | $ | 2,279 | | $ | 12 | (c) | | $ | 2,291 | | | | | Unrealized economic activity | | | | | | (232) | (d) | | | (232) | | | | | | 394 | (d) | | | 394 | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | | to affiliate | | | 26 | | | | | | | 26 | | | 38 | | | | | | | 38 | | Unregulated retail electric and gas | | | 483 | | | 12 | (d) | | | 495 | | | 406 | | | (2) | (d) | | | 404 | | Net energy trading margins | | | (11) | | | | | | | (11) | | | 18 | | | | | | | 18 | | Energy-related businesses | | | | | | 235 | | | | 235 | | | | | | 208 | | | | 208 | | | | Total Operating Revenues | | | 2,287 | | | 13 | | | | 2,300 | | | 2,741 | | | 612 | | | | 3,353 | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | | | | | | | | | Fuel | | | 522 | | | | | | | 522 | | | 385 | | | 22 | (e) | | | 407 | | Energy purchases | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | | 855 | | | (3) | | | | 852 | | | 1,251 | | | 43 | (c) | | | 1,294 | | | | | Unrealized economic activity | | | | | | (155) | (d) | | | (155) | | | | | | 149 | (d) | | | 149 | | Energy purchases from affiliate | | | 2 | | | | | | | 2 | | | 1 | | | | | | | 1 | | Other operation and maintenance | | | 8 | | | 497 | | | | 505 | | | 11 | | | 538 | | | | 549 | | Depreciation | | | | | | 157 | | | | 157 | | | | | | 133 | | | | 133 | | Taxes, other than income | | | 18 | | | 15 | | | | 33 | | | 16 | | | 19 | | | | 35 | | Energy-related businesses | | | | | | 228 | | | | 228 | | | | | | 201 | | | | 201 | | | | Total Operating Expenses | | | 1,405 | | | 739 | | | | 2,144 | | | 1,664 | | | 1,105 | | | | 2,769 | Total | | $ | 882 | | $ | (726) | | | $ | 156 | | $ | 1,077 | | $ | (493) | | | $ | 584 |
(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 six months ended March 31,June 30, 2012, "Wholesale energy marketing - Realized" and "Energy purchases - Realized" includes ainclude net pre-tax losslosses of $21$12 million and $33 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. |
(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 six months ended June 30, 2012 include a pre-tax loss of $12 million related to coal contract modification payments. |
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,June 30, as well as the change between periods. The factors that gave rise to the changes are described below the table.
| | | | | Three Months | | | Three Months | | Six Months | | | | | | | | | | 2013 | | 2012 | | Change | | | 2013 | | 2012 | | Change | | 2013 | | 2012 | | Change | | | | | | | | | | | | | | | | | | | | | | | | | | | | Non-trading | Non-trading | | | | | | | | | | | | | Non-trading | | | | | | | | | | | | | | Eastern U.S. | | | | | | | | $ | 430 | | $ | 489 | | $ | (59) | Eastern U.S. | | $ | 349 | | $ | 407 | | $ | (58) | | $ | 779 | | $ | 896 | | $ | (117) | | Western U.S. | | | | | | | | 58 | | 87 | | (29) | Western U.S. | | 56 | | 76 | | (20) | | 114 | | 163 | | (49) | Net energy trading | Net energy trading | | | | | | | | | (11) | | | 8 | | | (19) | Net energy trading | | | | | | 10 | | | (10) | | | (11) | | | 18 | | | (29) | Total | Total | | | | | | | | $ | 477 | | $ | 584 | | $ | (107) | Total | | $ | 405 | | $ | 493 | | $ | (88) | | $ | 882 | | $ | 1,077 | | $ | (195) |
Unregulated Gross Energy Margins
Unregulated Gross Energy Margins | | | | | | | | | | | | | | Eastern U.S. | | | | | | | | | | | | | | The changeincrease (decrease) in non-trading margins for the periodperiods ended March 31,June 30, 2013 compared with 2012 waswere 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) |
| | Three Months | | Six Months | | | | | | | | Baseload energy prices | | $ | (121) | | $ | (246) | Nuclear fuel prices | | | (4) | | | (10) | Coal prices | | | 1 | | | (9) | Intermediate and peaking Spark Spreads | | | (7) | | | 7 | Nuclear generation volume | | | 9 | | | 9 | Full-requirement sales contracts | | | 5 | | | 10 | Gas optimization and storage | | | 10 | | | 11 | Ironwood Acquisition which eliminated tolling expense | | | 2 | | | 17 | Net economic availability of coal and hydroelectric plants | | | 7 | | | 39 | Capacity prices | | | 36 | | | 47 | Other | | | 4 | | | 8 | Total | | $ | (58) | | $ | (117) |
Western U.S.
Non-trading margins for the three and six months ended March 31,June 30, 2013 compared with the same periods in 2012 were lower due to $43$20 million and $59 million of lower wholesale prices,prices. The six-month period was partially offset by $12$7 million of higher wholesale volumes.
Net Energy Trading Margins
Net energy trading margins for the three months ended March 31,June 30, 2013 compared with the same period in 2012 decreased as a result of lower margins of $16$5 million on power positions and $3 million on FTRs.
Net energy trading margins for the six months ended June 30, 2013 compared with the same period in 2012 decreased as a result of lower margins of $15 million on gas positions due to higher prices.and $7 million on power positions.
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) |
Other Operation and Maintenance | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | Three Months | | Six Months | | | | | | | | Brunner Island Unit 3 outage in 2012 | $ | (4) | | $ | (19) | Uncollectible accounts (a) | | (4) | | | (15) | PPL Susquehanna projects | | (6) | | | (9) | PPL Susquehanna refueling outage | | (5) | | | (8) | Conemaugh Unit 2 outage in 2013 | | 3 | | | 5 | Other generation plant costs | | (7) | | | (1) | Other | | (1) | | | 3 | Total | $ | (24) | | $ | (44) |
(a) | The decrease for the six-month period 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$10 million and $24 million for the three and six months ended March 31,June 30, 2013 compared with 2012, primarily due to $10 million and $20 million related to PP&E additions, and $6 million attributable to the Ironwood Acquisition.Acquisition for the six-month period.
Other Income (Expense) - net
For the three and six months ended June 30, 2013 compared with 2012, other income (expense) - net increased by $6 million and $5 million, primarily due to the impact of a $4 million worker's compensation adjustment.
See Note 12 to the Financial Statements for additional information on other income (expense) - net.
Interest Expense | | | | | | | | | | | | | | | The increase (decrease) in interest expense for the periodperiods ended March 31,June 30, 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. |
| | Three Months | | Six Months | | | | | | | | | Ironwood Acquisition financing | | | | | $ | 4 | Capitalized interest | | $ | 3 | | | 6 | Other | | | | | | 2 | Total | | $ | 3 | | $ | 12 |
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) |
Income Taxes | | | | | | | | | | | | | | The increase (decrease) in income taxes for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | | | | | | | Three Months | | Six Months | | | | | | | | Higher (lower) pre-tax income | | $ | 53 | | $ | (172) | Federal and state tax reserve adjustments (a) | | | 7 | | | 6 | State deferred tax rate change (b) | | | | | | 11 | Other | | | (2) | | | 1 | Total | | $ | 58 | | $ | (154) |
(a) | During the three and six months ended March 31,June 30, 2013, PPL Energy Supply reversed $3 million tax benefit related to a 2008 change in method of accounting for certain expenditures for tax purposes and recorded $4 million in federal tax reserves related to differences in over (under) payment interest rates applied to audit claims as a result of the U.S. Supreme Court decision related to the Windfall Profits tax. |
(b) | During the six months ended June 30, 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 | | June 30, 2013 | | December 31, 2012 | | | | | | | | | | Cash and cash equivalents | | $ | 147 | | $ | 413 | | $ | 265 | | $ | 413 | Short-term debt | | $ | 481 | | $ | 356 | | $ | 575 | | $ | 356 |
The $266$148 million decrease in PPL Energy Supply's cash and cash equivalents position was primarily the net result of:
· | distributions to memberMember of $313$408 million; |
· | capital expenditures of $124 million; |
· | a net increase in restricted cash and cash equivalents of $59$241 million; |
· | net cash provided by operating activities of $125$227 million; |
· | contributions from Member of $105 million; and |
· | a netan increase in short-term debt of $125$219 million. |
PPL Energy Supply's cash provided by operating activities decreased by $129$81 million for the threesix months ended March 31,June 30, 2013, compared with 2012. This was primarilypartially due to a $45$37 million increase in defined benefit plans funding and an $11 million increase in cash used by components of working capital components,(primarily due to changes in counterparty collateral of $118 million, partially offset by changes in fuel, materials and supplies of $79 million). In addition, a decrease in net income when adjusted for non-cash componentschange of $31 million and a $36 million increase in defined benefit plans funding.other operating activities contributed to the decrease, partially due to changes in certain tax-related accounts. Credit Facilities
PPL Energy Supply maintains credit facilities to provide liquidity and to backstop commercial paper issuances. At March 31,June 30, 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 |
| | | | | | | | | Letters of | | | | | | | | | | | | | Credit Issued | | | | | | | | | | | and | | | | | | Committed | | | | Commercial | | Unused | | | | Capacity | | Borrowed | | Paper Backup | | Capacity | | | | | | | | | | | | | | | PPL Energy Supply Credit Facilities (a) | | $ | 3,150 | | | | | $ | 785 | | $ | 2,365 |
(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%9% 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 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,June 30, 2013 and December 31, 2012, PPL Energy Supply had $481$575 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%0.29% and 0.50%.
Rating Agency Actions
Fitch, Moody's and 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 Fitch, Moody's and 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 aton PPL Montana.Montana's pass-through trust certificates due 2020.
In July 2013, Moody's withdrew its rating and outlook for PPL Ironwood.
In July 2013, S&P lowered its rating, from BBB- to BB+, and retained the negative outlook for PPL Montana's pass-through trust certificates due 2020.
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,June 30, 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 periodperiods ended March 31.June 30. See Notes 13 and 14 to the Financial Statements for additional information.
| | | | | | Gains (Losses) | | Gains (Losses) | | | | | Three Months | | Three Months | | Six Months | | | | | | | 2013 | | 2012 | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | | | | | $ | 473 | | $ | 1,082 | | $ | 229 | | $ | 1,215 | | $ | 473 | | $ | 1,082 | Contracts realized or otherwise settled during the period | | | | | | (137) | | (279) | | (100) | | (261) | | (237) | | (540) | Fair value of new contracts entered into during the period (a) | | | | | | 9 | | (1) | | 37 | | 13 | | 46 | | 12 | Other changes in fair value | | | | | | | (116) | | | 413 | | | 119 | | | (6) | | | 3 | | | 407 | Fair value of contracts outstanding at the end of the period | | | | | | $ | 229 | | $ | 1,215 | | $ | 285 | | $ | 961 | | $ | 285 | | $ | 961 |
(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,June 30, 2013, based on the 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) | | $ | 238 | | $ | (21) | | $ | (8) | | $ | 6 | | $ | 215 | Prices based on significant observable inputs (Level 2) | | $ | 226 | | $ | 32 | | $ | (10) | | $ | 5 | | $ | 253 | Prices based on significant unobservable inputs (Level 3) | Prices based on significant unobservable inputs (Level 3) | | | (1) | | | 12 | | | 3 | | | | | | 14 | Prices based on significant unobservable inputs (Level 3) | | | 10 | | | 18 | | | 4 | | | | | | 32 | Fair value of contracts outstanding at the end of the period | Fair value of contracts outstanding at the end of the period | | $ | 237 | | $ | (9) | | $ | (5) | | $ | 6 | | $ | 229 | Fair value of contracts outstanding at the end of the period | | $ | 236 | | $ | 50 | | $ | (6) | | $ | 5 | | $ | 285 |
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 2017.2018. The following table sets forth changes in the net fair value of trading commodity derivative contracts for the periodperiods ended March 31.June 30. See Notes 13 and 14 to the Financial Statements for additional information.
| | | Gains (Losses) | | | | | Three Months | | Three Months | | Six Months | | | | | | | 2013 | | 2012 | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | | | | | $ | 29 | | $ | (4) | | $ | 15 | | $ | 2 | | $ | 29 | | $ | (4) | Contracts realized or otherwise settled during the period | | | | | | (2) | | | | | | (1) | | (2) | | (1) | Fair value of new contracts entered into during the period (a) | | | | | | | (12) | | | 6 | | (4) | | (1) | | (16) | | 5 | Other changes in fair value | | | | 7 | | | 17 | | | 7 | | | 17 | Fair value of contracts outstanding at the end of the period | | | | | | $ | 15 | | $ | 2 | | $ | 18 | | $ | 17 | | $ | 18 | | $ | 17 |
(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,June 30, 2013, based on the 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) | | | 5 | | $ | 9 | | | | | | | | | 14 | | $ | 4 | | $ | 6 | | | | | | | $ | 10 | Prices based on significant unobservable inputs (Level 3) | | | | 6 | | | 2 | | | | | | | | | 8 | Fair value of contracts outstanding at the end of the period | | $ | 6 | | $ | 9 | | | | | | | | $ | 15 | | $ | 10 | | $ | 8 | | | | | | | | $ | 18 |
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 periodssix months ended June 30, 2013 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 |
| | | | | | Non-Trading | | | | Trading VaR | | VaR | 95% Confidence Level, Five-Day Holding Period | | | | | | | | Period End | | $ | 2 | | $ | 8 | | Average for the Period | | | 4 | | | 9 | | High | | | 6 | | | 10 | | Low | | | 2 | | | 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,June 30, 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,June 30, 2013.
At March 31,June 30, 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,June 30, 2013 would increase the fair value of its debt portfolio by $47$50 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,June 30, 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,June 30, 2013, a hypothetical 10% increase in interest rates and a 10% decrease in equity prices would have resulted in an estimated $55$57 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 costcosts of compliance or alleged non-compliance cannot be predicted with certainty but could be material. In addition, costscost 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 offor their products or their demand for PPL Energy Supply's services. Physical effects associated with possible 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 hydrohydroelectric 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)non-hazardous waste) 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. On July 25, 2013, the U.S. House of Representatives passed House Bill H.R. 2218, the Coal Residuals and Reuse Management Act of 2013, which would preempt the EPA from regulating CCRs under RCRA and sets rules governing state programs. Prospects remain uncertain for similar legislation to pass in the U.S. Senate.
Effluent Limitation Guidelines (ELGs) On April 19,In June 2013, the EPA issuedpublished 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 handlingtransport water and metal cleaning wastes,waste waters, as well as new limits for scrubber wastewater gasification wastewater and landfill leachate. The EPA's proposed ELG regulations also contain some requirements that would affect the inspection and operation of CCR facilities, if finalized. 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 requiresrequiring 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 imposesimposing standards for reduction of mortality of aquatic organisms trapped on water intake screens (impingement). A final rule is expected to be issued in JuneNovember 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 June 2013, President Obama released his Climate Action Plan which reiterates the goal of reducing greenhouse gas emissions in the U.S. "in the range of" 17% below 2005 levels by 2020 through such actions as regulating power plant emissions, promoting increased use of renewables and clean energy technology, and establishing tighter energy efficiency standards. Also, by Presidential Memorandum the EPA is expectedwas directed to finalize limits on GHG emissions fromissue a new proposal for new power plants by September 20, 2013, with a final rule to be issued in a timely fashion thereafter, and to begin working on a proposalissue proposed standards 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 theby June 1, 2014 with a final rule by June 1, 2015. The EPA was further directed to require that states develop implementation plans for existing plants by June 2016. Regulation of existing plants could have a significant industry-wide impact could be significant, depending on the structure and stringency of the final rule. PPL Energy Supply, alongrule and the state implementation plans. The Administration's recent increase in its estimate of the "social cost of carbon" (which is used to calculate benefits associated with othersproposed regulations) from $23.80 to $38 per metric ton in the industry, filed comments on the EPA's proposal related2015 may lead to GHG emissions from new plants.more costly regulatory requirements.
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.
CSAPRRegional Haze
Under the EPA's regional haze programs (developed to eliminate man-made visibility degradation by 2064), states are required to make reasonable progress every decade, including the application of Best Available Retrofit Technology (BART) on power plants commissioned between 1962 and CAIR In 2011,1977. For the eastern U.S. 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,had determined that region-wide reductions under the CAIR or CSAPR targeted sources intrading program could be utilized by states programs to satisfy BART requirements. However, the eastern United States. In December 2011,August 2012 decision by the U.S. Court of Appeals for the District of Columbia.Columbia Circuit (the(Circuit 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
vacate and remand CSAPR will likely expose power plants located in the eastern U.S., including PPL Energy Supply's 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 plantsreductions 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 EPAsulfur dioxide and nitrogen oxides as required 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.BART.
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).
CSAPR and CAIR In 2011, the EPA finalized its CSAPR regulating emissions of nitrogen 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 U.S. In December 2011, the Circuit Court stayed implementation of CSAPR, leaving CAIR in place. Subsequently, in August 2012, the Circuit Court vacated and remanded CSAPR back to the EPA for further rulemaking, again leaving CAIR in place in the interim, and on June 24, 2013 the U.S. Supreme Court granted the EPA's petition for review of the Circuit Court's decision.
PPL Energy Supply plants in Pennsylvania will continue to comply with CAIR through optimization of existing controls, balanced with emission allowance purchases. The Circuit Court's August 2012 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.
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 ofadditional information on 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 and six months ended March 31,June 30, 2013 with the same periods in 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,programs, 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. The recently approved DSIC mechanism will help reduce regulatory lag on distribution reliability-related capital investment. See "Legislation"Financial and Operational Developments - Regulatory Procedures and Mechanisms"Distribution System Improvement Charge" 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 PPLPennsylvania Gross Delivery Margins
Net Income Available to PPLDistribution
Margins increased for the three months ended June 30, 2013 compared with 2012, primarily due to an $11 million favorable effect of price as a result of higher base rates, effective January 1, 2013.
Margins increased for the six months ended June 30, 2013 compared with 2012, primarily due to a $13 million adverse effect of mild weather in 2012 and a $32 million favorable effect of price, largely comprised of higher base rates, effective January 1, 2013, and higher volumes of $4 million.
Transmission
Margins increased for the three and six months ended June 30, 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 increase (decrease) in non-trading margins for the periods ended June 30, 2013 compared with 2012 were due to: | | | | | | | | | | Three Months | | Six Months | | | | | | | | Baseload energy prices | | $ | (121) | | $ | (246) | Nuclear fuel prices | | | (4) | | | (10) | Coal prices | | | 1 | | | (9) | Intermediate and peaking Spark Spreads | | | (7) | | | 7 | Nuclear generation volume | | | 9 | | | 9 | Full-requirement sales contracts | | | 5 | | | 10 | Gas optimization and storage | | | 10 | | | 11 | Ironwood Acquisition which eliminated tolling expense | | | 2 | | | 17 | Net economic availability of coal and hydroelectric plants | | | 7 | | | 39 | Capacity prices | | | 36 | | | 47 | Other | | | 4 | | | 8 | Total | | $ | (58) | | $ | (117) |
Western U.S.
Non-trading margins for the three and six months ended June 30, 2013 compared with the same periods in 2012 were lower due to $20 million and $59 million of lower wholesale prices. The six-month period was partially offset by $7 million of higher wholesale volumes.
Net Energy Trading Margins
Net energy trading margins for the three months ended June 30, 2013 compared with the same period in 2012 decreased as a result of lower margins of $5 million on power positions and $3 million on FTRs.
Net energy trading margins for the six months ended June 30, 2013 compared with the same period in 2012 decreased as a result of lower margins of $15 million on gas positions and $7 million on power positions.
Utility Revenues | | | | | | | | | | | | | The increase (decrease) in utility revenues for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | | | | | | | | | | | Three Months | | Six Months | Domestic: | | | | | | | | PPL Electric (a) | | $ | 10 | | $ | 65 | | LKE (b) | | | 24 | | | 119 | | Total Domestic | | | 34 | | | 184 | | | | | | | | | | | U.K.: | | | | | | | | Price (c) | | | 50 | | | 113 | | Volume (d) | | | 23 | | | 28 | | DPCR4 accrual adjustments (e) | | | (24) | | | (24) | | Foreign currency exchange rates | | | (26) | | | (16) | | Other (f) | | | (7) | | | 1 | | Total U.K. | | | 16 | | | 102 | Total | | $ | 50 | | $ | 286 |
(a) | See "Pennsylvania Gross Delivery Margins" for further information. |
(b) | See "Kentucky Gross Margins" for further information. |
(c) | The increase for the three and six-month periods is primarily due to price increases effective April 1, 2013 and April 1, 2012. |
(d) | The increase for the three and six-month periods is primarily due to the favorable effect of weather. |
(e) | The decrease for the three and six-month periods is due to a $24 million reduction in revenue based on information provided by Ofgem regarding the calculation of line loss incentive/penalty for all network operators related to DPCR4. See Note 6 to the Financial Statements for additional information. |
(f) | The decrease for the three month period is primarily related to a $6 million reduction in third-party engineering revenue, which is partially offset by a reduction in costs in "Other operation and maintenance" on the Statements of Income. |
Other Operation and Maintenance | | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance for the periods ended June 30, 2013 compared with 2012 was due to: |
| | | Three Months | | Six Months | Domestic: | | | | | | | Uncollectible accounts (a) | $ | (4) | | $ | (20) | | LKE coal plant outages (b) | | (4) | | | (17) | | Brunner Island Unit 3 outage in 2012 | | (4) | | | (19) | | PPL Susquehanna projects | | (6) | | | (9) | | PPL Susquehanna refueling outage | | (5) | | | (8) | | Act 129 (c) | | (7) | | | (7) | | Conemaugh Unit 2 outage in 2013 | | 3 | | | 5 | | Other generation plant costs | | (7) | | | (1) | | Other | | (7) | | | 1 | U.K.: | | | | | | | Third-party engineering (d) | | (3) | | | 2 | | Network maintenance (e) | | 6 | | | 13 | | Insurance claim provision release | | 6 | | | 6 | | Severance compensation (f) | | (4) | | | (8) | | Pension | | (2) | | | (4) | | Foreign currency exchange rates | | (5) | | | (3) | | Other | | 2 | | | (2) | Total | $ | (41) | | $ | (71) |
(a) | The decrease for the six-month period 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 for the three and six month periods is due to the timing and scope of scheduled outages. |
(c) | The decrease for the three and six month periods is due to a reduction in Act 129 energy efficiency and conservation plan costs for Phase 1 programs. Phase 1 ended May 31, 2013. |
(d) | These costs are offset by revenues reflected in "Utility" on the Statement of Income. |
(e) | The increase for the three and six month periods is primarily due to higher vegetation management costs. |
(f) | The decrease for the three and six month periods is primarily due to costs incurred in 2012 related to the WPD Midlands reorganization. |
Depreciation | | | | | | | | | | | The increase (decrease) in depreciation for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | | | | | Three Months | | Six Months | | | | | | | | | Additions to PP&E | | $ | 23 | | $ | 44 | LKE lower depreciation rates effective January 1, 2013 | | | (6) | | | (11) | Ironwood Acquisition | | | | | | 6 | Other | | | (2) | | | (4) | Total | | $ | 15 | | $ | 35 |
Other Income (Expense) - net
The $17 million decrease in other income (expense) - net for the three months ended June 30, 2013 compared with 2012 was primarily due to a decrease of $21 million from realized and unrealized gains on foreign currency contracts.
The $122 million increase in other income (expense) - net for the six months ended June 30, 2013 compared with 2012 was primarily due to an increase of $116 million from realized and unrealized gains on foreign currency contracts.
