Generating
Through Time
wfec western farmers
2011 Annual Report
electric cooperative
A Touchstone Energy速 Cooperative
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Kansas Alfalfa
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Okla Ok laho homa ma
Northwestern
Cimarron Kiwash
East Central Oklahoma
Northfork Caddo
Oklahoma
Canadian Valley
Harmon Southh west Rural
New Ne w Me Mexi xico co
Farmers’
R sevelt Roo lt Cou ounty n
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People’s Cotton Red River Valley Rural
Texas
Central Valley
Kiamichi
Rural
Lea County C
Southeastern
Choctaw
WFEC Service Area WFEC provides essential electric service to 23 member cooperatives, Altus Air Force Base and other power users. These members are located primarily in Oklahoma and New Mexico, with some service territories extending into portions of Texas and Kansas. WFEC crews operate and maintain over 3,650 miles of transmission line and 329 sub and switch stations across this service territory.
About WFEC
W
estern Farmers Electric Cooperative (WFEC) is a generation and transmission (G&T) cooperative that provides essential electric service to 23 member cooperatives, Altus Air Force Base and other power users. These members are located primarily in Oklahoma and New Mexico, with some service territories extending into portions of Texas and Kansas. Organized in 1941, WFEC marked its 70th year of operation in 2011. The G&T was formed when western Oklahoma rural electric distribution cooperatives found it necessary to secure an adequate power supply at rates farmers and rural industrial developers could afford. WFEC has five generating facilities located at Mooreland, Anadarko and Hugo, and a total power capacity of more than 1,700 megawatts (MW) when purchased hydropower is included. WFEC owns and maintains approximately 3,650 miles of transmission line to 272 substations and 57 switch stations. WFEC maintains a well-balanced and diversified portfolio of generation resources that includes owned facilities and capacity and energy provided through purchase power agreements. These resources reflect a mix of technologies and fuel types, including one of the state’s largest renewable energy portfolios. The diversity in WFEC’s generation mix helps reduce exposure to changing market conditions, helping to keep rates competitive. WFEC is led by an experienced management group, with years of industry experience, and governed by a 24-member Board of Trustees.
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(Clockwise, from left) Anadarko Headquarters Anadarko Plant Hugo Plant Mooreland Plant
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President & CEO Report
A
year of records, at least weather-wise, will mark 2011. The winter months delivered lots of snow and excessively cold temperatures. And if that was not enough, the summer brought relentless heat and drought. In Anadarko, a record 61 days above 100 degrees eclipsed the old record of 50 days. Parts of Oklahoma saw in excess of 75 days with temperatures above the century mark. As expected with these extreme temperatures, annual sales for Western Farmers Electric Cooperative (WFEC) were over 7.8 million megawatt-hours (MWh), which is an increase over prior year sales by 5.8%. Generation for these sales came from a diverse mix of resources with 36% generated by coal, 16% from natural gas, 17% from renewable resources and 31% from economy and contract purchases. WFEC also enjoyed several significant accomplishments during the year. Among these was the completion of WFEC’s new mortgage indenture that provides a more predictable and timely process for future borrowing alternatives. In addition, WFEC, with assistance from CoBank, completed its first multi-year, syndicated, line of credit. With the indenture and lines of credit, WFEC will be more flexible and responsive to its members’ facility requirements, while continuing to keep member wholesale power costs competitive. During 2011, WFEC completed and received Rural Utilities Service (RUS) loan approvals for transmission,
2011... A Year of Records distribution and generation projects that will finance additions and improvements through 2015. New facilities and upgrades provided by these loans will continue the steady construction plans required for the next few years. Stable, competitively priced fuel delivery and resources are important to keep wholesale power costs low. In 2011, WFEC continued its natural gas hedging program by placing positions to cap the cost of natural gas for a portion of its portfolio through 2012. Coal supply and delivery contracts expiring in early 2012 were successfully re-negotiated for additional years at competitive prices. While coal delivery was sporadic during 2011 due to flooding and rail delivery outages, WFEC maintained adequate coal inventory at the plant site and ended the year at normal levels, above 50 days. Plans to provide power to WFEC’s four New Mexico members continue with initial service starting in mid-2012. Transmission and generation plans for additional service are well under way for the 2017 period. The transition of these new members is expected to be completed by 2026.
Gary Roulet (right) serves as the chief executive officer of WFEC, a position he has had since July 2003. Overall, Roulet has 37 years of service with the G&T. Bob Allen, who serves as Board president, represents Harmon Electric Association on the WFEC Board of Trustees. Allen has served as president since October 2009.
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The WFEC Board of Trustees take part in two strategic retreats each year to keep advised of upcoming events within WFEC and the utility industry as a whole. Senior management and other WFEC staff discuss information from within their respective departments.
Nitrogen Oxide (NOx) and mercury reductions were all proposed by the Environmental Protection Agency (EPA) with the Cross State Air Pollution Rule (CSAPR) and the Mercury and Air Toxics Standards (MATS). WFEC’s Board of Trustees approved projects that would bring WFEC into compliance with NOx and CSAPR. The mercury reduction rule did not require compliance so quickly, but WFEC expects to comply with this rule also within the proposed EPA schedule. Annual margins needed to exceed $4 million to meet all required end-of-year lender covenants and ratios. For 2011, margins exceeded $10 million, with all margins allocated to member patronage. Although many challenges presented themselves during 2011, WFEC finished the year with a competitive, reliable power supply and sound financial performance and is well positioned to continue its high level of service into the future.
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Bob Allen (right), president of the WFEC Board of Trustees, congratulates Leslie Hinds on his 35 years of service on the WFEC Board. Thirty-five years is the longest length of service of any previous Board member. Many longtime members make up the 24-member Board.
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2011 Fuel Mix
Coal Naturall Gas Econom my Purchases
* 9%
7% 36%
8%
Hydro Other *
24%
16%
Contrac ct Purchases
*Energy generated by wind facilities for which WFEC does not retain or retire the environmental attributes.
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2011 Highlights Energy Sales (to Members & Cities)
$427 million
Total Operating Revenue
$463 million
Net Margins Assets Members
$10 million $1,118 million 24
Member Consumer Meters Served
273,813 (est.)
Member Population Served
473,500 (est.)
System Peak Demand Miles of Transmission Line Substations Switch Stations
1,582 megawatts 3,650 miles 272 57
Generating Capacity Coal Natural Gas
450 megawatts 870 megawatts
Purchased Power Capacity Natural Gas Hydro Portfolio of GRDA Assets
70 megawatts 260 megawatts 75 megawatts
Total Capacity Number of Employees
1, 725 megawatts 370
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th
WFEC’s 70 Year...
Continued Reliability, Relati
T
he energy business is constantly changing. Today, the ability to generate and deliver a continuous supply of electric power is even more significant than in times past. Society, as a whole, as well as the economy itself, is dependent on the benefits and values provided by affordable, reliable and dependable electricity. Each of these traits is a key factor in the success of Western Farmers Electric Cooperative (WFEC), which in 2011 marked its 70th year of “Generating Through Time.” 2011 was a productive year in many ways, from the continuing support of organizational goals to the building of valuable financial relationships. However, it will also likely be a year remembered most for its challenging and record-setting weather extremes.
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Growth & Sales Looking back at 2011 from the regional market perspective, it was a year of record-setting statistics. New records were set for Oklahoma weather for low and high temperatures and days above 100 degrees. Drought conditions plagued a large section of the service territory for much of the summer. All of these factors influenced record WFEC peak demands and energy sales. Although much of the national economy continued in a recessionary mode, WFEC member and municipal kilowatt-hour (kWh) sales grew approximately 5.8% in 2011, compared to about 3% growth in the previous year. In August 2011, WFEC recorded a new total system hourly peak of 1,582 megawatts (MW), eclipsing the
ionship Building & Record-Setting Extremes
prior year system peak of 1,509 MW by 73 MW or 5%. More significantly, the 2011 peak hour occurred during summer conditions, at a time when peak day load reductions considerably reduced the potential peak. WFEC and its member distribution cooperatives continue to utilize the demand management programs deployed over the last decade to improve efficiencies. These programs provided over 80 MW of peak load reduction in 2011. Together with other WFEC programs, such as distributed generation, municipal generation and load curtailment, the WFEC system can remove up to approximately 150 MW of load during peak periods to improve overall system efficiency. On the other hand, in 2010, the peak occurred during the winter when peak day load reductions
were not being called upon. This factor supports the determination that WFEC load is indeed growing despite the weather variant. Many of our member distribution cooperatives have experienced significant growth, much of it oil and gas related. In 2011, WFEC member cooperatives signed agreements for approximately 75 MW of new load. A portion of this load was connected to the electric system immediately; however, the remaining portion requires upgrades to WFEC’s transmission and distribution system, again pointing to continuing growth potential. Power sales to members and cities in 2011 were approximately $427 million. This reflects a slight (Continued on Page 10)
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increase of only $9 million, or 2%, as compared to 2010 sales. This small increase reflects the support in 2010 of about $16.5 million of revenue deferred from prior years. Energy Resources Active participation by staff within the Southwest Power Pool’s (SPP) working groups has contributed to WFEC’s preparedness for the future market. Known as the Integrated Market (IM), it has a projected start date of March 2014. The first version of these market rules, released in April 2011, is continuously evolving and is anticipated to affect every aspect of electrical service. In addition, rules of the current SPP Energy Imbalance Market (EIM), launched in February 2007, present another focus of staff’s efforts as the 30th version of these rules was in place for 2011. Diversification of fuels, purchased power and renewable resources have been among WFEC’s priorities and strategies, in an effort to minimize the impact of fuel volatility and environmental regulation. Generation diversity offers protection against increased prices of any single fuel source. WFEC’s strategy includes the purchase of fuels on a deliberate and planned schedule. The schedule takes into account projected member loads, fuel needs and purchased power opportunities. WFEC’s fuel risk management strategy focuses on catastrophic protection and provides a measure of protection against significant price increases in natural gas, while participating more fully in price decreases.
The diverse energy mix, self-generated and purchased, actual versus budgeted by WFEC during 2011 included:
WFEC practices a conservative budget strategy to serve load with owned generation. The cooperative coordinates power supply to members in the SPP market, which adds to reliability and helps achieve greater value of generating assets. WFEC takes advantage of lower-priced economic purchases and sales of excess energy, when available, by utilizing the bilateral spot market and SPP EIM. Market purchases of energy represented approximately 24% of WFEC’s total energy during 2011. Internal staff reviews day-to-day resource planning in collaboration with Aces Power Marketing (APM) to position WFEC assets for reliable energy service to its members. APM, owned by WFEC and other electric cooperatives, serves as an agent for, and works with, WFEC in a concerted effort to schedule the physical assets, including contract purchases, as well as generation from natural gas and coal, while participating extensively in the power marketplace. This relationship also focuses on risk management policies, counterparty credit analysis, locating transmission liquidity, market participation and new market readiness, identification of potential new counterparties, hedging activity and standardized contracts. Power Production Staff provided support for a safe and secure workplace by assessing and managing safe work practices and training. All of WFEC power generation employees, operating and maintaining 15 generating units at three locations, achieved an accident-free 2011.
