· | Lower income taxes for the nine-month period, primarily due tothat 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 higher pre-tax income. |
· | Lower noncontrolling interests for the three and nine-month periods due to the preference stock redemption in June 2012. | 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) |
Outlook
PPL projects lower segment earnings in (a) | 2012 compared with 2011, primarily driven by higher other operation and maintenance expense, higher depreciation and lower distribution revenue, which are expectedincludes an adjustment to be partially offset by higher transmission revenue, lower financing costs, and lower income taxes.
In Marchan 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 PPL Electric filed a request with the PUC to increase distribution rates by approximately $105 million effective January 1, 2013. The proposed distribution rate increase would result in a 2.9% increase over PPL Electric's total rates at the time of the request. PPL Electric's application includes a request for an authorized return-on-equity of 11.25%. On October 19, 2012, the presiding Administrative Law Judge (ALJ) issued a decision recommending a rate increase of approximately $64 million, which represents an allowed return on equity of 9.74%. Exceptions to the ALJ's recommendation are due November 8, 2012. PPL Electric expects to file exceptions, together with certain other parties, to the ALJ's recommended decision. The PUC, which is expected to issue its order on the rate request in December 2012, can accept, reject or modify the ALJ's recommendation. PPL cannot predict the outcome of this proceeding.
Earnings in 2012 and future periods are subject to various risks and uncertainties. See "Forward-Looking Information," the rest of this Item 2 and Notes 6 and 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in PPL's 2011 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.
U.K. Regulated Segment
The U.K. Regulated segment consists of 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 thePPL Energy Supply's energy marketing and trading activities, as well as theits competitive generation and development operations of PPL Energy Supply.operations. In addition, the Supply segment is allocated certain financing costs.
Net Income Attributable to PPL Shareowners for the periods ended September 30 includes the following results: | | Net Income Attributable to PPL Shareowners for the periods ended June 30 includes the following results: | | Net Income Attributable to PPL Shareowners for the periods ended June 30 includes the following results: | | | | | | | | �� | | | | | | | | | | | | | | | | | | | | | | | Three Months | | Nine Months | | | Three Months | | Six Months | | | | 2012 | | 2011 | | % Change | | 2012 | | 2011 | | % Change | | | 2013 | | 2012 | | % Change | | 2013 | | 2012 | | % Change | Energy revenues | Energy revenues | | | | | | | | | | | | | Energy revenues | | | | | | | | | | | | | | External (a) | | $ | 567 | | $ | 1,305 | | (57) | | $ | 3,673 | | $ | 3,437 | | 7 | External (a) | | $ | 1,658 | | $ | 816 | | 103 | | $ | 2,039 | | $ | 3,106 | | (34) | | Intersegment | | 23 | | 5 | | 360 | | 61 | | 15 | | 307 | Intersegment | | 12 | | 17 | | (29) | | 26 | | 38 | | (32) | Energy-related businesses | Energy-related businesses | | | 133 | | | 132 | | 1 | | | 346 | | | 360 | | (4) | Energy-related businesses | | | 122 | | | 115 | | 6 | | | 235 | | | 213 | | 10 | | Total operating revenues | | | 723 | | | 1,442 | | (50) | | | 4,080 | | | 3,812 | | 7 | Total operating revenues | | | 1,792 | | | 948 | | 89 | | | 2,300 | | | 3,357 | | (31) | Fuel (a) | Fuel (a) | | 321 | | 358 | | (10) | | 728 | | 826 | | (12) | Fuel (a) | | 224 | | 196 | | 14 | | 522 | | 407 | | 28 | Energy purchases | Energy purchases | | | | | | | | | | | | | Energy purchases | | | | | | | | | | | | | | External (a) | | (150) | | 335 | | (145) | | 1,288 | | 746 | | 73 | External (a) | | 897 | | 191 | | 370 | | 697 | | 1,438 | | (52) | | Intersegment | | 1 | | 2 | | (50) | | 2 | | 3 | | (33) | Intersegment | | 1 | | | | n/a | | 2 | | 1 | | 100 | Other operation and maintenance | Other operation and maintenance | | 215 | | 191 | | 13 | | 750 | | 707 | | 6 | Other operation and maintenance | | 270 | | 293 | | (8) | | 505 | | 548 | | (8) | Depreciation | Depreciation | | 81 | | 66 | | 23 | | 229 | | 194 | | 18 | Depreciation | | 79 | | 70 | | 13 | | 157 | | 135 | | 16 | Taxes, other than income | Taxes, other than income | | 19 | | 18 | | 6 | | 54 | | 49 | | 10 | Taxes, other than income | | 16 | | 17 | | (6) | | 33 | | 35 | | (6) | Energy-related businesses | Energy-related businesses | | | 129 | | | 131 | | (2) | | | 339 | | | 356 | | (5) | Energy-related businesses | | | 118 | | | 113 | | 4 | | | 228 | | | 210 | | 9 | | Total operating expenses | | | 616 | | | 1,101 | | (44) | | | 3,390 | | | 2,881 | | 18 | Total operating expenses | | | 1,605 | | | 880 | | 82 | | | 2,144 | | | 2,774 | | (23) | Other Income (Expense) - net | Other Income (Expense) - net | | 6 | | 22 | | (73) | | 15 | | 41 | | (63) | Other Income (Expense) - net | | 12 | | 4 | | 200 | | 16 | | 9 | | 78 | Other-Than-Temporary Impairments | Other-Than-Temporary Impairments | | | | 5 | | (100) | | 1 | | 6 | | (83) | Other-Than-Temporary Impairments | | | | 1 | | (100) | | | | 1 | | (100) | Interest Expense | Interest Expense | | 62 | | 59 | | 5 | | 163 | | 159 | | 3 | Interest Expense | | 60 | | 53 | | 13 | | 120 | | 101 | | 19 | Income Taxes | Income Taxes | | 3 | | 99 | | (97) | | 180 | | 299 | | (40) | Income Taxes | | | 62 | | | 6 | | 933 | | | 21 | | | 177 | | (88) | Income (Loss) from Discontinued Operations | | | | | | 1 | | (100) | | | | | | 3 | | (100) | | Net Income | | 48 | | 201 | | (76) | | 361 | | 511 | | (29) | | Net Income Attributable to Noncontrolling Interests | | | | | | 1 | | (100) | | | | | | 1 | | (100) | | Net Income Attributable to PPL Shareowners | Net Income Attributable to PPL Shareowners | | $ | 48 | | $ | 200 | | (76) | | $ | 361 | | $ | 510 | | (29) | 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 marginsUnregulated Gross Energy Margins and certain items that management considers special. See additional detail of these special items in the table below.
| | Three Months | | Nine Months | | Three Months | | Six Months | | | | | | | | | | Unregulated gross energy margins | | $ | (38) | | $ | (125) | | Unregulated Gross Energy Margins | | | $ | (88) | | $ | (195) | Other operation and maintenance | | (23) | | (42) | | 16 | | 29 | Depreciation | | (15) | | (35) | | (9) | | (22) | Taxes, other than income | | | 3 | | 4 | Other Income (Expense) - net | | (18) | | (30) | | 9 | | 10 | Interest expense | | | (7) | | (19) | Other | | 7 | | 1 | | 2 | | 2 | Income Taxes | | 33 | | 106 | | 27 | | 60 | Discontinued operations, after-tax | | (1) | | 2 | | Special items, after-tax | | | (97) | | | (26) | | | 112 | | | (151) | Total | | $ | (152) | | $ | (149) | | $ | 65 | | $ | (282) |
· | See "Statement of Income Analysis - Margins - Changes in Non-GAAP Financial Measures" for an explanation of Unregulated Gross Energy Margins. |
· | HigherLower other operation and maintenance for the three-month period primarily due to $8$11 million of higherlower 2013 project and refueling outage costs at PPL Susquehanna $7 million due to a planned outage at PPL Brunner Island in September 2012 and $4 million of higherBrunner Island Unit 3 outage costs from Ironwood as a result of the acquisition.in 2012 with no comparable outage in 2013. |
HigherLower other operation and maintenance for the nine-monthsix-month period primarily due to $27$19 million of higherBrunner 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, including refuelingpartially offset by $5 million of Conemaugh Unit 2 outage costs payroll-related costs and timing of projects and $13 million of higher costs from Ironwood as a result of the acquisition.in 2013 with no comparable outage in 2012.
· | Higher depreciation for the three and nine-monthsix-month periods primarily due to the impact of PP&E additions, and $7additions. The six-month period also includes $6 million and $11 million dueattributable to the Ironwood Acquisition. |
· | LowerHigher other income (expense) - net for the three and nine-monthsix-month periods primarilypartially due to the impact of a $22worker's compensation adjustment of $4 million. |
· | Higher interest expense for the six-month period due to $7 million gain onfrom PPL Capital Funding's June 2012 $400 million debt issuance, $6 million due to lower capitalized interest in 2013 and $4 million due to financing associated with PPL Ironwood. Interest expense associated with certain PPL Capital Funding debt issuances is allocated to the redemption of debt in the third quarter of 2011.Supply segment. |
· | Lower income taxes for the three-month period primarilythree and six-month periods due to lower pre-tax income.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. |
Lower income taxes for the nine-month period due to lower pre-tax income, which reduced income taxes by $73 million, $15 million of net deferred tax benefits from state tax adjustments recorded in 2012 and $11 million of Pennsylvania net operating loss valuation allowance adjustments recorded in 2011, driven primarily by the impact of bonus depreciation.
The following after-tax gains (losses), which management considers special items, also impacted the Supply segment's results during the periods ended SeptemberJune 30.
| | | Income Statement | | Three Months | | Nine Months | | | Income Statement | | Three Months | | Six Months | | | | Line Item | | 2012 | | 2011 | | 2012 | | 2011 | | | Line Item | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | | | | | | | Adjusted energy-related economic activity, net, net of tax of $63, $8, ($16), ($2) | (a) | | $ | (95) | | $ | (10) | | $ | 23 | | $ | 4 | | Adjusted energy-related economic activity, net, net of tax of ($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: | | | | | | | | | | | Emission allowances, net of tax of $0, $0, $0, $1 | Other O&M | | | | | | | | (1) | | | Renewable energy credits, net of tax of $0, $0, $0, $2 | Other O&M | | | | | | | | (3) | | | Adjustments - nuclear decommissioning trust investments, net of tax of $0, $2, ($2), $2 | Other Income-net | | | | (1) | | 1 | | | | LKE acquisition-related adjustments: | | | | | | | | | | | | Sale of certain non-core generation facilities, net of tax of $0, $0, $0, $0 | Disc. Operations | | | | | | | | (2) | Adjustments - nuclear decommissioning trust investments, net of tax of $0, ($1), $0, ($2) | Other Income-net | | | | | | | | 1 | Other: | Other: | | | | | | | | | | Other: | | | | | | | | | | | Montana hydroelectric litigation, net of tax of $0, $0, $0, $1 | Interest Expense | | | | (1) | | | | (2) | Change in tax accounting method related to repairs | Income Taxes | | (3) | | | | (3) | | | | Litigation settlement - spent nuclear fuel storage, net of tax of $0, ($2), $0, ($23) (b) | Fuel | | | | 4 | | | | 33 | | Other Operation | | | | | | | | | | Counterparty bankruptcy, net of tax of $0, $0, $5, $0 (c) | Other O&M | | | | | | (6) | | | 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 | (d) | | | | | | 1 | | | Wholesale supply cost reimbursement, net of tax of $0, $0, $0, $0 | (c) | | | | 1 | | | | 1 | | Ash basin leak remediation adjustment, net of tax of $0, $0, ($1), $0 | Other O&M | | | | | | 1 | | | | | Other Operation | | | | | | | | | | Coal contract modification payments, net of tax of $7, $0, $12, $0 (e) | Fuel | | | (10) | | | | | | (17) | | | | 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 | | | $ | (105) | | $ | (8) | | $ | 3 | | $ | 29 | Total | | | $ | 74 | | $ | (38) | | $ | (43) | | $ | 108 |
(a) | See "Reconciliation of Economic Activity" below. |
(b) | In May 2011, PPL Susquehanna entered into a settlement agreement with the U.S. Government relating to PPL Susquehanna's lawsuit, seeking damages for the DOE's failure to accept spent nuclear fuel from the PPL Susquehanna plant. PPL Susquehanna recorded credits to fuel expense to recognize recovery, under the settlement agreement, of certain costs to store spent nuclear fuel at the Susquehanna plant. The amounts recorded through September 2011 cover the costs incurred from 1998 through December 2010. |
(c)(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. |
(d)(c) | Recorded in "Wholesale energy marketing - Realized" on the Statement of Income. |
(e)(d) | As a result of lower electricity and natural gas prices, coal unit utilization has decreased.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 SeptemberJune 30, from the table within "Commodity Price Risk (Non-trading) - Economic Activity" in Note 14 to the Financial Statements to the special item identified as "Adjusted energy-related economic activity, net."
| | | | Three Months | | Nine Months | | | | Three Months | | Six Months | | | | | 2012 | | 2011 | | 2012 | | 2011 | | | | 2013 | | 2012 | | 2013 | | 2012 | Operating Revenues | Operating Revenues | | | | | | | | | Operating Revenues | | | | | | | | | | | Unregulated retail electric and gas | | $ | (13) | | $ | 4 | | $ | (15) | | $ | 9 | | Unregulated retail electric and gas | | $ | 20 | | $ | (12) | | $ | 12 | | $ | (2) | | | Wholesale energy marketing | | (716) | | 216 | | (322) | | 229 | | Wholesale energy marketing | | 590 | | (458) | | (232) | | 394 | Operating Expenses | Operating Expenses | | | | | | | | | Operating Expenses | | | | | | | | | | | Fuel | | 3 | | (28) | | (11) | | (16) | | Fuel | | (4) | | (16) | | (5) | | (14) | | | Energy Purchases | | | 569 | | | (176) | | | 420 | | | (49) | | Energy Purchases | | | (479) | | | 442 | | | 155 | | | (149) | Energy-related economic activity (a) | Energy-related economic activity (a) | | (157) | | 16 | | 72 | | 173 | Energy-related economic activity (a) | | 127 | | (44) | | (70) | | 229 | Option premiums (b) | Option premiums (b) | | | | | | 6 | | | 1 | | | 17 | Option premiums (b) | | | | | | 1 | | | 1 | | | 1 | Adjusted energy-related economic activity | Adjusted energy-related economic activity | | (157) | | 22 | | 73 | | 190 | Adjusted energy-related economic activity | | 127 | | (43) | | (69) | | 230 | Less: Economic activity realized, associated with the monetization of | Less: Economic activity realized, associated with the monetization of | | | | | | | | | Less: Economic activity realized, associated with the monetization of | | | | | | | | | | certain full-requirement sales contracts in 2010 | | | 1 | | | 40 | | | 34 | | | 184 | 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 | | $ | (158) | | $ | (18) | | $ | 39 | | $ | 6 | 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 | | $ | (95) | | $ | (10) | | $ | 23 | | $ | 4 | Adjusted energy-related economic activity, net, after-tax | | $ | 76 | | $ | (32) | | $ | (41) | | $ | 118 |
(a) | See Note 14 to the Financial Statements for additional information. |
(b) | Adjustment for the net deferral and amortization of option premiums over the delivery period of the item that was hedged or upon realization. Option premiums are recorded in "Wholesale energy marketing - Realized" and "Energy purchases - Realized" on the Statements of Income. |
2013 Outlook
Excluding special items, PPL projects lower segment earnings in 20122013 compared with 2011. The decrease is2012, primarily driven by lower energy margins as a result ofprices, higher fuel costs, higher depreciation and higher financing costs, partially offset by lower energy and capacity prices and lower generation volumes, higher other operation and maintenance expense, higher capacity prices and higher depreciation.nuclear generation output.
Earnings in 2012 and future periods are subject to various risks and uncertainties. See "Forward-Looking Information," the rest of this Item 2, and Note 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in PPL's 20112012 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.
Statement of Income Analysis --
Margins
Non-GAAP Financial Measures
The following discussion includes financial information prepared in accordance with GAAP, as well as three non-GAAP financial measures: "Kentucky Gross Margins," "Pennsylvania Gross Delivery Margins" and "Unregulated Gross Energy Margins." These measures are not intended to replace "Operating Income," which is determined in accordance with GAAP, as an indicator of overall operating performance. Other companies may use different measures to analyze and to report on the results of their operations. PPL believes that these measures provide additional criteria to make investment decisions. These performance measures are used, in conjunction with other information, internally by senior management and the Board of Directors to manage the Kentucky Regulated, Pennsylvania Regulated and Supply segment operations, analyze each respective segment's actual results compared with budget and, in certain cases, to measure certain corporate financial goals used in determining variable compensation.
PPL's three non-GAAP financial measures include: · | "Kentucky Gross Margins" is a single financial performance measure of the Kentucky Regulated segment's electricity generation, transmission and distribution operations as well as its distribution and sale of natural gas. In calculating this measure, fuel and energy purchases are deducted from revenues. In addition, utility revenues and expenses associated with approved cost recovery tracking mechanisms are offset. These mechanisms allow for recovery of certain expenses, return on capital investments and performance incentives. Certain costs associated with these mechanisms, primarily ECR, DSM and DSM,GLT, are recorded as "Other operation and maintenance" and "Depreciation." These mechanisms allow for recovery of certain expenses, returns on capital investments and performance incentives. 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. |
· | "Unregulated Gross Energy Margins" is a single financial performance measure of the Supply segment's competitive energy non-trading and trading activities. In calculating this measure, the Supply segment's energy revenues which include operating revenues associated with certain Supply segment businesses that are classified as discontinued operations, are offset by the cost of fuel, energy purchases, certain other operation and maintenance expenses, primarily ancillary charges and gross receipts tax, which is recorded in "Taxes, other than income," and operating expenses associated with certain Supply segment businesses that are classified as discontinued operations.income". This performance measure is relevant to PPL due to the volatility in the individual revenue and expense lines on the Statements of Income that comprise "Unregulated Gross Energy Margins." This volatility stems from a number of factors, including the required netting of certain transactions with ISOs and significant swingsfluctuations in unrealized gains and losses. Such factors could result in gains or losses being recorded in either "Wholesale energy marketing" or "Energy purchases" on the Statements of Income. This performance measure includes PLR revenues from energy sales to PPL Electric by PPL EnergyPlus, which are reflectedrecorded in "PLR intersegment utility revenue (expense)" in the table below. PPL excludes from "Unregulated Gross Energy Margins" the Supply segment's adjusted energy-related economic activity, which includes the changes in fair value of positions used to economically hedge a portion of the economic value of PPL's competitive generation assets, full-requirement sales contracts and retail activities. This economic value is subject to changes in fair value due to market price volatility of the input and output commodities (e.g., fuel and power) prior to the delivery period that was hedged. Also included in adjusted energy-related economic activity is the premium amortization associated with options and for 2012 the ineffective portion of qualifying cash flow hedges and realized economic activity associated with the monetization of certain full-requirement sales contracts and premium amortization associated with options.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 marginsUnregulated Gross Energy Margins over the delivery period that was hedged or upon realization. |
Reconciliation of Non-GAAP Financial Measures | Reconciliation of Non-GAAP Financial Measures
The following tables reconcile "Operating Income" to PPL's three non-GAAP financial measures to "Operating Income" for the periods ended SeptemberJune 30.
| | | | | | 2012 Three Months | | 2011 Three Months | | | | | | | | | | | Unregulated | | | | | | | | | | | Unregulated | | | | | | | | | | | | | Kentucky | | PA Gross | | Gross | | | | | | | | Kentucky | | PA Gross | | Gross | | | | | | | | | | | | Gross | | Delivery | | Energy | | | | | Operating | | Gross | | Delivery | | Energy | | | | | | | | | | | | | Margins | | Margins | | Margins | | Other (a) | | Income (b) | | Margins | | Margins | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Revenues | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Utility | | $ | 732 | | $ | 443 | | | | | $ | 518 | (c) | | $ | 1,693 | | $ | 734 | | $ | 454 | | | | | $ | 487 | (c) | | $ | 1,675 | | PLR intersegment utility | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | revenue (expense) (d) | | | | | | (23) | | $ | 23 | | | | | | | | | | | | | (5) | | $ | 5 | | | | | | | | | Unregulated retail | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | electric and gas | | | | | | | | | 232 | | | (14) | (g) | | | 218 | | | | | | | | | 186 | | | 3 | (g) | | | 189 | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | | | | | | | | 1,074 | | | 2 | (f) | | | 1,076 | | | | | | | | | 897 | | | 10 | (f) | | | 907 | | | | Unrealized economic | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | activity | | | | | | | | | | | | (716) | (g) | | | (716) | | | | | | | | | | | | 216 | (g) | | | 216 | | Net energy trading margins | | | | | | | | | (11) | | | | | | | (11) | | | | | | | | | (7) | | | | | | | (7) | | Energy-related businesses | | | | | | | | | | | | 143 | | | | 143 | | | | | | | | | | | | 140 | | | | 140 | | | | Total Operating Revenues | | | 732 | | | 420 | | | 1,318 | | | (67) | | | | 2,403 | | | 734 | | | 449 | | | 1,081 | | | 856 | | | | 3,120 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | 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 | | | | | 2012 Three Months | | 2011 Three Months | | | | | | | Unregulated | | | | | | | | | | Unregulated | | | | | | | | | | | | | Unregulated | | | | | | | | | | Unregulated | | | | | | | | | Kentucky | | PA Gross | | Gross | | | | | Operating | | Kentucky | | PA Gross | | Gross | | | | | Operating | | | | | Kentucky | | PA Gross | | Gross | | | | | | | Kentucky | | PA Gross | | Gross | | | | | | | | | Gross | | Delivery | | Energy | | | | | Income | | Gross | | Delivery | | Energy | | | | | Income | | | | | Gross | | Delivery | | Energy | | | | | Operating | | Gross | | Delivery | | Energy | | | | | Operating | | | | Margins | | Margins | | Margins | | Other (a) | | (b) | | Margins | | Margins | | Margins | | Other (a) | | (b) | | | | | Margins | | Margins | | Margins | | Other (a) | | Income (b) | | Margins | | Margins | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | Operating Expenses | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | | | | | | | | | | | Fuel | | 249 | | | | 310 | | 11 | (e) | | 570 | | 245 | | | | 338 | | 20 | (e) | | 603 | Fuel | | 216 | | | | 223 | | 2 | | | 441 | | 215 | | | | 170 | | 26 | (g) | | 411 | | Energy purchases | | | | | | | | | | | | | | | | | | | | | | | Energy purchases | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | 27 | | 137 | | 418 | | 1 | (f) | | 583 | | 32 | | 171 | | 119 | | 40 | (f) | | 362 | | Realized | | 37 | | 120 | | 419 | | (4) | | | 572 | | 34 | | 120 | | 617 | | 16 | (e) | | 787 | | | Unrealized economic | | | | | | | | | | | | | | | | | | | | | | | | Unrealized economic | | | | | | | | | | | | | | | | | | | | | | | | | activity | | | | | | | | (569) | (g) | | (569) | | | | | | | | 176 | (g) | | 176 | | activity | | | | | | | | 479 | (f) | | 479 | | | | | | | | (442) | (f) | | (442) | | Other operation and | | | | | | | | | | | | | | | | | | | | | | | Other operation and | | | | | | | | | | | | | | | | | | | | | | | | | maintenance | | 28 | | 25 | | 1 | | 596 | | | 650 | | 26 | | 30 | | | | 679 | | | 735 | | maintenance | | 23 | | 21 | | 3 | | 651 | | | 698 | | 24 | | 26 | | 7 | | 682 | | | 739 | | Depreciation | | 13 | | | | | | 265 | | | 278 | | 12 | | | | | | 240 | | | 252 | Depreciation | | 2 | | | | | | 284 | | | 286 | | 13 | | | | | | 258 | | | 271 | | Taxes, other than income | | | | 23 | | 11 | | 56 | | | 90 | | | | 24 | | 8 | | 58 | | | 90 | Taxes, other than income | | | | 19 | | 10 | | 57 | | | 86 | | | | 20 | | 7 | | 60 | | | 87 | | Energy-related businesses | | | | | | | | 137 | | | 137 | | | | | | | | 135 | | | 135 | Energy-related businesses | | | | | | | | 130 | | | 130 | | | | | | | | 124 | | | 124 | | Intercompany eliminations | | | | | | (1) | | | 1 | | | | | | | | | | | | | (1) | | | 1 | | | | | | | | Intercompany eliminations | | | | | | (1) | | | 1 | | | | | | | | | | | | | (1) | | | | | | 1 | | | | | | | Total Operating Expenses | | | 317 | | | 184 | | | 741 | | | 497 | | | | 1,739 | | | 315 | | | 224 | | | 466 | | | 1,348 | | | | 2,353 | | Total Operating Expenses | | | 278 | | | 159 | | | 656 | | | 1,599 | | | | 2,692 | | | 286 | | | 165 | | | 801 | | | 725 | | | | 1,977 | Total | Total | | $ | 415 | | $ | 236 | | $ | 577 | | $ | (564) | | | $ | 664 | | $ | 419 | | $ | 225 | | $ | 615 | | $ | (492) | | | $ | 767 | Total | | $ | 404 | | $ | 242 | | $ | 405 | | $ | (293) | | | $ | 758 | | $ | 372 | | $ | 221 | | $ | 493 | | $ | (514) | | | $ | 572 |
| | | | 2012 Nine Months | | 2011 Nine Months | | | | 2013 Six Months | | 2012 Six Months | | | | | | | | Unregulated | | | | | | | | | | Unregulated | | | | | | | | | | | | Unregulated | | | | | | | | | | Unregulated | | | | | | | | | | Kentucky | | PA Gross | | Gross | | | | | | | Kentucky | | PA Gross | | Gross | | | | | | | | | Kentucky | | PA Gross | | Gross | | | | | Operating | | Kentucky | | PA Gross | | Gross | | | | | Operating | | | | | Gross | | Delivery | | Energy | | | | | Operating | | Gross | | Delivery | | Energy | | | | | Operating | | | | Gross | | Delivery | | Energy | | | | | Income | | Gross | | Delivery | | Energy | | | | | Income | | | | | Margins | | Margins | | Margins | | Other (a) | | Income (b) | | Margins | | Margins | | Margins | | Other (a) | | Income (b) | | | | Margins | | Margins | | Margins | | Other (a) | | (b) | | Margins | | Margins | | Margins | | Other (a) | | (b) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Revenues | Operating Revenues | | | | | | | | | | | | | | | | | | | | | | | Operating Revenues | | | | | | | | | | | | | | | | | | | | | | | | Utility | | $ | 2,095 | | $ | 1,303 | | | | $ | 1,614 | (c) | | $ | 5,012 | | $ | 2,139 | | $ | 1,444 | | | | $ | 1,112 | (c) | | $ | 4,695 | Utility | | $ | 1,482 | | $ | 925 | | | | $ | 1,198 | (c) | | $ | 3,605 | | $ | 1,363 | | $ | 860 | | | | $ | 1,096 | (c) | | $ | 3,319 | | PLR intersegment utility | | | | | | | | | | | | | | | | | | | | | | | PLR intersegment utility | | | | | | | | | | | | | | | | | | | | | | | | | revenue (expense) (d) | | | | (61) | | $ | 61 | | | | | | | | | (15) | | $ | 15 | | | | | | | revenue (expense) (d) | | | | (26) | | $ | 26 | | | | | | | | | (38) | | $ | 38 | | | | | | | Unregulated retail | | | | | | | | | | | | | | | | | | | | | | | Unregulated retail | | | | | | | | | | | | | | | | | | | | | | | | | electric and gas | | | | | | 638 | | (18) | (g) | | 620 | | | | | | 509 | | 8 | (g) | | 517 | | electric and gas | | | | | | 483 | | 11 | (f) | | 494 | | | | | | 406 | | (4) | (f) | | 402 | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | | | | | 3,353 | | 14 | (f) | | 3,367 | | | | | | 2,635 | | 42 | (f) | | 2,677 | | Realized | | | | | | 1,789 | | (2) | | | 1,787 | | | | | | 2,279 | | 12 | (e) | | 2,291 | | | Unrealized economic | | | | | | | | | | | | | | | | | | | | | | | | Unrealized economic | | | | | | | | | | | | | | | | | | | | | | | | | activity | | | | | | | | (322) | (g) | | (322) | | | | | | | | 229 | (g) | | 229 | | activity | | | | | | | | (232) | (f) | | (232) | | | | | | | | 394 | (f) | | 394 | | Net energy trading margins | | | | | | 7 | | | | | 7 | | | | | | 14 | | | | | 14 | Net energy trading margins | | | | | | (11) | | | | | (11) | | | | | | 18 | | | | | 18 | | Energy-related businesses | | | | | | | | | | | | 380 | | | | 380 | | | | | | | | | | | | 387 | | | | 387 | Energy-related businesses | | | | | | | | | | | | 264 | | | | 264 | | | | | | | | | | | | 237 | | | | 237 | | | Total Operating Revenues | | | 2,095 | | | 1,242 | | | 4,059 | | | 1,668 | | | | 9,064 | | | 2,139 | | | 1,429 | | | 3,173 | | | 1,778 | | | | 8,519 | | Total Operating Revenues | | | 1,482 | | | 899 | | | 2,287 | | | 1,239 | | | | 5,907 | | | 1,363 | | | 822 | | | 2,741 | | | 1,735 | | | | 6,661 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | Operating Expenses | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | | | | | | | | | | | Fuel | | 677 | | | | 695 | | 33 | (e) | | 1,405 | | 666 | | | | 872 | | (46) | (e) | | 1,492 | Fuel | | 447 | | | | 522 | | 1 | | | 970 | | 428 | | | | 385 | | 22 | (g) | | 835 | | Energy purchases | | | | | | | | | | | | | | | | | | | | | | | Energy purchases | | | | | | | | | | | | | | | | | | | | | | | | | Realized | | 135 | | 410 | | 1,669 | | 39 | (f) | | 2,253 | | 179 | | 591 | | 496 | | 201 | (f) | | 1,467 | | Realized | | 123 | | 292 | | 855 | | (7) | | | 1,263 | | 108 | | 273 | | 1,251 | | 38 | (e) | | 1,670 | | | Unrealized economic | | | | | | | | | | | | | | | | | | | | | | | | Unrealized economic | | | | | | | | | | | | | | | | | | | | | | | | | activity | | | | | | | | (420) | (g) | | (420) | | | | | | | | 49 | (g) | | 49 | | activity | | | | | | | | (155) | (f) | | (155) | | | | | | | | 149 | (f) | | 149 | | Other operation and | | | | | | | | | | | �� | | | | | | | | | | | | Other operation and | | | | | | | | | | | | | | | | | | | | | | | | | maintenance | | 76 | | 74 | | 12 | | 1,933 | | | 2,095 | | 67 | | 77 | | 13 | | 1,884 | | | 2,041 | | maintenance | | 48 | | 43 | | 8 | | 1,275 | | | 1,374 | | 46 | | 49 | | 11 | | 1,339 | | | 1,445 | | Depreciation | | 39 | | | | | | 774 | | | 813 | | 37 | | | | | | 660 | | | 697 | Depreciation | | 2 | | | | | | 568 | | | 570 | | 26 | | | | | | 509 | | | 535 | | Taxes, other than income | | | | 67 | | 27 | | 174 | | | 268 | | | | 77 | | 22 | | 139 | | | 238 | Taxes, other than income | | | | 47 | | 18 | | 117 | | | 182 | | | | 44 | | 16 | | 118 | | | 178 | | Energy-related businesses | | | | | | | | 363 | | | 363 | | | | | | | | 368 | | | 368 | Energy-related businesses | | | | | | | | 252 | | | 252 | | | | | | | | 226 | | | 226 | | Intercompany eliminations | | | | | | (3) | | | 2 | | | 1 | | | | | | | | | | (9) | | | 3 | | | 6 | | | | | Intercompany eliminations | | | | | | (2) | | | 2 | | | | | | | | | | | | | (2) | | | 1 | | | 1 | | | | | | | Total Operating Expenses | | 927 | | 548 | | 2,405 | | 2,897 | | | 6,777 | | 949 | | 736 | | 1,406 | | 3,261 | | | 6,352 | | Total Operating Expenses | | | 620 | | | 380 | | | 1,405 | | | 2,051 | | | | 4,456 | | | 608 | | | 364 | | | 1,664 | | | 2,402 | | | | 5,038 | | Discontinued operations | | | | | | | | | | | | | | | | | | | | | | | | | 12 | | | (12) | (h) | | | | | Total | Total | | $ | 1,168 | | $ | 694 | | $ | 1,654 | | $ | (1,229) | | | $ | 2,287 | | $ | 1,190 | | $ | 693 | | $ | 1,779 | | $ | (1,495) | | | $ | 2,167 | Total | | $ | 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) | Includes economic activity related to fuel as described in "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements. The three and nine months ended September 30, 2012, include pre-tax losses of $17 million and $29 million related to coal contract modification payments. The three and nine months ended September 30, 2011 include pre-tax credits of $6 million and $56 million for the spent nuclear fuel litigation settlement. |
(f) | Represents 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 ninesix months ended SeptemberJune 30, 2012, "Wholesale energy marketing - Realized" and "Energy purchases - Realized" include net pre-tax losses of $1$12 million and $34$33 million related to the monetization of certain full-requirement sales contracts. The three and nine months ended September 30, 2011 include net pre-tax losses of $40 million and $184 million related to the monetization of certain full-requirement sales contracts and net pre-tax gains of $6 million and $17 million related to the amortization of option premiums. |
(g)(f) | Represents energy-related economic activity, which is subject to fluctuations in value due to market price volatility, as described in "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements. |
(h)(g) | RepresentsIncludes economic activity related to fuel as described in "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the netFinancial Statements. The three and six months ended June 30, 2012 include a pre-tax loss of certain revenues and expenses associated with certain businesses that are classified as discontinued operations. These revenues and expenses are not reflected in "Operating Income" on the Statements of Income.$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 SeptemberJune 30 as well as the change between periods. The factors that gave rise to the changes are described below the table.
| | | Three Months | | Nine Months | | | | 2012 | | 2011 | | Change | | 2012 | | 2011 | | Change | | | | | | | | | | | | | | | | | | | | | Kentucky Gross Margins | | $ | 415 | | $ | 419 | | $ | (4) | | $ | 1,168 | | $ | 1,190 | | $ | (22) | PA Gross Delivery Margins by Component | | | | | | | | | | | | | | | | | | | | Distribution | | $ | 185 | | $ | 179 | | $ | 6 | | $ | 544 | | $ | 560 | | $ | (16) | | Transmission | | | 51 | | | 46 | | | 5 | | | 150 | | | 133 | | | 17 | Total | | $ | 236 | | $ | 225 | | $ | 11 | | $ | 694 | | $ | 693 | | $ | 1 | | | | | | | | | | | | | | | | | | | | | Unregulated Gross Energy Margins by Region | | | | | | | | | | | | | | | | | | | Non-trading | | | | | | | | | | | | | | | | | | | | Eastern U.S. | | $ | 521 | | $ | 530 | | $ | (9) | | $ | 1,417 | | $ | 1,502 | | $ | (85) | | Western U.S. | | | 67 | | | 92 | | | (25) | | | 230 | | | 263 | | | (33) | Net energy trading | | | (11) | | | (7) | | | (4) | | | 7 | | | 14 | | | (7) | Total | | $ | 577 | | $ | 615 | | $ | (38) | | $ | 1,654 | | $ | 1,779 | | $ | (125) |
| | | 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 decreasedincreased for the ninethree months ended SeptemberJune 30, 20122013 compared with the same period in 2011,2012, primarily due to $16higher base rates of $25 million, environmental cost recoveries added to base rates of lower retail margins, as volumes were impacted by unseasonably mild weather during the first four months$14 million and increased environmental investments of 2012, and $6$3 million, of lower wholesale margins, as volumes were impactedpartially offset by lower market prices. Total heatingvolumes of $9 million. The change in volumes was partially attributable to weather, as cooling degree days decreased 24%14% compared to the same period in 2011.2012.