See Note 12 to the Financial Statements for additional information on other income (expense) - net. Interest Expense | | | | | | | | | | | | The increase (decrease) in interest expense for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | | Three Months | | Six Months | | | | | | | | | Long-term debt interest expense (a) | | $ | 8 | | $ | 22 | Loss on extinguishment of debt (b) | | | 10 | | | 10 | Ironwood Acquisition financing | | | | | | 4 | Capitalized interest | | | 3 | | | 4 | Other | | | 1 | | | 3 | Total | | $ | 22 | | $ | 43 |
(a) | The increase for the three-month period was primarily due to PPL Capital Funding's debt issuances in March 2013, June 2012 and October 2012. See Note 7 to the Financial Statements in this Form 10-Q and in PPL's 2012 Form 10-K for additional information. |
| The increase for the six-month period was primarily due to PPL Capital Funding's debt issuances as discussed above as well as higher accretion expense on WPD index linked notes and interest on WPD (East Midlands') April 2012 issuance of £100 million, 5.25% Senior Notes due 2023. |
(b) | In May 2013, PPL Capital Funding remarketed and exchanged junior subordinated notes that were originally issued in June 2010 as a component of PPL's 2010 Equity Units. See Note 7 to the Financial Statements for additional information. |
Income Taxes | | | | | | | | | | | The increase (decrease) in income taxes for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | Three Months | | Six Months | | | | | | | | | Higher (lower) pre-tax income | | $ | 52 | | $ | (67) | Federal and state tax reserve adjustments (a) | | | (35) | | | (35) | U.S. income tax on foreign earnings net of foreign tax credit (b) | | | (6) | | | (6) | Foreign tax reserve adjustments (c) | | | 8 | | | 5 | Foreign tax return adjustments | | | (4) | | | (4) | Net operating loss carryforward adjustments (d) | | | 3 | | | 9 | State deferred tax rate change (e) | | | | | | 11 | Other | | | 3 | | | | Total | | $ | 21 | | $ | (87) |
(a) | In May 2013, the U.S. Supreme Court reversed the December 2011 ruling of the U.S. Court of Appeals for the Third Circuit on the creditability of U.K. Windfall Profits Tax for tax purposes. As a result of this decision, PPL recorded a tax benefit of $44 million during the three and six months ended June 30, 2013. See Note 5 to the Financial Statements for additional information. |
(b) | During the three and six months ended June 30, 2013, PPL recorded a $14 million increase to income tax expense primarily attributable to a revision in the expected taxable amount of cash repatriation in 2013 and recorded a tax benefit of $19 million associated with a ruling obtained from the IRS impacting the recalculation of 2010 U.K. earnings and profits that will be reflected on an amended 2010 U.S. tax return. |
(c) | During the three and six months ended June 30, 2012, PPL recorded a tax benefit following resolution of a U.K. tax issue related to the tax deductibility of interest expense. |
(d) | During the three and six months ended June 30, 2012, PPL recorded adjustments to deferred taxes related to net operating loss carryforwards of LKE based on income tax return adjustments. |
(e) | During the six months ended June 30, 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: | | | | | | | | | | June 30, 2013 | | December 31, 2012 | | | | | | | | Cash and cash equivalents | | $ | 711 | | $ | 901 | Short-term debt | | $ | 1,206 | | $ | 652 |
At June 30, 2013, $178 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. income taxes, net of allowable foreign income 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 $190 million decrease in PPL's cash and cash equivalents position was primarily the net result of:
· | capital expenditures of $1.8 billion; |
· | the payment of $426 million of common stock dividends; |
· | net cash provided by operating activities of $947 million; |
· | net increase in short-term debt of $563 million; and |
· | proceeds of $450 million from the issuance of long-term debt. |
PPL's cash provided by operating activities had no net change for the six months ended June 30, 2013 compared with 2012. The result was the net effect of:
· | a $219 million increase in net income, when adjusted for non-cash components; and |
· | a $25 million decrease in defined benefit plan funding, offset by |
· | a $245 million increase in cash used by components of working capital (primarily due to changes in accounts receivable of $210 million and in counterparty collateral of $118 million, partially offset by a $95 million change in fuel, materials and supplies). |
Capital expenditures increased by $488 million for the six months ended June 30, 2013 compared with 2012, primarily due to PPL Electric's Susquehanna-Roseland transmission project and projects to enhance system reliability, and LKE's environmental projects at Mill Creek and Ghent and construction of Cane Run Unit 7.
PPL maintains credit facilities to provide liquidity and to backstop commercial paper issuances. At June 30, 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 | | $ | 3,150 | | | | | $ | 785 | | $ | 2,365 | PPL Electric Credit Facilities | | | 400 | | | | | | 86 | | | 314 | LG&E Syndicated Credit Facility | | | 500 | | | | | | 80 | | | 420 | KU Credit Facilities | | | 598 | | | | | | 370 | | | 228 | | Total Domestic Credit Facilities (a) | | $ | 4,648 | | | | | $ | 1,321 | | $ | 3,327 | | | | | | | | | | | | | | | Total WPD Credit Facilities (b) | | £ | 1,055 | | £ | 193 | | | | | £ | 862 |
(a) | 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 8% of the total committed capacity. |
(b) | At June 30, 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 June 30, 2013 and December 31, 2012, PPL Energy Supply had $575 million and $356 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.29% 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 June 30, 2013, PPL Electric had $85 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheet, at a weighted-average interest rate of 0.34%. 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 June 30, 2013 and December 31, 2012, LG&E had $80 million and $55 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.32% and 0.42%. At June 30, 2013 and December 31, 2012, KU had $172 million and $70 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.33% and 0.42%.
Long-term Debt and Equity Securities
See "Overview - Financial and Operational Developments" above for information regarding equity forward agreements and the 2010 Equity Units. PPL has no plans to issue new shares of common stock for the remainder of 2013.
In March 31,2013, 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 was loaned to or invested in affiliates of PPL Capital Funding and used to fund their capital expenditures and other general corporate purposes.
In July 2013, PPL Electric issued $350 million of 4.75% First Mortgage Bonds due 2043. PPL Electric received proceeds of $345 million, net of a discount and underwriting fees, which will be used for capital expenditures, to fund pension obligations and for other general corporate purposes.
See Note 7 to the Financial Statements for further discussion of Long-term Debt and Equity Securities.
Common Stock Dividends
In May 2013, PPL declared its quarterly common stock dividend, payable July 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
Fitch, Moody's and S&P 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 Fitch, Moody's and S&P 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, Fitch, Moody's and S&P 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 on PPL Montana's pass-through trust certificates due 2020.
In May 2013, Fitch, Moody's and S&P assigned ratings of BBB, Baa3 and BBB- to PPL Capital Funding's $250 million 1.90% Senior Notes due 2018, $600 million 3.40% Senior Notes due 2023 and $300 million 4.70% Senior Notes due 2043. Fitch also assigned a stable outlook to these notes.
In July 2013, Fitch, Moody's and S&P assigned ratings of A-, A3 and A- to PPL Electric's $350 million 4.75% First Mortgage Bonds due 2043. Fitch also assigned a stable outlook to these notes and S&P assigned a recovery rating of 1+.
In July 2013, S&P confirmed the AA+ ratings for KU's 2000 Series A Solid Waste Disposal Facility Revenue Bonds and KU's 2004 Series A, 2006 Series B and 2008 Series A Environmental Facilities Revenue Bonds. S&P also confirmed the A-1+ short term rating on these Bonds.
In July 2013, Moody's withdrew its rating and outlook for PPL Ironwood.
In July 2013, S&P lowered its rating, from BBB- to BB+, and retained the negative outlook for PPL Montana's pass-through trust certificates due 2020.
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 June 30, 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 June 30. See Notes 13 and 14 to the Financial Statements for additional information.
| | Gains (Losses) | | | Three Months | | Six Months | | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | $ | 229 | | $ | 1,215 | | $ | 473 | | $ | 1,082 | Contracts realized or otherwise settled during the period | | | (100) | | | (261) | | | (237) | | | (540) | Fair value of new contracts entered into during the period (a) | | | 37 | | | 13 | | | 46 | | | 12 | Other changes in fair value | | | 119 | | | (6) | | | 3 | | | 407 | Fair value of contracts outstanding at the end of the period | | $ | 285 | | $ | 961 | | $ | 285 | | $ | 961 |
(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 June 30, 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) | | $ | 226 | | $ | 32 | | $ | (10) | | $ | 5 | | $ | 253 | Prices based on significant unobservable inputs (Level 3) | | | 10 | | | 18 | | | 4 | | | | | | 32 | Fair value of contracts outstanding at the end of the period | | $ | 236 | | $ | 50 | | $ | (6) | | $ | 5 | | $ | 285 |
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 2018. The following table sets forth changes in the net fair value of trading commodity derivative contracts for the periods ended June 30. See Notes 13 and 14 to the Financial Statements for additional information.
| | Gains (Losses) | | | Three Months | | Six Months | | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | $ | 15 | | $ | 2 | | $ | 29 | | $ | (4) | Contracts realized or otherwise settled during the period | | | | | | (1) | | | (2) | | | (1) | Fair value of new contracts entered into during the period (a) | | | (4) | | | (1) | | | (16) | | | 5 | Other changes in fair value | | | 7 | | | 17 | | | 7 | | | 17 | Fair value of contracts outstanding at the end of the period | | $ | 18 | | $ | 17 | | $ | 18 | | $ | 17 |
(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 June 30, 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) | | $ | 4 | | $ | 6 | | | | | | | | $ | 10 | Prices based on significant unobservable inputs (Level 3) | | | 6 | | | 2 | | | | | | | | | 8 | Fair value of contracts outstanding at the end of the period | | $ | 10 | | $ | 8 | | | | | | | | $ | 18 |
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 six months ended June 30, 2013 was $64as follows.
| | | | | | Non-Trading | | | | Trading VaR | | VaR | 95% Confidence Level, Five-Day Holding Period | | | | | | | | Period End | | $ | 2 | | $ | 8 | | Average for the Period | | | 4 | | | 9 | | High | | | 6 | | | 10 | | Low | | | 2 | | | 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 June 30, 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 June 30, 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 June 30, 2013 would increase the fair value of its debt portfolio by $631 million.
At June 30, 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) | | $ | 1,930 | | $ | 129 | | $ | (74) | | Cross-currency swaps (d) | | | 1,262 | | | 61 | | | (171) | Economic activity | | | | | | | | | | | Interest rate swaps (e) | | | 179 | | | (44) | | | (4) |
(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 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 June 30, 2013 mature through 2044. |
(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 June 30, 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 June 30, 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 June 30, 2013, PPL had the following foreign currency hedges outstanding:
| | | | | | | Effect of a | | | | | | | | 10% | | | | | | | | Adverse | | | | | | | | Movement | | | | | | | | in Foreign | | | | | | Fair Value, | | Currency | | | | Exposure | | Net - Asset | | Exchange | | | | Hedged | | (Liability) | | Rates (a) | | | | | | | | | | | | Net investment hedges (b) | | £ | 166 | | $ | 11 | | $ | (25) | Economic activity (c) | | | 1,185 | | | 71 | | | (171) |
(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 June 30, 2013 mature through 2014. Excludes the amount of intercompany loans classified as net investment hedges. 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 June 30, 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 June 30, 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 June 30, 2013, a hypothetical 10% increase in interest rates and a 10% decrease in equity prices would have resulted in an estimated $57 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 $269 million for the six months ended June 30, 2013, which primarily reflected a $714 million reduction to PP&E and goodwill offset by a reduction of $445 million to net liabilities. Changes in this exchange rate resulted in a foreign currency translation loss of $104 million for the six months ended June 30, 2012, which primarily reflected a $259 million reduction to PP&E and goodwill offset by a reduction of $155 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 possible 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 hydroelectric 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 waste) 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. On July 25, 2013, the U.S. House of Representatives passed House Bill H.R. 2218, the Coal Residuals and Reuse Management Act of 2013, which would preempt the EPA from regulating CCRs under RCRA and sets rules governing state programs. Prospects remain uncertain for similar legislation to pass in the U.S. Senate.
Effluent Limitation Guidelines (ELGs) In June 2013, the EPA published 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 transport water and metal cleaning waste waters, as well as new limits for scrubber wastewater and landfill leachate. The EPA's proposed ELG regulations also contain some requirements that would affect the inspection and operation of CCR facilities, if finalized. 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: requiring installation of Best Technology Available (BTA) to reduce mortality of aquatic organisms that are pulled into the plant cooling water system (entrainment); and imposing standards for reduction of mortality of aquatic organisms trapped on water intake screens (impingement). A final rule is expected to be issued in November 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 June 2013, President Obama released his Climate Action Plan which reiterates the goal of reducing greenhouse gas emissions in the U.S. "in the range of" 17% below 2005 levels by 2020 through such actions as regulating power plant emissions, promoting increased use of renewables and clean energy technology, and establishing tighter energy efficiency standards. Also, by Presidential Memorandum the EPA was directed to issue a new proposal for new power plants by September 20, 2013, with a final rule to be issued in a timely fashion thereafter, and to issue proposed standards for existing power plants by June 1, 2014 with a final rule by June 1, 2015. The EPA was further directed to require that states develop implementation plans for existing plants by June 2016. Regulation of existing plants could have a significant industry-wide impact depending on the structure and stringency of the final rule and state implementation plans. The Administration's recent increase in its estimate of the "social cost of carbon" (which is used to calculate benefits associated with proposed regulations) from $23.80 to $38 per metric ton in 2015 may lead to more costly regulatory requirements. Additionally, the Climate Action Plan requirements related to preparing the U.S. for the impacts of climate change could affect PPL and others in the industry as transmission system modifications to improve the ability to withstand major storms may be needed in order to meet those requirements.
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.
Regional Haze Under the EPA's regional haze programs (developed to eliminate man-made visibility degradation by 2064), states are required to make reasonable progress every decade, including the application of Best Available Retrofit Technology (BART) on power plants commissioned between 1962 and 1977. For the eastern U.S., the EPA had determined that region-wide reductions under the CAIR or CSAPR trading program could be utilized by state programs to satisfy BART requirements. However, the August 2012 decision by the U.S. Court of Appeals for the District of Columbia Circuit (Circuit Court) to vacate and remand CSAPR exposes power plants located in the eastern U.S., including PPL's plants in Pennsylvania and Kentucky, to reductions in sulfur dioxide and nitrogen oxides as required by BART.
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).
CSAPR and CAIR In 2011, the EPA finalized its CSAPR regulating emissions of nitrogen 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 U.S. In December 2011, the Circuit Court stayed implementation of CSAPR, leaving CAIR in place. Subsequently, in August 2012, the Circuit Court vacated and remanded CSAPR back to the EPA for further rulemaking, again leaving CAIR in place in the interim, and on June 24, 2013 the U.S. Supreme Court granted the EPA's petition for review of the Circuit Court's decision.
PPL plants in Pennsylvania and Kentucky will continue to comply with CAIR through optimization of existing controls, balanced with emission allowance purchases. The Circuit Court's August 2012 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.
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 additional information on 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 and six months ended June 30, 2013 with the same periods in 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.
The capacity (summer rating) of PPL Energy Supply's competitive electricity generation facilities at June 30, 2013 was:
| | | Ownership or | | | | | Lease Interest | | Primary Fuel | | in MW (a) | | | | | | | Coal (b) (c) | | 4,146 | | Natural Gas/Oil | | 3,316 | | Nuclear (c) | | 2,275 | | Hydro | | 807 | | Other (d) | | 70 | | | | | | | Total | | 10,614 | |
(a) | The capacity of generation units is based on a number of factors, including the operating experience and physical conditions of the units, and may be revised periodically to reflect changed circumstances. See "Item 2. Properties" in PPL Energy Supply's 2012 Form 10-K for additional information on ownership percentages. |
(b) | Includes a leasehold interest held by PPL Montana. See Note 11 to the Financial Statements in PPL Energy Supply's 2012 Form 10-K for additional information. |
(c) | Includes units that are jointly owned. Each owner is entitled to its proportionate share of the unit's total output and funds its proportionate share of fuel and other operating costs. See Note 14 to the Financial Statements in PPL Energy Supply's 2012 Form 10-K for additional information. |
(d) | Includes facilities owned, controlled or for which PPL Energy Supply has the rights to the output. |
Business Strategy
PPL Energy Supply's strategy is to achieve disciplined optimization of energy supply margins while mitigating near-term 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 managing profitability during the current and projected period of low commodity prices. See "Financial and Operational Developments - Economic and Market Conditions" below.
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 Attributable to PPL Energy Supply Member
Net Income Attributable to PPL Energy Supply Member for the three and six months ended June 30, 2013 was $86 million and $48 million compared to $33$19 million and $328 million for the same periods in 2012, representing a 94% increase.2012.
See "Results of Operations" below for further discussion and analysis of PPL Electric's earnings.the consolidated results of operations.
Rate Case ProceedingEconomic and Market Conditions
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 and additional renewable energy sources, primarily wind in the western U.S. Unregulated Gross Energy Margins associated with PPL Energy Supply's competitive generation and marketing business are impacted by changes in energy and capacity market prices and demand for electricity and natural gas, power plant availability, competition in the markets for retail customers, fuel costs and availability, transmission constraints that impact the locational pricing of electricity at PPL Energy Supply's power plants, fuel transportation costs and the level and price of hedging activities. As a result of these factors, lower energy margins are expected when compared to the 2012 energy margins. 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, its hedging strategies, and potential plant modifications to burn lower cost fuels.
As previously disclosed, PPL Energy Supply's businesses are subject to extensive federal, state and local environmental laws, rules and regulations, including those surrounding coal combustion residuals, GHG, effluent limitation guidelines and MATS. See "Financial Condition - Environmental Matters" below for additional information on these requirements. These more stringent environmental requirements, combined with low energy margins for competitive generation, have led several energy companies, including PPL Energy Supply, to announce plans to either temporarily or permanently close, or place in long-term reserve status, certain of their coal-fired generating plants.
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 filedEnergy Supply announced its LTIIP describing projects eligibleintention, beginning in April 2015, to place its Corette plant in long-term reserve status, suspending the plant's operation due to expected market conditions and the costs to comply with MATS. PPL Energy Supply continues to monitor its Corette plant for inclusion inpotential impairment. The Corette plant asset group's carrying value at June 30, 2013 was $68 million. See Note 10 to the DSIC.
The PUC approvedFinancial Statements for additional information. PPL Energy Supply believes its remaining competitive generation assets are well positioned to meet the LTIIPadditional environmental requirements based on January 10, 2013prior 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 Electricplanned investments and does not expect any new ratescurrently anticipate the need to be effective before the third quarter of 2013.temporarily or permanently shut down additional coal-fired plants.
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 ElectricEnergy Supply cannot predict the outcomefuture impact that economic and market conditions and changes in regulatory requirements may have on its financial condition or results of operations.
Susquehanna Turbine Blade Inspection
In the spring of 2013, PPL Susquehanna made modifications to address the causes of turbine blade cracking at the PPL Susquehanna nuclear plant that was first identified in 2011. The modifications were made during the Unit 2 refueling outage and an additional planned outage for Unit 1. Additional modifications will be made during the planned outages in 2014 and 2015. Following completion of these modifications, PPL Susquehanna will continue monitoring the turbine blades using enhanced diagnostic equipment.
Colstrip Unit 4 Outage
On July 1, 2013, Colstrip Unit 4 tripped off line as a result of damage that occurred in the unit's generator. The cost to repair Unit 4 is estimated to be between $30 million to $40 million and is expected to take at least six months to complete. Property damage insurance for Unit 4 is subject to a $2.5 million self-insured retention. PPL Montana operates Unit 4 pursuant to an agreement with the owners and, pursuant to a separate agreement with NorthWestern, is entitled to receive 15% of Unit 4's
electricity output and is responsible for 15% of the waiver or audit proceedings, which remain pending beforecapital, operating, maintenance and repair costs associated with Unit 4. PPL Montana's estimated pre-tax loss of earnings attributable to the FERC.Unit 4 outage is between $5 million and $10 million.
Results of Operations
The following discussion provides a summary of PPL Electric'sEnergy 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 PennsylvaniaUnregulated Gross DeliveryEnergy Margins by componentregion and principal line items on PPL Electric'sEnergy Supply's Statements of Income, comparing the three and six months ended March 31,June 30, 2013 with the same periods in 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 |
Earnings | | | | | | | | | | | | | | | Net Income Attributable to PPL Energy Supply Member for the periods ended June 30 was: | | | | | | | | | | | | | | | | | | Three Months | | Six Months | | | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | Net Income Attributable to PPL Energy Supply Member | | $ | 86 | | $ | 19 | | $ | 48 | | $ | 328 |
The changes in the components of Net Income AvailableAttributable to PPL Energy Supply Member between these periods were due to the following factors, which reflect reclassifications for items included in PennsylvaniaUnregulated Gross Delivery Margins.Energy Margins and certain items that management considers special. See additional detail of these special items in the tables below.
| | | | 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 |
| | Three Months | | Six Months | | | | | | | | Unregulated Gross Energy Margins | | $ | (88) | | $ | (195) | Other operation and maintenance | | | 17 | | | 30 | Depreciation | | | (10) | | | (24) | Taxes, other than income | | | 3 | | | 4 | Other Income (Expense) - net | | | 7 | | | 8 | Interest Expense | | | (3) | | | (12) | Other | | | 4 | | | 2 | Income Taxes | | | 25 | | | 58 | Special items, after-tax | | | 112 | | | (151) | Total | | $ | 67 | | $ | (280) |
· | 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 for the three-month period primarily due to $11 million of lower corporate service costs.2013 project and refueling outage costs at PPL Susquehanna and $4 million of Brunner Island Unit 3 outage costs in 2012 with no comparable outage in 2013. |
· Higher depreciationLower other operation and maintenance for the six-month period primarily due to PP&E additions.$19 million of Brunner Island Unit 3 outage costs in 2012 with no comparable outage in 2013 and $17 million of lower 2013 project and refueling outage costs at PPL Susquehanna, partially offset by $5 million of Conemaugh Unit 2 outage costs in 2013 with no comparable outage in 2012.
