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EX-12.1 - PUGET ENERGY RATIO OF EARNINGS TO FIXED CHARGES - PUGET SOUND ENERGY INCpe-ex121_2016331xq1.htm
EX-12.2 - PSE RATIO OF EARNINGS TO FIXED CHARGES - PUGET SOUND ENERGY INCpe-ex122_2016331xq1.htm
EX-31.1 - PUGET ENERGY CHIEF EXECUTIVE OFFICER CERTIFICATION - PUGET SOUND ENERGY INCpe-ex311_2016331xq1.htm
EX-31.2 - PUGET ENERGY CHIEF FINANCIAL OFFICER CERTIFICATION - PUGET SOUND ENERGY INCpe-ex312_2016331xq1.htm
EX-31.3 - PSE CHIEF EXECUTIVE OFFICER CERTIFICATION - PUGET SOUND ENERGY INCpe-ex313_2016331xq1.htm
EX-31.4 - PSE CHIEF FINANCIAL OFFICER CERTIFICATION - PUGET SOUND ENERGY INCpe-ex314_2016331xq1.htm
EX-32.1 - CHIEF EXECUTIVE OFFICER CERTIFICATION - PUGET SOUND ENERGY INCpe-ex321_2016331xq1.htm
EX-32.2 - CHIEF FINANCIAL OFFICER CERTIFICATION - PUGET SOUND ENERGY INCpe-ex322_2016331xq1.htm
10-Q - PUGET ENERGY AND PSE FORM 10-Q - PUGET SOUND ENERGY INCpe201633110qfinal.pdf

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2016
OR
[  ]
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
Exact name of registrant as specified in its charter, state of incorporation,
address of principal executive offices, telephone number
I.R.S.
Employer
Identification
Number
1-16305
PUGET ENERGY, INC.
A Washington Corporation
10885 NE 4th Street, Suite 1200
Bellevue, Washington 98004-5591
(425) 454-6363
91-1969407
1-4393
PUGET SOUND ENERGY, INC.
A Washington Corporation
10885 NE 4th Street, Suite 1200
Bellevue, Washington 98004-5591
(425) 454-6363
91-0374630

Indicate by check mark whether the registrants: (1) have 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) have been subject to such filing requirements for the past 90 days.
Puget Energy, Inc.
Yes
/X/
No
/  /
 
Puget Sound Energy, Inc.
Yes
/X/
No
/  /
Indicate by check mark whether the registrants have submitted electronically and posted on their corporate websites, if any, every interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Puget Energy, Inc.
Yes
/X/
No
/  /
 
Puget Sound Energy, Inc.
Yes
/X/
No
/  /
Indicate by check mark whether registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definition of “large accelerated filer, accelerated filer and smaller reporting company” in Rule 12b-2 of the Exchange Act.
Puget Energy, Inc.
Large accelerated filer
/  /
Accelerated filer
/  /
Non-accelerated filer
/X/
Smaller reporting company
/  /
Puget Sound Energy, Inc.
Large accelerated filer
/  /
Accelerated filer
/  /
Non-accelerated filer
/X/
Smaller reporting company
/  /
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Puget Energy, Inc.
Yes
/  /
No
/X/
 
Puget Sound Energy, Inc.
Yes
/  /
No
/X/
All of the outstanding shares of voting stock of Puget Energy, Inc. are held by Puget Equico LLC, an indirect wholly-owned subsidiary of Puget Holdings LLC.  All of the outstanding shares of voting stock of Puget Sound Energy, Inc. are held by Puget Energy, Inc.



Table of Contents

 
 
Page
 
 
 
Financial Information
 
 
 
Financial Statements
 
Puget Energy, Inc.
 
 
Consolidated Statements of Income – Three Months Ended March 31, 2016 and 2015
 
Consolidated Statements of Comprehensive Income – Three Months Ended March 31, 2016 and 2015
 
Consolidated Balance Sheets – March 31, 2016 and December 31, 2015
 
Consolidated Statements of Cash Flows – Three Months Ended March 31, 2016 and 2015
 
 
 
 
Puget Sound Energy, Inc.
 
 
Consolidated Statements of Income – Three Months Ended March 31, 2016 and 2015
 
Consolidated Statements of Comprehensive Income – Three Months Ended March 31, 2016 and 2015
 
Consolidated Balance Sheets – March 31, 2016 and December 31, 2015
 
Consolidated Statements of Cash Flows – Three Months Ended March 31, 2016 and 2015
 
 
 
 
Notes
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2


DEFINITIONS

ARO
Asset Retirement and Environmental Obligations
ASU
Accounting Standards Update
ASC
Accounting Standards Codification
EBITDA
Earnings Before Interest, Tax, Depreciation and Amortization
ERF
Expedited Rate Filing
FASB
Financial Accounting Standards Board
GAAP
U.S. Generally Accepted Accounting Principles
GRC
General Rate Case
ISDA
International Swaps and Derivatives Association
LIBOR
London Interbank Offered Rate
MMBtu
One Million British Thermal Units
MWh
Megawatt Hour (one MWh equals one thousand kWh)
NAESB
North American Energy Standards Board
NPNS
Normal Purchase Normal Sale
PCA
Power Cost Adjustment
PCORC
Power Cost Only Rate Case
PGA
Purchased Gas Adjustment
PSE
Puget Sound Energy, Inc.
Puget Energy
Puget Energy, Inc.
Puget Holdings
Puget Holdings LLC
REP
Residential Exchange Program
SERP
Supplemental Executive Retirement Plan
Washington Commission
Washington Utilities and Transportation Commission
WSPP
WSPP, Inc.



3


FILING FORMAT
This report on Form 10-Q is a Quarterly Report filed separately by two registrants, Puget Energy, Inc. (Puget Energy) and Puget Sound Energy, Inc. (PSE).  Any references in this report to “the Company” are to Puget Energy and PSE collectively.

FORWARD-LOOKING STATEMENTS

Puget Energy and PSE include the following cautionary statements in this Form 10-Q to make applicable and to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 for any forward-looking statements made by or on behalf of Puget Energy or PSE.  This report includes forward-looking statements, which are statements of expectations, beliefs, plans, objectives and assumptions of future events or performance.  Words or phrases such as “anticipates,” “believes,” “continues,” “could,” “estimates,” “expects,” “future,” “intends,” “may,” “might,” “plans,” “potential,” “predicts,” “projects,” “should,” “will likely result,” “will continue” or similar expressions are intended to identify certain of these forward-looking statements and may be included in discussion of, among other things, our anticipated operating or financial performance, business plans and prospects, planned capital expenditures and other future expectations. In particular, these include statements relating to future actions, business plans and prospects, future performance expenses, the outcome of contingencies, such as legal proceedings, government regulation and financial results.
Forward-looking statements reflect current expectations and involve risks and uncertainties that could cause actual results or outcomes to differ materially from those expressed.  There can be no assurance that Puget Energy’s and PSE’s expectations, beliefs or projections will be achieved or accomplished.  
In addition to other factors and matters discussed elsewhere in this report, some important factors that could cause actual results or outcomes for Puget Energy and PSE to differ materially from past results and those discussed in forward-looking statements include:
Ÿ
Governmental policies and regulatory actions, including those of the Federal Energy Regulatory Commission (FERC) and the Washington Utilities and Transportation Commission (Washington Commission), that may affect our ability to recover costs and earn a reasonable return, including but not limited to disallowance or delays in the recovery of capital investments and operating costs and discretion over allowed return on investment;
Ÿ
Changes in, adoption of and compliance with laws and regulations, including decisions and policies concerning the environment, climate change, greenhouse gas or other emissions or byproducts of electric generation (including coal ash or other substances), natural resources, and fish and wildlife (including the Endangered Species Act) as well as the risk of litigation arising from such matters, whether involving public or private claimants or regulatory investigative or enforcement measures;
Ÿ
Changes in tax law, related regulations or differing interpretation or enforcement of applicable law by the Internal Revenue Service (IRS) or other taxing jurisdiction; and PSE's ability to recover costs in a timely manner arising from such changes;
Ÿ
Inability to realize deferred tax assets and use production tax credits (PTCs) due to insufficient future taxable income;
Ÿ
Inability to manage costs during the rate stay out period through March 31, 2016, which would cause increases in costs of operations;
Ÿ
Accidents or natural disasters, such as hurricanes, windstorms, earthquakes, floods, fires and landslides, and other acts of God, terrorism, asset-based or cyber-based attacks, flu pandemic or similar significant events, which can interrupt service and lead to lost revenue, cause temporary supply disruptions and/or price spikes in the cost of fuel and raw materials and impose extraordinary costs;
Ÿ
Commodity price risks associated with procuring natural gas and power in wholesale markets from creditworthy counterparties;
Ÿ
Wholesale market disruption, which may result in a deterioration of market liquidity, increase the risk of counterparty default, affect the regulatory and legislative process in unpredictable ways, negatively affect wholesale energy prices and/or impede PSE's ability to manage its energy portfolio risks and procure energy supply, affect the availability and access to capital and credit markets and/or impact delivery of energy to PSE from its suppliers;
Ÿ
Financial difficulties of other energy companies and related events, which may affect the regulatory and legislative process in unpredictable ways, adversely affect the availability of and access to capital and credit markets and/or impact delivery of energy to PSE from its suppliers;
Ÿ
The effect of wholesale market structures (including, but not limited to, regional market designs or transmission organizations) or other related federal initiatives;
Ÿ
PSE electric or natural gas distribution system failure, blackouts or large curtailments of transmission systems (whether PSE's or others'), or failure of the interstate natural gas pipeline delivering to PSE's system, all of which can affect PSE's ability to deliver power or natural gas to its customers and generating facilities;
Ÿ
Electric plant generation and transmission system outages, which can have an adverse impact on PSE's expenses with respect to repair costs, added costs to replace energy or higher costs associated with dispatching a more expensive generation resource;
Ÿ
The ability to restart generation following a regional transmission disruption;
Ÿ
The ability of a natural gas or electric plant to operate as intended;
Ÿ
Changes in climate or weather conditions in the Pacific Northwest, which could have effects on customer usage and PSE's revenue and expenses;
Ÿ
Regional or national weather, which could impact PSE's ability to procure adequate supplies of natural gas, fuel or purchased power to serve its customers and the cost of procuring such supplies;
Ÿ
Variable hydrological conditions, which can impact streamflow and PSE's ability to generate electricity from hydroelectric facilities;
Ÿ
The ability to renew contracts for electric and natural gas supply and the price of renewal;
Ÿ
Industrial, commercial and residential growth and demographic patterns in the service territories of PSE;
Ÿ
General economic conditions in the Pacific Northwest, which may impact customer consumption or affect PSE's accounts receivable;
Ÿ
The loss of significant customers, changes in the business of significant customers or the condemnation of PSE's facilities as a result of municipalization or other government action or negotiated settlement, which may result in changes in demand for PSE's services;
Ÿ
The failure of information systems or the failure to secure information system data, which may impact the operations and cost of PSE's customer service, generation, distribution and transmission;
Ÿ
Capital market conditions, including changes in the availability of capital and interest rate fluctuations;
Ÿ
Employee workforce factors, including strikes, work stoppages, availability of qualified employees or the loss of a key executive;
Ÿ
The ability to obtain insurance coverage, the availability of insurance for certain specific losses, and the cost of such insurance;
Ÿ
The ability to maintain effective internal controls over financial reporting and operational processes;
Ÿ
Changes in Puget Energy's or PSE's credit ratings, which may have an adverse impact on the availability and cost of capital for Puget Energy or PSE generally; and
Ÿ
Deteriorating values of the equity, fixed income and other markets which could significantly impact the value of investments of PSE's retirement plan, post-retirement medical benefit plan trusts and the funding of obligations thereunder.