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 effective January 1, 2013. The environmental cost recoveries added to base rates were due to the elimination of the 2005 and 2006 ECR plans as a result of the 2012 Kentucky rate 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, while the recovery of such costs remain in Margins through base rates.
Pennsylvania Gross Delivery Margins
Distribution
Margins decreasedincreased for the ninethree months ended SeptemberJune 30, 20122013 compared with the same period in 2011,2012, primarily due to an $18$11 million unfavorablefavorable 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 early in 2012. The three2012 and nine-month periods were impacted by a $7$32 million charge recorded in 2011 to reduce a portionfavorable effect of the transmission service charge regulatory asset associated with a 2005 undercollection that was not included in any subsequent rate reconciliations filed with the PUC.price, largely comprised of higher base rates, effective January 1, 2013, and higher volumes of $4 million.
Transmission
Margins increased for the three and nine-month periodssix months ended SeptemberJune 30, 2012,2013 compared with the same periods in 2011,2012, primarily due to increased investment in plant and the recovery of additional costs through the FERC formula-based rates.
Unregulated Gross Energy Margins
Eastern U.S. | | | | | | | | | | | | | | The changes in non-trading margins for the periods ended September 30, 2012 compared with 2011 were due to: | | | | | | | | | | Three Months | | Nine Months | | | | | | | | Baseload energy prices | | $ | (44) | | $ | (132) | Baseload capacity prices | | | 3 | | | (47) | Intermediate and peaking capacity prices | | | 5 | | | (22) | Impact of non-core generation facilities sold in the first quarter of 2011 | | | | | | (12) | Full-requirement sales contracts | | | 3 | | | (10) | Net economic availability of coal and hydroelectric units | | | (7) | | | 12 | Retail electric | | | 5 | | | 12 | Ironwood acquisition which eliminates tolling expense (a) | | | 14 | | | 27 | Nuclear generation volume (b) | | | 11 | | | 93 | Other | | | 1 | | | (6) | | | $ | (9) | | $ | (85) |
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) |
(a) | See Note 8 to the Financial Statements for additional information. |
(b) | Volumes were higher for the nine-month period due to a shorter outage period for blade inspections, an unplanned outage in March 2011 and an uprate in the third quarter of 2011. Volumes were higher for the three-month period due to higher availability in 2012. |
Western U.S.
Non-trading margins for the three and ninesix months ended SeptemberJune 30, 20122013 compared with the same periods in 20112012 were lower due to $14$20 million and $31$59 million of lower wholesale sales, including $10 million and $23 million related to the bankruptcy of SMGT.prices. The three-monthsix-month period was also lower due to $5partially offset by $7 million of higher fuel costs.wholesale volumes.
Utility Revenues | | | | | | | | | | | | | The increase (decrease) in utility revenues for the periods ended September 30, 2012 compared with 2011 was due to: | | | | | | | | | | | | | | | | | | Three Months | | Nine Months | Domestic: | | | | | | | | PPL Electric (a) | | $ | (11) | | $ | (141) | | LKE (b) | | | (4) | | | (45) | | Total Domestic | | | (15) | | | (186) | | | | | | | | | | | U.K.: | | | | | | | | PPL WW | | | | | | | | | Price (c) | | | 14 | | | 69 | | | Volume (d) | | | (2) | | | (17) | | | Recovery of allowed revenues (e) | | | 3 | | | (8) | | | Foreign currency exchange rates | | | (7) | | | (15) | | | Other | | | 5 | | | 2 | | | Total PPL WW | | | 13 | | | 31 | | WPD Midlands (f) | | | 20 | | | 472 | | Total U.K. | | | 33 | | | 503 | Total | | $ | 18 | | $ | 317 |
Net Energy Trading Margins
Net energy trading margins for the three months ended 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 three-increase for the three and nine-monthsix-month periods were impacted by ais primarily due to price increaseincreases effective April 1, 2012. The nine-month period was also impacted by a price increase effective2013 and April 1, 2011.2012. |
(d) | The decreaseincrease for the nine-month periodthree and six-month periods is primarily due to the downturn in the economy and the unfavorablefavorable effect of weather. |
(e) | The decrease for the nine-month periodthree and six-month periods is primarily due to a 2012 charge$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 incomeDPCR4. See Note 6 to the Financial Statements for the over-recovery of revenues from customers.additional information. |
(f) | The increasedecrease for the three-monththree month period is primarily duerelated to a price increase effective April 1, 2012. The nine-month period ended September 30, 2012$6 million reduction in third-party engineering revenue, which is not comparable to 2011 as 2011 includes only five monthspartially offset by a reduction in costs in "Other operation and maintenance" on the Statements of WPD Midlands' results. |
Other Operation and Maintenance
The increase (decrease) in other operation and maintenance expense for the periods ended September 30, 2012 compared with 2011 were due to:
| | | Three Months | | Nine Months | Domestic: | | | | | | | Uncollectible accounts (a) | $ | (5) | | $ | 11 | | LKE coal plant maintenance costs (b) | | 2 | | | 13 | | LKE storm costs (c) | | | | | 6 | | PPL Susquehanna nuclear plant costs (d) | | 8 | | | 27 | | Ironwood Acquisition (e) | | 4 | | | 13 | | PUC-reportable storm costs, net of insurance recoveries | | (3) | | | (18) | | Costs at Western fossil and hydroelectric plants | | (4) | | | (9) | | Costs at Eastern fossil and hydroelectric plants (f) | | 9 | | | (4) | | Payroll-related costs - PPL Electric | | 9 | | | 16 | | Vegetation management | | 3 | | | 12 | | Stock based compensation | | 2 | | | 15 | | Other | | | | | 20 | U.K.: | | | | | | | PPL WW (g) | | 4 | | | 21 | | WPD Midlands (h) | | (114) | | | (69) | Total | $ | (85) | | $ | 54 |
(a) | In October 2011, SMGT filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code. The increase for the nine-month period primarily reflects an $11 million increase to a reserve on SMGT unpaid amounts. |
(b) | The increase for the nine-month period is primarily due to an increased scope of scheduled outages. |
(c) | A credit to establish a regulatory asset was recorded in the first quarter of 2011 related to 2009 storm costs. |
(d) | Primarily due to refueling outage costs, payroll-related costs and timing of projects. |
(e) | There are no comparable amounts in the 2011 periods as the Ironwood Acquisition occurred in April 2012. |
(f) | The increase for the three-month period is primarily due to a planned outage at PPL Brunner Island in September 2012. |
(g) | The increase for the nine-month period includes $15 million of higher pension expense resulting from an increase in amortization of actuarial losses and $8 million of higher network maintenance expense. |
(h) | The decrease for the three-month period is primarily due to lower charges recorded as a result of the acquisition, including $85 million for severance compensation, early retirement deficiency costs and outplacement services for employees separating from WPD Midlands and $5 million of other acquisition-related adjustments, and a decrease in pension costs of $6 million. The nine-month period ended September 30, 2012 is not comparable to 2011 as 2011 includes only five months of WPD Midlands' results. The nine-month period also reflects $81 million of lower charges recorded as a result of the acquisition for severance compensation, early retirement deficiency costs and outplacement services for employees separating from WPD Midlands and $12 million of lower other acquisition-related costs. |
Depreciation | | | | | | | | | | | The increase (decrease) in depreciation expense for the periods ended September 30, 2012 compared with 2011 was due to: | | | | | | | | | | | | Three Months | | Nine Months | | | | | | | | | Additions to PP&E | | $ | 16 | | $ | 52 | WPD Midlands (a) | | | 6 | | | 59 | Ironwood Acquisition (Note 8) | | | 7 | | | 11 | Other | | | (3) | | | (6) | Total | | $ | 26 | | $ | 116 |
(a) | The nine-month period ended September 30, 2012 is not comparable to 2011 as 2011 includes only five months of WPD Midlands' results.Income. |
Taxes, Other Than IncomeOperation and Maintenance | | | | | | | | | The increase in taxes, other than income for the nine months ended September 30, 2012 compared with 2011 was due to: | | | | | | | | | Nine Months | | | | | | Pennsylvania gross receipts tax (a) | | $ | (14) | Domestic property tax | | | 7 | WPD Midlands (b) | | | 31 | Other | | | 6 | Total | | $ | 30 |
(a) | The decrease for the nine-month period is primarily due to a decrease in taxable electric revenue. This tax is included in "Unregulated Gross Energy Margins" and "Pennsylvania Gross Delivery Margins." |
(b) | The nine-month period ended September 30, 2012 is not comparable to 2011 as 2011 includes only five months of WPD Midlands' results. |
Other Income (Expense) - net | | | | | | | | | | | | | | The increase (decrease) in other income (expense) - net for the periods ended September 30, 2012 compared with 2011 was due to: | | | | | | | | | | Three Months | | Nine Months | | | | | | | | Change in the fair value of economic foreign currency exchange contracts (Note 14) | | $ | (58) | | $ | (51) | Net hedge gains associated with the 2011 Bridge Facility (a) | | | | | | (55) | Foreign currency loss on 2011 Bridge Facility (b) | | | | | | 57 | Gain on redemption of debt (c) | | | (22) | | | (22) | WPD Midlands acquisition-related adjustments in 2011 (Note 8) | | | | | | 57 | Earnings (losses) from equity method investments | | | (2) | | | (8) | Other | | | 1 | | | (7) | Total | | $ | (81) | | $ | (29) |
(a) | Represents a gain on foreign currency contracts that hedged the repayment of the 2011 Bridge Facility borrowing. |
(b) | Represents a foreign currency loss related to the repayment of the 2011 Bridge Facility borrowing. |
(c) | In July 2011, as a result of PPL Electric's redemption of 7.125% Senior Secured Bonds due 2013, PPL recorded a gain on the accelerated amortization of the fair value adjustment to the debt recorded in connection with previously settled fair value hedges. |
See Note 12 to the Financial Statements for further details.
Interest Expense | | | | | | | | | | | | The increase (decrease) in interest expenseother operation and maintenance for the periods ended SeptemberJune 30, 20122013 compared with 20112012 was due to: |
| | | | | | | | Three Months | | Nine Months | | | | | | | | | 2011 Bridge Facility costs related to financing the acquisition of WPD Midlands | | | | | $ | (43) | 2011 Equity Units (a) | | | | | | 13 | Long-term debt interest expense (b) | | $ | (1) | | | (11) | Short-term debt interest expense (c) | | | (4) | | | (11) | Hedging activity and ineffectiveness | | | 6 | | | 25 | Inflation adjustment on U.K. Index-linked Senior Unsecured Notes | | | (3) | | | (11) | Net amortization of debt discounts, premiums and issuance costs | | | (6) | | | (5) | WPD Midlands (d) | | | 9 | | | 77 | Ironwood Acquisition (Note 8) | | | 4 | | | 8 | Other | | | 3 | | | (6) | Total | | $ | 8 | | $ | 36 |
| | | 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) | Interest relatedThe decrease for the six-month period is primarily due to SMGT filing for protection under Chapter 11 of the issuanceU.S. Bankruptcy Code in April 20112011. $11 million of damages billed to support the WPD Midlands acquisition.SMGT were fully reserved in 2012. |
(b) | The decrease was primarilyfor the three and six month periods is due to the redemptiontiming and scope of $250 million of 7.0% Senior Notes due 2046 in July 2011 along with the repayment of $500 million of 6.4% Senior Notes and subsequent issuance of $500 million of 4.6% Senior Notes, both in the fourth quarter of 2011.scheduled outages. |
(c) | The decrease was primarilyfor the three and six month periods is due to lower interest rates on 2012 short-term borrowings.a reduction in Act 129 energy efficiency and conservation plan costs for Phase 1 programs. Phase 1 ended May 31, 2013. |
(d) | The nine-month period ended September 30, 2012 is not comparable to 2011 as 2011 includes only five monthsThese costs are offset by revenues reflected in "Utility" on the Statement of WPD Midlands' results.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. Income Taxes | | | | | | | | | | | The increase (decrease) in income taxes for the periods ended September 30, 2012 compared with 2011 was due to: | | | | | | | | Three Months | | Nine Months | | | | | | | | | Lower pre-tax book income | | $ | (108) | | $ | (131) | State valuation allowance adjustments (a) | | | 2 | | | (9) | Federal and state tax reserve adjustments | | | (6) | | | (8) | Federal and state tax return adjustments | | | | | | 2 | U.S. income tax on foreign earnings net of foreign tax credit (b) | | | 9 | | | 27 | Foreign tax reserve adjustments (c) | | | | | | (5) | Net operating loss carryforward adjustments (d) | | | | | | (9) | Depreciation not normalized (a) | | | (1) | | | 1 | WPD Midlands (e) | | | 25 | | | 86 | State deferred tax rate change (f) | | | (6) | | | (17) | Other | | | (8) | | | (2) | Total | | $ | (93) | | $ | (65) |
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 FebruaryMay 2013, the U.S. Supreme Court reversed the December 2011 ruling of the Pennsylvania DepartmentU.S. Court of Revenue issued interpretive guidanceAppeals for the Third Circuit on the treatmentcreditability of bonus depreciationU.K. Windfall Profits Tax for Pennsylvania income tax purposes. In accordance with Corporation Tax Bulletin 2011-01, Pennsylvania allows 100% bonus depreciation for qualifying assets inAs a result of this decision, PPL recorded a tax benefit of $44 million during the same year bonus depreciation is allowed for federal income tax purposes. Duethree and six months ended June 30, 2013. See Note 5 to the decrease in projected taxable income related to bonus depreciation, PPL recorded an $11 million state deferred income tax expense during the nine months ended September 30, 2011 related to valuation allowances.Financial Statements for additional information. |
Additionally, the 100% Pennsylvania bonus depreciation deduction created a current state income tax benefit for the flow-through impact of Pennsylvania regulated state tax depreciation. The federal provision for 100% bonus depreciation generally applies to property placed in service before January 1, 2012. The placed in-service deadline is extended to January 1, 2013 for property that exceeds $1 million, has a production period longer than one year and has a tax life of at least 10 years.
(b) | During the three and ninesix months ended SeptemberJune 30, 2011,2013, PPL recorded a $7$14 million and $21 million federalincrease to income tax expense primarily attributable to a revision in the expected taxable amount of cash repatriation in 2013 and recorded a tax benefit related toof $19 million associated with a ruling obtained from the IRS impacting the recalculation of 2010 U.K. pension contributions.earnings and profits that will be reflected on an amended 2010 U.S. tax return. |
(c) | During the ninethree and six months ended SeptemberJune 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 ninethree and six months ended SeptemberJune 30, 2012, PPL recorded adjustments to deferred taxes related to net operating loss carryforwards of LKE based on income tax return adjustments. |
(e) | The increase for the three-month period was due to an increase in pre-tax book income, which increased taxes by $30 million, partially offset by an incremental $6 million deferred tax benefit related to the 2012 U.K. Finance Act compared with the 2011 U.K. Finance Act. The nine-month period ended September 30, 2012 is not comparable to 2011 as 2011 includes only five months of WPD Midlands' results. |
(f) | During the three and ninesix months ended SeptemberJune 30, 2012, PPL recorded adjustments related to state deferred tax liabilities. |
See Note 5 to the Financial Statements for additional information on income taxes.
Income (Loss) from Discontinued Operations (net of income taxes)
Loss from discontinued operations increased by $8 million for the nine months ended September 30, 2012, compared with 2011. The increase was primarily related to an adjustment to a liability for indemnifications related to the termination of the WKE lease in 2009.
Noncontrolling Interests
"Net Income Attributable to Noncontrolling Interests" decreased by $5 million and $9 million for the three and nine months ended September 30, 2012 compared with 2011. The decrease is primarily due to PPL Electric's June 2012 redemption of all 2.5 million shares of its preference stock. The price paid was the par value, without premium ($250 million in the aggregate).
Financial Condition | | | | | | | | | | Liquidity and Capital Resources | | | | | | | | | | PPL had the following at: | | | | | | | | | | | | September 30, 2012 | | December 31, 2011 | | June 30, 2013 | | December 31, 2012 | | | | | | | | | | Cash and cash equivalents | | $ | 946 | | $ | 1,202 | | $ | 711 | | $ | 901 | Short-term investments | | | | | | 16 | | | | $ | 946 | | $ | 1,218 | | Short-term debt | | $ | 526 | | $ | 578 | | $ | 1,206 | | $ | 652 |
At SeptemberJune 30, 2012, $3602013, $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 20112012 Form 10-K for additional information on undistributed earnings of WPD.
The $256$190 million decrease in PPL's cash and cash equivalents position was primarily the net result of:
| · | capital expenditures of $2.1$1.8 billion; |
| · | the payment of $623$426 million of common stock dividends; |
| · | the redemption of preference stock of a subsidiary of $250 million; |
| · | the retirement of long-term debt of $105 million; |
| · | the Ironwood Acquisition for $84 million, net of cash acquired; |
| · | net cash provided by operating activities of $2.1 billion;$947 million; |
· | net increase in short-term debt of $563 million; and |
| · | proceeds of $824$450 million from the issuance of long-term debt. |
PPL's cash provided by operating activities increased by $248 millionhad no net change for the ninesix months ended SeptemberJune 30, 20122013 compared with 2011.2012. The increaseresult was primarily due to:the net effect of:
| · | ana $219 million increase of $185 million in net income, when adjusted for non-cash components; and |
| · | a $25 million decrease of $39 million in defined benefit plan funding.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 SeptemberJune 30, 2012,2013, PPL's total committed borrowing capacity under its credit facilities and the use of this borrowing capacity were:
| | | | | | | | Letters of | | | | | | | | | | | | | Credit Issued | | | | | | | | | | | | | and | | | | | | | Committed | | | | Commercial | | Unused | | | | Capacity | | Borrowed | | Paper Backstop | | Capacity | | | | | | | | | | | PPL Energy Supply Credit Facilities | | $ | 3,200 | | | | | $ | 594 | | $ | 2,606 | PPL Electric Credit Facilities (a) | | | 400 | | | | | | 1 | | | 399 | LG&E Credit Facility | | | 400 | | | | | | | | | 400 | KU Credit Facilities (b) | | | 598 | | | | | | 198 | | | 400 | | Total Domestic Credit Facilities (c) (d) | | $ | 4,598 | | | | | $ | 793 | | $ | 3,805 | | | | | | | | | | | | | | | PPL WW Credit Facility (e) | | £ | 150 | | £ | 107 | | | n/a | | £ | 43 | WPD (South West) Credit Facility (f) | | | 245 | | | | | | n/a | | | 245 | WPD (East Midlands) Credit Facility | | | 300 | | | | | | | | | 300 | WPD (West Midlands) Credit Facility | | | 300 | | | | | | | | | 300 | | Total WPD Credit Facilities (g) | | £ | 995 | | £ | 107 | | | | | £ | 888 |
| | | | | | | | | Letters of | | | | | | | | | | | | | Credit Issued | | | | | | | | | | | | | and | | | | | | | Committed | | | | Commercial | | Unused | | | | Capacity | | Borrowed | | Paper Backup | | Capacity | | | | | | | | | | | PPL Energy Supply Credit Facilities | | $ | 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) | In April 2012, PPL Electric increased the capacity of its syndicated credit facility from $200 million to $300 million. |
Committed capacity includes a $100 million credit facility related to an asset-backed commercial paper program through which PPL Electric obtains financing by selling and contributing its eligible accounts receivable and unbilled revenue to a special purpose, wholly owned subsidiary on an ongoing basis. The subsidiary pledges these assets to secure loans of up to an aggregate of $100 million from a commercial paper conduit sponsored by a financial institution. At September 30, 2012, based on accounts receivable and unbilled revenue pledged, the amount available for borrowing under the facility was $100 million. In July 2012, PPL Electric and the subsidiary reduced the capacity from $150 million and in September 2012 extended the agreement to September 2013.
(b) | In August 2012, the KU letter of credit facility agreement was amended and restated to allow for certain payments under the letter of credit facility to be converted to loans rather than requiring immediate payment. |
(c) | 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. |
(d) | In November 2012, the syndicated credit facilities were amended to extend the expiration dates to November 2017 for PPL Energy Supply, LG&E and KU and to October 2017 for PPL Electric. In addition, LG&E increased the credit facility capacity to $500 million. |
(e) | The amount outstanding at September 30, 2012 was a USD-denominated borrowing of $171 million, which equated to £107 million at the time of borrowing and bore interest at 0.8818%. |
(f) | In January 2012, WPD (South West) entered into a £245 million 5-year syndicated credit facility to replace its previous £210 million 3-year syndicated credit facility. Under the facility, WPD (South West) has the ability to make cash borrowings but cannot request the lenders to issue letters of credit. WPD (South West) pays customary commitment fees under this facility and borrowings bear interest at LIBOR-based rates plus a margin. The credit facility contains financial covenants that require WPD (South West) to maintain an interest coverage ratio of not less than 3.0 times consolidated earnings before income taxes, depreciation and amortization and total net debt not in excess of 85% of its RAV, in each case calculated in accordance with the credit facility. |
(g)(b) | At SeptemberJune 30, 2012,2013, the U.S. dollarUSD equivalent of unused capacity under WPD's committed credit facilities was $1.4$1.3 billion. The commitments under WPD's credit facilities are provided by a diverse bank group with no one bank providing more than 16%13% of the total committed capacity. |
See Note 7 to the Financial Statements for further discussion of PPL's credit facilities.
Commercial Paper
In February 2012, LG&E and KU each establishedPPL Energy Supply maintains a commercial paper program for up to $250 million to provide an additional financing source to fund their short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by LG&E's and KU's Syndicated Credit Facilities. LG&E and KU had no commercial paper outstanding at September 30, 2012.
In April 2012, PPL Energy Supply increased the capacity of its commercial paper program from $500 million to $750 million to provide an additional financing source to fund its short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by PPL Energy Supply's Syndicated Credit Facility. At SeptemberJune 30, 2013 and December 31, 2012, PPL Energy Supply had $355$575 million and $356 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheet,Sheets, at a weighted-average interest raterates of 0.48%0.29% and 0.50%.
In May 2012, PPL Electric increased the capacity of itsmaintains a commercial paper program from $200 millionfor up to $300 million to provide an additional financing source to fund its short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by PPL Electric's Syndicated Credit Facility. At 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 SeptemberDecember 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, 2012.2013 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
In April 2012,See "Overview - Financial and Operational Developments" above for information regarding equity forward agreements and the 2010 Equity Units. PPL made a registered underwritten public offering of 9.9 millionhas no plans to issue new shares of its common stock. In conjunction with that offering, the underwriters exercised an option to purchase 591 thousand additional shares of PPL common stock solely to cover over-allotments.for the remainder of 2013.
In connection with the registered public offering, PPL entered into forward sale agreements with two counterparties covering the 9.9 million shares of PPL common stock. Settlement of these initial forward sale agreements will occur no later than April 2013. As a result of the underwriters' exercise of the overallotment option, PPL entered into additional forward sale agreements covering the additional 591 thousand shares of PPL common stock. Settlement of the subsequent forward sale agreements will occur in July 2013. Upon any physical settlement of any forward sale agreement, PPL will issue and deliver to the forward counterparties shares of its common stock in exchange for cash proceeds per share equal to the forward sale price. The forward sale price will be calculated based on an initial forward price of $27.02 per share reduced during the period the contracts are outstanding as specified in the forward sale agreements. PPL may, in certain circumstances, elect cash settlement or net share settlement for all or a portion of its rights or obligations under the forward sale agreements.
PPL will not receive any proceeds or issue any shares of common stock until settlement of the forward sale agreements. PPL intends to use any net proceeds that it receives upon settlement to repay short-term debt obligations and for other general corporate purposes.
The forward sale agreements are classified as equity transactions. As a result, no amounts will be recorded in the consolidated financial statements until the settlement of the forward sale agreements. Prior to those settlements, the only impact to the financial statements will be the inclusion of incremental shares within the calculation of diluted EPS using the treasury stock method.
In April 2012, an indirect, wholly owned subsidiary of PPL Energy Supply completed the Ironwood Acquisition. See Note 8 to the Financial Statements for information on the transaction and the long-term debt of PPL Ironwood, LLC assumed through consolidation as part of the acquisition.
In April 2012, WPD (East Midlands) issued £100 million aggregate principal amount of 5.25% Senior Notes due 2023. WPD (East Midlands) received proceeds of approximately £111 million, which equated to $178 million at the time of issuance, net of underwriting fees. The net proceeds were used for general corporate purposes.
In June 2012, LKE completed an exchange of all its outstanding 4.375% Senior Notes due 2021 issued in September 2011 in a transaction not registered under the Securities Act of 1933, for similar securities that were issued in a transaction registered with the SEC. See Note 7 in PPL's and LKE's 2011 Form 10-K for additional information.
In June 2012,March 2013, PPL Capital Funding issued $400$450 million of 4.20% Seniorits 5.90% Junior Subordinated Notes due 2022. The notes may be redeemed at PPL Capital Funding's option any time prior to maturity at make-whole redemption prices.2073. PPL Capital Funding received proceeds of $396$436 million, net of 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 werewill be used for general corporate purposes.
In June 2012, PPL Electric redeemed all 2.5 million shares of its 6.25% Series Preference Stock, par value $100 per share. The price paid for the redemption was the par value, without premium ($250 million in the aggregate). At December 31, 2011, the preference stock was reflected in "Noncontrolling Interests" on PPL's Balance Sheet.
In August 2012, PPL Capital Funding redeemed at par, plus accrued interest, the $99 million outstanding principal amount of its 6.85% Senior Notes due 2047.
In August 2012, PPL Electric issued $250 million of 2.50% First Mortgage Bonds due 2022. The notes may be redeemed at PPL Electric's option any time prior to maturity at make-whole redemption prices. PPL Electric received proceeds of $247 million, net of a discount and underwriting fees. The net proceeds were used to repay short-term indebtedness incurredcapital expenditures, to fund PPL Electric's redemption of its 6.25% Series Preference Stock in June 2012pension obligations and for other general corporate purposes.
In October 2012, PPL Capital Funding issued $400 million of 3.50% Senior Notes due 2022. The notes may be redeemed at PPL Capital Funding's option any time prior to maturity at make-whole redemption prices. PPL Capital Funding received proceeds of $397 million, net of an underwriting discount and fees, which will be used to repay short-term debt obligations, including commercial paper borrowings and for general corporate purposes.
See Note 7 in PPL's 2011 Form 10-Kto the Financial Statements for information on the 2010further discussion of Long-term Debt and Equity Units (with respect to which the related $1.150 billion of Notes are expected to be remarketed in 2013), the 2011 Bridge Facility, the 2011 Equity Units and the April 2011 issuance of common stock.Securities.
Common Stock Dividends
In August 2012,May 2013, PPL declared its quarterly common stock dividend, payable OctoberJuly 1, 2012,2013, at 36.036.75 cents per share (equivalent to $1.44$1.47 per annum). Future dividends, declared at the discretion of the Board of Directors, will be dependent upon future earnings, cash flows, financial and legal requirements and other factors.
Rating Agency Actions
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.
As a result of the passage of the Dodd-Frank Act, PPL is limiting its credit rating disclosure to a description of the actions taken by the rating agencies with respect to PPL's ratings, but without stating what ratings have been assigned to PPL or its subsidiaries, or their securities. The ratings assigned by the rating agencies to PPL and its subsidiaries and their respective securities may be found, without charge, on eachhave no credit rating triggers that would result in the reduction of access to capital markets or the respective rating agencies' websites, which ratings together with all other information contained on such rating agency websites is, hereby, explicitly not incorporated by reference in this report.acceleration of maturity dates of outstanding debt.
The rating agencies took the following actions related to PPL and its subsidiaries:subsidiaries during 2013:
In January 2012,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 itsthe BBB- rating and revised itsstable outlook foron PPL Montana's Pass Through Certificatespass-through trust certificates due 2020.
In February 2012,May 2013, Fitch, Moody's and S&P assigned ratings of BBB, Baa3 and BBB- to the two newly established commercial paper programs for LG&EPPL Capital Funding's $250 million 1.90% Senior Notes due 2018, $600 million 3.40% Senior Notes due 2023 and KU.$300 million 4.70% Senior Notes due 2043. Fitch also assigned a stable outlook to these notes.