· | Higher depreciation for the three and six-month periods primarily due to PP&E additions. The six-month period also includes $6 million attributable to the Ironwood Acquisition. |
· | Higher other income taxes primarily(expense) - net for the three and six-month periods partially due to the impact of higher pre-tax income.a worker's compensation adjustment of $4 million. |
· | Higher interest expense for the six-month period primarily due to $6 million of lower capitalized interest in 2013 and $4 million due to financings associated with PPL Ironwood. |
· | Lower distributions on preference stockincome taxes for the three and six-month periods due to lower pre-tax income in 2013, which reduced income taxes by $30 million and $77 million, partially offset for the six-month period 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 June 30.
| | | Income Statement | | Three Months | | Six Months | | | | Line Item | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | | | Adjusted energy-related economic activity, net, net of tax of ($51), $23, $28, ($79) | (a) | | $ | 76 | | $ | (32) | | $ | (41) | | $ | 118 | Impairments: | | | | | | | | | | | | | | | Adjustments - nuclear decommissioning trust investments, net of tax of $0, ($1), $0, ($2) | Other Income-net | | | | | | | | | | | | 1 | Other: | | | | | | | | | | | | | | | Change in tax accounting method related to repairs | Income Taxes | | | (3) | | | | | | (3) | | | | | | Other Operation | | | | | | | | | | | | | | Counterparty bankruptcy, net of tax of ($1), $0, ($1), $5 (b) | and Maintenance | | | 1 | | | | | | 1 | | | (6) | | Wholesale supply cost reimbursement, net of tax of $0, $0, $0, $0 | (c) | | | | | | 1 | | | | | | 1 | | | | Other Operation | | | | | | | | | | | | | | Ash basin leak remediation adjustment, net of tax of $0, $0, $0, ($1) | and Maintenance | | | | | | | | | | | | 1 | | Coal contract modification payments, net of tax of $0, $5, $0, $5 (d) | Fuel | | | | | | (7) | | | | | | (7) | Total | | | $ | 74 | | $ | (38) | | $ | (43) | | $ | 108 |
(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. In June 2013, PPL EnergyPlus received an approval for an administrative claim in the amount of $2 million. |
(c) | Recorded in "Wholesale energy marketing - Realized" on the Statement of Income. |
(d) | As a result of lower electricity and natural gas prices, coal-fired generation output decreased during 2012. Contract modification payments were incurred to reduce 2012 redemption of all 2.5 million shares of preference stock.and 2013 contracted coal deliveries. |
Reconciliation of Economic Activity
The following table reconciles unrealized pre-tax gains (losses) for the periods ended June 30, to the special item identified as "Adjusted energy-related economic activity, net."
| | | | Three Months | | Six Months | | | | | 2013 | | 2012 | | 2013 | | 2012 | Operating Revenues | | | | | | | | | | | | | | | Unregulated retail electric and gas | | $ | 20 | | $ | (12) | | $ | 12 | | $ | (2) | | | Wholesale energy marketing | | | 590 | | | (458) | | | (232) | | | 394 | Operating Expenses | | | | | | | | | | | | | | | Fuel | | | (4) | | | (16) | | | (5) | | | (14) | | | Energy Purchases | | | (479) | | | 442 | | | 155 | | | (149) | Energy-related economic activity (a) | | | 127 | | | (44) | | | (70) | | | 229 | Option premiums | | | | | | 1 | | | 1 | | | 1 | Adjusted energy-related economic activity | | | 127 | | | (43) | | | (69) | | | 230 | Less: Economic activity realized, associated with the monetization of | | | | | | | | | | | | | | certain full-requirement sales contracts in 2010 | | | | | | 12 | | | | | | 33 | Adjusted energy-related economic activity, net, pre-tax | | $ | 127 | | $ | (55) | | $ | (69) | | $ | 197 | | | | | | | | | | | | | | | | Adjusted energy-related economic activity, net, after-tax | | $ | 76 | | $ | (32) | | $ | (41) | | $ | 118 |
(a) | See Note 14 to the Financial Statements for additional information. |
2013 Outlook
Excluding special items, PPL ElectricEnergy Supply projects higherlower earnings in 2013 compared with 2012, primarily driven by lower energy prices, higher distribution revenues from a distribution base rate increasefuel costs, higher depreciation and higher transmission margins,financing costs, partially offset by lower operation and maintenance expense, higher depreciation.capacity prices and higher nuclear generation output.
Earnings in 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'sEnergy 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 realized economic activity associated with the monetization of certain full-requirement sales contracts in 2010. This economic activity was 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 "Unregulated Gross Energy Margins" as defined by PPL Energy Supply to "Operating Income" for the periods ended June 30.
| | | | | 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 | $ | 812 | | $ | (1) | | | $ | 811 | | $ | 1,075 | | $ | 8 | (c) | | $ | 1,083 | | | | | Unrealized economic activity | | | | | 590 | (d) | | | 590 | | | | | | (458) | (d) | | | (458) | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | to affiliate | | 12 | | | | | | | 12 | | | 17 | | | | | | | 17 | | Unregulated retail electric and gas | | 237 | | | 20 | (d) | | | 257 | | | 192 | | | (12) | (d) | | | 180 | | Net energy trading margins | | | | | | | | | | | | 10 | | | | | | | 10 | | Energy-related businesses | | | | | 122 | | | | 122 | | | | | | 112 | | | | 112 | | | | Total Operating Revenues | | 1,061 | | | 731 | | | | 1,792 | | | 1,294 | | | (350) | | | | 944 | | | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | | | | | | | | Fuel | | 223 | | | 1 | | | | 224 | | | 170 | | | 26 | (e) | | | 196 | | Energy purchases | | | | | | | | | | | | | | | | | | | | | | | | Realized | | 419 | | | (1) | | | | 418 | | | 617 | | | 18 | (c) | | | 635 | | | | | Unrealized economic activity | | | | | 479 | (d) | | | 479 | | | | | | (442) | (d) | | | (442) | | Energy purchases from affiliate | | 1 | | | | | | | 1 | | | | | | | | | | | | Other operation and maintenance | | 3 | | | 267 | | | | 270 | | | 7 | | | 287 | | | | 294 | | Depreciation | | | | | 79 | | | | 79 | | | | | | 69 | | | | 69 | | Taxes, other than income | | 10 | | | 6 | | | | 16 | | | 7 | | | 10 | | | | 17 | | Energy-related businesses | | | | | 118 | | | | 118 | | | | | | 109 | | | | 109 | | | | Total Operating Expenses | | 656 | | | 949 | | | | 1,605 | | | 801 | | | 77 | | | | 878 | Total | $ | 405 | | $ | (218) | | | $ | 187 | | $ | 493 | | $ | (427) | | | $ | 66 |
| | | | | | 2013 Six Months | | 2012 Six 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 | | $ | 1,789 | | $ | (2) | | | $ | 1,787 | | $ | 2,279 | | $ | 12 | (c) | | $ | 2,291 | | | | | Unrealized economic activity | | | | | | (232) | (d) | | | (232) | | | | | | 394 | (d) | | | 394 | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | | to affiliate | | | 26 | | | | | | | 26 | | | 38 | | | | | | | 38 | | Unregulated retail electric and gas | | | 483 | | | 12 | (d) | | | 495 | | | 406 | | | (2) | (d) | | | 404 | | Net energy trading margins | | | (11) | | | | | | | (11) | | | 18 | | | | | | | 18 | | Energy-related businesses | | | | | | 235 | | | | 235 | | | | | | 208 | | | | 208 | | | | Total Operating Revenues | | | 2,287 | | | 13 | | | | 2,300 | | | 2,741 | | | 612 | | | | 3,353 | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | | | | | | | | | Fuel | | | 522 | | | | | | | 522 | | | 385 | | | 22 | (e) | | | 407 | | Energy purchases | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | | 855 | | | (3) | | | | 852 | | | 1,251 | | | 43 | (c) | | | 1,294 | | | | | Unrealized economic activity | | | | | | (155) | (d) | | | (155) | | | | | | 149 | (d) | | | 149 | | Energy purchases from affiliate | | | 2 | | | | | | | 2 | | | 1 | | | | | | | 1 | | Other operation and maintenance | | | 8 | | | 497 | | | | 505 | | | 11 | | | 538 | | | | 549 | | Depreciation | | | | | | 157 | | | | 157 | | | | | | 133 | | | | 133 | | Taxes, other than income | | | 18 | | | 15 | | | | 33 | | | 16 | | | 19 | | | | 35 | | Energy-related businesses | | | | | | 228 | | | | 228 | | | | | | 201 | | | | 201 | | | | Total Operating Expenses | | | 1,405 | | | 739 | | | | 2,144 | | | 1,664 | | | 1,105 | | | | 2,769 | Total | | $ | 882 | | $ | (726) | | | $ | 156 | | $ | 1,077 | | $ | (493) | | | $ | 584 |
(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 six months ended June 30, 2012, "Wholesale energy marketing - Realized" and "Energy purchases - Realized" include net pre-tax losses of $12 million and $33 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. |
(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 six months ended June 30, 2012 include a pre-tax loss of $12 million related to coal contract modification payments. |
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 June 30, as well as the change between periods. The factors that gave rise to the changes are described below the table.
| | | Three Months | | Six Months | | | | 2013 | | 2012 | | Change | | 2013 | | 2012 | | Change | | | | | | | | | | | | | | | | | | | | | Non-trading | | | | | | | | | | | | | | | | | | | | Eastern U.S. | | $ | 349 | | $ | 407 | | $ | (58) | | $ | 779 | | $ | 896 | | $ | (117) | | Western U.S. | | | 56 | | | 76 | | | (20) | | | 114 | | | 163 | | | (49) | Net energy trading | | | | | | 10 | | | (10) | | | (11) | | | 18 | | | (29) | Total | | $ | 405 | | $ | 493 | | $ | (88) | | $ | 882 | | $ | 1,077 | | $ | (195) |
Unregulated Gross Energy Margins
Eastern U.S. | | | | | | | | | | | | | | The increase (decrease) in non-trading margins for the periods ended June 30, 2013 compared with 2012 were due to: |
| | Three Months | | Six Months | | | | | | | | Baseload energy prices | | $ | (121) | | $ | (246) | Nuclear fuel prices | | | (4) | | | (10) | Coal prices | | | 1 | | | (9) | Intermediate and peaking Spark Spreads | | | (7) | | | 7 | Nuclear generation volume | | | 9 | | | 9 | Full-requirement sales contracts | | | 5 | | | 10 | Gas optimization and storage | | | 10 | | | 11 | Ironwood Acquisition which eliminated tolling expense | | | 2 | | | 17 | Net economic availability of coal and hydroelectric plants | | | 7 | | | 39 | Capacity prices | | | 36 | | | 47 | Other | | | 4 | | | 8 | Total | | $ | (58) | | $ | (117) |
Western U.S.
Non-trading margins for the three and six months ended June 30, 2013 compared with the same periods in 2012 were lower due to $20 million and $59 million of lower wholesale prices. The six-month period was partially offset by $7 million of higher wholesale volumes.
Net Energy Trading Margins
Net energy trading margins for the three months ended June 30, 2013 compared with the same period in 2012 decreased as a result of lower margins of $5 million on power positions and $3 million on FTRs.
Net energy trading margins for the six months ended June 30, 2013 compared with the same period in 2012 decreased as a result of lower margins of $15 million on gas positions and $7 million on power positions.
Other Operation and Maintenance | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | Three Months | | Six Months | | | | | | | | Brunner Island Unit 3 outage in 2012 | $ | (4) | | $ | (19) | Uncollectible accounts (a) | | (4) | | | (15) | PPL Susquehanna projects | | (6) | | | (9) | PPL Susquehanna refueling outage | | (5) | | | (8) | Conemaugh Unit 2 outage in 2013 | | 3 | | | 5 | Other generation plant costs | | (7) | | | (1) | Other | | (1) | | | 3 | Total | $ | (24) | | $ | (44) |
(a) | The decrease for the six-month period 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. |
Depreciation
Depreciation increased by $10 million and $24 million for the three and six months ended June 30, 2013 compared with 2012, primarily due to $10 million and $20 million related to PP&E additions, and $6 million attributable to the Ironwood Acquisition for the six-month period.
Other Income (Expense) - net
For the three and six months ended June 30, 2013 compared with 2012, other income (expense) - net increased by $6 million and $5 million, primarily due to the impact of a $4 million worker's compensation adjustment.
See Note 12 to the Financial Statements for additional information on other income (expense) - net.
Interest Expense | | | | | | | | | | | | | | | The increase (decrease) in interest expense for the periods ended June 30, 2013 compared with 2012 was due to: |
| | Three Months | | Six Months | | | | | | | | | Ironwood Acquisition financing | | | | | $ | 4 | Capitalized interest | | $ | 3 | | | 6 | Other | | | | | | 2 | Total | | $ | 3 | | $ | 12 |
Income Taxes | | | | | | | | | | | | | | The increase (decrease) in income taxes for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | | | | | | | Three Months | | Six Months | | | | | | | | Higher (lower) pre-tax income | | $ | 53 | | $ | (172) | Federal and state tax reserve adjustments (a) | | | 7 | | | 6 | State deferred tax rate change (b) | | | | | | 11 | Other | | | (2) | | | 1 | Total | | $ | 58 | | $ | (154) |
(a) | During the three and six months ended June 30, 2013, PPL Energy Supply reversed $3 million tax benefit related to a 2008 change in method of accounting for certain expenditures for tax purposes and recorded $4 million in federal tax reserves related to differences in over (under) payment interest rates applied to audit claims as a result of the U.S. Supreme Court decision related to the Windfall Profits tax. |
(b) | During the six months ended June 30, 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: | | | | | | | | | | June 30, 2013 | | December 31, 2012 | | | | | | | | Cash and cash equivalents | | $ | 265 | | $ | 413 | Short-term debt | | $ | 575 | | $ | 356 |
The $148 million decrease in PPL Energy Supply's cash and cash equivalents position was primarily the net result of:
· | distributions to Member of $408 million; |
· | capital expenditures of $241 million; |
· | net cash provided by operating activities of $227 million; |
· | contributions from Member of $105 million; and |
· | an increase in short-term debt of $219 million. |
PPL Energy Supply's cash provided by operating activities decreased by $81 million for the six months ended June 30, 2013, compared with 2012. This was partially due to a $37 million increase in defined benefit plans funding and an $11 million increase in cash used by components of working capital (primarily due to changes in counterparty collateral of $118 million, partially offset by changes in fuel, materials and supplies of $79 million). In addition, a change of $31 million in other operating activities contributed to the decrease, partially due to changes in certain tax-related accounts.
Credit Facilities
PPL Energy Supply maintains credit facilities to provide liquidity and to backstop commercial paper issuances. At June 30, 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 | | | | | | | | | | | | | | | PPL Energy Supply Credit Facilities (a) | | $ | 3,150 | | | | | $ | 785 | | $ | 2,365 |
(a) | 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 9% 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 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 June 30, 2013 and December 31, 2012, PPL Energy Supply had $575 million and $356 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.29% and 0.50%.
Rating Agency Actions
Fitch, Moody's and S&P 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 Fitch, Moody's and S&P 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 on PPL Montana's pass-through trust certificates due 2020.
In July 2013, Moody's withdrew its rating and outlook for PPL Ironwood.
In July 2013, S&P lowered its rating, from BBB- to BB+, and retained the negative outlook for PPL Montana's pass-through trust certificates due 2020.
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 June 30, 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 periods ended June 30. See Notes 13 and 14 to the Financial Statements for additional information.
| | Gains (Losses) | | | Three Months | | Six Months | | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | $ | 229 | | $ | 1,215 | | $ | 473 | | $ | 1,082 | Contracts realized or otherwise settled during the period | | | (100) | | | (261) | | | (237) | | | (540) | Fair value of new contracts entered into during the period (a) | | | 37 | | | 13 | | | 46 | | | 12 | Other changes in fair value | | | 119 | | | (6) | | | 3 | | | 407 | Fair value of contracts outstanding at the end of the period | | $ | 285 | | $ | 961 | | $ | 285 | | $ | 961 |
(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 June 30, 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) | | $ | 226 | | $ | 32 | | $ | (10) | | $ | 5 | | $ | 253 | Prices based on significant unobservable inputs (Level 3) | | | 10 | | | 18 | | | 4 | | | | | | 32 | Fair value of contracts outstanding at the end of the period | | $ | 236 | | $ | 50 | | $ | (6) | | $ | 5 | | $ | 285 |
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 2018. The following table sets forth changes in the net fair value of trading commodity derivative contracts for the periods ended June 30. See Notes 13 and 14 to the Financial Statements for additional information.
| | Gains (Losses) | | | Three Months | | Six Months | | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | $ | 15 | | $ | 2 | | $ | 29 | | $ | (4) | Contracts realized or otherwise settled during the period | | | | | | (1) | | | (2) | | | (1) | Fair value of new contracts entered into during the period (a) | | | (4) | | | (1) | | | (16) | | | 5 | Other changes in fair value | | | 7 | | | 17 | | | 7 | | | 17 | Fair value of contracts outstanding at the end of the period | | $ | 18 | | $ | 17 | | $ | 18 | | $ | 17 |
(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 June 30, 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) | | $ | 4 | | $ | 6 | | | | | | | | $ | 10 | Prices based on significant unobservable inputs (Level 3) | | | 6 | | | 2 | | | | | | | | | 8 | Fair value of contracts outstanding at the end of the period | | $ | 10 | | $ | 8 | | | | | | | | $ | 18 |
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 six months ended June 30, 2013 was as follows.
| | | | | | Non-Trading | | | | Trading VaR | | VaR | 95% Confidence Level, Five-Day Holding Period | | | | | | | | Period End | | $ | 2 | | $ | 8 | | Average for the Period | | | 4 | | | 9 | | High | | | 6 | | | 10 | | Low | | | 2 | | | 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 June 30, 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 June 30, 2013.
At June 30, 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 June 30, 2013 would increase the fair value of its debt portfolio by $50 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 June 30, 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 June 30, 2013, a hypothetical 10% increase in interest rates and a 10% decrease in equity prices would have resulted in an estimated $57 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 costs of compliance or alleged non-compliance cannot be predicted with certainty but could be material. In addition, cost 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 Energy Supply's services.
Physical effects associated with possible 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 hydroelectric 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 waste) 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. On July 25, 2013, the U.S. House of Representatives passed House Bill H.R. 2218, the Coal Residuals and Reuse Management Act of 2013, which would preempt the EPA from regulating CCRs under RCRA and sets rules governing state programs. Prospects remain uncertain for similar legislation to pass in the U.S. Senate.
Effluent Limitation Guidelines (ELGs) In June 2013, the EPA published 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 transport water and metal cleaning waste waters, as well as new limits for scrubber wastewater and landfill leachate. The EPA's proposed ELG regulations also contain some requirements that would affect the inspection and operation of CCR facilities, if finalized. 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: requiring installation of Best Technology Available (BTA) to reduce mortality of aquatic organisms that are pulled into the plants cooling water system (entrainment); and imposing standards for reduction of mortality of aquatic organisms trapped on water intake screens (impingement). A final rule is expected to be issued in November 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 June 2013, President Obama released his Climate Action Plan which reiterates the goal of reducing greenhouse gas emissions in the U.S. "in the range of" 17% below 2005 levels by 2020 through such actions as regulating power plant emissions, promoting increased use of renewables and clean energy technology, and establishing tighter energy efficiency standards. Also, by Presidential Memorandum the EPA was directed to issue a new proposal for new power plants by September 20, 2013, with a final rule to be issued in a timely fashion thereafter, and to issue proposed standards for existing power plants by June 1, 2014 with a final rule by June 1, 2015. The EPA was further directed to require that states develop implementation plans for existing plants by June 2016. Regulation of existing plants could have a significant industry-wide impact depending on the structure and stringency of the final rule and the state implementation plans. The Administration's recent increase in its estimate of the "social cost of carbon" (which is used to calculate benefits associated with proposed regulations) from $23.80 to $38 per metric ton in 2015 may lead to more costly regulatory requirements.
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.
Regional Haze Under the EPA's regional haze programs (developed to eliminate man-made visibility degradation by 2064), states are required to make reasonable progress every decade, including the application of Best Available Retrofit Technology (BART) on power plants commissioned between 1962 and 1977. For the eastern U.S. the EPA had determined that region-wide reductions under the CAIR or CSAPR trading program could be utilized by states programs to satisfy BART requirements. However, the August 2012 decision by the U.S. Court of Appeals for the District of Columbia Circuit (Circuit Court) to
vacate and remand CSAPR will likely expose power plants located in the eastern U.S., including PPL Energy Supply's plants in Pennsylvania, to reductions in sulfur dioxide and nitrogen oxides as required by BART.
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).
CSAPR and CAIR In 2011, the EPA finalized its CSAPR regulating emissions of nitrogen 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 U.S. In December 2011, the Circuit Court stayed implementation of CSAPR, leaving CAIR in place. Subsequently, in August 2012, the Circuit Court vacated and remanded CSAPR back to the EPA for further rulemaking, again leaving CAIR in place in the interim, and on June 24, 2013 the U.S. Supreme Court granted the EPA's petition for review of the Circuit Court's decision.
PPL Energy Supply plants in Pennsylvania will continue to comply with CAIR through optimization of existing controls, balanced with emission allowance purchases. The Circuit Court's August 2012 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.
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 additional information on 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 and six months ended June 30, 2013 with the same periods in 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 capital expenditure programs, 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 in order to achieve more timely recovery. The recently approved DSIC mechanism will help reduce regulatory lag on distribution reliability-related capital investment. See "Financial and Operational Developments - Distribution System Improvement Charge" 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 June 30, 2013 compared with 2012, primarily due to an $11 million favorable effect of price as a result of higher base rates, effective January 1, 2013.
Margins increased for the six months ended June 30, 2013 compared with 2012, primarily due to a $13 million adverse effect of mild weather in 2012 and a $32 million favorable effect of price, largely comprised of higher base rates, effective January 1, 2013, and higher volumes of $4 million.
Transmission
Margins increased for the three and six months ended June 30, 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 increase (decrease) in non-trading margins for the periods ended June 30, 2013 compared with 2012 were due to: | | | | | | | | | | Three Months | | Six Months | | | | | | | | Baseload energy prices | | $ | (121) | | $ | (246) | Nuclear fuel prices | | | (4) | | | (10) | Coal prices | | | 1 | | | (9) | Intermediate and peaking Spark Spreads | | | (7) | | | 7 | Nuclear generation volume | | | 9 | | | 9 | Full-requirement sales contracts | | | 5 | | | 10 | Gas optimization and storage | | | 10 | | | 11 | Ironwood Acquisition which eliminated tolling expense | | | 2 | | | 17 | Net economic availability of coal and hydroelectric plants | | | 7 | | | 39 | Capacity prices | | | 36 | | | 47 | Other | | | 4 | | | 8 | Total | | $ | (58) | | $ | (117) |
Western U.S.
Non-trading margins for the three and six months ended June 30, 2013 compared with the same periods in 2012 were lower due to $20 million and $59 million of lower wholesale prices. The six-month period was partially offset by $7 million of higher wholesale volumes.
Net Energy Trading Margins
Net energy trading margins for the three months ended June 30, 2013 compared with the same period in 2012 decreased as a result of lower margins of $5 million on power positions and $3 million on FTRs.
Net energy trading margins for the six months ended June 30, 2013 compared with the same period in 2012 decreased as a result of lower margins of $15 million on gas positions and $7 million on power positions.
Utility Revenues | | | | | | | | | | | | | The increase (decrease) in utility revenues for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | | | | | | | | | | | Three Months | | Six Months | Domestic: | | | | | | | | PPL Electric (a) | | $ | 10 | | $ | 65 | | LKE (b) | | | 24 | | | 119 | | Total Domestic | | | 34 | | | 184 | | | | | | | | | | | U.K.: | | | | | | | | Price (c) | | | 50 | | | 113 | | Volume (d) | | | 23 | | | 28 | | DPCR4 accrual adjustments (e) | | | (24) | | | (24) | | Foreign currency exchange rates | | | (26) | | | (16) | | Other (f) | | | (7) | | | 1 | | Total U.K. | | | 16 | | | 102 | Total | | $ | 50 | | $ | 286 |
(a) | See "Pennsylvania Gross Delivery Margins" for further information. |
(b) | See "Kentucky Gross Margins" for further information. |
(c) | The increase for the three and six-month periods is primarily due to price increases effective April 1, 2013 and April 1, 2012. |
(d) | The increase for the three and six-month periods is primarily due to the favorable effect of weather. |
(e) | The decrease for the three and six-month periods is due to a $24 million reduction in revenue based on information provided by Ofgem regarding the calculation of line loss incentive/penalty for all network operators related to DPCR4. See Note 6 to the Financial Statements for additional information. |
(f) | The decrease for the three month period is primarily related to a $6 million reduction in third-party engineering revenue, which is partially offset by a reduction in costs in "Other operation and maintenance" on the Statements of Income. |
Other Operation and Maintenance | | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance for the periods ended June 30, 2013 compared with 2012 was due to: |
| | | Three Months | | Six Months | Domestic: | | | | | | | Uncollectible accounts (a) | $ | (4) | | $ | (20) | | LKE coal plant outages (b) | | (4) | | | (17) | | Brunner Island Unit 3 outage in 2012 | | (4) | | | (19) | | PPL Susquehanna projects | | (6) | | | (9) | | PPL Susquehanna refueling outage | | (5) | | | (8) | | Act 129 (c) | | (7) | | | (7) | | Conemaugh Unit 2 outage in 2013 | | 3 | | | 5 | | Other generation plant costs | | (7) | | | (1) | | Other | | (7) | | | 1 | U.K.: | | | | | | | Third-party engineering (d) | | (3) | | | 2 | | Network maintenance (e) | | 6 | | | 13 | | Insurance claim provision release | | 6 | | | 6 | | Severance compensation (f) | | (4) | | | (8) | | Pension | | (2) | | | (4) | | Foreign currency exchange rates | | (5) | | | (3) | | Other | | 2 | | | (2) | Total | $ | (41) | | $ | (71) |
(a) | The decrease for the six-month period 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 for the three and six month periods is due to the timing and scope of scheduled outages. |
(c) | The decrease for the three and six month periods is due to a reduction in Act 129 energy efficiency and conservation plan costs for Phase 1 programs. Phase 1 ended May 31, 2013. |
(d) | These costs are offset by revenues reflected in "Utility" on the Statement of Income. |
(e) | The increase for the three and six month periods is primarily due to higher vegetation management costs. |
(f) | The decrease for the three and six month periods is primarily due to costs incurred in 2012 related to the WPD Midlands reorganization. |
Depreciation | | | | | | | | | | | The increase (decrease) in depreciation for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | | | | | Three Months | | Six Months | | | | | | | | | Additions to PP&E | | $ | 23 | | $ | 44 | LKE lower depreciation rates effective January 1, 2013 | | | (6) | | | (11) | Ironwood Acquisition | | | | | | 6 | Other | | | (2) | | | (4) | Total | | $ | 15 | | $ | 35 |
Other Income (Expense) - net
The $17 million decrease in other income (expense) - net for the three months ended June 30, 2013 compared with 2012 was primarily due to a decrease of $21 million from realized and unrealized gains on foreign currency contracts.
