tep-20210331

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2021

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

Commission File Number 1-5924

TUCSON ELECTRIC POWER COMPANY

(Exact name of registrant as specified in its charter)


Arizona						86-0062700
(State or other jurisdiction of incorporation or organization)						(I.R.S. Employer Identification No.)

88 East Broadway Boulevard, Tucson, AZ 85701

(Address of principal executive offices)(Zip Code)

Registrant's telephone number, including area code: (520) 571-4000

Former name, former address and former fiscal year, if changed since last report: N/A

Securities registered pursuant to Section 12(b) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer ☐ Accelerated Filer ☐ Non-Accelerated Filer ☒ Smaller Reporting Company ☐ Emerging Growth Company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

All shares of outstanding common stock of Tucson Electric Power Company are held by its parent company, UNS Energy Corporation, which is an indirect, wholly-owned subsidiary of Fortis Inc. There were 32,139,434 shares of common stock, no par value, outstanding as of May 4, 2021.

Table of Contents


Definitions			iii
Forward-Looking Information			v
PART I

Item 1. Financial Statements
Condensed Consolidated Statements of Income			1

Condensed Consolidated Statements of Cash Flows			2
Condensed Consolidated Balance Sheets			3
Condensed Consolidated Statements of Changes in Stockholder's Equity			5
Notes to Condensed Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			20
Critical Accounting Policies and Estimates			32
New Accounting Standards Issued and Not Yet Adopted			32
Item 3. Quantitative and Qualitative Disclosures about Market Risk			32
Item 4. Controls and Procedures			33

PART II

Item 1. Legal Proceedings			34
Item 1A. Risk Factors			34

Item 6. Exhibits			35
Signatures			36

DEFINITIONS

The abbreviations and acronyms used in this Form 10-Q are defined below:

INDUSTRY ACRONYMS AND CERTAIN DEFINITIONS


2015 Credit Agreement						The 2015 Credit Agreement provides for a $250 million revolving credit and letter of credit facilities with a sublimit of $50 million; the credit agreement matures in October 2022
2019 FERC Rate Case						In 2019, the FERC issued an order approving TEP's proposed OATT revisions effective August 1, 2019, subject to refund and further proceedings
2020 IRP						TEP's 2020 Integrated Resource Plan filed with the ACC in June 2020, which outlines TEP's energy portfolio over the next 15 years
2020 Rate Order						A rate order issued by the ACC resulting in a new rate structure for TEP, effective on January 1, 2021

ACC						Arizona Corporation Commission
ACC Refund Order						An order issued in 2018 by the ACC approving TEP’s proposal to return savings from TEP’s federal corporate income tax rate under the TCJA to its customers through a combination of customer bill credits and a regulatory liability deferral that reflects the return of a portion of the savings, effective May 1, 2018
ADEQ						Arizona Department of Environmental Quality
AFUDC						Allowance for Funds Used During Construction


BTA						Build-Transfer Agreement

COVID-19						Coronavirus Disease 2019
DG						Distributed Generation
DSM						Demand Side Management
EDIT						Excess Deferred Income Taxes
EE Standards						Energy Efficiency Standards


FERC						Federal Energy Regulatory Commission
GAAP						Generally Accepted Accounting Principles in the United States of America
IRS						Internal Revenue Service
LFCR						Lost Fixed Cost Recovery

LOC						Letter(s) of Credit
OATT						Open Access Transmission Tariff
Phase 2						Second phase of TEP's 2020 Rate Case proceedings originally filed in April 2019
PPA						Power Purchase Agreement
PPFAC						Purchased Power and Fuel Adjustment Clause

RES						Renewable Energy Standard
Retail Rates						Rates designed to allow a regulated utility recovery of its costs of providing services and an opportunity to earn a reasonable return on its investment



TCJA						Tax Cuts and Jobs Act
TEAM						Tax Expense Adjustor Mechanism

ENTITIES AND GENERATING STATIONS


Fortis						Fortis Inc., a corporation incorporated under the Corporations Act of Newfoundland and Labrador, Canada, whose principal executive offices are located at Fortis Place, Suite 1100, 5 Springdale Street, St. John's, NL A1E 0E4
Four Corners						Four Corners Generating Station
Gila River						Gila River Generating Station

Navajo						Navajo Generating Station
Oso Grande						A 250 MW nominal capacity wind-powered electric generation facility, located in southeastern New Mexico

iii


San Juan						San Juan Generating Station
SES						Southwest Energy Solutions, Inc.
Springerville						Springerville Generating Station

Sundt						H. Wilson Sundt Generating Station
TEP						Tucson Electric Power Company, the principal subsidiary of UNS Energy Corporation

UNS Electric						UNS Electric, Inc., an indirect wholly-owned subsidiary of UNS Energy Corporation
UNS Energy						UNS Energy Corporation, the parent company of TEP, whose principal executive offices are located at 88 East Broadway Boulevard, Tucson, Arizona 85701
UNS Energy Affiliates						Affiliated subsidiaries of UNS Energy Corporation including UniSource Energy Services, Inc., UNS Electric, Inc., UNS Gas, Inc., and Southwest Energy Solutions, Inc.
UNS Gas						UNS Gas, Inc., an indirect wholly-owned subsidiary of UNS Energy Corporation

UNITS OF MEASURE


BBtu						Billion British thermal unit(s), a measure of the quantity of heat required to raise the temperature of one pound of liquid water by one degree Fahrenheit at the temperature at which water has its greatest density, in billions
GWh						Gigawatt-hour(s), a measure of electricity that represents one billion watts of power expended over one hour
kWh						Kilowatt-hour(s), a measure of electricity that represents one thousand watts of power expended over one hour
MW						Megawatt(s), a measure of electricity that represents one million watts of power

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FORWARD-LOOKING INFORMATION

This Quarterly Report on Form 10-Q contains forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. TEP, or the Company, is including the following cautionary statements to make applicable and take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 for any forward-looking statements made by TEP in this Quarterly Report on Form 10-Q. Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events, future economic conditions, future operational or financial performance and underlying assumptions, and other statements that are not statements of historical facts. Forward-looking statements may be identified by the use of words such as anticipates, believes, estimates, expects, intends, may, plans, predicts, potential, projects, would, and similar expressions. From time to time, we may publish or otherwise make available forward-looking statements of this nature. All such forward-looking statements, whether written or oral, and whether made by or on behalf of TEP, are expressly qualified by these cautionary statements and any other cautionary statements which may accompany the forward-looking statements. In addition, TEP disclaims any obligation to update any forward-looking statements to reflect events or circumstances after the date of this report, except as may otherwise be required by the federal securities laws.

Forward-looking statements involve risks and uncertainties which could cause actual results or outcomes to differ materially from those expressed therein. We express our estimates, expectations, beliefs, and projections in good faith and believe them to have a reasonable basis. However, we make no assurances that management’s estimates, expectations, beliefs, or projections will be achieved or accomplished. We have identified the following important factors that could cause actual results to differ materially from those discussed in our forward-looking statements. These may be in addition to other factors and matters discussed in: Part I, Item 1A. Risk Factors of our 2020 Annual Report on Form 10-K; Part II, Item 1A. Risk Factors; Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations; and other parts of this report. These factors include: voter initiatives and state and federal regulatory and legislative decisions and actions, including changes in tax and energy policies and any change in the structure of utility service in Arizona resulting from the ACC or state legislature's examination of the state's energy policies; changes in, and compliance with, environmental laws and regulatory decisions and policies that could increase operating and capital costs, reduce generation facility output, or accelerate generation facility retirements; the final outcome of the FERC order effective August 2019, subject to refund, approving revisions to TEP's OATT; unfavorable rulings, penalties, or findings by the FERC; regional economic and market conditions that could affect customer growth and energy usage; changes in energy consumption by retail customers; weather variations affecting energy usage; our forecasts of peak demand and whether existing generation capacity and PPAs are sufficient to meet the expected demand plus reserve margin requirements; the cost of debt and equity capital and access to capital markets and bank markets, which may affect our ability to raise additional capital and use the proceeds from any capital that we do raise as originally intended; the performance of the stock market and a changing interest rate environment, which affect the value of our pension and other postretirement benefit plan assets and the related contribution requirements and expenses; the potential inability to make additions to our existing high voltage transmission system; unexpected increases in operations and maintenance expense; resolution of pending litigation matters; changes in accounting standards; changes in our critical accounting policies and estimates; the ongoing impact of mandated energy efficiency and DG initiatives; changes to long-term contracts; the cost of fuel and power supplies; the ability to obtain coal from our suppliers; cyber-attacks, data breaches, or other challenges to our information security, including our operations and technology systems; the performance of TEP's generation facilities, including renewable generation resources; the development of our wind-powered electric generation facility in southeastern New Mexico; participation in the Energy Imbalance Market; the extent of the impact of the COVID-19 pandemic on our business and operations, and the economic and societal disruptions resulting from the COVID-19 pandemic and government actions taken in response thereto; and the implementation of our 2020 IRP.

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PART I

ITEM 1. FINANCIAL STATEMENTS

TUCSON ELECTRIC POWER COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(Amounts in thousands)


	Three Months Ended March 31,
		2021		2020
Operating Revenues		$	335,543	$	278,556

Operating Expenses
Fuel		91,158		63,299
Purchased Power		31,377		18,318
Transmission and Other PPFAC Recoverable Costs		13,901		10,595
Decrease to Reflect PPFAC Recovery Treatment		(16,992)		(1,182)
Total Fuel and Purchased Power		119,444		91,030
Operations and Maintenance		111,188		87,455
Depreciation		47,758		46,499
Amortization		10,631		6,956
Taxes Other Than Income Taxes		15,557		14,909
Total Operating Expenses		304,578		246,849

Operating Income		30,965		31,707

Other Income (Expense)
Interest Expense		(21,062)		(20,481)
Allowance For Borrowed Funds		2,702		2,882
Allowance For Equity Funds		7,094		3,034
Unrealized Gains (Losses) on Investments		1,864		(6,427)
Other, Net		2,808		853
Total Other Income (Expense)		(6,594)		(20,139)

Income Before Income Tax Expense		24,371		11,568
Income Tax Expense		1,827		3,650
Net Income		$	22,544	$	7,918

The accompanying notes are an integral part of these financial statements.

TUCSON ELECTRIC POWER COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(Amounts in thousands)


	Three Months Ended March 31,
	2021		2020
Cash Flows from Operating Activities
Net Income	$	22,544	$	7,918
Adjustments to Reconcile Net Income to Net Cash Flows from Operating Activities:
Depreciation Expense	47,758		46,499
Amortization Expense	10,631		6,956

Amortization of Debt Issuance Costs	686		612
Use of Renewable Energy Credits for Compliance	12,217		10,773
Deferred Income Taxes	6,793		10,567

Pension and Other Postretirement Benefits Expense	3,835		3,721
Pension and Other Postretirement Benefits Funding	(1,324)		(1,310)

Allowance for Equity Funds Used During Construction	(7,094)		(3,034)
Regulatory Deferral, ACC Refund Order	—		4,259



Changes in Current Assets and Current Liabilities:
Accounts Receivable	15,155		29,646
Materials, Supplies, and Fuel Inventory	(17,185)		7,028
Regulatory Assets	(21,034)		(6,399)

Other Current Assets	(5,812)		2,079
Accounts Payable and Accrued Charges	19,372		(31,905)

Income Taxes Payable, Net	(4,147)		(7,185)
Regulatory Liabilities	(7,588)		3,338
Other, Net	3,208		7,463
Net Cash Flows—Operating Activities	78,015		91,026
Cash Flows from Investing Activities
Capital Expenditures	(104,381)		(364,012)



Purchase Intangibles, Renewable Energy Credits	(11,408)		(10,625)


Contributions in Aid of Construction	1,449		1,592

Net Cash Flows—Investing Activities	(114,340)		(373,045)
Cash Flows from Financing Activities
Proceeds from Borrowings, Revolving Credit Facility	20,000		105,000
Repayments of Borrowings, Revolving Credit Facility	(20,000)		(20,000)
Proceeds from Borrowings, Term Loan	—		60,000





Payments of Finance Lease Obligations	—		(11,535)

Contribution from Parent	—		150,000
Other, Net	374		599
Net Cash Flows—Financing Activities	374		284,064
Net Increase (Decrease) in Cash, Cash Equivalents, and Restricted Cash	(35,951)		2,045
Cash, Cash Equivalents, and Restricted Cash, Beginning of Period	82,003		28,472
Cash, Cash Equivalents, and Restricted Cash, End of Period	$	46,052	$	30,517

The accompanying notes are an integral part of these financial statements.