In March 2012, Moody's affirmed the following ratings: · | the long-term ratings of the First Mortgage Bonds for LG&E and KU; |
· | the issuer ratings for LG&E and KU; and |
· | the bank loan ratings for LG&E and KU. |
Also in March 2012,July 2013, Fitch, Moody's and S&P each assigned short-term ratings of A-, A3 and A- to the two newly established commercial paper programs for LG&EPPL Electric's $350 million 4.75% First Mortgage Bonds due 2043. Fitch also assigned a stable outlook to these notes and KU.S&P assigned a recovery rating of 1+.
In March and May 2012, Moody's,July 2013, S&P and Fitch affirmedconfirmed the long-termAA+ ratings for LG&E's 2003KU's 2000 Series A Solid Waste Disposal Facility Revenue Bonds and 2007KU's 2004 Series A, 2006 Series B pollution control bonds.
Followingand 2008 Series A Environmental Facilities Revenue Bonds. S&P also confirmed the announcement of the then-pending acquisition of AES Ironwood, L.L.C. in February 2012, theA-1+ short term rating agencies took the following actions:
· | In March 2012, Moody's placed AES Ironwood, L.L.C.'s senior secured bonds under review for possible ratings upgrade. |
· | In April 2012, S&P affirmed the rating of AES Ironwood, L.L.C.'s senior secured bonds. | on these Bonds.
In May 2012, Fitch downgradedJuly 2013, Moody's withdrew its rating and revisedoutlook 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 Certificatespass-through trust certificates due 2020.
In June 2012, Fitch assigned a rating and outlook to PPL Capital Funding's $400 million of 4.20% Senior Notes.
In August 2012, Fitch assigned a rating and outlook to PPL Electric's $250 million First Mortgage Bonds.
In August 2012, S&P and Moody's assigned a rating to PPL Electric's $250 million First Mortgage Bonds.
In October 2012, Fitch affirmed the long-term issuer default rating and senior unsecured rating of PPL WW, WPD (South Wales) and WPD (South West).
In October 2012, Moody's, S&P and Fitch assigned a rating to PPL Capital Funding's $400 million of 3.50% Senior Notes.
In October 2012, S&P affirmed its rating for PPL.
In November 2012, S&P revised its outlook for PPL Montana's Pass Through Certificates due 2020.
Ratings Triggers
PPL and PPL Energy Supply have various derivative and non-derivative contracts, including contracts for the sale and purchase of electricity and fuel, commodity transportation and storage, tolling agreements and interest rate and foreign currency instruments, which contain provisions that require PPL and PPL Energy Supply to post additional collateral or permit the counterparty to terminate the contract, if PPL's or PPL Energy Supply's credit rating were to fall below investment grade. See Note 14 to the Financial
Statements for a discussion of "Credit Risk-Related Contingent Features," including a discussion of the potential additional collateral that would have been required for derivative contracts in a net liability position at SeptemberJune 30, 2012. At September 30, 2012, if PPL's and its subsidiaries' credit ratings had been below investment grade, PPL would have been required to prepay or post an additional $486 million of collateral to counterparties for both derivative and non-derivative commodity and commodity-related contracts used in its generation, marketing and trading operations and interest rate and foreign currency contracts.
Capital Expenditures
Capital expenditure plans are revised periodically to reflect changes in operational, market and regulatory conditions. PPL has lowered its projected environmental capital spending for the period 2012 through 2016 by approximately $0.5 billion from the previously disclosed $3.4 billion projection of environmental capital spending included in PPL's 2011 Form 10-K. The lower projected capital spending is based on current project evaluations and pricing contained in contracts executed to date for environmental construction projects. PPL continues to evaluate potential new generation supply sources, including self-build options and power sourced from the market, as an alternative to installing additional emission control equipment at E.W. Brown, which is jointly dispatched for LG&E and KU, and in lieu of the terminated Bluegrass CTs acquisition discussed in Notes 6 and 8 to the Financial Statements. PPL expects to complete its evaluation during the first half of 2013. The outcome of that evaluation may lead to additional changes in projected capital spending.
For additional information on PPL's liquidity and capital resources, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," in PPL's 20112012 Form 10-K.
Risk Management
Market Risk
See Notes 13 and 14 to the Financial Statements for information about PPL's risk management objectives, valuation techniques and accounting designations.
The forward-looking information presented below provides estimates of what may occur in the future, assuming certain adverse market conditions and model assumptions. Actual future results may differ materially from those presented. These disclosures are not precise indicators of expected future losses, but only indicators of possible losses under normal market conditions at a given confidence level.
Commodity Price Risk (Non-trading)
PPL segregates its non-trading activities into two categories: hedge activity and economic activity. Transactions that are accounted for as hedge activity qualify for hedge accounting treatment. The economic activity category includes transactions that address a specific risk, but were not eligible for hedge accounting or for which hedge accounting was not elected. This activity includes the changes in fair value of positions used to hedge a portion of the economic value of PPL's competitive generation assets and full-requirement sales contracts and retail contracts. This economic activity is subject to changes in fair value due to market price volatility of the input and output commodities (e.g., fuel and power). Although they do not receive hedge accounting treatment, these transactions are considered non-trading activity. The fair value of economic positions at September 30, 2012 and December 31, 2011 was a net asset/(liability) of $491 million and $(63) million. The change in fair value is largely attributable to the dedesignation of cash flow hedges that are now classified as economic hedges. See Note 14 to the Financial Statements for additional information.
To hedge the impact of market price volatility on PPL's energy-related assets, liabilities and other contractual arrangements, PPL both sells and purchases physical energy at the wholesale level under FERC market-based tariffs throughout the U.S. and enters into financial exchange-traded and over-the-counter contracts. PPL's non-trading commodity derivative contracts range in maturity through 2019.
The following table sets forth the changes in the net fair value of non-trading commodity derivative contracts for the periods ended SeptemberJune 30. See Notes 13 and 14 to the Financial Statements for additional information.
| | Gains (Losses) | | Gains (Losses) | | | Three Months | | Nine Months | | Three Months | | Six Months | | | 2012 | | 2011 | | 2012 | | 2011 | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | $ | 961 | | $ | 894 | | $ | 1,082 | | $ | 956 | | $ | 229 | | $ | 1,215 | | $ | 473 | | $ | 1,082 | Contracts realized or otherwise settled during the period | | (224) | | (100) | | (764) | | (237) | | (100) | | (261) | | (237) | | (540) | Fair value of new contracts entered into during the period (a) | | (11) | | 4 | | 1 | | 19 | | 37 | | 13 | | 46 | | 12 | Other changes in fair value | | | (101) | | | 46 | | | 306 | | | 106 | | | 119 | | | (6) | | | 3 | | | 407 | Fair value of contracts outstanding at the end of the period | | $ | 625 | | $ | 844 | | $ | 625 | | $ | 844 | | $ | 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 SeptemberJune 30, 2012,2013, based on the level of observability of the information used to determine the fair value.
| | | Net Asset (Liability) | | | Net Asset (Liability) | | | | Maturity | | | | | | Maturity | | | | | Maturity | | | | | | Maturity | | | | | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | Source of Fair Value | Source of Fair Value | | | | | | | | | | | Source of Fair Value | | | | | | | | | | | Prices based on significant observable inputs (Level 2) | Prices based on significant observable inputs (Level 2) | | $ | 520 | | $ | 94 | | $ | (19) | | $ | 7 | | $ | 602 | Prices based on significant observable inputs (Level 2) | | $ | 226 | | $ | 32 | | $ | (10) | | $ | 5 | | $ | 253 | Prices based on significant unobservable inputs (Level 3) | Prices based on significant unobservable inputs (Level 3) | | | 11 | | | 8 | | | 4 | | | | | | 23 | Prices based on significant unobservable inputs (Level 3) | | | 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 | | $ | 531 | | $ | 102 | | $ | (15) | | $ | 7 | | $ | 625 | 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 couldwould be based on the difference between the market price and the contract price of the commodity. Depending on price changes in the wholesale energy markets, such damages could be significant. Extreme weather conditions, unplanned power plant outages, transmission disruptions, nonperformance by counterparties (or their own counterparties) with which it has energy contracts and other factors could affect PPL's ability to meet its obligations, or cause significant increases in the market price of replacement energy. Although PPL attempts to mitigate these risks, there can be no assurance that it will be able to fully meet its firm obligations, that it will not be required to pay damages for failure to perform, or that it will not experience counterparty nonperformance in the future. In connection with its bankruptcy proceedings, a significant counterparty, SMGT, had been purchasing lower volumes of electricity than prescribed in the contract and effective April 1, 2012 the contract was terminated. PPL Energy Supply cannot predict the prices or other terms on which it will be able to market to third parties the power that SMGT will not purchase from PPL EnergyPlus due to the termination of this contract. See Note 10 to the Financial Statements for additional information.
Commodity Price Risk (Trading)
PPL's trading commodity derivative contracts range in maturity through 2017.2018. The following table sets forth changes in the net fair value of trading commodity derivative contracts for the periods ended SeptemberJune 30. See Notes 13 and 14 to the Financial Statements for additional information.
| | Gains (Losses) | | Gains (Losses) | | | Three Months | | Nine Months | | Three Months | | Six Months | | | 2012 | | 2011 | | 2012 | | 2011 | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | $ | 17 | | $ | 15 | | $ | (4) | | $ | 4 | | $ | 15 | | $ | 2 | | $ | 29 | | $ | (4) | Contracts realized or otherwise settled during the period | | 17 | | (10) | | 16 | | (7) | | | | (1) | | (2) | | (1) | Fair value of new contracts entered into during the period (a) | | 13 | | (2) | | 18 | | 6 | | (4) | | (1) | | (16) | | 5 | Other changes in fair value | | | (15) | | | 4 | | | 2 | | | 4 | | | 7 | | | 17 | | | 7 | | | 17 | Fair value of contracts outstanding at the end of the period | | $ | 32 | | $ | 7 | | $ | 32 | | $ | 7 | | $ | 18 | | $ | 17 | | $ | 18 | | $ | 17 |
(a) | Represents the fair value of contracts at the end of the quarter of their inception. |
Unrealized gains of approximately $4 million will be reversed over the next three months as the transactions are realized.
The following table segregates the net fair value of trading commodity derivative contracts at SeptemberJune 30, 2012,2013, based on the level of observability of the information used to determine the fair value.
| | Net Asset (Liability) | | Net Asset (Liability) | | | Maturity | | | | | | Maturity | | | | Maturity | | | | | | Maturity | | | | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | Source of Fair Value | | | | | | | | | | | | | | | | | | | | | Prices based on significant observable inputs (Level 2) | | $ | 18 | | $ | 11 | | $ | 1 | | | | $ | 30 | | $ | 4 | | $ | 6 | | | | | | | $ | 10 | Prices based on significant unobservable inputs (Level 3) | | | 2 | | | | | | | | | | | | 2 | | | 6 | | | 2 | | | | | | | | | 8 | Fair value of contracts outstanding at the end of the period | | $ | 20 | | $ | 11 | | $ | 1 | | | | | $ | 32 | | $ | 10 | | $ | 8 | | | | | | | | $ | 18 |
VaR Models
A VaR model is utilized to measure commodity price risk in domesticunregulated gross energy margins for the non-trading and trading portfolios. VaR is a statistical model that attempts to estimate the value of potential loss over a given holding period under normal market conditions at a given confidence level. VaR is calculated using a Monte Carlo simulation technique based on a five-day holding period at a 95% confidence level. Given the company's conservativedisciplined hedging program, the non-trading VaR exposure is expected to be limited in the short-term. The VaR for portfolios using end-of-month results for the periodsix months ended June 30, 2013 was as follows.
| | | Trading VaR | | Non-Trading VaR | | | | Nine Months | | Twelve Months | | Nine Months | | Twelve Months | | | | Ended | | Ended | | Ended | | Ended | | | | September 30, | | December 31, | | September 30, | | December 31, | | | | 2012 | | 2011 | | 2012 | | 2011 | 95% Confidence Level, Five-Day Holding Period | | | | | | | | | | | | | | Period End | | $ | 6 | | $ | 1 | | $ | 10 | | $ | 6 | | Average for the Period | | | 3 | | | 3 | | | 9 | | | 5 | | High | | | 8 | | | 6 | | | 11 | | | 7 | | Low | | | 1 | | | 1 | | | 7 | | | 4 |
| | | | | | 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 speculativeproprietary trading positions, regardless of the delivery period. All positions not considered speculativeproprietary trading are considered non-trading. The non-trading portfolio includes the entire portfolio, including generation, with delivery periods through the next 12 months. Both the trading and non-trading VaR computations exclude FTRs due to the absence of reliable spot and forward markets. The fair value of the non-trading and trading FTR positions was insignificant at SeptemberJune 30, 2012.2013.
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 SeptemberJune 30, 2012,2013, 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 SeptemberJune 30, 20122013 would increase the fair value of its debt portfolio by $609$631 million.
At SeptemberJune 30, 2012,2013, PPL had the following interest rate hedges outstanding:
| | | | | | | Effect of a | | | | | | | Effect of a | | | | | | Fair Value, | | 10% Adverse | | | | | Fair Value, | | 10% Adverse | | | | Exposure | | Net - Asset | | Movement | | | Exposure | | Net - Asset | | Movement | | | | Hedged | | (Liability) (a) | | in Rates (b) | | | Hedged | | (Liability) (a) | | in Rates (b) | Cash flow hedges | Cash flow hedges | | | | | | | Cash flow hedges | | | | | | | | Interest rate swaps (c) | | $ | 618 | | $ | (21) | | $ | (14) | Interest rate swaps (c) | | $ | 1,930 | | $ | 129 | | $ | (74) | | Cross-currency swaps (d) | | 1,262 | | 20 | | (180) | Cross-currency swaps (d) | | 1,262 | | 61 | | (171) | Economic hedges | | | | | | | | Economic activity | | Economic activity | | | | | | | | Interest rate swaps (e) | | 179 | | (62) | | (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.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. Sensitivities represent a 10% adverse movement in interest rates. The positions outstanding at SeptemberJune 30, 20122013 mature through 2024.2044. |
(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. Sensitivities represent a 10% adverse movement in both interest rates and foreign currency exchange rates. The positions outstanding at SeptemberJune 30, 20122013 mature through 2028. |
(e) | PPL utilizes various risk management instruments to reduce its exposure to the expected future cash flow variability of its debt instruments. These risks include exposure to adverse interest rate movements for outstanding variable rate debt and for future anticipated financing. While PPL is exposed to changes in the fair value of these instruments, any realized changes in the fair value of such economic hedgespositions are recoverable through regulated rates and any subsequent changes in fair value of these derivatives are included in regulatory assets or liabilities. Sensitivities represent a 10% adverse movement in interest rates. The positions outstanding at SeptemberJune 30, 20122013 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 SeptemberJune 30, 2012,2013, PPL had the following foreign currency hedges outstanding:
| | | | | | | Effect of a | | | | | | | Effect of a | | | | | | | | 10% | | | | | | | 10% | | | | | | | | Adverse | | | | | | | Adverse | | | | | | | | Movement | | | | | | | Movement | | | | | | | | in Foreign | | | | | | | in Foreign | | | | | | Fair Value, | | Currency | | | | | Fair Value, | | Currency | | | | Exposure | | Net - Asset | | Exchange | | | Exposure | | Net - Asset | | Exchange | | | | Hedged | | (Liability) | | Rates (a) | | | Hedged | | (Liability) | | Rates (a) | | | | | | | | | | | | | | | | Net investment hedges (b) | Net investment hedges (b) | | £ | 163 | | $ | (1) | | $ | (26) | Net investment hedges (b) | | £ | 166 | | $ | 11 | | $ | (25) | Economic hedges (c) | | 1,199 | | (35) | | (185) | | Economic activity (c) | | 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 SeptemberJune 30, 20122013 mature through 2013.2014. Excludes the amount of an intercompany loanloans classified as a net investment hedge.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 positionsforwards and options outstanding at SeptemberJune 30, 20122013 mature through 2014.2015. |
NDT Funds - Securities Price Risk
In connection with certain NRC requirements, PPL Susquehanna maintains trust funds to fund certain costs of decommissioning the PPL Susquehanna nuclear plant (Susquehanna). At SeptemberJune 30, 2012,2013, these funds were invested primarily in domestic equity securities and fixed-rate, fixed-income securities and are reflected at fair value on the Balance Sheet. The mix of securities is designed to provide returns sufficient to fund Susquehanna's decommissioning and to compensate for inflationary increases in decommissioning costs. However, the equity securities included in the trusts are exposed to price fluctuation in equity markets, and the values of fixed-rate, fixed-income securities are primarily exposed to changes in interest rates. PPL actively monitors the investment performance and periodically reviews asset allocation in accordance with its NDTnuclear decommissioning trust policy statement. At SeptemberJune 30, 2012,2013, a hypothetical 10% increase in interest rates and a 10% decrease in equity prices would have resulted in an estimated $49$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 20112012 Form 10-K for additional information.
Foreign Currency Translation
The value of the British pound sterling fluctuates in relation to the U.S. dollar. Changes in thesethis exchange ratesrate resulted in a foreign currency translation gainloss of $53$269 million for the ninesix months ended SeptemberJune 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 $93$259 million increasereduction to PP&E and goodwill offset by an increasea reduction of $40 million to net liabilities. Changes in these exchange rates resulted in a foreign currency translation gain of $154 million for the nine months ended September 30, 2011, which primarily reflected a $242 million increase to PP&E offset by an increase of $88$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. See Note 11 to the Financial Statements for additional information on related party transactions.
Acquisitions, Development and Divestitures
See Note 8PPL from time to the Financial Statementstime evaluates opportunities for information on the April 2012 Ironwood Acquisitionpotential acquisitions, divestitures and LG&E's and KU's June 2012 termination of the asset purchase agreement for the Bluegrass CTs.
See Note 8 to the Financial Statements in this Form 10-Q and Note 10 to the Financial Statements in PPL's 2011 Form 10-K for information on PPL's April 2011 acquisition of WPD Midlands.
development projects. Development projects are continuously reexamined based on market conditions and other factors to determine whether to proceed with the projects, sell, cancel or expand them, execute tolling agreements or pursue other options. See Note 8 to the Financial Statements for additional information on the more significant activities.
Environmental Matters
Extensive federal, state and local environmental laws and regulations are applicable to PPL's air emissions, water discharges and the management of hazardous and solid waste, amongas well as other areas; and theaspects of PPL's business. The cost of compliance or alleged non-compliance cannot be predicted with certainty but could be material. In addition, costs may increase significantly if the requirements or scope of environmental laws or regulations, or similar rules, are expanded or changed by the relevant regulatory agencies. Costs may take the form of increased capital expenditures or operating and maintenance expenses;expenses, monetary fines, penalties or other restrictions. Many of these environmental law considerations are also applicable to the operations of key suppliers, or customers, such as coal producers and industrial power users, and may impact the cost ofcosts for their products or their demand for PPL's services.
Physical effects associated with 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 20112012 Form 10-K for a discussion ofadditional information on environmental matters.
New Accounting Guidance
See Notes 2 and 1819 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.
Application of Critical Accounting Policies
Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies. The following accounting policies are particularly important to the financial condition or results of operations, and require estimates or other judgments of matters inherently uncertain: price risk management, defined benefits, asset impairment (excluding investments), loss accruals, AROs, income taxes, and regulatory assets and liabilities and business combinations - purchase price allocation.liabilities. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in PPL's 20112012 Form 10-K for a discussion of each critical accounting policy.
PPL ENERGY SUPPLY, LLC AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following should be read in conjunction with PPL Energy Supply's Condensed Consolidated Financial Statements and the accompanying Notes and with PPL Energy Supply's 20112012 Form 10-K. Capitalized terms and abbreviations are defined in the glossary. Dollars are in millions, unless otherwise noted.
"Management's Discussion and Analysis of Financial Condition and Results of Operations" includes the following information:
· | "Overview" provides a description of PPL Energy Supply and its business strategy, a summary of Net Income Attributable to PPL Energy Supply Member and a discussion of certain events related to PPL Energy Supply's results of operations and financial condition. |
· | "Results of Operations" provides a summary of PPL Energy Supply's earnings and a description of key factors expected to impact future earnings. This section ends with explanations of significant changes in principal line items on PPL Energy Supply's Statements of Income, comparing the three and ninesix months ended SeptemberJune 30, 20122013 with the same periods in 2011.2012. |
· | "Financial Condition - Liquidity and Capital Resources" provides an analysis of PPL Energy Supply's liquidity position and credit profile. This section also includes a discussion of rating agency actions. |
· | "Financial Condition - Risk Management" provides an explanation of PPL Energy Supply's risk management programs relating to market and credit risk. |
Overview
Introduction
PPL Energy Supply is an energy company with headquarters in Allentown, Pennsylvania. Through its subsidiaries, PPL Energy Supply is primarily engaged in the competitive generation and marketing of electricity in two key markets - the northeastern and northwestern U.S.
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 overall 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 risk,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 offor PPL Energy Supply's business strategySupply is to maintain a strong credit profile. PPL Energy Supply continually focuses on maintaining an appropriate capital structureprofile and liquidity position. In addition, PPL Energy Supply has financial and operational risk management programs that, among other things, are designed to monitor and manage its exposure to earnings and cash flow volatility related to changes in energy and fuel prices, interest rates, counterparty credit quality and the operating performance of its generating units.
Financial and Operational Developments
Net Income Attributable to PPLUnregulated Gross Energy Supply MemberMargins
Net Income Attributable to PPL Energy Supply MemberEastern 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 ninesix months ended SeptemberJune 30, 2012 was $54 million and $382 million2013 compared to $169 million and $472 million forwith the same periods in 2011, representing decreases2012 were lower due to $20 million and $59 million of 68% and 19% fromlower 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 periodsperiod in 2011.
See "Results of Operations" for details of special items 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. As2012 decreased as a result of these factors, PPL Energy Supply has experienced a shift in the dispatchinglower margins of its competitive generation from coal-fired to combined-cycle gas-fired generation as illustrated in the following table:$5 million on power positions and $3 million on FTRs.
| | | Average Utilization Factors (a) | | | | 2009 - 2011 | | | YTD 2012 | Pennsylvania coal plants | | | 89% | | | 70% | Montana coal plants | | | 87% | | | 59% | Combined-cycle gas plants | | | 70% | | | 96% |
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) | All periods reflect the nine months ending September 30.See "Pennsylvania Gross Delivery Margins" for further information. |
This reduction in coal-fired generation output had resulted in a surplus of coal inventory at certain of PPL Energy Supply's Pennsylvania coal plants. To mitigate the risk of exceeding available coal storage, PPL Energy Supply incurred pre-tax charges of $17 million and $29 million during the three and nine months ended September 30, 2012 to reduce its 2012 and 2013 contracted coal deliveries. PPL Energy Supply will continue to manage its coal inventory to mitigate the financial impact and physical implications of an oversupply.
In addition, current economic and commodity market conditions indicated a lower value of unhedged future energy margins (primarily in 2014 and forward years) compared to the hedged energy margins in 2012. As has been PPL Energy Supply's practice in periods of changing business conditions, PPL Energy Supply continues to review its future business and operational plans, including capital and operation and maintenance expenditures, as well as its hedging strategies.
PPL Energy Supply's businesses are also subject to extensive federal, state and local environmental laws, rules and regulations. PPL Energy Supply's competitive generation assets are well positioned to meet these requirements. See Note 10 to the Financial Statements in this Form 10-Q and Note 15 to the Financial Statements in PPL Energy Supply's 2011 Form 10-K for additional information on these requirements. As a result of these requirements, PPL Energy Supply announced in September 2012 its intention, beginning in April 2015, 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 the Mercury and Air Toxics Standards. The Corette plant's carrying value at September 30, 2012 was approximately $67 million. Although the Corette plant was not determined to be impaired at September 30, 2012, it is reasonably possible that an impairment charge could be recorded in the fourth quarter of 2012 or in future periods, as higher priced sales contracts settle, adversely impacting projected cash flows.
In light of these economic and market conditions, as well as current and projected environmental regulatory requirements, PPL Energy Supply considered whether certain of its other generating assets were impaired, and determined that no impairment charges were required at September 30, 2012. PPL Energy Supply is unable to predict whether future environmental requirements or market conditions will result in impairment charges for other generating assets or additional retirements.
PPL Energy Supply and its subsidiaries may also be impacted in future periods by the uncertainty in the worldwide financial and credit markets partially caused by the European sovereign debt crisis. In addition, PPL Energy Supply may be impacted by reductions in the credit ratings of financial institutions and evolving regulations in the financial sector. Collectively, these factors could reduce availability or restrict PPL Energy Supply and its subsidiaries' ability to maintain sufficient levels of liquidity, reduce capital market activities, change collateral posting requirements and increase the associated costs to PPL Energy Supply and its subsidiaries.
PPL Energy Supply cannot predict the future impact that these economic and market conditions and regulatory requirements may have on its financial condition or results of operations.
Susquehanna Turbine Blade Inspection
PPL Energy Supply previously announced that a shutdown of Unit 1 of its Susquehanna nuclear power plant in October 2012 will include an inspection of that unit's turbine blades that could lead to the finalization of a plan to resolve the issue of turbine blade cracking that was first identified in 2011. Unit 1 is expected to resume operations by November 8, 2012. PPL Energy Supply plans to take an inspection outage for Unit 2. The projected pre-tax earnings impact of these inspections, including reduced energy-sales margins and possible repair expenses, is estimated in the range of $43 million to $58 million ($26 million to $35 million, after-tax), and the ultimate financial impact will depend on the duration of the Unit 2 outage.
Ironwood Acquisition
In April 2012, an indirect, wholly owned subsidiary of PPL Energy Supply completed the acquisition of the equity interests in the owner and operator of the Ironwood Facility. The Ironwood Facility began operation in 2001 and, since 2008, PPL EnergyPlus has supplied natural gas for the operation of the facility and received the facility's full electricity output and capacity value pursuant to a tolling agreement that expires in 2021. The acquisition provides PPL Energy Supply, through its subsidiaries, operational control of additional combined-cycle gas generation in PJM. See Note 8 to the Financial Statements for additional information.
Bankruptcy of SMGT
In October 2011, SMGT, a Montana cooperative and purchaser of electricity under a long-term supply contract with PPL EnergyPlus expiring in June 2019 (SMGT Contract), filed for protection under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the District of Montana. At the time of the bankruptcy filing, SMGT was PPL EnergyPlus' largest unsecured credit exposure.
The SMGT Contract provided for fixed volume purchases on a monthly basis at established prices. Pursuant to a court order and subsequent stipulations entered into between the SMGT bankruptcy trustee and PPL EnergyPlus, since the date of its Chapter 11 filing through January 2012, SMGT continued to purchase electricity from PPL EnergyPlus at the price specified in the SMGT Contract, and made timely payments for such purchases, but at lower volumes than as prescribed in the SMGT Contract. In January 2012, the trustee notified PPL EnergyPlus that SMGT would not purchase electricity under the SMGT Contract for the month of February. In March 2012, the U.S. Bankruptcy Court for the District of Montana issued an order approving the request of the SMGT bankruptcy trustee and PPL EnergyPlus to terminate the SMGT Contract. As a result, the SMGT Contract was terminated effective April 1, 2012, allowing PPL EnergyPlus to resell the electricity previously contracted to SMGT under the SMGT Contract to other customers.
PPL EnergyPlus' receivable under the SMGT Contract totaled approximately $21 million at September 30, 2012, which has been fully reserved.
In July 2012, PPL EnergyPlus filed its proof of claim in the SMGT bankruptcy proceeding. The total claim is approximately $375 million, predominantly an unsecured claim representing the value for energy sales that will not occur as a result of the termination of the SMGT Contract. No assurance can be given as to the collectability of the claim.
PPL Energy Supply cannot predict any amounts that it may recover in connection with the SMGT bankruptcy or the prices and other terms on which it will be able to market to third parties the power that SMGT will not purchase from PPL EnergyPlus due to the termination of the SMGT Contract.
Results of Operations
The following discussion provides a summary of PPL Energy Supply's earnings and a description of factors that are expected to impact future earnings. This section ends with "Statement of Income Analysis," which includes explanations of significant changes in principal items on PPL Energy Supply's Statements of Income, comparing the three and nine months ended September 30, 2012 with the same periods in 2011.
The results for interim periods can be disproportionately influenced by numerous factors and developments and by seasonal variations. As such, the results of operations for interim periods do not necessarily indicate results or trends for the year or future periods.