Any forward-looking statement speaks only as of the date on which such statement is made, and, except as required by law, the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events.  New factors emerge from time to time and it is not possible for management to predict all such factors, nor can it assess the impact of any such factor on the business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement.  You are also advised to consult Item 1A - “Risk Factors” in the Company's most recent Annual Report on Form 10-K.


4


PART I                    FINANCIAL INFORMATION

Item 1.                      Financial Statements

PUGET ENERGY, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in Thousands)
(Unaudited)


 
Three Months Ended March 31,
 
2016
2015
Operating revenue:
 
 
Electric
$
630,191

$
573,628

Natural gas
323,408

348,861

Other
9,098

4,346

Total operating revenue
962,697

926,835

Operating expenses:
 

 

Energy costs:
 

 

Purchased electricity
142,897

153,480

Electric generation fuel
54,193

48,017

Residential exchange
(20,140
)
(43,714
)
Purchased natural gas
123,103

156,433

Unrealized (gain) loss on derivative instruments, net
(16,822
)
(3,696
)
Utility operations and maintenance
145,990

137,175

Non-utility expense and other
5,634

3,210

Depreciation and amortization
107,515

106,178

Conservation amortization
33,211

29,604

Taxes other than income taxes
102,292

94,913

Total operating expenses
677,873

681,600

Operating income (loss)
284,824

245,235

Other income (deductions):
 

 

Other income
5,977

4,781

Other expense
(1,340
)
(1,407
)
Non-hedged interest rate swap (expense) income
(855
)
(1,975
)
Interest charges:
 

 

AFUDC
2,358

1,432

Interest expense
(88,813
)
(88,909
)
Income (loss) before income taxes
202,151

159,157

Income tax (benefit) expense
60,965

43,481

Net income (loss)
$
141,186

$
115,676


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

5


PUGET ENERGY, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in Thousands)
(Unaudited)


 
Three Months Ended March 31,
 
2016
2015
Net income (loss)
$
141,186

$
115,676

Other comprehensive income (loss):
 

 

Net unrealized gain (loss) from pension and postretirement plans, net of tax of $100 and $312, respectively
(186
)
579

Reclassification of net unrealized (gain) loss on energy derivative instruments, net of tax of $0 and $179, respectively

333

Other comprehensive income (loss)
(186
)
912

Comprehensive income (loss)
$
141,000

$
116,588


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

6


PUGET ENERGY, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)


ASSETS
 
(Unaudited)
 
 
March 31,
2016
December 31,
2015
Utility plant (at original cost, including construction work in progress of $400,373 and $408,795, respectively):
 
 
Electric plant
$
7,505,180

$
7,432,490

Natural gas plant
2,893,374

2,850,290

Common plant
513,012

508,750

Less: Accumulated depreciation and amortization
(1,954,650
)
(1,878,868
)
Net utility plant
8,956,916

8,912,662

Other property and investments:
 

 

Goodwill
1,656,513

1,656,513

Other property and investments
86,389

86,731

Total other property and investments
1,742,902

1,743,244

Current assets:
 

 

Cash and cash equivalents
30,041

42,494

Restricted cash
8,804

7,949

Accounts receivable, net of allowance for doubtful accounts of $8,276 and $9,756, respectively
308,677

324,391

Unbilled revenue
165,078

217,274

Materials and supplies, at average cost
100,572

78,244

Fuel and gas inventory, at average cost
44,482

58,658

Unrealized gain on derivative instruments
39,574

24,418

Taxes
148

293

Prepaid expense and other
36,962

16,827

Power contract acquisition adjustment gain
33,833

37,031

Total current assets
768,171

807,579

Other long-term and regulatory assets:
 

 

Regulatory asset for deferred income taxes
72,171

73,231

Power cost adjustment mechanism
4,780

4,749

Regulatory assets related to power contracts
25,542

26,223

Other regulatory assets
899,009

894,071

Unrealized gain on derivative instruments
7,951

5,225

Power contract acquisition adjustment gain
275,349

288,757

Other
61,426

58,513

Total other long-term and regulatory assets
1,346,228

1,350,769

Total assets
$
12,814,217

$
12,814,254


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





PUGET ENERGY, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)


CAPITALIZATION AND LIABILITIES
 
(Unaudited)
 
 
March 31,
2016
December 31,
2015
Capitalization:
 
 
Common shareholder’s equity:
 
 
Common stock $0.01 par value, 1,000 shares authorized, 200 shares outstanding
$

$

Additional paid-in capital
3,308,957

3,308,957

Retained earnings
353,553

249,534

Accumulated other comprehensive income (loss), net of tax
(27,452
)
(27,266
)
Total common shareholder’s equity
3,635,058

3,531,225

Long-term debt:
 

 

First mortgage bonds and senior notes
3,364,412

3,364,412

Pollution control bonds
161,860

161,860

Junior subordinated notes
250,000

250,000

Long-term debt
1,800,000

1,800,000

Debt discount, issuance costs and other
(245,229
)
(248,754
)
Total long-term debt
5,331,043

5,327,518

Total capitalization
8,966,101

8,858,743

Current liabilities:
 

 

Accounts payable
223,359

259,353

Short-term debt

159,004

Purchased gas adjustment liability
14,479

12,589

Accrued expenses:
 

 

  Taxes
135,512

114,854

  Salaries and wages
32,380

38,457

  Interest
78,445

73,378

Unrealized loss on derivative instruments
141,580

136,173

Power contract acquisition adjustment loss
3,448

3,611

Other
75,472

53,867

Total current liabilities
704,675

851,286

Other long-term and regulatory liabilities:
 

 

Deferred income taxes
1,495,760

1,435,955

Unrealized loss on derivative instruments
30,223

48,073

Regulatory liabilities
642,239

652,441

Regulatory liabilities related to power contracts
309,182

325,788

Power contract acquisition adjustment loss
22,094

22,613

Other deferred credits
643,943

619,355

Total other long-term and regulatory liabilities
3,143,441

3,104,225

Commitments and contingencies (Note 8)




Total capitalization and liabilities
$
12,814,217

$
12,814,254


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

7


 PUGET ENERGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
(Unaudited)
 
Three Months Ended March 31,
 
2016
2015
Operating activities:
 
 
Net income (loss)
$
141,186

$
115,676

Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 

 
Depreciation and amortization
107,515

106,178

Conservation amortization
33,211

29,604

Deferred income taxes and tax credits, net
60,965

43,483

Net unrealized (gain) loss on derivative instruments
(17,523
)
(3,372
)
Derivative contracts classified as financing activities due to merger

8,045

AFUDC – equity
(3,321
)
(1,714
)
Funding of pension liability
(4,500
)
(4,500
)
Regulatory assets and liabilities
(49,152
)
(60,706
)
Other long-term assets and liabilities
(320
)
6,778

Change in certain current assets and liabilities:
 

 
Accounts receivable and unbilled revenue
67,910

14,362

Materials and supplies
(22,328
)
(1,810
)
Fuel and gas inventory
13,989

25,880

Taxes
145

150

Prepayments and other
(20,136
)
3,193

Purchased gas adjustment
1,890

26,618

Accounts payable
(26,305
)
(73,907
)
Taxes payable
20,658

17,373

Accrued expenses and other
6,224

(11,445
)
Net cash provided by (used in) operating activities
310,108

239,886

Investing activities:
 

 