TUCSON ELECTRIC POWER COMPANY

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(Amounts in thousands, except share data)


	March 31, 2021		December 31, 2020
ASSETS
Utility Plant
Plant in Service	$	7,142,367	$	7,073,292

Construction Work in Progress	660,042		627,382
Total Utility Plant	7,802,409		7,700,674
Accumulated Depreciation and Amortization	(2,714,230)		(2,645,333)

Total Utility Plant, Net	5,088,179		5,055,341

Investments and Other Property	77,824		76,299

Current Assets
Cash and Cash Equivalents	25,559		60,960
Accounts Receivable (Net of Allowance for Credit Losses of $13,053 and $13,260)	157,948		173,412
Fuel Inventory	27,734		21,946
Materials and Supplies	138,551		126,788
Regulatory Assets	158,751		123,588
Derivative Instruments	17,999		16,094

Other	31,911		23,895
Total Current Assets	558,453		546,683
Regulatory and Other Assets
Regulatory Assets	298,534		318,474
Derivative Instruments	1,013		725
Other	88,254		92,605
Total Regulatory and Other Assets	387,801		411,804
Total Assets	$	6,112,257	$	6,090,127

The accompanying notes are an integral part of these financial statements.

(Continued)

TUCSON ELECTRIC POWER COMPANY

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(Amounts in thousands, except share data)


	March 31, 2021		December 31, 2020
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock Equity:
Common Stock (No Par Value, 75,000,000 Shares Authorized, 32,139,434 Shares Outstanding as of March 31, 2021 and December 31, 2020)	$	1,646,539	$	1,646,539
Capital Stock Expense	(6,357)		(6,357)
Retained Earnings	734,741		712,197
Accumulated Other Comprehensive Loss	(10,723)		(10,942)
Total Common Stock Equity	2,364,200		2,341,437
Preferred Stock (No Par Value, 1,000,000 Shares Authorized, None Outstanding as of March 31, 2021 and December 31, 2020)	—		—

Long-Term Debt, Net	1,814,454		1,814,059
Total Capitalization	4,178,654		4,155,496
Current Liabilities
Current Maturities of Long-Term Debt, Net	249,826		249,752


Accounts Payable	135,575		109,461
Accrued Taxes Other than Income Taxes	65,955		50,278
Accrued Employee Expenses	25,352		35,129
Accrued Interest	17,022		16,337
Regulatory Liabilities	145,322		151,189
Customer Deposits	12,920		16,450
Derivative Instruments	42,231		27,789
Other	26,806		22,031
Total Current Liabilities	721,009		678,416
Regulatory and Other Liabilities
Deferred Income Taxes, Net	498,251		492,919
Regulatory Liabilities	350,987		390,164
Pension and Other Postretirement Benefits	163,626		163,652
Derivative Instruments	29,853		37,958
Other	169,877		171,522
Total Regulatory and Other Liabilities	1,212,594		1,256,215

Commitments and Contingencies

Total Capitalization and Other Liabilities	$	6,112,257	$	6,090,127

The accompanying notes are an integral part of these financial statements.

(Concluded)

TUCSON ELECTRIC POWER COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY (Unaudited)

(Amounts in thousands)



	Common Stock		Capital Stock Expense		Retained Earnings		Accumulated Other Comprehensive Loss		Total Stockholder's Equity
Balances as of December 31, 2019	$	1,396,539	$	(6,357)	$	595,792	$	(7,771)	$	1,978,203
Net Income					7,918				7,918
Other Comprehensive Income, Net of Tax							135		135


Contribution from Parent	150,000								150,000
Balances as of March 31, 2020	$	1,546,539	$	(6,357)	$	603,710	$	(7,636)	$	2,136,256


Balances as of December 31, 2020	$	1,646,539	$	(6,357)	$	712,197	$	(10,942)	$	2,341,437
Net Income					22,544				22,544
Other Comprehensive Income, Net of Tax							219		219



Balances as of March 31, 2021	$	1,646,539	$	(6,357)	$	734,741	$	(10,723)	$	2,364,200

The accompanying notes are an integral part of these financial statements.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. NATURE OF OPERATIONS AND FINANCIAL STATEMENT PRESENTATION

TEP is a regulated utility that generates, transmits, and distributes electricity to approximately 436,000 retail customers in a 1,155 square mile area in southeastern Arizona. TEP also sells electricity to other utilities and power marketing entities, located primarily in the western United States. TEP is a wholly-owned subsidiary of UNS Energy, a utility services holding company. UNS Energy is an indirect wholly-owned subsidiary of Fortis.

BASIS OF PRESENTATION

TEP's Condensed Consolidated Financial Statements and disclosures are presented in accordance with GAAP, including specific accounting guidance for regulated operations and the Securities and Exchange Commission's (SEC) interim reporting requirements.

The Condensed Consolidated Financial Statements include the accounts of TEP and its subsidiaries. In the consolidation process, accounts of the parent and subsidiaries are combined and intercompany balances and transactions are eliminated. TEP jointly owns several generation and transmission facilities with both affiliated and non-affiliated entities. TEP records its proportionate share of: (i) jointly-owned facilities in Utility Plant on the Condensed Consolidated Balance Sheets; and (ii) operating costs associated with these facilities in the Condensed Consolidated Statements of Income. These Condensed Consolidated Financial Statements exclude some information and footnotes required by GAAP and the SEC for annual financial statement reporting and should be read in conjunction with the Consolidated Financial Statements and footnotes in TEP's 2020 Annual Report on Form 10-K.

The Condensed Consolidated Financial Statements are unaudited, but, in management's opinion, include all normal, recurring adjustments necessary for a fair statement of the results for the interim periods presented. Because weather and other factors cause seasonal fluctuations in sales, TEP's quarterly operating results are not indicative of annual operating results. Certain amounts from prior periods have been reclassified to conform to the current period presentation.

Variable Interest Entities

TEP regularly reviews contracts to determine if it has a variable interest in an entity, if that entity is a Variable Interest Entity (VIE), and if TEP is the primary beneficiary of the VIE. The primary beneficiary is required to consolidate the VIE when it has: (i) the power to direct activities that most significantly impact the economic performance of the VIE; and (ii) the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE.

TEP has entered into long-term renewable PPAs with various entities. Some of these entities are VIEs due to the long-term fixed price component in the agreements. These PPAs effectively transfer commodity price risk to TEP, the buyer of the power, creating a variable interest. TEP has determined it is not a primary beneficiary of these VIEs as it lacks the power to direct the activities that most significantly impact the economic performance of the VIEs. TEP reconsiders whether it is a primary beneficiary of the VIEs on a quarterly basis.

As of March 31, 2021, the carrying amounts of assets and liabilities on the balance sheet that relate to variable interests under long-term PPAs are predominantly related to working capital accounts and generally represent the amounts owed by TEP for the deliveries associated with the current billing cycle. TEP's maximum exposure to loss is limited to the cost of replacing the power if the providers do not meet the production guarantee. However, the exposure to loss is mitigated as TEP would likely recover these costs through cost recovery mechanisms. See Note 2 for additional information related to cost recovery mechanisms.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Restricted Cash

Restricted cash includes cash balances restricted with respect to withdrawal or usage based on contractual or regulatory considerations. The following table presents the line items and amounts of cash, cash equivalents, and restricted cash reported on the balance sheet and reconciles their sum to the cash flow statement:


	March 31,
(in millions)	2021		2020
Cash and Cash Equivalents	$	26	$	12
Restricted Cash included in:
Investments and Other Property	18		16
Current Assets—Other	2		3
Total Cash, Cash Equivalents, and Restricted Cash	$	46	$	31

Restricted cash included in Investments and Other Property on the Condensed Consolidated Balance Sheets represents cash contractually required to be set aside to pay TEP's share of mine reclamation costs at San Juan and various contractual agreements. Restricted cash included in Current Assets—Other represents the current portion of TEP's share of San Juan's mine reclamation costs.

Uncertain Tax Position

In February 2021, TEP received approval from the IRS for a change in accounting method on uncertain tax positions, resulting in a $17 million decrease in uncertain tax position obligations on a prospective basis.

Depreciation

Depreciation is recorded for owned utility plant on a group method straight-line basis at depreciation rates based on the economic lives of the assets. The ACC approves depreciation rates for all generation and distribution assets. Transmission assets are subject to the jurisdiction of the FERC. As part of the 2020 Rate Order, the ACC approved new annual depreciation rates based on the 2017 depreciation study available for the major classes of Plant in Service, effective January 1, 2021. To reflect the impact of the revised depreciation rates on estimated cost of removal, TEP transferred $33 million from Regulatory Liabilities to Accumulated Depreciation and Amortization on the Condensed Consolidated Balance Sheets as of March 31, 2021.

NEW ACCOUNTING STANDARDS ISSUED AND NOT YET ADOPTED

New authoritative accounting guidance issued by the Financial Accounting Standards Board was assessed and either determined to not be applicable or is expected to have an insignificant impact on TEP’s financial position, results of operations, cash flows, and disclosures.

NOTE 2. REGULATORY MATTERS

The ACC and the FERC each regulate portions of the utility accounting practices and rates of TEP. The ACC regulates rates charged to retail customers, the siting of generation and transmission facilities, the issuance of securities, transactions with affiliated parties, and other utility matters. The ACC also enacts other regulations and policies that can affect TEP's business decisions and accounting practices. The FERC regulates rates and services for electric transmission and wholesale power sales in interstate commerce.

RATE CASE MATTERS

2020 Rate Order

In December 2020, the ACC issued a rate order for new rates that took effect January 1, 2021.

Provisions of the 2020 Rate Order include, but are not limited to:

•a non-fuel retail revenue increase of $58 million over test year retail revenues;

•a 7.04% return on original cost rate base of $2.7 billion, which includes a cost of equity of 9.15% and an average cost of debt of 4.65%; and

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

•a capital structure for rate making purposes of approximately 53% common equity and 47% long-term debt.

In addition, the 2020 Rate Order established a second phase of TEP’s rate case to address the impact on certain communities due to the closures of fossil-based generation facilities (Phase 2). In January 2021, the ACC staff opened a generic docket related to this matter and will consider additional evidence or recommendations in Phase 2. TEP cannot predict the timing or outcome of these proceedings.

2019 FERC Rate Case

In 2019, the FERC issued an order approving TEP's proposed OATT revisions effective August 1, 2019, subject to refund and further proceedings.