Earnings | | | | | | | | | | | | | | | Net Income Attributable to PPL Energy Supply Member for the periods ended September 30 was: | | | | | | | | | | | | | | | | | | Three Months | | Nine Months | | | | 2012 | | 2011 | | 2012 | | 2011 | | | | | | | | | | | | | | | Net Income Attributable to PPL Energy Supply Member | | $ | 54 | | $ | 169 | | $ | 382 | | $ | 472 |
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 | | Nine Months | | | | | | | | Unregulated gross energy margins | | $ | (38) | | $ | (125) | Other operation and maintenance | | | (11) | | | (27) | Depreciation | | | (11) | | | (25) | Other Income (Expense) - net | | | | | | (10) | Interest Expense | | | 8 | | | 24 | Other | | | 9 | | | 6 | Income Taxes | | | 25 | | | 90 | Discontinued operations, after-tax | | | | | | 3 | Special items, after-tax | | | (97) | | | (26) | Total | | $ | (115) | | $ | (90) |
(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 "StatementNote 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 Analysis - Unregulated Gross Energy Margins - Changes in Non-GAAP Financial Measures" for an explanation of Unregulated Gross Energy Margins.Income. |
·Other Operation and Maintenance | Higher | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance for the three-month period primarilyperiods ended June 30, 2013 compared with 2012 was due to $8 million of higher costs at PPL Susquehanna, $7 million due to a planned outage at PPL Brunner Island in September 2012 and $4 million of higher costs from Ironwood as a result of the acquisition, partially offset by $9 million of trademark royalties with an affiliate in 2011 for which the agreement was terminated December 31, 2011.to: |
| Higher other operation and maintenance for the nine-month period primarily due to $27 million of higher costs at PPL Susquehanna including refueling outage costs, payroll-related costs and timing of projects, $17 million from higher systems-related costs and timing of projects and $13 million of higher costs from Ironwood as a result of the acquisition, partially offset by $26 million of trademark royalties with an affiliate in 2011 for which the agreement was terminated December 31, 2011. |
· | Higher depreciation for the three and nine-month periods due to the impact of PP&E additions, including $7 million and $11 million due to the Ironwood Acquisition. |
· | Lower other income (expense) - net for the nine-month period partly due to lower earnings on securities in the NDT funds. |
· | Lower interest expense for the three and nine-month periods due to 2011 including the acceleration of deferred financing fees of $7 million related to the July 2011 redemption of $250 million of 7.00% Senior Notes. In addition, the nine-month period was lower due to a $10 million impact of not replacing the $250 million of debt, a $7 million impact from $500 million in debt that matured in 2011 being replaced with debt at a lower interest rate, and a $10 million impact from less short-term debt in 2012, partially offset by an $8 million increase related to the debt assumed through consolidation as a result of the Ironwood Acquisition. |
· | Lower income taxes for the three-month period primarily due to lower pre-tax income. |
| Lower income taxes for the nine-month period due to lower pre-tax income, which reduced income taxes by $67 million, $15 million of net deferred tax benefits from state tax adjustments recorded in 2012 and $6 million of Pennsylvania net operating loss valuation allowance adjustments recorded in 2011, driven primarily by the impact of bonus depreciation. |
The following after-tax gains (losses), which management considers special items, also impacted the results during the periods ended September 30.
| | | Income Statement | | Three Months | | Nine Months | | | | Line Item | | 2012 | | 2011 | | 2012 | | 2011 | | | | | | | | | | | | | | | | | Adjusted energy-related economic activity, net, net of tax of $63, $8, ($16), ($2) | (a) | | $ | (95) | | $ | (10) | | $ | 23 | | $ | 4 | Impairments: | | | | | | | | | | | | | | | Emission allowances, net of tax of $0, $0, $0, $1 | Other O&M | | | | | | | | | | | | (1) | | Renewable energy credits, net of tax of $0, $0, $0, $2 | Other O&M | | | | | | | | | | | | (3) | | Adjustments - nuclear decommissioning trust investments, net of tax of $0, $2, ($2), $2 | Other Income-net | | | | | | (1) | | | 1 | | | | LKE acquisition-related adjustments: | | | | | | | | | | | | | | | Sale of certain non-core generation facilities, net of tax of $0, $0, $0, $0 | Disc. Operations | | | | | | | | | | | | (2) | Other: | | | | | | | | | | | | | | | Montana hydroelectric litigation, net of tax of $0, $0, $0, $1 | Interest Expense | | | | | | (1) | | | | | | (2) | | Litigation settlement - spent nuclear fuel storage, net of tax of $0, ($2), $0, ($23) (b) | Fuel | | | | | | 4 | | | | | | 33 | | Counterparty bankruptcy, net of tax of $0, $0, $5, $0 (c) | Other O&M | | | | | | | | | (6) | | | | | Wholesale supply cost reimbursement, net of tax of $0, $0, $0, $0 | (d) | | | | | | | | | 1 | | | | | Ash basin leak remediation adjustment, net of tax of $0, $0, ($1), $0 | Other O&M | | | | | | | | | 1 | | | | | Coal contract modification payments, net of tax of $7, $0, $12, $0 (e) | Fuel | | | (10) | | | | | | (17) | | | | Total | | | $ | (105) | | $ | (8) | | $ | 3 | | $ | 29 |
| | | 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) | See "Reconciliation of Economic Activity" below. |
(b) | In May 2011, PPL Susquehanna entered into a settlement agreement with the U.S. Government relating to PPL Susquehanna's lawsuit, seeking damagesThe decrease for the DOE's failuresix-month period is primarily due to accept spent nuclear fuel from the PPL Susquehanna plant. PPL Susquehanna recorded credits to fuel expense to recognize recovery, under the settlement agreement, of certain costs to store spent nuclear fuel at the Susquehanna plant. The amounts recorded through September 2011 cover the costs incurred from 1998 through December 2010. |
(c) | In October 2011, a wholesale customer, SMGT filedfiling 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 CourtCode in 2011. $11 million of damages billed to SMGT were fully reserved in 2012. |
(b) | The decrease for the Districtthree and six month periods is due to the timing and scope of Montana approvedscheduled outages. |
(c) | The decrease for the requestthree and six month periods is due to terminate the contract, effective Aprila reduction in Act 129 energy efficiency and conservation plan costs for Phase 1 2012.programs. Phase 1 ended May 31, 2013. |
(d) | RecordedThese costs are offset by revenues reflected in "Wholesale energy marketing - Realized""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 lower electricitythis decision, PPL recorded a tax benefit of $44 million during the three and natural gas prices, coal unit utilization has decreased. Contract modification payments were incurredsix months ended June 30, 2013. See Note 5 to reducethe 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 2013 contracted coal deliveries.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. |
ReconciliationSee 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 Economic Activitycash 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 following table reconciles unrealized pre-tax gains (losses)$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 periodssix months ended SeptemberJune 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 table within "CommodityBalance 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) - Economic Activity"
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 to the special item identified as "Adjusted energy-related economic activity, net."for additional information.
| | | | Three Months | | Nine Months | | | | | 2012 | | 2011 | | 2012 | | 2011 | Operating Revenues | | | | | | | | | | | | | | | Unregulated retail electric and gas | | $ | (13) | | $ | 4 | | $ | (15) | | $ | 9 | | | Wholesale energy marketing | | | (716) | | | 216 | | | (322) | | | 229 | Operating Expenses | | | | | | | | | | | | | | | Fuel | | | 3 | | | (28) | | | (11) | | | (16) | | | Energy Purchases | | | 569 | | | (176) | | | 420 | | | (49) | Energy-related economic activity (a) | | | (157) | | | 16 | | | 72 | | | 173 | Option premiums (b) | | | | | | 6 | | | 1 | | | 17 | Adjusted energy-related economic activity | | | (157) | | | 22 | | | 73 | | | 190 | Less: Economic activity realized, associated with the monetization of | | | | | | | | | | | | | | certain full-requirement sales contracts in 2010 | | | 1 | | | 40 | | | 34 | | | 184 | Adjusted energy-related economic activity, net, pre-tax | | $ | (158) | | $ | (18) | | $ | 39 | | $ | 6 | | | | | | | | | | | | | | | | Adjusted energy-related economic activity, net, after-tax | | $ | (95) | | $ | (10) | | $ | 23 | | $ | 4 |
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. |
(b)(c) | Adjustment forTo economically hedge the net deferraltranslation of expected income denominated in GBP to U.S. dollars, PPL enters into a combination of average rate forwards and amortization of option premiums over the delivery period of the item that was hedged or upon realization. Option premiums are recorded in "Wholesale energy marketing - Realized"average rate options to sell GBP. The forwards and "Energy purchases - Realized" on the Statements of Income.options outstanding at June 30, 2013 mature through 2015. |
OutlookNDT Funds - Securities Price Risk
Excluding special items,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 lower earnings in 2012 comparedare reexamined based on market conditions and other factors to determine whether to proceed with 2011.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 decrease is primarily drivencost 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 lower energy margins as a resultthe relevant agencies. Costs may take the form of lower energy and capacity prices and lower generation volumes, higher other operationincreased capital expenditures or operating and maintenance expenseexpenses, 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 higher depreciation.industrial power users, and may impact the costs for their products or their demand for PPL's services.
EarningsPhysical effects associated with possible climate change could include the impact of changes in 2012weather 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 subjectregulated 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 various riskspass 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 uncertainties. See "Forward-Looking Information,"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 restinspection 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 Itemmatter 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"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 1A. Risk Factors"7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in PPL Energy Supply's 2011PPL's 2012 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.each critical accounting policy.
Statement of Income Analysis --
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
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 which include operating revenues associated with certain PPL Energy Supply businesses that are classified as discontinued operations, are offset by the cost of fuel, energy purchases, certain other operation and maintenance expenses, primarily ancillary charges and gross receipts tax, which is recorded in "Taxes, other than income," and operating expenses associated with certain PPL Energy Supply businesses that are classified as discontinued operations.income". This performance measure is relevant to PPL Energy Supply due to the volatility in the individual revenue and expense lines on the Statements of Income that comprise "Unregulated Gross Energy Margins." This volatility stems from a number of factors, including the required netting of certain transactions with ISOs and significant swingsfluctuations in unrealized gains and losses. Such factors could result in gains or losses being recorded in either "Wholesale energy marketing" or "Energy purchases" on the Statements of Income. This performance measure includes PLR revenues from energy sales to PPL Electric by PPL EnergyPlus, which are recorded in "Wholesale energy marketing to affiliate" revenue. PPL Energy Supply excludes from "Unregulated Gross Energy Margins" adjusted energy-related economic activity, which includes the changes in fair value of positions used to economically hedge a portion of the economic value of PPL Energy Supply's competitive generation assets, full-requirement sales contracts and retail activities. This economic value is subject to changes in fair value due to market price volatility of the input and output commodities (e.g., fuel and power) prior to the delivery period that was hedged. Also included in adjusted energy-related economic activity is the premium amortization associated with options and for 2012 the ineffective portion of qualifying cash flow hedges and realized economic activity associated with the monetization of certain full-requirement sales contracts and premium amortization associated with options.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 tables reconcile "Operating Income" to "Unregulated Gross Energy Margins" as defined by PPL Energy Supply to "Operating Income" for the periods ended SeptemberJune 30.
| | | | | 2012 Three Months | | 2011 Three Months | | | | | | Unregulated | | | | | | | | Unregulated | | | | | | | | | | | | Gross Energy | | | | | Operating | | Gross Energy | | | | | | Operating | | | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | Operating Revenues | | | | | | | | | | | | | | | | | | | | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | | | Realized | $ | 1,074 | | $ | 2 | (c) | | $ | 1,076 | | $ | 897 | | $ | 10 | (c) | | $ | 907 | | | | | Unrealized economic activity | | | | | (716) | (d) | | | (716) | | | | | | 216 | (d) | | | 216 | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | to affiliate | | 23 | | | | | | | 23 | | | 5 | | | | | | | 5 | | Unregulated retail electric and gas | | 232 | | | (13) | (d) | | | 219 | | | 186 | | | 4 | (d) | | | 190 | | Net energy trading margins | | (11) | | | | | | | (11) | | | (7) | | | | | | | (7) | | Energy-related businesses | | | | | 128 | | | | 128 | | | | | | 130 | | | | 130 | | | | Total Operating Revenues | | 1,318 | | | (599) | | | | 719 | | | 1,081 | | | 360 | | | | 1,441 | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | 2013 Three Months | | 2012 Three Months | | | | | | Unregulated | | | | | | | | Unregulated | | | | | | | | | | | | Gross Energy | | | | | Operating | | Gross Energy | | | | | | Operating | | | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | Operating Revenues | | | | | | | | | | | | | | | | | | | | | Wholesale energy marketing | | | | | | | | | | | | | | | | | | | | | | | | Realized | $ | 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 |
| | | | | 2012 Three Months | | 2011 Three Months | | | | | | Unregulated | | | | | | | | Unregulated | | | | | | | | | | | | Gross Energy | | | | | Operating | | Gross Energy | | | | | | Operating | | | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | Operating Expenses | | | | | | | | | | | | | | | | | | | | | Fuel | | 310 | | | 11 | (e) | | | 321 | | | 338 | | | 20 | (e) | | | 358 | | Energy purchases | | | | | | | | | | | | | | | | | | | | | | | | Realized | | 418 | | | 3 | (c) | | | 421 | | | 119 | | | 42 | (c) | | | 161 | | | | | Unrealized economic activity | | | | | (569) | (d) | | | (569) | | | | | | 176 | (d) | | | 176 | | Energy purchases from affiliate | | 1 | | | | | | | 1 | | | 1 | | | | | | | 1 | | Other operation and maintenance | | 1 | | | 219 | | | | 220 | | | | | | 208 | | | | 208 | | Depreciation | | | | | 73 | | | | 73 | | | | | | 62 | | | | 62 | | Taxes, other than income | | 11 | | | 7 | | | | 18 | | | 8 | | | 10 | | | | 18 | | Energy-related businesses | | | | | 125 | | | | 125 | | | | | | 130 | | | | 130 | | | | Total Operating Expenses | | 741 | | | (131) | | | | 610 | | | 466 | | | 648 | | | | 1,114 | Total | $ | 577 | | $ | (468) | | | $ | 109 | | $ | 615 | | $ | (288) | | | $ | 327 |
| | | | 2012 Nine Months | | 2011 Nine Months | | | | 2013 Six Months | | 2012 Six 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 | | $ | 3,353 | | $ | 14 | (c) | | $ | 3,367 | | $ | 2,635 | | $ | 42 | (c) | | $ | 2,677 | | Realized | | $ | 1,789 | | $ | (2) | | | $ | 1,787 | | $ | 2,279 | | $ | 12 | (c) | | $ | 2,291 | | | Unrealized economic activity | | | | (322) | (d) | | (322) | | | | 229 | (d) | | 229 | | Unrealized economic activity | | | | (232) | (d) | | (232) | | | | 394 | (d) | | 394 | | Wholesale energy marketing | | | | | | | | | | | | | | | Wholesale energy marketing | | | | | | | | | | | | | | | | | to affiliate | | 61 | | | | | 61 | | 15 | | | | | 15 | | to affiliate | | 26 | | | | | 26 | | 38 | | | | | 38 | | Unregulated retail electric and gas | | 638 | | (15) | (d) | | 623 | | 509 | | 9 | (d) | | 518 | Unregulated retail electric and gas | | 483 | | 12 | (d) | | 495 | | 406 | | (2) | (d) | | 404 | | Net energy trading margins | | 7 | | | | | 7 | | 14 | | | | | 14 | Net energy trading margins | | (11) | | | | | (11) | | 18 | | | | | 18 | | Energy-related businesses | | | | | | 336 | | | | 336 | | | | | | 354 | | | | 354 | Energy-related businesses | | | | | | 235 | | | | 235 | | | | | | 208 | | | | 208 | | | Total Operating Revenues | | | 4,059 | | | 13 | | | | 4,072 | | | 3,173 | | | 634 | | | | 3,807 | | Total Operating Revenues | | | 2,287 | | | 13 | | | | 2,300 | | | 2,741 | | | 612 | | | | 3,353 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | Operating Expenses | | | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | | | Fuel | | 695 | | 33 | (e) | | 728 | | 872 | | (46) | (e) | | 826 | Fuel | | 522 | | | | | 522 | | 385 | | 22 | (e) | | 407 | | Energy purchases | | | | | | | | | | | | | | | Energy purchases | | | | | | | | | | | | | | | | | Realized | | 1,669 | | 46 | (c) | | 1,715 | | 496 | | 205 | (c) | | 701 | | Realized | | 855 | | (3) | | | 852 | | 1,251 | | 43 | (c) | | 1,294 | | | Unrealized economic activity | | | | (420) | (d) | | (420) | | | | 49 | (d) | | 49 | | Unrealized economic activity | | | | (155) | (d) | | (155) | | | | 149 | (d) | | 149 | | Energy purchases from affiliate | | 2 | | | | | 2 | | 3 | | | | | 3 | Energy purchases from affiliate | | 2 | | | | | 2 | | 1 | | | | | 1 | | Other operation and maintenance | | 12 | | 757 | | | 769 | | 13 | | 728 | | | 741 | Other operation and maintenance | | 8 | | 497 | | | 505 | | 11 | | 538 | | | 549 | | Depreciation | | | | 206 | | | 206 | | | | 181 | | | 181 | Depreciation | | | | 157 | | | 157 | | | | 133 | | | 133 | | Taxes, other than income | | 27 | | 26 | | | 53 | | 22 | | 28 | | | 50 | Taxes, other than income | | 18 | | 15 | | | 33 | | 16 | | 19 | | | 35 | | Energy-related businesses | | | | | | 326 | | | | 326 | | | | | | 350 | | | | 350 | Energy-related businesses | | | | | | 228 | | | | 228 | | | | | | 201 | | | | 201 | | | Total Operating Expenses | | 2,405 | | 974 | | | 3,379 | | 1,406 | | 1,495 | | | 2,901 | | Total Operating Expenses | | | 1,405 | | | 739 | | | | 2,144 | | | 1,664 | | | 1,105 | | | | 2,769 | | Discontinued Operations | | | | | | | | | | | | | 12 | | | (12) | (f) | | | | | Total | Total | | $ | 1,654 | | $ | (961) | | | $ | 693 | | $ | 1,779 | | $ | (873) | | | $ | 906 | 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 ninesix months ended SeptemberJune 30, 2012, "Wholesale energy marketing - Realized" and "Energy purchases - Realized" include net pre-tax losses of $1$12 million and $34$33 million related to the monetization of certain full-requirement sales contracts. The three and nine months ended September 30, 2011 include net pre-tax losses of $40 million and $184 million related to the monetization of certain full-requirement sales contracts and net pre-tax gains of $6 million and $17 million related to the amortization of option premiums. |
(d) | Represents energy-related economic activity, which is subject to fluctuations in value due to market price volatility, as described in "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements. |
(e) | Includes economic activity related to fuel as described in "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements. The three and ninesix months ended SeptemberJune 30, 2012 include a pre-tax lossesloss of $17 million and $29$12 million related to coal contract modification payments. The three and nine months ended September 30, 2011 include pre-tax credits of $6 million and $56 million for the spent nuclear fuel litigation settlement. |
(f) | Represents the net of certain revenues and expenses associated with certain businesses that are classified as discontinued operations. These revenues and expenses are not reflected in "Operating Income" on the Statements of Income. |
Changes in Non-GAAP Financial Measures
Unregulated Gross Energy Margins are generated through PPL Energy Supply's competitive non-trading and trading activities. PPL Energy Supply's non-trading energy business is managed on a geographic basis that is aligned with its generation fleet. The following table shows PPL Energy Supply's non-GAAP financial measure, Unregulated Gross Energy Margins, for the periods ended SeptemberJune 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 | | Nine Months | | | | 2012 | | 2011 | | Change | | 2012 | | 2011 | | Change | | | | | | | | | | | | | | | | | | | | | Non-trading | | | | | | | | | | | | | | | | | | | | Eastern U.S. | | $ | 521 | | $ | 530 | | $ | (9) | | $ | 1,417 | | $ | 1,502 | | $ | (85) | | Western U.S. | | | 67 | | | 92 | | | (25) | | | 230 | | | 263 | | | (33) | Net energy trading | | | (11) | | | (7) | | | (4) | | | 7 | | | 14 | | | (7) | Total | | $ | 577 | | $ | 615 | | $ | (38) | | $ | 1,654 | | $ | 1,779 | | $ | (125) |
| | 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) |
Eastern U.S. | | | | | | | | | | | | | | The changes in non-trading margins for the periods ended September 30, 2012 compared with 2011 were due to: | | | | | | | | | | Three Months | | Nine Months | | | | | | | | Baseload energy prices | | $ | (44) | | $ | (132) | Baseload capacity prices | | | 3 | | | (47) | Intermediate and peaking capacity prices | | | 5 | | | (22) | Impact of non-core generation facilities sold in the first quarter of 2011 | | | | | | (12) | Full-requirement sales contracts | | | 3 | | | (10) | Net economic availability of coal and hydroelectric units | | | (7) | | | 12 | Retail electric | | | 5 | | | 12 | Ironwood acquisition which eliminates tolling expense (a) | | | 14 | | | 27 | Nuclear generation volume (b) | | | 11 | | | 93 | Other | | | 1 | | | (6) | Total | | $ | (9) | | $ | (85) |
(a) | See Note 8 to the Financial Statements for additional information. |
(b) | Volumes were higher for the nine-month period due to a shorter outage period for blade inspections, an unplanned outage in March 2011 and an uprate in the third quarter of 2011. Volumes were higher for the three-month period due to higher availability in 2012. |
Western U.S.
Non-trading margins for the three and ninesix months ended SeptemberJune 30, 20122013 compared with the same periods in 20112012 were lower due to $14$20 million and $31$59 million of lower wholesale sales, including $10 million and $23 million related to the bankruptcy of SMGT.prices. The three-monthsix-month period was also lower due to $5partially offset by $7 million of higher fuel costs.wholesale volumes.
Other Operation and Maintenance | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance expense for the periods ended September 30, 2012 compared with 2011 was due to: | | | | | | Three Months | | Nine Months | | | | | | | | Susquehanna nuclear plant costs (a) | $ | 8 | | $ | 27 | Uncollectible accounts (b) | | (2) | | | 9 | Ironwood acquisition (c) | | 4 | | | 13 | Costs at Western fossil and hydroelectric plants | | (4) | | | (9) | Costs at Eastern fossil and hydroelectric plants (d) | | 9 | | | (4) | Gain on disposition of RECs | | (2) | | | (8) | Trademark royalties (e) | | (9) | | | (26) | Corporate service costs (f) | | 5 | | | 19 | Other | | 3 | | | 7 | Total | $ | 12 | | $ | 28 |
Net Energy Trading Margins
Net energy trading margins for the three months ended 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) | PrimarilyThe decrease for the six-month period is primarily due to refueling outage costs, payroll-related costs and timing of projects. |
(b) | In October 2011, SMGT filedfiling for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code. The increase for the nine-month period primarily reflects anCode in 2011. $11 million increaseof damages billed to a reserve on SMGT unpaid amounts. |
(c) | There are no comparable amountswere fully reserved in the 2011 periods as the Ironwood Acquisition occurred in April 2012. |
(d) | Increase for the three-month period primarily due to a planned outage at PPL Brunner Island in September 2012. |
(e) | In 2011, PPL Energy Supply was charged trademark royalties by an affiliate. The agreement was terminated December 31, 2011. |
(f) | Primarily due to systems-related costs and timing of projects. | Depreciation
Depreciation | | | | | | | | | | | | | | The increase (decrease) in depreciation expense for the periods ended September 30, 2012 compared with 2011 was due to: | | | | | | | | | | Three Months | | Nine Months | | | | | | | | Additions to PP&E | | $ | 4 | | $ | 14 | Ironwood Acquisition (Note 8) | | | 7 | | | 11 | Total | | $ | 11 | | $ | 25 |
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 details.additional information on other income (expense) - net.
Interest Expense | | | | | | | | | | | | | | | The increase (decrease) in interest expense for the periods ended September 30, 2012 compared with 2011 was due to: | | | | | | | | | | | | | | | | | | | | | | | | | | Three Months | | Nine Months | | | | | | | | | Long-term debt interest expense (a) | | $ | (3) | | $ | (13) | Short-term debt interest expense (b) | | | (3) | | | (10) | Ironwood Acquisition (Note 8) | | | 4 | | | 8 | Net amortization of debt discounts, premiums and issuance costs (c) | | | (8) | | | (9) | Other | | | 1 | | | (3) | Total | | $ | (9) | | $ | (27) |
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) | The decrease was primarily due toDuring the redemption of $250 million of 7.0% Senior Notes due 2046 in July 2011 along with the repayment of $500 million of 6.4% Senior Notes and subsequent issuance of $500 million of 4.6% Senior Notes, both in the fourth quarter of 2011. |
(b) | The decrease was primarily due to lower interest rates on 2012 short-term borrowings. |
(c) | The three and nine-month periods include the impact of accelerating the amortization of deferred financing fees of $7 million in 2011, due to the July 2011 redemption. |
Income Taxes | | | | | | | | | | | | | | The increase (decrease) in income taxes for the periods ended September 30, 2012 compared with 2011 was due to: | | | | | | | | | | | | | | Three Months | | Nine Months | | | | | | | | Lower pre-tax book income | | $ | (82) | | $ | (80) | State valuation allowance adjustments (a) | | | 2 | | | (4) | State deferred tax rate change (b) | | | (6) | | | (17) | Other | | | (2) | | | (2) | Total | | $ | (88) | | $ | (103) |
(a) | In February 2011, the Pennsylvania Department of Revenue issued interpretive guidance on the treatment of bonus depreciation for Pennsylvania income tax purposes. In accordance with Corporation Tax Bulletin 2011-01, Pennsylvania allows 100% bonus depreciation for qualifying assets in the same year bonus depreciation is allowed for federal tax purposes. Due to the decrease in projected taxable income related to bonus depreciation,six months ended June 30, 2013, PPL Energy Supply recorded $6reversed $3 million of state deferred income tax expense during the nine months ended September 30, 2011benefit related to valuation allowances on state net operating loss carryforwards.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 three and ninesix months ended SeptemberJune 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: | | | | | | | | | | | | September 30, 2012 | | December 31, 2011 | | June 30, 2013 | | December 31, 2012 | | | | | | | | | | Cash and cash equivalents | | $ | 432 | | $ | 379 | | $ | 265 | | $ | 413 | Short-term debt | | $ | 355 | | $ | 400 | | $ | 575 | | $ | 356 |
The $53$148 million increasedecrease in PPL Energy Supply's cash and cash equivalents position was primarily the net result of:
· | net cash provided by operating activities of $674 million; |
· contributions from Member of $472 million;
· | a net decrease in notes receivable from affiliate of $198 million; |
· | distributions to Member of $733$408 million; |
· | capital expenditures of $460$241 million; |
· | net cash provided by operating activities of $227 million; |
· | contributions from Member of $105 million; and |
· | the Ironwood Acquisition for $84 million, netan increase in short-term debt of cash acquired.$219 million. |
PPL Energy Supply's cash provided by operating activities increaseddecreased by $234$81 million for the ninesix months ended SeptemberJune 30, 2012,2013, compared with 2011.2012. This was primarilypartially due to a $177$37 million increase in defined benefit plans funding and an $11 million increase in cash fromused by components of working capital (primarily due to changes in counterparty collateral of $118 million, partially offset by changes in unbilled revenuesfuel, materials and accrued taxes) andsupplies of $79 million). In addition, a $66change of $31 million in other operating activities contributed to the decrease, partially due to changes in defined benefit plan funding.certain tax-related accounts.
Credit Facilities
PPL Energy Supply maintains credit facilities to provide liquidity and to backstop commercial paper issuances. At SeptemberJune 30, 2012,2013, 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 Backstop | | Capacity | | | | | | | | | | | | | | | Syndicated Credit Facility (a) | | $ | 3,000 | | | | | $ | 468 | | $ | 2,532 | Letter of Credit Facility | | | 200 | | | n/a | | | 126 | | | 74 | Total PPL Energy Supply Credit Facilities (b) | | $ | 3,200 | | | | | $ | 594 | | $ | 2,606 |
| | | | | | | | | 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 November 2012, PPL Energy Supply amended its syndicated credit facility to extend the expiration date to November 2017. |
(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
In April 2012, PPL Energy Supply increased the capacity of itsmaintains a commercial paper program from $500 millionfor 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 SeptemberJune 30, 2013 and December 31, 2012, PPL Energy Supply had $355$575 million and $356 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheet,Sheets, at a weighted-average interest raterates of 0.48%.
Long-term Debt Securities
In April 2012, an indirect, wholly owned subsidiary of PPL Energy Supply completed the Ironwood Acquisition. See Note 8 to the Financial Statements for information on the transaction0.29% and the debt of PPL Ironwood, LLC assumed through consolidation as part of the acquisition.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.
As a result of the passage of the Dodd-Frank Act, PPL Energy Supply is limiting its credit rating disclosure to a description of the actions taken by the rating agencies with respect to PPL Energy Supply's ratings, but without stating what ratings have been assigned to PPL Energy Supply or its subsidiaries, or their securities. The ratings assigned by the rating agencies to PPL Energy Supply and its subsidiaries and their respective securities may be found, without charge, on eachhave no credit rating triggers that would result in the reduction of access to capital markets or the respective rating agencies' websites, which ratings together with all other information contained on such rating agency websites is, hereby, explicitly not incorporated by reference in this report.acceleration of maturity dates of outstanding debt.
The rating agencies took the following actions related to PPL Energy Supply and its subsidiaries:subsidiaries in 2013:
In January 2012, S&PFebruary 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 revisedoutlook 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 Certificatespass-through trust certificates due 2020.
Following the announcement of the then-pending acquisition of AES Ironwood, L.L.C. in February 2012, the rating agencies took the following actions:
· | In March 2012, Moody's placed AES Ironwood, L.L.C.'s senior secured bonds under review for possible ratings upgrade. |
· | In April 2012, S&P affirmed the rating of AES Ironwood, L.L.C.'s senior secured bonds. |
· | In May 2012, Fitch downgraded its rating and revised its outlook for PPL Montana's Pass Through Certificates due 2020. |
· | In November 2012, S&P revised its outlook for PPL Montana's Pass Through Certificates due 2020. |
Ratings Triggers
PPL Energy Supply has various derivative and non-derivative contracts, including contracts for the sale and purchase of electricity and fuel, commodity transportation and storage, tolling agreements and interest rate instruments, which contain provisions that require PPL Energy Supply to post additional collateral or permit the counterparty to terminate the contract, if PPL Energy Supply's credit rating were to fall below investment grade. See Note 14 to the Financial Statements for a discussion of "Credit Risk-Related Contingent Features," including a discussion of the potential additional collateral that would have been required for derivative contracts in a net liability position at SeptemberJune 30, 2012. At September 30, 2012, if PPL Energy Supply's credit rating had been below investment grade, PPL Energy Supply would have been required to prepay or post an additional $341 million of collateral to counterparties for both derivative and non-derivative commodity and commodity-related contracts used in its generation, marketing and trading operations and interest rate contracts.2013.
For additional information on PPL Energy Supply's liquidity and capital resources, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," in PPL Energy Supply's 20112012 Form 10-K.
Risk Management
Market Risk
See Notes 13 and 14 to the Financial Statements for information about PPL Energy Supply's risk management objectives, valuation techniques and accounting designations.
The forward-looking information presented below provides estimates of what may occur in the future, assuming certain adverse market conditions and model assumptions. Actual future results may differ materially from those presented. These disclosures are not precise indicators of expected future losses, but only indicators of possible losses under normal market conditions at a given confidence level.
Commodity Price Risk (Non-trading)
PPL Energy Supply segregates its non-trading activities into two categories: hedge activity and economic activity. Transactions that are accounted for as hedge activity qualify for hedge accounting treatment. The economic activity category includes transactions that address a specific risk, but were not eligible for hedge accounting or for which hedge accounting was not elected. This activity includes the changes in fair value of positions used to hedge a portion of the economic value of PPL Energy Supply's competitive generation assets and full-requirement sales contracts and retail contracts. This economic activity is subject to changes in fair value due to market price volatility of the input and output commodities (e.g., fuel and power). Although they do not receive hedge accounting treatment, these transactions are considered non-trading activity. The fair value of economic positions at September 30, 2012 and December 31, 2011 was a net asset/(liability) of $491 million and $(63) million. The change in fair value is largely attributable to the dedesignation of cash flow hedges that are now classified as economic hedges. See Note 14 to the Financial Statements for additional information.
To hedge the impact of market price volatility on PPL Energy Supply's energy-related assets, liabilities and other contractual arrangements, PPL Energy Supply both sells and purchases physical energy at the wholesale level under FERC market-based tariffs throughout the U.S. and enters into financial exchange-traded and over-the-counter contracts. PPL Energy Supply's non-trading commodity derivative contracts range in maturity through 2019.
The following table sets forth the changes in the net fair value of non-trading commodity derivative contracts for the periods ended SeptemberJune 30. See Notes 13 and 14 to the Financial Statements for additional information.
| | Gains (Losses) | | Gains (Losses) | | | Three Months | | Nine Months | | Three Months | | Six Months | | | 2012 | | 2011 | | 2012 | | 2011 | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | $ | 961 | | $ | 896 | | $ | 1,082 | | $ | 958 | | $ | 229 | | $ | 1,215 | | $ | 473 | | $ | 1,082 | Contracts realized or otherwise settled during the period | | (224) | | (99) | | (764) | | (234) | | (100) | | (261) | | (237) | | (540) | Fair value of new contracts entered into during the period (a) | | (11) | | 4 | | 1 | | 19 | | 37 | | 13 | | 46 | | 12 | Other changes in fair value | | | (101) | | | 43 | | | 306 | | | 101 | | | 119 | | | (6) | | | 3 | | | 407 | Fair value of contracts outstanding at the end of the period | | $ | 625 | | $ | 844 | | $ | 625 | | $ | 844 | | $ | 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 SeptemberJune 30, 2012,2013, based on the level of observability of the information used to determine the fair value.
| | | Net Asset (Liability) | | | Net Asset (Liability) | | | | Maturity | | | | | | Maturity | | | | | Maturity | | | | | | Maturity | | | | | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | Source of Fair Value | Source of Fair Value | | | | | | | | | | | Source of Fair Value | | | | | | | | | | | Prices based on significant observable inputs (Level 2) | Prices based on significant observable inputs (Level 2) | | $ | 520 | | $ | 94 | | $ | (19) | | $ | 7 | | $ | 602 | Prices based on significant observable inputs (Level 2) | | $ | 226 | | $ | 32 | | $ | (10) | | $ | 5 | | $ | 253 | Prices based on significant unobservable inputs (Level 3) | Prices based on significant unobservable inputs (Level 3) | | | 11 | | | 8 | | | 4 | | | | | | 23 | Prices based on significant unobservable inputs (Level 3) | | | 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 | | $ | 531 | | $ | 102 | | $ | (15) | | $ | 7 | | $ | 625 | 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 couldwould be based on the difference between the market price and the contract price of the commodity. Depending on price changes in the wholesale energy markets, such damages could be significant. Extreme weather conditions, unplanned power plant outages, transmission disruptions, nonperformance by counterparties (or their own counterparties) with which it has energy contracts and other factors could affect PPL Energy Supply's ability to meet its obligations, or cause significant increases in the market price of replacement energy. Although PPL Energy Supply attempts to mitigate these risks, there can
be no assurance that it will be able to fully meet its firm obligations, that it will not be required to pay damages for failure to perform, or that it will not experience counterparty nonperformance in the future. In connection with its bankruptcy proceedings, a significant counterparty, SMGT, had been purchasing lower volumes of electricity than prescribed in the contract and effective April 1, 2012 the contract was terminated. PPL Energy Supply cannot predict the prices or other terms on which it will be able to market to third parties the power that SMGT will not purchase from PPL EnergyPlus due to the termination of this contract. See Note 10 to the Financial Statements for additional information.