The $122 million increase in other income (expense) - net for the six months ended June 30, 2013 compared with 2012 was primarily due to an increase of $116 million from realized and unrealized gains on foreign currency contracts.
See Note 12 to the Financial Statements for additional information on other income (expense) - net. Interest Expense | | | | | | | | | | | | The increase (decrease) in interest expense for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | | Three Months | | Six Months | | | | | | | | | Long-term debt interest expense (a) | | $ | 8 | | $ | 22 | Loss on extinguishment of debt (b) | | | 10 | | | 10 | Ironwood Acquisition financing | | | | | | 4 | Capitalized interest | | | 3 | | | 4 | Other | | | 1 | | | 3 | Total | | $ | 22 | | $ | 43 |
(a) | The increase for the three-month period was primarily due to PPL Capital Funding's debt issuances in March 2013, June 2012 and October 2012. See Note 7 to the Financial Statements in this Form 10-Q and in PPL's 2012 Form 10-K for additional information. |
| The increase for the six-month period was primarily due to PPL Capital Funding's debt issuances as discussed above as well as higher accretion expense on WPD index linked notes and interest on WPD (East Midlands') April 2012 issuance of £100 million, 5.25% Senior Notes due 2023. |
(b) | In May 2013, PPL Capital Funding remarketed and exchanged junior subordinated notes that were originally issued in June 2010 as a component of PPL's 2010 Equity Units. See Note 7 to the Financial Statements for additional information. |
Income Taxes | | | | | | | | | | | The increase (decrease) in income taxes for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | Three Months | | Six Months | | | | | | | | | Higher (lower) pre-tax income | | $ | 52 | | $ | (67) | Federal and state tax reserve adjustments (a) | | | (35) | | | (35) | U.S. income tax on foreign earnings net of foreign tax credit (b) | | | (6) | | | (6) | Foreign tax reserve adjustments (c) | | | 8 | | | 5 | Foreign tax return adjustments | | | (4) | | | (4) | Net operating loss carryforward adjustments (d) | | | 3 | | | 9 | State deferred tax rate change (e) | | | | | | 11 | Other | | | 3 | | | | Total | | $ | 21 | | $ | (87) |
(a) | In May 2013, the U.S. Supreme Court reversed the December 2011 ruling of the U.S. Court of Appeals for the Third Circuit on the creditability of U.K. Windfall Profits Tax for tax purposes. As a result of this decision, PPL recorded a tax benefit of $44 million during the three and six months ended June 30, 2013. See Note 5 to the Financial Statements for additional information. |
(b) | During the three and six months ended June 30, 2013, PPL recorded a $14 million increase to income tax expense primarily attributable to a revision in the expected taxable amount of cash repatriation in 2013 and recorded a tax benefit of $19 million associated with a ruling obtained from the IRS impacting the recalculation of 2010 U.K. earnings and profits that will be reflected on an amended 2010 U.S. tax return. |
(c) | During the three and six months ended June 30, 2012, PPL recorded a tax benefit following resolution of a U.K. tax issue related to the tax deductibility of interest expense. |
(d) | During the three and six months ended June 30, 2012, PPL recorded adjustments to deferred taxes related to net operating loss carryforwards of LKE based on income tax return adjustments. |
(e) | During the six months ended June 30, 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: | | | | | | | | | | June 30, 2013 | | December 31, 2012 | | | | | | | | Cash and cash equivalents | | $ | 711 | | $ | 901 | Short-term debt | | $ | 1,206 | | $ | 652 |
At June 30, 2013, $178 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. income taxes, net of allowable foreign income 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 $190 million decrease in PPL's cash and cash equivalents position was primarily the net result of:
· | capital expenditures of $1.8 billion; |
· | the payment of $426 million of common stock dividends; |
· | net cash provided by operating activities of $947 million; |
· | net increase in short-term debt of $563 million; and |
· | proceeds of $450 million from the issuance of long-term debt. |
PPL's cash provided by operating activities had no net change for the six months ended June 30, 2013 compared with 2012. The result was the net effect of:
· | a $219 million increase in net income, when adjusted for non-cash components; and |
· | a $25 million decrease in defined benefit plan funding, offset by |
· | a $245 million increase in cash used by components of working capital (primarily due to changes in accounts receivable of $210 million and in counterparty collateral of $118 million, partially offset by a $95 million change in fuel, materials and supplies). |
Capital expenditures increased by $488 million for the six months ended June 30, 2013 compared with 2012, primarily due to PPL Electric's Susquehanna-Roseland transmission project and projects to enhance system reliability, and LKE's environmental projects at Mill Creek and Ghent and construction of Cane Run Unit 7.
PPL maintains credit facilities to provide liquidity and to backstop commercial paper issuances. At June 30, 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 | | $ | 3,150 | | | | | $ | 785 | | $ | 2,365 | PPL Electric Credit Facilities | | | 400 | | | | | | 86 | | | 314 | LG&E Syndicated Credit Facility | | | 500 | | | | | | 80 | | | 420 | KU Credit Facilities | | | 598 | | | | | | 370 | | | 228 | | Total Domestic Credit Facilities (a) | | $ | 4,648 | | | | | $ | 1,321 | | $ | 3,327 | | | | | | | | | | | | | | | Total WPD Credit Facilities (b) | | £ | 1,055 | | £ | 193 | | | | | £ | 862 |
(a) | 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 8% of the total committed capacity. |
(b) | At June 30, 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 June 30, 2013 and December 31, 2012, PPL Energy Supply had $575 million and $356 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.29% 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 June 30, 2013, PPL Electric had $85 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheet, at a weighted-average interest rate of 0.34%. 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 June 30, 2013 and December 31, 2012, LG&E had $80 million and $55 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.32% and 0.42%. At June 30, 2013 and December 31, 2012, KU had $172 million and $70 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.33% and 0.42%.
Long-term Debt and Equity Securities
See "Overview - Financial and Operational Developments" above for information regarding equity forward agreements and the 2010 Equity Units. PPL has no plans to issue new shares of common stock for the remainder of 2013.
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 was loaned to or invested in affiliates of PPL Capital Funding and used to fund their capital expenditures and other general corporate purposes.
In July 2013, PPL Electric issued $350 million of 4.75% First Mortgage Bonds due 2043. PPL Electric received proceeds of $345 million, net of a discount and underwriting fees, which will be used for capital expenditures, to fund pension obligations and for other general corporate purposes.
See Note 7 to the Financial Statements for further discussion of Long-term Debt and Equity Securities.
Common Stock Dividends
In May 2013, PPL declared its quarterly common stock dividend, payable July 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
Fitch, Moody's and S&P 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 Fitch, Moody's and S&P 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, Fitch, Moody's and S&P 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 on PPL Montana's pass-through trust certificates due 2020.
In May 2013, Fitch, Moody's and S&P assigned ratings of BBB, Baa3 and BBB- to PPL Capital Funding's $250 million 1.90% Senior Notes due 2018, $600 million 3.40% Senior Notes due 2023 and $300 million 4.70% Senior Notes due 2043. Fitch also assigned a stable outlook to these notes.
In July 2013, Fitch, Moody's and S&P assigned ratings of A-, A3 and A- to PPL Electric's $350 million 4.75% First Mortgage Bonds due 2043. Fitch also assigned a stable outlook to these notes and S&P assigned a recovery rating of 1+.
In July 2013, S&P confirmed the AA+ ratings for KU's 2000 Series A Solid Waste Disposal Facility Revenue Bonds and KU's 2004 Series A, 2006 Series B and 2008 Series A Environmental Facilities Revenue Bonds. S&P also confirmed the A-1+ short term rating on these Bonds.
In July 2013, Moody's withdrew its rating and outlook for PPL Ironwood.
In July 2013, S&P lowered its rating, from BBB- to BB+, and retained the negative outlook for PPL Montana's pass-through trust certificates due 2020.
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 June 30, 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 June 30. See Notes 13 and 14 to the Financial Statements for additional information.
| | Gains (Losses) | | | Three Months | | Six Months | | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | $ | 229 | | $ | 1,215 | | $ | 473 | | $ | 1,082 | Contracts realized or otherwise settled during the period | | | (100) | | | (261) | | | (237) | | | (540) | Fair value of new contracts entered into during the period (a) | | | 37 | | | 13 | | | 46 | | | 12 | Other changes in fair value | | | 119 | | | (6) | | | 3 | | | 407 | Fair value of contracts outstanding at the end of the period | | $ | 285 | | $ | 961 | | $ | 285 | | $ | 961 |
(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 June 30, 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) | | $ | 226 | | $ | 32 | | $ | (10) | | $ | 5 | | $ | 253 | Prices based on significant unobservable inputs (Level 3) | | | 10 | | | 18 | | | 4 | | | | | | 32 | Fair value of contracts outstanding at the end of the period | | $ | 236 | | $ | 50 | | $ | (6) | | $ | 5 | | $ | 285 |
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 2018. The following table sets forth changes in the net fair value of trading commodity derivative contracts for the periods ended June 30. See Notes 13 and 14 to the Financial Statements for additional information.
| | Gains (Losses) | | | Three Months | | Six Months | | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | $ | 15 | | $ | 2 | | $ | 29 | | $ | (4) | Contracts realized or otherwise settled during the period | | | | | | (1) | | | (2) | | | (1) | Fair value of new contracts entered into during the period (a) | | | (4) | | | (1) | | | (16) | | | 5 | Other changes in fair value | | | 7 | | | 17 | | | 7 | | | 17 | Fair value of contracts outstanding at the end of the period | | $ | 18 | | $ | 17 | | $ | 18 | | $ | 17 |
(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 June 30, 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) | | $ | 4 | | $ | 6 | | | | | | | | $ | 10 | Prices based on significant unobservable inputs (Level 3) | | | 6 | | | 2 | | | | | | | | | 8 | Fair value of contracts outstanding at the end of the period | | $ | 10 | | $ | 8 | | | | | | | | $ | 18 |
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 six months ended June 30, 2013 was as follows.
| | | | | | Non-Trading | | | | Trading VaR | | VaR | 95% Confidence Level, Five-Day Holding Period | | | | | | | | Period End | | $ | 2 | | $ | 8 | | Average for the Period | | | 4 | | | 9 | | High | | | 6 | | | 10 | | Low | | | 2 | | | 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 June 30, 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 June 30, 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 June 30, 2013 would increase the fair value of its debt portfolio by $631 million.
At June 30, 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) | | $ | 1,930 | | $ | 129 | | $ | (74) | | Cross-currency swaps (d) | | | 1,262 | | | 61 | | | (171) | Economic activity | | | | | | | | | | | Interest rate swaps (e) | | | 179 | | | (44) | | | (4) |
(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 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 June 30, 2013 mature through 2044. |
(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 June 30, 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 June 30, 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 June 30, 2013, PPL had the following foreign currency hedges outstanding:
| | | | | | | Effect of a | | | | | | | | 10% | | | | | | | | Adverse | | | | | | | | Movement | | | | | | | | in Foreign | | | | | | Fair Value, | | Currency | | | | Exposure | | Net - Asset | | Exchange | | | | Hedged | | (Liability) | | Rates (a) | | | | | | | | | | | | Net investment hedges (b) | | £ | 166 | | $ | 11 | | $ | (25) | Economic activity (c) | | | 1,185 | | | 71 | | | (171) |
(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 June 30, 2013 mature through 2014. Excludes the amount of intercompany loans classified as net investment hedges. 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 June 30, 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 June 30, 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 June 30, 2013, a hypothetical 10% increase in interest rates and a 10% decrease in equity prices would have resulted in an estimated $57 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 $269 million for the six months ended June 30, 2013, which primarily reflected a $714 million reduction to PP&E and goodwill offset by a reduction of $445 million to net liabilities. Changes in this exchange rate resulted in a foreign currency translation loss of $104 million for the six months ended June 30, 2012, which primarily reflected a $259 million reduction to PP&E and goodwill offset by a reduction of $155 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 possible 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 hydroelectric 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 waste) 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. On July 25, 2013, the U.S. House of Representatives passed House Bill H.R. 2218, the Coal Residuals and Reuse Management Act of 2013, which would preempt the EPA from regulating CCRs under RCRA and sets rules governing state programs. Prospects remain uncertain for similar legislation to pass in the U.S. Senate.
Effluent Limitation Guidelines (ELGs) In June 2013, the EPA published 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 transport water and metal cleaning waste waters, as well as new limits for scrubber wastewater and landfill leachate. The EPA's proposed ELG regulations also contain some requirements that would affect the inspection and operation of CCR facilities, if finalized. 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: requiring installation of Best Technology Available (BTA) to reduce mortality of aquatic organisms that are pulled into the plant cooling water system (entrainment); and imposing standards for reduction of mortality of aquatic organisms trapped on water intake screens (impingement). A final rule is expected to be issued in November 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 June 2013, President Obama released his Climate Action Plan which reiterates the goal of reducing greenhouse gas emissions in the U.S. "in the range of" 17% below 2005 levels by 2020 through such actions as regulating power plant emissions, promoting increased use of renewables and clean energy technology, and establishing tighter energy efficiency standards. Also, by Presidential Memorandum the EPA was directed to issue a new proposal for new power plants by September 20, 2013, with a final rule to be issued in a timely fashion thereafter, and to issue proposed standards for existing power plants by June 1, 2014 with a final rule by June 1, 2015. The EPA was further directed to require that states develop implementation plans for existing plants by June 2016. Regulation of existing plants could have a significant industry-wide impact depending on the structure and stringency of the final rule and state implementation plans. The Administration's recent increase in its estimate of the "social cost of carbon" (which is used to calculate benefits associated with proposed regulations) from $23.80 to $38 per metric ton in 2015 may lead to more costly regulatory requirements. Additionally, the Climate Action Plan requirements related to preparing the U.S. for the impacts of climate change could affect PPL and others in the industry as transmission system modifications to improve the ability to withstand major storms may be needed in order to meet those requirements.
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.
Regional Haze Under the EPA's regional haze programs (developed to eliminate man-made visibility degradation by 2064), states are required to make reasonable progress every decade, including the application of Best Available Retrofit Technology (BART) on power plants commissioned between 1962 and 1977. For the eastern U.S., the EPA had determined that region-wide reductions under the CAIR or CSAPR trading program could be utilized by state programs to satisfy BART requirements. However, the August 2012 decision by the U.S. Court of Appeals for the District of Columbia Circuit (Circuit Court) to vacate and remand CSAPR exposes power plants located in the eastern U.S., including PPL's plants in Pennsylvania and Kentucky, to reductions in sulfur dioxide and nitrogen oxides as required by BART.
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).
CSAPR and CAIR In 2011, the EPA finalized its CSAPR regulating emissions of nitrogen 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 U.S. In December 2011, the Circuit Court stayed implementation of CSAPR, leaving CAIR in place. Subsequently, in August 2012, the Circuit Court vacated and remanded CSAPR back to the EPA for further rulemaking, again leaving CAIR in place in the interim, and on June 24, 2013 the U.S. Supreme Court granted the EPA's petition for review of the Circuit Court's decision.
PPL plants in Pennsylvania and Kentucky will continue to comply with CAIR through optimization of existing controls, balanced with emission allowance purchases. The Circuit Court's August 2012 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.
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 additional information on 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 and six months ended June 30, 2013 with the same periods in 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.
The capacity (summer rating) of PPL Energy Supply's competitive electricity generation facilities at June 30, 2013 was:
| | | Ownership or | | | | | Lease Interest | | Primary Fuel | | in MW (a) | | | | | | | Coal (b) (c) | | 4,146 | | Natural Gas/Oil | | 3,316 | | Nuclear (c) | | 2,275 | | Hydro | | 807 | | Other (d) | | 70 | | | | | | | Total | | 10,614 | |
(a) | The capacity of generation units is based on a number of factors, including the operating experience and physical conditions of the units, and may be revised periodically to reflect changed circumstances. See "Item 2. Properties" in PPL Energy Supply's 2012 Form 10-K for additional information on ownership percentages. |
(b) | Includes a leasehold interest held by PPL Montana. See Note 11 to the Financial Statements in PPL Energy Supply's 2012 Form 10-K for additional information. |
(c) | Includes units that are jointly owned. Each owner is entitled to its proportionate share of the unit's total output and funds its proportionate share of fuel and other operating costs. See Note 14 to the Financial Statements in PPL Energy Supply's 2012 Form 10-K for additional information. |
(d) | Includes facilities owned, controlled or for which PPL Energy Supply has the rights to the output. |
Business Strategy
PPL Energy Supply's strategy is to achieve disciplined optimization of energy supply margins while mitigating near-term 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 managing profitability during the current and projected period of low commodity prices. See "Financial and Operational Developments - Economic and Market Conditions" below.
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 Attributable to PPL Energy Supply Member
Net Income Attributable to PPL Energy Supply Member for the three and six months ended June 30, 2013 was $86 million and $48 million compared to $19 million and $328 million for the same periods in 2012.
See "Results of Operations" below for further discussion and analysis of the consolidated results of operations.
Economic and Market Conditions
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 and additional renewable energy sources, primarily wind in the western U.S. Unregulated Gross Energy Margins associated with PPL Energy Supply's competitive generation and marketing business are impacted by changes in energy and capacity market prices and demand for electricity and natural gas, power plant availability, competition in the markets for retail customers, fuel costs and availability, transmission constraints that impact the locational pricing of electricity at PPL Energy Supply's power plants, fuel transportation costs and the level and price of hedging activities. As a result of these factors, lower energy margins are expected when compared to the 2012 energy margins. 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, its hedging strategies, and potential plant modifications to burn lower cost fuels.
As previously disclosed, PPL Energy Supply's businesses are subject to extensive federal, state and local environmental laws, rules and regulations, including those surrounding coal combustion residuals, GHG, effluent limitation guidelines and MATS. See "Financial Condition - Environmental Matters" below for additional information on these requirements. These more stringent environmental requirements, combined with low energy margins for competitive generation, have led several energy companies, including PPL Energy Supply, to announce plans to either temporarily or permanently close, or place in long-term reserve status, certain of their coal-fired generating plants.
In 2012, PPL Energy Supply announced its intention, beginning in April 2015, to place its Corette plant in long-term reserve status, suspending the plant's operation due to expected market conditions and the costs to comply with MATS. PPL Energy Supply continues to monitor its Corette plant for potential impairment. The Corette plant asset group's carrying value at June 30, 2013 was $68 million. See Note 10 to the Financial Statements for additional information. PPL Energy Supply believes its remaining competitive generation assets are well positioned to meet the additional environmental requirements based on prior and planned investments and does not currently anticipate the need to temporarily or permanently shut down additional coal-fired plants. PPL Energy Supply cannot predict the future impact that economic and market conditions and changes in regulatory requirements may have on its financial condition or results of operations.
Susquehanna Turbine Blade Inspection
In the spring of 2013, PPL Susquehanna made modifications to address the causes of turbine blade cracking at the PPL Susquehanna nuclear plant that was first identified in 2011. The modifications were made during the Unit 2 refueling outage and an additional planned outage for Unit 1. Additional modifications will be made during the planned outages in 2014 and 2015. Following completion of these modifications, PPL Susquehanna will continue monitoring the turbine blades using enhanced diagnostic equipment.
Colstrip Unit 4 Outage
On July 1, 2013, Colstrip Unit 4 tripped off line as a result of damage that occurred in the unit's generator. The cost to repair Unit 4 is estimated to be between $30 million to $40 million and is expected to take at least six months to complete. Property damage insurance for Unit 4 is subject to a $2.5 million self-insured retention. PPL Montana operates Unit 4 pursuant to an agreement with the owners and, pursuant to a separate agreement with NorthWestern, is entitled to receive 15% of Unit 4's
electricity output and is responsible for 15% of the capital, operating, maintenance and repair costs associated with Unit 4. PPL Montana's estimated pre-tax loss of earnings attributable to the Unit 4 outage is between $5 million and $10 million.
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 six months ended June 30, 2013 with the same periods in 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 June 30 was: | | | | | | | | | | | | | | | | | | Three Months | | Six Months | | | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | Net Income Attributable to PPL Energy Supply Member | | $ | 86 | | $ | 19 | | $ | 48 | | $ | 328 |
The changes in the components of Net Income 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 | | Six Months | | | | | | | | Unregulated Gross Energy Margins | | $ | (88) | | $ | (195) | Other operation and maintenance | | | 17 | | | 30 | Depreciation | | | (10) | | | (24) | Taxes, other than income | | | 3 | | | 4 | Other Income (Expense) - net | | | 7 | | | 8 | Interest Expense | | | (3) | | | (12) | Other | | | 4 | | | 2 | Income Taxes | | | 25 | | | 58 | Special items, after-tax | | | 112 | | | (151) | Total | | $ | 67 | | $ | (280) |
· | 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 for the three-month period primarily due to $11 million of lower 2013 project and refueling outage costs at PPL Susquehanna and $4 million of Brunner Island Unit 3 outage costs in 2012 with no comparable outage in 2013. |
Lower other operation and maintenance for the six-month period primarily due to $19 million of Brunner Island Unit 3 outage costs in 2012 with no comparable outage in 2013 and $17 million of lower 2013 project and refueling outage costs at PPL Susquehanna, partially offset by $5 million of Conemaugh Unit 2 outage costs in 2013 with no comparable outage in 2012.