Coal Gas Economy Purchases Contract Purchases Hydro Other* Total
2011 Actual
2011 Budget
36% 16% 24% 7% 8% 9% 100%
45% 22% 6% 7% 8% 12% 100%
* Energy generated by wind facilities for which WFEC does not retain or retire all of the environmental attributes.
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Building upon this accomplishment, staff is pursuing the development of a safety management system to facilitate compliance with safety and security standards. Like the utility industry as a whole, WFEC faces numerous employee retirements in the near future. As part of preparing new employees, a state-ofthe-art online, self-paced training curriculum that allows employees and apprentices to access hundreds of courses related to power plant operations and maintenance has also been developed. Hugo Plant: There were no major outages scheduled in 2011; however, there were two planned load reductions,
during spring and fall, to perform maintenance on plant equipment. Coal and Transportation Maintaining an adequate coal supply to WFEC’s coal-fired Hugo Plant can oftentimes range from routine to challenging during any given year. In 2011, coal supply proved challenging as a result of unprecedented flooding in the upper Midwest, disrupting railroad traffic and delivery of coal. These conditions literally put railroad tracks under water and even washed away portions of the tracks all together for more than five months. Using coal supplies stored at the plant site, some planned offloading of the plant and rerouting of trains, WFEC was able to keep the facility online without any fuelrelated interruptions. Also in 2011, favorable long-term rail transportation delivery services and base coal supply agreements were put in place. These agreements will provide security of supply for this important asset and continue to position the Hugo facility as a competitively priced generation resource for the future. Anadarko Plant: Combined Cycle Units 4 and 5 both had combustion inspections in 2011, with the generator rotor from Unit 5 being shipped for a rewind in December. Mooreland Plant: Mooreland Unit 2 underwent a major outage and generator rewind and new cooling towers were installed for Unit 1 during the year. (Continued on Page 12)
A 140,000 pound generator housing is tilted to an impressive 90 degree angle for repair work during an overhaul of Mooreland Plant Unit 2. This overhaul began in September 2011, continuing until January 2012.
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Environmental Regulations: New and proposed aggressive regulations by the Environmental Protection Agency (EPA) continue to present challenges, with a significant potential to impact WFEC operations, resulting in increased cost and complexity associated with timely evaluation and modeling of the potential impacts and the most costeffective compliance solutions. The Cross State Air Pollution Rule (CSAPR) and Mercury and Air Toxics Standards (MATS) are two proposed guidelines with fast-approaching compliance deadlines. Originally, CSAPR required compliance in May 2012, but since has been delayed by legal challenges, leaving compliance deadlines unclear. To achieve the original May 2012 deadline, WFEC contracted to install dry low NOx burners on three Anadarko gas-fired generating units. Since litigation has delayed the compliance deadline, WFEC plans to install the burners on Anadarko Units 4 and 6 in 2012 and on Unit 5 in 2013. The combined installed cost at Anadarko is estimated at $16.5 million. As for the Hugo Plant, plant staff undertook a study to prepare for the MATS regulation, anticipating a requirement to install mercury controls in 2014. WFEC’s environmental team obtained necessary environmental permits for existing and future generation resources, while ensuring compliance with operating permits. Generation Resource Planning As a generation and transmission (G&T) cooperative, WFEC’s core responsibilities include providing reliable and affordable power for its members’ current needs, while identifying and planning the necessary resources to meet future requirements. Even with the implementation of a number of member-wide energy-efficiency programs and WFEC’s demand side management programs, a much greater system load growth was experienced in 2011 than was forecast. WFEC met these 2011 demands seamlessly, utilizing our diverse fleet of generators and through purchases of market energy. Integration of the uncharacteristic increase in the 2011 demand into ongoing WFEC member cooperative load forecasts further emphasizes the need for additional capacity in the 2017 time frame. Resource planning
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A technician adjusts instrumentation for testing at the Hugo Plant stack. These tests provide baseline numbers about the plant’s emissions to determine compliance with future EPA rules and regulations.
continues to evaluate those needs through either selfbuild or market options. Power Delivery Member growth also created the need for upgrades and new construction of substations and transmission lines in 2011. Reliability oriented projects, primarily involving WFEC’s switch stations, were a key focus for the transmission and distribution crews. A large transmission project that will increase reliability in the northern part of WFEC’s system and allow distribution cooperative members to increase load and improve reliability was also supported. This project will address tremendous planned load growth in north central and northwestern Oklahoma. Additionally, a new approach to contracting for services was developed to augment current staff. This will enable a number of transmission and distribution projects to be completed more timely. The final repairs due to the 2009 tornado that ripped through the transmission and distribution maintenance facility were completed during the year. This building was reoccupied at year-end 2011. (Continued on Page 14)
2011 WFEC Statistics Equity growth is intended to ensure that WFEC remains a robust resource for members and a financially strong player attractive to lenders as the balance sheet grows. WFEC’s equity balance grew to $187 million as of year-end. The equity growth prior to 2011 was a result of earnings. Equity in 2011 was boosted by the first year of equity contributions by four new members.
Equity (Millions of Dollars) $112
2007
$130
2008 2009
$146 $170
2010
$187
2011
Coincident Peak Demand (Megawatts) 1,444
1,392
A reflection of the growth, coincident peak demand tipped the scale at 1,582 MW, establishing a new all-time peak demand on Aug. 3, 2011. This summer peak surpassed the previous record coincident peak demand set in the winter of 2010, by 5%
1,308
1,366
2007
2008 Winter
1,455 1,352
2009
1,582
1,479 1,509
2010
1,499
2011
Summer
Energy Sales to Members and Municipals (Millions of kWhs) 2007
336
6,468
6,804
2008
306
6,807
7,113
2009
310
6,860
7,170
2010
216
7,156
7,372
2011
161
7,638
7,799
Municipal
Rural Oklahoma growth is an important ingredient in WFEC’s past and future strategic goals, with exciting challenges and new opportunities becoming evident for many parts of the state. Some municipal contracts have been allowed to expire to provide for members’ load needs.
Member
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Ron Cunningham (left), vice president, power delivery, and Terry Lisenbery, lead station technician, discuss progress at the Cana Substation, which was completely destroyed by a tornado passing through the area on May 24. This facility serves the Devon Energy Cana Gas Plant, located west of El Reno. Shown in the background, working with a transformer, are Rex Mathis and Mark Palesano, journeyman station technicians, and Jeramy Tackett, apprentice station technician. (Photo inset) Mark Palesano guides crews working at the substation site.
Electronic communication systems continue to be a focal point for WFEC and its members. A dialogue with member cooperative managers regarding necessary system upgrades to accommodate automation requirements resulted in a study to develop a longrange communication plan. Also during the year, staff initiated a project to develop a system to access and maintain 360 degree photographs for virtual tours of all WFEC substations and switch stations. The tour will identify equipment and nameplate data to be shared with WFEC and members’ employees for purposes of improved communications in the field, maintenance activities, employee training, troubleshooting and knowledge retention. A secondary power feed to the headquarters complex was designed and installed to improve the reliability of headquarters’ operations. Additional efforts to improve WFEC efficiencies and operation included a transmission maintenance system that will be used to track transmission system assets and to schedule, record
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and track system maintenance and testing activities. Copper and other metal thefts are costly and time consuming issues that WFEC and other electric and public service utilities are facing. WFEC has supported the Oklahoma Association of Electric Cooperatives, which has taken a leading role in organizing the copper theft task force in Oklahoma. The task force meetings have been well attended by law enforcement, public officials, salvage dealers and utilities. The efforts are focused on reducing theft activity and may result in legislative efforts aimed at preventing theft. New Mexico legislature is also considering a proposed law intended to regulate salvage of metals and deter thieves. Relationship Building & Indenture Mortgage Over the next several years, WFEC has plans to add capacity through owned plants or purchase power agreements (PPAs) needed to serve growing member loads and incremental sales to the New Mexico members. WFEC’s goal is to continue to develop and
maintain a power supply portfolio that includes a mix relationships will continue to be important while new of renewable, gas-fired and coal-fired resources and relationships will be formed that will provide additional a delivery system that will supply its members with options and flexibility for the future. reliable and reasonably priced power. Line of Credit Syndication With a strategic planning horizon, WFEC maintains target financial ratios that are deemed appropriate to ensure adequate liquidity, equity and To increase access to liquidity in preparation for debt service coverage (DSC) ratios to support the serving an increased volume of sales and developing additional debt that will be needed to fund system capacity, a short-term $100 million CoBank revolving projects. The target ratios influence management and facility was replaced with a $200 million four-year the Board of Trustees in establishing annual budgets unsecured committed syndicated line of credit. and setting rates. WFEC’s financial policies are WFEC selected CoBank to act as lead arranger and intended to enable the financing of all future projects administrative agent for this effort, and the process with an appropriate mix of debt and equity while offered an opportunity to build relationships with other maintaining strong financial ratios. financial institutions active in the cooperative utility To support its need for access to capital, in an sector. The syndication was over-subscribed by $60 historic move on April 8, 2011, WFEC adopted a million and one of the terms of the agreement provides mortgage indenture (Indenture) to replace its existing a feature to upsize the facility an additional $50 million joint mortgage with the Rural Utilities Service (Continued on Page 16) (RUS), CoBank, ACB (CoBank) and National Rural Utilities Cooperative Finance Corporation (CFC). The Indenture closely models those indentures recently adopted by other G&Ts and offers opportunities that are a departure from the practices used since the cooperative’s inception. While the Indenture preserves access to RUS guaranteed financing, it sets the strategic environment to provide greater access to a broader range of capital sources in a more timely fashion when RUS financing is not an option. This will help in providing greater certainty of meeting WFEC’s capital needs and supporting strong credit ratings. Peter Fozzard (center) speaks to WFEC personnel regarding a newly adopted The Indenture provides a more mortgage indenture (Indenture) and Rural Utilities Service (RUS) Loan Contract predictable approach to issuance that will affect WFEC loan practices and numerous typical employee activities. of additional secured debt, subject Within WFEC, power requirement studies, construction work plans and financial to objective, mechanical tests. forecasts will still require Board approval, for example. However, when RUS The result is a more streamlined financing is not the preferred option, WFEC will now have greater access to a approach to lending partners as broader range of capital sources subject to objective, mechanical tests. This typically represents a much quicker time frame for approval. The model for WFEC’s new WFEC moves forward in financing Indenture is based on those recently adopted by other G&Ts. Fozzard is a law its capital program. WFEC believes partner with Sutherland Asbill & Brennan LLP. that long-standing financial
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During 2011, RUS approved a loan guarantee commitment in the amount of $184.1 million for the purpose of financing certain WFEC generation and transmission projects planned for the 2012 to 2015 construction work plan period. Capital Budget Approximately $37 million was expended for capital construction efforts in 2011 for normal transmission additions and replacements and for generation system improvement projects. In comparison, the $72 million 2012 capital budget includes approximately $38 million for transmission additions, upgrades and expansion efforts for increased oil and gas activity in northern Oklahoma as well as generation projects at each plant location. These projects include dry low NOx burner conversions for certain Anadarko units to address approaching EPA compliance deadlines.