Construction expenditures – excluding equity AFUDC
(127,329
)
(117,106
)
Proceeds from disposition of assets

487

Restricted cash
(855
)
16,062

Other
(1,337
)
1,947

Net cash provided by (used in) investing activities
(129,521
)
(98,610
)
Financing activities:
 

 

Change in short-term debt, net
(159,004
)
(85,000
)
Dividends paid
(37,167
)
(64,744
)
Derivative contracts classified as financing activities due to merger

(8,045
)
Issuance cost of bonds and other
3,131

(1,895
)
Net cash provided by (used in) financing activities
(193,040
)
(159,684
)
Net increase (decrease) in cash and cash equivalents
(12,453
)
(18,408
)
Cash and cash equivalents at beginning of period
42,494

37,527

Cash and cash equivalents at end of period
$
30,041

$
19,119

Supplemental cash flow information:
 

 

Cash payments for interest (net of capitalized interest)
$
77,193

$
88,598

Cash payments (refunds) for income taxes


Non-cash financing and investing activities:
 
 
Accounts payable for capital expenditures eliminated from cash flows
$
41,899

$
44,657


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

8



PUGET SOUND ENERGY, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in Thousands)
(Unaudited)

 
Three Months Ended March 31,
 
2016
2015
Operating revenue:
 
 
Electric
$
630,191

$
573,628

Natural gas
323,408

348,861

Other
9,098

4,354

Total operating revenue
962,697

926,843

Operating expenses:
 

 

Energy costs:
 

 

Purchased electricity
142,897

153,480

Electric generation fuel
54,193

48,017

Residential exchange
(20,140
)
(43,714
)
Purchased natural gas
123,103

156,433

Unrealized (gain) loss on derivative instruments, net
(16,822
)
(3,152
)
Utility operations and maintenance
145,990

137,175

Non-utility expense and other
9,033

7,006

Depreciation and amortization
107,515

106,178

Conservation amortization
33,211

29,604

Taxes other than income taxes
102,292

94,913

Total operating expenses
681,272

685,940

Operating income (loss)
281,425

240,903

Other income (deductions):
 

 

Other income
5,975

4,782

Other expense
(1,340
)
(1,407
)
Interest charges:
 

 

AFUDC
2,358

1,432

Interest expense
(60,775
)
(63,196
)
Interest expense on parent note

(31
)
Income (loss) before income taxes
227,643

182,483

Income tax (benefit) expense
71,138

53,383

Net income (loss)
$
156,505

$
129,100


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

9


PUGET SOUND ENERGY, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in Thousands)
(Unaudited)

 
Three Months Ended March 31,
 
2016
2015
Net income (loss)
$
156,505

$
129,100

Other comprehensive income (loss):
 

 

Net unrealized gain (loss) from pension and postretirement plans, net of tax of $1,260 and $1,821, respectively
2,340

3,381

Reclassification of net unrealized (gain) loss on energy derivative instruments, net of tax of $0, and $369, respectively

686

Amortization of treasury interest rate swaps to earnings, net of tax of $43, and $43, respectively
79

79

Other comprehensive income (loss)
2,419

4,146

Comprehensive income (loss)
$
158,924

$
133,246


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

10


PUGET SOUND ENERGY, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)


ASSETS
 
(Unaudited)
 
 
March 31,
2016
December 31,
2015
Utility plant (at original cost, including construction work in progress of $400,373 and $408,795, respectively):
 
 
Electric plant
$
9,670,724

$
9,601,091

Natural gas plant
3,484,670

3,444,744

Common plant
552,919

548,657

Less:  Accumulated depreciation and amortization
(4,751,397
)
(4,681,830
)
Net utility plant
8,956,916

8,912,662

Other property and investments:
 

 

Other property and investments
82,727

83,069

Total other property and investments
82,727

83,069

Current assets:
 

 

Cash and cash equivalents
29,447

41,856

Restricted cash
8,804

7,949

Accounts receivable, net of allowance for doubtful accounts of $8,276 and $9,756, respectively
308,696

324,358

Unbilled revenue
165,078

217,274

Materials and supplies, at average cost
100,572

78,244

Fuel and gas inventory, at average cost
43,335

57,324

Unrealized gain on derivative instruments
39,574

24,418

Taxes
148

293

Prepaid expense and other
36,962

16,826

Total current assets
732,616

768,542

Other long-term and regulatory assets:
 

 

Regulatory asset for deferred income taxes
71,637

72,694

Power cost adjustment mechanism
4,780

4,749

Other regulatory assets
899,001

894,059

Unrealized gain on derivative instruments
7,951

5,225

Other
61,426

58,513

Total other long-term and regulatory assets
1,044,795

1,035,240

Total assets
$
10,817,054

$
10,799,513


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

11



PUGET SOUND ENERGY, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)

CAPITALIZATION AND LIABILITIES

 
(Unaudited)
 
 
March 31,
2016
December 31,
2015
Capitalization:
 
 
Common shareholder’s equity:
 
 
Common stock $0.01 par value, 150,000,000 shares authorized, 85,903,791 shares outstanding
$
859

$
859

Additional paid-in capital
3,275,105

3,275,105

Retained earnings
325,736

236,578

Accumulated other comprehensive income (loss), net of tax
(147,131
)
(149,550
)
Total common shareholder’s equity
3,454,569

3,362,992

Long-term debt:
 

 

First mortgage bonds and senior notes
3,364,412

3,364,412

Pollution control bonds
161,860

161,860

Junior subordinated notes
250,000

250,000

Debt discount, issuance costs and other
(31,171
)
(31,910
)
Total long-term debt
3,745,101

3,744,362

Total capitalization
7,199,670

7,107,354

Current liabilities:
 

 

Accounts payable
223,359

259,353

Short-term debt

159,004

Purchased gas adjustment liability
14,479

12,589

Accrued expenses:
 

 

Taxes
135,512

114,854

Salaries and wages
32,380

38,457

Interest
55,749

47,772

       Unrealized loss on derivative instruments
137,230

131,420

       Other
75,473

53,868

Total current liabilities
674,182

817,317

Other long-term and regulatory liabilities:
 

 

Deferred income taxes
1,628,000

1,556,616

Unrealized loss on derivative instruments
30,223

47,776

Regulatory liabilities
641,084

651,094

Other deferred credits
643,895

619,356

Total other long-term and regulatory liabilities
2,943,202

2,874,842

Commitments and contingencies (Note 8)




Total capitalization and liabilities
$
10,817,054

$
10,799,513


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

12


PUGET SOUND ENERGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
(Unaudited)
 
Three Months Ended March 31,
 
2016
2015
Operating activities:
 
 
Net income (loss)
$
156,505

$
129,100

Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 

 
Depreciation and amortization
107,515

106,178

Conservation amortization
33,211

29,604

Deferred income taxes and tax credits, net
71,138

53,381

Net unrealized (gain) loss on derivative instruments
(16,822
)
(3,152
)
AFUDC – equity
(3,321
)
(1,714
)
Funding of pension liability
(4,500
)
(4,500
)
Regulatory assets and liabilities
(49,152
)
(60,706
)
Other long-term assets and liabilities
827

7,968

Change in certain current assets and liabilities:
 

 
Accounts receivable and unbilled revenue
67,858

13,949

Materials and supplies
(22,328
)
(1,810
)
Fuel and gas inventory
13,989

25,880

Taxes
145

150

Prepayments and other
(20,136
)
3,193

Purchased gas adjustment
1,890

26,618

Accounts payable
(26,305
)
(73,901
)
Taxes payable
20,658

17,373

Accrued expenses and other
7,534

(6,308
)
Net cash provided by (used in) operating activities
338,706

261,303

Investing activities:
 

 

Construction expenditures – excluding equity AFUDC
(127,329
)
(117,106
)
Proceeds from disposition of assets

487

Restricted cash
(855
)
16,062

Other
261

2,786

Net cash provided by (used in) investing activities
(127,923
)
(97,771
)
Financing activities:
 

 

Change in short-term debt, net
(159,004
)
(85,000
)
Dividends paid
(67,347
)
(95,624
)
Issuance cost of bonds and other
3,159

(1,895
)
Net cash provided by (used in) financing activities
(223,192
)
(182,519
)
Net increase (decrease) in cash and cash equivalents
(12,409
)
(18,987
)
Cash and cash equivalents at beginning of period
41,856

37,466

Cash and cash equivalents at end of period
$
29,447

$
18,479

Supplemental cash flow information:
 

 

Cash payments for interest (net of capitalized interest)
$
48,982

$
59,135

Cash payments (refunds) for income taxes


Non-cash financing and investing activities:
 
 
Accounts payable for capital expenditures eliminated from cash flows
$
41,899

$
44,657


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

13


COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(1)
Summary of Consolidation Policy

Basis of Presentation
Puget Energy is an energy services holding company that owns PSE.  PSE is a public utility incorporated in the state of Washington that furnishes electric and natural gas services in a territory covering approximately 6,000 square miles, primarily in the Puget Sound region.  Puget Energy is an indirect wholly-owned subsidiary of Puget Holdings, LLC (Puget Holdings).
The consolidated financial statements of Puget Energy reflect the accounts of Puget Energy and its subsidiary, PSE.  PSE’s consolidated financial statements include the accounts of PSE and its subsidiary, Puget Western, Inc.  Puget Energy and PSE are collectively referred to herein as “the Company.”  The consolidated financial statements are presented after elimination of intercompany transactions.  PSE’s consolidated financial statements continue to be accounted for on a historical basis and do not include any purchase accounting adjustments.
The consolidated financial statements contained in this Form 10-Q are unaudited.  In the respective opinions of the management of Puget Energy and PSE, all adjustments necessary for a fair statement of the results for the interim periods have been reflected and were of a normal recurring nature.  These consolidated financial statements should be read in conjunction with the audited financial statements (and the Combined Notes thereto) included in the combined Puget Energy and PSE Annual Report on Form 10-K for the year ended December 31, 2015.
The preparation of financial statements in conformity with U.S. Generally Accepted Accounting Principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period.  Actual results could differ from those estimates.
PSE collected Washington State excise taxes (which are a component of general retail customer rates) and municipal taxes totaling $74.6 million and $69.5 million for the three months ended March 31, 2016 and 2015, respectively.  The Company reports the collection of such taxes on a gross basis in operating revenue and as expense in taxes other than income taxes in the accompanying consolidated statements of income.