Commodity Price Risk (Trading)
PPL Energy Supply's trading commodity derivative contracts range in maturity through 2017.2018. The following table sets forth changes in the net fair value of PPL Energy Supply's trading commodity derivative contracts for the periods ended SeptemberJune 30. See Notes 13 and 14 to the Financial Statements for additional information.
| | Gains (Losses) | | Gains (Losses) | | | Three Months | | Nine Months | | Three Months | | Six Months | | | 2012 | | 2011 | | 2012 | | 2011 | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | Fair value of contracts outstanding at the beginning of the period | | $ | 17 | | $ | 15 | | $ | (4) | | $ | 4 | | $ | 15 | | $ | 2 | | $ | 29 | | $ | (4) | Contracts realized or otherwise settled during the period | | 17 | | (10) | | 16 | | (7) | | | | (1) | | (2) | | (1) | Fair value of new contracts entered into during the period (a) | | 13 | | (2) | | 18 | | 6 | | (4) | | (1) | | (16) | | 5 | Other changes in fair value | | | (15) | | | 4 | | | 2 | | | 4 | | | 7 | | | 17 | | | 7 | | | 17 | Fair value of contracts outstanding at the end of the period | | $ | 32 | | $ | 7 | | $ | 32 | | $ | 7 | | $ | 18 | | $ | 17 | | $ | 18 | | $ | 17 |
(a) | Represents the fair value of contracts at the end of the quarter of their inception. |
Unrealized gains of approximately $4 million will be reversed over the next three months as the transactions are realized.
The following table segregates the net fair value of trading commodity derivative contracts at SeptemberJune 30, 2012,2013, based on the level of observability of the information used to determine the fair value.
| | Net Asset (Liability) | | Net Asset (Liability) | | | Maturity | | | | | | Maturity | | | | Maturity | | | | | | Maturity | | | | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | Less Than | | Maturity | | Maturity | | in Excess | | Total Fair | | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | | 1 Year | | 1-3 Years | | 4-5 Years | | of 5 Years | | Value | Source of Fair Value | | | | | | | | | | | | | | | | | | | | | Prices based on significant observable inputs (Level 2) | | $ | 18 | | $ | 11 | | $ | 1 | | | | $ | 30 | | $ | 4 | | $ | 6 | | | | | | | $ | 10 | Prices based on significant unobservable inputs (Level 3) | | | 2 | | | | | | | | | | | | 2 | | | 6 | | | 2 | | | | | | | | | 8 | Fair value of contracts outstanding at the end of the period | | $ | 20 | | $ | 11 | | $ | 1 | | | | �� | $ | 32 | | $ | 10 | | $ | 8 | | | | | | | | $ | 18 |
VaR Models
A VaR model is utilized to measure commodity price risk in domesticunregulated gross energy margins for the non-trading and trading portfolios. VaR is a statistical model that attempts to estimate the value of potential loss over a given holding period under normal market conditions at a given confidence level. VaR is calculated using a Monte Carlo simulation technique based on a five-day holding period at a 95% confidence level. Given the company's conservativedisciplined hedging program, the non-trading VaR exposure is expected to be limited in the short-term. The VaR for portfolios using end-of-month results for the periodsix months ended June 30, 2013 was as follows.
| | | Trading VaR | | Non-Trading VaR | | | | Nine Months | | Twelve Months | | Nine Months | | Twelve Months | | | | Ended | | Ended | | Ended | | Ended | | | | September 30, | | December 31, | | September 30, | | December 31, | | | | 2012 | | 2011 | | 2012 | | 2011 | 95% Confidence Level, Five-Day Holding Period | | | | | | | | | | | | | | Period End | | $ | 6 | | $ | 1 | | $ | 10 | | $ | 6 | | Average for the Period | | | 3 | | | 3 | | | 9 | | | 5 | | High | | | 8 | | | 6 | | | 11 | | | 7 | | Low | | | 1 | | | 1 | | | 7 | | | 4 |
| | | | | | 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 speculativeproprietary trading positions, regardless of the delivery period. All positions not considered speculativeproprietary trading are considered non-trading. The non-trading portfolio includes the entire portfolio, including generation, with delivery periods through the next 12 months. Both the trading and non-trading VaR computations exclude FTRs due to the absence of reliable spot and forward markets. The fair value of the non-trading and trading FTR positions was insignificant at SeptemberJune 30, 2012.2013.
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 SeptemberJune 30, 2012.2013.
At SeptemberJune 30, 2012,2013, 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 SeptemberJune 30, 20122013 would increase the fair value of its debt portfolio by $56$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 SeptemberJune 30, 2012,2013, these funds were invested primarily in domestic equity securities and fixed-rate, fixed-income securities and are reflected at fair value on the Balance Sheet. The mix of securities is designed to provide returns sufficient to fund Susquehanna's decommissioning and to compensate for inflationary increases in decommissioning costs. However, the equity securities included in the trusts are exposed to price fluctuation in equity markets, and the values of fixed-rate, fixed-income securities are primarily exposed to changes in interest rates. PPL actively monitors the investment performance and periodically reviews asset allocation in accordance with its NDTnuclear decommissioning trust policy statement. At SeptemberJune 30, 2012,2013, a hypothetical 10% increase in interest rates and a 10% decrease in equity prices would have resulted in an estimated $49$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 20112012 Form 10-K for additional information.
Related Party Transactions
PPL Energy Supply is not aware of any material ownership interests or operating responsibility by senior management of PPL Energy Supply in outside partnerships, including leasing transactions with variable interest entities or other entities doing business with PPL Energy Supply. See Note 11 to the Financial Statements for additional information on related party transactions.
Acquisitions, Development and Divestitures
PPL Energy Supply from time to time evaluates opportunities for potential acquisitions, divestitures and development projects. Development projects are continuously reexamined based on market conditions and other factors to determine whether to proceed with the projects, sell, cancel or expand them, execute tolling agreements or pursue other options. See Note 8 to the Financial Statements for information on the more significant activities, including the April 2012 Ironwood Acquisition.activities.
Environmental Matters
Extensive federal, state and local environmental laws and regulations are applicable to PPL Energy Supply's air emissions, water discharges and the management of hazardous and solid waste, amongas well as other areas; and theaspects 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 regulatory agencies. Costs may take the form of increased capital expenditures or operating and maintenance expenses;expenses, monetary fines, penalties or other restrictions. Many of these environmental law considerations are also applicable to the operations of key suppliers, or customers, such as coal producers and industrial power users, and may impact the costs 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 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 20112012 Form 10-K for a discussion ofadditional information on environmental matters.
New Accounting Guidance
See Notes 2 and 1819 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.
Application of Critical Accounting Policies
Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies. The following accounting policies are particularly important to the financial condition or results of operations, and require estimates or other judgments of matters inherently uncertain: price risk management, defined benefits, asset impairment (excluding investments), loss accruals, AROs and income taxes. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in PPL Energy Supply's 20112012 Form 10-K for a discussion of each critical accounting policy.
PPL ELECTRIC UTILITIES CORPORATION AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following should be read in conjunction with PPL Electric's Condensed Consolidated Financial Statements and the accompanying Notes and with PPL Electric's 20112012 Form 10-K. Capitalized terms and abbreviations are defined in the glossary. Dollars are in millions, unless otherwise noted.
"Management's Discussion and Analysis of Financial Condition and Results of Operations" includes the following information:
· | "Overview" provides a description of PPL Electric and its business strategy, a summary of Net Income Available to PPL and a discussion of certain events related to PPL Electric's results of operations and financial condition. |
· | "Results of Operations" provides a summary of PPL Electric's earnings and a description of key factors expected to impact future earnings. This section ends with explanations of significant changes in principal line items on PPL Electric's Statements of Income, comparing the three and ninesix months ended SeptemberJune 30, 20122013 with the same periods in 2011.2012. |
· | "Financial Condition - Liquidity and Capital Resources" provides an analysis of PPL Electric's liquidity position and credit profile. This section also includes a discussion of rating agency actions. |
· | "Financial Condition - Risk Management" provides an explanation of PPL Electric's risk management programs relating to market and credit risk. |
Overview
Introduction
PPL Electric is an electricity transmission and distribution service provider in eastern and central Pennsylvania with headquarters in Allentown, Pennsylvania. PPL Electric is subject to regulation as a public utility by the PUC, and certain of its transmission activities are subject to the jurisdiction of FERC under the Federal Power Act. PPL Electric delivers electricity in its Pennsylvania service area and provides electricity supply to retail customers in that area as a PLR under the Customer Choice Act.
Business Strategy
PPL Electric's strategy and principal challenge is to own and operatefor its regulated electricity delivery business is to provide safe, reliable service to its customers and achieve stable, long-term growth in earnings and rate base. Rate base is expected to grow as a result of significant capital expenditure programs aimed at the mostmaintaining existing assets and improving system reliability. PPL Electric is focused on timely recovery of costs, efficient cost while maintaining high qualityoperations, strong customer service and reliability. PPL Electric anticipates that it will have significant capital expenditure requirements for at least the next five years. In order toconstructive regulatory relationships.
To manage financing costs and access to credit markets and to fund capital expenditure programs, a key objective for PPL Electric's business strategyElectric is to maintain a strong credit profile. PPL Electric continually focuses on maintaining an appropriate capital structureprofile and strong liquidity position.
Timely recovery of costs to maintain and enhance the reliability of its delivery system, including the replacement of aging distribution assets, is required in order to maintain strong cash flows and a strong credit profile. Traditionally, such cost recovery would be pursued through periodic base rate case proceedings with the PUC. As such costs continue to increase, more frequent rate case proceedings may be required or an alternative rate making process would need to be implemented in order to achieve more timely recovery. The recently approved DSIC mechanism will help reduce regulatory lag on distribution reliability-related capital investment. See "Regulatory Matters"Financial and Operational Developments - Pennsylvania Activities - Legislation - Regulatory Procedures and Mechanisms" in Note 6 to the Financial StatementsDistribution 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 Available(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 AvailableAttributable to PPL Energy Supply Member
Net Income Attributable to PPL Energy Supply Member for the three and ninesix months ended SeptemberJune 30, 20122013 was $33$86 million and $95$48 million compared to $28$19 million and $116$328 million for the same periods in 2011, representing an 18% increase over and an 18% decrease from the same periods in 2011.2012.
See "Results of Operations" below for afurther discussion and analysis of PPL Electric's earnings.the consolidated results of operations.
RedemptionEconomic 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 Preference Stockexpanded 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 June 2012, PPL Electric redeemed all 2.5 million shares ofEnergy Supply announced its 6.25% Series Preference Stock, parintention, 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 $100 per share. The price paidat 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 redemption wasadditional environmental requirements based on prior and planned investments and does not currently anticipate the par value, without premium ($250 million in the aggregate). At December 31, 2011, the preference stock was reflected on PPL Electric's Balance Sheets in "Preference stock."
Hurricane Sandyneed to temporarily or permanently shut down additional coal-fired plants.
In late October 2012, PPL Electric experienced widespread significant damage toEnergy Supply cannot predict the future impact that economic and market conditions and changes in regulatory requirements may have on its transmission and distribution network from Hurricane Sandy. The total costs associated with the restoration efforts are still being finalized but are estimated to be in excessfinancial condition or results of $60 million. PPL Electric has insurance coverage that could cover a portion of the costs incurred from Hurricane Sandy. PPL Electric will have the ability to file a request with the PUC for permission to defer for future recovery certain of the costs incurred to repair the distribution network in excess of the insurance coverage. Costs incurred to repair the transmission network are recoverable through the FERC Formula Rate mechanism which is updated annually.operations.
Regional Transmission Line Expansion PlanSusquehanna 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 OctoberJuly 1, 2012, the National Park Service (NPS) issued its Record2013, Colstrip Unit 4 tripped off line as a result of Decision (ROD) on the proposed Susquehanna-Roseland transmission line affirming the route chosen by PPL Electric and Public Service Electric & Gas as the preferred alternative under the NPS's National Environmental Policy Act review. On October 15, 2012, a complaint was fileddamage that occurred in the United States District Court for the District of Columbia by various environmental groups, including the Sierra Club, challenging the RODunit's generator. The cost to repair Unit 4 is estimated to be between $30 million to $40 million and seeking to prohibit its implementation. Construction activities have begun on portions of the 101-mile route in Pennsylvania. The line is expected to be in service beforetake 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 peak summer demand periodowners and, pursuant to a separate agreement with NorthWestern, is entitled to receive 15% of 2015. The chosen route had previously been approved by the PUC and New Jersey Board of Public Utilities. An appeal of the New Jersey Board of Public Utilities approval is pending before the New Jersey Superior Court Appellate Division. PPL Electric cannot predict the ultimate outcome or timing of any further legal challenges to the project. PJM has developed a strategy to manage potential reliability problems until the line is built. PPL Electric cannot predict what additional actions, if any, PJM might take in the event of a further delay to its scheduled in-service date for the new line.Unit 4's
At September 30, 2012, PPL Electric's estimated share of the project cost was $560 million, an increase from approximately $500 million at December 31, 2011, due primarily to increased material costs. See Note 8 in PPL Electric's 2011 Form 10-K for additional information.
On October 9, 2012, the FERC issued an order in response to PPL Electric's December 2011 request for ratemaking incentives for the Northeast/Pocono Reliability project (a new 58-mile 230 kV transmission line, three new substations and upgrades to adjacent facilities). The incentives were specifically tailored to address the risks and challenges PPL Electric will face in building the project. The FERC granted the incentive for inclusion of 100% of prudently incurred construction work in progress (CWIP) costs in rate base and denied the request for a 100 basis point adder to the return on equity incentive. The order requires a follow-up compliance filing from PPL Electric to ensure proper accounting treatment of AFUDC and CWIP for the project. PPL Electric estimates the project costs to be approximately $180 million.
Legislation - Regulatory Procedures and Mechanisms
In June 2011, the Pennsylvania House Consumer Affairs Committee approved legislation authorizing the PUC to approve regulatory procedures and mechanisms to provide more timely recovery of a utility's costs. In the first quarter of 2012, the Governor signed an amended version of the legislation (Act 11 of 2012), which became effective April 14, 2012. The legislation authorizes the PUC to approve two specific ratemaking mechanisms - a fully projected future test year and, subject to certain conditions, a distribution system improvements charge (DSIC). Such alternative ratemaking procedures and mechanisms are important to PPL Electric as it begins a period of significant capital investment to maintain and enhance the reliability of its delivery system, including the replacement of aging distribution assets. In August 2012, the PUC issued a Final Implementation Order adopting procedures, guidelines and a model tariff for the implementation of Act 11 of 2012.
In September 2012,electricity output and is responsible for 15% of the capital, operating, maintenance and repair costs associated with Unit 4. PPL Electric filed its Long Term Infrastructure Improvement Plan (LTIIP) describing projects eligible for inclusion in the DSIC. In October 2012, several parties filed commentsMontana's estimated pre-tax loss of earnings attributable to the LTIIP but none of the comments requested evidentiary hearings on the LTIIP. A decision on the LTIIPUnit 4 outage is expected in January 2013. PPL Electric expects to file a petition requesting permission to establish a DSIC in January 2013 with rates proposed to be effective in April 2013.
FERC Formula Rates
In March 2012, PPL Electric filed a request with the FERC seeking recovery, over a 34-year period beginning in June 2012, of its unrecovered regulatory asset related to the deferred state tax liability that existed at the time of the transition from the flow-through treatment of state income taxes to full normalization. This change in tax treatment occurred in 2008 as a result of prior FERC initiatives that transferred regulatory jurisdiction of certain transmission assets from the PUC to FERC. A regulatory asset of approximately $50between $5 million related to this transition, classified as taxes recoverable through future rates, is included in "Other Noncurrent Assets - Regulatory assets" on the Balance Sheets at September 30, 2012 and December 31, 2011. In May 2012, the FERC issued an order approving PPL Electric's request effective June 1, 2012.$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 management expects mayare expected to impact future earnings. This section ends with "Statement of Income Analysis," which includes explanations of significant changes in Unregulated Gross Energy Margins by region and principal line items on PPL Electric'sEnergy Supply's Statements of Income, comparing the three and ninesix months ended SeptemberJune 30, 20122013 with the same periods in 2011.2012.
The results for interim periods can be disproportionately influenced by numerous factors and developments and by seasonal variations. As such, the results of operations for interim periods do not necessarily indicate results or trends for the year or future periods.
Earnings | | | | | | | | | | | | | | | | | | | | | | | | | | | Net Income Available to PPL for the periods ended September 30 was: | | | | | | | | | | | | | | | | | | Three Months | | Nine Months | | | | 2012 | | 2011 | | 2012 | | 2011 | | | | | | | | | | | | | | | Net Income Available to PPL | | $ | 33 | | $ | 28 | | $ | 95 | | $ | 116 |
Earnings | | | | | | | | | | | | | | | Net Income 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 gross delivery margins.Unregulated Gross Energy Margins and certain items that management considers special. See additional detail of these special items in the tables below.
| | Three Months | | Nine Months | | Three Months | | Six Months | | | | | | | | | | | | Pennsylvania gross delivery margins | | $ | 11 | | $ | 1 | | Unregulated Gross Energy Margins | | | $ | (88) | | $ | (195) | Other operation and maintenance | | (7) | | (32) | | 17 | | 30 | Depreciation | | (3) | | (11) | | (10) | | (24) | Taxes, other than income | | | 3 | | 4 | Other Income (Expense) - net | | | 7 | | 8 | Interest Expense | | | (3) | | (12) | Other | | 2 | | 4 | | 4 | | 2 | Income Taxes | | (2) | | 9 | | 25 | | 58 | Distributions on preference stock | | | 4 | | | 8 | | Special items, after-tax | | | | 112 | | | (151) | Total | | $ | 5 | | $ | (21) | | $ | 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. |
· | HigherLower other operation and maintenance for the three-month period primarily due to $9 million of higher payroll-related costs, $2 million of higher vegetation management costs and $2 million of higher corporate service costs, partially offset by $6$11 million of lower PUC-reportable storm 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. |
HigherLower other operation and maintenance for the nine-monthsix-month period primarily due to $16$19 million of higher payroll-relatedBrunner Island Unit 3 outage costs $10in 2012 with no comparable outage in 2013 and $17 million of higher vegetation managementlower 2013 project and refueling outage costs $7 million of higher corporate service costs and $4 million of higher contractor costs,at PPL Susquehanna, partially offset by $13$5 million of lower PUC-reportable storm costs.Conemaugh Unit 2 outage costs in 2013 with no comparable outage in 2012.
· | Higher depreciation for the nine-monththree and six-month periods primarily due to PP&E additions. The six-month period primarilyalso 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 PP&E additions relateda worker's compensation adjustment of $4 million. |
· | Higher interest expense for the six-month period primarily due to the ongoing efforts$6 million of lower capitalized interest in 2013 and $4 million due to ensure the reliability of the delivery system and replace aging infrastructure.financings associated with PPL Ironwood. |
· | Lower income taxes for the nine-month period, primarilythree and six-month periods due to lower pre-tax income.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) | Lower distributions on preference stockSee "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 threeDistrict 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 nine month periods duenatural gas prices, coal-fired generation output decreased during 2012. Contract modification payments were incurred to the preference stock redemption in June 2012.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 ElectricEnergy Supply projects lower earnings in 20122013 compared with 2011,2012, primarily driven by lower energy prices, higher otherfuel costs, higher depreciation and higher financing costs, partially offset by lower operation and maintenance expense, higher depreciationcapacity prices and lower distribution revenue, which are expected to be partially offset by higher transmission revenue, lower financing costs, and lower income taxes.nuclear generation output.
In March 2012, PPL Electric filed a request with the PUC to increase distribution rates by approximately $105 million effective January 1, 2013. The proposed distribution rate increase would result in a 2.9% increase over PPL Electric's total rates at the time of the request. PPL Electric's application includes a request for an authorized return-on-equity of 11.25%. On October 19, 2012, the presiding Administrative Law Judge (ALJ) issued a decision recommending a rate increase of approximately $64 million, which represents an allowed return on equity of 9.74%. Exceptions to the ALJ's recommendation are due November 8, 2012. PPL Electric expects to file exceptions, together with certain other parties, to the ALJ's recommended decision. The PUC, which is expected to issue its order on the rate request in December 2012, can accept, reject or modify the ALJ's recommendation. PPL Electric cannot predict the outcome of this proceeding.
Earnings in 2012 and future periods are subject to various risks and uncertainties. See "Forward-Looking Information," the rest of this Item 2, and Notes 6 andNote 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in PPL Electric's 2011Energy Supply's 2012 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.
Statement of Income Analysis --
Unregulated Gross Energy Margins
Non-GAAP Financial Measure
The following discussion includes financial information prepared in accordance with GAAP, as well as a non-GAAP financial measure, "Unregulated Gross Energy Margins." "Unregulated Gross Energy Margins" is a single financial performance measure of PPL Energy Supply's competitive energy non-trading and trading activities. In calculating this measure, PPL Energy Supply's energy revenues are offset by the cost of fuel, energy purchases, certain other operation and maintenance expenses, primarily ancillary charges and gross receipts tax, which is recorded in "Taxes, other than income". This performance measure is relevant to PPL Energy Supply due to the volatility in the individual revenue and expense lines on the Statements of Income that comprise "Unregulated Gross Energy Margins." This volatility stems from a number of factors, including the required netting of certain transactions with ISOs and significant fluctuations in unrealized gains and losses. Such factors could result in gains or losses being recorded in either "Wholesale energy marketing" or "Energy purchases" on the Statements of Income. This performance measure includes PLR revenues from energy sales to PPL Electric by PPL EnergyPlus, which are recorded in "Wholesale energy marketing to affiliate" revenue. PPL Energy Supply excludes from "Unregulated Gross Energy Margins" adjusted energy-related economic activity, which includes the changes in fair value of positions used to economically hedge a portion of the economic value of PPL Energy Supply's competitive generation assets, full-requirement sales contracts and retail activities. This economic value is subject to changes in fair value due to market price volatility of the input and output commodities (e.g., fuel and power) prior to the delivery period that was hedged. Also included in adjusted energy-related economic activity is the premium amortization associated with options and for 2012 the ineffective portion of qualifying cash flow hedges and 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 tables reconcile "Operating Income" to "Pennsylvania Gross Delivery Margins" to "Operating Income" as defined by PPL Electric for the periods ended SeptemberJune 30.
| | | | | 2012 Three Months | | 2011 Three Months | | | | | | PA Gross | | | | | | | PA Gross | | | | | | | | | | | Delivery | | | | Operating | | Delivery | | | | | Operating | | | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | Operating Revenues | | | | | | | | | | | | | | | | | | | Retail electric | $ | 443 | | | | | $ | 443 | | $ | 454 | | | | | $ | 454 | | Electric revenue from affiliate | | 1 | | | | | | 1 | | | 1 | | | | | | 1 | | | | Total Operating Revenues | | 444 | | | | | | 444 | | | 455 | | | | | | 455 |
| | | | 2013 Three Months | | 2012 Three Months | | | | | PA Gross | | | | | | PA Gross | | | | | | | | | Delivery | | | | Operating | | Delivery | | | | Operating | | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | Operating Revenues | | Operating Revenues | | | | | | | | | | | | | | | | 2012 Three Months | | 2011 Three Months | Retail electric | $ | 413 | | | | $ | 413 | | $ | 403 | | | | $ | 403 | | | | PA Gross | | | | | | PA Gross | | | | | Electric revenue from affiliate | | 1 | | | | | | 1 | | | 1 | | | | | | 1 | | | | Delivery | | | | Operating | | Delivery | | | | Operating | | Total Operating Revenues | | 414 | | | | | | 414 | | | 404 | | | | | | 404 | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | Operating Expenses | Operating Expenses | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | Energy purchases | | 137 | | | | 137 | | 171 | | | | 171 | Energy purchases | | 120 | | | | 120 | | 120 | | | | 120 | | Energy purchases from affiliate | | 23 | | | | 23 | | 5 | | | | 5 | Energy purchases from affiliate | | 12 | | | | 12 | | 17 | | | | 17 | | Other operation and maintenance | | 25 | | $ | 123 | | 148 | | 30 | | $ | 116 | | 146 | Other operation and maintenance | | 21 | | $ | 103 | | 124 | | 26 | | $ | 117 | | 143 | | Depreciation | | | | 41 | | 41 | | | | 38 | | 38 | Depreciation | | | | 44 | | 44 | | | | 39 | | 39 | | Taxes, other than income | | 23 | | | 1 | | | 24 | | | 24 | | | 2 | | | 26 | Taxes, other than income | | 19 | | | 3 | | | 22 | | | 20 | | | 2 | | | 22 | | | Total Operating Expenses | | 208 | | | 165 | | | 373 | | | 230 | | | 156 | | | 386 | | Total Operating Expenses | | 172 | | | 150 | | | 322 | | | 183 | | | 158 | | | 341 | Total | Total | $ | 236 | | $ | (165) | | $ | 71 | | $ | 225 | | $ | (156) | | $ | 69 | Total | $ | 242 | | $ | (150) | | $ | 92 | | $ | 221 | | $ | (158) | | $ | 63 |
| | | | 2012 Nine Months | | 2011 Nine 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 | | $ | 1,303 | | | | $ | 1,303 | | $ | 1,444 | | | | $ | 1,444 | Retail electric | | $ | 925 | | | | $ | 925 | | $ | 860 | | | | $ | 860 | | Electric revenue from affiliate | | | 3 | | | | | | 3 | | | 9 | | | | | | 9 | Electric revenue from affiliate | | | 2 | | | | | | 2 | | | 2 | | | | | | 2 | | | Total Operating Revenues | | | 1,306 | | | | | | 1,306 | | | 1,453 | | | | | | 1,453 | | Total Operating Revenues | | | 927 | | | | | | 927 | | | 862 | | | | | | 862 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Expenses | Operating Expenses | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | Energy purchases | | 410 | | | | 410 | | 591 | | | | 591 | Energy purchases | | 292 | | | | 292 | | 273 | | | | 273 | | Energy purchases from affiliate | | 61 | | | | 61 | | 15 | | | | 15 | Energy purchases from affiliate | | 26 | | | | 26 | | 38 | | | | 38 | | Other operation and maintenance | | 74 | | $ | 357 | | 431 | | 77 | | $ | 325 | | 402 | Other operation and maintenance | | 43 | | $ | 214 | | 257 | | 49 | | $ | 234 | | 283 | | Depreciation | | | | 119 | | 119 | | | | 108 | | 108 | Depreciation | | | | 87 | | 87 | | | | 78 | | 78 | | Taxes, other than income | | | 67 | | | 5 | | | 72 | | | 77 | | | 6 | | | 83 | Taxes, other than income | | | 47 | | | 5 | | | 52 | | | 44 | | | 4 | | | 48 | | | Total Operating Expenses | | | 612 | | | 481 | | | 1,093 | | | 760 | | | 439 | | | 1,199 | | Total Operating Expenses | | | 408 | | | 306 | | | 714 | | | 404 | | | 316 | | | 720 | Total | Total | | $ | 694 | | $ | (481) | | $ | 213 | | $ | 693 | | $ | (439) | | $ | 254 | 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 SeptemberJune 30, as well as the change between periods. The factors that gave rise to the change are described below the table. | | | Three Months | | Nine Months | | | | 2012 | | 2011 | | Change | | 2012 | | 2011 | | Change | | | | | | | | | | | | | | | | | | | | | PA Gross Delivery Margins by Component | | | | | | | | | | | | | | | | | | | | Distribution | | $ | 185 | | $ | 179 | | $ | 6 | | $ | 544 | | $ | 560 | | $ | (16) | | Transmission | | | 51 | | | 46 | | | 5 | | | 150 | | | 133 | | | 17 | | Total | | $ | 236 | | $ | 225 | | $ | 11 | | $ | 694 | | $ | 693 | | $ | 1 |
| | | Three Months | | 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 decreasedincreased for the ninethree months ended SeptemberJune 30, 20122013 compared with the same period in 2011,2012, primarily due to an $18$11 million unfavorablefavorable 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 early in 2012. The three2012 and nine-month periods were impacted by a $7$32 million charge recorded in 2011 to reduce a portionfavorable effect of the transmission service charge regulatory asset associated with a 2005 undercollection that was not included in any subsequent rate reconciliations filed with the PUC.price, largely comprised of higher base rates, effective January 1, 2013, and higher volumes of $4 million.
Transmission
Margins increased for the three and nine-month periodssix months ended SeptemberJune 30, 2012,2013 compared with the same periods in 2011,2012, primarily due to increased investment in plant and the recovery of additional costs through the FERC formula-based rates.
Other Operation and Maintenance | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance for the 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) |
Other Operation and Maintenance | | | | | | | | | | | | | The increase (decrease) in other operation and maintenance expense for the periods ended September 30, 2012 compared with 2011 was due to: | | | | | | Three Months | | Nine Months | | | | | | | | | | | | | | Payroll-related costs | $ | 9 | | $ | 16 | Contractor-related expenses | | 1 | | | 4 | Vegetation management | | 2 | | | 10 | PUC-reportable storm costs, net of insurance recovery | | (6) | | | (13) | Act 129 costs | | (5) | | | (6) | Uncollectible accounts | | (1) | | | 3 | Allocation of certain corporate support group costs | | 2 | | | 7 | Other | | | | | 8 | Total | $ | 2 | | $ | 29 |
(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 storm insurance policy premiums for coverage that was in place in 2012 but was not renewed in 2013. |
Depreciation
Depreciation expense increased by $11$5 million and $9 million for the ninethree and six months ended SeptemberJune 30, 20122013 compared with 2011,2012, primarily due to PP&E additions relatedas part of ongoing investments to PPL Electric's ongoing efforts to ensure the reliability of its deliveryenhance system and replace aging infrastructure.reliability.
Taxes, Other Than Income
Taxes, other than income decreasedincreased by $11$4 million for the ninesix months ended SeptemberJune 30, 20122013 compared with 2011,2012, primarily due to lowerhigher Pennsylvania gross receipts tax expense due to a decrease in taxable electrichigher retail electricity revenue. This tax is included in "Pennsylvania Gross Delivery Margins."
Financing Costs | | | | | | | | | | | | | | The increase (decrease) in financing costs for the periods ended September 30, 2012 compared with 2011 was due to: | | | | | | | | | | Three Months | | Nine Months | | | | | | | | Long-term debt interest expense | | $ | 1 | | $ | (1) | Distributions on preference stock (a) | | | (4) | | | (8) | Amortization of debt issuance costs | | | (2) | | | 1 | Other | | | | | | (1) | Total | | $ | (5) | | $ | (9) |
(a) | Decreases for both periods are 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 periods ended September 30, 2012 compared with 2011 was due to: | | | | | | | | | | | | | | Three Months | | Nine Months | | | | | | | | Higher (lower) pre-tax book income | | $ | 1 | | $ | (15) | Federal and state tax reserve adjustments | | | | | | 1 | Federal and state tax return adjustments (a) | | | | | | 2 | Depreciation not normalized (a) | | | | | | 1 | Other | | | 1 | | | 2 | Total | | $ | 2 | | $ | (9) |
(a) | In February 2011, the Pennsylvania Department of Revenue issued interpretive guidance on the treatment of bonus depreciation for Pennsylvania income tax purposes. In accordance with Corporation Tax Bulletin 2011-01, Pennsylvania allows 100% bonus depreciation for qualifying assets in the same year bonus depreciation is allowed for federal income tax purposes. The 100% Pennsylvania bonus depreciation deduction created a current state income tax benefit for the flow-through impact of Pennsylvania regulated state tax depreciation. The federal provision for 100% bonus depreciation generally applies to property placed in service before January 1, 2012. |
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 | | $ | 11 | | $ | 27 | Depreciation not normalized | | | 2 | | | | Other | | | | | | (1) | Total | | $ | 13 | | $ | 26 |
See Note 5 to the Financial Statements for additional information on income taxes.