The $72 million 2012 capital budget includes approximately $38 million for transmission additions, upgrades and expansion efforts for increased oil and gas activity in northern Oklahoma.
with additional commitments from existing lenders or new commitments from other financial institutions under certain conditions. With this facility and a $75 million revolving facility with CFC, WFEC is well positioned for normal operating needs, bridge financing for immediate and on-going construction efforts and to take advantage of market opportunities. Liquidity is also supported by a Board strategy to maintain a fuel hedging program to protect against catastrophic prices, a banked fuel balance to moderate the volatility of fuel prices to its members and a contingent cash reserve for significant unbudgeted events. Loans Approximately $36 million in Federal Financing Bank (FFB) loan funds were advanced at an approximate weighted average long-term fixed rate of 3.3% with maturities ranging from 2024 to 2043.
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Financial Performance WFEC reported a net margin of $10.5 million in 2011, compared with $24.0 million in 2010, which included approximately $16.5 million of deferred revenue from prior years. A positive operating margin target was also achieved. WFEC’s DSC ratio in 2011 and 2010 was 1.13 and 1.20, respectively, exceeding the 1.1 minimum target. The equity-to-assets ratio was 16.7% and 15.5% at year-end 2011 and 2010, respectively. WFEC has a goal of not permitting this ratio to fall below 15% through 2017, as a substantial multi-year capital expenditure program is implemented. Members’ equity increased in 2011 due to the normal margin impact, but also due to the first year of equity contributions from New Mexico members. These equity contribution payments are determined by WFEC’s projected capital resource additions or purchase power contract, or share thereof, required to supply power and energy to the respective cooperative. In 2011, the cooperatives contributed approximately $6.3 million in equity to WFEC, which was directly assigned to their respective patronage accounts. The target DSC ratio and minimum equity ratio are intended to ensure that WFEC remains a robust resource for members and a
financially strong player attractive to lenders as the balance sheet grows. In addition, WFEC monitors its annual margins for interest (MFI) ratio that is defined in its mortgage Indenture. A minimum annual MFI ratio of 1.10 is required in order to permit the issuance of secured obligations under the Indenture. The annual MFI ratio was 1.29 and 1.78 for 2011 and 2010, respectively. The variable components of the rate schedule for members that are adopted each year during the annual budget are intended to cover WFEC’s cost of service and meet target financial ratios. WFEC reviews its financial position each month with the Board of Trustees, which may make adjustments to certain components of the member rate schedule during the year in order to meet financial targets and other objectives. Wholesale Power Contracts Strong credit ratings are an important tool for accessing capital as WFEC embarks on its next significant construction phase and validates the members’ ownership purpose in their G&T cooperative. WFEC’s financial stability, a key to strong credit ratings, is based on its long-term, allrequirements contracts with member-owners and our combined financial strength. In March 2011, WFEC’s Standard and Poor’s “BBB+” rating was affirmed and the outlook revised to positive from negative. This action reflected steps taken to restructure the 2001 financial lease, the addition of four distribution cooperative members, the increasing diversity of power supply resources and mechanisms for timely cost recovery. When combined with its FitchRatings “A-” (stable) ratings, WFEC management anticipates access to capital markets on favorable terms. Twenty-one of 23 cooperative members have allrequirements contracts through 2050, with the two remaining members’ contracts effective into 2025. These commitments facilitate long-term planning to meet WFEC’s energy and financing needs. In 2011, the distribution cooperative members with contracts through 2050 represented 83% of WFEC member cooperative sales. There were no sales to the New Mexico members in 2010 or 2011.
Upgrades to the switch station, located adjacent to the Anadarko Plant, were among the many transmission, switch and substation projects completed during 2011.
Energy Resources A new wholesale tariff and rate structure, R-15(a), was developed in cooperation with members and implemented in April 2011. The new tariff is designed to provide a range of demand and energy surcharge rates that will provide adequate recovery for projected costs associated with the National Electric Reliability Council (NERC) compliance costs, the full cost of permanent long-term financing of the Bob Orme Combustion Turbine Plant, charges for escalating demand associated with long-term PPAs and projected costs associated with a 2001 financial lease amendment, which had previously been covered by deferred revenue in 2010. Members were billed an average price of $53.93 per MWh in 2011 compared with $52.73 per MWh in 2010. There was no rate change budgeted for 2012. (Continued on Page 18)
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WFEC line crews work to rebuild transmission structures destroyed by a spring tornado. A nearby home and adjacent buildings were completely leveled by the same storm that blew through the area west of Fairview, Oklahoma. (Photo inset) Journeyman Power Line Technician Vince Lalli drills into a rebuilt cross arm structure. Several spring tornadoes destroyed homes and transmission structures across Oklahoma.
Human Resources WFEC continues to prepare for the effects of experienced employees retiring. WFEC enrolled its first eight participants in the new Growing Leaders Program to develop internal talent for future opportunities at WFEC. This program, requiring two years to complete, provides training courses that support the goals identified in the participant’s individual needs assessments and participation in several additional on and off-site activities. Benefit plan design and cost management strategies played an important role in meeting the WFEC Board of Trustees’ targets for controlling employee benefit costs, while continuing to offer competitive benefit packages to attract and retain qualified employees. Staff continued to meet or exceed the Board’s cost targets while providing flexibility and opportunities for employees to partially fund programs with tax savings. Meeting cost management goals is facilitated by increasing numbers of employees and retirees choosing consumer-directed health care consisting of high deductible health plans, combined with health savings accounts.
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Risk Management Risk management staff spent a significant portion of 2011 directing and assisting with the physical repairs and insurance recovery associated with recent storm damage. This damage was caused by the direct hit of a tornado in the spring of 2009 and hail storms in 2010. The damages from the tornado and hail storms were in excess of $16 million and recovery is now essentially complete. More recently, the May 24, 2011 tornado outbreak that swept across parts of the WFEC service territory destroyed the Mooreland Power Plant Unit 1 Cooling Tower and the Cana Substation. Fortunately for consumers, 2011 natural gas prices continued to decline, seeing a 70% drop since 2008. WFEC’s risk management strategy allows its members to enjoy lower costs as a result of participation in the move to lower prices. WFEC continues to review and revise, as warranted, its fuel hedging strategy to minimize associated costs. Hydro and wind energy deliveries, with their more stable pricing, have also reduced exposure to volatile fuel prices. WFEC’s portfolio of wind will again be expanded in 2012 due to the renewable energy
purchase agreement for the output of the 150 MW Rocky Ridge Wind Project in western Oklahoma, planned for operation in late spring 2012. Marketing & Communication In 2011, WFEC member cooperatives sold 19,022,700 kWh hours of energy generated by local wind resources to Oklahoma cooperative consumers through the WindWorks® program. This is a 15% increase compared to 2010. The WindWorks® program is just one way that WFEC is promoting renewables. Other ways include events to support Earth Day awareness and the promotion of energy efficiency Key account managers, commercial customers, cooperative websites, such as “Together We Save.” representatives and industry-related vendors took part in the annual Education regarding the development, Emerging Technology Conference that was hosted over a two-day value, limitations and challenges associated period in late August. This popular event was hosted by WFEC, with with renewable energy is essential. the support of its member Touchstone Energy Cooperatives. Various 2011 marked the completion of two speakers addressed a wide range of topics during the conference that years of the WFEC Energy Efficiency is designed to allow networking opportunities and discuss innovative Rebate Program targeting more efficient ideas and cooperative services. commercial and residential heating and cooling. Upon evaluation of the results of the program to date, necessary changes were identified the Internet. This is just another example of how the that will help attain load reduction goals. WFEC rural electric cooperatives work to improve the standard and its member distribution systems are working to of living in rural Oklahoma. implement those changes to the program to enhance its Conclusion success. WFEC continues to use the Touchstone Energy® Overall, 2011 offered some challenging, but brand to offer services and benefits to rural electric innovative and exciting, times. As usual, weatherconsumers. For the third straight year, the Co-op related events were in the forefront of the year, with Connections® Card Program provided rural electric drought, tornadoes, powerful thunderstorms and consumers in Oklahoma savings on prescriptions extreme heat taking its toll across WFEC’s service exceeding $1 million. This success has spurred new territory. However, work continued for both WFEC national programs offering member consumers savings and its cooperatives. on vision, dental and hearing products and services. Preparations continued to be made for the future Much of 2011 was focused on the development with the potential to strategically bolster WFEC of the new “Member’s Only” section of the WFEC and all of its members into the electrical industry of corporate website as a primary tool for acquiring tomorrow. Members can be assured that their G&T information. Another endeavor in 2011 for the will continue its strong and loyal commitment to Touchstone Energy brand was the title sponsorship provide cost-effective, reliable and quality service, of a streaming video network used by over 40 schools with a dedicated focus on future progress. across Oklahoma and New Mexico. This network has been, and will be, used to stream everything from high school sporting events to graduation ceremonies over wfec
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WFEC Board of Trustees
Bob S. Allen President Harmon Electric Association
David Ray Vice President Kiamichi Electric Cooperative
Mike Lebeda Secretary/Treasurer Kay Electric Cooperative
Rusty Grissom Asst. Secretary/Treasurer Oklahoma Electric Cooperative
Max W. Ott Alfalfa Electric Cooperative
Bob Thomasson Caddo Electric Cooperative
Gary Crain Canadian Valley Electric Cooperative
Charles G. Wagner Central Valley Electric Cooperative (NM)
Bob Holley Choctaw Electric Cooperative
Russell D. Pollard Cimarron Electric Cooperative
WFEC is governed by a 24-member Board of Trustees, including a representative from each member system & Altus
Air Force Base.