Change in Accounting Principle
On January 1, 2016, the Company changed its method of presenting unamortized debt issuance costs in the balance sheet. The new method of presenting debt issuance costs was adopted to comply with ASU 2015-03, "Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs." ASU 2015-03 requires debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the debt liability, consistent with the presentation of a debt discount. The prior year comparative balance sheet has been adjusted to apply the new method retrospectively. Due to the change in accounting principle, the December 31, 2015 financial statement line item “Other long-term assets” decreased and “Debt discount, issuance costs and other” increased $38.4 million and $30.0 million at Puget Energy and PSE, respectively.


(2)  New Accounting Pronouncements

Revenue Recognition
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, "Revenue from Contracts with Customers (Topic 606)", which outlines a single comprehensive model for use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The ASU is based on the principle that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to fulfill a contract.
In August 2015, the FASB issued ASU 2015-14, "Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date," deferring the effective date for ASU 2014-09 to fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. In addition to the FASB's deferral decision, the FASB provided reporting entities with an option to adopt ASU 2014-09 for the fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016, the original effective date.

14


In March 2016, the FASB issued ASU 2016-08, "Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)." The amendments in ASU 2016-08 are intended to improve the operability and understanding of the implementation guidance on principal versus agent considerations. Topic 606 requires an entity to determine whether the nature of its promise is to provide a good or service to the customer (i.e., the entity is a principal) or to arrange for the good or service to be provided to the customer by another party (i.e., the entity is an agent). The effective date and transition requirements for ASU 2016-08 are the same as the effective date and transition requirements of ASU 2014-09.
The Company plans to adopt ASU 2014-09 according to the original effective date.  Reporting entities also have the option of using either a full retrospective or a modified retrospective approach for the adoption of the new standard.  The Company initiated a steering committee and project team to evaluate the impact of this standard, update any policies and procedures that may be affected and implement the new revenue recognition guidance. At this time, the Company cannot determine the impact this standard will have on its consolidated financial statements.

Lease Accounting
In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)." ASU 2016-02 requires lessees to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (i) a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and (ii) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged.
This amendment is effective for financial statements issued for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Earlier adoption is permitted for all entities upon issuance. Reporting entities must apply a modified retrospective approach for the adoption of the new standard.  The Company plans to adopt ASU 2016-02 during the first quarter of fiscal year 2019.  At this time, the Company cannot determine the impact this standard will have on its consolidated financial statements.

Derivatives and Hedging
In March 2016, the FASB issued ASU 2016-06, "Derivatives and Hedging (Topic 815): Contingent Put and Call Options in Debt Instruments." Topic 815 requires that embedded derivatives be separated from the host contract and accounted for separately as derivatives if certain criteria are met, including the “clearly and closely related” criterion. ASU 2016-06 clarifies the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. An entity performing the assessment under the amendment is required to assess the embedded call (put) options solely in accordance with the four-step decision sequence.
This amendment is effective for financial statements issued for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. Earlier adoption is permitted for all entities upon issuance. Reporting entities must apply a modified retrospective approach for the adoption of the new standard.  The Company plans to adopt ASU 2016-06 during the first quarter of fiscal year 2017, and is in the process of evaluating the potential impacts, if any, of this new guidance on its financial statements.


(3)
Accounting for Derivative Instruments and Hedging Activities

PSE employs various energy portfolio optimization strategies, but is not in the business of assuming risk for the purpose of realizing speculative trading revenue. The nature of serving regulated electric customers with its portfolio of owned and contracted electric generation resources exposes PSE and its customers to some volumetric and commodity price risks within the sharing mechanism of the Power Cost Adjustment (PCA). Therefore, wholesale market transactions and PSE's related hedging strategies are focused on reducing costs and risks where feasible, thus reducing volatility in costs in the portfolio. In order to manage its exposure to the variability in future cash flows for forecasted energy transactions, PSE utilizes a programmatic hedging strategy which extends out three years. PSE's energy risk portfolio management function monitors and manages these risks using analytical models and tools. In order to manage risks effectively, PSE enters into forward physical electric and natural gas purchase and sale agreements, fixed-for-floating swap contracts, and commodity call/put options. The forward physical electric agreements are both fixed and variable (at index), while the physical natural gas agreements are variable. To fix the price of wholesale electricity and natural gas, PSE may enter into fixed-for-floating swap (financial) contracts with various counterparties. PSE also utilizes natural gas call and put options as an additional hedging instrument to increase the hedging portfolio's flexibility to react to commodity price fluctuations.

15


The Company manages its interest rate risk through the issuance of mostly fixed-rate debt with varied maturities. The Company utilizes internal cash from operations, borrowings under its commercial paper program and its credit facilities to meet short-term funding needs. The Company may enter into swap instruments or other financial hedge instruments to manage the interest rate risk associated with these debts. As of March 31, 2016, Puget Energy had two interest rate swap contracts outstanding which extend to January 2017. As of the date of this report, these swap instruments are no longer hedging any variable interest rate debt. Management continues to monitor the economics of terminating the swaps, and unless the economics of terminating the swaps become more favorable, management intends to let them mature in January 2017. PSE did not have any outstanding interest rate swap instruments.
The following table presents the volumes, fair values and locations of the Company's derivative instruments recorded on the balance sheets:
Puget Energy and
Puget Sound Energy
 
 
 
 
 
 
 
March 31, 2016
December 31, 2015
(Dollars in Thousands)
Volumes
Assets 1
Liabilities 2
Volumes
Assets 1
Liabilities 2
Interest rate swap derivatives 3
$450 million
$

$
4,349

$450 million
$

$
5,050

Electric portfolio derivatives
*
40,129

111,970

*
23,443

112,106

Natural gas derivatives (MMBtus) 4
333.4 million
7,396

55,484

369.5 million
6,200

67,090

Total derivative contracts
 
$
47,525

$
171,803

 
$
29,643

$
184,246

Current
 
$
39,575

$
141,580

 
$
24,418

$
136,173

Long-term
 
7,950

30,223

 
5,225

48,073

Total derivative contracts
 
$
47,525

$
171,803

 
$
29,643

$
184,246

_______________
1 
Balance sheet locations: Current and Long-term Unrealized gain on derivative instruments.
2 
Balance sheet locations: Current and Long-term Unrealized loss on derivative instruments.
3 
Interest rate swap contracts are only held at Puget Energy.
4 
All fair value adjustments on derivatives relating to the natural gas business have been deferred in accordance with ASC 980, “Regulated Operations,” due to the Purchased Gas Adjustment (PGA) mechanism. The net derivative asset or liability and offsetting regulatory liability or asset are related to contracts used to economically hedge the cost of physical gas purchased to serve natural gas customers.
* 
Electric portfolio derivatives consist of electric generation fuel of 203.6 million One Million British Thermal Units (MMBtu) and purchased electricity of 1.7 million Megawatt Hours (MWhs) at March 31, 2016, and 202.1 million MMBtus and 0.1 million MWhs at December 31, 2015.

For further details regarding the fair value of derivative instruments, see Note 4.

It is the Company's policy to record all derivative transactions on a gross basis at the contract level, without offsetting assets or liabilities. The Company generally enters into transactions using the following master agreements: WSPP, Inc. (WSPP) agreements, which standardize physical power contracts; International Swaps and Derivatives Association (ISDA) agreements, which standardize financial gas and electric contracts; and North American Energy Standards Board (NAESB) agreements, which standardize physical gas contracts. The Company believes that such agreements reduce credit risk exposure because such agreements provide for the netting and offsetting of monthly payments as well as the right of set-off in the event of counterparty default. The set-off provision can be used as a final settlement of accounts which extinguishes the mutual debts owed between the parties in exchange for a new net amount.

16


The following tables present the potential effect of netting arrangements, including rights of set-off associated with the Company's derivative assets and liabilities:
Puget Energy and
Puget Sound Energy
 
 
 
 
March 31, 2016
 
Gross Amount Recognized in the Statement of Financial Position 1
Gross Amounts Offset in the Statement of Financial Position
Net of Amounts Presented in the Statement of Financial Position
Gross Amounts Not Offset in the Statement of Financial Position
 

(Dollars in Thousands)
Commodity Contracts
Cash Collateral Received/Posted
Net Amount
Assets:
 
 
 
 
 
 
Energy derivative contracts
$
47,525

$

$
47,525

$
(38,846
)
$

$
8,679

Liabilities:
 
 
 
 
 
 
Energy derivative contracts
167,454


167,454

(38,846
)

128,608

Interest rate swaps 2
4,349


4,349



4,349

 
 
 
 
 
 
 
Puget Energy and
Puget Sound Energy
 
 
 
 
December 31, 2015
 
Gross Amount Recognized in the Statement of Financial Position 1
Gross Amounts Offset in the Statement of Financial Position
Net of Amounts Presented in the Statement of Financial Position
Gross Amounts Not Offset in the Statement of Financial Position
 

(Dollars in Thousands)
Commodity Contracts
Cash Collateral Received/Posted
Net Amount
Assets:
 
 
 
 
 
 
Energy derivative contracts
$
29,643

$

$
29,643

$
(23,998
)
$

$
5,645

Liabilities:
 
 
 
 
 
 
Energy derivative contracts
179,196


179,196

(23,998
)

155,198

Interest rate swaps 2
5,050


5,050



5,050

_______________
1 
All derivative contract deals are executed under ISDA, NAESB and WSPP master netting agreements with right of set-off.
2 
Interest rate swap contracts are only held at Puget Energy.