Financial Condition | | | | | | | | | | Liquidity and Capital Resources | | | | | | | | | | PPL Electric had the following at: | | | | | | | | | | | | September 30, 2012 | | December 31, 2011 | | June 30, 2013 | | December 31, 2012 | | | | | | | | | | Cash and cash equivalents | | $ | 31 | | $ | 320 | | $ | 24 | | $ | 140 | Short-term debt | | | $ | 85 | | $ | |
The $289$116 million decrease in PPL Electric's cash and cash equivalents position was primarily the net result of:
· | capital expenditures of $407 million; |
· | redemption of preference stock of $250 million; |
· | a net increase in notes receivable from affiliate of $210$451 million; |
· | the payment of $75$66 million of common stock dividends to parent; |
· | contributions from parent of $205 million; |
· | net cash provided by operating activities of $261 million; |
· | long-term debt issuance of $249$115 million; and |
· | contributions from parenta net increase in short-term debt of $150$85 million. |
PPL Electric's cash provided by operating activities increased by $14 million for the six months ended June 30, 2013 compared with 2012. The increase was primarily the net effect 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.
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.
Credit Facilities
PPL Electric maintains credit facilities to provide liquidity and to backstop commercial paper issuances. At SeptemberJune 30, 2012,2013, 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 Backstop | | Capacity | | | | | | | | | | | Syndicated Credit Facility (a) (b) | | $ | 300 | | | | | $ | 1 | | $ | 299 | Asset-backed Credit Facility (c) | | | 100 | | | | | | n/a | | | 100 | Total PPL Electric Credit Facilities | | $ | 400 | | | | | $ | 1 | | $ | 399 |
| | | | | | | | | 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 7%5% of the total committed capacity. |
(b) | In November 2012, PPL Electric amended its syndicated credit facility to extend the expiration date to October 2017. |
(c) | PPL Electric obtains financing by selling and contributing its eligible accounts receivable and unbilled revenue to a special purpose, wholly owned subsidiary on an ongoing basis. The subsidiary pledges these assets to secure loans of up to an aggregate of $100 million from a commercial paper conduit sponsored by a financial institution. At September 30, 2012, based on accounts receivable and unbilled revenue pledged, the amount available for borrowing under the facility was $100 million. In July 2012, PPL Electric and the subsidiary extended this agreement to September 2012 and reduced the capacity from $150 million. In September 2012, the agreement was extended to September 2013. |
See Note 7 to the Financial Statements for further discussion of PPL Electric's credit facilities.
Commercial Paper
In May 2012, PPL Electric increased the capacity of itsmaintains a commercial paper program from $200 millionfor up to $300 million to provide an additional financing source to fund its short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by PPL Electric's Syndicated Credit Facility. At 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 September 30,December 31, 2012.
Long-term Debt and Equity Securities
In June 2012, PPL Electric redeemed all 2.5 million shares of its 6.25% Series Preference Stock, par value $100 per share. The price paid for the redemption was the par value, without premium ($250 million in the aggregate). At December 31, 2011, the preference stock was reflected in "Preference stock" on PPL Electric's Balance Sheet.
In August 2012,July 2013, PPL Electric issued $250$350 million of 2.50%4.75% First Mortgage Bonds due 2022. The notes may be redeemed at PPL Electric's option any time prior to maturity at make-whole redemption prices.2043. PPL Electric received proceeds of $247$345 million, net of a discount and underwriting fees. The net proceeds werefees, which will be used to repay short-term indebtedness incurredfor capital expenditures, to fund PPL Electric's redemption of its 6.25% Series Preference Stock in June 2012pension 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.
As a result of the passage of the Dodd-Frank Act, PPL Electric is limiting itsdoes not have credit rating disclosuretriggers that would result in the reduction of access to a descriptioncapital markets or the acceleration of the actions taken by the rating agencies with respect to PPL Electric's ratings, but without stating what ratings have been assigned to PPL Electric or its securities. The ratings assigned by the rating agencies to PPL Electric and its respective securities may be found, without charge, on eachmaturity dates of the respective rating agencies' websites, which ratings together with all other information contained on such rating agency websites is, hereby, explicitly not incorporated by reference in this report.outstanding debt.
The rating agencies took the following actions related to PPL Electric:Electric in 2013:
In August 2012,July 2013, Fitch, Moody's and S&P assigned a ratingratings of A-, A3 and outlookA- to PPL Electric's $250$350 million 4.75% First Mortgage Bonds.
In August 2012,Bonds due 2043. Fitch also assigned a stable outlook to these notes and S&P and Moody's assigned a recovery rating to PPL Electric's $250 million First Mortgage Bonds.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 20112012 Form 10-K.
Risk Management
Market Risk and Credit Risk
PPL Electric issues debt to finance its operations, which exposes it to interest rate risk. At SeptemberJune 30, 2012,2013, PPL Electric had noElectric's potential annual exposure to increased interest expense, based on its current debt portfolio.a 10% increase in interest rates, was not significant.
PPL Electric is also exposed to changes in the fair value of its debt portfolio. PPL Electric estimated that a 10% decrease in interest rates at SeptemberJune 30, 20122013 would increase the fair value of its debt portfolio by $97$95 million.
See Notes 13 and 14 to the Financial Statements in this Form 10-Q and "Risk Management" in PPL Electric's 20112012 Form 10-K for additional information on market and credit risk.
Related Party Transactions
PPL Electric is not aware of any material ownership interests or operating responsibility by senior management of PPL Electric in outside partnerships, including leasing transactions with variable interest entities or other entities doing business with PPL Electric. See Note 11 to the Financial Statements for additional information on related party transactions.
Environmental Matters
Physical effects associated with 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 20112012 Form 10-K for a discussion ofadditional information on environmental matters.
New Accounting Guidance
See Notes 2 and 1819 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.
Application of Critical Accounting Policies
Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies. The following accounting policies are particularly important to the financial condition or results of operations, and require estimates or other judgments of matters inherently uncertain: defined benefits, loss accruals, income taxes, regulatory assets and liabilities and revenue recognition - unbilled revenue. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in PPL Electric's 20112012 Form 10-K for a discussion of each critical accounting policy.
LG&E AND KU ENERGY LLC AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following should be read in conjunction with LKE's Condensed Consolidated Financial Statements and the accompanying Notes and with LKE's 20112012 Form 10-K. Capitalized terms and abbreviations are defined in the glossary. Dollars are in millions, unless otherwise noted.
"Management's Discussion and Analysis of Financial Condition and Results of Operations" includes the following information:
| · | "Overview" provides a description of LKE and its business strategy, a summary of Net Income and a discussion of certain events related to LKE's results of operations and financial condition. |
| · | "Results of Operations" provides a summary of LKE's earnings and a description of key factors expected to impact future earnings. This section ends with explanations of significant changes in principal line items on LKE's Statements of Income, comparing the three and ninesix months ended SeptemberJune 30, 20122013 with the same periods in 2011.2012. |
| · | "Financial Condition - Liquidity and Capital Resources" provides an analysis of LKE's liquidity position and credit profile. This section also includes a discussion of rating agency actions. |
| · | "Financial Condition - Risk Management" provides an explanation of LKE's risk management programs relating to market and credit risk. |
Overview
Introduction
LKE, headquartered in Louisville, Kentucky, is a holding company withand a wholly owned subsidiary of PPL. LKE has regulated utility operations through its subsidiaries, LG&E and KU. LG&E and KU, which constitute substantially all of LKE's operations,assets. LG&E and KU are regulated utilities engaged in the generation, transmission, distribution and sale of electricity, in Kentucky, Virginia and Tennessee.electric energy. LG&E also engages in the distribution and sale of natural gasgas. LG&E and KU maintain their separate identities and serve customers in Kentucky.Kentucky under their respective names. KU also serves customers in Virginia under the Old Dominion Power name and in Tennessee under the KU name.
Business Strategy
LKE's overall strategy is to provide reliable, safe, and competitively priced energy to its customers.customers and reasonable returns on regulated investments to its member. 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 ninesix months ended SeptemberJune 30, 20122013 was $83$64 million and $180$160 million compared to $89$44 million and $217$97 million for the same periods in 20112012 representing decreasesincreases of 7%45% and 17% from the same periods in 2011.65% over 2012.
See "Results of Operations" for a discussion and analysis of LKE's earnings.
Terminated Bluegrass CTs AcquisitionEconomic and Market Conditions
In September 2011, LG&EThe KPSC has adopted a series of regulatory mechanisms (ECR, DSM, GLT, a fuel adjustment clause, a gas supply clause and KU entered into an asset purchase agreement with Bluegrass Generationrecovery on certain construction work-in-progress) that provide for the purchaserecovery of the Bluegrass CTs, aggregating approximately 495 MW, plus limited associated contractual arrangements required for operation of the units, for a purchase price of $110 million, pending receipt of applicable regulatory approvals. In May 2012, the KPSC issued an order approving the request to purchase the Bluegrass CTs. Also in May 2012, the FERC issued an order conditionally authorizing the acquisition of the Bluegrass CTs, subject to approval by the FERC of satisfactory mitigation measures to address market-power concerns. After a review of potentially available mitigation options, LG&E and KU determined that the options were not commercially justifiable. In June 2012, LG&E and KU terminated the asset purchase agreement for the Bluegrass CTs in accordance with its terms and made applicable filings withprudently 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 KPSCload utilized by industrial and FERC.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 are currently assessing the impact of the asset purchase agreement termination and potential future generation capacity options.
NGCC Construction
In September 2011,will require substantial capital investment. LG&E and KU filed a CPCNproject $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 the KPSC requesting approval to build a 640 MW NGCC at the existing Cane Run plant site in Kentucky. In May 2012, the KPSC issued an order approving the request. LG&E will own a 22% undivided interest and KU will own a 78% undivided interest in the new NGCC. LG&E and KU commenced preliminary construction activities in the third quarter of 2012 and project construction is expected to be completed by May 2015. The project, which includes building a natural gas supply pipeline and related transmission projects, has an estimated cost of approximately $600 million.
In conjunction with this construction and to meet new, more stringent federal EPA regulations with a 2015 compliance date, LG&E and KU anticipate retiring six older coal-fired electric generating units at the Cane Run, Green River and Tyrone plants, which have a combined summer capacity rating of 797726 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.
Capital ExpendituresLKE 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.
Capital expenditure plans are revised periodically to reflect changesRate Case Proceedings
In December 2012, the KPSC approved a rate case settlement agreement providing for increases in operational, market and regulatory conditions. LKE has lowered its projected environmental capital spending for the period 2012 through 2016 by approximately $0.5 billion from the previously disclosed $3.1 billion projection included in LKE's 2011 Form 10-K. The lower projected capital spending is based on current project evaluations and pricing contained in contracts executed to date for environmental construction projects. LKE continues to evaluate potential new generation supply sources, including self-build options and power sourced from the market, as alternatives to installing additional emission control equipment at E.W. Brown, which is jointly dispatchedannual base electricity rates of $34 million for LG&E and $51 million for KU and an increase in lieuannual base gas rates of the terminated Bluegrass CTs acquisition discussed in Notes 6 and 8 to the Financial Statements. LKE expects to complete its evaluation during the first half of 2013. The outcome of that evaluation may lead to additional changes in projected capital spending.
Registered Debt Exchange Offer by LKE
In June 2012, LKE completed an exchange of all its outstanding 4.375% Senior Notes due 2021 issued in September 2011 in a transaction not registered under the Securities Act of 1933,$15 million for similar securities that were issued in a transaction registered with the SEC. See Note 7 in LKE's 2011 Form 10-K for additional information.
Commercial Paper
In February 2012, LG&E and KU each establishedusing a commercial paper program for up to $250 million to provide an additional financing source to fund their short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by LG&E's and KU's Syndicated Credit Facilities. LG&E and KU had no commercial paper outstanding at September 30, 2012.10.25% 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 that management expects mayexpected to impact future earnings. This section ends with "Statement of Income Analysis," which includes explanations of significant changes in Margins and principal line items on LKE's Statements of Income, comparing the three and ninesix months ended SeptemberJune 30, 20122013 with the same periods in 2011.2012.
The results for interim periods can be disproportionately influenced by numerous factors and developments and by seasonal variations. As such, the results of operations for interim periods do not necessarily indicate results or trends for the year or for future periods.
Earnings | | | | | | | | | | | | | | | | | | | | Net Income for the periods ended September 30 was: | | | | | | | | | | Net Income for the periods ended June 30 was: | | Net Income for the periods ended June 30 was: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Three Months | | Nine Months | | | Three Months | | Six Months | | | | 2012 | | 2011 | | 2012 | | 2011 | | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | | | Net Income | Net Income | | $ | 83 | | $ | 89 | | $ | 180 | | $ | 217 | 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 marginsMargins and certain items that management considers special. See additional detail of these special items in the table below.
| | Three Months | | Nine Months | | Three Months | | Six Months | | | | | | | | | | Margins | | $ | (4) | | $ | (22) | | $ | 32 | | $ | 107 | Other operation and maintenance | | 3 | | (12) | | | | 10 | Depreciation | | (2) | | (8) | | (8) | | (17) | Taxes, other than income | | (1) | | (6) | | | | (1) | Other | | (2) | | (5) | | Other Income (Expense) - net | | (4) | | (13) | | 7 | | 7 | Interest Expense | | | | | 1 | Income Taxes | | 4 | | 30 | | (17) | | (47) | Special items | | | | | | (1) | | Special items, after-tax | | | | 6 | | | 3 | Total | | $ | (6) | | $ | (37) | | $ | 20 | | $ | 63 |
· | See "Statement of Income Analysis - Margins - Changes in Non-GAAP Financial Measures" for an explanation of margins.Margins. |
· | HigherLower other operation and maintenance for the nine-monthsix-month period primarily due to $12$17 million of higherlower 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 resulting from an increased scope of scheduled plant outages.$3 million. |
· | Higher depreciation for the nine-month period,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 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 taxes, other than income (expense) - net for the nine-month period,three and six-month periods primarily due to an increaselosses from the EEI investment recorded in property taxes resulting from property additions, higher assessed values, and changes2012. The EEI investment was fully impaired in property classifications to categories with higher tax rates.the fourth quarter of 2012. |
· | Lower other income (expense) - net for the nine-month period, primarily due to losses from an equity method investment. |
· | LowerHigher income taxes for the nine-month period,three and six-month periods primarily due to lowerhigher pre-tax income. |
The following after-tax gains (losses), which management considers special items, also impacted earnings during the periods ended SeptemberJune 30.
| | Income Statement | | Three Months | | Nine Months | | | Line Item | | 2012 | | 2011 | | 2012 | | 2011 | | | | | | | | | | | | | | | | Acquisition-related adjustments: | | | | | | | | | | | | | | | Net operating loss carryforward and other tax related adjustments | Income Taxes and Other O&M | | | | | | | | $ | 4 | | | | Other: | | | | | | | | | | | | | | | Discontinued Operations, net of tax of $0, $1, $4, $1 (a) | Discontinued Operations | | | | | $ | (1) | | | (5) | | $ | (1) | | Energy-related economic activity, net of tax of $0, ($1), $0, $0 | Operating Revenues | | | | | | 1 | | | | | | 1 | Total | | | | | | | | | $ | (1) | | | |
| | Income Statement | | Three Months | | Six Months | | | Line Item | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | | EEI adjustments | Other Income (Expense) - net | | | | | | | | $ | 1 | | | | | | Income Taxes and Other | | | | | | | | | | | | | 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 | | $ | 1 | | $ | (5) | | | 1 | | | (5) | Total | | | $ | 1 | | $ | (5) | | $ | 2 | | $ | (1) |
(a) | The nine months ended September 30, 2012 includes an adjustment to an indemnification liability. |
2013 Outlook
Excluding special items, LKE projects lowerhigher earnings in 20122013 compared with 2011 as a result of2012, primarily driven by electric and gas base rate increases, returns on additional environmental capital investments and load growth, partially offset by higher other operation and maintenance expense, higher depreciation, higher property taxes and losses from an equity method investment.
In June 2012, LG&E and KU filed requests with the KPSC for increases in annual base electric rates of approximately $62 million at LG&E and approximately $82 million at KU and an increase in annual base gas rates of approximately $17 million at LG&E. The proposed base rate increases would result in electric rate increases of 6.9% at LG&E and 6.5% at KU and a gas rate increase of 7.0% at LG&E and would be effective in January 2013. LG&E's and KU's applications include requests for authorized returns-on-equity at LG&E and KU of 11% each. In November 2012, the KPSC issued an order for a settlement conference to begin on November 13, 2012. A hearing on the original application and subsequent testimony is scheduled to begin on November 27, 2012. LG&E and KU cannot predict the outcome of these proceedings, including the possibility of any agreed stipulations or settlement, which would remain subject to KPSC approval. A final order may be issued in December 2012 or January 2013.expense.
Earnings in 2012 and future periods are subject to various risks and uncertainties. See "Forward-Looking Information," the rest of this Item 2, Notes 6 and 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in LKE's 20112012 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.
Statement of Income Analysis --
Margins
Non-GAAP Financial Measure
The following discussion includes financial information prepared in accordance with GAAP, as well as a non-GAAP financial measure, "Margins." Margins is not intended to replace "Operating Income," which is determined in accordance with GAAP as an indicator of overall operating performance. Other companies may use different measures to analyze and to report on the results of their operations. Margins is a single financial performance measure of LKE's operations.electricity generation, transmission and distribution operations as well as its distribution and sale of natural gas. In calculating this measure, fuel and energy purchases are deducted from revenues. In addition, utility revenues and expenses associated with approved cost recovery tracking mechanisms are offset. These mechanisms allow for recovery of certain expenses, returns on capital investments associated with environmental regulations and performance incentives. Certain costs associated with these mechanisms, primarily ECR, DSM and DSM,GLT, are recorded as "Other operation and maintenance" and "Depreciation." As a result, this measure represents the net revenues from LKE's operations. This performance measure is used, in conjunction with other information, internally by senior management to manage operations and analyze actual results compared towith budget.
Reconciliation of Non-GAAP Financial Measures
The following tables reconcile "Margins" to "Operating Income" to "Margins" as defined by LKE for the periods ended SeptemberJune 30.
| | | | | | 2012 Three Months | | | 2011 Three Months | | | | | | | | | | | Operating | | | | | | | | Operating | | | | | | | Margins | | Other (a) | | Income (b) | | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | Operating Revenues | | $ | 732 | | | | | $ | 732 | | | $ | 734 | | $ | 2 | | $ | 736 | Operating Expenses | | | | | | | | | | | | | | | | | | | | | Fuel | | | 249 | | | | | | 249 | | | | 245 | | | | | | 245 | | Energy purchases | | | 27 | | | | | | 27 | | | | 32 | | | | | | 32 | | Other operation and maintenance | | | 28 | | $ | 158 | | | 186 | | | | 26 | | | 161 | | | 187 | | Depreciation | | | 13 | | | 74 | | | 87 | | | | 12 | | | 72 | | | 84 | | Taxes, other than income | | | | | | 11 | | | 11 | | | | | | | 10 | | | 10 | | | | Total Operating Expenses | | | 317 | | | 243 | | | 560 | | | | 315 | | | 243 | | | 558 | Total | | $ | 415 | | $ | (243) | | $ | 172 | | | $ | 419 | | $ | (241) | | $ | 178 |
| | | | 2012 Nine Months | | 2011 Nine Months | | | | 2013 Three Months | | 2012 Three Months | | | | | | | | | Operating | | | | | | Operating | | | | | | | | Operating | | | | | | Operating | | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Revenues | Operating Revenues | | $ | 2,095 | | | | $ | 2,095 | | $ | 2,139 | | $ | 1 | | $ | 2,140 | Operating Revenues | | $ | 682 | | | | $ | 682 | | $ | 658 | | | | $ | 658 | Operating Expenses | Operating Expenses | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | Fuel | | 677 | | | | 677 | | 666 | | | | 666 | Fuel | | 216 | | | | 216 | | 215 | | | | 215 | | Energy purchases | | 135 | | | | 135 | | 179 | | | | 179 | Energy purchases | | 37 | | | | 37 | | 34 | | | | 34 | | Other operation and maintenance | | 76 | | $ | 513 | | 589 | | 67 | | 499 | | 566 | Other operation and maintenance | | 23 | | $ | 174 | | 197 | | 24 | | $ | 173 | | 197 | | Depreciation | | 39 | | 220 | | 259 | | 37 | | 212 | | 249 | Depreciation | | 2 | | 81 | | 83 | | 13 | | 73 | | 86 | | Taxes, other than income | | | | | | 34 | | | 34 | | | | | | 28 | | | 28 | Taxes, other than income | | | | | | 12 | | | 12 | | | | | | 12 | | | 12 | | | Total Operating Expenses | | | 927 | | | 767 | | | 1,694 | | | 949 | | | 739 | | | 1,688 | | Total Operating Expenses | | | 278 | | | 267 | | | 545 | | | 286 | | | 258 | | | 544 | Total | Total | | $ | 1,168 | | $ | (767) | | $ | 401 | | $ | 1,190 | | $ | (738) | | $ | 452 | 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 decreasedincreased by $22$32 million for the nine months ended September 30, 2012 compared with the samethree-month period in 2011, primarily due to $16higher base rates of $25 million, environmental cost recoveries added to base rates of lower retail margins, as volumes were impacted by unseasonably mild weather during the first four months$14 million and increased environmental investments of 2012, and $6$3 million, of lower wholesale margins, as volumes were impactedpartially offset by lower market prices. Total heatingvolumes of $9 million. The change in volumes was partially attributable to weather, as cooling degree days decreased 24%14% compared to the same period in 2011.2012.
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 effective January 1, 2013. The environmental cost recoveries added to base rates were due to the elimination of the 2005 and 2006 ECR plans as a result of the 2012 Kentucky rate 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, 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 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 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:
Other Operation and Maintenance
Other operation and maintenance increased by $23 million for the nine months ended September 30, 2012 compared with 2011, primarily due to:
· | a $13 million increase in coal plant maintenance costs, including certain amounts included in margins, primarily resulting from an increased scope of scheduled outages; |
· | a $6 million credit to establish a regulatory asset was recorded in the first quarter of 2011 related to 2009 storm costs; and |
· | a $3 million increase in restricted stock awards. |
Depreciation
Depreciation increased by $3 million and $10 million for the three and nine months ended September 30, 2012 compared with 2011, primarily due to PP&E additions.
Taxes, Other Than Income
Taxes, other than income increased by $6 million for the nine months ended September 30, 2012 compared with 2011, primarily due to an increase in property taxes resulting from property additions, higher assessed values, and changes in property classifications to categories with higher tax rates. | | 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 decreasedincreased by $13$7 million and $8 million for the ninethree and six months ended SeptemberJune 30, 2012,2013 compared with 2011,2012 primarily due to $8 million in losses from an equity method investment.the EEI investment recorded in 2012. The EEI investment was fully impaired in the fourth quarter of 2012.
Income Taxes
Income taxes decreasedincreased by $36$17 million and $53 million for the ninethree and six months ended SeptemberJune 30, 2012,2013 compared with 2011,2012 primarily due to a $68 million decrease inhigher pre-tax income and $9 million of adjustments to deferred taxes related to net operating loss carryforwards based on income tax return adjustments.income.
See Note 5 to the Financial Statements for additional information on income taxes.
Income (Loss) from Discontinued Operations (net of income taxes)
LossIncome (loss) from discontinued operations increased by $5$7 million for the ninethree and six months ended SeptemberJune 30, 2012,2013 compared with 2011.2012. 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 2009.2012.
Financial Condition | | | | | | | | | | Liquidity and Capital Resources | | | | | | | | | | LKE had the following at: | | | | | | | | | | | | September 30, 2012 | | December 31, 2011 | | June 30, 2013 | | December 31, 2012 | | | | | | | | | | Cash and cash equivalents | | $ | 90 | | $ | 59 | | $ | 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 $31$20 million increasedecrease in LKE's cash and cash equivalents position was primarily the net result of: · | cash provided by operating activities of $646 million; |
· | capital expenditures of $525$579 million; and |
· | distributions to member of $95$69 million; partially offset by |
· | cash provided by operating activities of $297 million; |
· | capital contributions from member of $146 million; |
· | an increase in short term debt of $127 million; and |
· | an increase in notes payable with affiliates of $47 million. |
LKE's cash provided by operating activities decreased by $37$57 million for the ninesix months ended SeptemberJune 30, 2012,2013, compared with 2011,2012, primarily due to:
· | an increase in cash outflows from other operating activities of $119 million driven by a $94 million increase in discretionary defined benefit plan contributions; and |
· | a decline in working capital cash flow changes of $36 million driven primarily by increases in accounts receivable and unbilled revenues due to extended payment terms and higher rates and a lower federal income tax accrual in 2013 as a result of a federal settlement payment, 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 at the plants and higher gas consumption from storage; partially offset by |
· | a decreasean increase in net income of $37 million due to unseasonably mild weather during the first four months of 2012 and higher operation and maintenance expenses, adjusted for non-cash effectsitems of $103$98 million (deferred income taxes and investment tax credits of $114$39 million, and defined benefit plans - expense of $8$7 million, partially offset by depreciation of $10$7 million and other noncashnon-cash items of $9$4 million); and. |
· | a decrease in cash inflows related to income tax receivable of $37 million due to fewer income tax payments received from member; partially offset by |
· | a decrease in cash outflows related to accrued taxes of $49 million primarily due to the timing of property and income tax payments; and |
· | a decrease in cash outflows of $93 million due to a reduction in discretionary defined benefit plan contributions. |
LKE's cash used in investing activitiesCapital expenditures increased by $383$255 million forduring the ninesix months ended SeptemberJune 30, 2012,2013 compared with 2011,2012 primarily due to proceeds fromenvironmental air projects at the saleMill Creek and Ghent plants, coal consumption residual projects at the Ghent plant and construction of other investments of $163 million in 2011 and an increase in capital expenditures of $229 million as a result of increased environmental spending, primarily related to landfills; and infrastructure improvements at generation, distribution and transmission facilities.
LKE's cash used in financing activities decreased by $292 million for the nine months ended September 30, 2012, compared with 2011, primarily due to the issuance of long-term debt of $250 million and a repayment on a revolving line of credit of $163 million in 2011 and lower distributions to member of $374 million in 2012.Cane Run Unit 7.
Credit Facilities
At SeptemberJune 30, 2012,2013, LKE's total committed borrowing capacity under its credit facilities and the use of this borrowing capacity were: | | | Committed | | | | Letters of | | Unused | | | | | | | Letters of | | | | | | Capacity | | Borrowed | | Credit Issued | | Capacity | | | | | | | Credit Issued | | | | | | | | | | | | | | | | | | | and | | | LKE Credit Facility with a subsidiary of PPL Energy Supply | | $ | 300 | | | | | | $ | 300 | | | | | | Committed | | | | Commercial | | Unused | | | | | Capacity | | Borrowed | | Paper Backup | | Capacity | | | | | | | | | | | | LKE Credit Facility with a subsidiary of PPL Energy Funding Corporation | | LKE Credit Facility with a subsidiary of PPL Energy Funding Corporation | | $ | 300 | | $ | 72 | | | | $ | 228 | LG&E Credit Facility (a) | LG&E Credit Facility (a) | | 400 | | | | | | | | | 400 | LG&E Credit Facility (a) | | 500 | | | | | $ | 80 | | | 420 | KU Credit Facilities (a) (b) | KU Credit Facilities (a) (b) | | | 598 | | | | | $ | 198 | | | 400 | KU Credit Facilities (a) (b) | | | 598 | | | | | | 370 | | | 228 | | Total Credit Facilities (c) | | $ | 1,298 | | | | | $ | 198 | | $ | 1,100 | | Total LG&E and KU Credit Facilities (c) | | Total LG&E and KU Credit Facilities (c) | | $ | 1,398 | | $ | 72 | | $ | 450 | | $ | 876 |
(a) | In November 2012, LG&E and KU amended theEach company pays customary fees under their respective syndicated credit facility to extend the expiration dates to November 2017. In addition, LG&E increased thefacilities, as well as KU's letter of credit facility, capacity to $500 million.and borrowings generally bear interest at LIBOR-based rates plus an applicable margin. |
(b) | In August 2012, theMay 2013, KU letter of credit facility agreement was amended and restated to allow for certain payments under theextended its $198 million letter of credit facility to be converted to loans rather than requiring immediate payment.May 2016. |
(c) | The $1.098 billion of commitments under LKE'sLG&E's and KU's domestic credit facilities are provided by a diverse bank group, with no one bank and its affiliates providing an aggregate commitment of more than 10%13% of the total committed capacity; however, the PPL affiliate providesprovided a commitment of approximately 23%21% of the total facilities listed above. The syndicated credit facilities, as well as KU's letter of credit facility, each contain a financial covenant requiring debt to total capitalization not to exceed 70% for LG&E or KU, as calculated in accordance with the facility, and other customary covenants. |
See Note 7 to the Financial Statements for further discussion of LKE's credit facilities.
Long-term Debt Securities
LKE's long-term debt securities activity through September 30, 2012 was: | | | | | | | | | | | | | | Debt | | | | | Issuances | | Retirement | | | | | | | | | | Non-cash Exchanges (a) | | | | | | | | LKE Senior Unsecured Notes | | $ | 250 | | $ | (250) |
(a) | In June 2012, LKE completed an exchange of all of its outstanding 4.375% Senior Notes due 2021 issued in September 2011, in a transaction not registered under the Securities Act of 1933, for similar securities that were issued in a transaction registered with the SEC. | During 2012, LG&E and KU received KPSC and other state approvals to issue, up to $350 million for LG&E and $300 million for KU, of first mortgage bond indebtedness in 2013, the proceeds of which will be used to fund capital expenditures and for other general corporate purposes.
See Note 7 to the Financial Statements for additional information about long-term debt securities.
Rating Agency Actions
Moody's, S&P and Fitch periodically review the credit ratings on the debt securities of LKE and its subsidiaries. Based on their respective independent reviews, the rating agencies may make certain ratings revisions or ratings affirmations.
A credit rating reflects an assessment by the rating agency of the creditworthiness associated with an issuer and particular securities that it issues. The credit ratings of LKE and its subsidiaries are based on information provided by LKE and other sources. The ratings of Moody's, S&P and Fitch are not a recommendation to buy, sell or hold any securities of LKE or its subsidiaries. Such ratings may be subject to revisions or withdrawal by the agencies at any time and should be evaluated independently of each other and any other rating that may be assigned to the securities. A downgrade in LKE's or its subsidiaries'The credit ratings could result in higher borrowing costs and reduced access to capital markets.
As a result of the passage of the Dodd-Frank Act and the attendant uncertainties relating to the extent to which issuers of non-asset backed securities may disclose credit ratings without being required to obtain rating agency consent to the inclusion of such disclosure, or incorporation by reference of such disclosure, in a registrant's registration statement or section 10(a) prospectus, LKE is limiting its credit rating disclosure to a description of the actions taken by the rating agencies with respect to LKE's ratings, but without stating what ratings have been assigned to LKE or its subsidiaries, or their securities. The ratings assigned by the rating agencies to LKE and its subsidiaries affect its liquidity, access to capital markets and their respective securities may be found, without charge, on eachcost of the respective rating agencies' websites, which ratings together with all other information contained on such rating agency websites is, hereby, explicitly not incorporated by reference in this report.borrowing under its credit facilities.
The rating agencies took the following actionsaction related to LKE and its subsidiaries:subsidiaries during 2013:
In February 2012, Fitch assigned ratings to the two newly established commercial paper programs for LG&E and KU.
In March 2012, Moody's affirmed the following ratings:
· | the long-term ratings of the First Mortgage Bonds for LG&E and KU; |
· | the issuer ratings for LG&E and KU; and |
· | the bank loan ratings for LG&E and KU. |
Also in March 2012, Moody's andJuly 2013, S&P each assigned short-term ratings to the two newly established commercial paper programs for LG&E and KU.