20
Generating Through Time
Charles Spencer Cotton Electric Cooperative
Jerry Rempe East Central Oklahoma Electric Cooperative
Michael B. West Farmers’ Electric Cooperative (NM)
Charles Hickey Northfork Electric Cooperative
Ray O. Smith Northwestern Electric Cooperative
Jerry W. Partin Roosevelt County Electric Cooperative (NM)
Gary Jones Rural Electric Cooperative
John Ingle Lea County Electric Cooperative (NM)
Leslie Hinds Kiwash Electric Cooperative
Jack Lambert People’s Electric Cooperative
King Martin Red River Valley Rural Electric Association
Lloyd G. Owens Southeastern Electric Cooperative
Fred J. Stowe Southwest Rural Electric Association
WFEC Annual Report
21
WFEC Senior Management A qualifed senior management level staff, with an impressive combined 208 years of service with WFEC, oversee the daily operations of the G&T. Each vice president and senior manager has particular areas of expertise within the electric utility industry, providing valuable years of experience for WFEC overall and for its member cooperatives
22
Gary Roulet Chief Executive Officer
Ron Cunningham Vice President Power Delivery
Gary Gilleland Vice President Generation
Brian Hobbs Vice President Legal & Corporate Services
Jane Lafferty Vice President & Chief Financial Officer
Dan Fleming Senior Manager Resource Planning
Roy Klusmeyer Senior Manager Regional Market Planning
Generating Through Time
KPMG LLP 210 Park Avenue, Suite 2850 Oklahoma City, OK 73102-5683
Independent Auditors’ Report
Board of Trustees Western Farmers Electric Cooperative: We have audited the accompanying consolidated balance sheets of Western Farmers Electric Cooperative (WFEC) and subsidiaries as of December 31, 2011 and 2010, and the related consolidated statements of operations, changes in members’ equity and comprehensive income, and cash flows for the years then ended. These consolidated financial statements are the responsibility of WFEC’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of WFEC’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of WFEC as of December 31, 2011 and 2010, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.
March 6, 2012
KPMG LLP is a Delaware limited liability partnership, the U.S. member firm of KPMG International Cooperative (“KPMG International”), a Swiss entity.
23
WESTERN FARMERS ELECTRIC COOPERATIVE Consolidated Balance Sheets December 31, 2011 and 2010 (In thousands) Assets Electric utility plant, at cost: In-service Construction work-in-progress
2011 $
1,352,795 27,554
1,325,257 27,653
1,380,349
1,352,910
592,388
572,387
787,961
780,523
125,039
118,766
2,449 31,428 36,995 15,900
3,840 23,530 34,592 16,229
16,731 42,890 3,905
22,426 43,026 3,662
150,298
147,305
1,272 53,050
1,272 53,958
$
1,117,620
1,101,824
$
180,610 6,256 828,437
170,331 — 784,058
1,015,303
954,389
37,012 57,183 —
31,126 61,364 46,678
94,195
139,168
8,122
8,267
1,117,620
1,101,824
Total electric utility plant Less accumulated depreciation and amortization Net electric utility plant Investments in associated organizations and other investments, at cost Current assets: Cash and cash equivalents Restricted cash Accounts receivable from energy sales Other accounts receivable Inventories, at average cost: Coal and oil Material and supplies Other Total current assets Other noncurrent assets Deferred debits Total assets
2010
Members’ Equity and Liabilities Capitalization: Patronage capital Contributed capital Long-term debt Total capitalization Current liabilities: Current portion of long-term debt Accounts payable and accrued liabilities Short-term notes payable Total current liabilities Other liabilities Commitments and contingencies (note 13) Total members’ equity and liabilities See accompanying notes to consolidated financial statements.
24
$
WESTERN FARMERS ELECTRIC COOPERATIVE Consolidated Statements of Operations Years ended December 31, 2011 and 2010 (In thousands)
Operating revenues: Power sales to members and cities Other power sales and operating revenues
$
Total operating revenues Operating expenses: Operations: Production Purchased and interchanged power Transmission Distribution General and administrative Maintenance Depreciation and amortization Total operating expenses Operating margin before interest Interest expense, less amounts capitalized during construction of approximately $855 and $1,032 in 2011 and 2010, respectively Interest income Operating margin Other nonoperating margin (loss), net Patronage capital assigned by associated organizations Net margin
$
2011
2010
427,270 35,625
417,959 37,693
462,895
455,652
161,011 142,977 44,243 5,204 15,383 17,643 31,294
170,481 121,353 39,300 4,980 14,091 19,817 30,299
417,755
400,321
45,140
55,331
(43,177) 6,678
(40,395) 7,008
8,641
21,944
(294) 2,116
280 1,731
10,463
23,955
See accompanying notes to consolidated financial statements.
25
WESTERN FARMERS ELECTRIC COOPERATIVE Consolidated Statements of Changes in Members’ Equity and Comprehensive Income Years ended December 31, 2011 and 2010 (In thousands)
Memberships Balance, December 31, 2009
$
Patronage capital
Contributed capital —
Accumulated other comprehensive income (loss) (2,752)
148,864
Net margin
—
23,955
Change in fair value of derivative financial instrument
—
—
—
(1,374)
(1,374)
Reclassification adjustment of derivative losses reclassified into interest expense
—
—
—
1,224
1,224
Change in net asset associated with postretirement benefit plan
—
—
—
412
412
2
172,819
—
(2,490)
170,331
Net margin
—
10,463
—
—
10,463
Contributed capital
—
—
6,256
—
6,256
Change in fair value of derivative financial instrument
—
—
—
(1,593)
(1,593)
Reclassification adjustment of derivative losses reclassified into interest expense
—
—
—
1,147
1,147
Change in net asset associated with postretirement benefit plan
—
—
—
262
262
2
183,282
6,256
(2,674)
186,866
—
Total comprehensive income
Total comprehensive income Balance, December 31, 2011
146,114 23,955
24,217
Balance, December 31, 2010
16,535 $
See accompanying notes to consolidated financial statements.
26
Total
2
WESTERN FARMERS ELECTRIC COOPERATIVE Consolidated Statements of Cash Flows Years ended December 31, 2011 and 2010 (In thousands) 2011 Cash flows from operating activities: Net margin Adjustments to reconcile net margin to net cash provided by operating activities: Depreciation Other depreciation included in operating expenses Amortization of regulatory asset expense Accretion of asset retirement obligation Noncash interest income Noncash interest expense Deferred (recognized) revenue Changes in assets and liabilities: Restricted cash Accounts receivable from energy sales Other accounts receivable Coal and oil inventory Materials and supplies inventory Other current assets Deferred debits and other Accounts payable and accrued liabilities Other liabilities
$
Net cash provided by operating activities Cash flows from investing activities: Net extension and replacement of electric utility plant Proceeds from use of restricted cash – Special Construction Fund (SCF) Proceeds from liquidation of lease securities Purchase of lease securities held to maturity Net cash used in investing activities Cash flows from financing activities: Advances of long-term debt Payments on long-term debt Advances of short-term debt Payments on short-term debt Net cash (used in) provided by financing activities Net decrease in cash and cash equivalents Cash and cash equivalents, beginning of year
2010
10,463
23,955
28,330 1,876 2,964 78 (5,456) 5,344 —
27,335 1,820 2,964 71 (5,829) 5,717 (16,530)
(7,898) (2,403) 329 5,695 136 (243) 1,693 (2,402) (407)
(283) (1,004) (9,071) (1,740) 3,064 (2,386) (788) (13,551) 775
38,099
14,519
(39,190) — — —
(52,141) 24,757 78,083 (102,840)
(39,190)
(52,141)
238,216 (191,838) 351,279 (397,957)
63,432 (29,010) 549,617 (545,049)
(300)
38,990
(1,391)
1,368
3,840
2,472
Cash and cash equivalents, end of year
$
2,449
3,840
Supplemental schedule of cash flow information: Cash paid during the year for interest
$
38,372
27,777
$
1,179
(40,687)
— —
3,942 36,745
Supplemental schedule of noncash financing and investing activities: Lease-leaseback amendments Deferral of loss on restructure of lease-leaseback Adjustments in present value of long-term debt related to lease-leaseback restructure Loss on restructure of lease-leaseback See accompanying notes to consolidated financial statements.
27
WESTERN FARMERS ELECTRIC COOPERATIVE Notes to Consolidated Financial Statements December 31, 2011 and 2010
(1)
Summary of Significant Accounting Policies (a)
Nature of Operations Western Farmers Electric Cooperative (WFEC) is a generation and transmission cooperative headquartered in Anadarko, Oklahoma. WFEC owns and operates five generating plants, fueled by coal and gas, three located in Anadarko, one in Mooreland, Oklahoma, and one near Hugo, Oklahoma. WFEC also owns and maintains more than 3,650 miles of transmission line. WFEC has a combined capacity of over 1,700 megawatts, including hydropower allocation. With the addition of four New Mexico cooperatives in 2010, member-owners consist of 23 distribution cooperatives and a United States Air Force base. Substantially all of WFEC’s assets are currently located in Oklahoma and substantially all revenue is related to Oklahoma operations. See note 13 for further information related to the addition of and sales to the New Mexico cooperatives.
(b)
Basis of Presentation WFEC maintains its accounting records in accordance with the Uniform System of Accounts of the United States Department of Agriculture Rural Development Utilities Programs (RDUP), formerly known as the Rural Utilities Service, which conforms with U.S. generally accepted accounting principles in all material respects. These consolidated financial statements reflect the transactions of WFEC and its wholly owned subsidiaries, WFEC Railroad Company and WFEC EnergyCo, LLC (EnergyCo). WFEC GenCo, LLC (GenCo) is a wholly owned subsidiary of EnergyCo. All significant intercompany balances and transactions have been eliminated upon consolidation. The more significant accounting policies of WFEC are described below.
(c)
Use of Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
(d)
Electric Utility Plant Electric utility plant is stated at original cost. The capitalized cost of additions to electric utility plant includes the cost of material, direct labor, contract services, and various other indirect charges, such as engineering, supervision and overhead costs, and interest on funds used during construction. Retirements or other dispositions of electric utility plant are based on an average unit cost that is deducted from plant and, together with removal costs less salvage, is charged to accumulated depreciation. The cost of repairs and minor renewals is charged to maintenance expense in the period incurred.