17


The following tables present the effect and locations of the Company's derivatives not designated as hedging instruments, recorded on the statements of income:
Puget Energy
 
Three Months Ended March 31,
(Dollars in Thousands)
Location
2016
2015
Interest rate contracts:
Non-hedged interest rate swap
(expense) income
$
(855
)
$
(1,975
)
 
Interest expense

(162
)
Commodity contracts:
 
 
 

Electric derivatives
Unrealized gain (loss) on derivative instruments, net 1
16,822

3,696

 
Electric generation fuel
(20,683
)
(10,662
)
 
Purchased electricity
(11,219
)
(21,884
)
Total gain (loss) recognized in income on derivatives
 
$
(15,935
)
$
(30,987
)

Puget Sound Energy
 
Three Months Ended March 31,
(Dollars in Thousands)
Location
2016
2015
Commodity contracts:
 
 
 
Electric derivatives
Unrealized gain (loss) on derivative instruments, net 1
$
16,822

$
3,152

 
Electric generation fuel
(20,683
)
(10,662
)
 
Purchased electricity
(11,219
)
(21,884
)
Total gain (loss) recognized in income on derivatives
 
$
(15,080
)
$
(29,394
)
_______________
1 
Differences between Puget Energy and PSE for the three months ending March 31, 2015 are due to certain derivative contracts recorded at fair value in 2009 and subsequently designated as Normal Purchase Normal Sale (NPNS) or cash flow hedges. These differences occurred through February 2015.

The unrealized gain or loss on derivative contracts is reported in the statement of cash flows under the operating activities section. However, due to purchase accounting requirements, all derivative contracts at Puget Energy were assessed to identify contracts that have a “more than an insignificant” fair value. If the fair value was greater than 10% of the notional value, the contract was deemed as having a financing element. For those contracts, the cash inflows (outflows) are presented in the financing activities section of the statement of cash flows. As of February 2015, all derivative contracts having a financing element have settled.
For derivative instruments previously designated as cash flow hedges (including both commodity contracts and interest rate swaps), the effective portion of the gain or loss on the derivative was recorded as a component of Other Comprehensive Income (OCI), and then reclassified into earnings in the same period(s) during which the hedged transaction affected earnings. As of March 31, 2015, all purchased electricity derivative losses at Puget Energy and PSE, previously recorded in OCI, have been reclassified into earnings. The Company does not attempt cash flow hedging for any new transactions and records all mark-to-market adjustments through earnings.
The Company is exposed to credit risk primarily through buying and selling electricity and natural gas to serve its customers. Credit risk is the potential loss resulting from a counterparty's non-performance under an agreement. The Company manages credit risk with policies and procedures for, among other things, counterparty credit analysis, exposure measurement, exposure monitoring and exposure mitigation.
The Company monitors counterparties that have significant swings in credit default swap rates, have credit rating changes by external rating agencies, have changes in ownership or are experiencing financial distress. Where deemed appropriate, the Company may request collateral or other security from its counterparties to mitigate potential credit default losses. Criteria employed in this decision include, among other things, the perceived creditworthiness of the counterparty and the expected credit exposure.
It is possible that volatility in energy commodity prices could cause the Company to have material credit risk exposure with one or more counterparties. If such counterparties fail to perform their obligations under one or more agreements, the Company could suffer a material financial loss. However, as of March 31, 2016, approximately 97.5% of the Company's energy portfolio exposure, excluding NPNS transactions, is with counterparties that are rated at least investment grade by rating agencies and 2.5%

18


are either rated below investment grade or not rated by rating agencies. The Company assesses credit risk internally for counterparties that are not rated by the major rating agencies.
The Company computes credit reserves at a master agreement level by counterparty. The Company considers external credit ratings and market factors, such as credit default swaps and bond spreads, in the determination of reserves. The Company recognizes that external ratings may not always reflect how a market participant perceives a counterparty's risk of default. The Company uses both default factors published by Standard & Poor's and factors derived through analysis of market risk, which reflect the application of an industry standard recovery rate. The Company selects a default factor by counterparty at an aggregate master agreement level based on a weighted average default tenor for that counterparty's deals. The default tenor is determined by weighting the fair value and contract tenors for all deals for each counterparty to derive an average value. The default factor used is dependent upon whether the counterparty is in a net asset or a net liability position after applying the master agreement levels.
The Company applies the counterparty's default factor to compute credit reserves for counterparties that are in a net asset position. The Company calculates a non-performance risk on its derivative liabilities by using its estimated incremental borrowing rate over the risk-free rate. Credit reserves are netted against the unrealized gain (loss) positions. As of March 31, 2016, the Company was in a net liability position with many of its counterparties, so the default factors of counterparties did not have a significant impact on reserves for the period. The majority of the Company's derivative contracts are with financial institutions and other utilities operating within the Western Electricity Coordinating Council. As of March 31, 2016, PSE has posted a $1.0 million letter of credit as a condition of transacting on a physical energy exchange and clearinghouse in Canada. PSE did not trigger any collateral requirements with any of its counterparties during the quarter ended March 31, 2016, nor were any of PSE's counterparties required to post collateral resulting from credit rating downgrades.
The table below presents the fair value of the overall contractual contingent liability positions for the Company's derivative activity at March 31, 2016:
Puget Energy and
Puget Sound Energy
 
 
 
(Dollars in Thousands)
 
 
 
 
Fair Value 1
Posted
Contingent
Contingent Feature
Liability
Collateral
Collateral
Credit rating 2
$
(15,189
)
$

$
15,189

Requested credit for adequate assurance
(55,059
)


Total
$
(70,248
)
$

$
15,189

_______________
1 
Represents the derivative fair value of contracts with contingent features for counterparties in net derivative liability positions. Excludes NPNS, accounts payable and accounts receivable.
2 
Failure by PSE to maintain an investment grade credit rating from each of the major credit rating agencies provides counterparties a contractual right to demand collateral.


(4)
Fair Value Measurements

ASC 820 established a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy categorizes the inputs into three levels with the highest priority given to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority given to unobservable inputs (Level 3 measurement). The three levels of the fair value hierarchy are as follows:

Level 1 - Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Level 1 primarily consists of financial instruments such as exchange-traded derivatives and listed equities. Equity securities that are also classified as cash equivalents are considered Level 1 if there are unadjusted quoted prices in active markets for identical assets or liabilities.

Level 2 - Pricing inputs are other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reporting date. Level 2 includes those financial instruments that are valued using models or other valuation methodologies. Instruments in this category include non-exchange-traded derivatives such as over-the-counter forwards and options.


19


Level 3 - Pricing inputs include significant inputs that have little or no observability as of the reporting date. These inputs may be used with internally developed methodologies that result in management's best estimate of fair value.

Financial assets and liabilities measured at fair value are classified in their entirety in the appropriate fair value hierarchy based on the lowest level of input that is significant to the fair value measurement. The Company's assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy. The Company primarily determines fair value measurements classified as Level 2 or Level 3 using a combination of the income and market valuation approaches. The process of determining the fair values is the responsibility of the derivative accounting department which reports to the Controller and Principal Accounting Officer. Inputs used to estimate the fair value of forwards, swaps and options include market-price curves, contract terms and prices, credit-risk adjustments, and discount factors. Additionally, for options, the Black-Scholes option valuation model and implied market volatility curves are used. Inputs used to estimate fair value in industry-standard models are categorized as Level 2 inputs as substantially all assumptions and inputs are observable in active markets throughout the full term of the instruments. On a daily basis, the Company obtains quoted forward prices for the electric and natural gas markets from an independent external pricing service. For interest rate swaps, the Company obtains monthly market values from an independent external pricing service using London Interbank Offered Rate (LIBOR) forward rates, which is a significant input. Some of the inputs of the interest rate swap valuations, which are less significant, include the credit standing of the counterparties, assumptions for time value and the impact of the Company's nonperformance risk of its liabilities. The Company classifies cash and cash equivalents, and restricted cash as Level 1 financial instruments due to cash being at stated value, and cash equivalents at quoted market prices.
The Company considers its electric, natural gas and interest rate swap contracts as Level 2 derivative instruments as such contracts are commonly traded as over-the-counter forwards with indirectly observable price quotes. However, certain energy derivative instruments with maturity dates falling outside the range of observable price quotes are classified as Level 3 in the fair value hierarchy. Management's assessment is based on the trading activity in real-time and forward electric and natural gas markets. Each quarter, the Company confirms the validity of pricing-service quoted prices used to value Level 2 commodity contracts with the actual prices of commodity contracts entered into during the most recent quarter.

Assets and Liabilities with Estimated Fair Value

The following table presents the carrying value for cash, cash equivalents, restricted cash, notes receivable and short-term debt by fair value hierarchy level. The carrying values below are representative of fair values due to the short-term nature of these financial instruments.
 