In March and May 2012, Moody's, S&P and Fitch affirmedconfirmed the long-term AA+ ratings for LG&E's 2003KU's 2000 Series A Solid Waste Disposal Facility Revenue Bonds and 2007KU's 2004 Series A, 2006 Series B pollution control bonds.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 SeptemberJune 30, 2012. At September 30, 2012, if LKE and its subsidiaries' credit ratings had been below investment grade, the maximum amount that LKE would have been required to post as additional collateral to counterparties was $87 million for both derivative and non-derivative commodity and commodity-related contracts used in its generation and marketing operations, gas supply and interest rate contracts.2013.
Risk Management
Market Risk
See Notes 13 and 14 to the Financial Statements for information about LKE's risk management objectives, valuation techniques and accounting designations.
The forward-looking information presented below provides estimates of what may occur in the future, assuming certain adverse market conditions and model assumptions. Actual future results may differ materially from those presented. These disclosures are not precise indicators of expected future losses, but only indicators of possible losses under normal market conditions at a given confidence level.
Commodity Price Risk (Non-trading)
LG&E's and KU's rates are set by regulatory commissions and the fuel costs incurred are directly recoverable from customers. As a result, LG&E and KU are subject to commodity price risk for only a small portion of on-going business operations. LKE conducts energy trading and risk management activitiessells excess economic generation to maximize the value of the physical assets at times when the assets are not required to serve LG&E's andor KU's customers. See Note 14 to the Financial Statements for additional disclosures.
Interest Rate Risk
LKE and its subsidiaries issue debt to finance their operations, which exposes them to interest rate risk. LKE utilizes various financial derivative instruments to adjust the mix of fixed and floating interest rates in its debt portfolio when appropriate. Risk limits under LKE's risk management program are designed to balance risk, exposure to volatility in interest expense and changes in the fair value of LKE's debt portfolio due to changes in the absolute level of interest rates.
At SeptemberJune 30, 2012,2013, 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 SeptemberJune 30, 2012,2013, would increase the fair value of its debt portfolio by $117$112 million.
At September 30, 2012, LKE had the following interest rate hedges outstanding: | | | | | | | | | | | | | | | | | | | Effect of a | | | | | | Fair Value, | | 10% Adverse | | | | Exposure | | Net - Asset | | Movement | | | | Hedged | | (Liability) (a) | | in Rates | Economic hedges | | | | | | | | | | | Interest rate swaps (b) | | $ | 179 | | $ | (62) | | $ | (3) |
At June 30, 2013, LKE had the following interest rate hedges outstanding: | | | | | | | | | | | | | | | | | | | Effect of a | | | | | | | | | 10% Adverse | | | | | | | Fair Value, | | Movement | | | | Exposure | | Net - Asset | | In Interest | | | | Hedged | | (Liability) (a) | | Rates | Economic activity | | | | | | | | | | | Interest rate swaps (b) | | $ | 179 | | $ | (44) | | $ | (4) | Cash flow hedges | | | | | | | | | | | 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 and cash flow hedges are recoverable through regulated rates and any subsequent changes in fair value of these derivatives are included in regulatory assets or liabilities. Sensitivities represent a 10% adverse movement in interest rates. The positions outstanding at SeptemberJune 30, 20122013 mature through 2033.2043. |
Credit Risk
See Notes 13 and 14 to the Financial Statements in this Form 10-Q and "Risk Management - Energy Marketing & Trading and Other - Credit Risk" in LKE's 20112012 Form 10-K for additional information.
Related Party Transactions
LKE is not aware of any material ownership interest or operating responsibility by senior management of LKE, LG&E or KU in outside partnerships, including leasing transactions with variable interest entities, or other entities doing business with LKE. See Note 11 to the Financial Statements for additional information on related party transactions.
Environmental Matters
Protection of the environment is a major priority for LKE and a significant element of its business activities. Extensive federal, state and local environmental laws and regulations are applicable to LKE'sLG&E's and KU's air emissions, water discharges and the management of hazardous and solid waste, amongas well as other areas, and the costsaspects of LKE's business. The cost of compliance or alleged non-compliance cannot be predicted with certainty but could be material. In addition, costs may increase significantly if the requirements or scope of environmental laws or regulations, or similar rules, are expanded or changed from prior versions by the relevant agencies. Costs may take the form of increased capital expenditures or operating and maintenance expenses;expenses, monetary fines, penalties or forfeitures; or other restrictions. Many of these environmental law considerations are also applicable to the operations of key suppliers, or customers, such as coal producers and industrial power users, etc. and may impact the costscost for their products or their demand for LKE'sLG&E's and KU's services.
Physical effects associated with 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 hydroelectric 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 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 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: 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 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 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 LKE 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. 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 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.
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 and "Item 1. Business - Environmental Matters" in LKE's 20112012 Form 10-K and Note 10 to the Financial Statements for a discussion ofadditional information on environmental matters.
New Accounting Guidance
See Notes 2 and 1819 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.
Application of Critical Accounting Policies
Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies. The following accounting policies are particularly important to the financial condition or results of operations and require estimates or other judgments of matters inherently uncertain: revenue recognition - unbilled revenue, price risk management, defined benefits, asset impairment, loss accruals, AROs, income taxes, and regulatory assets and liabilities. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in LKE's 20112012 Form 10-K for a discussion of each critical accounting policy.
LOUISVILLE GAS AND ELECTRIC COMPANY
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following should be read in conjunction with LG&E's Condensed Financial Statements and the accompanying Notes and with LG&E's 20112012 Form 10-K. Capitalized terms and abbreviations are defined in the glossary. Dollars are in millions, unless otherwise noted.
"Management's Discussion and Analysis of Financial Condition and Results of Operations" includes the following information:
| · | "Overview" provides a description of LG&E and its business strategy, a summary of Net Income and a discussion of certain events related to LG&E's results of operations and financial condition. |
| · | "Results of Operations" provides a summary of LG&E's earnings and a description of key factors expected to impact future earnings. This section ends with explanations of significant changes in principal line items on LG&E's Statements of Income, comparing the three and ninesix months ended SeptemberJune 30, 20122013 with the same periods in 2011.2012. |
| · | "Financial Condition - Liquidity and Capital Resources" provides an analysis of LG&E's liquidity position and credit profile. This section also includes a discussion of rating agency actions. |
| · | "Financial Condition - Risk Management" provides an explanation of LG&E's risk management programs relating to market and credit risk. |
Overview
Introduction
LG&E, headquartered in Louisville, Kentucky, is a regulated utility engaged in the generation, transmission, distribution and sale of electricityelectric energy and the distribution and sale of natural gas in Kentucky. LG&E and its affiliate, KU, are wholly owned subsidiaries of LKE. LKE is an intermediary holding company in PPL's group of companies.
Business Strategy
LG&E's overall strategy is to provide reliable, safe, and competitively priced energy to its customers.customers and reasonable returns on regulated investments to its shareowner. 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 ninesix months ended SeptemberJune 30, 20122013 was $43$29 million and $94$73 million compared to $43$26 million and $102$51 million for the same periods in 20112012 representing an 8% decrease from the nine-month period in 2011.increases of 12% and 43% over 2012.
See "Results of Operations" for a discussion and analysis of LG&E's earnings.
Terminated Bluegrass CTs AcquisitionEconomic and Market Conditions
In September 2011,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 KU entered into an asset purchase agreement with Bluegrass Generation foreconomic factors that impact the purchase of the Bluegrass CTs, aggregating approximately 495 MW, plus limited associated contractual arrangements required for operation of the units, for a purchase price of $110 million, pending receipt of applicable regulatory approvals. In May 2012, the KPSC issued an order approving the request to purchase the Bluegrass CTs. Also in May 2012, the FERC issued an order conditionally authorizing the acquisition of the Bluegrass CTs, subject to approvalload utilized by the FERC of satisfactory mitigation measures to address market-power concerns. After a review of potentially available mitigation options, LG&Eindustrial and KU determined that the options were not commercially justifiable. In June 2012, LG&E and KU terminated the asset purchase agreement for the Bluegrass CTs in accordance with its terms and made applicable filings with the KPSC and FERC. LG&E and KU are currently assessing the impact of the asset purchase agreement termination and potential future generation capacity options.commercial customers.
NGCC Construction
In September 2011, LG&E is subject to extensive federal, state and KU filed a CPCN with the KPSC requesting approval to build a 640 MW NGCC at the existing Cane Run plant site in Kentucky. In May 2012, the KPSC issued an order approving the request.local environmental laws, rules and regulations. Certain regulated generation assets will require substantial capital investment. LG&E will own a 22% undivided interest and KU will own a 78% undivided interestprojects $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 the new NGCC. LG&E and KU commenced preliminary construction activities in the third quarter&E's anticipated retirement by 2015 of 2012 and project construction is expected to be completed by May 2015. The project, which includes building a natural gas supply pipeline and related transmission projects, has an estimated cost of approximately $600 million.
In conjunctionthree coal-fired units with this construction and to meet new, more stringent federal EPA regulations with a 2015 compliance date, LG&E and KU anticipate retiring six older coal-fired electric generating units at the Cane Run, Green River and Tyrone plants, which have a combined summer capacity rating of 797563 MW.
Capital Expenditures
Capital expenditure plans are revised periodically to reflect changes in operational, market and regulatory conditions. LG&E has lowered its projected environmental capital spending for the period 2012 through 2016 by approximately $0.4 billion from the previously disclosed $1.6 billion projection included in LG&E's 2011 Form 10-K. The lower projected capital spending is based on current project evaluations and pricing contained in contracts executed to date for environmental construction projects. LG&E continues to evaluate potential new generation supply sources, including self-build options and power sourced from the market, as alternatives to installing additional emission control equipment at E.W. Brown, which is jointly dispatched for LG&E and KU, and in lieuretirement of the terminated Bluegrass CTs acquisition discussed in Notes 6 andthree 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. 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 expects to complete its evaluation duringcannot predict the first half of 2013. The outcome offuture impact that evaluation may lead to additionalthese economic and market conditions and changes in projected capital spending.regulatory requirements may have on its financial condition or results of operations.
Commercial PaperRate Case Proceedings
In FebruaryDecember 2012, LG&E establishedthe KPSC approved a commercial paper programrate case settlement agreement providing for up to $250increases in annual base electricity rates of $34 million to provideand an additional financing source to fund its short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by LG&E's Syndicated Credit Facility. LG&E had no commercial paper outstanding at September 30, 2012.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 that management expects mayexpected to impact future earnings. This section ends with "Statement of Income Analysis," which includes explanations of significant changes in Margins and principal line items on LG&E's Statements of Income, comparing the three and ninesix months ended SeptemberJune 30, 20122013 with the same periods in 2011.2012.
The results for interim periods can be disproportionately influenced by numerous factors and developments and by seasonal variations. As such, the results of operations for interim periods do not necessarily indicate results or trends for the year or for future periods.
Earnings | | | | | | | | | | | | | | | | | | | | Net Income for the periods ended September 30 was: | | Net Income for the periods ended June 30 was: | | Net Income for the periods ended June 30 was: | | | | | | | | | | | | | | | | | | | | | | | Three Months | | Nine Months | | | Three Months | | Six Months | | | | 2012 | | 2011 | | 2012 | | 2011 | | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | | | Net Income | Net Income | | $ | 43 | | $ | 43 | | $ | 94 | | $ | 102 | 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.Margins.
| | Three Months | | Nine Months | | Three Months | | Six Months | | | | | | | | | | Margin | | $ | (1) | | $ | (5) | | Margins | | | $ | 8 | | $ | 29 | Other operation and maintenance | | 7 | | 1 | | (3) | | 5 | Depreciation | | (1) | | (4) | | 1 | | 3 | Taxes, other than income | | (1) | | (3) | | | | (1) | Other | | | (4) | | | 3 | | Other Income (Expense) - net | | | | | (2) | Interest Expense | | | | | 1 | Income Taxes | | | | (3) | | | (13) | Total | | $ | | | $ | (8) | | $ | 3 | | $ | 22 |
| · | See "Statement of Income Analysis - Margins - Changes in Non-GAAP Financial Measures" for an explanation of margins.Margins. |
| · | Lower other operation and maintenance for the three-monthsix-month period primarily due to less storm restorationthe timing and tree trimming costs, less gas operation andscope of scheduled coal plant maintenance costs, lower bad debt expenses as a result of milder weather and improving economy and lower pension expenses.outages. |
· | Higher income taxes for the six-month period primarily due to higher pre-tax income. |
2013 Outlook
LG&E projects lowerhigher earnings in 20122013 compared with 2011 as a result of2012, primarily driven by electric and gas base rate increases, returns
on additional environmental capital investments and load growth, partially offset by higher other operation and maintenance expense, higher depreciation and higher property taxes.
In June 2012, LG&E filed a request with the KPSC for an increase in annual base electric rates of approximately $62 million and an increase in annual base gas rates of approximately $17 million. The proposed request would result in a 6.9% increase in the base electric rates and a 7.0% increase in the base gas rates, and would be effective in January 2013. LG&E's application includes a request for authorized return-on-equity of 11%. In November 2012, the KPSC issued an order for a settlement conference to begin on November 13, 2012. A hearing on the original application and subsequent testimony is scheduled to begin on November 27, 2012. LG&E cannot predict the outcome of these proceedings, including the possibility of any agreed stipulations or settlement, which would remain subject to KPSC approval. A final order may be issued in December 2012 or January 2013.expense.
Earnings in 2012 and future periods are subject to various risks and uncertainties. See "Forward-Looking Information," the rest of this Item 2, Notes 6 and 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in LG&E's 20112012 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.
Statement of Income Analysis --
Margins
Non-GAAP Financial Measure
The following discussion includes financial information prepared in accordance with GAAP, as well as a non-GAAP financial measure, "Margins." Margins is not intended to replace "Operating Income," which is determined in accordance with GAAP as an indicator of overall operating performance. Other companies may use different measures to analyze and to report on the results of their operations. Margins is a single financial performance measure of LG&E's operations.electricity generation, transmission and distribution operations as well as its distribution and sale of natural gas. In calculating this measure, fuel and energy purchases are deducted from revenues. In addition, utility revenues and expenses associated with approved cost recovery tracking mechanisms are offset. These mechanisms allow for recovery of certain expenses, returns on capital investments associated with environmental regulations and performance incentives. Certain costs associated with these mechanisms, primarily ECR, DSM and DSM,GLT, are recorded as "Other operation and maintenance" and "Depreciation." As a result, this measure represents the net revenues from LG&E's operations. This performance measure is used, in conjunction with other information, internally by senior management to manage operations and analyze actual results compared towith budget.
Reconciliation of Non-GAAP Financial Measures
The following tables reconcile "Margins" to "Operating Income" to "Margins" as defined by LG&E for the periods ended SeptemberJune 30.
| | | | | | 2012 Three Months | | | 2011 Three Months | | | | | | | | | | | Operating | | | | | | | | Operating | | | | | | | Margins | | Other (a) | | Income (b) | | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | Operating Revenues | | $ | 333 | | | | | $ | 333 | | | $ | 339 | | $ | 1 | | $ | 340 | Operating Expenses | | | | | | | | | | | | | | | | | | | | | Fuel | | | 100 | | | | | | 100 | | | | 98 | | | | | | 98 | | Energy purchases | | | 21 | | | | | | 21 | | | | 31 | | | | | | 31 | | Other operation and maintenance | | | 13 | | $ | 74 | | | 87 | | | | 10 | | | 81 | | | 91 | | Depreciation | | | 1 | | | 37 | | | 38 | | | | 1 | | | 36 | | | 37 | | Taxes, other than income | | | | | | 6 | | | 6 | | | | | | | 5 | | | 5 | | | | Total Operating Expenses | | | 135 | | | 117 | | | 252 | | | | 140 | | | 122 | | | 262 | Total | | $ | 198 | | $ | (117) | | $ | 81 | | | $ | 199 | | $ | (121) | | $ | 78 |
| | | | | | 2013 Three Months | | | 2012 Three Months | | | | | | | | | | | Operating | | | | | | | | Operating | | | | | | | Margins | | Other (a) | | Income (b) | | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | Operating Revenues | | $ | 316 | | | | | $ | 316 | | | $ | 304 | | | | | $ | 304 | Operating Expenses | | | | | | | | | | | | | | | | | | | | | Fuel | | | 88 | | | | | | 88 | | | | 92 | | | | | | 92 | | Energy purchases | | | 34 | | | | | | 34 | | | | 25 | | | | | | 25 | | Other operation and maintenance | | | 10 | | $ | 84 | | | 94 | | | | 11 | | $ | 81 | | | 92 | | Depreciation | | | 1 | | | 36 | | | 37 | | | | 1 | | | 37 | | | 38 | | Taxes, other than income | | | | | | 6 | | | 6 | | | | | | | 6 | | | 6 | | | | Total Operating Expenses | | | 133 | | | 126 | | | 259 | | | | 129 | | | 124 | | | 253 | Total | | $ | 183 | | $ | (126) | | $ | 57 | | | $ | 175 | | $ | (124) | | $ | 51 |
| | | | 2012 Nine Months | | 2011 Nine Months | | | | 2013 Six Months | | 2012 Six 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 | | $ | 990 | | | | $ | 990 | | $ | 1,034 | | $ | 1 | | $ | 1,035 | Operating Revenues | | $ | 706 | | | | $ | 706 | | $ | 657 | | | | $ | 657 | Operating Expenses | Operating Expenses | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | Fuel | | 281 | | | | 281 | | 265 | | | | 265 | Fuel | | 184 | | | | 184 | | 181 | | | | 181 | | Energy purchases | | 119 | | | | 119 | | 180 | | | | 180 | Energy purchases | | 115 | | | | 115 | | 98 | | | | 98 | | Other operation and maintenance | | 36 | | $ | 241 | | 277 | | 30 | | 242 | | 272 | Other operation and maintenance | | 21 | | $ | 164 | | 185 | | 21 | | $ | 169 | | 190 | | Depreciation | | 2 | | 112 | | 114 | | 2 | | 108 | | 110 | Depreciation | | 1 | | 72 | | 73 | | 1 | | 75 | | 76 | | Taxes, other than income | | | | | | 17 | | | 17 | | | | | | 14 | | | 14 | Taxes, other than income | | | | | | 12 | | | 12 | | | | | | 11 | | | 11 | | | Total Operating Expenses | | | 438 | | | 370 | | | 808 | | | 477 | | | 364 | | | 841 | | Total Operating Expenses | | | 321 | | | 248 | | | 569 | | | 301 | | | 255 | | | 556 | Total | Total | | $ | 552 | | $ | (370) | | $ | 182 | | $ | 557 | | $ | (363) | | $ | 194 | 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 decreasedincreased by $5$8 million duringfor the nine months ended September 30, 2012 compared with the samethree-month period in 2011, primarily due to $4higher base rates of $10 million and increased environmental investments of lower wholesale margins, as volumes were impacted$3 million, partially offset by lower market prices. Retail margins were consistent with the prior yearvolumes of $5 million. The change in volumes was partially attributable to weather, as increased industrial sales offset declines associated with unseasonably mild weather during the first four months of 2012. Total heatingcooling degree days decreased 28%25% compared to the same period in 2011.2012.
Margins increased by $29 million for the six-month period due to higher base rates of $22 million and increased environmental investments of $5 million.
The increase in base rates was the result of new KPSC rates effective January 1, 2013.
Other Operation and Maintenance
Other operation and maintenance increaseddecreased by $5 million for the ninesix months ended SeptemberJune 30, 20122013 compared with 2011,2012 primarily due to an $8$7 million increase inof lower costs due to the timing and scope of scheduled coal plant maintenance costs, primarily resulting from an increased scope of scheduled outages. This increase was offset by a $2 million decrease in pension expense.
Financial Condition | | | | | | | | Liquidity and Capital Resources | | | | | | | | LG&E had the following at: | | | | | | | | | | September 30, 2012 | | December 31, 2011 | | | | | | | | Cash and cash equivalents | | $ | 48 | | $ | 25 |
Income Taxes
Income taxes increased by $13 million for the six months ended 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: | | | | | | | | | | June 30, 2013 | | December 31, 2012 | | | | | | | | Cash and cash equivalents | | $ | 13 | | $ | 22 | | | | | | | | Short-term debt (a) | | $ | 80 | | $ | 55 |
(a) | Represents borrowings under LG&E's commercial paper program. See Note 7 to the Financial Statements for additional information. |
The $23$9 million increasedecrease in LG&E's cash and cash equivalents position was primarily the net result of:
· | cash provided by operating activitiescapital expenditures of $267 million,$236 million; and |
· | the payment of common stock dividends to parent of $48 million; partially offset by |
· | cash provided by operating activities of $186 million, |
· | capital expenditurescontributions from parent of $193$54 million; and |
· | common stock dividendsan increase in short term debt of $47$25 million. |
LG&E's cash provided by operating activities decreasedincreased by $12$26 million for the ninesix months ended SeptemberJune 30, 2012,2013, compared with 2011,2012, primarily due to:
· | a decreasean increase in working capital cash inflows from accounts receivableflow changes of $26 million which isdriven primarily by lower fuel levels in 2013 compared with 2012 due to increased generation at the result of a decreaseplants and higher gas consumption from storage compared to 2012 due to the unseasonably milder weather in accounts receivable from affiliates of $20 million for receivables from KU for TC2 coal inventory and other shared costs and from LKE for income tax settlements;December 2011; and |
· | a decrease in coal consumption resulting primarily from lower coal-fired generation due to the mild winter weather and an increase in combustion turbine generation that led to an increasenet income adjusted for non-cash items of $34$18 million in coal inventory,(other non-cash items of $6 million; partially offset by adeferred income taxes and investment tax credits of $7 million greater decline in gas storage in comparison to 2011;and depreciation of $3 million); partially offset by |
· | a decreasean increase in cash outflows from other operating activities of $42$18 million due todriven by a reduction$19 million increase in discretionary defined benefit plan contributions. |
LG&E's cash used in investing activitiesCapital expenditures increased by $221$116 million forduring the ninesix months ended SeptemberJune 30, 2012,2013 compared with 2011,2012 primarily due to proceeds from the saleenvironmental air projects at Mill Creek plant and construction of other investments of $163 million in 2011 and an increase in capital expenditures of $66 million as a result of increased environmental spending, primarily related to landfills; and infrastructure improvements at generation, distribution and transmission facilities.
LG&E's cash used in financing activities decreased by $183 million for the nine months ended September 30, 2012, compared with 2011, primarily due to a repayment on a revolving line of credit of $163 million and a net decrease in notes payable with affiliates of $12 million in 2011, along with lower common stock dividends paid to LKE of $8 million in 2012.Cane Run Unit 7.
Credit Facilities,
At SeptemberJune 30, 2012,2013, LG&E's committed borrowing capacity under its credit facilities and the use of this borrowing capacity were: | | | Committed | | | | Letters of | | Unused | | | | Capacity | | Borrowed | | Credit Issued | | Capacity | | | | | | | | | | | Syndicated Credit Facility (a) (b) | | $ | 400 | | | | | | | | $ | 400 |
| | | | | | | | | Letters of | | | | | | | | | | | | | Credit Issued | | | | | | | | | | | | | and | | | | | | | Committed | | | | Commercial | | Unused | | | | Capacity | | Borrowed | | Paper Backup | | Capacity | | | | | | | | | | | Syndicated Credit Facility (a) (b) | | $ | 500 | | | | | $ | 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) | In November 2012, LG&E amended thepays customary fees under its syndicated credit facility, to extend the expiration date to November 2017. In addition, LG&E increased the credit facility capacity to $500 million.and borrowings generally bear interest at LIBOR-based rates plus an applicable margin. |
LG&E participates in an intercompany money pool agreement whereby LKE and/or KU make available to LG&E funds up to $500 million at an interest rate based on a market index of commercial paper issues. At SeptemberJune 30, 20122013 and December 31, 2011,2012, there was no balance outstanding.
See Note 7 to the Financial Statements for further discussion of LG&E's credit facilities.
Long-term Debt Securities
During 2012, LG&E received KPSC and other state approvals to issue, up to $350 million of first mortgage bond indebtedness in 2013, the proceeds of which will be used to fund capital expenditures and for other general corporate purposes.
See Note 7 to the Financial Statements for additional information about long-term debt securities.
Rating Agency Actions
Moody's, S&P and Fitch periodically review the credit ratings on the debt securities of LG&E. Based on their respective independent reviews, the rating agencies may make certain ratings revisions or ratings affirmations.
A credit rating reflects an assessment by the rating agency of the creditworthiness associated with an issuer and particular securities that it issues. The credit ratings of LG&E are based on information provided by LG&E and other sources. The ratings of Moody's, S&P and Fitch are not a recommendation to buy, sell or hold any securities of LG&E. Such ratings may be subject to revisions or withdrawal by the agencies at any time and should be evaluated independently of each other and any other rating that may be assigned to the securities. A downgrade in LG&E'sThe credit ratings could result in higher borrowing costs and reducedof LG&E affect its liquidity, access to capital markets.
As a resultmarkets and cost of the passage of the Dodd-Frank Act and the attendant uncertainties relating to the extent to which issuers of non-asset backed securities may disclose credit ratings without being required to obtain rating agency consent to the inclusion of such disclosure, or incorporation by reference of such disclosure, in a registrant's registration statement or section 10(a) prospectus, LG&E is limitingborrowing under its credit rating disclosure to a description of the actions taken by the rating agencies with respect to LG&E's ratings, but without stating what ratings have been assigned to LG&E's securities. The ratings assigned by the rating agencies to LG&E and its securities may be found, without charge, on each of the respective rating agencies' websites, which ratings together with all other information contained on such rating agency websites is, hereby, explicitly not incorporated by reference in this report.facilities.
The rating agencies took the followingdid not take any actions related to LG&E:&E during the second quarter of 2013.
In February 2012, Fitch assigned ratings to LG&E's newly established commercial paper program.
In March 2012, Moody's affirmed the following ratings:
· | the long-term ratings of the First Mortgage Bonds for LG&E; |
· | the issuer ratings for LG&E; and |
· | the bank loan ratings for LG&E. |
Also in March 2012, Moody's and S&P each assigned short-term ratings to LG&E's newly established commercial paper program.
In March and May 2012, Moody's, S&P and Fitch affirmed the long-term ratings for LG&E's 2003 Series A and 2007 Series B pollution control bonds.
Ratings Triggers
LG&E has various derivative and non-derivative contracts, including contracts for the sale and purchase of electricity, fuel, commodity transportation and storage and interest rate instruments, which contain provisions requiring LG&E to post additional collateral, or permitting the counterparty to terminate the contract, if LG&E's credit rating were to fall below investment grade. See Note 14 to the Financial Statements for a discussion of "Credit Risk-Related Contingent Features," including a discussion of the potential additional collateral that would have been required for derivative contracts in a net liability position at SeptemberJune 30, 2012. At September 30, 2012, if LG&E's credit ratings had been below investment grade, the maximum amount that LG&E would have been required to post as additional collateral to counterparties was $62 million for both derivative and non-derivative commodity and commodity-related contracts used in its generation and marketing operations, gas supply and interest rate contracts.2013.
Risk Management
Market Risk
See Notes 13 and 14 to the Financial Statements for information about LG&E's risk management objectives, valuation techniques and accounting designations.
The forward-looking information presented below provides estimates of what may occur in the future, assuming certain adverse market conditions and model assumptions. Actual future results may differ materially from those presented. These disclosures are not precise indicators of expected future losses, but only indicators of possible losses under normal market conditions at a given confidence level.
Commodity Price Risk (Non-trading)
LG&E's rates are set by a regulatory commissioncommissions and the fuel costs incurred are directly recoverable from customers. As a result, LG&E is subject to commodity price risk for only a small portion of on-going business operations. LG&E conducts energy trading and risk management activitiessells excess economic generation to maximize the value of the physical assets at times when the assets are not required to serve LG&E's or KU's customers. See Note 14 to the Financial Statements for additional disclosures.
Interest Rate Risk
LG&E issues debt to finance its operations, which exposes it to interest rate risk. LG&E utilizes various financial derivative instruments to adjust the mix of fixed and floating interest rates in its debt portfolio when appropriate. Risk limits under LG&E's risk management program are designed to balance risk, exposure to volatility in interest expense and changes in the fair value of LG&E's debt portfolio due to changes in the absolute level of interest rates.
At SeptemberJune 30, 2012,2013, 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 SeptemberJune 30, 2012,2013, would increase the fair value of its debt portfolio by $27 million.
At September 30, 2012, LG&E had the following interest rate hedges outstanding: | | | | | | | | | | | | | | | | | | | Effect of a | | | | | | Fair Value, | | 10% Adverse | | | | Exposure | | Net - Asset | | Movement | | | | Hedged | | (Liability) (a) | | in Rates | Economic hedges | | | | | | | | | | | Interest rate swaps (b) | | $ | 179 | | $ | (62) | | $ | (3) |
At June 30, 2013, LG&E had the following interest rate hedges outstanding: | | | | | | | | | | | | | | | | | | | Effect of a | | | | | | | | | 10% Adverse | | | | | | | Fair Value, | | Movement | | | | Exposure | | Net - Asset | | in Interest | | | | Hedged | | (Liability) (a) | | Rates | Economic activity | | | | | | | | | | | Interest rate swaps (b) | | $ | 179 | | $ | (44) | | $ | (4) | Cash flow hedges | | | | | | | | | | | 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 and cash flow hedges are recoverable through regulated rates and any subsequent changes in fair value of these derivatives are included in regulatory assets or liabilities. Sensitivities represent a 10% adverse movement in interest rates. The positions outstanding at SeptemberJune 30, 20122013 mature through 2033.2043. |
Credit Risk
See Notes 13 and 14 to the Financial Statements in this Form 10-Q and "Risk Management - Energy Marketing & Trading and Other - Credit Risk" in LG&E's 20112012 Form 10-K for additional information.
Related Party Transactions
LG&E is not aware of any material ownership interest or operating responsibility by senior management of LG&E in outside partnerships, including leasing transactions with variable interest entities, or other entities doing business with LG&E. See Note 11 to the Financial Statements for additional information on related party transactions.
Environmental Matters
Protection of the environment is a major priority for LG&E and a significant element of its business activities. Extensive federal, state and local environmental laws and regulations are applicable to LG&E's air emissions, water discharges and the management of hazardous and solid waste, amongas well as other areas, and the costsaspects of LG&E's business. The cost of compliance or alleged non-compliance cannot be predicted with certainty but could be material. In addition, costs may increase significantly if the requirements or scope of environmental laws or regulations, or similar rules, are expanded or changed from prior versions by the relevant agencies. Costs may take the form of increased capital expenditures or operating and maintenance expenses;expenses, monetary fines, penalties or forfeitures; or other restrictions. Many of these environmental law considerations are also applicable to the operations of key suppliers, or customers, such as coal producers and industrial power users, etc. and may impact the costscost for their products or their demand for LG&E's services.
Physical effects associated with 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 hydroelectric generating facilities or where river water is used to cool its fossil-powered generators. LG&E cannot currently predict whether its business 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 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 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: 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 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 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 LG&E 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. 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 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, 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.
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 and "Item 1. Business - Environmental Matters" in LG&E's 20112012 Form 10-K and Note 10 to the Financial Statements for a discussion ofadditional information on environmental matters.
New Accounting Guidance
See Notes 2 and 1819 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.
Application of Critical Accounting Policies
Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies. The following accounting policies are particularly important to the financial condition or results of operations and require estimates or other judgments of matters inherently uncertain: revenue recognition - unbilled revenue, price risk management, defined benefits, asset impairment, loss accruals, AROs, income taxes, and regulatory assets and liabilities. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in LG&E's 20112012 Form 10-K for a discussion of each critical accounting policy.
KENTUCKY UTILITIES COMPANY
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following should be read in conjunction with KU's Condensed Financial Statements and the accompanying Notes and with KU's 20112012 Form 10-K. Capitalized terms and abbreviations are defined in the glossary. Dollars are in millions, unless otherwise noted.