(Continued)
28
WESTERN FARMERS ELECTRIC COOPERATIVE Notes to Consolidated Financial Statements December 31, 2011 and 2010
Provision for depreciation of electric utility plant is computed on the straight-line method at rates based on estimated service lives and salvage values of the class of property. These rates are applied on a composite class basis. Annual depreciation rates used in 2011 and 2010 are as follows: Production plant Transmission plant Distribution plant General plant
0.79 – 17.04% 2.75 – 10.00% 2.88 – 10.00% 3.00 – 33.33%
Depreciation and amortization for the year ended December 31, 2011 was $33,170,000, of which $28,330,000 was charged to depreciation expense, $1,876,000 was included in fuel and other operating expenses, and $2,964,000 was charged to amortization of regulatory assets. Depreciation and amortization for the year ended December 31, 2010 was $32,119,000, of which $27,335,000 was charged to depreciation expense, $1,820,000 was included in fuel and other operating expenses, and $2,964,000 was charged to amortization of regulatory assets. WFEC periodically reviews the carrying values of its utility plant assets for impairment whenever events or changes in circumstances indicate the carrying amount of an asset or group of assets may not be recoverable through the future net cash flows expected to be generated by the asset or group of assets. If such assets are considered impaired, the impairment is recognized by the extent that carrying value exceeds fair value. (e)
Capitalization of Interest Interest costs are capitalized as part of the cost of various capital assets under construction. WFEC uses the weighted average rate of interest associated with long-term borrowings. Interest charged to construction during 2011 and 2010 totaled $855,000 and $1,032,000, respectively.
(f)
Restricted Cash Restricted cash consists of the following: x
A Contingent Cash Reserve (CCR) that is restricted by WFEC Board Policy to be utilized based upon certain significant events or other approved uses as determined by the Board. The CCR had a balance of $22,790,000 and $21,896,000 as of December 31, 2011 and 2010, respectively.
x
A Cushion of Credit (Unapplied Advance Payment) account with the RDUP. As an RDUP borrower, WFEC may participate in the RDUP Cushion of Credit Program, which allows voluntary prepayment of debt. These advance payments are held on behalf of WFEC and earn interest at 5% per annum. The prepaid account balance and earned interest may only be used for debt service on loans made or guaranteed under the Rural Electrification Act. The Cushion of Credit account had a balance of $29,048,000, of which $22,790,000 represents CCR funds as of December 31, 2011, and $17,359,000 as of December 31, 2010 which represented a portion of the CCR balance.
(Continued)
29
WESTERN FARMERS ELECTRIC COOPERATIVE Notes to Consolidated Financial Statements December 31, 2011 and 2010
(g)
x
Other cash accounts with funds that are restricted as to withdrawal for various purposes had a total balance of $2,380,000 and $1,634,000 as of December 31, 2011 and 2010, respectively.
x
A Debt Service Reserve account that is set aside in case of default on an interest and/or principal payment of long-term debt. The Debt Service Reserve account had a balance of $1,272,000 as of December 31, 2011 and 2010, and is reflected as other noncurrent assets in the accompanying financial statements.
Cash and Cash Equivalents For purposes of reporting cash flows, cash and cash equivalents include unrestricted cash on hand and investments purchased with original maturities of three months or less.
(h)
Investments in Associated Organizations Investments in associated organizations are stated at cost plus WFEC’s share of patronage capital credits allocated, reduced by distributions received.
(i)
Inventories Inventories of coal and oil, and materials and supplies of WFEC are valued at average cost. These inventories are consumed by WFEC’s operations or utilized as additions to electric utility plant and are not held for resale.
(j)
Emission Allowances In accordance with the Federal Clean Air Act, WFEC has received an annual allocation of SO2 (sulfur dioxide) emission allowances from the Environmental Protection Agency as part of a nationwide program to limit SO2 emissions. An allowance provides authority to emit one ton of SO2. Under this program, WFEC has received more SO2 allowances than it has utilized. The unutilized SO2 allowances have no cost basis and are therefore not recorded on the balance sheet.
(k)
Electric Rates The Board of Trustees of WFEC has full authority to establish the electric rates charged to members, subject to approval by RDUP. WFEC bills its members fuel costs as a component of electric rates. The fuel billing rate is designed to accumulate and maintain an over recovered fuel account balance. An over recovery of approximately $10,064,000 and $15,853,000 at December 31, 2011 and 2010, respectively, was recorded in accounts payable and accrued liabilities.
(l)
Regulatory Assets and Liabilities WFEC defers certain expenses that will be recovered through WFEC’s future rates (see note 5) in accordance with accounting principles generally accepted in the United States of America applicable to rate-regulated enterprises. Regulatory assets are charged as an expense, if and when future recovery in rates of that asset is no longer probable. WFEC also defers certain gains that will be credited to revenues over future periods for rate making purposes. (Continued)
30
WESTERN FARMERS ELECTRIC COOPERATIVE Notes to Consolidated Financial Statements December 31, 2011 and 2010
(m)
Revenues Revenues from the sale of electricity are recorded based on energy provided, including cost of fuel, to customers and on contracts and scheduled power usages, as appropriate.
(n)
Derivative Instruments and Hedging Activities WFEC’s activities expose it to a variety of market risks, including interest rates and commodity prices. Management has established risk management policies and strategies to reduce the potentially adverse effects that the volatility of the markets may have on its operating results. These policies and strategies include the use of derivative instruments for hedging purposes. WFEC designates its interest rate cash flow hedge derivatives as such on the date the derivative contract is entered into. WFEC formally documents all relationships between interest rate hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions. WFEC also assesses, both at the interest rate hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows of hedged items. These derivative instruments generally qualify as cash flow hedges under Accounting Standard Codification (ASC) 815-30, Derivatives and Hedging – Cash Flow Hedges, as amended. If hedge treatment is obtained, unrealized gains or losses resulting from these instruments are deferred as a component of accumulated other comprehensive income (loss) until the corresponding item being hedged is settled, at which time the gain or loss is recognized. See note 12.
(o)
Related Parties The members of WFEC purchase power from WFEC. The terms of transactions are based upon formal long-term contracts approved by WFEC’s Board of Trustees and are settled monthly, generally requiring the members to purchase 100% of the members’ purchased power requirements from WFEC. The contracts allow the Board of Trustees to establish base energy rates that allow recovery of cost of utility plant, fuel, and other operating costs incurred by WFEC. No collateral is pledged to WFEC from its members to collateralize the outstanding accounts receivable. The only exception relates to four New Mexico members with Transition Agreements providing for immediate and short-term power requirements to be provided from their existing contracts with Southwestern Public Service Company (SPS) at prescribed contract quantities and periods. No WFEC power sales were made to the New Mexico members in 2010 or 2011. See note 13. WFEC has wholesale power contracts with 21 of its distribution cooperative members through the year 2050 and with two of its members through the year 2025. In 2011, the distribution cooperative members with contracts through 2050 represented 83% of WFEC member cooperative sales.
(p)
Concentration of Credit Risk Concentration of credit risk exists with respect to trade accounts receivable of which approximately 98% of accounts receivable from energy sales at December 31, 2011 are from power sales from WFEC’s members. The credit risk for accounts receivable from nonmember sales is managed through monitoring procedures.
(Continued)
31
WESTERN FARMERS ELECTRIC COOPERATIVE Notes to Consolidated Financial Statements December 31, 2011 and 2010
(q)
Regional Transmission Organization Accounting WFEC participates in the Energy Imbalance Services Market under the Southwest Power Pool (SPP) Regional Transmission Organization (RTO). An RTO is an organization that is established to control and manage the transportation and flows of electricity over an area that is generally larger than a single power company’s system. WFEC records RTO transactions on an hour-to-hour basis. Transactions within each individual hour are netted to a single purchase or sale based on actual load and net megawatt hour generation.
(r)
New and Recently Adopted Accounting Pronouncements In 2011, the FASB issued ASU 2011-09 Disclosures about an Employer’s Participation in Multiemployer Plans, which requires additional disclosures related to an employer’s participation in multiemployer retirement plans. The additional disclosure requirements are effective for annual periods ending after December 15, 2012 for nonpublic entities. Under ASU 2011-09, employers that participate in multiemployer pension plans are required to provide a tabular disclosure for individually significant pension plans. This disclosure should include, among other items, the plan legal name, the most recent “zone status” and the plan’s year-end date, the indication of date(s) of collective bargaining agreements, required minimum contributions, and indication of what plans are subject to a funding improvement plan, whether the employer paid a surcharge to the plan, the amount of contributions made to each individually significant plan, the total contributions made to all other plans in aggregate, and whether the employer’s contributions represent more than 5% of total plan contributions. The company is currently evaluating this new guidance.
(2)
Electric Utility Plant Major classes of electric utility plant as of December 31 are as follows: 2011 Production plant Transmission plant Distribution plant General plant Unclassified plant
$
Electric utility plant-in-service Construction work-in-progress Total electric utility plant
$
(In thousands)
2010
833,221 280,212 136,554 80,734 22,074
699,944 271,791 132,165 78,661 142,696
1,352,795
1,325,257
27,554
27,653
1,380,349
1,352,910
Unclassified plant decreased and production plant increased approximately $121,086,000 due primarily to the classification of the new 145-megawatt Anadarko capacity addition.
(Continued)
32
WESTERN FARMERS ELECTRIC COOPERATIVE Notes to Consolidated Financial Statements December 31, 2011 and 2010
In May 2001, GenCo completed construction of two 45.5 megawatt simple cycle generating facilities, fueled by natural gas, in Anadarko, Oklahoma. An agreement was entered into with another party to purchase 100% of the capacity of these units at commercial operation for a term of up to 20 years, with WFEC retaining certain recall rights. Currently, WFEC has recalled 51 megawatts. WFEC has the right, but not the obligation, to recall the remaining 40 megawatts of capacity of the plant during the remaining operating term. In 2007, WFEC entered into a purchase power agreement with the other party to utilize the remaining 40 megawatts of capacity of the plant for specific months from June 1, 2007 through February 29, 2012. In 2010, the purchase power agreement was extended through February 28, 2017. WFEC will be responsible for fuel and related costs under the terms of the agreement for these contracted periods. The other party provided $6,800,000 of financing. This note has a fixed rate of interest and is payable annually through 2021. Interest of approximately $400,000 that had accumulated through September 2001 (during the construction phase) was added to the note principal. As of December 31, 2011, the balance of the note was $4,999,000 and is included in long-term debt. (3)
Investments in Associated Organizations and Other Investments 2011 National Rural Utilities Cooperative Finance Corporation (CFC): 3% capital term certificates 5% capital term certificates Patronage capital certificates CoBank Class A stock ACES Power Marketing Lease – leaseback related investments (see note 4) Other
(In thousands)
2010
$
300 6,130 1,077 4,577 1,141 111,770 44
300 6,130 971 3,910 1,097 106,315 43
$
125,039
118,766
WFEC purchased capital term certificates and stock as required by institutions under borrowing arrangements. Fair value of the certificates and stock is not readily determinable. In 2002, WFEC joined ACES Power Marketing (ACES) as a member. As of December 31, 2011, WFEC owned 5.26% of ACES equity. The investment in the partnership is accounted for using the equity method of accounting. The Lease – leaseback investment includes $8,930,000 of accrued interest receivable and $102,840,000 of government agency obligations presented at cost. Fair value of the government agency obligations at December 31, 2011 and 2010, were $146,009,000 and $109,621,000, respectively.