· | Higher depreciation for the three and six-month periods primarily due to PP&E additions. The six-month period also includes $6 million attributable to the Ironwood Acquisition. |
· | Higher other income (expense) - net for the three and six-month periods partially due to the impact of a worker's compensation adjustment of $4 million. |
· | Higher interest expense for the six-month period primarily due to $6 million of lower capitalized interest in 2013 and $4 million due to financings associated with PPL Ironwood. |
· | Lower income taxes for the three and six-month periods due to lower pre-tax income in 2013, which reduced income taxes by $30 million and $77 million, partially offset for the six-month period 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 June 30.
| | | Income Statement | | Three Months | | Six Months | | | | Line Item | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | | | Adjusted energy-related economic activity, net, net of tax of ($51), $23, $28, ($79) | (a) | | $ | 76 | | $ | (32) | | $ | (41) | | $ | 118 | Impairments: | | | | | | | | | | | | | | | Adjustments - nuclear decommissioning trust investments, net of tax of $0, ($1), $0, ($2) | Other Income-net | | | | | | | | | | | | 1 | Other: | | | | | | | | | | | | | | | Change in tax accounting method related to repairs | Income Taxes | | | (3) | | | | | | (3) | | | | | | Other Operation | | | | | | | | | | | | | | Counterparty bankruptcy, net of tax of ($1), $0, ($1), $5 (b) | and Maintenance | | | 1 | | | | | | 1 | | | (6) | | Wholesale supply cost reimbursement, net of tax of $0, $0, $0, $0 | (c) | | | | | | 1 | | | | | | 1 | | | | Other Operation | | | | | | | | | | | | | | Ash basin leak remediation adjustment, net of tax of $0, $0, $0, ($1) | and Maintenance | | | | | | | | | | | | 1 | | Coal contract modification payments, net of tax of $0, $5, $0, $5 (d) | Fuel | | | | | | (7) | | | | | | (7) | Total | | | $ | 74 | | $ | (38) | | $ | (43) | | $ | 108 |
(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. In June 2013, PPL EnergyPlus received an approval for an administrative claim in the amount of $2 million. |
(c) | Recorded in "Wholesale energy marketing - Realized" on the Statement of Income. |
(d) | As a result of lower electricity and natural gas prices, coal-fired generation output decreased during 2012. 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 June 30, to the special item identified as "Adjusted energy-related economic activity, net."
| | | | Three Months | | Six Months | | | | | 2013 | | 2012 | | 2013 | | 2012 | Operating Revenues | | | | | | | | | | | | | | | Unregulated retail electric and gas | | $ | 20 | | $ | (12) | | $ | 12 | | $ | (2) | | | Wholesale energy marketing | | | 590 | | | (458) | | | (232) | | | 394 | Operating Expenses | | | | | | | | | | | | | | | Fuel | | | (4) | | | (16) | | | (5) | | | (14) | | | Energy Purchases | | | (479) | | | 442 | | | 155 | | | (149) | Energy-related economic activity (a) | | | 127 | | | (44) | | | (70) | | | 229 | Option premiums | | | | | | 1 | | | 1 | | | 1 | Adjusted energy-related economic activity | | | 127 | | | (43) | | | (69) | | | 230 | Less: Economic activity realized, associated with the monetization of | | | | | | | | | | | | | | certain full-requirement sales contracts in 2010 | | | | | | 12 | | | | | | 33 | Adjusted energy-related economic activity, net, pre-tax | | $ | 127 | | $ | (55) | | $ | (69) | | $ | 197 | | | | | | | | | | | | | | | | Adjusted energy-related economic activity, net, after-tax | | $ | 76 | | $ | (32) | | $ | (41) | | $ | 118 |
(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 depreciation and higher financing costs, partially offset by lower operation and maintenance expense, higher capacity prices and higher nuclear generation output.
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 realized economic activity associated with the monetization of certain full-requirement sales contracts in 2010. This economic activity was 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 "Unregulated Gross Energy Margins" as defined by PPL Energy Supply to "Operating Income" for the periods ended June 30.
| | | | | 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 | $ | 812 | | $ | (1) | | | $ | 811 | | $ | 1,075 | | $ | 8 | (c) | | $ | 1,083 | | | | | Unrealized economic activity | | | | | 590 | (d) | | | 590 | | | | | | (458) | (d) | | | (458) | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | to affiliate | | 12 | | | | | | | 12 | | | 17 | | | | | | | 17 | | Unregulated retail electric and gas | | 237 | | | 20 | (d) | | | 257 | | | 192 | | | (12) | (d) | | | 180 | | Net energy trading margins | | | | | | | | | | | | 10 | | | | | | | 10 | | Energy-related businesses | | | | | 122 | | | | 122 | | | | | | 112 | | | | 112 | | | | Total Operating Revenues | | 1,061 | | | 731 | | | | 1,792 | | | 1,294 | | | (350) | | | | 944 | | | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | | | | | | | | Fuel | | 223 | | | 1 | | | | 224 | | | 170 | | | 26 | (e) | | | 196 | | Energy purchases | | | | | | | | | | | | | | | | | | | | | | | | Realized | | 419 | | | (1) | | | | 418 | | | 617 | | | 18 | (c) | | | 635 | | | | | Unrealized economic activity | | | | | 479 | (d) | | | 479 | | | | | | (442) | (d) | | | (442) | | Energy purchases from affiliate | | 1 | | | | | | | 1 | | | | | | | | | | | | Other operation and maintenance | | 3 | | | 267 | | | | 270 | | | 7 | | | 287 | | | | 294 | | Depreciation | | | | | 79 | | | | 79 | | | | | | 69 | | | | 69 | | Taxes, other than income | | 10 | | | 6 | | | | 16 | | | 7 | | | 10 | | | | 17 | | Energy-related businesses | | | | | 118 | | | | 118 | | | | | | 109 | | | | 109 | | | | Total Operating Expenses | | 656 | | | 949 | | | | 1,605 | | | 801 | | | 77 | | | | 878 | Total | $ | 405 | | $ | (218) | | | $ | 187 | | $ | 493 | | $ | (427) | | | $ | 66 |
| | | | | | 2013 Six Months | | 2012 Six 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 | | $ | 1,789 | | $ | (2) | | | $ | 1,787 | | $ | 2,279 | | $ | 12 | (c) | | $ | 2,291 | | | | | Unrealized economic activity | | | | | | (232) | (d) | | | (232) | | | | | | 394 | (d) | | | 394 | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | | to affiliate | | | 26 | | | | | | | 26 | | | 38 | | | | | | | 38 | | Unregulated retail electric and gas | | | 483 | | | 12 | (d) | | | 495 | | | 406 | | | (2) | (d) | | | 404 | | Net energy trading margins | | | (11) | | | | | | | (11) | | | 18 | | | | | | | 18 | | Energy-related businesses | | | | | | 235 | | | | 235 | | | | | | 208 | | | | 208 | | | | Total Operating Revenues | | | 2,287 | | | 13 | | | | 2,300 | | | 2,741 | | | 612 | | | | 3,353 | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | | | | | | | | | Fuel | | | 522 | | | | | | | 522 | | | 385 | | | 22 | (e) | | | 407 | | Energy purchases | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | | 855 | | | (3) | | | | 852 | | | 1,251 | | | 43 | (c) | | | 1,294 | | | | | Unrealized economic activity | | | | | | (155) | (d) | | | (155) | | | | | | 149 | (d) | | | 149 | | Energy purchases from affiliate | | | 2 | | | | | | | 2 | | | 1 | | | | | | | 1 | | Other operation and maintenance | | | 8 | | | 497 | | | | 505 | | | 11 | | | 538 | | | | 549 | | Depreciation | | | | | | 157 | | | | 157 | | | | | | 133 | | | | 133 | | Taxes, other than income | | | 18 | | | 15 | | | | 33 | | | 16 | | | 19 | | | | 35 | | Energy-related businesses | | | | | | 228 | | | | 228 | | | | | | 201 | | | | 201 | | | | Total Operating Expenses | | | 1,405 | | | 739 | | | | 2,144 | | | 1,664 | | | 1,105 | | | | 2,769 | Total | | $ | 882 | | $ | (726) | | | $ | 156 | | $ | 1,077 | | $ | (493) | | | $ | 584 |
(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 six months ended June 30, 2012, "Wholesale energy marketing - Realized" and "Energy purchases - Realized" include net pre-tax losses of $12 million and $33 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. |
(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 six months ended June 30, 2012 include a pre-tax loss of $12 million related to coal contract modification payments. |
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 June 30, as well as the change between periods. The factors that gave rise to the changes are described below the table.
| | | Three Months | | Six Months | | | | 2013 | | 2012 | | Change | | 2013 | | 2012 | | Change | | | | | | | | | | | | | | | | | | | | | Non-trading | | | | | | | | | | | | | | | | | | | | Eastern U.S. | | $ | 349 | | $ | 407 | | $ | (58) | | $ | 779 | | $ | 896 | | $ | (117) | | Western U.S. | | | 56 | | | 76 | | | (20) | | | 114 | | | 163 | | | (49) | Net energy trading | | | | | | 10 | | | (10) | | | (11) | | | 18 | | | (29) | Total | | $ | 405 | | $ | 493 | | $ | (88) | | $ | 882 | | $ | 1,077 | | $ | (195) |
Unregulated Gross Energy Margins
Eastern U.S. | | | | | | | | | | | | | | The increase (decrease) in non-trading margins for the periods ended June 30, 2013 compared with 2012 were due to: |
| | Three Months | | Six Months | | | | | | | | Baseload energy prices | | $ | (121) | | $ | (246) | Nuclear fuel prices | | | (4) | | | (10) | Coal prices | | | 1 | | | (9) | Intermediate and peaking Spark Spreads | | | (7) | | | 7 | Nuclear generation volume | | | 9 | | | 9 | Full-requirement sales contracts | | | 5 | | | 10 | Gas optimization and storage | | | 10 | | | 11 | Ironwood Acquisition which eliminated tolling expense | | | 2 | | | 17 | Net economic availability of coal and hydroelectric plants | | | 7 | | | 39 | Capacity prices | | | 36 | | | 47 | Other | | | 4 | | | 8 | Total | | $ | (58) | | $ | (117) |
Western U.S.
Non-trading margins for the three and six months ended June 30, 2013 compared with the same periods in 2012 were lower due to $20 million and $59 million of lower wholesale prices. The six-month period was partially offset by $7 million of higher wholesale volumes.
Net Energy Trading Margins
Net energy trading margins for the three months ended June 30, 2013 compared with the same period in 2012 decreased as a result of lower margins of $5 million on power positions and $3 million on FTRs.
Net energy trading margins for the six months ended June 30, 2013 compared with the same period in 2012 decreased as a result of lower margins of $15 million on gas positions and $7 million on power positions.
Other Operation and Maintenance | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | Three Months | | Six Months | | | | | | | | Brunner Island Unit 3 outage in 2012 | $ | (4) | | $ | (19) | Uncollectible accounts (a) | | (4) | | | (15) | PPL Susquehanna projects | | (6) | | | (9) | PPL Susquehanna refueling outage | | (5) | | | (8) | Conemaugh Unit 2 outage in 2013 | | 3 | | | 5 | Other generation plant costs | | (7) | | | (1) | Other | | (1) | | | 3 | Total | $ | (24) | | $ | (44) |
(a) | The decrease for the six-month period 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. |
Depreciation
Depreciation increased by $10 million and $24 million for the three and six months ended June 30, 2013 compared with 2012, primarily due to $10 million and $20 million related to PP&E additions, and $6 million attributable to the Ironwood Acquisition for the six-month period.
Other Income (Expense) - net
For the three and six months ended June 30, 2013 compared with 2012, other income (expense) - net increased by $6 million and $5 million, primarily due to the impact of a $4 million worker's compensation adjustment.
See Note 12 to the Financial Statements for additional information on other income (expense) - net.
Interest Expense | | | | | | | | | | | | | | | The increase (decrease) in interest expense for the periods ended June 30, 2013 compared with 2012 was due to: |
| | Three Months | | Six Months | | | | | | | | | Ironwood Acquisition financing | | | | | $ | 4 | Capitalized interest | | $ | 3 | | | 6 | Other | | | | | | 2 | Total | | $ | 3 | | $ | 12 |
Income Taxes | | | | | | | | | | | | | | The increase (decrease) in income taxes for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | | | | | | | Three Months | | Six Months | | | | | | | | Higher (lower) pre-tax income | | $ | 53 | | $ | (172) | Federal and state tax reserve adjustments (a) | | | 7 | | | 6 | State deferred tax rate change (b) | | | | | | 11 | Other | | | (2) | | | 1 | Total | | $ | 58 | | $ | (154) |
(a) | During the three and six months ended June 30, 2013, PPL Energy Supply reversed $3 million tax benefit related to a 2008 change in method of accounting for certain expenditures for tax purposes and recorded $4 million in federal tax reserves related to differences in over (under) payment interest rates applied to audit claims as a result of the U.S. Supreme Court decision related to the Windfall Profits tax. |
(b) | During the six months ended June 30, 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: | | | | | | | | | | June 30, 2013 | | December 31, 2012 | | | | | | | | Cash and cash equivalents | | $ | 265 | | $ | 413 | Short-term debt | | $ | 575 | | $ | 356 |
The $148 million decrease in PPL Energy Supply's cash and cash equivalents position was primarily the net result of:
· | distributions to Member of $408 million; |
· | capital expenditures of $241 million; |
· | net cash provided by operating activities of $227 million; |
· | contributions from Member of $105 million; and |
· | an increase in short-term debt of $219 million. |
PPL Energy Supply's cash provided by operating activities decreased by $81 million for the six months ended June 30, 2013, compared with 2012. This was partially due to a $37 million increase in defined benefit plans funding and an $11 million increase in cash used by components of working capital (primarily due to changes in counterparty collateral of $118 million, partially offset by changes in fuel, materials and supplies of $79 million). In addition, a change of $31 million in other operating activities contributed to the decrease, partially due to changes in certain tax-related accounts.
Credit Facilities
PPL Energy Supply maintains credit facilities to provide liquidity and to backstop commercial paper issuances. At June 30, 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 | | | | | | | | | | | | | | | PPL Energy Supply Credit Facilities (a) | | $ | 3,150 | | | | | $ | 785 | | $ | 2,365 |
(a) | 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 9% 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 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 June 30, 2013 and December 31, 2012, PPL Energy Supply had $575 million and $356 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheets, at weighted-average interest rates of 0.29% and 0.50%.
Rating Agency Actions
Fitch, Moody's and S&P 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 Fitch, Moody's and S&P 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 on PPL Montana's pass-through trust certificates due 2020.
In July 2013, Moody's withdrew its rating and outlook for PPL Ironwood.
In July 2013, S&P lowered its rating, from BBB- to BB+, and retained the negative outlook for PPL Montana's pass-through trust certificates due 2020.
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 June 30, 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 periods ended June 30. See Notes 13 and 14 to the Financial Statements for additional information.
| | Gains (Losses) | | | Three Months | | Six Months | | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | $ | 229 | | $ | 1,215 | | $ | 473 | | $ | 1,082 | Contracts realized or otherwise settled during the period | | | (100) | | | (261) | | | (237) | | | (540) | Fair value of new contracts entered into during the period (a) | | | 37 | | | 13 | | | 46 | | | 12 | Other changes in fair value | | | 119 | | | (6) | | | 3 | | | 407 | Fair value of contracts outstanding at the end of the period | | $ | 285 | | $ | 961 | | $ | 285 | | $ | 961 |
(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 June 30, 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) | | $ | 226 | | $ | 32 | | $ | (10) | | $ | 5 | | $ | 253 | Prices based on significant unobservable inputs (Level 3) | | | 10 | | | 18 | | | 4 | | | | | | 32 | Fair value of contracts outstanding at the end of the period | | $ | 236 | | $ | 50 | | $ | (6) | | $ | 5 | | $ | 285 |
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 2018. The following table sets forth changes in the net fair value of trading commodity derivative contracts for the periods ended June 30. See Notes 13 and 14 to the Financial Statements for additional information.
| | Gains (Losses) | | | Three Months | | Six Months | | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | $ | 15 | | $ | 2 | | $ | 29 | | $ | (4) | Contracts realized or otherwise settled during the period | | | | | | (1) | | | (2) | | | (1) | Fair value of new contracts entered into during the period (a) | | | (4) | | | (1) | | | (16) | | | 5 | Other changes in fair value | | | 7 | | | 17 | | | 7 | | | 17 | Fair value of contracts outstanding at the end of the period | | $ | 18 | | $ | 17 | | $ | 18 | | $ | 17 |
(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 June 30, 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) | | $ | 4 | | $ | 6 | | | | | | | | $ | 10 | Prices based on significant unobservable inputs (Level 3) | | | 6 | | | 2 | | | | | | | | | 8 | Fair value of contracts outstanding at the end of the period | | $ | 10 | | $ | 8 | | | | | | | | $ | 18 |
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 six months ended June 30, 2013 was as follows.
| | | | | | Non-Trading | | | | Trading VaR | | VaR | 95% Confidence Level, Five-Day Holding Period | | | | | | | | Period End | | $ | 2 | | $ | 8 | | Average for the Period | | | 4 | | | 9 | | High | | | 6 | | | 10 | | Low | | | 2 | | | 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 June 30, 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 June 30, 2013.
At June 30, 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 June 30, 2013 would increase the fair value of its debt portfolio by $50 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 June 30, 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 June 30, 2013, a hypothetical 10% increase in interest rates and a 10% decrease in equity prices would have resulted in an estimated $57 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 costs of compliance or alleged non-compliance cannot be predicted with certainty but could be material. In addition, cost 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 Energy Supply's services.
Physical effects associated with possible 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 hydroelectric 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 waste) 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. On July 25, 2013, the U.S. House of Representatives passed House Bill H.R. 2218, the Coal Residuals and Reuse Management Act of 2013, which would preempt the EPA from regulating CCRs under RCRA and sets rules governing state programs. Prospects remain uncertain for similar legislation to pass in the U.S. Senate.
Effluent Limitation Guidelines (ELGs) In June 2013, the EPA published 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 transport water and metal cleaning waste waters, as well as new limits for scrubber wastewater and landfill leachate. The EPA's proposed ELG regulations also contain some requirements that would affect the inspection and operation of CCR facilities, if finalized. 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: requiring installation of Best Technology Available (BTA) to reduce mortality of aquatic organisms that are pulled into the plants cooling water system (entrainment); and imposing standards for reduction of mortality of aquatic organisms trapped on water intake screens (impingement). A final rule is expected to be issued in November 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 June 2013, President Obama released his Climate Action Plan which reiterates the goal of reducing greenhouse gas emissions in the U.S. "in the range of" 17% below 2005 levels by 2020 through such actions as regulating power plant emissions, promoting increased use of renewables and clean energy technology, and establishing tighter energy efficiency standards. Also, by Presidential Memorandum the EPA was directed to issue a new proposal for new power plants by September 20, 2013, with a final rule to be issued in a timely fashion thereafter, and to issue proposed standards for existing power plants by June 1, 2014 with a final rule by June 1, 2015. The EPA was further directed to require that states develop implementation plans for existing plants by June 2016. Regulation of existing plants could have a significant industry-wide impact depending on the structure and stringency of the final rule and the state implementation plans. The Administration's recent increase in its estimate of the "social cost of carbon" (which is used to calculate benefits associated with proposed regulations) from $23.80 to $38 per metric ton in 2015 may lead to more costly regulatory requirements.
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.
Regional Haze Under the EPA's regional haze programs (developed to eliminate man-made visibility degradation by 2064), states are required to make reasonable progress every decade, including the application of Best Available Retrofit Technology (BART) on power plants commissioned between 1962 and 1977. For the eastern U.S. the EPA had determined that region-wide reductions under the CAIR or CSAPR trading program could be utilized by states programs to satisfy BART requirements. However, the August 2012 decision by the U.S. Court of Appeals for the District of Columbia Circuit (Circuit Court) to
vacate and remand CSAPR will likely expose power plants located in the eastern U.S., including PPL Energy Supply's plants in Pennsylvania, to reductions in sulfur dioxide and nitrogen oxides as required by BART.
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).
CSAPR and CAIR In 2011, the EPA finalized its CSAPR regulating emissions of nitrogen 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 U.S. In December 2011, the Circuit Court stayed implementation of CSAPR, leaving CAIR in place. Subsequently, in August 2012, the Circuit Court vacated and remanded CSAPR back to the EPA for further rulemaking, again leaving CAIR in place in the interim, and on June 24, 2013 the U.S. Supreme Court granted the EPA's petition for review of the Circuit Court's decision.
PPL Energy Supply plants in Pennsylvania will continue to comply with CAIR through optimization of existing controls, balanced with emission allowance purchases. The Circuit Court's August 2012 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.
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 additional information on 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 and six months ended June 30, 2013 with the same periods in 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 capital expenditure programs, 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 in order to achieve more timely recovery. The recently approved DSIC mechanism will help reduce regulatory lag on distribution reliability-related capital investment. See "Financial and Operational Developments - Distribution System Improvement Charge" 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 and six months ended June 30, 2013 was $45 million and $109 million compared to $29 million and $62 million for the same periods in 2012, representing a 55% and 76% increase over the same periods in 2012.
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.
Distribution System Improvement Charge
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. In May 2013, the PUC approved PPL Electric's proposal to establish a DSIC, with an initial rate effective July 1, 2013, subject to refund after hearings. See Note 6 to the Financial Statements for additional information.
FERC Formula Rates
PPL Electric must follow FERC's Uniform System of Accounts, which requires subsidiaries to be presented, for FERC reporting purposes, using the equity method of accounting unless a waiver has been granted. The FERC has granted waivers of this requirement to other utilities when alternative accounting would more accurately present the integrated operations of a utility and its subsidiaries. In March 2013, as part of a routine FERC audit of PPL and its subsidiaries, PPL Electric determined that it never obtained a required waiver of the equity method accounting requirement for its subsidiary, PPL Receivables Corporation (PPL Receivables) for FERC Form No. 1 reporting. In March 2013, PPL Electric filed a request for waiver with the FERC that, if approved, would allow it to continue to consolidate the results of PPL Receivables, as it has done since 2004. If PPL Electric is not successful in obtaining the waiver, its 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. See Note 6 to the Financial Statements for additional information.
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 and six months ended June 30, 2013 with the same periods in 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 June 30 was: | | | | | | | | | | | | | | | | | | Three Months | | Six Months | | | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | Net Income Available to PPL | | $ | 45 | | $ | 29 | | $ | 109 | | $ | 62 |
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 | | Six Months | | | | | | | | Pennsylvania Gross Delivery Margins | | $ | 21 | | $ | 61 | Other operation and maintenance | | | 13 | | | 20 | Depreciation | | | (5) | | | (9) | Interest Expense | | | (1) | | | (2) | Other | | | 1 | | | (1) | Income Taxes | | | (13) | | | (26) | Distributions on preference stock | | | | | | 4 | Total | | $ | 16 | | $ | 47 |
· | 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 for the three-month period primarily due to lower corporate service costs of $6 million and lower vegetation management of $2 million. |
Lower other operation and maintenance for the six-month period primarily due to lower corporate service costs of $11 million and lower vegetation management of $3 million.