"Management's Discussion and Analysis of Financial Condition and Results of Operations" includes the following information:
| · | "Overview" provides a description of KU and its business strategy, a summary of Net Income and a discussion of certain events related to KU's results of operations and financial condition. |
| · | "Results of Operations" provides a summary of KU's earnings and a description of key factors expected to impact future earnings. This section ends with explanations of significant changes in principal line items on KU's Statements of Income, comparing the three and ninesix months ended SeptemberJune 30, 20122013 with the same periods in 2011.2012. |
| · | "Financial Condition - Liquidity and Capital Resources" provides an analysis of KU's liquidity position and credit profile. This section also includes a discussion of rating agency actions. |
| · | "Financial Condition - Risk Management" provides an explanation of KU's risk management programs relating to market and credit risk. |
Overview
Introduction
KU, headquartered in Lexington, Kentucky, is a regulated utility engaged in the generation, transmission, distribution and sale of electricity,electric energy in Kentucky, Virginia and Tennessee. KU and its affiliate, LG&E, are wholly owned subsidiaries of LKE. LKE is an intermediary holding company in PPL's group of companies.
Business Strategy
KU's overall strategy is to provide reliable, safe, and competitively priced energy to its customers.customers and reasonable returns on regulated investments to its shareowner. 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 ninesix months ended SeptemberJune 30, 20122013 was $50$44 million and $118$108 million compared to $56$30 million and $144$68 million for the same periods in 20112012 representing decreasesincreases of 11%47% and 18% from the same periods in 2011.59% over 2012.
See "Results of Operations" for a discussion and analysis of KU's earnings.
Terminated Bluegrass CTs AcquisitionEconomic and Market Conditions
In September 2011,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 LG&E entered into an asset purchase agreement with Bluegrass Generation foreconomic factors that impact the purchase of the Bluegrass CTs, aggregating approximately 495 MW, plus limited associated contractual arrangements required for operation of the units, for a purchase price of $110 million, pending receipt of applicable regulatory approvals. In May 2012, the KPSC issued an order approving the request to purchase the Bluegrass CTs. Also in May 2012, the FERC issued an order conditionally authorizing the acquisition of the Bluegrass CTs, subject to approvalload utilized by the FERC of satisfactory mitigation measures to address market-power concerns. After a review of potentially available mitigation options, KUindustrial and LG&E determined that the options were not commercially justifiable. In June 2012, KU and LG&E terminated the asset purchase agreement for the Bluegrass CTs in accordance with its terms and made applicable filings with the KPSC and FERC. KU and LG&E are currently assessing the impact of the asset purchase agreement termination and potential future generation capacity options.commercial customers.
NGCC Construction
In September 2011, KU is subject to extensive federal, state and LG&E filed a CPCNlocal 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 the KPSC requesting approval to build a 640 MW NGCC at the existing Cane Run plant site in Kentucky. In May 2012, the KPSC issued an order approving the request. KU will own a 78% undivided interest and LG&E will own a 22% undivided interest in the new NGCC. KU and LG&E commenced preliminary construction activities in the third quarter of 2012 and project construction is expected to be completed by May 2015. The project, which includes building a natural gas supply pipeline and related transmission projects, has an estimated cost of approximately $600 million.
In conjunction with this construction and to meet new, more stringent federal EPA regulations with a 2015 compliance date, KU and LG&E anticipate retiring six older coal-fired electric generating units at the Cane Run, Green River and Tyrone plants, which have a combined summer capacity rating of 797163 MW.
Capital Expenditures
Capital expenditure plans are revised periodically to reflect changes KU retired the 71 MW unit at the Tyrone plant in operational, market and regulatory conditions. KU has lowered its projected environmental capital spending for the period 2012 through 2016 by approximately $0.1 billion from the previously disclosed $1.5 billion projection included in KU's 2011 Form 10-K.February 2013. The lower projected capital spending is based on current project evaluations and pricing contained in contracts executed to date for environmental construction projects. KU continues to evaluate potential new generation supply sources, including self-build options and power sourced from the market, as alternatives to installing additional emission control equipment at E.W. Brown, which is jointly dispatched for KU and LG&E, and in lieuretirement of the terminated Bluegrass CTs acquisition discussed in Notes 6 andtwo 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. 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 expects to complete its evaluation duringcannot predict the first half of 2013. The outcome offuture impact that evaluation may lead to additionalthese economic and market conditions and changes in projected capital spending.regulatory requirements may have on its financial condition or results of operations.
Commercial PaperRate 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 FebruaryDecember 2012, KU establishedthe KPSC approved a commercial paper programrate case settlement agreement providing for up to $250increases in annual base electricity rates of $51 million to provide an additional financing source to fund its short-term liquidity needs, if and when necessary. Commercial paper issuances are supported by KU's Syndicated Credit Facility. KU had no commercial paper outstanding at September 30, 2012.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 that management expects mayexpected to impact future earnings. This section ends with "Statement of Income Analysis," which includes explanations of significant changes in Margins and principal line items on KU's Statements of Income, comparing the three and ninesix months ended SeptemberJune 30, 20122013 with the same periods in 2011.2012.
The results for interim periods can be disproportionately influenced by numerous factors and developments and by seasonal variations. As such, the results of operations for interim periods do not necessarily indicate results or trends for the year or for future periods.
Earnings | | | | | | | | | | | | | | | | | | | | Net Income for the periods ended September 30 was: | | Net Income for the periods ended June 30 was: | | Net Income for the periods ended June 30 was: | | | | | | | | | | | | | | | | | | | | | | | Three Months | | Nine Months | | | Three Months | | Six Months | | | | 2012 | | 2011 | | 2012 | | 2011 | | | 2013 | | 2012 | | 2013 | | 2012 | | | | | | | | | | | | | | | | | | | | Net Income | Net Income | | $ | 50 | | $ | 56 | | $ | 118 | | $ | 144 | 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 | | Nine Months | | Three Months | | Six Months | | | | | | | | | | Margin | | $ | (5) | | $ | (17) | | Margins | | | $ | 23 | | $ | 77 | Other operation and maintenance | | (1) | | (8) | | 1 | | | Depreciation | | (2) | | (5) | | (9) | | (19) | Other | | (1) | | (2) | | Other Income (Expense) - net | | 1 | | (6) | | 7 | | 6 | Income Taxes | | | 2 | | | 12 | | (8) | | (25) | Special item - EEI adjustments, after-tax | | | | | | | 1 | Total | | $ | (6) | | $ | (26) | | $ | 14 | | $ | 40 |
| · | See "Statement of Income Analysis - Margins - Changes in Non-GAAP Financial Measures" for an explanation of margins.Margins. |
| · | Higher other operation and maintenance for the nine-month period primarily due to a $6 million credit recorded in 2011 to establish a regulatory asset related to 2009 storm costs. |
| · | Higher depreciation for the three and nine-monthsix-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 $12 million and $24 million to depreciation |
| that is excluded from 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 events are the result of the 2012 rate case proceedings. |
| · | LowerHigher other income (expense) - net for the nine-month periodthree and six-month periods primarily due to losses from an equity method investment.the EEI investment recorded in 2012. The EEI investment was fully impaired in the fourth quarter of 2012. |
| · | LowerHigher income taxes for the nine-month periodthree and six-month periods primarily due to lowerhigher pre-tax income. |
2013 Outlook
KU projects lowerhigher earnings in 20122013 compared with 2011 as a result of2012, primarily driven by electric base rate increases, returns on additional environmental capital investments and load growth, partially offset by higher other operation and maintenance expense, higher depreciation, higher property taxes and losses from an equity method investment.
In June 2012, KU filed a request with the KPSC for an increase in annual base electric rates of approximately $82 million. The proposed base electric rate increase would result in a 6.5% increase over KU's present rate and would be effective in January 2013. KU's application includes a request for authorized return-on-equity of 11%. In November 2012, the KPSC issued an order for a settlement conference to begin on November 13, 2012. A hearing on the original application and subsequent testimony is scheduled to begin on November 27, 2012. KU cannot predict the outcome of these proceedings, including the possibility of any agreed stipulations or settlement, which would remain subject to KPSC approval. A final order may be issued in December 2012 or January 2013.expense.
Earnings in 2012 and future periods are subject to various risks and uncertainties. See "Forward-Looking Information," the rest of this Item 2, Notes 6 and 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in KU's 20112012 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.
Statement of Income Analysis --
Margins
Non-GAAP Financial Measure
The following discussion includes financial information prepared in accordance with GAAP, as well as a non-GAAP financial measure, "Margins." Margins is not intended to replace "Operating Income," which is determined in accordance with GAAP as an indicator of overall operating performance. Other companies may use different measures to analyze and to report on the results of their operations. Margins is a single financial performance measure of KU's electricity generation, transmission and distribution operations. In calculating this measure, fuel and energy purchases are deducted from revenues. In addition, utility revenues and expenses associated with approved cost recovery tracking mechanisms are offset. These mechanisms allow for recovery of certain expenses, returns on capital investments associated with environmental regulations and performance incentives. Certain costs associated with these mechanisms, primarily ECR and DSM, are recorded as "Other operation and maintenance" and "Depreciation." As a result, this measure represents the net revenues from KU's operations. This performance measure is used, in conjunction with other information, internally by senior management to manage operations and analyze actual results compared towith budget.
Reconciliation of Non-GAAP Financial Measures
The following tables reconcile "Margins" to "Operating Income" to "Margins" as defined by KU for the periods ended SeptemberJune 30.
| | | | 2012 Three Months | | 2011 Three Months | | | | 2013 Three Months | | 2012 Three Months | | | | | | | | | Operating | | | | | | Operating | | | | | | | | Operating | | | | | | Operating | | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | Margins | | Other (a) | | Income (b) | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Operating Revenues | Operating Revenues | | $ | 411 | | | | $ | 411 | | $ | 419 | | $ | 1 | | $ | 420 | Operating Revenues | | $ | 383 | | | | $ | 383 | | $ | 374 | | | | $ | 374 | Operating Expenses | Operating Expenses | | | | | | | | | | | | | Operating Expenses | | | | | | | | | | | | | | Fuel | | 149 | | | | 149 | | 147 | | | | 147 | Fuel | | 128 | | | | 128 | | 123 | | | | 123 | | Energy purchases | | 18 | | | | 18 | | 25 | | | | 25 | Energy purchases | | 20 | | | | 20 | | 29 | | | | 29 | | Other operation and maintenance | | 16 | | $ | 77 | | 93 | | 14 | | 76 | | 90 | Other operation and maintenance | | 13 | | $ | 85 | | 98 | | 12 | | $ | 86 | | 98 | | Depreciation | | 12 | | 37 | | 49 | | 12 | | 35 | | 47 | Depreciation | | 1 | | 45 | | 46 | | 12 | | 36 | | 48 | | Taxes, other than income | | | | | | 5 | | | 5 | | | | | | 5 | | | 5 | Taxes, other than income | | | | | | 6 | | | 6 | | | | | | 6 | | | 6 | | | Total Operating Expenses | | | 195 | | | 119 | | | 314 | | | 198 | | | 116 | | | 314 | | Total Operating Expenses | | | 162 | | | 136 | | | 298 | | | 176 | | | 128 | | | 304 | Total | Total | | $ | 216 | | $ | (119) | | $ | 97 | | $ | 221 | | $ | (115) | | $ | 106 | Total | | $ | 221 | | $ | (136) | | $ | 85 | | $ | 198 | | $ | (128) | | $ | 70 |
| | | | | | 2012 Nine Months | | | 2011 Nine Months | | | | | | | | | | | Operating | | | | | | | | Operating | | | | | | | Margins | | Other (a) | | Income (b) | | | Margins | | Other (a) | | Income (b) | | | | | | | | | | | | | | | | | | | Operating Revenues | | $ | 1,165 | | | | | $ | 1,165 | | | $ | 1,191 | | | | | $ | 1,191 | Operating Expenses | | | | | | | | | | | | | | | | | | | | | Fuel | | | 396 | | | | | | 396 | | | | 401 | | | | | | 401 | | Energy purchases | | | 76 | | | | | | 76 | | | | 85 | | | | | | 85 | | Other operation and maintenance | | | 41 | | $ | 245 | | | 286 | | | | 37 | | $ | 237 | | | 274 | | Depreciation | | | 36 | | | 109 | | | 145 | | | | 35 | | | 104 | | | 139 | | Taxes, other than income | | | | | | 17 | | | 17 | | | | | | | 14 | | | 14 | | | | Total Operating Expenses | | | 549 | | | 371 | | | 920 | | | | 558 | | | 355 | | | 913 | Total | | $ | 616 | | $ | (371) | | $ | 245 | | | $ | 633 | | $ | (355) | | $ | 278 |
| | | | | | 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 decreasedincreased by $5$23 million for the three months ended September 30, 2012 compared with the samethree-month period in 2011, primarily due to higher base rates of $15 million and environmental cost recoveries added to base rates of $13 million, partially offset by lower volumes of $4 million of lower retail margins.million.
Margins decreasedincreased by $17$77 million for the nine months ended September 30, 2012 compared with the samesix-month period in 2011, primarily due to $16higher base rates of $33 million, environmental cost recoveries added to base rates of lower retail margins,$30 million, higher volumes of $9 million and increased environmental investments of $5 million. The change in volumes was attributable to weather, as volumes were impacted by unseasonably mild weather during the first four months of 2012. Total heating degree days decreased 21% asincreased 31% compared to the same period in 2011.2012.
Other OperationThe increase in base rates was the result of new KPSC rates effective January 1, 2013. The environmental cost recoveries added to base rates were due to the elimination of the 2005 and Maintenance
Other2006 ECR plans as a result of the 2012 Kentucky rate case. This elimination results in depreciation and other operation and maintenance increased by $12 million forexpenses associated with the nine months ended September 30, 2012 compared with 2011, primarily due to a $6 million credit to establish a regulatory asset was recorded2005 and 2006 ECR plans being excluded from Margins in 2013, while the first quarterrecovery of 2011 related to 2009 stormsuch costs and a $5 million increaseremain in coal plant maintenance costs, primarily resulting from an increased scope of scheduled outages.Margins through base rates.
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
Depreciation increased by $2 million and $6 millionThe increase (decrease) in depreciation for the three and nine monthsperiods ended SeptemberJune 30, 20122013 compared with 2011, primarily2012 was due to PP&E additions.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 decreasedincreased by $6$7 million for the ninethree and six months ended SeptemberJune 30, 2012,2013 compared with 2011,2012 primarily due to losses from an equity method investment.the EEI investment recorded in 2012. The EEI investment was fully impaired in the fourth quarter of 2012.
Income Taxes
Income taxes decreasedincreased by $12$8 million and $25 million for the ninethree and six months ended SeptemberJune 30, 2012,2013 compared with 2011,2012 primarily due to a $38 million decrease inhigher pre-tax income.
See Note 5 to the Financial Statements for additional information on income taxes.
Financial Condition | | | | | | | | | | Liquidity and Capital Resources | | | | | | | | | | KU had the following at: | | | | | | | | | | | | September 30, 2012 | | December 31, 2011 | | June 30, 2013 | | December 31, 2012 | | | | | | | | | | Cash and cash equivalents | | $ | 42 | | $ | 31 | | $ | 10 | | $ | 21 | | | | | | | Short-term debt (a) | | | $ | 172 | | $ | 70 |
(a) | Represents borrowings made under KU's commercial paper program. See Note 7 to the Financial Statements for additional information. |
The $11 million increasedecrease in KU's cash and cash equivalents position was the net result of:
· | capital expenditures of $341 million; and |
· | the payment of common stock dividends to parent of $55 million; partially offset by |
· | cash provided by operating activities of $410$190 million; partially offset by |
· | capital expendituresan increase in short term debt of $331$102 million; and |
· | common stock dividendscapital contributions from parent of $68$92 million. |
KU's cash provided by operating activities increaseddecreased by $51$27 million for the ninesix months ended SeptemberJune 30, 2012,2013, compared with 2011,2012, primarily due to:
· | a decreasean increase in cash outflows for accounts payable to affiliatesfrom other operating activities of $17$69 million primarily as a result of payables to LG&E for TC2 coal inventory and other shared costs, partially offsetdriven by a decrease in income tax settlements with LKE in 2011; |
· | a decrease in cash outflows of $26$43 million due to a reductionincrease in discretionary defined benefit plan contributions; and |
· | a decreasedecline in working capital cash outflows relatedflow of $18 million driven primarily by increases in accounts receivable due to accrued taxeshigher sales volumes, higher rates and extended payment terms and a lower tax accrual due to timing of $31 millionsettlements, partially offset by an increase in accounts payable primarily due to the timing of propertyfuel purchase commitments and income tax payments; partially offset by |
· | a decrease in cash inflows for accounts receivable of $42 million due to an increase in customer receivables in 2012 resulting from increased revenues in 2012 following unseasonably mild weather in December 2011net income adjusted for non-cash items of $60 million (deferred income taxes and the timinginvestment tax credits of cash receipts$19 million and payments,defined benefit plans - expense of $7 million, partially offset by depreciation of $4 million and an increase in accounts receivable from affiliates balance for income tax settlements with LKE in 2012.other non-cash items of $2 million). |
KU's cash used in investing activities increased by $163 million for the nine months ended September 30, 2012, compared with 2011, due to an increase in capital expenditures of $163 million as a result of increased environmental spending, primarily related to landfills; and infrastructure improvements at generation, distribution and transmission facilities.
KU's cash used in financing activities decreasedCapital expenditures increased by $32$138 million forduring the ninesix months ended SeptemberJune 30, 2012,2013 compared with 2011,2012 primarily due to lower common stock dividends paid to LKEenvironmental air projects and coal consumption residual projects at the Ghent plant and construction of $20 million in 2012.Cane Run Unit 7.
Credit Facilities
At SeptemberJune 30, 2012,2013, KU's committed borrowing capacity under its credit facilities and the use of this borrowing capacity were: | | | Committed | | | | Letters of | | Unused | | | | Capacity | | Borrowed | | Credit Issued | | Capacity | | | | | | | | | | | Syndicated Credit Facility (a) | | $ | 400 | | | | | | | | $ | 400 | Letter of Credit Facility (b) | | | 198 | | | | | $ | 198 | | | | | Total Credit Facilities (c) | | $ | 598 | | | | | $ | 198 | | $ | 400 |
| | | | | | | | | Letters of | | | | | | | | | | | | | Credit Issued | | | | | | | | | | | | | and | | | | | | | Committed | | | | Commercial | | Unused | | | | Capacity | | Borrowed | | Paper Backup | | Capacity | | | | | | | | | | | Total KU Credit Facilities (a) (b) | | $ | 598 | | | | | $ | 370 | | $ | 228 |
(a) | In November 2012, KU amended the syndicated credit facility to extend the expiration date to November 2017. |
(b) | In August 2012, the KU letter of credit facility agreement was amended and restated to allow for certain payments under the letter of credit facility to be converted to loans rather than requiring immediate payment. |
(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 SeptemberJune 30, 20122013 and December 31, 2011,2012, there was no balance outstanding.
See Notes 7 and 11 to the Financial Statements for further discussion of KU's credit facilities.
Long-term Debt Securities 175
During 2012, KU received KPSC and other state approvals to issue, up to $300 million of first mortgage bond indebtedness in 2013, the proceeds of which will be used to fund capital expenditures and for other general corporate purposes.
See Note 7 to the Financial Statements for additional information about long-term debt securities.
Rating Agency Actions
Moody's, S&P and Fitch periodically review the credit ratings on the debt securities of KU. Based on their respective independent reviews, the rating agencies may make certain ratings revisions or ratings affirmations.
A credit rating reflects an assessment by the rating agency of the creditworthiness associated with an issuer and particular securities that it issues. The credit ratings of KU are based on information provided by KU and other sources. The ratings of Moody's, S&P and Fitch are not a recommendation to buy, sell or hold any securities of KU. Such ratings may be subject to revisions or withdrawal by the agencies at any time and should be evaluated independently of each other and any other rating that may be assigned to the securities. A downgrade in KU'sThe credit ratings could result in higher borrowing costs and reducedof KU affect its liquidity, access to capital markets.
As a resultmarkets and cost of the passage of the Dodd-Frank Act and the attendant uncertainties relating to the extent to which issuers of non-asset backed securities may disclose credit ratings without being required to obtain rating agency consent to the inclusion of such disclosure, or incorporation by reference of such disclosure, in a registrant's registration statement or section 10(a) prospectus, KU is limitingborrowing under its credit rating disclosure to a description of the actions taken by the rating agencies with respect to KU's ratings, but without stating what ratings have been assigned to KU's securities. The ratings assigned by the rating agencies to KU and its securities may be found, without charge, on each of the respective rating agencies' websites, which ratings together with all other information contained on such rating agency websites is, hereby, explicitly not incorporated by reference in this report.facilities.
The rating agencies took the following actionsaction related to KU:KU during 2013:
In February 2012, Fitch assignedJuly 2013, S&P confirmed the long-term AA+ ratings tofor KU's newly established commercial paper program.
In March 2012, Moody's affirmed2000 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 following ratings:
· | the long-term ratings of the First Mortgage Bonds for KU; |
· | the issuer ratings for KU; and |
· | the bank loan ratings for KU. |
Also in March 2012, Moody's and S&P each assignedA-1+ short-term ratings to KU's newly established commercial paper program.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 SeptemberJune 30, 2012. At September 30, 2012, if KU's credit ratings had been below investment grade, the maximum amount that KU would have been required to post as additional collateral to counterparties was $25 million for both derivative and non-derivative commodity and commodity-related contracts used in its generation and marketing operations.2013.
Risk Management
Market Risk
See Notes 13 and 14 to the Financial Statements for information about KU's risk management objectives, valuation techniques and accounting designations.
The forward-looking information presented below provides estimates of what may occur in the future, assuming certain adverse market conditions and model assumptions. Actual future results may differ materially from those presented. These disclosures are not precise indicators of expected future losses, but only indicators of possible losses under normal market conditions at a given confidence level.
Commodity Price Risk (Non-trading)
KU's rates are set by regulatory commissions and the fuel costs incurred are directly recoverable from customers. As a result, KU is subject to commodity price risk for only a small portion of on-going business operations. KU conducts energy trading and risk management activitiessells excess economic generation to maximize the value of the physical assets at times when the assets are not required to serve KU'sLG&E's or LG&E'sKU's customers. See Note 14 to the Financial Statements for additional disclosures.
Interest Rate Risk
KU issues debt to finance its operations, which exposes it to interest rate risk. KU utilizes various financial derivative instruments to adjust the mix of fixed and floating interest rates in its debt portfolio when appropriate. Risk limits under KU's risk management program are designed to balance risk, exposure to volatility in interest expense and changes in the fair value of KU's debt portfolio due to changes in the absolute level of interest rates.
At SeptemberJune 30, 2012,2013, 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 SeptemberJune 30, 2012,2013, would increase the fair value of its debt portfolio by $70$68 million.
At June 30, 2013, KU had the following interest rate hedges outstanding: | | | | | | | | | | | | | | | | | | | Effect of a | | | | | | | | | 10% Adverse | | | | | | | Fair Value, | | Movement | | | | Exposure | | Net - Asset | | in Interest | | | | Hedged | | (Liability) | | Rates | Cash flow hedges | | | | | | | | | | | Interest rate swaps (a) | | $ | 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 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 20112012 Form 10-K for additional information.
Related Party Transactions
KU is not aware of any material ownership interest or operating responsibility by senior management of KU in outside partnerships, including leasing transactions with variable interest entities, or other entities doing business with KU. See Note 11 to the Financial Statements for additional information on related party transactions.
Environmental Matters
Protection of the environment is a major priority for KU and a significant element of its business activities. Extensive federal, state and local environmental laws and regulations are applicable to KU's air emissions, water discharges and the management of hazardous and solid waste, amongas well as other areas, and the costsaspects of KU's business. The cost of compliance or alleged non-compliance cannot be predicted with certainty but could be material. In addition, costs may increase significantly if the requirements or scope of environmental laws or regulations, or similar rules, are expanded or changed from prior versions by the relevant agencies. Costs may take the form of increased capital expenditures or operating and maintenance expenses;expenses, monetary fines, penalties or forfeitures; or other restrictions. Many of these environmental law considerations are also applicable to the operations of key suppliers, or customers, such as coal producers and industrial power users, etc. and may impact the costscost for their products or their demand for KU's services.
Physical effects associated with 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 hydroelectric generating facilities or where river water is used to cool its fossil-powered generators. KU cannot currently predict whether its business 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 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 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: 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 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 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 KU 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. 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 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.
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 and "Item 1. Business - Environmental Matters" in KU's 20112012 Form 10-K and Note 10 to the Financial Statements for a discussion ofadditional information on environmental matters.
New Accounting Guidance
See Notes 2 and 1819 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.
Application of Critical Accounting Policies
Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies. The following accounting policies are particularly important to the financial condition or results of operations and require estimates or other judgments of matters inherently uncertain: revenue recognition - unbilled revenue, price risk management, defined benefits, asset impairment, loss accruals, AROs, income taxes, and regulatory assets and liabilities. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in KU's 20112012 Form 10-K for a discussion of each critical accounting policy.
PPL Corporation PPL Energy Supply, LLC PPL Electric Utilities Corporation LG&E and KU Energy LLC Louisville Gas and Electric Company Kentucky Utilities Company
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Reference is made to "Risk Management" in each Registrant's "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations."
Item 4. Controls and Procedures
(a) Evaluation of disclosure controls and procedures.
PPL Corporation, PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company, and Kentucky Utilities Company
The registrants' principal executive officers and principal financial officers, based on their evaluation of the registrants' disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934) have concluded that, as of SeptemberJune 30, 2012,2013, the registrants' disclosure controls and procedures are effective to ensure that material information relating to the registrants and their consolidated subsidiaries is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms, particularly during the period for which this quarterly report has been prepared. The aforementioned principal officers have concluded that the disclosure controls and procedures are also effective to ensure that information required to be disclosed in reports filed under the Exchange Act is accumulated and communicated to management, including the principal executive and principal financial officers, to allow for timely decisions regarding required disclosure.
(b) Change in internal controls over financial reporting.
PPL Corporation,
The registrant's principal executive officer and principal financial officer have concluded that there were no changes in the registrant's internal control over financial reporting during the registrant's third fiscal quarter that have materially affected, or are reasonably likely to materially affect, the registrant's internal control over financial reporting.
As reported in the 2011 Form 10-K, PPL's principal executive officer and principal financial officer concluded that a systems migration related to the WPD Midlands acquisition created a material change to its internal control over financial reporting. Specifically, on December 1, 2011, the use of legacy information technology systems at WPD Midlands was discontinued and the related data, processes and internal controls were migrated to the systems, processes and controls currently in place at PPL WW.
Risks related to the systems migration were partially mitigated by PPL's expanded internal control over financial reporting that were implemented subsequent to the acquisition and PPL's existing policy of consolidating foreign subsidiaries on a one-month lag, which provided management additional time for review and analysis of WPD Midlands' results and their incorporation into PPL's consolidated financial statements.
PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company, and Kentucky Utilities Company
The registrants' principal executive officers and principal financial officers 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' third 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
Item 1. Legal Proceedings
For additional information regarding various pending administrative and judicial proceedings involving regulatory, environmental and other matters, which information is incorporated by reference into this Part II, see:
| · | | "Item 3. Legal Proceedings" in each Registrant's 20112012 Form 10-K; and | | · | | Notes 5, 6 and 10 to the Financial Statements. |
There have been no material changes in the Registrant's risk factors from those disclosed in "Item 1A. Risk Factors" of the 20112012 Form 10-K.
Item 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) | - | Supplemental Indenture No. 14, datedAmended and Restated Articles of Incorporation of PPL Corporation, effective as of August 1, 2012, made and entered into by and between PPL Electric Utilities Corporation and The Bank of New York Mellon, as Trustee, under the Indenture dated as of August 1, 2001May 15, 2013 (Exhibit 4(a)3(i) to PPL Corporation Form 8-K Report (File No. 1-11459) dated August 24, 2012)May 20, 2013) | 4(b)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. 9,10, dated as of October 15, 2012,May 24, 2013, among PPL Capital Funding, Inc., PPL Corporation and The Bank of New York Mellon (as successor to JPMorgan Chase Bank, N. A. (formerly known as The Chase Manhattan Bank))Bank of New York), as Trustee (Exhibit 4(b)4.2 to PPL Corporation Form 8-K Report (File No. 1-11459) dated October 15, 2012)May 24, 2013) | 4(b) | - | AmendmentSupplemental Indenture No. 611, 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 CreditPPL 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 Security Agreement,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 24, 2012, by and among PPL Receivables Corporation, as Borrower,1, 2013, of PPL Electric Utilities Corporation as Servicer, Victory Receivables Corporation, as a Lender, andto The Bank of Tokyo-Mitsubishi UFJ, Ltd., New York Branch,Mellon, as Liquidity Bank and as Agent | | - | Amendment No. 7Trustee (Exhibit 4(a) to Credit and Security Agreement, dated as of September 24, 2012, by and among PPL Receivables Corporation, as Borrower, PPL Electric Utilities Corporation as Servicer, Victory Receivables Corporation, as a Lender, and The Bank of Tokyo-Mitsubishi UFJ, Ltd., New York Branch, as Liquidity Bank and as Agent | | - | Amendment and Restatement Agreement,Form 8-K Report (File No. 1-905) dated as of August 16, 2012, to Letter of Credit Agreement, dated as of April 29, 2011, as amended, among Kentucky Utilities Company, the Borrower; the Lenders from time to time party thereto, the Lenders; Banco Bilbao Vizcaya Argentaria, S.A., New York Branch, the Agent and Sumitomo Mitsui Banking Corporation, New York Branch, the Issuing Lender and LenderJuly 11, 2013) | | - | PPL Corporation and Subsidiaries Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends | | - | PPL Energy Supply, LLC and Subsidiaries Computation of Ratio of Earnings to Fixed Charges | | - | PPL Electric Utilities Corporation and Subsidiaries Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends | | - | LG&E and KU Energy LLC and Subsidiaries Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends | | - | Louisville Gas and Electric Company Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends | | - | Kentucky Utilities Company Computation of Ratio of Earnings to Fixed Charges | | | | Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, for the quarterly period ended SeptemberJune 30, 2012,2013, 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 SeptemberJune 30, 2012,2013, furnished by the following officers for the following companies: | | | | | - | PPL Corporation's principal executive officer and principal financial officer | | - | PPL Energy Supply, LLC's principal executive officer and principal financial officer | | - | PPL Electric Utilities Corporation's principal executive officer and principal financial officer | | - | LG&E and KU Energy LLC's principal executive officer and principal financial officer | | - | Louisville Gas and Electric Company's principal executive officer and principal financial officer | | - | Kentucky Utilities Company's principal executive officer and principal financial officer | | | | 101.INS | - | XBRL Instance Document for PPL Corporation, PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company and Kentucky Utilities Company | 101.SCH | - | XBRL Taxonomy Extension Schema for PPL Corporation, PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company and Kentucky Utilities Company | 101.CAL | - | XBRL Taxonomy Extension Calculation Linkbase for PPL Corporation, PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company and Kentucky Utilities Company | 101.DEF | - | XBRL Taxonomy Extension Definition Linkbase for PPL Corporation, PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company and Kentucky Utilities Company | 101.LAB | - | XBRL Taxonomy Extension Label Linkbase for PPL Corporation, PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company and Kentucky Utilities Company | 101.PRE | - | XBRL Taxonomy Extension Presentation Linkbase for PPL Corporation, PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company and Kentucky Utilities Company |
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrants have duly caused this report to be signed on their behalf by the undersigned thereunto duly authorized. The signature for each undersigned company shall be deemed to relate only to matters having reference to such company or its subsidiaries.
| PPL Corporation | | (Registrant) | | | | | | PPL Energy Supply, LLC | | (Registrant) | | | | | | | | | | | Date: November 8, 2012August 2, 2013 | /s/ Vincent Sorgi | | | Vincent Sorgi | | | Vice President and Controller | | | (Principal Accounting Officer) | | | | | | | | | | | | PPL Electric Utilities Corporation | | (Registrant) | | | | | | | | | | | Date: November 8, 2012August 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: November 8, 2012August 2, 2013 | /s/ Kent W. Blake | | | Kent W. Blake Chief Financial Officer | | | (Principal Financial Officer and Principal Accounting Officer) | |
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