(Continued)
33
WESTERN FARMERS ELECTRIC COOPERATIVE Notes to Consolidated Financial Statements December 31, 2011 and 2010
(4)
Lease – Leaseback Transaction On May 31, 2001, WFEC entered into a long-term lease transaction with a limited liability company (LLC) owned by a partnership for the benefit of two unaffiliated institutional equity investors. Under the terms of the transaction, WFEC entered into a 56-year lease of its interest in the Hugo Generation Station and certain of its transmission facilities (collectively, the Facility) to such LLC, and simultaneously entered into a 26-year lease of the Facility back from the LLC. This transaction is reflected as a financing transaction for financial reporting purposes. All rent under the long-term lease of the Facility was paid by the LLC to WFEC on the closing date of the transaction in an amount equal to $420,000,000. From these proceeds, approximately $293,000,000 was paid to a Payment Undertaker for its entering into a Payment Undertaking Agreement (PUA) with WFEC. Under the terms of the PUA, the Payment Undertaker assumed primary liability to pay a portion of WFEC’s rental obligations. In accordance with meeting the provisions of ASC Topic 860, Transfers and Servicing, such portion of the liability and the corresponding PUA were extinguished for financial reporting purposes. As of December 31, 2009, the investments balance was $112,474,000 and the debt balance was $156,440,000. The investments were pledged as collateral for WFEC’s obligations under certain credit enhancement purchased in connection with the lease. In addition, the transaction resulted in a gross cash benefit to WFEC of $46,814,000 that, pursuant to U.S. generally accepted accounting principles applicable to rate regulated enterprises and as authorized by the Board of Trustees, is being recognized on a straight-line basis over the term of the leaseback to WFEC, by deferring interest expense in the early years as a regulatory asset and amortizing the deferral in the later years. At the expiration of the leaseback period, one option available to WFEC is to exercise a fixed price purchase option, which, if exercised, would allow WFEC to terminate the long-term lease from WFEC to the LLC, repay the outstanding debt associated with the lease, and retain all other rights of ownership with respect to the Facility. The use of the cash benefit of $46,814,000 from the transaction was restricted by the RDUP. With RDUP approval, $26,000,000 funded specific construction projects and the balance of $20,814,000 was available to be utilized based upon certain significant events. RDUP authorized a transfer of the funds to a Special Construction Fund (SCF) account in 2007. The SCF account was available to fund WFEC Board and RDUP approved construction projects or other uses as mutually agreed by both parties. The SCF balance as of December 31, 2009 was $25,711,000. The PUA and Investments described above were entered into with affiliates of Ambac Assurance Corporation (Ambac). Ambac also provided the equity investors in the lease with credit enhancement that protected their outstanding exposure upon the event of default by WFEC. In 2008, Ambac was downgraded on several occasions by the major credit rating agencies principally as a result of its exposure to troubled investments in the securitized debt and mortgage markets. Under the terms of the agreement, WFEC was required to provide a replacement or additional enhancement within 60 days of Ambac no longer meeting the minimum credit criteria. In June 2008, the equity investors notified WFEC of its obligation under the lease due to Ambac’s rating falling below the requisite threshold. During this challenging credit environment, WFEC pursued a number of options for addressing the situation presented by Ambac’s downgrade and at the same time negotiated multiple extensions of the deadline for replacement or additional enhancement with the equity investors.
(Continued)
34
WESTERN FARMERS ELECTRIC COOPERATIVE Notes to Consolidated Financial Statements December 31, 2011 and 2010
On February 27, 2009, the participants to the lease-leaseback transaction (lease) agreed to restructure a portion of the 2001 lease, which was affected by a prepayment of the portion of basic rent that was due from an affiliate of Ambac for 90% of the nonrecourse debt (Series A debt) in the lease. This repayment was provided by WFEC using the redemption proceeds of the Payment Undertaking Agreement (PUA), which was also held by Ambac. Although the Series A debt, for which the PUA provided economic defeasance had been extinguished for financial accounting purposes, continued reliance on the PUA would have left WFEC with substantial exposure if Ambac were unable to pay this portion of ongoing rent. The Series B debt, which was provided originally by a third party, remained in place. In order to keep the equity investors whole, as required by the terms of the lease, the rent prepayment required WFEC to make an additional rent payment of $3,749,000 at closing. The additional payment adjusted the original amount of transaction gain and, as such, reduced the straight-line gain recognition from approximately $1,819,000 per year to $1,673,000 per year, prospectively. As of December 31, 2009, the deferred gain was approximately $28,601,000. On May 3, 2010, the participants to the lease agreed to further amend the 2001 lease and the Ambac Credit Products was replaced with Berkshire Hathaway Assurance Corporation as the credit enhancement provider. Ambac liquidated the Guaranteed Investment Contracts (GIC) held for the equity investors and Series B loan payments at an amount less than full accreted value (for approximately 68% of the accreted value or $78,083,000 as of May 3, 2010). In connection with such amendment and liquidation, the Ambac credit default swap and surety bond securing such swap, which provided credit enhancement in the lease, were terminated and Ambac was released from further liability under such swap, surety bond and GIC’s. The proceeds of the liquidation were reinvested in U.S. government agency securities to economically defease the remaining equity investor periodic rent payments, the equity investor portion of the purchase option price at the end of the lease term and the Series B loan balloon payment due at the end of the lease term (2027). This required an additional cash contribution (over and above the Ambac GIC liquidation proceeds) of $24,757,000. With Board and RDUP approval, the cash source was a portion of the original proceeds of the lease transaction held in the SCF. As a result of the above described substitution of the agency securities for the Ambac GIC’s, the amount of interest to be earned on the securities defeasance account will be lower over the lease term by $35,848,000. Additional rent of $4,360,000 is owed due to a change in interest rate on the Series B debt. In turn, the net gain of the transaction was reduced from $1,673,000 per year to $102,000 per year, prospectively. As of December 31, 2011, gain to be recognized in the future is $1,523,000. The remaining Series B loan payments (prior to the balloon) are no longer economically defeased and WFEC will pay them as they are due out of the remaining original proceeds and operating cash flows. At December 31, 2011, the Series B debt balance was $35,254,000, of which the present value of the nondefeased payment obligations was $26,213,000. WFEC contracted with Berkshire Hathaway to provide credit enhancement for the equity termination value. WFEC paid the enhancement fee for the remaining portion of 2011 and 2012 at closing and, hereafter, is required under the amended lease to make payments every October for the subsequent calendar year through the remainder of the lease term.
(Continued)
35
WESTERN FARMERS ELECTRIC COOPERATIVE Notes to Consolidated Financial Statements December 31, 2011 and 2010
WFEC received Board and RDUP authority to defer and amortize as a regulatory asset (a) the reduced gain of $2,856,000, (b) the GIC liquidation loss of $36,745,000, (c) the adjustment to reflect reduced interest income and the change in pattern of gain amortization of $13,487,000, and (d) the remaining transaction fees of $167,000 straight line over the remaining term of the lease (2027) under ASC 980, which approximates $2,853,000 annual amortization. At December 31, 2011, the regulatory asset balance is $51,456,000. See note 5. WFEC’s electric rates are designed to recover this cost. As of December 31, 2011, the investments balance is $111,770,000 and the debt balance is $163,357,000. (5)
Regulatory Assets and Other Assets and Liabilities WFEC is subject to the provisions of ASC 980, Regulated Operations. Regulatory assets represent probable future revenue to WFEC associated with certain costs which will be recovered from customers through the ratemaking process. Deferred debits and credits at December 31 contained the following: 2011 Regulatory assets: Unamortized cost associated with lease/leaseback (see note 4) Other assets: Preliminary survey and investigation charges Unamortized debt expense Other liabilities: Unearned revenue
$
(In thousands)
2010
51,456
53,241
659 935
697 20
$
53,050
53,958
$
1,029
1,373
As of December 31, 2011, WFEC’s regulatory assets are being reflected in rates charged to customers over 16 years. The regulatory and other assets are reflected in deferred debits and unearned revenue is reflected in other liabilities in the accompanying consolidated balance sheet. With Board and RDUP approval, in 2009 and 2008 WFEC deferred recognition of $13,038,000 and $3,492,000, respectively, of revenue from additional utilization of utility plants. This was to mitigate the rate impact of a new generation facility and other increased costs to WFEC’s members. The cash equivalent of the deferred revenue was segregated and restricted until subsequently amortized into revenue in 2010. (6)
Patronage Capital WFEC’s mortgage and certain loan agreements (See note 7) contain restrictions on distributions of capital contributed by members. There was no patronage retirement for the years 2010 and 2011.