· | Higher depreciation for the three and six-month periods primarily due to the impact of PP&E additions related to the ongoing efforts to ensure the reliability of the delivery system and replace aging infrastructure. |
· | Higher income taxes for the three and six-month periods primarily due to higher pre-tax income. |
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 and 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 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 table reconcilestables reconcile "Pennsylvania Gross Delivery Margins" to "Operating Income" as defined by PPL Electric to "Operating Income" for the periods ended March 31.June 30. | | | | | 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 | | | | | | | | | | | | | | | | | | | Retail electric | $ | 413 | | | | | $ | 413 | | $ | 403 | | | | | $ | 403 | | Electric revenue from affiliate | | 1 | | | | | | 1 | | | 1 | | | | | | 1 | | | | Total Operating Revenues | | 414 | | | | | | 414 | | | 404 | | | | | | 404 | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | | | | | | Energy purchases | | 120 | | | | | | 120 | | | 120 | | | | | | 120 | | Energy purchases from affiliate | | 12 | | | | | | 12 | | | 17 | | | | | | 17 | | Other operation and maintenance | | 21 | | $ | 103 | | | 124 | | | 26 | | $ | 117 | | | 143 | | Depreciation | | | | | 44 | | | 44 | | | | | | 39 | | | 39 | | Taxes, other than income | | 19 | | | 3 | | | 22 | | | 20 | | | 2 | | | 22 | | | | Total Operating Expenses | | 172 | | | 150 | | | 322 | | | 183 | | | 158 | | | 341 | Total | $ | 242 | | $ | (150) | | $ | 92 | | $ | 221 | | $ | (158) | | $ | 63 |
| | | | 2013 Three Months | | 2012 Three Months | | | | 2013 Six Months | | 2012 Six Months | | | | | PA Gross | | | | | | PA Gross | | | | | | | | PA Gross | | | | | | PA Gross | | | | | | | | | Delivery | | | | Operating | | Delivery | | | | Operating | | | | Delivery | | | | Operating | | Delivery | | | | 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 | | | | | | | | | | | | | Operating Revenues | | | | | | | | | | | | | | Retail electric | | $ | 512 | | | | $ | 512 | | $ | 457 | | | | $ | 457 | Retail electric | | $ | 925 | | | | $ | 925 | | $ | 860 | | | | $ | 860 | | Electric revenue from affiliate | | | 1 | | | | | | 1 | | | 1 | | | | | | 1 | Electric revenue from affiliate | | | 2 | | | | | | 2 | | | 2 | | | | | | 2 | | | Total Operating Revenues | | | 513 | | | | | | 513 | | | 458 | | | | | | 458 | | Total Operating Revenues | | | 927 | | | | | | 927 | | | 862 | | | | | | 862 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | Operating Expenses | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | Energy purchases | | 172 | | | | 172 | | 153 | | | | 153 | Energy purchases | | 292 | | | | 292 | | 273 | | | | 273 | | Energy purchases from affiliate | | 14 | | | | 14 | | 21 | | | | 21 | Energy purchases from affiliate | | 26 | | | | 26 | | 38 | | | | 38 | | Other operation and maintenance | | 22 | | $ | 111 | | 133 | | 22 | | $ | 118 | | 140 | Other operation and maintenance | | 43 | | $ | 214 | | 257 | | 49 | | $ | 234 | | 283 | | Depreciation | | | | 43 | | 43 | | | | 39 | | 39 | Depreciation | | | | 87 | | 87 | | | | 78 | | 78 | | Taxes, other than income | | | 28 | | | 2 | | | 30 | | | 25 | | | 1 | | | 26 | Taxes, other than income | | | 47 | | | 5 | | | 52 | | | 44 | | | 4 | | | 48 | | | Total Operating Expenses | | | 236 | | | 156 | | | 392 | | | 221 | | | 158 | | | 379 | | Total Operating Expenses | | | 408 | | | 306 | | | 714 | | | 404 | | | 316 | | | 720 | Total | Total | | $ | 277 | | $ | (156) | | $ | 121 | | $ | 237 | | $ | (158) | | $ | 79 | Total | | $ | 519 | | $ | (306) | | $ | 213 | | $ | 458 | | $ | (316) | | $ | 142 |
(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 March 31,June 30, as well as the change between periods. The factors that gave rise to the change are described below the table. | | | | | | | | | | | | Three Months | | | | | | | | | | | | | 2013 | | 2012 | | Change | PA Gross Delivery Margins by Component | | | | | | | | | | | | | | | | | | | | Distribution | | | | | | | | | | | $ | 224 | | $ | 189 | | $ | 35 | | Transmission | | | | | | | | | | | | 53 | | | 48 | | | 5 | | Total | | | | | | | | | | | $ | 277 | | $ | 237 | | $ | 40 |
| | | Three Months | | Six Months | | | | 2013 | | 2012 | | Change | | 2013 | | 2012 | | Change | | | | | | | | | | | | | | | | | | | | | PA Gross Delivery Margins by Component | | | | | | | | | | | | | | | | | | | | Distribution | | $ | 183 | | $ | 170 | | $ | 13 | | $ | 407 | | $ | 359 | | $ | 48 | | Transmission | | | 59 | | | 51 | | | 8 | | | 112 | | | 99 | | | 13 | | Total | | $ | 242 | | $ | 221 | | $ | 21 | | $ | 519 | | $ | 458 | | $ | 61 |
Distribution
Margins increased for the three months ended March 31,June 30, 2013 compared with 2012, primarily due to an $11 million favorable effect of price as a result of higher base rates, effective January 1, 2013.
Margins increased for the six months ended June 30, 2013 compared with 2012, primarily due to a $13 million favorableadverse effect of mild weather in 2012 and a $19$32 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$4 million.
Transmission
Margins increased for the three and six months ended March 31,June 30, 2013 compared with 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) |
Other Operation and Maintenance | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | Three Months | | Six Months | | | | | | | | | | | | | | Vegetation management | $ | (2) | | $ | (3) | Act 129 costs (a) | | (7) | | | (7) | Uncollectible accounts | | (1) | | | (3) | Corporate service costs (b) | | (6) | | | (11) | Other | | (3) | | | (2) | Total | $ | (19) | | $ | (26) |
(a) | The decrease is due to a reduction in Act 129 energy efficiency and conservation plan costs for Phase 1 programs. Phase 1 ended May 31, 2013. |
(b) | 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. |
Depreciation
Depreciation increased by $4$5 million and $9 million for the three and six months ended March 31,June 30, 2013 compared with 2012, primarily due to PP&E additions as part of ongoing investments to enhance system reliability.
Taxes, Other Than Income
Taxes, other than income increased by $4 million for the threesix months ended March 31,June 30, 2013 compared with 2012, primarily due to higher Pennsylvania gross receipts tax expense due to higher retail electricity revenue. This tax is included in "Pennsylvania Gross Delivery Margins."
Financing CostsIncome Taxes | | | | | | | | | | | | | | The increase (decrease) in income taxes for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | | | | | | | | | Three Months | | Six Months | | | | | | | | Higher (lower) pre-tax income | | $ | 11 | | $ | 27 | Depreciation not normalized | | | 2 | | | | Other | | | | | | (1) | Total | | $ | 13 | | $ | 26 |
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.
Income Taxes | | | �� | | | | | | | | | | | The increase (decrease) in income taxes for the period ended March 31, 2013 compared with 2012 was due to: | | | | | | | | | | | | | | | | Three Months | | | | | | | | Higher pre-tax book income | | | | | $ | 16 | Depreciation not normalized | | | | | | (2) | Other | | | | | | (1) | Total | | | | | $ | 13 |
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: | | | | | | | | | | | | March 31, 2013 | | December 31, 2012 | | June 30, 2013 | | December 31, 2012 | | | | | | | | | | Cash and cash equivalents | | $ | 31 | | $ | 140 | | $ | 24 | | $ | 140 | Short-term debt | | $ | 125 | | | | | $ | 85 | | $ | |
The $109$116 million decrease in PPL Electric's cash and cash equivalents position was primarily the net result of:
· | capital expenditures of $189 million; |
· | net cash used in operating activities of $77$451 million; |
· | the payment of $25$66 million of common stock dividends to parent; partially offset |
· | contributions from parent of $205 million; |
· | net cash provided by operating activities of $115 million; and |
· | a net increase in short-term debt of $125 million; and |
· | contributions from parent of $60$85 million. |
PPL Electric's cash used inprovided by operating activities increased by $67$14 million for the threesix months ended March 31,June 30, 2013 compared with 2012. The increase was aprimarily the net effect of:of a $72 million increase in net income when adjusted for non-cash components, partially offset by an increase of $55 million in cash used by components of working capital.
· | 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 | Capital expenditures increased by $195 million for the six months ended June 30, 2013 compared with 2012, primarily due to the Susquehanna-Roseland transmission project and projects to enhance system reliability.· | 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 March 31,June 30, 2013, PPL Electric'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 (a) | | $ | 300 | | | | | $ | 126 | | $ | 174 | Asset-backed Credit Facility (b) | | | 100 | | | | | | n/a | | | 100 | Total PPL Electric Credit Facilities | | $ | 400 | | | | | $ | 126 | | $ | 274 |
| | | | | | | | | Letters of | | | | | | | | | | | | | Credit Issued | | | | | | | | | | | and | | | | | | Committed | | | | Commercial | | Unused | | | | Capacity | | Borrowed | | Paper Backup | | Capacity | | | | | | | | | | | PPL Electric Credit Facilities (a) | | $ | 400 | | | | | $ | 86 | | $ | 314 |
(a) | The commitments under thisthe $300 million syndicated credit facility are provided by a diverse bank group, with no one bank and its affiliates providing an aggregate commitment of more than 5% of the total committed capacity. |
(b) | 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. |
See Note 7 to the Financial Statements for further discussion of PPL Electric's credit facilities.
Commercial Paper
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,June 30, 2013, PPL Electric had $125$85 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheet, at a weighted-average interest rate of 0.39%0.34%. PPL Electric had no commercial paper outstanding at December 31, 2012.
Long-term Debt
In July 2013, PPL Electric issued $350 million of 4.75% First Mortgage Bonds due 2043. PPL Electric received proceeds of $345 million, net of a discount and underwriting fees, which will be used for capital expenditures, to fund pension obligations and for other general corporate purposes.
Rating Agency Actions
Fitch, Moody's and 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 Fitch, Moody's and 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. PPL Electric does not have 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 did not take anytook the following actions related to PPL Electric in 2013.2013:
In July 2013, Fitch, Moody's and S&P assigned ratings of A-, A3 and A- to PPL Electric's $350 million 4.75% First Mortgage Bonds due 2043. Fitch also assigned a stable outlook to these notes and S&P assigned a recovery rating of 1+.
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 2012 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 March 31,June 30, 2013, PPL Electric's potential annual exposure to increased interest expense, based on 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 March 31,June 30, 2013 would increase the fair value of its debt portfolio by $71$95 million.
See Notes 13 and 14 to the Financial Statements in this Form 10-Q and "Risk Management" in PPL Electric's 2012 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 possible 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.
The following is a discussion of the more significant environmental matters.
GHG Regulations In June 2013, President Obama released his Climate Action Plan which, among other things, calls for actions to be taken to prepare the U.S. for the impacts of climate change. PPL Electric and others in the industry could be affected by resulting guidelines and standards which may require transmission system modifications to improve the ability of critical infrastructure to withstand major storms.
See Note 10 to the Financial Statements in this Form 10-Q and "Item 1. Business - Environmental Matters" in PPL Electric's 2012 Form 10-K for a discussion ofadditional information on 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: 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 2012 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 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 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 six months ended March 31,June 30, 2013 with 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 and a wholly owned subsidiary of PPL. LKE has regulated utility operations through its subsidiaries, LG&E and KU, which constitute substantially all of LKE's assets. LG&E and KU are engaged in the generation, transmission, distribution and sale of electric energy. LG&E also engages in the distribution and sale of natural gas. LG&E and KU maintain their separate identities and serve customers in 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, competitively priced energy to its customers and reasonable returns on regulated investments to its member. Rate base is expected to grow as a result of significant capital expenditure programs to maintain reliable service and comply with federal and state regulations. LKE is focused on efficient operations, strong customer service, timely recovery of costs and constructive regulatory relationships.
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 six months ended March 31,June 30, 2013 was $96$64 million and $160 million compared to $53$44 million and $97 million for the same periods in 2012 representing an 81% increaseincreases of 45% and 65% over 2012.
See "Results of Operations" for a discussion and analysis of LKE's earnings.
Economic and Market Conditions
The KPSC has adopted a series of regulatory mechanisms (ECR, DSM, GLT, a fuel adjustment clause, a gas supply clause and recovery on certain construction work-in-progress) that provide for recovery of prudently incurred costs. The utility
businesses are impacted by changes in customer usage levels which can be driven by a number of factors including weather conditions and economic factors that impact the load utilized by industrial and commercial customers.
LKE's businesses are subject to extensive federal, state and local environmental laws, rules and regulations. Certain regulated generation assets at LG&E and KU will require substantial capital investment. LG&E and KU project $2.1 billion of capital investment over the next five years to satisfy certain of these requirements. See Note 10 to the Financial Statements for additional information on these requirements. These requirements have resulted in LKE's anticipated retirement by 2015 of five coal-fired units with a combined summer capacity rating of 726 MW. KU retired the 71 MW unit at the Tyrone plant in February 2013. The retirement of the five coal-fired units is not expected to have a material impact on the financial condition or results of operations of LKE. See Note 8 to the Financial Statements in LKE's 2012 Form 10-K for additional information regarding the anticipated retirement of these units as well as plans to build a combined-cycle natural gas facility in Kentucky.
LKE cannot predict the future impact that these economic and market conditions and changes in regulatory requirements may have on its financial condition or results of operations.
Rate Case Proceedings
In 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 and an increase in annual base gas rates of $15 million for LG&E using a 10.25% return on equity. The approved rates became effective January 1, 2013. Results of Operations
The following discussion provides a summary of LKE's earnings and a description of key factors expected 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 six months ended March 31,June 30, 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 for future periods.
Earnings | | | | | | | | | | | | | | | | | | | | Net Income for the period ended March 31 was: | | | | | | | | | | Net Income for the periods ended June 30 was: | | Net Income for the periods ended June 30 was: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Three Months | | | Three Months | | Six Months | | | | | | | | 2013 | | 2012 | | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | | | Net Income | Net Income | | | | | | $ | 96 | | $ | 53 | Net Income | | $ | 64 | | $ | 44 | | $ | 160 | | $ | 97 |
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 and certain items that management considers special. See additional detail of these special items in the table below.
| | | | 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 |
| | Three Months | | Six Months | | | | | | | | Margins | | $ | 32 | | $ | 107 | Other operation and maintenance | | | | | | 10 | Depreciation | | | (8) | | | (17) | Taxes, other than income | | | | | | (1) | Other Income (Expense) - net | | | 7 | | | 7 | Interest Expense | | | | | | 1 | Income Taxes | | | (17) | | | (47) | Special items, after-tax | | | 6 | | | 3 | Total | | $ | 20 | | $ | 63 |
· | See "Statement of Income Analysis - Margins - Changes in Non-GAAP Financial Measures" for an explanation of Margins. |
· | Lower other operation and maintenance for the six-month period primarily due to $14$17 million of lower costs due to the timing and scope of scheduled coal plant maintenance outages,outages. This decrease was partially offset by $4 million of adjustments to regulatory assets and liabilities.liabilities and increased coal plant operation costs of $3 million. |
· | Higher depreciation for the three and six-month periods primarily due to environmental costs related to the elimination of the 2005 and 2006 ECR plans now being included in base rates, which added $13 million and $26 million to depreciation that is excluded from Margins,Margins. This increase was partially offset by lower depreciation of $5$6 million and $11 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 other income (expense) - net for the three and six-month periods primarily due to losses from the EEI investment recorded in 2012. The EEI investment was fully impaired in the fourth quarter of 2012. |
· | Higher income taxes for the three and six-month periods primarily due to higher pre-tax income. |
The following after-tax gains (losses), which management considers special items, also impacted earnings during the periods ended March 31.June 30.
| | Income Statement | | Three Months | | Income Statement | | Three Months | | Six Months | | | Line Item | | 2013 | | 2012 | | Line Item | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | EEI adjustments | EEI adjustments | Other Income (Expense) - net | | $ | 1 | | | EEI adjustments | Other Income (Expense) - net | | | | | | $ | 1 | | | | | | Income Taxes and Other | | | | | | | | | Net operating loss carryforward and other tax-related adjustments | Net operating loss carryforward and other tax-related adjustments | Income Taxes and Other O&M | | | | | $ | 4 | Net operating loss carryforward and other tax-related adjustments | Operation and Maintenance | | | | | | | | $ | 4 | Discontinued Operations, net of tax of ($1), $4, ($1), $4 | | Discontinued Operations, net of tax of ($1), $4, ($1), $4 | Discontinued Operations | | $ | 1 | | $ | (5) | | | 1 | | | (5) | Total | Total | | | $ | 1 | | $ | 4 | Total | | | $ | 1 | | $ | (5) | | $ | 2 | | $ | (1) |
2013 Outlook
Excluding special items, LKE projects higher 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, 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 2012 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 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 mechanisms are offset. 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 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 with budget.
Reconciliation of Non-GAAP Financial Measures
The following table reconcilestables reconcile "Margins" to "Operating Income" as defined by LKE for the periods ended March 31.June 30.
| | | | | | 2013 Three Months | | | 2012 Three Months | | | | | | | | | | | Operating | | | | | | | | Operating | | | | | | | Margins | | Other (a) | | Income (b) | | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | Operating Revenues | | $ | 800 | | | | | $ | 800 | | | $ | 705 | | | | | $ | 705 | Operating Expenses | | | | | | | | | | | | | | | | | | | | | Fuel | | | 231 | | | | | | 231 | | | | 213 | | | | | | 213 | | Energy purchases | | | 86 | | | | | | 86 | | | | 74 | | | | | | 74 | | Other operation and maintenance | | | 25 | | $ | 172 | | | 197 | | | | 22 | | $ | 184 | | | 206 | | Depreciation | | | | | | 82 | | | 82 | | | | 13 | | | 73 | | | 86 | | Taxes, other than income | | | | | | 12 | | | 12 | | | | | | | 11 | | | 11 | | | | Total Operating Expenses | | | 342 | | | 266 | | | 608 | | | | 322 | | | 268 | | | 590 | Total | | $ | 458 | | $ | (266) | | $ | 192 | | | $ | 383 | | $ | (268) | | $ | 115 |
| | | | | | 2013 Three Months | | | 2012 Three Months | | | | | | | | | | | Operating | | | | | | | | Operating | | | | | | | Margins | | Other (a) | | Income (b) | | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | Operating Revenues | | $ | 682 | | | | | $ | 682 | | | $ | 658 | | | | | $ | 658 | Operating Expenses | | | | | | | | | | | | | | | | | | | | | Fuel | | | 216 | | | | | | 216 | | | | 215 | | | | | | 215 | | Energy purchases | | | 37 | | | | | | 37 | | | | 34 | | | | | | 34 | | Other operation and maintenance | | | 23 | | $ | 174 | | | 197 | | | | 24 | | $ | 173 | | | 197 | | Depreciation | | | 2 | | | 81 | | | 83 | | | | 13 | | | 73 | | | 86 | | Taxes, other than income | | | | | | 12 | | | 12 | | | | | | | 12 | | | 12 | | | | Total Operating Expenses | | | 278 | | | 267 | | | 545 | | | | 286 | | | 258 | | | 544 | Total | | $ | 404 | | $ | (267) | | $ | 137 | | | $ | 372 | | $ | (258) | | $ | 114 |
| | | | | | 2013 Six Months | | | 2012 Six Months | | | | | | | | | | | Operating | | | | | | | | Operating | | | | | | | Margins | | Other (a) | | Income (b) | | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | Operating Revenues | | $ | 1,482 | | | | | $ | 1,482 | | | $ | 1,363 | | | | | $ | 1,363 | Operating Expenses | | | | | | | | | | | | | | | | | | | | | Fuel | | | 447 | | | | | | 447 | | | | 428 | | | | | | 428 | | Energy purchases | | | 123 | | | | | | 123 | | | | 108 | | | | | | 108 | | Other operation and maintenance | | | 48 | | $ | 346 | | | 394 | | | | 46 | | $ | 357 | | | 403 | | Depreciation | | | 2 | | | 163 | | | 165 | | | | 26 | | | 146 | | | 172 | | Taxes, other than income | | | | | | 24 | | | 24 | | | | | | | 23 | | | 23 | | | | Total Operating Expenses | | | 620 | | | 533 | | | 1,153 | | | | 608 | | | 526 | | | 1,134 | Total | | $ | 862 | | $ | (533) | | $ | 329 | | | $ | 755 | | $ | (526) | | $ | 229 |
(a) | Represents amounts excluded from Margins. |
(b) | As reported on the Statements of Income. |
Changes in Non-GAAP Financial Measures
Margins increased by $75$32 million for the three months ended March 31, 2013 compared with 2012three-month period primarily due to higher base rates of $31 million, higher volumes of $19$25 million, environmental costscost recoveries added to base rates of $18$14 million and increased environmental investments of $7$3 million, partially offset by lower volumes of $9 million. The change in volumes was partially attributable to weather, as cooling degree days decreased 14% compared to the same period in 2012.
Margins increased by $107 million for the six-month period primarily due to higher base rates of $56 million, environmental cost recoveries added to base rates of $32 million, increased environmental investments of $10 million and higher volumes of $10 million. The change in volumes was attributable to weather, as heating degree days increased 40% compared to the same period in 2012, offsetting the lower cooling degree days for the three-month period.
The increase in base rates was the result of new KPSC rates going into effect oneffective January 1, 2013. The increase in volumes was attributable to colder weather in 2013 compared with 2012. Total heating degree days increased 41%. The environmental costscost recoveries added to base rates waswere due to the elimination of the 2005 and 2006 ECR plans as a result of the 2012 Kentucky rate case.cases. This elimination results in depreciation and other operation and maintenance expenses associated with the 2005 and 2006 ECR plans being excluded from Margins in 2013.2013, while the recovery of such costs remain in Margins through base rates.
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) | | | | $ | (14) | Bad debt expense | | | | | (3) | Adjustments to regulatory assets and liabilities | | | | | 4 | Other | | | | | 4 | Total | | | | $ | (9) |
Other Operation and Maintenance | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance expense for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | Three Months | | Six Months | | | | | | | | Coal plant outages (a) | $ | (4) | | $ | (17) | Adjustments to regulatory assets and liabilities | | | | | 4 | Coal plant operations | | | | | 3 | Other | | 4 | | | 1 | Total | $ | | | $ | (9) |
(a) | Decrease is primarily due to the timing and scope of scheduled outages. |
Depreciation | | | | | | | | | The increase (decrease) in 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
The increase (decrease) in depreciation for the periods ended June 30, 2013 compared with 2012 was due to:
| | Three Months | | Six Months | | | | | | | Lower depreciation rates effective January 1, 2013 | $ | (6) | | $ | (11) | Additions to PP&E | | 2 | | | 4 | Other | | 1 | | | | Total | $ | (3) | | $ | (7) |
Other Income (Expense) - net
Other income (expense) - net increased by $7 million and $8 million for the three and six months ended June 30, 2013 compared with 2012 primarily due to losses from the EEI investment recorded in 2012. The EEI investment was fully impaired in the fourth quarter of 2012.
Income Taxes
Income taxes increased by $36$17 million and $53 million for the three and six months ended March 31,June 30, 2013 compared with 2012 primarily due to higher pre-tax income.
See Note 5 to the Financial Statements for additional information on 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 |
Income (Loss) from Discontinued Operations (net of income taxes)
Income (loss) from discontinued operations increased by $7 million for the three and six months ended June 30, 2013 compared with 2012. The increase was primarily related to an adjustment to the estimated liability for indemnifications related to the 2009 termination of the WKE lease recorded in 2012.
Financial Condition | | | | | | | | Liquidity and Capital Resources | | | | | | | | LKE had the following at: | | | | | | | | | | June 30, 2013 | | December 31, 2012 | | | | | | | | Cash and cash equivalents | | $ | 23 | | $ | 43 | | | | | | | | Short-term debt (a) | | $ | 252 | | $ | 125 | | | | | | | | Notes payable with affiliates | | $ | 72 | | $ | 25 |
(a) | Represents borrowings under LG&E's and KU's commercial paper programs. See Note 7 to the Financial Statements for additional information. |
The $9$20 million increasedecrease in LKE's cash and cash equivalents position was primarily the net result of:
· | capital expenditures of $579 million; and |
· | distributions to member of $69 million; partially offset by |
· | cash provided by operating activities of $85$297 million; |
· | capital contributions from member of $146 million; |
· | an increase in short term debt of $60$127 million; and |
· | an increase in notes payable with affiliates of $60 million; and |
· | capital contributions from member of $75 million; offset by |
· | capital expenditures of $271$47 million. |
LKE's cash provided by operating activities decreased by $147$57 million for the threesix months ended March 31,June 30, 2013, compared with 2012, primarily as a result of:due to:
· | an increase in cash outflows from other operating activities of $110$119 million driven by a $96$94 million increase in discretionary defined benefit plan contributions; and |
· | a decline in working capital cash flow changes of $98$36 million driven primarily by changesincreases in accounts receivable and unbilled revenues due to higher sales volumes,extended payment terms and higher rates and extendeda lower federal income tax accrual in 2013 as a result of a federal settlement payment, terms, offset by an increase in accounts payable primarily due to timing of fuel purchase commitments and payments, and lower inventory levels in 2013 compared with 2012 driven by increased generation;generation at the plants and higher gas consumption from storage; partially offset by |
· | an increase in net income adjusted for non-cash items of $61$98 million (deferred income taxes and investment tax credits of $13$39 million, defined benefit plans - expense of $7 million, partially offset by depreciation of $7 million and other non-cash items of $2 million, offset by depreciation of $4 million). |
Capital expenditures increased by $97$255 million during the threesix months ended March 31,June 30, 2013 compared with 2012 primarily due to environmental air projects at the Mill Creek and Ghent plants, coal consumption residual projects at the Ghent plant and construction of Cane Run Unit 7.