Provisions of the order include, but are not limited to:

•replacing TEP's stated transmission rates with a forward-looking formula rate;

•a 10.4% return on equity; and

•elimination of transmission rates that are bifurcated between high-voltage and lower-voltage facilities, as well as elimination of the bifurcated loss factor.

The requested forward-looking formula rate is intended to allow for a more timely recovery of transmission-related costs. As part of the order, the FERC established hearing and settlement procedures. In February 2021, a Presiding Judge was appointed to continue the formula rate case proceeding after the settlement procedures resulted in an impasse. All rates charged under the revised OATT pursuant to the FERC order are subject to refund until the proceeding concludes. TEP had reserved $18 million as of March 31, 2021, and $15 million as of December 31, 2020, of wholesale revenues in Current Liabilities—Regulatory Liabilities on the Condensed Consolidated Balance Sheets. TEP cannot predict the outcome of the proceeding.

OTHER FERC MATTERS

In January 2021, the FERC notified TEP that it is commencing an audit that is intended to evaluate TEP's compliance with: (i) the accounting requirements of the Uniform System of Accounts; and (ii) the reporting requirements of the FERC Form 1 Annual Report and Supplemental Form 3-Q Quarterly Financial Reports. The audit will cover the period of January 1, 2018 to the present. TEP cannot predict the outcome or findings, if any, of the FERC audit at this time.

COST RECOVERY MECHANISMS

TEP has received regulatory decisions that allow for more timely recovery of certain costs through recovery mechanisms. Cost recovery mechanisms that have a material impact on TEP's operations or financial results are described below.

Purchased Power and Fuel Adjustment Clause

TEP's PPFAC rate is typically adjusted annually on April 1st and goes into effect for the subsequent 12-month period unless the schedule is modified by the ACC. The PPFAC rate includes: (i) a forward component which is calculated by taking the difference between forecasted fuel and purchased power costs and the amount of those costs established in Retail Rates; and (ii) a true-up component that reconciles the difference between actual costs and those recovered in the preceding 12-month period.

The table below summarizes the PPFAC regulatory asset (liability) balance:


	Three Months Ended March 31,
(in millions)		2021		2020
Beginning of Period		$	23	$	36
Deferred Fuel and Purchased Power Costs (1)		67		48
PPFAC and Base Power Recoveries (2)		(50)		(48)
End of Period		$	40	$	36

(1)Includes costs eligible for recovery through the PPFAC and base power rates.

(2)In March 2021, the ACC approved a PPFAC surcharge as part of TEP's annual rate adjustment request, which will go into effect on June 1, 2021.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Tax Expense Adjustor Mechanism

The TEAM allows for the timely recovery of future significant income tax changes. The TEAM provides the Company the ability to pass through: (i) the TCJA Regulatory Deferral balance to the initial 2021 TEAM rate; (ii) the change in EDIT compared to the test year; and (iii) the income tax effects of tax legislation that materially impacts TEP's 2018 test year revenue requirements. The TEAM went into effect January 1, 2021, as approved in the 2020 Rate Order. TEP had recorded a regulatory liability balance related to the TEAM of $19 million as of March 31, 2021, and $29 million as of December 31, 2020, in Current Liabilities—Regulatory Liabilities on the Condensed Consolidated Balance Sheets.

Federal Tax Legislation

In 2018, the ACC approved TEP’s proposal to return savings from TEP’s federal corporate income tax rate under the TCJA to its customers through a combination of customer bill credits and a regulatory liability deferral that reflected the return of a portion of the savings. TEP recognized a reduction in Operating Revenues on the Condensed Consolidated Statements of Income of $7 million in the three months ended March 31, 2020 related to the ACC approved refunds. As part of the 2020 Rate Order, the balances in the regulatory liability deferral and TCJA balancing account were moved to the TEAM regulatory account in December 2020.

Renewable Energy Standard

The ACC’s RES requires Arizona-regulated utilities to supply an increasing percentage of their retail sales from renewable generation sources each year. The renewable energy requirement in 2021 is 11% of retail electric sales, which will increase annually until renewable retail sales represent at least 15% by 2025. The RES also requires that DG account for 30% of the renewable energy requirement. Arizona utilities are required to file annual RES implementation plans for review and approval by the ACC.

In 2019, the ACC approved TEP's 2019 RES implementation plan with a budget amount of $55 million. The recovery funds: (i) above market cost of renewable power purchases; (ii) previously awarded incentives for customer-installed DG; and (iii) various other program costs.

Energy Efficiency Standards

TEP is required to implement cost-effective DSM programs to comply with the ACC’s EE Standards. The EE Standards provide regulated utilities a DSM surcharge to recover from retail customers the costs to implement DSM programs, as well as an annual performance incentive. TEP records its annual DSM performance incentive for the prior calendar year in the first quarter of each year. TEP recorded $2 million in both 2021 and 2020 related to performance in Operating Revenues on the Condensed Consolidated Statements of Income.

In 2019, the ACC approved TEP’s 2018 energy efficiency implementation plan with a budget of approximately $23 million, which is collected through the DSM surcharge, and approved a waiver of the 2018 EE Standard. In addition, the ACC ordered that TEP's 2018 energy efficiency implementation plan be considered as its 2019 and 2020 energy efficiency implementation plans. In June 2020, TEP filed its 2021 energy efficiency implementation plan with a budget of approximately $23 million. TEP plans to file a new energy efficiency implementation plan by the end of 2021.

Lost Fixed Cost Recovery Mechanism

The LFCR mechanism provides for recovery of certain non-fuel costs that would go unrecovered between rate cases due to reduced retail kWh sales as a result of implementing ACC-approved energy efficiency programs and customer-installed DG. The LFCR mechanism is adjusted in each rate case when the ACC approves new base rates. TEP records a regulatory asset and recognizes LFCR revenues when amounts are verifiable regardless of when the lost retail kWh sales occurred. TEP is required to make an annual filing with the ACC requesting recovery of LFCR revenues recognized in the prior year. The recovery is subject to a year-over-year increase cap of 2% of TEP's applicable retail revenues.

The table below summarizes the LFCR revenues recognized in Operating Revenues on the Condensed Consolidated Statements of Income:


	Three Months Ended March 31,
(in millions)		2021		2020
LFCR Revenues		$	6	$	12

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

REGULATORY ASSETS AND LIABILITIES

Regulatory assets and liabilities recorded in the balance sheet are summarized in the table below:


($ in millions)	Remaining Recovery Period (years)	March 31, 2021		December 31, 2020
Regulatory Assets
Pension and Other Postretirement Benefits	Various	$	164	$	166
Derivatives (Note 9)	9	61		55
Lost Fixed Cost Recovery	2	57		59
Early Generation Retirement Costs	Various	41		43
Under Recovered Purchased Energy Costs	1	40		23
Income Taxes Recoverable through Future Rates (1)	Various	26		27
Property Tax Deferrals (2)	1	26		26
Final Mine Reclamation and Retiree Healthcare Costs (3)	8	20		20
Springerville Unit 1 Leasehold Improvements (4)	2	6		7
Other Regulatory Assets	Various	17		16
Total Regulatory Assets		458		442
Less Current Portion	1	159		124
Total Non-Current Regulatory Assets		$	299	$	318


Regulatory Liabilities
Income Taxes Payable through Future Rates (1)	Various	$	295	$	298
Net Cost of Removal (5)	Various	88		125
Renewable Energy Standard	Various	62		63
Tax Reform Bill Credit	Various	19		29
Transmission Revenue Subject to Refund—FERC	Various	18		15


Other Regulatory Liabilities	Various	14		11
Total Regulatory Liabilities		496		541
Less Current Portion	1	145		151
Total Non-Current Regulatory Liabilities		$	351	$	390

(1)Amortized over five years, 10 years, or the lives of the assets.

(2)Recorded as a regulatory asset based on historical ratemaking treatment allowing regulated utilities recovery of property taxes on a pay-as-you-go or cash basis. TEP records a liability to reflect the accrual for financial reporting purposes and an offsetting regulatory asset to reflect recovery for regulatory purposes. This asset is fully recovered in rates with a recovery period of approximately six months.

(3)Represents costs associated with TEP’s jointly-owned facilities at San Juan and Four Corners. TEP recognizes these costs at future value and is permitted to fully recover these costs on a pay-as-you-go basis through the PPFAC mechanism. The majority of final mine reclamation costs are expected to be funded by TEP through 2028.

(4)Represents investments TEP made, which were previously recorded in Plant in Service on the Condensed Consolidated Balance Sheets, to ensure that the facilities continued to provide safe, reliable service to TEP's customers. TEP received ACC authorization to recover leasehold improvement costs at Springerville Unit 1 over a 10-year period.

(5)Represents an estimate of the future cost of retirement, net of salvage value. These are amounts collected through revenue for transmission, distribution, generation, and general and intangible plant which are not yet expended. As a result of the 2020 Rate Order, TEP transferred costs from Net Cost of Removal to Accumulated Depreciation and Amortization. See Note 1 for additional information related to new depreciation rates approved as part of the 2020 Rate Order.

Regulatory assets are either being collected or are expected to be collected through Retail Rates. With the exception of Early Generation Retirement Costs, Income Taxes Recoverable through Future Rates, and Springerville Unit 1 Leasehold Improvements, TEP does not earn a return on regulatory assets. Regulatory liabilities represent items that TEP either expects to

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pay to customers through billing reductions in future periods or plans to use for the purpose for which they were collected from customers. TEP pays a return on the majority of its regulatory liability balances.

NOTE 3. REVENUE

DISAGGREGATION OF REVENUES

TEP earns the majority of its revenues from the sale of power to retail and wholesale customers based on regulator-approved tariff rates. The following table presents the disaggregation of TEP’s Operating Revenues on the Condensed Consolidated Statements of Income by type of service:


	Three Months Ended March 31,
(in millions)		2021		2020
Retail (1)		$	215	$	192
Wholesale (2)		56		36
Other Services		36		24
Revenues from Contracts with Customers		307		252
Alternative Revenues		8		14
Other		21		13
Total Operating Revenues		$	336	$	279

(1)In 2020, the ACC issued a rate order for new rates that took effect January 1, 2021. See Note 2 for more information regarding the 2020 Rate Order.

(2)In 2019, the FERC issued an order approving TEP's proposed OATT revisions effective August 1, 2019, subject to refund and further proceedings. TEP recognizes a provision for revenues subject to refund for the estimate of revenues that are probable for refund. See Note 2 for more information regarding the 2019 FERC Rate Case.

NOTE 4. ACCOUNTS RECEIVABLE

The following table presents the components of Accounts Receivable on the Condensed Consolidated Balance Sheets:


(in millions)	March 31, 2021		December 31, 2020
Retail	$	73	$	90
Retail, Unbilled	35		41
Retail, Allowance for Credit Losses	(13)		(13)
Wholesale (1)	29		33
Due from Affiliates (Note 5)	12		9
Other	22		13
Accounts Receivable	$	158	$	173

(1)Includes $8 million as of March 31, 2021, and $7 million as of December 31, 2020, of receivables related to revenue from derivative instruments.