(Continued)
36
WESTERN FARMERS ELECTRIC COOPERATIVE Notes to Consolidated Financial Statements December 31, 2011 and 2010
Patronage capital is calculated based on WFEC’s net income as determined for federal income tax purposes. For financial reporting purposes, net margins are assigned to members on a patronage basis. Member capital as of December 31, 2011 of $189,538,000 is comprised of $160,326,000, which has been assigned to members, $10,463,000 of 2011 net margin and $18,749,000 of prior years net unassigned margins. Member capital as of December 31, 2010 of $172,819,000 is comprised of $130,115,000, which has been assigned to members, $23,955,000 of 2010 net margin and $18,749,000 of prior years net unassigned margins. (7)
Debt Long-term debt at December 31 consisted of the following: 2011 First mortgage notes: Notes payable to Federal Financing Bank (FFB), interest from 2.14% to 11.37%, a weighted average of 5.14%, due in quarterly installments through 2043 Notes payable to the RDUP, interest from 4.75% to 5.00%, a weighted average of 4.76%, due in monthly and quarterly installments through 2025 Note payable to CoBank, interest at 5.71%, due in quarterly installments through January 2019 Note payable to CoBank, interest at 6.22%, due in monthly installments through November 2025 Notes payable to CFC with varying amounts, interest from 5.15% to 5.50%, due in annual installments through 2016 Notes payable to CoBank, interest at a weighted average of 6.36%, due in quarterly installments through April 2038 Notes payable to CFC with varying amounts, interest from 2.35% to 4.55%, due in quarterly installments through June 2024 Other notes: Notes payable to CFC, interest at 5.65% through 2018 and 5.55% through 2023, due in quarterly installments through 2023 Note payable to CoBank, interest at 6.34% due in quarterly installments through April 2016 Lease termination obligation payable to Hugo Generation, at maturity in 2027, interest imputed at a fixed rate of 4.09% Note payable to CoBank, at a variable interest rate, with a fixed rate swap at 5.88% plus 1.875%, principal due annually through 2020, interest payments quarterly Note payable, interest at 7.56%, due in annual installments through 2021
$
(In thousands)
2010
460,835
444,316
8,275
8,689
7,832
8,536
2,920
3,028
3,299
4,615
118,998
120,681
18,410
19,740
16,491
17,430
2,183
2,602
163,357
159,470
19,125
20,750
4,999
5,327
(Continued)
37
WESTERN FARMERS ELECTRIC COOPERATIVE Notes to Consolidated Financial Statements December 31, 2011 and 2010
2011 Notes payable to CoBank, interest from 1.56% to 3.50% at December 31, 2011, due May 2015, syndicated revolving loan agreement
$
Less current portion of long-term debt Total long-term debt
$
(In thousands)
2010
38,725
—
865,449
815,184
37,012
31,126
828,437
784,058
Annual payments of long-term debt for years subsequent to December 31, 2011 are as follows (in thousands): 2012 2013 2014 2015 2016 Thereafter
$
37,012 32,924 34,462 74,621 29,114 657,316
$
865,449
In 2009, a $150,000,000 CoBank revolving line of credit facility was amended to provide for bridge funding and term-out provisions for long-term permanent financing of the 145-megawatt Anadarko Capacity Addition declared commercial June 30, 2009. With a lien accommodation authorized by RDUP, the commitment was secured and reduced to $125,000,000. WFEC converted the drawn balance of $121,086,000 in September 2010 to permanent fixed-rate financing with CoBank maturing April 2038. In 2010, WFEC’s unsecured committed revolving line of credit with CoBank to provide interim financing of construction projects and general operating needs was increased from $75,000,000 to $100,000,000 and the term extended to May 31, 2011. In May 2011, the line was replaced with a $200,000,000 unsecured committed four-year syndicated revolver with CoBank acting as lead arranger and administrative agent. The outstanding balance on the CoBank lines of credit at December 31, 2011 and 2010 was $38,275,000 and $46,678,000, respectively. During 2011, WFEC was able to refinance the previous short term notes to long term debt. The commitment matures in 2015. WFEC also has a three-year unsecured committed revolving line of credit with CFC totaling $75,000,000 with a term through October 2013. Advances on the CFC facility bear interest at a floating rate and the facility is renewable at the discretion of the lender and WFEC. No advances were outstanding on the CFC line of credit at December 31, 2011 and 2010, respectively. A $670,000 letter of credit had been issued under this arrangement.
(Continued)
38
WESTERN FARMERS ELECTRIC COOPERATIVE Notes to Consolidated Financial Statements December 31, 2011 and 2010
Approximately $161,275,000 and $74,330,000 of borrowing capacity was available on the CoBank and CFC lines of credit, respectively, at December 31, 2011, net of outstanding Letters of Credit and line advances. In order to provide additional financing alternatives, during 2011 WFEC took action to substitute an indenture of mortgage for its Restated and Consolidated Mortgage and Security Agreement. Consequently, WFEC executed an Indenture of Mortgage, Deed of Trust, Security Agreement and Financing Statement, dated as of April 8, 2011 (Indenture), between WFEC, as Grantor, to U.S. Bank National Association, as Trustee. All mortgage notes secured by the Indenture are secured equally and ratably by a first priority lien on substantially all of the assets of WFEC, subject to certain exceptions and limitations. Under the terms of WFEC’s Indenture, substantially all of the after-acquired assets of WFEC become subject to the lien of the Indenture. Also, under the terms of the Indenture, the RDUP Loan Contract and other loan agreements, WFEC must maintain certain financial covenants. WFEC was in compliance with these financial convenants at December 31, 2011. WFEC had approximately $120,436,000 of unadvanced funds available at December 31, 2011 from FFB on notes previously executed. Approximately $62,474,000 is available for transmission and distribution additions and replacements and $57,962,000 for generation system improvement projects. During 2011, RDUP approved a loan guarantee commitment in the amount of $184,100,000 for the purpose of financing certain WFEC generation and transmission projects planned for the 2012-2015 construction work plan period. Approximately $62,509,000 is committed for transmission and distribution additions and replacement and $121,591,000 for generation system improvement projects. In 2001, a construction loan, used to finance GenCo’s two new generating units, totaling approximately $35,000,000, was converted to a 20-year term loan with a variable interest rate. GenCo simultaneously entered into an interest rate swap agreement to fix the rate at 5.88%. In addition to the variable rate, GenCo must pay an additional 1.875% to CoBank, which increases over the life of the loan to 2.25%. This term loan is classified as long-term debt. (8)
Production Expenses WFEC’s production expenses for the years ended December 31 include the following:
2011 Fuel Other production expenses Total production expenses
(In thousands)
2010
$
142,782 18,229
151,562 18,919
$
161,011
170,481
As disclosed in note 1, under WFEC’s contracts with its members, costs of fuel are recovered through rates charged to members.
(Continued)
39
WESTERN FARMERS ELECTRIC COOPERATIVE Notes to Consolidated Financial Statements December 31, 2011 and 2010
(9)
Income Taxes WFEC is a nonexempt cooperative subject to federal and state income taxes and files a consolidated tax return. As a cooperative, WFEC is entitled to exclude patronage dividends from taxable income. WFEC’s bylaws require it to declare patronage dividends in an aggregate amount equal to WFEC’s federal taxable income from its furnishing of electric energy and other services to its member-patrons. Accordingly, such income will not be subject to income taxes. Nonmember operations are subject to federal income taxes. Historically, WFEC’s nonmember operations have generated tax losses. The primary differences between WFEC’s book income and WFEC’s nonmember tax losses are the result of the tax accounting for certain leases. As of December 31, 2011 and 2010, WFEC’s deferred tax asset before valuation allowance was approximately $8,154,000 and $9,146,000, respectively. Based on WFEC’s historical results, management does not believe that it is more likely than not that WFEC will be able to realize the benefit of the deferred tax asset, which includes net operating loss carryforwards of approximately $18,512,000, which expire in 2011 and thereafter. No income tax expense was provided in 2011 and 2010, due to the availability of net operating loss carryforwards to offset nonmember income for tax purposes. The approximate net deferred tax asset and valuation allowance at December 31 were as follows: 2011
2010 (In thousands)
Tax-effected gross deductible temporary differences Tax-effected gross taxable temporary differences
$
Deferred tax asset Less valuation allowance Net deferred tax asset
$
11,894 (3,740)
13,900 (4,754)
8,154
9,146
(8,154)
(9,146)
—
—
(10) Retirement Plans Substantially all employees of WFEC participate in the National Rural Electric Cooperative Association (NRECA) Retirement Security Plan (RS Plan), a defined benefit pension plan qualified under Section 401 and tax-exempt under Section 501(a) of the Code. WFEC makes monthly contributions to the plan equal to the amounts accrued for pension expense, which is dependent on the employee’s date of hire. During 2011 and 2010, WFEC contributed approximately $6,902,000 and $6,737,000, respectively, to the plan. In this master multiemployer plan that is available to all member cooperatives of the NRECA, the accumulated benefits and plan assets are not determined or allocated separately by individual employer.
(Continued)
40
WESTERN FARMERS ELECTRIC COOPERATIVE Notes to Consolidated Financial Statements December 31, 2011 and 2010
Substantially all employees of WFEC also participate in the NRECA 401(k) Pension Plan option. Under the plan, WFEC contributes amounts not to exceed 8% of the respective employee’s base pay to the plan, dependent on the employee’s level of participation and the employee’s date of hire. Employees may contribute up to the IRS prescribed limit of their base pay to the plan. Contributions are immediately 100% vested. Benefits paid under the plan are limited to the sum of the employee’s and WFEC’s contributions and investment earnings or losses on those contributions. WFEC contributed approximately $1,063,000 and $869,000 to the plan in 2011 and 2010, respectively. In addition to the defined benefit and defined contribution retirement plans, WFEC sponsors a health care plan that provides postretirement medical benefits to non-Medicare eligible retired employees who meet minimum age and years-of-service requirements. The plan is contributory with retiree contributions subject to annual adjustment, and contains other cost-sharing features such as deductibles and coinsurance. WFEC contributes to retiree health care benefits in years when retiree claims exceed premiums. WFEC’s policy is to fund the cost of medical benefits as incurred. (11) Fair Value of Financial Instruments At December 31, 2011 and 2010, WFEC’s financial instruments included cash, cash equivalents, restricted cash, investments in associated organizations and other investments, accounts receivable, accounts payable, long-term debt and a cash flow hedge. At December 31, 2011 and 2010, the fair market values of cash and cash equivalents, restricted cash, accounts receivable, and accounts payable approximated carrying values because of the short-term nature of these instruments. The fair value of investments in patronage capital and stock is not readily determinable. The carrying value of the capital term certificates are considered to be their fair value, as they represent an ownership interest in member-owned institutions and do not have a market for exchange. The assumption used in determining the fair value of WFEC’s long-term variable interest rate debt is that the fair value approximates the carrying value, as the debt reprices at least annually to a market interest rate. Fair value of WFEC’s long-term fixed interest rate debt is calculated to be the discounted cash flows of the debt based upon long-term fixed interest rates that WFEC could obtain at December 31, 2011 and 2010, respectively. Under the provision of ASC 820-10, Fair Value Measurements and Disclosure, the fair value is determined based upon Level 2, significant other observable inputs, defined as inputs that are either directly or indirectly observable. The estimated fair value of the long-term debt at December 31, 2011 and 2010 is approximately $898,116,000 and $817,811,000, respectively. See note 12 for a discussion of the fair value of derivative instruments. (12) Derivative Instruments and Hedging Activities The Company periodically enters into commodity swap, collar and option contracts for a portion of its anticipated natural gas or power purchases, to manage the price risk associated with fluctuations in market prices. These contracts limit the unfavorable effect that price increases will have on natural gas or power purchases. WFEC has elected to not designate its commodity contracts as cash flow hedges; therefore, changes in the fair value of the commodity contracts are recorded as an asset or liability and as an increase or reduction to production or purchased power expense. In accordance with ASC 980-10, Regulated Operations, gains and losses from price management activities are included in WFEC’s fuel cost recovered from members as part of WFEC’s rate-making policy. As such, an asset or liability, that offsets the change (Continued)
41
WESTERN FARMERS ELECTRIC COOPERATIVE Notes to Consolidated Financial Statements December 31, 2011 and 2010
in the fair value of the commodity contracts recorded in production or purchased power expense, is established to record the amount of fuel costs over collected from or unbilled to members of WFEC. The fair value of the commodity swaps resulted in a liability and a related receivable from members (through future increased fuel charges) of $4,261,000 and $2,818,000 as of December 31, 2011 and 2010, respectively. The fair value of the liability is reflected in accounts payable and accrued liabilities in the accompanying financial statements. WFEC has entered into derivative type commodity contracts for future transactions with terms expiring through December 2012. GenCo entered into an interest rate swap agreement to manage fluctuations in cash flows resulting from interest rate risk. This swap changes the variable-rate cash flow exposure on the debt obligation to fixed cash flows. Under the terms of the interest rate swap, GenCo receives variable interest rate payments and makes fixed interest rate payments, thereby creating the equivalent of fixed-rate debt. Changes in the fair value of the interest rate swap, which is designated as a hedging instrument that effectively offsets the variability of cash flows associated with variable-rate, long-term debt obligation is reported in equity as other comprehensive income. This amount subsequently is reclassified into interest expense as a yield adjustment of the hedged interest payments in the same period in which the related interest affects earnings. For the years ended December 31, 2011 and 2010, WFEC reclassified losses of $1,147,000 and $1,224,000, respectively, into interest expense. The fair value of the interest rate swap was obtained from dealer quotes. This value represents the estimated amount WFEC would receive or pay to terminate the agreement, taking into consideration current interest rates. The fair value of the swap at December 31, 2011 and 2010 was a liability of $3,966,000 and $3,520,000, respectively, and is included in other liabilities in the accompanying consolidated balance sheets. WFEC expects $1,000,000 of the existing losses that are reported on accumulated other comprehensive income at December 31, 2011, to be reclassified into earnings within the next twelve months. WFEC utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible. WFEC determines fair value based on assumptions that market participants would use in pricing an asset or liability in the principal or most advantageous market. When considering market participant assumptions in fair value measurements, the following fair value hierarchy distinguishes between observable and unobservable inputs, which are categorized in one of the following levels: x
Level 1 Inputs: Unadjusted quoted prices in active markets for identical assets or liabilities accessible to the reporting entity at the measurement date.