Credit Facilities
At March 31,June 30, 2013, LKE'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 Backup | | Capacity | | | 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 | LKE Credit Facility with a subsidiary of PPL Energy Funding Corporation | | $ | 300 | | $ | 72 | | | | $ | 228 | LG&E Credit Facility (a) | LG&E Credit Facility (a) | | 500 | | | | | $ | 70 | | | 430 | LG&E Credit Facility (a) | | 500 | | | | | $ | 80 | | | 420 | KU Credit Facilities (a) (b) | KU Credit Facilities (a) (b) | | | 598 | | | | | | 313 | | | 285 | KU Credit Facilities (a) (b) | | | 598 | | | | | | 370 | | | 228 | | Total Credit Facilities (c) | | $ | 1,398 | | $ | 85 | | $ | 383 | | $ | 930 | | Total LG&E and KU Credit Facilities (c) | | Total LG&E and KU Credit Facilities (c) | | $ | 1,398 | | $ | 72 | | $ | 450 | | $ | 876 |
(a) | Each company pays customary fees under their respective syndicated credit facilities, as well as KU's letter of credit facility, and borrowings generally bear interest at LIBOR-based rates plus an applicable margin. |
(b) | In May 2013, KU extended its $198 million letter of credit facility to May 2016. |
(c) | The $1.098 billion of commitments under LG&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 11%13% of the total committed capacity; however, the PPL affiliate provided a commitment of approximately 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
During 2012, LG&E and KU currently planreceived KPSC and other state approvals 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. The credit ratings of LKE and its subsidiaries affect its liquidity, access to capital markets and cost of borrowing under its credit facilities.
The rating agencies did not take any actionstook the following action related to LKE and its subsidiaries during 2013:
In July 2013, S&P confirmed the first quarter of 2013.long-term AA+ ratings for KU's 2000 Series A Solid Waste Disposal Facility Revenue Bonds and KU's 2004 Series A, 2006 Series B and 2008 Series A Environmental Facilities Revenue Bonds. S&P also confirmed the A-1+ short-term rating on these Bonds.
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 March 31,June 30, 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 sells 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
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 March 31,June 30, 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 March 31,June 30, 2013, would increase the fair value of its debt portfolio by $111$112 million.
At March 31, 2013, LKE had the following interest rate hedges outstanding: | | At June 30, 2013, LKE had the following interest rate hedges outstanding: | | At June 30, 2013, LKE had the following interest rate hedges outstanding: | | | | | | | | | | | | | | | | | | | | | | | Effect of a | | | | | | | Effect of a | | | | | | | | 10% Adverse | | | | | | | 10% Adverse | | | | | | Fair Value, | | Movement | | | | | Fair Value, | | Movement | | | | Exposure | | Net - Asset | | in Interest | | | Exposure | | Net - Asset | | In Interest | | | | Hedged | | (Liability) (a) | | Rates | | | Hedged | | (Liability) (a) | | Rates | Economic activity | Economic activity | | | | | | | Economic activity | | | | | | | | Interest rate swaps (b) | | $ | 179 | | $ | (55) | | $ | (3) | Interest rate swaps (b) | | $ | 179 | | $ | (44) | | $ | (4) | Cash flow hedges | Cash flow hedges | | | | | | | Cash flow hedges | | | | | | | | Interest rate swaps (b) | | 300 | | 24 | | (17) | Interest rate swaps (b) | | 500 | | 72 | | (32) |
(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. The positions outstanding at March 31,June 30, 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 LKE's 2012 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
Extensive federal, state and local environmental laws and regulations are applicable to LG&E's and KU's air emissions, water discharges and the management of hazardous and solid waste, as well as other aspects 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 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 cost for their products or their demand for LG&E's and KU's services.
Physical effects associated with possible 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 hydrohydroelectric 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)non-hazardous waste) 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. On July 25, 2013, the U.S. House of Representatives passed House Bill H.R. 2218, the Coal Residuals and Reuse Management Act of 2013, which would preempt the EPA from regulating CCRs under RCRA and sets rules governing state programs. Prospects remain uncertain for similar legislation to pass in the U.S. Senate.
Effluent Limitation Guidelines (ELGs) On April 19,In June 2013, the EPA issuedpublished 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 handlingtransport water and metal cleaning wasteswaste waters, as well as new limits for scrubber wastewater gasification wastewater and landfill leachate. The EPA's proposed ELG regulations also contain some requirements that would affect the inspection and operation of CCR facilities, if finalized. 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 requiresrequiring 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 imposesimposing standards for reduction of mortality of aquatic organisms trapped on water intake screens (impingement). A final rule is expected to be issued in JuneNovember 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 June 2013, President Obama released his Climate Action Plan, which reiterates the goal of reducing greenhouse gas emissions in the U.S. "in the range of" 17% below 2005 levels by 2020 through such actions as regulating power plant emissions, promoting increased use of renewables and clean energy technology, and establishing tighter energy efficiency standards. Also, by Presidential Memorandum, the EPA is expectedwas directed to finalize limits on GHG emissions fromissue a new proposal for new power plants by
September 20, 2013, with a final rule to be issued in a timely fashion thereafter, and to begin working on a proposalissue proposed standards 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 theby June 1, 2014 with a final rule by June 1, 2015. The EPA was further directed to require that states develop implementation plans for existing plants by June 2016. Regulation of existing plants could have a significant industry-wide impact could be very significant, depending on the structure and stringency of the final rule. On behalfrule and state implementation plans. The Administration's recent increase in its estimate of LG&Ethe "social cost of carbon" (which is used to calculate benefits associated with proposed regulations) from $23.80 to $38 per metric ton in 2015 may lead to more costly regulatory requirements. Additionally, the Climate Action Plan requirements related to preparing the U.S. for the impacts of climate change could affect LKE and KU, PPL, along with others in the industry filed comments onas transmission system modifications to improve the EPA's proposal relatedability to GHG emissions from new plants.withstand major storms may be needed in order to meet those requirements. 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. In connection with a unanimous settlement agreement filed with the KPSC in November 2011, KU agreed to defer the requested approval for certain environmental upgrades to Units 1 and 2 at its E.W. Brown generating plant which represented approximately $200 million in capital costs. LG&E and KU are evaluating, among other measures, chemical additive systems for mercury control at Trimble County and Brown plants. These measures, combined with the completion of recent feasibility studies conducted based on current market conditions, provide alternative compliance options for KU on Units 1 and 2 at the E.W. Brown station. 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 nitrousnitrogen 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.U.S. In December 2011, the U.S.Circuit Court of Appeals for the District of Columbia Circuit (the Court) stayed implementation of CSAPR, leaving CAIR in place. Subsequently, in August 2012, the Circuit Court vacated and remanded CSAPR back to the EPA for further rulemaking, again leaving CAIR in place. place in the interim, and on June 24, 2013, the U.S. Supreme Court granted the EPA's petition for review of the Circuit Court's decision.
LG&E and KU plants in Kentucky will continue to comply with CAIR through optimization of existing controls, balanced with emission allowance purchases. The Circuit Court's August 2012 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 2012 Form 10-K for a discussion ofadditional information on 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: revenue recognition - unbilled revenue, 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 2012 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 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 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 six months ended March 31,June 30, 2013 with 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 electric energy and 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, competitively priced energy to its customers and reasonable returns on regulated investments to its shareowner. Rate base is expected to grow as a result of significant capital expenditure programs to maintain reliable service and comply with federal and state regulations. LG&E is focused on efficient operations, strong customer service, timely recovery of costs and constructive regulatory relationships.
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 six months ended March 31,June 30, 2013 was $44$29 million and $73 million compared to $25$26 million and $51 million for the same periods in 2012 representing a 76% increaseincreases of 12% and 43% over 2012.
See "Results of Operations" for a discussion and analysis of LG&E's earnings.
Economic and Market Conditions
The KPSC has adopted a series of regulatory mechanisms (ECR, DSM, GLT, a fuel adjustment clause, a gas supply clause and recovery on certain construction work-in-progress) that provide for recovery of prudently incurred costs. LG&E is impacted by changes in customer usage levels which can be driven by a number of factors including weather conditions and economic factors that impact the load utilized by industrial and commercial customers.
LG&E is subject to extensive federal, state and local environmental laws, rules and regulations. Certain regulated generation assets will require substantial capital investment. LG&E projects $1.1 billion of capital investment over the next five years to satisfy certain of these requirements. See Note 10 to the Financial Statements for additional information on these requirements. These requirements have resulted in LG&E's anticipated retirement by 2015 of three coal-fired units with a combined summer capacity rating of 563 MW. The retirement of the three coal-fired units is not expected to have a material impact on the financial condition or results of operations of LG&E. See Note 8 to the Financial Statements in LG&E's 2012 Form 10-K for additional information regarding the anticipated retirement of these units as well as plans to build a combined-cycle natural gas facility in Kentucky.
LG&E cannot predict the future impact that these economic and market conditions and changes in regulatory requirements may have on its financial condition or results of operations.
Rate Case Proceedings
In December 2012, the KPSC approved a rate case settlement agreement providing for increases in annual base electricity rates of $34 million and an increase in annual base gas rates of $15 million using a 10.25% return on equity. The approved rates became effective January 1, 2013. Results of Operations
The following discussion provides a summary of LG&E's earnings and a description of key factors expected 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 six months ended March 31,June 30, 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 for future periods.
Earnings | | | | | | | | | | | | | | | | | | | | Net Income for the periods ended March 31 was: | | Net Income for the periods ended June 30 was: | | Net Income for the periods ended June 30 was: | | | | | | | | | | | | | | | | | | | | | | | | | Three Months | | | Three Months | | Six Months | | | | | | | | 2013 | | 2012 | | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | | | Net Income | Net Income | | | | | | $ | 44 | | $ | 25 | Net Income | | $ | 29 | | $ | 26 | | $ | 73 | | $ | 51 |
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 | | | | | | | | 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 |
| | Three Months | | Six Months | | | | | | | | Margins | | $ | 8 | | $ | 29 | Other operation and maintenance | | | (3) | | | 5 | Depreciation | | | 1 | | | 3 | Taxes, other than income | | | | | | (1) | Other Income (Expense) - net | | | | | | (2) | Interest Expense | | | | | | 1 | Income Taxes | | | (3) | | | (13) | Total | | $ | 3 | | $ | 22 |
· | See "Statement of Income Analysis - Margins - Changes in Non-GAAP Financial Measures" for an explanation of Margins. |
· | Lower other operation and maintenance for the six-month period primarily due to the timing and scope of scheduled coal plant maintenance outages. |
· | Higher income taxes for the six-month period primarily due to higher pre-tax income. |
2013 Outlook
LG&E projects higher earnings in 2013 compared with 2012, primarily driven by electric and gas base rate increases, returns
on additional environmental capital investments and retail 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, 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 2012 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 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 mechanisms are offset. 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 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 with budget.
Reconciliation of Non-GAAP Financial Measures
The following table reconcilestables reconcile "Margins" to "Operating Income" as defined by LG&E for the periods ended March 31.June 30.
| | | | 2013 Three Months | | 2012 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 | | $ | 390 | | | | $ | 390 | | $ | 353 | | | | $ | 353 | Operating Revenues | | $ | 316 | | | | $ | 316 | | $ | 304 | | | | $ | 304 | Operating Expenses | Operating Expenses | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | Fuel | | 96 | | | | 96 | | 89 | | | | 89 | Fuel | | 88 | | | | 88 | | 92 | | | | 92 | | Energy purchases | | 81 | | | | 81 | | 73 | | | | 73 | Energy purchases | | 34 | | | | 34 | | 25 | | | | 25 | | Other operation and maintenance | | 11 | | $ | 80 | | 91 | | 10 | | $ | 88 | | 98 | Other operation and maintenance | | 10 | | $ | 84 | | 94 | | 11 | | $ | 81 | | 92 | | Depreciation | | | | 36 | | 36 | | 1 | | 37 | | 38 | Depreciation | | 1 | | 36 | | 37 | | 1 | | 37 | | 38 | | Taxes, other than income | | | | | | 6 | | | 6 | | | | | | 5 | | | 5 | Taxes, other than income | | | | | | 6 | | | 6 | | | | | | 6 | | | 6 | | | Total Operating Expenses | | | 188 | | | 122 | | | 310 | | | 173 | | | 130 | | | 303 | | Total Operating Expenses | | | 133 | | | 126 | | | 259 | | | 129 | | | 124 | | | 253 | Total | Total | | $ | 202 | | $ | (122) | | $ | 80 | | $ | 180 | | $ | (130) | | $ | 50 | Total | | $ | 183 | | $ | (126) | | $ | 57 | | $ | 175 | | $ | (124) | | $ | 51 |
| | | | | | 2013 Six Months | | | 2012 Six Months | | | | | | | | | | | Operating | | | | | | | | Operating | | | | | | | Margins | | Other (a) | | Income (b) | | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Revenues | | $ | 706 | | | | | $ | 706 | | | $ | 657 | | | | | $ | 657 | Operating Expenses | | | | | | | | | | | | | | | | | | | | | Fuel | | | 184 | | | | | | 184 | | | | 181 | | | | | | 181 | | Energy purchases | | | 115 | | | | | | 115 | | | | 98 | | | | | | 98 | | Other operation and maintenance | | | 21 | | $ | 164 | | | 185 | | | | 21 | | $ | 169 | | | 190 | | Depreciation | | | 1 | | | 72 | | | 73 | | | | 1 | | | 75 | | | 76 | | Taxes, other than income | | | | | | 12 | | | 12 | | | | | | | 11 | | | 11 | | | | Total Operating Expenses | | | 321 | | | 248 | | | 569 | | | | 301 | | | 255 | | | 556 | Total | | $ | 385 | | $ | (248) | | $ | 137 | | | $ | 356 | | $ | (255) | | $ | 101 |
(a) | Represents amounts excluded from Margins. |
(b) | As reported on the Statements of Income. |
Changes in Non-GAAP Financial Measures
Margins increased by $22$8 million for the three months ended March 31, 2013 compared with 2012three-month period primarily due to higher base rates of $13$10 million higher volumes of $6 million,and increased environmental investments of $2$3 million, and environmental costs addedpartially offset by lower volumes of $5 million. The change in volumes was partially attributable to weather, as cooling degree days decreased 25% compared to the same period in 2012.
Margins increased by $29 million for the six-month period due to higher base rates of $1$22 million and increased environmental investments of $5 million.
The increase in base rates was the result of new KPSC rates going into effect oneffective January 1, 2013. The increase in volumes was attributable to colder weather in
Other Operation and Maintenance
Other operation and maintenance decreased by $5 million for the six months ended June 30, 2013 compared with 2012. Total heating degree days increased 48%. The environmental2012 primarily due to $7 million of lower costs added to base rates was due to the eliminationtiming and scope of the 2005 and 2006 ECR plans as a result of the 2012 Kentucky rate case. This elimination results in depreciation and other operation andscheduled coal plant 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 $10$13 million for the threesix months ended March 31,June 30, 2013 compared with 2012 primarily due to higher pre-tax income.
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 | | June 30, 2013 | | December 31, 2012 | | | | | | | | | | Cash and cash equivalents | | $ | 34 | | $ | 22 | | $ | 13 | | $ | 22 | | | | | | | | | | Short-term debt (a) | | $ | 70 | | $ | 55 | | $ | 80 | | $ | 55 |
(a) | Represents borrowings under LG&E's commercial paper program. See Note 7 to the Financial Statements for additional information. |
The $12$9 million increasedecrease in LG&E's cash and cash equivalents position was primarily the net result of:
· | cash provided by operating activities of $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 $98$236 million; and |
· | the payment of common stock dividends to parent of $19$48 million; partially offset by |
· | cash provided by operating activities of $186 million, |
· | capital contributions from parent of $54 million; and |
· | an increase in short term debt of $25 million. |
LG&E's cash provided by operating activities decreasedincreased by $17$26 million for the threesix months ended March 31,June 30, 2013, compared with 2012, primarily due to:
· | an increase in working capital cash flow changes of $26 million driven primarily by lower fuel levels in 2013 compared with 2012 due to increased generation at the plants and higher gas consumption from storage compared to 2012 due to the unseasonably milder weather in December 2011; and |
· | an increase in net income adjusted for non-cash items of $18 million (other non-cash items of $6 million; partially offset by deferred income taxes and investment tax credits of $7 million and depreciation of $3 million); partially offset by |
· | an increase in cash outflows from other operating activities of $18 million driven by a $19 million increase in discretionary defined benefit plan contributions; and |
· | a decline in working capital cash flow changes of $12 million driven primarily by changes in accounts receivable and unbilled revenues due to higher sales volume, higher rates and extended payment terms, partially offset by lower fuel levels in 2013 compared with 2012 driven by increased generation and a higher federal income tax accrual in 2013; offset by |
· | an increase in net income adjusted for non-cash items of $13 million (amortization of $3 million and defined benefit 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).contributions. |
Capital expenditures increased by $38$116 million during the threesix months ended March 31,June 30, 2013 compared with 2012 primarily due to environmental air projects at Mill Creek plant and construction of Cane Run Unit 7.
Credit Facilities,
At March 31,June 30, 2013, LG&E's 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 (a) (b) | | $ | 500 | | | | | $ | 70 | | $ | 430 |
| | | | | | | | | Letters of | | | | | | | | | | | | | Credit Issued | | | | | | | | | | | | | and | | | | | | | Committed | | | | Commercial | | Unused | | | | Capacity | | Borrowed | | Paper Backup | | Capacity | | | | | | | | | | | Syndicated Credit Facility (a) (b) | | $ | 500 | | | | | $ | 80 | | $ | 420 |
(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) | LG&E pays customary fees under its syndicated credit facility, 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 March 31,June 30, 2013 and December 31, 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
During 2012, LG&E currently plansreceived KPSC and other state approvals 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. The credit ratings of LG&E affect its liquidity, access to capital markets and cost of borrowing under its credit facilities.
The rating agencies did not take any actions related to LG&E during the firstsecond quarter of 2013.
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 March 31,June 30, 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 regulatory commissions 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 sells 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 March 31,June 30, 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 March 31,June 30, 2013, would increase the fair value of its debt portfolio by $27 million.
At March 31, 2013, LG&E had the following interest rate hedges outstanding: | | At June 30, 2013, LG&E had the following interest rate hedges outstanding: | | At June 30, 2013, LG&E had the following interest rate hedges outstanding: | | | | | | | | | | | | | | | | | | | | | | | Effect of a | | | | | | | Effect of a | | | | | | | | 10% Adverse | | | | | | | 10% Adverse | | | | | | Fair Value, | | Movement | | | | | Fair Value, | | Movement | | | | Exposure | | Net - Asset | | in Interest | | | Exposure | | Net - Asset | | in Interest | | | | Hedged | | (Liability) (a) | | Rates | | | Hedged | | (Liability) (a) | | Rates | Economic activity | Economic activity | | | | | | | Economic activity | | | | | | | | Interest rate swaps (b) | | $ | 179 | | $ | (55) | | $ | (3) | Interest rate swaps (b) | | $ | 179 | | $ | (44) | | $ | (4) | Cash flow hedges | Cash flow hedges | | | | | | | Cash flow hedges | | | | | | | | Interest rate swaps (b) | | 150 | | 12 | | (8) | Interest rate swaps (b) | | 250 | | 36 | | (16) |
(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. The positions outstanding at March 31,June 30, 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 LG&E's 2012 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
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, as well as other aspects 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 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 cost for their products or their demand for LG&E's services.
Physical effects associated with possible 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 hydrohydroelectric generating facilities or where river water is used to cool its fossil-powered generators. LG&E cannot currently predict whether its businessesbusiness 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)non-hazardous waste) 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. On July 25, 2013, the U.S. House of Representatives passed House Bill H.R. 2218, the Coal Residuals and Reuse Management Act of 2013, which would preempt the EPA from regulating CCRs under RCRA and sets rules governing state programs. Prospects remain uncertain for similar legislation to pass in the U.S. Senate. Effluent Limitation Guidelines (ELGs) On April 19,In June 2013, the EPA issuedpublished 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 handlingtransport water and metal cleaning wasteswaste waters, as well as new limits for scrubber wastewater gasification wastewater and landfill leachate. The EPA's proposed ELG regulations also contain some requirements that would affect the inspection and operation of CCR facilities, if finalized. 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 requiresrequiring 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 imposesimposing standards for reduction of mortality of aquatic organisms trapped on water intake screens (impingement). A final rule is expected to be issued in JuneNovember 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 June 2013, President Obama released his Climate Action Plan, which reiterates the goal of reducing greenhouse gas emissions in the U.S. "in the range of" 17% below 2005 levels by 2020 through such actions as regulating power plant emissions, promoting increased use of renewables and clean energy technology, and establishing tighter energy efficiency standards. Also, by Presidential Memorandum, the EPA is expectedwas directed to finalize limits on GHG emissions fromissue a new proposal for new power plants by September 20, 2013, with a final rule to be issued in a timely fashion thereafter, and to begin working on a proposalissue proposed standards 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 theby June 1, 2014 with a final rule by June 1, 2015. The EPA was further directed to require that states develop implementation plans for existing plants by June 2016. Regulation of existing plants could have a significant industry-wide impact could be very significant, depending on the structure and stringency of the final rule. On behalfrule and state implementation plans. The Administration's recent increase in its estimate of the "social cost of carbon" (which is used to calculate benefits associated with proposed regulations) from $23.80 to $38 per metric ton in 2015 may lead to more costly regulatory requirements. Additionally, the Climate Action Plan requirements related to preparing the U.S. for the impacts of climate change could affect LG&E PPL, along withand others in the industry filed comments onas transmission system modifications to improve the EPA's proposal relatedability to GHG emissions from new plants.withstand major storms may be needed in order to meet those requirements.
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 nitrousnitrogen 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.U.S. In December 2011, the U.S.Circuit Court of Appeals for the District of Columbia Circuit (the Court) stayed implementation of CSAPR, leaving CAIR in place. Subsequently, in August 2012, the Circuit Court vacated and remanded CSAPR back to the EPA for further rulemaking, again leaving CAIR in place. place in the interim, and on June 24, 2013, the U.S. Supreme Court granted the EPA's petition for review of the Circuit Court's decision.
LG&E plants in Kentucky will continue to comply with CAIR through optimization of existing controls, balanced with emission allowance purchases. The Circuit Court's August 2012 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 2012 Form 10-K for a discussion ofadditional information on 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: revenue recognition - unbilled revenue, 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 2012 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 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 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 six months ended March 31,June 30, 2013 with 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 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, competitively priced energy to its customers and reasonable returns on regulated investments to its shareowner. Rate base is expected to grow as a result of significant capital expenditure programs to maintain reliable service and comply with federal and state regulations. KU is focused on efficient operations, strong customer service, timely recovery of costs and constructive regulatory relationships.
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 six months ended March 31,June 30, 2013 was $64$44 million and $108 million compared to $38$30 million and $68 million for the same periods in 2012 representing a 68% increaseincreases of 47% and 59% over 2012.