Carrying / Fair Value
Carrying / Fair Value
Puget Energy
At March 31, 2016
At December 31, 2015
(Dollars in Thousands)
Level 1
Level 2
     Total
Level 1
Level 2
     Total
Assets:
 
 
 
 
 
 
Cash and cash equivalents
$
30,041

$

$
30,041

$
42,494

$

$
42,494

Restricted cash
8,804


8,804

7,949


7,949

Other investments

52,976

52,976


52,820

52,820

Total assets
$
38,845

$
52,976

$
91,821

$
50,443

$
52,820

$
103,263

Liabilities:
 
 
 
 
 
 
Short-term debt
$

$

$

$
159,004

$

$
159,004

Total liabilities
$

$

$

$
159,004

$

$
159,004



20


 
Carrying / Fair Value
Carrying / Fair Value
Puget Sound Energy
At March 31, 2016
At December 31, 2015
(Dollars in Thousands)
Level 1
Level 2
     Total
Level 1
Level 2
     Total
Assets:
 
 
 
 
 
 
Cash and cash equivalents
$
29,447

$

$
29,447

$
41,856

$

$
41,856

Restricted cash
8,804


8,804

7,949


7,949

Other investments

52,976

52,976


52,820

52,820

Total assets
$
38,251

$
52,976

$
91,227

$
49,805

$
52,820

$
102,625

Liabilities:
 
 
 
 
 
 
Short-term debt
$

$

$

$
159,004

$

$
159,004

Total liabilities
$

$

$

$
159,004

$

$
159,004


The fair value of the junior subordinated and long-term notes was estimated using the discounted cash flow method with the U.S. Treasury yields and the Company's credit spreads as inputs, interpolating to the maturity date of each issue. Carrying values and estimated fair values were as follows:
Puget Energy
 
March 31, 2016
December 31, 2015
(Dollars in Thousands)
Level
Carrying
Value
Fair
Value
Carrying
Value
Fair
Value
Liabilities:
 
 
 
 
 
Junior subordinated notes
2
$
250,000

$
204,257

$
250,000

$
211,173

Long-term debt (fixed-rate), net of discount
2
5,081,043

6,579,402

5,077,518

6,308,831

Total liabilities
 
$
5,331,043

$
6,783,659

$
5,327,518

$
6,520,004

 
 
 
 
 
 
Puget Sound Energy
 
March 31, 2016
December 31, 2015
(Dollars in Thousands)
Level
Carrying
Value
Fair
Value
Carrying
Value
Fair
Value
Liabilities:
 
 
 
 
 
Junior subordinated notes
2
$
250,000

$
204,257

$
250,000

$
211,173

Long-term debt (fixed-rate), net of discount
2
3,495,101

4,549,659

3,494,362

4,329,444

Total liabilities
 
$
3,745,101

$
4,753,916

$
3,744,362

$
4,540,617


21



Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following tables present the Company's financial assets and liabilities by level, within the fair value hierarchy, that were accounted for at fair value on a recurring basis:
 
Fair Value
Fair Value
Puget Energy
At March 31, 2016
At December 31, 2015
(Dollars in Thousands)
Level 2
Level 3
Total
Level 2
Level 3
Total
Liabilities:
 
 
 
 
 
 
Interest rate derivative instruments
$
4,349

$

$
4,349

$
5,050

$

$
5,050

Total liabilities
$
4,349

$

$
4,349

$
5,050

$

$
5,050


Puget Energy and
Fair Value
Fair Value
Puget Sound Energy
At March 31, 2016
At December 31, 2015
(Dollars in Thousands)
Level 2
Level 3
Total
Level 2
Level 3
Total
Assets:
 
 
 
 
 
 
Electric derivative instruments
$
21,513

$
18,616

$
40,129

$
10,709

$
12,734

$
23,443

Natural gas derivative instruments
5,337

2,059

7,396

4,538

1,662

6,200

Total assets
$
26,850

$
20,675

$
47,525

$
15,247

$
14,396

$
29,643

Liabilities:
 

 

 

 

 

 

Electric derivative instruments
$
94,956

$
17,014

$
111,970

$
92,027

$
20,079

$
112,106

Natural gas derivative instruments
51,803

3,681

55,484

63,045

4,045

67,090

Total liabilities
$
146,759

$
20,695

$
167,454

$
155,072

$
24,124

$
179,196


The following table presents the Company's reconciliation of the changes in the fair value of Level 3 derivatives in the fair value hierarchy:
Puget Energy and
Puget Sound Energy
Three Months Ended March 31,
(Dollars in Thousands)
2016
2015
Level 3 Roll-Forward Net Asset/(Liability)
Electric
Natural Gas
Total
Electric
Natural Gas
Total
Balance at beginning of period
$
(7,345
)
$
(2,383
)
$
(9,728
)
$
(12,062
)
$
(2,040
)
$
(14,102
)
Changes during period:
 
 
 
 
 
 
Realized and unrealized energy derivatives:
 
 
 
 
 
 
Included in earnings 1
4,608


4,608

(5,037
)

(5,037
)
Included in regulatory assets / liabilities

1,519

1,519


125

125

Settlements
(60
)
(937
)
(997
)
113

91

204

Transferred into Level 3
(2,080
)

(2,080
)
(787
)

(787
)
Transferred out of Level 3
6,479

179

6,658

1,682

223

1,905

Balance at end of period
$
1,602

$
(1,622
)
$
(20
)
$
(16,091
)
$
(1,601
)
$
(17,692
)
_______________
1 
Income Statement locations: Unrealized (gain) loss on derivative instruments, net. Includes unrealized gains (losses) on derivatives still held in position as of the reporting date for electric derivatives of $5.7 million and $(5.0) million for the three months ended March 31, 2016 and 2015, respectively.

Realized gains and losses on energy derivatives for Level 3 recurring items are included in energy costs in the Company's consolidated statements of income under purchased electricity, electric generation fuel or purchased natural gas when settled. Unrealized gains and losses on energy derivatives for Level 3 recurring items are included in net unrealized (gain) loss on derivative instruments in the Company's consolidated statements of income.

22


In order to determine which assets and liabilities are classified as Level 3, the Company receives market data from its independent external pricing service defining the tenor of observable market quotes. To the extent any of the Company's commodity contracts extend beyond what is considered observable as defined by its independent pricing service, the contracts are classified as Level 3. The actual tenor of what the independent pricing service defines as observable is subject to change depending on market conditions. Therefore, as the market changes, the same contract may be designated Level 3 one month and Level 2 the next, and vice versa. The changes of fair value classification into or out of Level 3 are recognized each month, and reported in the Level 3 Roll-Forward table above. The Company did not have any transfers between Level 2 and Level 1 during the reported periods. The Company does periodically transact at locations, or market price points, that are illiquid or for which no prices are available from the independent pricing service. In such circumstances, the Company uses a more liquid price point and performs a 15-month regression against the illiquid locations to serve as a proxy for market prices. Such transactions are classified as Level 3. The Company does not use internally developed models to make adjustments to significant unobservable pricing inputs.
The only significant unobservable input into the fair value measurement of the Company's Level 3 assets and liabilities is the forward price for electric and natural gas contracts. The following table presents the forward price ranges for the Company's Level 3 commodity contracts as of March 31, 2016:
 
Fair Value
 
 
Range
 
(Dollars in Thousands)
Assets 1
Liabilities 1
Valuation Technique
Unobservable Input
Low
High
 Weighted Average
Electric
$
18,616

$
17,014

Discounted cash flow
Power Prices
$9.83 per MWh
$27.57 per MWh
$22.27 per MWh
Natural gas
$
2,059

$
3,681

Discounted cash flow
Natural Gas Prices
$0.19 per MMBtu
$3.01 per MMBtu
$2.55 per MMBtu
_______________
1 
The valuation techniques, unobservable inputs and ranges are the same for asset and liability positions.

The following table presents the forward price ranges for the Company's Level 3 commodity contracts as of December 31, 2015:
 
Fair Value
 
 
Range
 
(Dollars in Thousands)
Assets 1
Liabilities 1
Valuation Technique
Unobservable Input
Low
High
 Weighted Average
Electric
$
12,734

$
20,079

Discounted cash flow
Power Prices
$10.69 per MWh
$29.18 per MWh
$23.39 per MWh
Natural gas
$
1,662

$
4,045

Discounted cash flow
Natural Gas Prices
$1.12 per MMBtu
$2.95 per MMBtu
$2.25 per MMBtu
_______________
1 
The valuation techniques, unobservable inputs and ranges are the same for asset and liability positions.

The significant unobservable inputs listed above would have a direct impact on the fair values of the above instruments if they were adjusted. Consequently, significant increases or decreases in the forward prices of electricity or natural gas in isolation would result in a significantly higher or lower fair value for Level 3 assets and liabilities. Generally, interrelationships exist between market prices of natural gas and power. As such, an increase in natural gas pricing would potentially have a similar impact on forward power markets. At March 31, 2016 and December 31, 2015, a hypothetical 10% increase or decrease in market prices of natural gas and electricity would change the fair value of the Company's derivative portfolio, classified as Level 3 within the fair value hierarchy, by $1.0 million and $1.3 million, respectively.

Long-Lived Assets Measured at Fair Value on a Nonrecurring Basis

Puget Energy records fair value of its intangible assets in accordance with ASC 360, “Property, Plant, and Equipment,” (ASC 360). The fair value assigned to the power contracts was determined using an income approach comparing the contract rate to the market rate for power over the remaining period of the contracts incorporating non-performance risk. Management also incorporated certain assumptions related to quantities and market presentation that it believes market participants would make in the valuation. The fair value of the power contracts is amortized as the contracts settle.