x
Level 2 Inputs: Other than quoted prices included in Level 1 inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.
x
Level 3 Inputs: Unobservable inputs for the asset or liability used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at measurement date.
(Continued)
42
WESTERN FARMERS ELECTRIC COOPERATIVE Notes to Consolidated Financial Statements December 31, 2011 and 2010
The following table presents the placement in the fair value hierarchy of liabilities that are measured at fair value on a recurring basis at December 31, 2011 and 2010: Quoted prices in active markets for identical assets (Level 1) Liabilities: Commodity derivatives Interest rate derivatives
Significant unobservable inputs (Level 3)
2011
$
— —
4,261,000 3,966,000
— —
4,261,000 3,966,000
$
—
8,227,000
—
8,227,000
Total liabilities
Quoted prices in active markets for identical assets (Level 1) Liabilities: Commodity derivatives Interest rate derivatives
Significant other observable inputs (Level 2)
Significant other observable inputs (Level 2)
Significant unobservable inputs (Level 3)
2010
$
— —
2,818,000 3,520,000
— —
2,818,000 3,520,000
$
—
6,338,000
—
6,338,000
Total liabilities
(13) Commitments and Contingencies Addition of and Sales to New Mexico Cooperatives In 2010, all necessary approvals were received to add four New Mexico distribution cooperatives (Cooperative, collectively Cooperatives) to the membership of WFEC. Each Cooperative executed a Wholesale Power Contract (WPC) through 2050 and has one vote on the Board of Trustees through their respective elected representative. Together, the Cooperatives have approximately 400 megawatts (MW) of load. Their service territories are adjacent to one another in southeastern New Mexico and are located in the Southwest Power Pool (SPP) footprint, as is WFEC. The Cooperatives will continue to own and maintain their respective transmission and distribution systems. Transmission service will be provided through the SPP Open Access Transmission Tariff. WFEC and the Cooperatives also executed a Transition Agreement (Agreement), effective in 2010 and terminating June 1, 2026. During this transition period, the Cooperatives are members of WFEC with all rights, privileges and obligations of membership, but with a separate cost of service rate (Segregated Rate). The Segregated Rate shall generate sufficient revenue to cover the Cooperative’s cost of service as well as produce sufficient revenues that when combined with all other WFEC revenues, meet WFEC Board-determined reserves. During the transition period, each Cooperative shall be responsible for (Continued)
43
WESTERN FARMERS ELECTRIC COOPERATIVE Notes to Consolidated Financial Statements December 31, 2011 and 2010
(1) costs which are directly and uniquely related to the supply and delivery of electric power and energy to the respective Cooperative, (2) its share of costs common to the Cooperatives and (3) its share of costs common to all members of WFEC. After the transition period and for the remaining term of the WPC, the Segregated Rate shall no longer be used, and the Cooperatives shall be a member with a then applicable cost of service rate or rates common with other members of WFEC (Member Rate) and consistent with the WPC. Immediate and short-term generation requirements of the Cooperatives will continue to be provided from their existing contracts with Southwestern Public Service Company (SPS). The Cooperatives will step out of those contracts in four increments in 2012, 2017, 2022 and finally 2026 when the contracts terminate. WFEC will be responsible for providing approximately 122 MW in 2017, 300 MW in 2022 and fully responsible for all needs of the Cooperatives after the SPS contracts terminate in 2026. Each of the Cooperatives is responsible for their power supply needs until 2017 through their SPS contracts, self-build generation or other third party contracts. When WFEC begins to supply portions of the requirements in 2017, the remainder will continue to be supplied from the SPS contracts during their remaining term. WFEC may, but is not obligated, to provide any power to the cooperatives until 2017. All Cooperative power supply resources, including the SPS contracts, shall be assigned to WFEC in the next few years, but in any event, no later than spring 2017. Upon such assignment and assumption of obligations, the Cooperatives shall, through June 1, 2026, continue to pay all charges and costs arising from such third party supplied contracts and contributed generation, as part of the Segregated Rate. Beginning June 1, 2026 and thereafter, the charges and costs arising from assigned third party supplier contracts and contributed generation shall be included in the WFEC Member Rate. One Cooperative has chosen to build capacity to self-generate a portion of its needs. The generation resources, declared commercial February 2012, will be assigned along with debt assumption to WFEC by 2017, possibly sooner, and an appropriate equity credit assigned to the Cooperative for its net contribution. This Cooperative has entered into a purchase power agreement for all the output from a wind farm with an approximate 28 MW nameplate rating. This wind energy purchase agreement shall be assigned to WFEC, like other resources as described above. Each Cooperative will contribute equity to WFEC in a manner and amount such that, as of June 1, 2026, the Cooperative has contributed equity to WFEC comparable to the amount of equity contributed to WFEC by prior existing members. These equity contribution payments are determined by WFEC’s projected capital resource additions or purchase power contracts, or share thereof, required to supply power and energy to the respective Cooperative, and are collected and paid to WFEC through the Segregated Rate. In 2011, the Cooperatives had contributed $6,256,000 in equity to WFEC which were assigned to their respective patronage accounts. The WFEC Board of Trustees and RDUP approved adoption of the Segregated Rate, (WFEC Rate Schedule TR-15(a)) in February and March, 2011, respectively. Additionally, the Board approved an agreement for WFEC to sell a combined approximately 50 MW of capacity and associated energy to three of the Cooperatives to help meet their power supply needs beginning June 2012 and ending May 2017.
(Continued)
44
WESTERN FARMERS ELECTRIC COOPERATIVE Notes to Consolidated Financial Statements December 31, 2011 and 2010
Purchase Requirements WFEC has a long-term standby power contract with Southwestern Power Administration under which it is obligated to purchase a minimum quantity of power annually through May 2012. It is expected that the contract will be extended through May, 2027 with the same minimum purchase requirements and with the same rate structure. At the prescribed 2012 rates, the minimum requirement approximates $17,916,000. During 2011 and 2010, WFEC purchased $20,114,000 and $21,587,000, respectively. WFEC has a long-term purchased power contract with a party, effective January 2010 through December 2025 under which it is obligated to purchase a minimum quantity of power on a monthly basis. Based on contract information and power cost adjustment information currently published, the annual obligation for 2012 is estimated at $46,117,000. During 2011 and 2010, WFEC purchased $24,042,000 and $12,828,000, respectively. The contract requires WFEC to purchase increasing minimum monthly quantities of power at prescribed contract intervals. In 2011, WFEC negotiated multiyear contracts to acquire and transport coal for the Hugo Generating Station. WFEC’s costs for both coal and transportation purchases were approximately $69,000,000 and $65,000,000 for the years ended December 31, 2011 and 2010, respectively. The current projection for the minimum contract commitments for coal and coal transportation are approximately $69,000,000 in 2012, and $43,000,000 in 2013. Environmental WFEC, as is common with other electric utilities, is subject to stringent existing environmental laws, rules, and regulations by federal, state, and local authorities with regard to air and water quality control, solid and hazardous waste disposal, hazardous material management, and toxic substance control. Management believes it is in substantial compliance with all existing laws, rules, and regulations. Legal WFEC was the defendant in two lawsuits, each involving one member distribution cooperative. Each suit centered on numerous claims, and one complaint sought to have the parties’ Wholesale Power Agreement declared invalid as an unlawful restraint of trade, each related to the adoption and implementation by WFEC of a member wholesale power rate, the R-15 rate, effective February 1, 2010. In January 2012, one of the suits was settled and dismissed with no monetary amount due. WFEC denies the allegations in the remaining suit and intends to vigorously defend the case. WFEC is involved in various other legal actions arising in the ordinary course of business. In the opinion of management, after consultation with counsel, the ultimate disposition of these matters will not have a material adverse effect on WFEC’s financial position or the results of future operations.
(Continued)
45
WESTERN FARMERS ELECTRIC COOPERATIVE Notes to Consolidated Financial Statements December 31, 2011 and 2010
(14) Asset Retirement Obligation WFEC has asset retirement obligations arising from regulatory requirements to perform certain asset retirement activities at the time that certain machinery and equipment is disposed of. The liability is initially measured at its discounted fair value and subsequently adjusted for accretion expense and changes in the amount or timing of the estimated cash flows. The corresponding asset retirement costs are capitalized as part of the carrying amount of the related long-lived asset and depreciated over the asset’s useful life. Activity for the asset retirement obligations for the years ended December 31 are as follows:
2011
(In thousands)
2010
Beginning balance Additional liabilities incurred Revisions to estimates Accretion expense
$
1,107 — — 78
1,036 — — 71
Ending balance
$
1,185
1,107
(15) Subsequent Events The Company has evaluated subsequent events from the balance sheet date through March 6, 2012, the date at which the financial statements were available to be issued, and determined there are no other items to disclose.
46
24
Generating Through Time