See "Results of Operations" for a discussion and analysis of KU's earnings.
Economic and Market Conditions
The KPSC has adopted a series of regulatory mechanisms (ECR, DSM, a fuel adjustment clause and recovery on certain construction work-in-progress) that provide for recovery of prudently incurred costs. KU is impacted by changes in customer usage levels which can be driven by a number of factors including weather conditions and economic factors that impact the load utilized by industrial and commercial customers.
KU is subject to extensive federal, state and local environmental laws, rules and regulations. Certain regulated generation assets will require substantial capital investment. KU projects $1 billion of capital investment over the next five years to satisfy certain of these requirements. See Note 10 to the Financial Statements for additional information on these requirements. These requirements have resulted in KU's anticipated retirement by 2015 of two coal-fired units with a combined summer capacity rating of 163 MW. KU retired the 71 MW unit at the Tyrone plant in February 2013. The retirement of the two coal-fired units is not expected to have a material impact on the financial condition or results of operations of KU. See Note 8 to the Financial Statements in KU's 2012 Form 10-K for additional information regarding the anticipated retirement of these units as well as plans to build a combined-cycle natural gas facility in Kentucky.
KU cannot predict the future impact that these economic and market conditions and changes in regulatory requirements may have on its financial condition or results of operations.
Rate Case Proceedings
Virginia
During April 2013, KU filed an application with the VSCC to increase annual Virginia base electric revenue by approximately $7 million, representing an increase of 9.6%. KU proposed an authorized 10.8% return on equity. Subject to regulatory approval, new rates would become effective January 1, 2014.
Kentucky
In December 2012, the KPSC approved a rate case settlement agreement providing for increases in annual base electricity rates of $51 million using a 10.25% return on equity. The approved rates became effective January 1, 2013.
Results of Operations
The following discussion provides a summary of KU's earnings and a description of key factors expected 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 six months ended March 31,June 30, 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 for future periods.
Earnings | | | | | | | | | | | | | | | | | | | | Net Income for the periods ended March 31 was: | | Net Income for the periods ended June 30 was: | | Net Income for the periods ended June 30 was: | | | | | | | | | | | | | | | | | | | | | | | | | Three Months | | | Three Months | | Six Months | | | | | | | | 2013 | | 2012 | | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | | | Net Income | Net Income | | | | | | $ | 64 | | $ | 38 | Net Income | | $ | 44 | | $ | 30 | | $ | 108 | | $ | 68 |
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 | | | | | | | | Margins | | | | | $ | 53 | Depreciation | | | | | | (10) | Other Income (Expense) - net | | | | | | (1) | Income Taxes | | | | | | (17) | Special item - EEI adjustments, after-tax | | | | �� | | 1 | Total | | | | | $ | 26 |
| | Three Months | | Six Months | | | | | | | | Margins | | $ | 23 | | $ | 77 | Other operation and maintenance | | | 1 | | | | Depreciation | | | (9) | | | (19) | Other Income (Expense) - net | | | 7 | | | 6 | Income Taxes | | | (8) | | | (25) | Special item - EEI adjustments, after-tax | | | | | | 1 | Total | | $ | 14 | | $ | 40 |
· | See "Statement of Income Analysis - Margins - Changes in Non-GAAP Financial Measures" for an explanation of Margins. |
· | Higher depreciation for the three and six-month periods primarily due to environmental costs related to the elimination of the 2005 and 2006 ECR plans now being included in base rates, which added $12 million and $24 million to depreciation |
| that is excluded from Margins,Margins. This increase was partially offset by lower depreciation of $3 million and $7 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 other income (expense) - net for the three and six-month periods primarily due to losses from the EEI investment recorded in 2012. The EEI investment was fully impaired in the fourth quarter of 2012. |
· | Higher income taxes for the three and six-month periods primarily due to higher pre-tax income. |
2013 Outlook
Excluding special items, KU projects higher earnings in 2013 compared with 2012, primarily driven by electric 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, 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 2012 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 mechanisms are offset. These mechanisms allow for recovery of certain expenses, returns on capital investments 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 with budget.
Reconciliation of Non-GAAP Financial Measures
The following table reconcilestables reconcile "Margins" to "Operating Income" as defined by KU for the periods ended March 31.June 30.
| | | | 2013 Three Months | | 2012 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 | | $ | 432 | | | | $ | 432 | | $ | 380 | | | | $ | 380 | Operating Revenues | | $ | 383 | | | | $ | 383 | | $ | 374 | | | | $ | 374 | Operating Expenses | Operating Expenses | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | Fuel | | 135 | | | | 135 | | 124 | | | | 124 | Fuel | | 128 | | | | 128 | | 123 | | | | 123 | | Energy purchases | | 27 | | | | 27 | | 29 | | | | 29 | Energy purchases | | 20 | | | | 20 | | 29 | | | | 29 | | Other operation and maintenance | | 14 | | $ | 83 | | 97 | | 12 | | $ | 83 | | 95 | Other operation and maintenance | | 13 | | $ | 85 | | 98 | | 12 | | $ | 86 | | 98 | | Depreciation | | | | 46 | | 46 | | 12 | | 36 | | 48 | Depreciation | | 1 | | 45 | | 46 | | 12 | | 36 | | 48 | | Taxes, other than income | | | | | | 6 | | | 6 | | | | | | 6 | | | 6 | Taxes, other than income | | | | | | 6 | | | 6 | | | | | | 6 | | | 6 | | | Total Operating Expenses | | | 176 | | | 135 | | | 311 | | | 177 | | | 125 | | | 302 | | Total Operating Expenses | | | 162 | | | 136 | | | 298 | | | 176 | | | 128 | | | 304 | Total | Total | | $ | 256 | | $ | (135) | | $ | 121 | | $ | 203 | | $ | (125) | | $ | 78 | Total | | $ | 221 | | $ | (136) | | $ | 85 | | $ | 198 | | $ | (128) | | $ | 70 |
| | | | | | 2013 Six Months | | | 2012 Six Months | | | | | | | | | | | Operating | | | | | | | | Operating | | | | | | | Margins | | Other (a) | | Income (b) | | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | Operating Revenues | | $ | 815 | | | | | $ | 815 | | | $ | 754 | | | | | $ | 754 | Operating Expenses | | | | | | | | | | | | | | | | | | | | | Fuel | | | 263 | | | | | | 263 | | | | 247 | | | | | | 247 | | Energy purchases | | | 47 | | | | | | 47 | | | | 58 | | | | | | 58 | | Other operation and maintenance | | | 27 | | $ | 168 | | | 195 | | | | 25 | | $ | 168 | | | 193 | | Depreciation | | | 1 | | | 91 | | | 92 | | | | 24 | | | 72 | | | 96 | | Taxes, other than income | | | | | | 12 | | | 12 | | | | | | | 12 | | | 12 | | | | Total Operating Expenses | | | 338 | | | 271 | | | 609 | | | | 354 | | | 252 | | | 606 | Total | | $ | 477 | | $ | (271) | | $ | 206 | | | $ | 400 | | $ | (252) | | $ | 148 |
(a) | Represents amounts excluded from Margins. |
(b) | As reported on the Statements of Income. |
Changes in Non-GAAP Financial Measures
Margins increased by $53$23 million for the three months ended March 31, 2013 compared with 2012,three-month period primarily due to higher base rates of $18$15 million and environmental costscost recoveries added to base rates of $16$13 million, partially offset by lower volumes of $4 million.
Margins increased by $77 million for the six-month period due to higher base rates of $33 million, environmental cost recoveries added to base rates of $30 million, higher volumes of $13$9 million and increased environmental investments of $5 million. The change in volumes was attributable to weather, as heating degree days increased 31% compared to the same period in 2012.
The increase in base rates was the result of new KPSC rates going into effect oneffective January 1, 2013. The increase in volumes was attributable to colder weather in 2013 compared with 2012. Total heating degree days increased 35%. The environmental costscost recoveries added to base rates waswere due to the elimination of the 2005 and 2006 ECR plans as a result of the 2012 Kentucky rate case. This elimination results in depreciation and other operation and maintenance expenses associated with the 2005 and 2006 ECR plans being excluded from Margins in 2013.2013, while the recovery of such costs remain in Margins through base rates.
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 Operation and Maintenance | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance expense for the periods ended June 30, 2013 compared with 2012 was due to: | | | | | | Three Months | | Six Months | | | | | | | | Coal plant outages (a) | $ | (5) | | $ | (10) | Coal plant operations | | 2 | | | 4 | Adjustments to regulatory assets and liabilities | | | | | 4 | Other | | 3 | | | 4 | Total | $ | | | $ | 2 |
(a) | Decrease is due to the timing and scope of scheduled outages. |
Depreciation
The increase (decrease) in depreciation for the periods ended June 30, 2013 compared with 2012 was due to:
| | Three Months | | Six Months | | | | | | | | Lower depreciation rates effective January 1, 2013 | $ | (3) | | $ | (7) | Additions to PP&E | | 1 | | | 3 | Total | $ | (2) | | $ | (4) |
Other Income (Expense) - net
Other income (expense) - net increased by $7 million for the three and six months ended June 30, 2013 compared with 2012 primarily due to losses from the EEI investment recorded in 2012. The EEI investment was fully impaired in the fourth quarter of 2012.
Income Taxes
Income taxes increased by $17$8 million and $25 million for the three and six months ended March 31,June 30, 2013 compared with 2012 primarily due to higher 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: | | | | | | | | | | | | March 31, 2013 | | December 31, 2012 | | June 30, 2013 | | December 31, 2012 | | | | | | | | | | Cash and cash equivalents | | $ | 16 | | $ | 21 | | $ | 10 | | $ | 21 | | | | | | | | | | Short-term debt (a) | | $ | 115 | | $ | 70 | | $ | 172 | | $ | 70 |
(a) | Represents borrowings made under KU's commercial paper program. See Note 7 to the Financial Statements for additional information. |
The $5$11 million decrease in KU's cash and cash equivalents position was the net result of:
· | capital expenditures of $172$341 million; and |
· | the payment of common stock dividends to parent of $13$55 million; partially offset by |
· | cash provided by operating activities of $85$190 million; |
· | capital contributions from parent of $50 million; and |
· | an increase in short term debt of $45$102 million; and |
· | capital contributions from parent of $92 million. |
KU's cash provided by operating activities decreased by $67$27 million for the threesix months ended March 31,June 30, 2013, compared with 2012, primarily due to:
· | an increase in cash outflows from other operating activities of $61$69 million driven by a $43 million increase in discretionary defined benefit plan contributions; and |
· | a decline in working capital cash flow changes of $49$18 million driven primarily by changesincreases 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 resultdue to timing of federal settlement payment,settlements, partially offset by an increase in cash from accounts payable primarily due to timing of fuel purchase commitments and payments; partially offset by |
· | an increase in net income adjusted for non-cash items of $43$60 million (deferred income taxes and investment tax credits of $10 million, amortization of $4 million, other non-cash items of $3$19 million and defined benefit plans - expense of $2$7 million, partially offset by depreciation of $4 million and other non-cash items of $2 million). |
Capital expenditures increased by $59$138 million during the threesix months ended March 31,June 30, 2013 compared with 2012 primarily due to environmental air projects and coal consumption residual projects at the Ghent plant and construction of Cane Run Unit 7.
Credit Facilities
At March 31,June 30, 2013, KU's 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 (a) | | $ | 400 | | | | | $ | 115 | | $ | 285 | Letter of Credit Facility (a) (b) | | | 198 | | | | | | 198 | | | | | Total Credit Facilities (c) | | $ | 598 | | | | | $ | 313 | | $ | 285 |
| | | | | | | | | Letters of | | | | | | | | | | | | | Credit Issued | | | | | | | | | | | | | and | | | | | | | Committed | | | | Commercial | | Unused | | | | Capacity | | Borrowed | | Paper Backup | | Capacity | | | | | | | | | | | Total KU Credit Facilities (a) (b) | | $ | 598 | | | | | $ | 370 | | $ | 228 |
(a) | KU pays customary fees under its syndicated credit facility as well as its letter of credit facility, and borrowings generally bear interest at LIBOR-based rates plus an applicable margin. |
(b) | In May 2013, KU extended its $198 million letter of credit facility to 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%22% of the total committed capacity available to KU. |
(b) | KU pays customary fees under its syndicated credit facility, and borrowings generally bear interest at LIBOR-based rates plus an applicable margin. |
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 March 31,June 30, 2013 and December 31, 2012, there was no balance outstanding.
See NoteNotes 7 to the Financial Statements for further discussion of KU's credit facilities.
Long-term Debt Securities
During 2012, KU currently plansreceived KPSC and other state approvals 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. The credit ratings of KU affect its liquidity, access to capital markets and cost of borrowing under its credit facilities.
The rating agencies did not take any actionstook the following action related to KU during 2013:
In July 2013, S&P confirmed the first quarter of 2013.long-term AA+ ratings for KU's 2000 Series A Solid Waste Disposal Facility Revenue Bonds and KU's 2004 Series A, 2006 Series B and 2008 Series A Environmental Facilities Revenue Bonds. S&P also confirmed the A-1+ short-term rating on these Bonds.
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 March 31,June 30, 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 sells 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
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 March 31,June 30, 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 March 31,June 30, 2013, would increase the fair value of its debt portfolio by $68 million.
At March 31, 2013, KU had the following interest rate hedges outstanding: | | At June 30, 2013, KU had the following interest rate hedges outstanding: | | At June 30, 2013, KU had the following interest rate hedges outstanding: | | | | | | | | | | | | | | | | | | | | | | | Effect of a | | | | | | | Effect of a | | | | | | | | 10% Adverse | | | | | | | 10% Adverse | | | | | | Fair Value, | | Movement | | | | | Fair Value, | | Movement | | | | Exposure | | Net - Asset | | in Interest | | | Exposure | | Net - Asset | | in Interest | | | | Hedged | | (Liability) | | Rates | | | Hedged | | (Liability) | | Rates | Cash flow hedges | Cash flow hedges | | | | | | | Cash flow hedges | | | | | | | | Interest rate swaps (a) | | $ | 150 | | $ | 12 | | $ | (8) | Interest rate swaps (a) | | $ | 250 | | $ | 36 | | $ | (16) |
(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,June 30, 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 2012 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
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, as well as other aspects 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 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 cost for their products or their demand for KU's services.
Physical effects associated with possible 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 hydrohydroelectric generating facilities or where river water is used to cool its fossil-powered generators. KU cannot currently predict whether its businessesbusiness 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)non-hazardous waste) 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. On July 25, 2013, the U.S. House of Representatives passed House Bill H.R. 2218, the Coal Residuals and Reuse Management Act of 2013, which would preempt the EPA from regulating CCRs under RCRA and sets rules governing state programs. Prospects remain uncertain for similar legislation to pass in the U.S. Senate.
Effluent Limitation Guidelines (ELGs) On April 19,In June 2013, the EPA issuedpublished 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 handlingtransport water and metal cleaning wasteswaste waters, as well as new limits for scrubber wastewater gasification wastewater and landfill leachate. The EPA's proposed ELG regulations also contain some requirements that would affect the inspection and operation of CCR facilities, if finalized. 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 requiresrequiring 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 imposesimposing standards for reduction of mortality of aquatic organisms trapped on water intake screens (impingement). A final rule is expected to be issued in JuneNovember of 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 June 2013, President Obama released his Climate Action Plan, which reiterates the goal of reducing greenhouse gas emissions in the U.S. "in the range of" 17% below 2005 levels by 2020 through such actions as regulating power plant emissions, promoting increased use of renewables and clean energy technology, and establishing tighter energy efficiency standards. Also, by Presidential Memorandum, the EPA is expectedwas directed to finalize limits on GHG emissions fromissue a new proposal for new power plants by September 20, 2013, with a final rule to be issued in a timely fashion thereafter, and to begin working on a proposalissue proposed standards 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 theby June 1, 2014 with a final rule by June 1, 2015. The EPA was further directed to require that states develop implementation plans for existing plants by June 2016. Regulation of existing plants could have a significant industry-wide impact could be very significant, depending on the structure and stringency of the final rule. On behalfrule and state implementation plans. The Administration's recent increase in its estimate of the "social cost of carbon" (which is used to calculate benefits associated with proposed regulations) from $23.80 to $38 per metric ton in 2015 may lead to more costly regulatory requirements. Additionally, the Climate Action Plan requirements related to preparing the U.S. for the impacts of climate change could affect KU PPL, along withand others in the industry filed comments onas transmission system modifications to improve the EPA's proposal relatedability to GHG emissions from new plants.withstand major storms may be needed in order to meet those requirements.
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. In connection with a unanimous settlement agreement filed with the KPSC in November 2011, KU agreed to defer the requested approval for certain environmental upgrades to Units 1 and 2 at its E.W. Brown generating plant which represented approximately $200 million in capital costs. KU is evaluating, among other measures, chemical additive systems for mercury control at Trimble County and Brown plants. These measures, combined with the completion of recent feasibility studies conducted based on current market conditions, provide alternative compliance options for KU on Units 1 and 2 at the E.W. Brown station. 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 nitrousnitrogen 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.U.S. In December 2011, the U.S.Circuit Court of Appeals for the District of Columbia Circuit (the Court) stayed implementation of CSAPR, leaving CAIR in place. Subsequently, in August 2012, the Circuit Court vacated and remanded CSAPR back to the EPA for further
rulemaking, again leaving CAIR in place. place in the interim, and on June 24, 2013, the U.S. Supreme Court granted the EPA's petition for review of the Circuit Court's decision.
KU plants in Kentucky will continue to comply with CAIR through optimization of existing controls, balanced with emission allowance purchases. The Circuit Court's August 2012 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 2012 Form 10-K for a discussion ofadditional information on 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: revenue recognition - unbilled revenue, 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 2012 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 March 31,June 30, 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, 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 of the above listed registrants have concluded that there were no changesthe implementation of a financial consolidation and reporting system for PPL and its primary U.S. subsidiaries during the quarter ended June 30, 2013 resulted in a material change to the registrants' internal control over financial reporting. The new system enhances the consolidation of subsidiary accounts, provides reporting tools for analysis and automates certain aspects of financial statement preparation for each of the registrants. Processes and controls over the consolidation and reporting processes that were previously considered to be effective were replaced with new or modified controls that were also determined to be effective.
The new consolidation and reporting system was subject to extensive testing and data reconciliation during implementation. Post-implementation reviews have been and will continue to be conducted to enable us to determine the effectiveness of the internal controls relating to the system implementation processes and to key business processes.
PPL Corporation
PPL's principal executive officer and principal financial officer have concluded that the implementation of a new general ledger system and a financial reporting system at WPD during the registrants' first fiscal quarter that have materially affected, or are reasonably likelyended June 30, 2013 resulted in a material change to materially affect, the registrants'its internal control over financial reporting. The general ledger system that was implemented at WPD replaced the existing mainframe system and resulted in more automation and enhanced controls over general ledger processing and consolidation. The reporting system that was implemented at WPD improves and automates controls over data transfer included in PPL's consolidation process and improves controls over GAAP and foreign currency adjustments. In each of the WPD system implementations, controls that were previously determined to be effective were replaced with new or modified controls that were also determined to be effective.
The general ledger and reporting systems were subject to extensive testing and data reconciliation during their implementation. Post-implementation reviews have been and will continue to be conducted to enable us to determine the effectiveness of the internal controls relating to the system implementation processes and to key business processes remain effective. Risks related to the system implementations at WPD were also partially mitigated by PPL's existing policy of consolidating foreign subsidiaries on a one-month lag, which provided management additional time for review and analysis of WPD results and their incorporation into PPL's consolidated financial statements.
PART II. OTHER INFORMATION
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 2012 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 2012 Form 10-K. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds | | | | | | | | | | | | | | | | Issuer Purchase of Equity Securities during the Second Quarter of 2013: | | | | | | | | | | | | | | | | | | | | | | (a) | (b) | (c) | (d) | | | | | | | | | | | | | | | | | | | | | | | | | | | | Maximum Number (or | | | | | | | | | | | | | | Approximate Dollar | | | | | | | | | | | Total Number of | Value) of Shares | | | | | | | | | | | Shares (or Units) | (or Units) that May | | | | | Total Number of | Average Price | Purchased as Part of | Yet Be Purchased | | | | | Shares (or Units) | Paid per Share | Publicly Announced | Under the Plans | Period | | | Purchased (1) | (or Unit) | Plans of Programs | or Programs | April 1 to April 30, 2013 | | | | | | | May 1 to May 31, 2013 | | | | | | | June 1 to June 30, 2013 | | | 930,000 | $29.92 | | | Total | | | 930,000 | $29.92 | | |
(1) | | Represents shares of common stock repurchased in the open market to offset a portion of shares issued under stock based compensation plans. |
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) 3(a) | - | Amended and Restated Articles of Incorporation of PPL Corporation, effective as of May 15, 2013 (Exhibit 3(i) to PPL Corporation Form 8-K Report (File No. 1-11459) dated May 20, 2013) | 3(b) | - | Amended and Restated Bylaws of PPL Corporation, effective as of May 15, 2013 (Exhibit 3(ii) to PPL Corporation Form 8-K Report (File No. 1-11459) dated May 20, 2013) | 4(a) | - | Supplemental Indenture No. 4,10, dated as of March 15,May 24, 2013, among PPL Capital Funding, Inc., PPL Corporation and The Bank of New York Mellon (formerly known as The Bank of New York), as Trustee (Exhibit 4(b)4.2 to PPL Corporation Form 8-K Report (File No. 1-11459) dated MarchMay 24, 2013) | 4(b) | - | Supplemental Indenture No. 11, dated as of May 24, 2013, among PPL Capital Funding, Inc., PPL Corporation and The Bank of New York Mellon (formerly known as The Bank of New York), as Trustee (Exhibit 4.3 to PPL Corporation Form 8-K Report (File No. 1-11459) dated May 24, 2013) | 4(c) | - | Supplemental Indenture No. 12, dated as of May 24, 2013, among PPL Capital Funding, Inc., PPL Corporation and The Bank of New York Mellon (formerly known as The Bank of New York), as Trustee (Exhibit 4.4 to PPL Corporation Form 8-K Report (File No. 1-11459) dated May 24, 2013) | 4(d) | - | Supplemental Indenture No. 15, dated as of July 1, 2013, of PPL Electric Utilities Corporation to The Bank of New York Mellon, as Trustee (Exhibit 4(a) to PPL Electric Utilities Corporation Form 8-K Report (File No. 1-905) dated July 11, 2013) | | - | Amendment No. 1, 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, and Banco Bilbao Vizcaya Argentaria, S.A., New York Branch, as Administrative Agent and Sumitomo Mitsui Banking Corporation, New York Branch as Issuing 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 Fixed Charges | | - | Louisville Gas and Electric Company Computation of Ratio of Earnings to Fixed Charges | | - | 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 March 31,June 30, 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 March 31,June 30, 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: May 3,August 2, 2013 | /s/ Vincent Sorgi | | | Vincent Sorgi | | | Vice President and Controller | | | (Principal Accounting Officer) | | | | | | | | | | | | PPL Electric Utilities Corporation | | (Registrant) | | | | | | | | | | | Date: May 3,August 2, 2013 | /s/ Vincent SorgiDennis A. Urban, Jr. | | | Vincent SorgiDennis A. Urban, Jr. | | | Vice President and | | | Chief Accounting OfficerController | | | (Principal Financial Officer and Principal Accounting Officer) | |
| LG&E and KU Energy LLC | | (Registrant) | | | | | | Louisville Gas and Electric Company | | (Registrant) | | | | | | Kentucky Utilities Company | | (Registrant) | | | | | | | | | | | Date: May 3,August 2, 2013 | /s/ Kent W. Blake | | | Kent W. Blake Chief Financial Officer | | | (Principal Financial Officer and Principal Accounting Officer) | |
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