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ALLOWANCE FOR CREDIT LOSSES

TEP separately evaluates retail, wholesale, and other accounts receivable for credit losses and has not recorded an allowance for credit losses for non-retail accounts receivable. The allowance is estimated based on historical collection patterns, sales, current conditions, and reasonable and supportable forecasts. The following table presents the change in the balance of Retail, Allowance for Credit Losses included in Accounts Receivable on the Condensed Consolidated Balance Sheets:


	Three Months Ended March 31,
(in millions)	2021		2020
Beginning of Period	$	(13)	$	(6)
Credit Loss Expense	(1)		(1)
Write-offs	1		1

End of Period	$	(13)	$	(6)

Service Disconnection Moratoriums

In 2019, the ACC enacted emergency rules that suspended service disconnections and late fees for electric residential customers who would have otherwise been eligible for service disconnection during the period from June 1 through October 15 (Summer Moratorium). The Summer Moratorium remained in effect for 2020 and will remain in effect each year until the ACC permanently adopts new rules regarding electric service disconnections. In addition, TEP voluntarily suspended service disconnections and late fees from March 2020 through January 2021 for all customers who would have otherwise been disconnected.

In December 2020, the ACC enacted a bill credit and payment program for residential customers who are behind on their electric bills as a result of the COVID-19 pandemic. For qualifying customers, the program included: (i) an upfront bill credit applied to their December 2020 bill; and (ii) automatic enrollment into an eight-month payment plan. TEP also voluntarily created payment arrangements for commercial customers.

TEP will continue to monitor collection activity and adjust its allowance for credit losses as needed.

NOTE 5. RELATED PARTY TRANSACTIONS

TEP engages in various transactions with Fortis, UNS Energy, and UNS Energy Affiliates. These transactions include: (i) the sale and purchase of power and transmission services; (ii) common cost allocations; and (iii) the provision of corporate and other labor-related services. Effective January 1, 2021, TEP hired SES' employees and will no longer utilize SES' services.

The following table presents the components of related party balances included in Accounts Receivable and Accounts Payable on the Condensed Consolidated Balance Sheets:


(in millions)	March 31, 2021		December 31, 2020
Receivables from Related Parties
UNS Electric	$	6	$	6
UNS Energy	5		2
UNS Gas	1		1








Total Due from Related Parties	$	12	$	9

Payables to Related Parties
UNS Energy	$	3	$	1
UNS Electric	1		—
SES	—		4




Total Due to Related Parties	$	4	$	5

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The following table presents the components of related party transactions included in the Condensed Consolidated Statements of Income:


	Three Months Ended March 31,
(in millions)	2021		2020
Goods and Services Provided by TEP to Affiliates
Transmission Revenues, UNS Electric (1)	$	3	$	2
Wholesale Revenues, UNS Electric (1)	1		—
Control Area Services, UNS Electric (2)	2		1
Common Costs, UNS Energy Affiliates (3)	5		5


Goods and Services Provided by Affiliates to TEP

Supplemental Workforce, SES (4)	—		4
Corporate Services, UNS Energy (5)	2		1
Corporate Services, UNS Energy Affiliates (6)	1		1

(1)TEP and UNS Electric sell power and transmission services to each other. Wholesale power is sold at prevailing market prices while transmission services are sold at FERC-approved rates through the applicable OATT.

(2)TEP charges UNS Electric for control area services under a FERC-approved Control Area Services Agreement.

(3)Common costs (information systems, facilities, etc.) are allocated on a cost-causative basis and recorded as revenue by TEP. The method of allocation is deemed reasonable by management and is reviewed by the ACC as part of the rate case process.

(4)SES provided supplemental workforce and meter-reading services to TEP based on related party service agreements. The charges were based on cost of services performed and deemed reasonable by management.

(5)Costs for corporate services at UNS Energy are allocated to its subsidiaries using the Massachusetts Formula, an industry-accepted method of allocating common costs to affiliated entities. TEP's allocation is approximately 85% of UNS Energy's allocated costs. Corporate Services, UNS Energy includes legal, audit, and Fortis' management fees. TEP's share of Fortis' management fees was $2 million for the three months ended March 31, 2021 and 2020.

(6)Costs for corporate services (e.g., finance, accounting, tax, legal, and information technology) and other labor services for UNS Energy Affiliates are directly assigned to the benefiting entity at a fully burdened cost when possible.

CONTRIBUTION FROM PARENT

On April 29, 2021, TEP received an equity contribution of $50 million from UNS Energy.

NOTE 6. DEBT AND CREDIT AGREEMENTS

There have been no significant changes to TEP's debt or credit agreements from those reported in its 2020 Annual Report on Form 10-K, except as noted below.

CREDIT AGREEMENTS

Amounts borrowed under the credit agreements are recorded in Borrowings Under Credit Agreements on the Consolidated Balance Sheets.

2015 Credit Agreement

In January 2020, $12 million in LOCs with fees accruing at a rate of 1.00% per annum were issued pursuant to TEP taking ownership of Oso Grande under the BTA. As of May 4, 2021, there was $223 million available under the 2015 Credit Agreement revolving credit commitment and LOC facility.

2019 Credit Agreement

In December 2019, TEP entered into an unsecured credit agreement with a maturity date of December 2020 that provided for $225 million in term loans (2019 Credit Agreement), of which $165 million was borrowed as of December 2019. In March 2020, TEP borrowed the remaining available balance of $60 million. Amounts borrowed were used (i) to complete the purchase

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

of Gila River Unit 2 Generating Station; (ii) to make payments for the construction of the Oso Grande project; and (iii) for other general corporate purposes. In April 2020, net proceeds from the sale of senior unsecured notes were used to repay the outstanding term loans and the agreement was terminated.

NOTE 7. COMMITMENTS AND CONTINGENCIES

COMMITMENTS

There have been no significant changes to TEP's long-term commitments from those reported in its 2020 Annual Report on Form 10-K.

CONTINGENCIES

Legal Matters

TEP is party to a variety of legal actions arising out of the normal course of business. Plaintiffs occasionally seek punitive or exemplary damages. TEP believes such normal and routine litigation will not have a material impact on its operations or consolidated financial results.

Mine Reclamation at Generation Facilities Not Operated by TEP

TEP pays ongoing mine reclamation costs related to coal mines that supply generation facilities in which TEP has an ownership interest but does not operate. Amounts recorded for final mine reclamation are subject to various assumptions, such as estimations of reclamation costs, timing of when final reclamation will occur, and the expected inflation rate. As these assumptions change, TEP prospectively adjusts the expense amounts for final reclamation over the remaining coal supply agreements’ terms. TEP’s PPFAC allows the Company to pass through final mine reclamation costs, as a component of fuel costs, to retail customers. Therefore, TEP defers these expenses until recovered from customers by increasing the regulatory asset and the reclamation liability over the remaining life of the coal supply agreements and recovers the regulatory asset through the PPFAC as final mine reclamation costs are paid.

TEP is liable for a portion of final mine reclamation costs upon closure of the mines servicing San Juan and Four Corners. TEP’s estimated share of final mine reclamation costs at both mines is $47 million upon expiration of the related coal supply agreements, which expire in 2022 and 2031, respectively. An aggregate liability balance related to San Juan and Four Corners final mine reclamation of $40 million as of March 31, 2021 and December 31, 2020, was recorded in Other on the Condensed Consolidated Balance Sheets. See Note 2 for additional information related to final mine reclamation costs.

Performance Guarantees

TEP has joint generation participation agreements with participants at San Juan, Four Corners, and Luna Generating Station, which expire in 2022, 2041, and 2046, respectively. The Navajo participation agreement expired in 2019, but certain performance obligations continue through the decommissioning of the generation facility. The participants in each of the generation facilities, including TEP, have guaranteed certain performance obligations. Specifically, in the event of payment default, each non-defaulting participant has agreed to bear its proportionate share of expenses otherwise payable by the defaulting participant. In exchange, the non-defaulting participants are entitled to receive their proportionate share of the generation capacity of the defaulting participant. Relative to Navajo performance obligations, in the case of a default, the non-defaulting participants would seek financial recovery directly from the defaulting party. With the exception of Four Corners, there is no maximum potential amount of future payments TEP could be required to make under the guarantees. The maximum potential amount of future payments on the non-defaulting parties is $250 million at Four Corners. As of March 31, 2021, there have been no such payment defaults under any of the participation agreements.

Environmental Matters

TEP is subject to federal, state, and local environmental laws and regulations regarding air and water quality, renewable portfolio standards, emissions performance standards, climate change, coal combustion byproduct disposal, hazardous and solid waste disposal, protected species, and other environmental matters that have the potential to impact TEP's current and future operations. Environmental laws and regulations are subject to a range of interpretations, which may ultimately be resolved by the courts. Because these laws and regulations continue to evolve, TEP is unable to predict the impact of the changing laws and regulations on its operations and consolidated financial results. TEP expects to recover the cost of environmental compliance from its customers. TEP believes it is in compliance with applicable environmental laws and regulations in all material respects.

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Broadway-Pantano Site

The Water Quality Assurance Revolving Fund (WQARF) imposes liability on parties responsible for, in whole or in part, the presence of hazardous substances at a site. Those who released, generated, or disposed of hazardous substances at a contaminated site, or transported to or owned such contaminated site, are among the Potentially Responsible Parties (PRP). PRPs may be strictly liable for clean-up. The ADEQ is administering a remediation plan to delineate and then apportion costs among anticipated adverse parties in the Broadway-Pantano WQARF site, a hazardous waste site in Tucson, Arizona, which includes the Broadway North and South Landfills. Collectively, these landfills were in operation from 1953 and 1973. TEP's Eastloop Substation and a portion of a related transmission line are located on two parcels adjacent to these landfills. In November 2019, the ADEQ notified TEP that it considers TEP to be a PRP with respect to the Broadway-Pantano WQARF site. TEP does not expect this matter to have a material impact on its financial statements; however, the overall investigation and remediation plan have not been finalized.

NOTE 8. EMPLOYEE BENEFIT PLANS

Net periodic benefit cost includes the following components:


	Pension Benefits				Other Postretirement Benefits
	Three Months Ended March 31,
(in millions)	2021		2020		2021		2020
Service Cost	$	5	$	4	$	2	$	1
Non-Service Cost (1)
Interest Cost	3		4		—		—
Expected Return on Plan Assets	(8)		(7)		—		—
Amortization of Net Loss	2		2		—		—
Net Periodic Benefit Cost	$	2	$	3	$	2	$	1

(1)The non-service components of net periodic benefit cost are included in Other, Net on the Condensed Consolidated Statements of Income.

NOTE 9. FAIR VALUE MEASUREMENTS AND DERIVATIVE INSTRUMENTS

TEP categorizes financial instruments into the three-level hierarchy based on inputs used to determine the fair value. Level 1 inputs are unadjusted quoted prices for identical assets or liabilities in an active market. Level 2 inputs include quoted prices for similar assets or liabilities, quoted prices in non-active markets, and pricing models whose inputs are observable, directly or indirectly. Level 3 inputs are unobservable and supported by little or no market activity. TEP has no financial instruments categorized as Level 3.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

FINANCIAL INSTRUMENTS MEASURED AT FAIR VALUE ON A RECURRING BASIS

The following tables present, by level within the fair value hierarchy, TEP’s assets and liabilities accounted for at fair value through net income on a recurring basis classified in their entirety based on the lowest level of input that is significant to the fair value measurement:


	Level 1		Level 2		Total
(in millions)	March 31, 2021
Assets

Restricted Cash (1)	$	20	$	—	$	20
Energy Derivative Contracts, Regulatory Recovery (2)	—		17		17
Energy Derivative Contracts, No Regulatory Recovery (2)	—		2		2
Total Assets	20		19		39
Liabilities
Energy Derivative Contracts, Regulatory Recovery (2)	—		(72)		(72)

Total Liabilities	—		(72)		(72)
Total Assets (Liabilities), Net	$	20	$	(53)	$	(33)


(in millions)	December 31, 2020
Assets

Restricted Cash (1)	$	21	$	—	$	21
Energy Derivative Contracts, Regulatory Recovery (2)	—		14		14
Energy Derivative Contracts, No Regulatory Recovery (2)	—		3		3
Total Assets	21		17		38
Liabilities
Energy Derivative Contracts, Regulatory Recovery (2)	—		(66)		(66)


Total Liabilities	—		(66)		(66)
Total Assets (Liabilities), Net	$	21	$	(49)	$	(28)

(1)Restricted Cash represents amounts held in money market funds, which approximates fair market value. Restricted Cash is included in Investments and Other Property and in Current Assets—Other on the Condensed Consolidated Balance Sheets.