23


ASC 360 requires long-lived assets to be tested for impairment on an annual basis, and upon the occurrence of any events or circumstances that would be more likely than not to reduce the fair value of the long-lived assets below their carrying value. One such triggering event is a significant decrease in the forward market prices of power.
At March 31, 2016, Puget Energy completed valuation and impairment testing of its power purchase contracts classified as intangible assets. Due to decreases in forward power prices of 8.6% at March 31, 2016 and 4.5% at December 31, 2015, the following impairments were recorded to one of the Company's intangible asset contracts, with corresponding reductions to the regulatory liability as follows:
Intangible Asset Contract
 
(Dollars in Thousands)
 
 
 
 
Valuation Date
Contract Name
Carrying Value
Fair Value
Write Down
March 31, 2016
Wells Hydro
$
25,193

$
19,855

$
5,338

December 31, 2015
Wells Hydro
32,988

27,628

5,360


The valuations were measured using a discounted cash flow, income-based valuation methodology. Significant inputs included forward electricity prices and power contract pricing which provided future net cash flow estimates which are classified as Level 3 within the fair value hierarchy. A less significant input is the discount rate reflective of PSE's cost of capital used in the valuation.
Below are significant unobservable inputs used in estimating the impaired long term power purchase contracts' fair value at March 31, 2016 and December 31, 2015:
Valuation Date
Unobservable Input
Low
High
Average
March 31, 2016
 
 
 
 
 
Power prices
$9.46 per MWh
$25.96 per MWh
$21.38 per MWh
 
Power contract costs (in thousands)
$4,100 per qtr
$4,659 per qtr
$4,452 per qtr
December 31, 2015
 
 
 
 
 
Power prices
$15.16 per MWh
$27.25 per MWh
$23.23 per MWh
 
Power contract costs (in thousands)
$4,100 per qtr
$4,659 per qtr
$4,417 per qtr


(5)
Retirement Benefits

PSE has a defined benefit pension plan (Qualified Pension Benefits) covering the largest portion of PSE employees.  Pension benefits earned are a function of age, salary, years of service and, in the case of employees in the cash balance formula plan, the applicable annual interest crediting rates.  Starting with January 1, 2014 all newly hired non-represented employees, United Association of Journeymen and Apprentices of the Plumbing and Pipe Fitting Industry (UA) employees, and International Brotherhood of Electrical Workers Local Union 77 (IBEW) employees hired on or after December 12, 2014 will receive annual pay credits of 4% each year, which is the Company contribution. Non-represented and IBEW employees can accumulate the Company contribution in the cash balance formula or the 401(k) plan. UA employees will automatically receive the Company contribution in the cash balance formula plan. They will also receive interest credits like other participants in the cash balance pension formula of the pension plan, which are at least 1% per quarter. When an employee with a vested cash balance formula benefit leaves PSE, he or she will have annuity and lump sum options for distribution. Those who select the lump sum option will receive their current cash balance amount. PSE also maintains a non-qualified Supplemental Executive Retirement Plan (SERP) for its key senior management employees.
In addition to providing pension benefits, PSE provides legacy group health care and life insurance benefits (Other Benefits) for certain retired employees.  These benefits are provided principally through an insurance company.  The insurance premiums, paid primarily by retirees, are based on the benefits provided during the prior year.
Puget Energy records purchase accounting adjustments associated with the re-measurement of the retirement plans.

24


The following tables summarize the Company’s net periodic benefit cost for the three months ended March 31, 2016 and 2015:
Puget Energy
Qualified
Pension Benefits
SERP
Pension Benefits
Other
Benefits
 
Three Months Ended March 31,
(Dollars in Thousands)
2016
2015
2016
2015
2016
2015
Components of net periodic benefit cost:
 
 
 
 
 
 
Service cost
$
4,604

$
5,472

$
271

$
277

$
25

$
33

Interest cost
7,226

7,107

581

570

156

161

Expected return on plan assets
(11,687
)
(11,402
)


(111
)
(133
)
Amortization of prior service cost
(495
)
(495
)
11

11



Amortization of net loss (gain)

981

228

410

(29
)
(15
)
Net periodic benefit cost
$
(352
)
$
1,663

$
1,091

$
1,268

$
41

$
46


Puget Sound Energy
Qualified
SERP
Other
Pension Benefits
Pension Benefits
Benefits
 
Three Months Ended March 31,
(Dollars in Thousands)
2016
2015
2016
2015
2016
2015
Components of net periodic benefit cost:
 

 

 

 

 

 

Service cost
$
4,604

$
5,472

$
271

$
277

$
25

$
33

Interest cost
7,226

7,107

581

570

156

161

Expected return on plan assets
(11,736
)
(11,508
)


(111
)
(133
)
Amortization of prior service cost
(393
)
(393
)
11

11


1

Amortization of net loss (gain)
3,740

5,136

333

530

(90
)
(83
)
Net periodic benefit cost
$
3,441

$
5,814

$
1,196

$
1,388

$
(20
)
$
(21
)


25


The following table summarizes the Company’s change in benefit obligation for the periods ended March 31, 2016 and December 31, 2015:
Puget Energy and
Puget Sound Energy
Qualified
Pension Benefits
SERP
Pension Benefits
Other
Benefits
 
Three Months Ended
Year
Ended
Three Months Ended
Year
Ended
Three Months Ended
Year
Ended
(Dollars in Thousands)
March 31,
2016
December 31,
2015
March 31,
2016
December 31,
2015
March 31,
2016
December 31,
2015
Change in benefit obligation:
 
 
 
 
 
 
Benefit obligation at beginning of period
$
643,088

$
690,194

$
51,279

$
55,855

$
13,946

$
15,688

Service cost
4,604

21,287

271

1,108

25

112

Interest cost
7,226

28,088

581

2,281

156

621

Actuarial loss (gain)

(55,665
)

(4,430
)

(1,416
)
Benefits paid
(10,324
)
(39,963
)
(1,078
)
(3,535
)
(332
)
(1,354
)
Medicare part D subsidy received




5

295

Administrative Expense

(853
)




Benefit obligation at end of period
$
644,594

$
643,088

$
51,053

$
51,279

$
13,800

$
13,946


The aggregate expected contributions by the Company to fund the qualified pension plan, SERP and the other postretirement plans for the year ending December 31, 2016 are expected to be at least $18.0 million, $2.5 million and $0.5 million, respectively. During the three months ended March 31, 2016, the Company contributed $4.5 million, $1.1 million and $0.2 million to fund the qualified pension plan, SERP and other postretirement plan, respectively.
 

(6)
Regulation and Rates

Decoupling Filings
While fluctuations in weather conditions will continue to affect PSE's billed revenue and energy supply expenses from month to month, PSE's decoupling mechanisms are expected to mitigate the impact of weather on operating revenue and net income. The Washington Commission has allowed PSE to record a monthly adjustment to its electric and natural gas operating revenues related to electric transmission and distribution, natural gas operations and general administrative costs from residential, commercial and industrial customers to mitigate the effects of abnormal weather, conservation impacts and changes in usage patterns per customer with the exception of the electric business where PCA is not part of the decoupling mechanism. As a result, these electric and natural gas revenues will be recovered on a per customer basis regardless of actual consumption levels. The energy supply costs, which are part of the PCA and PGA mechanisms, are not included in the decoupling mechanism. The revenue recorded under the decoupling mechanisms will be affected by customer growth and not actual consumption. Following each calendar year, PSE will recover or refund the difference between allowed decoupling revenue and the corresponding actual revenue to affected customers over a 12-month period beginning the following May. The decoupling mechanism will end on December 31, 2017 unless the continuation of the mechanism is approved in PSE's next GRC filing, which PSE is required to submit by January 17, 2017 at the latest.
On April 22, 2015, the Washington Commission approved PSE's request to change rates under its electric and natural gas decoupling mechanism, effective May 1, 2015. As part of this filing, PSE also requested to change the methodology of how decoupling deferrals are calculated going forward and adjust deferrals calculated in 2014. The change was done to ensure that the amortization of prior years’ accumulated decoupling deferrals were not included in the calculation of the current year decoupling deferrals. The effect of the methodology change was a reduction of approximately $12.0 million previously recognized revenue from May through December of 2014. The overall changes represent a rate increase for electric customers of $53.8 million, or 2.6%, annually, and a rate increase for natural gas customers of $22.0 million, or 2.1%, annually, effective May 1, 2015. In addition, PSE exceeded the earnings test threshold for its natural gas business in 2014. As a result, PSE recorded a reduction in natural gas decoupling deferral and revenue of $1.3 million. This was reflected as a reduction to the natural gas rate increases noted above. As noted earlier, the Company is also limited to a 3.0% annual decoupling related cap on increases in total revenue.  This limitation was triggered for certain rate classes. The resulting amount of deferral that was not included in the 2015 rate increase is $1.9

26


million for electric revenue and $8.2 million for natural gas revenue that was accrued through December 31, 2014. These amounts may be included in customer rates beginning in May 2016, subject to subsequent application of the earnings test and the 3.0% cap on decoupling related rate increases.  

General Rate Case Filing Postponed to 2017
On March 17, 2016, the Washington Commission approved a joint petition postponing the filing of PSE’s GRC until no later than January 17, 2017. All parties to PSE's 2011 GRC, including Public Counsel, Washington Commission Staff, Industrial Customers of Northwest Utilities (ICNU) and Northwest Industrial Gas Users (NWIGU), either supported the petition or did not oppose it. As part of the petition, PSE agreed to update power costs on December 1, 2016 in conjunction with the Centralia PPA compliance filing and to include in the GRC a filing regarding its interest in Colstrip Units 1 and 2. Monthly allowed revenue per customer values, which includes an automatic annual increase, will continue through December 2017 until new rates go into effect from PSE's 2017 GRC.