(2)Energy Derivative Contracts include gas swap agreements and forward power purchase and sale contracts entered into to reduce exposure to energy price risk. These contracts are included in Derivative Instruments on the Condensed Consolidated Balance Sheets.

All energy derivative contracts are subject to legally enforceable master netting arrangements to mitigate credit risk. TEP presents derivatives on a gross basis on the balance sheet. The tables below present the potential offset of counterparty netting and cash collateral:


	Gross Amount Recognized in the Balance Sheets		Gross Amount Not Offset in the Balance Sheets				Net Amount
			Counterparty Netting of Energy Contracts		Cash Collateral Received/Posted
(in millions)	March 31, 2021
Derivative Assets
Energy Derivative Contracts	$	19	$	17	$	—	$	2
Derivative Liabilities
Energy Derivative Contracts	(72)		(17)		(14)		(41)


(in millions)	December 31, 2020
Derivative Assets
Energy Derivative Contracts	$	17	$	14	$	—	$	3
Derivative Liabilities
Energy Derivative Contracts	(66)		(14)		(7)		(45)

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

DERIVATIVE INSTRUMENTS

TEP enters into various derivative and non-derivative contracts to reduce exposure to energy price risk associated with its natural gas and purchased power requirements. The objectives for entering into such contracts include: (i) creating price stability; (ii) meeting load and reserve requirements; and (iii) reducing exposure to price volatility that may result from delayed recovery under the PPFAC mechanism. In addition, TEP enters into derivative and non-derivative contracts to optimize the system's generation resources by selling power in the wholesale market for the benefit of TEP's retail customers.

TEP primarily applies the market approach for recurring fair value measurements. When TEP has observable inputs for substantially the full term of the asset or liability or uses quoted prices in an inactive market, it categorizes the instrument in Level 2. TEP categorizes derivatives in Level 3 when an aggregate pricing service or published prices that represent a consensus reporting of multiple brokers is used.

For both purchased power and natural gas prices, TEP obtains quotes from brokers, major market participants, exchanges, or industry publications and relies on its own price experience from active transactions in the market. TEP primarily uses one set of quotations each for purchased power and natural gas and then validates those prices using other sources. TEP believes that the market information provided is reflective of market conditions as of the time and date indicated.

Published prices for energy derivative contracts may not be available due to the nature of contract delivery terms such as non-standard time blocks and non-standard delivery points. In these cases, TEP applies adjustments based on historical price curve relationships, transmission costs, and line losses.

TEP also considers the impact of counterparty credit risk using current and historical default and recovery rates, as well as its own credit risk using credit default swap data.

The inputs and the Company's assessments of the significance of a particular input to the fair value measurements require judgment and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels. TEP reviews the assumptions underlying its price curves monthly.

Energy Derivative Contracts, Regulatory Recovery

TEP enters into energy contracts that are considered derivatives and qualify for regulatory recovery. The realized gains and losses on these energy contracts are recovered through the PPFAC mechanism and the unrealized gains and losses are deferred as a regulatory asset or a regulatory liability. The table below presents the unrealized gains and losses recorded to a regulatory asset or a regulatory liability on the balance sheet:


	Three Months Ended March 31,
(in millions)		2021		2020
Unrealized Net Gain (Loss)		$	(4)	$	9

Energy Derivative Contracts, No Regulatory Recovery

TEP enters into certain energy contracts that are considered derivatives but do not qualify for regulatory recovery. The Company records unrealized gains and losses for these contracts in the income statement unless a normal purchase or normal sale election is made. For contracts that meet the trading definition, as defined in the PPFAC plan of administration, TEP must share 10% of any realized gains with retail customers through the PPFAC mechanism. The table below presents amounts recorded in Operating Revenues on the Condensed Consolidated Statements of Income:


	Three Months Ended March 31,
(in millions)		2021		2020
Operating Revenues		$	1	$	—

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Derivative Volumes

As of March 31, 2021, TEP had energy contracts that will settle on various expiration dates through 2029. The following table presents volumes associated with the energy contracts:


	March 31, 2021	December 31, 2020
Power Contracts GWh	3,650	4,143
Gas Contracts BBtu	125,830	111,585

CREDIT RISK

The use of contractual arrangements to manage the risks associated with changes in energy commodity prices creates credit risk exposure resulting from the possibility of non-performance by counterparties pursuant to the terms of their contractual obligations. TEP enters into contracts for the physical delivery of power and natural gas which contain remedies in the event of non-performance by the supply counterparties. In addition, volatile energy prices can create significant credit exposure from energy market receivables and subsequent measurements at fair value.

TEP has contractual agreements for energy procurement and hedging activities that contain provisions requiring TEP and its counterparties to post collateral under certain circumstances. These circumstances include: (i) exposures in excess of unsecured credit limits due to the volume of trading activity; (ii) changes in natural gas or power prices; (iii) credit rating downgrades; or (iv) unfavorable changes in parties' assessments of each other's credit strength. In the event that such credit events were to occur, TEP, or its counterparties, would have to provide certain credit enhancements in the form of cash, LOCs, or other acceptable security to collateralize exposure beyond the allowed amounts.

TEP considers the effect of counterparty credit risk in determining the fair value of derivative instruments that are in a net asset position, after incorporating collateral posted by counterparties, and then allocates the credit risk adjustment to individual contracts. TEP also considers the impact of its credit risk on instruments that are in a net liability position, after considering the collateral posted, and then allocates the credit risk adjustment to the individual contracts.

The value of all derivative instruments in net liability positions under contracts with credit risk-related contingent features, including contracts under the normal purchase normal sale exception, was $63 million as of March 31, 2021, compared with $60 million as of December 31, 2020. As of March 31, 2021, TEP had $14 million of cash posted as collateral to provide credit enhancement which was reflected in Current Assets—Other on the Condensed Consolidated Balance Sheets. As of May 4, 2021, there was $19 million of cash posted as collateral to provide credit enhancement. If the credit risk contingent features were triggered on March 31, 2021, TEP would have been required to post an additional $49 million of collateral of which $12 million relates to outstanding net payable balances for settled positions.

FINANCIAL INSTRUMENTS NOT CARRIED AT FAIR VALUE

The fair value of a financial instrument is the market price to sell an asset or transfer a liability at the measurement date. Due to the short-term nature of borrowings under revolving credit facilities approximating fair value, they have been excluded from the table below.

The use of different estimation methods and/or market assumptions may yield different estimated fair value amounts. The following table includes the net carrying value and estimated fair value of TEP's long-term debt:


	Fair Value Hierarchy	Net Carrying Value				Fair Value
(in millions)		March 31, 2021		December 31, 2020		March 31, 2021		December 31, 2020
Liabilities
Long-Term Debt, including Current Maturities	Level 2	$	2,064	$	2,064	$	2,217	$	2,363

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NOTE 10. SUPPLEMENTAL CASH FLOW INFORMATION

NON-CASH TRANSACTIONS

Other significant non-cash investing and financing activities that resulted in recognition of assets and liabilities but did not result in cash receipts or payments were as follows:


	Three Months Ended March 31,
(in millions)	2021		2020
Accrued Capital Expenditures	$	40	$	32
Renewable Energy Credits	5		4

Net Cost of Removal Increase (Decrease) (1)	(34)		(3)

(1)Represents an accrual for future cost of retirement net of salvage values that does not impact earnings. See Note 1 for additional information related to new depreciation rates approved as part of the 2020 Rate Order.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s Discussion and Analysis explains the results of operations, the financial condition, and the outlook for TEP. It includes the following:

•outlook and strategies;

•factors affecting results of operations;

•results of operations;

•liquidity and capital resources, including capital expenditures and environmental matters;

•critical accounting policies and estimates; and

•new accounting standards issued and not yet adopted.

Management’s Discussion and Analysis includes financial information prepared in accordance with GAAP.

Management’s Discussion and Analysis should be read in conjunction with the financial statements and accompanying notes that appear in Part I, Item 1 of this Form 10-Q. For information on factors that may cause our actual future results to differ from those we currently anticipate, see Forward-Looking Information at the front of this report and Risk Factors in Part 1, Item 1A of our 2020 Annual Report on Form 10-K, and in Part II, Item 1A of this Form 10-Q.

References in this discussion and analysis to "we" and "our" are to TEP.

OUTLOOK AND STRATEGIES

TEP's financial performance and outlook are affected by many factors, including: (i) global, national, regional, and local economic conditions; (ii) volatility in the financial markets; (iii) environmental laws and regulations; and (iv) other regulatory and legislative actions. Our plans and strategies include:

•Achieving constructive outcomes in our regulatory proceedings that will provide us: (i) recovery of our full cost of service and an opportunity to earn an appropriate return on our rate base investments; (ii) updated rates that provide more accurate price signals and a more equitable allocation of costs to our customers; and (iii) the ability to continue providing safe, affordable, and reliable service.

•Continuing our transition from carbon-intensive sources to a more sustainable energy portfolio, while providing reliability and rate stability for our customers, mitigating environmental impacts, complying with regulatory requirements, leveraging and improving our existing utility infrastructure, and maintaining financial strength. In 2020, we announced our long-term goal to reduce carbon emissions by exiting coal-fired generation over the next 11 years and increasing renewable energy resources and energy storage. These goals may be impacted by various federal and state energy policies, including policies currently under consideration.

•Focusing on our core utility business through operational excellence, promoting economic development in our service territory, investing in infrastructure to ensure reliable service, and maintaining a strong community presence.

CURRENT ECONOMIC CONDITIONS—COVID-19

The COVID-19 pandemic caused changes in consumer and business behavior and disrupted economic activity in TEP’s service territory. We activated our business continuity plans and we continue to reevaluate and reassess protocols and plans as pandemic conditions evolve. Our protocols and plans are intended to support the continued delivery of safe and reliable service to our customers and the communities we serve.

Recognizing the potential effect that the COVID-19 pandemic had on many customers’ ability to pay their bills and the need for continued utility service, we voluntarily suspended service disconnections and late fees for non-payment of bills through January 2021.

The COVID-19 pandemic remains a continuously evolving situation. We cannot predict the duration of the pandemic or the ultimate effects of it on the economy and our service territory. We continue to monitor developments affecting our workforce, customers, suppliers, and operations. We have not experienced a material impact to our results of operations as a result of the COVID-19 pandemic.

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Performance - The first three months of 2021 compared with the first three months of 2020

TEP reported net income of $23 million in the first three months of 2021 compared with net income of $8 million in the first three months of 2020. The increase of $15 million, or 188%, was primarily due to:

•$17 million in higher retail revenue primarily due to an increase in rates as approved in the 2020 Rate Order;

•$8 million increase in the value of investments used to support certain post-employment benefits as a result of favorable market conditions;

•$3 million in higher AFUDC as a result of a change in the AFUDC rate;

•$3 million in higher transmission revenue due to an increase in volume; and

•$3 million in lower income tax expense primarily due to an increase in tax credits and a decrease in EDIT amortization.

The increase was partially offset by:

•$10 million in higher operations and maintenance expenses due to an increase in planned generation outages in 2021 and an increase in employee benefits expense;

•$6 million in lower LFCR revenues as a result of a rate adjustment as approved in the 2020 Rate Order; and

•$5 million in higher depreciation and amortization expense due to an increase in asset base and an increase in depreciation rates and amortization as a result of the 2020 Rate Order.

FACTORS AFFECTING RESULTS OF OPERATIONS

Several factors affect our current and future results of operations. The most significant factors are related to the potential economic impacts of the COVID-19 pandemic, regulatory matters, generation resource shift, and weather patterns.

COVID-19 Pandemic Impacts

The extent of the impact of the COVID-19 pandemic on our operational and financial performance depends on certain developments, including: (i) the duration of the declared health emergencies; (ii) actions by governmental authorities and regulators; (iii) impacts on our customers, employees, and vendors; and (iv) actions by us to assist our customers through this crisis. These developments are continuously evolving and are challenging to predict. Areas currently impacted, and areas we expect to continue to be impacted, that may have an effect on our results of operations, cash flows, and earnings are noted below.

Retail Sales

The COVID-19 pandemic changed consumer and business behavior as a result of safety measures taken to combat the spread. Energy usage by our commercial and industrial customers has decreased below average levels experienced in prior periods. This decrease is expected to last for the duration of the pandemic response and may continue beyond as a result of sustained economic impacts in our service territory. However, energy usage by our residential customers has increased due to stay at home orders and widespread adoption of work from home practices. We expect the increase to last for the duration of the pandemic response and possibly beyond as companies rethink their work from home practices. We have not experienced a significant impact to total retail sales as a result of the COVID-19 pandemic.

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Lower retail sales occur during the first quarter of the year, due to mild weather in our retail service territory. Electricity sold to retail customers by class of customer in the first three months of the last three years were as follows:


	Three Months Ended March 31,
(sales in GWh)	2021			2020			2019
Electric Sales
Residential	698	40	%	685	38	%	705	39	%
Commercial	396	22	%	416	23	%	436	24	%
Industrial, non-Mining	402	23	%	415	23	%	427	23	%
Industrial, Mining	268	15	%	280	16	%	264	14	%
Other	4	—	%	4	—	%	4	—	%
Total Retail Sales by Customer Class	1,768	100	%	1,800	100	%	1,836	100	%

Regulatory Matters

We are subject to comprehensive regulation. The discussion below contains material developments to those matters disclosed in Part II, Item 7 of our 2020 Annual Report on Form 10-K and new regulatory matters occurring in 2021.

2020 Rate Order

In December 2020, the ACC issued a rate order for new rates that took effect January 1, 2021.

Provisions of the 2020 Rate Order include, but are not limited to:

•a non-fuel retail revenue increase of $58 million over test year retail revenues;

•a 7.04% return on original cost rate base of $2.7 billion, which includes a cost of equity of 9.15% and an average cost of debt of 4.65%; and

•a capital structure for rate making purposes of approximately 53% common equity and 47% long-term debt.

In addition, the 2020 Rate Order established a second phase of our rate case to address the impact on certain communities due to the closures of fossil-based generation facilities (Phase 2). In January 2021, the ACC staff opened a generic docket related to this matter and will consider additional evidence or recommendations in Phase 2. We cannot predict the timing or outcome of these proceedings.

2019 FERC Rate Case

In 2019, the FERC issued an order approving our proposed OATT revisions effective August 1, 2019, subject to refund and further proceedings.

Provisions of the order include, but are not limited to:

•replacing our stated transmission rates with a forward-looking formula rate;

•a 10.4% return on equity; and

•elimination of transmission rates that are bifurcated between high-voltage and lower-voltage facilities, as well as elimination of the bifurcated loss factor rate.

The requested forward-looking formula rate is intended to allow for a more timely recovery of transmission-related costs. If this request is approved, transmission revenues would increase by approximately $7 million annually. As part of the order, the FERC established hearing and settlement procedures. In February 2021, a Presiding Judge was appointed to continue the formula rate case proceeding after the settlement procedures resulted in an impasse. All rates charged under the revised OATT pursuant to the FERC order are subject to refund until the proceeding concludes. We reserved $18 million as of March 31, 2021, and $15 million as of December 31, 2020, of wholesale revenues in Current Liabilities—Regulatory Liabilities on the Condensed Consolidated Balance Sheets. We cannot predict the outcome of the proceedings.

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Other FERC Matters

On January 29, 2021, the FERC notified TEP that it is commencing an audit that is intended to evaluate our compliance with: (i) the accounting requirements of the Uniform System of Accounts; and (ii) the reporting requirements of the FERC Form 1 Annual Report and Supplemental Form 3-Q Quarterly Financial Reports. The audit will cover the period of January 1, 2018 to the present. We cannot predict the outcome or findings, if any, of the FERC audit at this time.

Generation Resource Shift

Our long-term strategy is to continue our shift from carbon-intensive sources to a more sustainable energy portfolio including expanding renewable energy resources while reducing reliance on coal-fired generation resources. In June 2020, we filed our 2020 IRP with the ACC, which provides details on our long-term strategy.

2020 IRP

Our 2020 IRP includes a goal of reducing our carbon dioxide emissions by 80% compared to levels in 2005 by 2035. To achieve this goal, we plan to continue the retirement of older fossil-fuel resources and replace these assets with a combination of renewable resources, energy storage, and energy efficiency programs. The existing coal-fired generation fleet faces a number of uncertainties impacting the viability of continued operations, including changing state and federal law and energy policies, competition from other resources, fuel supply and land lease contract extensions, environmental regulations, and, for jointly owned facilities, the willingness of other owners to continue their participation. Given this uncertainty, we plan to exit all ownership interests in coal generation facilities over the next 11 years. We will seek regulatory recovery for amounts that would not otherwise be recovered, if any, as a result of these actions. The execution of our IRP is dependent on obtaining regulatory recovery approval.

Oso Grande Wind Project

In 2019, we entered into a BTA to develop Oso Grande, which is expected to be placed in service in May 2021. Oso Grande will add approximately 250 MW of wind-powered electric generation, increasing our total renewable nominal generation capacity to over 500 MW, which includes PPAs and owned utility-scale generation. The project is estimated to cost $446 million, which includes, among other costs, $34 million for AFUDC and $397 million related to the BTA. As of March 31, 2021, total cost of construction incurred from inception was $432 million, which included, among other costs, $30 million for AFUDC and $388 million related to the BTA. The project costs incurred are currently included in Construction Work in Progress on the Condensed Consolidated Balance Sheets.

We are planning to provide more than 70% of our power from wind and solar resources by 2035 as part of our cleaner energy portfolio. The Oso Grande project is expected to provide a significant shift towards renewable generation and further decrease TEP's dependency on coal-fired generation.

Arizona Energy Policy

In 2018, the ACC opened rulemaking dockets to evaluate possible modifications to various energy policies, including existing renewable energy and energy efficiency goals, integrated resource planning, and retail competition for generation services. In 2019 and 2020, the ACC discussed draft rules related to retail electric competition. The ACC discussed those draft rules during workshops, but such rules have not been officially proposed and no changes have been made.

In December 2020, ACC staff issued a Notice of Proposed Rulemaking based on energy rules approved by the ACC in November 2020. If adopted, the new rules would require TEP to: (i) reduce carbon emissions below a baseline level of 50% by 2032 and 100% by 2050; (ii) include a demand-side resource capacity of at least 35% of our 2020 peak demand by 2030; (iii) achieve on average 1.3% annual energy efficiency savings starting in 2021; and (iv) install energy storage systems with an aggregate capacity equal to at least 5% of TEP's 2020 peak demand. The new rules would repeal the existing RES and EE Standards. We would seek the ACC's approval to recover any costs related to new energy policies or requirements. We cannot predict the outcome of these matters or their impact on our financial position or results of operations.

Production Tax Credits

Production Tax Credits (PTCs) are earned as energy from qualifying wind-powered facilities is generated based on a per kilowatt rate as prescribed pursuant to the applicable federal income tax law. Qualifying generating facilities are eligible for the credit for 10 years from the date the facilities are placed in service. The PTC rate is published annually by the IRS and was $0.025 per kWh generated for 2020. The Company will begin earning PTCs once Oso Grande begins generating power to serve

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our customers. In 2021, Oso Grande is estimated to generate approximately $15 million in PTCs. The PTCs are anticipated to offset most of the operating and interest expenses of Oso Grande, which are not currently in base rates.

Electricity generated from Oso Grande depends heavily on wind conditions. If such conditions vary from our estimates, the project’s electricity generation and associated PTCs may be substantially different than forecasted.

Weather Patterns

Changing weather patterns and other factors cause seasonal fluctuations in sales of power. The Company's summer peaking load occurs during the third quarter of the year when cooling demand is higher, which results in higher revenue during such period. By contrast, lower sales of power occur during the first quarter of the year, due to mild winter weather in our retail service territory. Seasonal fluctuations affect the comparability of our results of operations.

Interest Rates

See Part II, Item 7A in our 2020 Annual Report on Form 10-K and Part I, Item 3 of this Form 10-Q for information regarding interest rate risks and its impact on earnings.

RESULTS OF OPERATIONS

Significant drivers of TEP's results of operations that do not have a significant impact on net income include:

•Cost Recovery Mechanisms — TEP records operating revenue related to cost recovery mechanisms that allow for more timely recovery of fuel and purchase power costs and certain operations and maintenance costs between rate case proceedings. These mechanisms, which include PPFAC, Renewable Energy Standard Tariff, DSM, and TEAM are generally reset annually through separate filings with the ACC. See Note 2 of Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q for additional information on cost recovery mechanisms.

•Short-Term Wholesale Sales — Revenues related to short-term wholesale sales are primarily related to ACC jurisdictional generation assets and are returned to retail customers by offsetting revenues against fuel and purchased power costs eligible for recovery through the PPFAC cost recovery mechanism.

•Springerville Units 3 and 4 — Operations and maintenance expenses related to Springerville Units 3 and 4 are reimbursed by Tri-State Generation and Transmission Association, Inc., the lessee of Springerville Unit 3, and Salt River Project Agricultural Improvement and Power District, the owner of Springerville Unit 4, through participant billings recorded in Operating Revenues on the Condensed Consolidated Statements of Income.

The following discussion provides the significant items that affected TEP's results of operations in the first three months of 2021 compared with the same period in 2020 presented on a pre-tax basis.

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Operating Revenues

The following table provides a disaggregation of Operating Revenues:


	Three Months Ended March 31,				Increase (Decrease)
(in millions)	2021		2020		Percent
Operating Revenues
Retail	$	215	$	192	12.0	%
Wholesale, Long-Term	10		7		42.9	%
Wholesale, Short-Term (1)	50		29		72.4	%
Transmission	11		7		57.1	%
Springerville Units 3 and 4 Participant Billings	31		20		55.0	%
Other	19		24		(20.8)	%
Total Operating Revenues	$	336	$	279	20.4	%

(1)Revenues associated with derivatives are primarily returned to retail customers by offsetting the fuel and purchase power costs eligible for recovery through the PPFAC mechanism similar to short-term wholesale sales. As a result, revenues associated with derivatives are included in Wholesale, Short-Term in the table above.