Electric Regulation and Rates
Storm Damage Deferral Accounting
The Washington Commission issued a GRC order that defined deferrable catastrophic/extraordinary losses and provided that costs in excess of $8.0 million annually can be recorded as a regulatory asset for qualifying storm damage costs that meet the Institute of Electrical and Electronics Engineers (IEEE) threshold criteria for a major event. For the three months ended March 31, 2016 and 2015, PSE incurred $16.7 million and $2.4 million, respectively, in storm-related electric transmission and distribution system restoration costs, of which $7.6 million was recorded as a regulatory asset in 2016 and $0.2 million in 2015.

Electric Property Tax Tracker Mechanism
The purpose of the property tax tracker mechanism is to pass through the cost of all property taxes incurred by the Company. The mechanism was implemented in 2013 and removed property taxes from general rates and included those costs as a component rate. After the implementation, the mechanism acts as a tracker rate schedule and collects the total amount of property taxes assessed. The tracker will be adjusted each year in May based on that year's assessed property taxes and true-ups to the rate from the prior year.
The following table sets forth property tax tracker mechanism rate adjustments approved by the Washington Commission and the corresponding impact on PSE’s revenue based on the effective dates:
Effective Date
Average
Percentage
Increase (Decrease)
in Rates
Increase (Decrease)
in Revenue
(Dollars in Millions)
May 1, 2016
0.3%
$5.7
May 1, 2015
0.4
8.4

Electric Conservation Rider
The electric conservation rider collects revenue to cover the costs incurred in providing services and programs for conservation. Rates change annually on May 1 to collect the annual budget that started the prior January.
The following table sets forth conservation rider rate adjustments approved by the Washington Commission and the corresponding impact on PSE’s revenue based on the effective dates:
Effective Date
Average
Percentage
Increase (Decrease)
in Rates
Increase (Decrease)
in Revenue
(Dollars in Millions)
May 1, 2016
(0.5)%
$(11.7)
May 1, 2015
0.2
4.2

Federal Incentive Tracker Tariff
The Federal Incentive Tracker Tariff passes through to customers the benefits associated with treasury grants received by the Company and production tax credits (PTCs). The filing results in a credit back to customers for pass-back of treasury grant

27


amortization and pass-through of interest and any related true-ups. The filing is adjusted annually for new Federal benefits, actual versus forecast interest and to true-up for actual load being different than the forecasted load set in rates.
The following table sets forth Federal Incentive Tracker Tariff rate adjustments approved by the Washington Commission and the corresponding impact on PSE’s revenue based on the effective dates:
Effective Date
Average
Percentage
Increase (Decrease)
in Rates
Total credit to be passed back to eligible customers
(Dollars in Millions)
January 1, 2016
(0.2)%
$(57.3)
January 1, 2015
(0.2)
(55.2)

Gas Regulation and Rates
Gas General Rate Cases and Other Filings Affecting Rates

Gas Conservation Rider
The gas conservation rider collects revenue to cover the costs incurred in providing services and programs for conservation. Rates change annually on May 1 to collect the annual budget that started the prior January.
The following table sets forth conservation rider rate adjustments approved by the Washington Commission and the corresponding impact on PSE’s revenue based on the effective dates:
 
Effective Date
Average
Percentage
Increase (Decrease)
in Rates
Increase (Decrease)
in Revenue
(Dollars in Millions)
 
 
 
 
May 1, 2016
0.3%
$2.9
 
May 1, 2015
0.2
2.3

Cost Recovery Mechanism
The purpose of the Cost Recovery Mechanism (CRM) is to recover capital costs related to enhancing the safety of the natural gas distribution system.
The following table sets forth CRM rate adjustments approved by the Washington Commission and the corresponding impact on PSE’s revenue based on the effective dates:
Effective Date
Average
Percentage
Increase (Decrease)
in Rates
Increase (Decrease)
in Revenue
(Dollars in Millions)
November 1, 2015
0.5%
$5.3

Property Tax Tracker Mechanism
The purpose of the property tax tracker mechanism is to pass through the cost of all property taxes incurred by the Company. The mechanism was implemented in 2013 and removed property taxes from general rates and included those costs as a component rate. After the implementation, the mechanism acts as a tracker rate schedule and collects the total amount of property taxes assessed. The tracker will be adjusted each year in May based on that year's assessed property taxes.

28


The following table sets forth property tax tracker mechanism rate adjustments approved by the Washington Commission and the corresponding impact on PSE’s revenue based on the effective dates:
Effective Date
Average
Percentage
Increase (Decrease)
in Rates
Increase (Decrease)
in Revenue
(Dollars in Millions)
May 1, 2016
0.4%
$3.5
June 1, 2015
(0.2)
(2.3)

Purchased Gas Adjustment
PSE has a PGA mechanism that allows PSE to recover expected natural gas supply and transportation costs and defer, as a receivable or liability, any natural gas supply and transportation costs that exceed or fall short of this expected natural gas cost amount in PGA mechanism rates, including accrued interest. PSE is authorized by the Washington Commission to accrue carrying costs on PGA receivable and payable balances. A receivable or payable balance in the PGA mechanism reflects an under recovery or over recovery, respectively, of natural gas cost through the PGA mechanism.
The following table sets forth PGA rate adjustments approved by the Washington Commission and the corresponding impact on PSE’s revenue based on the effective dates:
Effective Date
Average
Percentage
Increase (Decrease)
in Rates
Increase (Decrease)
in Revenue
(Dollars in Millions)
November 1, 2015
(17.4)%
$(185.9)


(7)
Asset Retirement Obligation

The Company has recorded liabilities for steam generation sites, combustion turbine generation sites, combined cycle generation sites, wind generation sites, distribution and transmission poles, gas mains, and leased facilities where disposal is governed by ASC 410 “Asset Retirement and Environmental Obligations (ARO)”.
On April 17, 2015, the U.S. Environmental Protection Agency (EPA) published a final rule, effective October 19, 2015, that regulates Coal Combustion Residuals (CCR) under the Resource Conservation and Recovery Act, Subtitle D. The CCR rule addresses the risks from coal ash disposal, such as leaking of contaminants into ground water, blowing of contaminants into the air as dust, and the catastrophic failure of coal ash surface impoundments by establishing technical requirements for CCR landfills and surface impoundments. The rule also sets out recordkeeping and reporting requirements including requirements to post specific information to a publicly-accessible website.
The CCR rule requires significant changes to the Company’s Colstrip, Montana coal-fired steam electric generation facility
(Colstrip) operations and those changes were reviewed by the Company and the plant operator in the second and third quarter of 2015. PSE had previously recognized a legal obligation under the EPA rules to dispose of coal ash material at Colstrip, in 2003. Due to the CCR rule, additional disposal costs were added to the ARO.
The actual ARO costs related to the CCR rule requirements may vary substantially from the estimates used to record the increased obligation due to uncertainty about the compliance strategies that will be used and the preliminary nature of available
data used to estimate costs. We will continue to gather additional data and coordinate with the plant operator to make decisions
about compliance strategies and the timing of closure activities. As additional information becomes available, the Company will update the ARO obligation for these changes, which could be material.
The Company updated its estimated decommissioning costs and timing of its ARO for Lower Snake River and Hopkins Ridge wind generation sites and increased the ARO liability by $19.7 million.

29


The following table describes the changes to the Company’s ARO for the three months ended March 31, 2016:
Puget Sound Energy
 
(Dollars in Thousands)
Changes in ARO
Balance at December 31, 2015
$
85,028

New asset retirement obligation recognized in the period

Liability adjustments
(412
)
Revisions in estimated cash flows
16,854

Accretion expense
544

Balance at March 31, 2016
$
102,014



(8)
Commitment and Contingencies

Colstrip
PSE has a 50% ownership interest in Colstrip Units 1 and 2, and a 25% interest in Colstrip Units 3 and 4. On March 6, 2013, the Sierra Club and the Montana Environmental Information Center filed a Clean Air Act citizen suit against all Colstrip owners in the U.S. District Court, District of Montana. Based on a second amended complaint filed in August 2014, the plaintiffs' lawsuit currently alleges violations of permitting requirements under the New Source Review program of the Clean Air Act and the Montana State Implementation Plan arising from seven projects undertaken at Colstrip during the time period from 2001 to 2012. Plaintiffs have since indicated that they do not intend to pursue claims with respect to three of the seven projects, leaving a total of four projects remaining subject to the lawsuit. The lawsuit claims that, for each of the four projects, the Colstrip plant should have obtained a permit and installed pollution control equipment at Colstrip. The Plaintiffs' complaint also seeks civil penalties and other appropriate relief. The case has been bifurcated into separate liability and remedy trials. The liability trial was set for May 2016, and a date for the remedy trial has yet to be determined. The parties are engaged in settlement discussions with the plaintiffs to resolve the claims raised in the litigation.  The parties have made sufficient progress in those negotiations that the parties have filed a joint motion to stay the trial date to allow further settlement efforts to proceed.

Other Proceedings
The Company is also involved in litigation relating to claims arising out of its operations in the normal course of business. The Company has recorded reserves of $0.4 million and $0.3 million relating to these claims as of March 31, 2016 and December 31, 2015, respectively.

There have been no material changes to the contractual obligations and consolidated commercial commitments set forth in Part II, Item 7 in the Company's Annual Report on Form 10-K for the year ended December 31, 2015