TEP reported Operating Revenues of $336 million in the first three months of 2021 compared with $279 million in the same period for 2020. The increase of $57 million, or 20%, was primarily due to:

•$23 million in higher retail revenue primarily due to: (i) an increase in rates as approved in the 2020 Rate Order; (ii) higher RES cost recoveries as a result of higher program expenses; and (iii) higher fuel and purchase power recoveries due to higher rates and increased volumes;

•$21 million in higher wholesale short-term sales primarily due to an increase in price as a result of a severe winter storm in the southwestern United States in February 2021 and an increase in sales volume;

•$11 million in higher participant billings related to Springerville Units 3 and 4;

•$4 million in higher transmission revenue due to an increase in volume; and

•$3 million in higher wholesale long-term sales primarily due to an increase in volume.

The increase was partially offset by $7 million in lower other revenue due to a decrease in LFCR revenues as a result of a rate adjustment as approved in the 2020 Rate Order.

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The following table provides key statistics impacting Operating Revenues:


	Three Months Ended March 31,		Increase (Decrease)
(kWh in millions)	2021	2020	Percent
Electric Sales (kWh) (1)
Retail Sales	1,768	1,800	(1.8)	%
Wholesale, Long-Term	137	72	90.3	%
Wholesale, Short-Term	1,596	1,246	28.1	%
Total Electric Sales	3,501	3,118	12.3	%

Average Revenue Per kWh (2)
Retail	12.16	10.67	14.0	%
Wholesale, Long-Term	6.97	10.04	(30.6)	%
Wholesale, Short-Term	3.11	2.30	35.2	%

Total Retail Customers (3)	436,454	431,691	1.1	%

(1)These numbers represent the kWh sold to retail, long-term wholesale, and short-term wholesale customers. Management uses kWh sold to retail and wholesale customers to monitor electricity usage.

(2)This metric represents the cents earned per kWh for retail and wholesale revenue. This number is calculated as revenue divided by Electric Sales (kWh) for each respective revenue class. Management uses this metric to monitor retail and wholesale rates.

(3)This number represents the total retail customer count across all customer classes including residential, commercial, industrial (mining), industrial (non-mining), and other. The customer count is based on the number of active service agreements at the end of each period. Management uses this count to monitor the growth of retail customers.

Operating Expenses

Fuel and Purchased Power Expense

TEP reported Fuel and Purchased Power expense of $119 million in the first three months of 2021 compared with $91 million in the same period for 2020. The increase of $28 million, or 31%, was primarily due to:

•$29 million in higher fuel costs primarily due to an increase in natural gas prices, net of realized gains on natural gas swaps as a result of a severe winter storm in the southwestern United States in February 2021; and

•$13 million in higher purchased power primarily due to an increase in short-term wholesale prices and volume as a result of a severe winter storm in the southwestern United States in February 2021.

The increase was partially offset by a $16 million decrease in expense due to higher PPFAC eligible costs, which exceeded PPFAC recoveries, and were deferred as a regulatory asset.

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The following provides key statistics impacting Fuel and Purchased Power:


	Three Months Ended March 31,		Increase (Decrease)
(kWh in millions)	2021	2020	Percent
Sources of Energy
Coal-Fired Generation	1,484	1,409	5.3	%
Gas-Fired Generation	1,608	1,476	8.9	%
Utility-Owned Renewable Generation	19	20	(5.0)	%
Total Generation	3,111	2,905	7.1	%
Purchased Power, Non-Renewable	212	170	24.7	%
Purchased Power, Renewable	186	151	23.2	%
Total Generation and Purchased Power (1)	3,509	3,226	8.8	%


(cents per kWh)
Average Fuel Cost of Generated Power (2)
Coal	2.21	2.53	(12.6)	%
Natural Gas (3) (4)	3.56	1.80	97.8	%
Average Cost of Purchased Power (5)
Purchased Power, Non-Renewable (4)	6.77	2.59	161.4	%
Purchased Power, Renewable	8.70	9.31	(6.6)	%

(1)This number represents the kWh generated from TEP's generating stations including coal-fired, gas-fired, and renewable generation, combined with the kWh of purchased power from both renewable and non-renewable sources. Management uses this number to monitor the performance of each energy source.

(2)This metric represents the fuel cost as cents per kWh for coal and natural gas generated power. This number is calculated as fuel cost divided by Generation (kWh) for each respective generation source. Management uses this metric to monitor rates and pricing as well as analyze the performance of generation stations.

(3)Includes realized gains and losses from hedging activity.

(4)In February 2021, a severe winter storm in the southwestern United States drove increased energy demand, limited the availability of natural gas to fuel generation stations, and increased the cost of natural gas and purchased power.

(5)This metric represents the fuel cost as cents per kWh for renewable and non-renewable purchased power. This number is calculated as purchased power cost divided by purchased power (kWh) for each respective form of purchased power. Management uses this metric to compare and monitor the costs of renewable and non-renewable purchased power.

Operations and Maintenance Expense

TEP reported Operations and Maintenance Expense of $111 million in the first three months of 2021 compared with $87 million in the same period for 2020. The increase of $24 million, or 28%, was primarily due to:

•$13 million in higher reimbursable maintenance expense related to Springerville Units 3 and 4 planned generation outages in 2021;

•$6 million in higher maintenance expense related to Sundt Units 3 and 4 planned generation outages in 2021; and

•$5 million in higher employee wages and benefits expense.

Depreciation and Amortization Expense

TEP reported Depreciation and Amortization expense of $58 million in the first three months of 2021 compared with $53 million in the same period for 2020. The increase of $5 million, or 9%, was primarily due to:

•$3 million in higher depreciation and amortization expense due to an increase in asset base; and

•$2 million in higher depreciation and amortization expense due to an increase in depreciation rates and amortization as a result of the 2020 Rate Order.

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Other Income (Expense)

TEP reported other expense of $7 million in the first three months of 2021 compared with $20 million in the same period for 2020. The decrease of $13 million, or 65%, was primarily due to:

•$8 million increase in the value of investments used to support certain post-employment benefits as a result of favorable market conditions; and

•$4 million in higher AFUDC as a result of a change in the AFUDC rate.

Income Tax Expense

TEP reported Income Tax Expense of $2 million in the first three months of 2021 compared with $4 million in the same period for 2020. The decrease of $2 million, or 50%, was primarily due to:

•$2 million increase in tax credits; and

•$1 million decrease in EDIT amortization.

The decrease was partially offset by $1 million in higher tax expense due to an increase in taxable earnings.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity

An extended period of economic disruption driven by the COVID-19 pandemic or other factors could negatively affect our business and financial condition, and access to sources of liquidity. In addition, cash flows may vary during the year with cash flows from operations typically being the lowest in the first quarter of the year and highest in the third quarter due to TEP's summer peaking load. We use our revolving credit under the 2015 Credit Agreement as needed to fund our business activities. We believe that we have sufficient liquidity under our revolving credit agreement to meet short-term working capital needs and to provide credit enhancement as necessary under energy procurement and hedging agreements. The availability and terms under which we have access to external financing depends on a variety of factors, including our credit ratings and conditions in the bank and capital markets.

Available Liquidity


(in millions)	March 31, 2021
Cash and Cash Equivalents	$	26
Amount Available under Revolving Credit Agreement (1)	238
Total Liquidity	$	264

(1)The 2015 Credit Agreement provides for $250 million of revolving credit commitments with a LOC sublimit of $50 million and a maturity date of October 2022.

Future Liquidity Requirements

We expect to meet all of our financial obligations and other anticipated cash outflows for the foreseeable future. These obligations and anticipated cash outflows include, but are not limited to: (i) dividend payments; (ii) debt maturities; (iii) employee benefit obligations; and (iv) contracted obligations including those forecasted in the Capital Expenditures table reported in our 2020 Annual Report on Form 10-K.

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Summary of Cash Flows

The table below presents net cash provided by (used for) operating, investing and financing activities:


	Three Months Ended March 31,				Increase (Decrease)
(in millions)	2021		2020		Percent
Operating Activities	$	78	$	91	(14.3)	%
Investing Activities	(114)		(373)		(69.4)	%
Financing Activities	—		284		*
Net Increase (Decrease)	(36)		2		*
Beginning of Period	82		28		192.9	%
End of Period	$	46	$	30	53.3	%

* Not meaningful

Operating Activities

In the first three months of 2021, net cash flows from operating activities decreased by $13 million compared with the same period in 2020. The decrease was primarily due to: (i) changes in working capital related to higher fuel costs and the timing of billing collections; and (ii) higher operations and maintenance expenses due to an increase in employee benefits expense and planned generation outages in 2021.

The decrease was partially offset by: (i) higher retail revenues related to an increase in rates as approved in the 2020 Rate Order; and (ii) higher transmission revenues due to an increase in volumes.

Investing Activities

In the first three months of 2021, net cash flows used for investing activities decreased by $259 million compared with the same period in 2020 primarily due to lower capital expenditures related to Oso Grande BTA payments in 2020 not occurring in 2021.

Financing Activities

In the first three months of 2021, net cash flows from financing activities decreased by $284 million compared with the same period in 2020 primarily due to: (i) a decrease in equity contributions from UNS Energy; and (ii) lower proceeds from credit facility borrowings, net of repayments.

Sources of Liquidity

Short-Term Investments

Our short-term investment policy governs the investment of excess cash balances. We periodically review and update this policy in response to market conditions. As of March 31, 2021, TEP had no short-term investments.

Access to Credit Agreements

We have access to working capital through our credit agreements.

In January 2020, $12 million in LOCs at a rate of 1.00% per annum were issued pursuant to TEP taking ownership of Oso Grande under the BTA. As of May 4, 2021, there was $223 million available under the 2015 Credit Agreement.

See Note 7 of Notes to Consolidated Financial Statements in Part II, Item 8 in our 2020 Annual Report on Form 10-K for additional information regarding our credit agreements.

Debt Financing

We use debt financing to meet a portion of our capital needs and lower our overall cost of capital. Our cost of capital is also affected by our credit ratings.

TEP has, from time to time, refinanced or repurchased portions of its outstanding debt before scheduled maturity. Depending on market conditions, we may refinance other debt issuances or repurchase debt in the future. We anticipate issuing long-term debt in the second quarter of 2021.

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Credit Ratings

Credit ratings affect our access to capital markets and supplemental bank financing. As of March 31, 2021, credit ratings from S&P Global Ratings and Moody’s Investors Service for our senior unsecured debt were A- and A3, respectively.

Our credit ratings depend on a number of factors, both quantitative and qualitative, and are subject to change at any time. The disclosure of these credit ratings is not a recommendation to buy, sell, or hold TEP securities. Each rating should be evaluated independently of any other ratings.

Certain of TEP's debt agreements contain pricing based on our credit ratings. A change in TEP’s credit ratings can cause an increase or decrease in the amount of interest we pay on our borrowings and the amount of fees we pay for LOCs and unused commitments.

Debt Covenants

Under certain agreements, should TEP fail to maintain compliance with covenants, lenders could accelerate the maturity of all amounts outstanding. As of March 31, 2021, TEP was in compliance with these covenants.

We do not have any provisions in any of our debt or lease agreements that would cause an event of default or cause amounts to become due and payable in the event of a credit rating downgrade.

Contributions from Parent

TEP received no equity contributions from UNS Energy in the first three months of 2021 and received equity contributions of $150 million in the first three months of 2020. On February 25, 2021, UNS Energy approved an equity contribution up to $50 million to TEP, to be paid on or before April 30, 2021. On April 29, 2021, TEP received an equity contribution of $50 million from UNS Energy.

Dividends Paid to Parent

TEP did not declare or pay dividends to UNS Energy in the first three months of 2021 or 2020.

Master Trading Agreements

TEP conducts its wholesale marketing and risk management activities under certain master trading agreements. Under these agreements, TEP may be required to post credit enhancements in the form of cash or LOCs due to exposures exceeding unsecured credit limits provided to TEP based on changes in: (i) contract values; (ii) our credit ratings; or (iii) material changes in our creditworthiness. As of March 31, 2021, TEP had $14 million of cash posted as collateral to provide credit enhancement related to our wholesale marketing or risk management activities. As of May 4, 2021, there was $19 million of cash posted as collateral to provide credit enhancement.

Capital Expenditures

TEP's routine capital expenditures include funds used for customer growth, system reinforcement, replacements and betterments, and costs to comply with environmental rules and regulations. In the first three months of 2021, there were no material changes to capital expenditures as reported in our 2020 Annual Report on Form 10-K.

Income Tax Position

TEP made a net tax sharing payment of $1 million to UNS Energy in the first three months of 2021. Based on our remaining tax credit carryforward balances and limitations on their use in individual years, we expect to make additional tax sharing payments in 2021. Future payment obligations are subject to change and are not expected to have a significant impact on our operating cash flows.

Payroll Tax

In response to the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was signed into law on March 27, 2020. As permitted by the CARES Act, TEP deferred payment of the employer's portion of social security taxes. In 2020, TEP recorded total deferred deposits of $7 million in Accrued Taxes Other than Income Taxes and Regulatory and Other Liabilities—Other on the Consolidated Balance Sheets. TEP expects the total deferred deposits to be paid to the IRS in equal payments in 2021 and 2022.

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Environmental Matters

The Environmental Protection Agency (EPA) regulates the amount of sulfur dioxide (SO2), nitrogen oxides (NOx), carbon dioxide (CO2), particulate matter, mercury and other by-products produced by generation facilities. We may incur additional costs to comply with future changes in federal and state environmental laws, regulations, and permit requirements at our generation facilities. Environmental laws and regulations are subject to a range of interpretations, which may ultimately be resolved by the courts. Because these laws and regulations continue to evolve, we are unable to predict the impact they may have on our operations and consolidated financial results. Complying with these changes may reduce operating efficiency and increase capital and operating costs. TEP will request recovery from its customers of the costs of environmental compliance through cost recovery mechanisms and Retail Rates. See Note 7 of Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q for additional information on the Broadway-Pantano site.

Regional Haze Regulations

The EPA's Regional Haze rule requires emission reductions from certain industrial facilities emitting air pollutants that reduce visibility in national parks and wilderness areas. The rule calls for states to establish goals and emission reduction strategies for improving visibility in these areas. States must submit these goals and strategies to the EPA for approval in the form of a State Implementation Plan (SIP), and must review and submit revisions to the SIP on a periodic basis.

In December 2016, the EPA signed a final rule that, among other things, changed the submittal date for the next Regional Haze SIP revisions from 2018 to 2021. The ADEQ began to develop a control strategy with a focus on making reasonable progress toward the national visibility goal. In July 2019, the ADEQ notified TEP that Sundt Unit 3 and Springerville Units 1 and 2 had been selected for potential emissions controls evaluation.

TEP conducted the potential emissions controls evaluation, commonly referred to as the four factor analysis, for both facilities. These evaluations were submitted to the ADEQ in March 2020 for the agency's use in developing the revised SIP. The regulatory deadline for ADEQ to submit the revised SIP to the EPA for approval is July 31, 2021. Based on current Regional Haze requirement time-frames, TEP anticipates that compliance strategies, if any, will likely be required to be implemented three to five years after the ADEQ submits the revised SIP to the EPA. TEP cannot predict the outcome of these matters at this time, but will continue to work with the agency to determine compliance strategies as needed.

Greenhouse Gas Regulation

In August 2015, the EPA issued the Clean Power Plan (CPP) limiting CO2 emissions from existing and new fossil fuel-based generation facilities. The CPP established state-level CO2 emission rates and mass-based goals that applied to fossil fuel-based generation. The plan targeted CO2 emissions reductions for existing facilities by 2030 and established interim goals that begin in 2022.

In June 2019, the EPA repealed the CPP and issued the Affordable Clean Energy (ACE) rule, establishing new emission guidelines for existing coal-fired generation facilities based on the Best System of Emission Reduction (BSER) for Greenhouse Gas (GHG) emissions. The BSER for GHG emissions from existing coal-fired generation facilities is defined as Heat-Rate Improvements (HRI) that can be applied at the source. The states would then use these emission guidelines to establish state performance standards, considering source specific factors such as the remaining useful life of an individual unit.

On March 5, 2021, the U.S. Court of Appeals for the D.C. Circuit issued a mandate vacating and remanding the ACE rule to the EPA. The mandate also vacated amendments that extended the timeline under which companies had to come into compliance with the rule.

TEP cannot predict the outcome of these matters at this time, but will continue to monitor legal challenges, legislative efforts, and administrative rulemakings.

Coal Combustion Residuals Regulation

In April 2015, the EPA issued a final rule requiring the disposal of coal ash and other Coal Combustion Residuals (CCR) to be managed as a solid waste under Subtitle D of the Resource Conservation and Recovery Act (RCRA) for disposal in landfills and/or surface impoundments. Our share of costs to comply with the CCR rule at Four Corners is estimated to be $3 million. This includes estimated costs for corrective action for two CCR units at the facility. Arizona Public Service, the operating agent of Four Corners, began an assessment of corrective measures in 2019, and expects the assessment to continue through 2021.

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Since these regulations were finalized, the EPA has taken steps to modify this rule. The following are pending rulemakings:

•In December 2016, Congress approved the Water Infrastructure Improvements for the Nation (WIIN) Act, which gave the EPA authority to either authorize states to establish their own permit program under RCRA for implementing regulation of CCR or issue federal permits in states without a program and on tribal lands. In accordance with this Act, the EPA proposed to establish a federal CCR permit program on February 20, 2020. Public comment on the EPA's proposal closed in August 2020.

•On March 15, 2018, the EPA proposed to add boron to the list of constituents that trigger corrective action requirements to remediate groundwater impacted by CCR disposal activities. In a separate proposal dated August 14, 2019, the EPA acknowledged that if it finalizes the addition of boron it will need to establish an alternative risk-based groundwater protection standard for boron, as boron does not have a Maximum Contaminant Level. TEP cannot predict the outcome or timing on when the EPA will take final action on this matter.

As of March 31, 2021, the EPA has not taken final action on these proposals. As a result, TEP cannot predict the impact of the proposed rulemakings.

Effluent Limitation Guidelines

In 2015, as part of the Clean Water Act, the EPA published the final Steam Electric Power Generating category Effluent Limitation Guidelines and Standard rule, revising standards and limitations for coal-fired generation wastewater discharges. The rule established new or additional Effluent Limitations Guidelines (ELG) for wastewater discharges associated with fly ash, bottom ash, flue gas desulfurization, flue gas mercury control, and gasification of fuels such as coal and petroleum coke. In response to legal challenges, the EPA revised the ELGs and issued a final rule on August 31, 2020, which became effective December 14, 2020. The final rule revised requirements for flue gas desulfurization wastewater and bottom ash transport water.

With the exception of Four Corners, none of TEP's coal-fired generation facilities are subject to the final rule. The revised ELGs warrant a modification of Four Corners' wastewater discharge permit, or National Pollution Discharge Elimination System permit, which was last issued in September 2019. APS filed a permit modification request on January 11, 2021, which is still pending EPA response. TEP does not anticipate a material impact on operations or financial results.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Management's Discussion and Analysis of Financial Condition and Results of Operations is based on our Condensed Consolidated Financial Statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires management to apply accounting policies and make estimates, judgments, and assumptions that affect results of operations and the amounts of assets and liabilities reported in the financial statements and related notes. Management believes that there have been no significant changes during the three months ended March 31, 2021, to the items that we disclosed as our critical accounting policies and estimates in Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in our 2020 Annual Report on Form 10-K.

NEW ACCOUNTING STANDARDS ISSUED AND NOT YET ADOPTED

For a discussion of new accounting pronouncements affecting TEP, see Note 1 of Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

TEP’s primary market risks include fluctuations in interest rates, commodity prices and volumes, and counterparty credit. Fluctuations in interest rates can affect earnings and cash flows. We can enter into interest rate swaps and financing transactions to manage changes in interest rates. Fluctuations in commodity prices and volumes and counterparty credit losses may temporarily affect cash flows, but are not expected to affect earnings due to expected recovery through regulatory mechanisms.

There have been no additional risks and no material changes to market risks disclosed in Part II, Item 7A in our 2020 Annual Report on Form 10-K.

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ITEM 4. CONTROLS AND PROCEDURES

TEP’s Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer) supervised and participated in TEP’s evaluation of its disclosure controls and procedures as such term is defined under Rule 13a–15(e) and Rule 15d–15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act), as of the end of the period covered by this report. Disclosure controls and procedures are controls and procedures designed to ensure that information required to be disclosed in TEP’s periodic reports filed or submitted under the Exchange Act, is recorded, processed, summarized, and reported within the time periods specified in the United States Securities and Exchange Commission’s rules and forms. These disclosure controls and procedures are also designed to ensure that information required to be disclosed by TEP in the reports that it files or submits under the Exchange Act is accumulated and communicated to management, including the principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Based upon the evaluation performed, TEP’s Chief Executive Officer and Chief Financial Officer concluded that TEP’s disclosure controls and procedures were effective as of March 31, 2021. There was no change in TEP’s internal control over financial reporting during the quarter ended March 31, 2021, that materially affected, or is reasonably likely to materially affect, TEP’s internal control over financial reporting.

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PART II

ITEM 1. LEGAL PROCEEDINGS

For a description of certain legal proceedings affecting TEP, refer to Note 7 of Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q.

ITEM 1A. RISK FACTORS

The business and financial results of TEP are subject to numerous risks and uncertainties. As a result, the risks and uncertainties discussed in Part I, Item 1A. Risk Factors in our 2020 Annual Report on Form 10-K should be carefully considered. There have been no material changes in the assessment of our risk factors from those set forth in our 2020 Annual Report on Form 10-K.

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ITEM 6. EXHIBITS

EXHIBIT INDEX

Exhibit No.

Description

31(a)

Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, by Susan M. Gray

31(b)

Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, by Frank P. Marino

*32

Statements of Corporate Officers (pursuant to Section 906 of the Sarbanes-Oxley Act of 2002)

101.INS

XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document

101.SCH

XBRL Taxonomy Extension Schema Document

101.CAL

XBRL Taxonomy Extension Calculation Linkbase Document

101.LAB

XBRL Taxonomy Extension Label Linkbase Document

101.PRE

XBRL Taxonomy Extension Presentation Linkbase Document

101.DEF

XBRL Taxonomy Extension Definition Linkbase Document

104

The cover page from the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2021, formatted in Inline XBRL and contained in Exhibit 101


*			Pursuant to Item 601(b)(32)(ii) of Regulation S-K, this certificate is not being “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


		TUCSON ELECTRIC POWER COMPANY
		(Registrant)

Date:	May 4, 2021	/s/ Frank P. Marino
		Frank P. Marino
		Sr. Vice President, Chief Financial Officer, and Director
		(Principal Financial Officer)