NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X and do not include all of the information and notes required by GAAP for complete financial statements. Similarly, the
December 31, 2011
, Consolidated Balance Sheet was derived from audited financial statements but does not include all disclosures required by GAAP. All adjustments are of a normal, recurring nature, except as otherwise disclosed. Operating results for the period ended
September 30, 2012
, are not necessarily indicative of results that may be expected for any other interim period or for the year ending December 31,
2012
. For further information, refer to the consolidated financial statements and notes included in our
2011
Form 10-K.
NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Inventories.
Inventories are stated at the lower of cost or market. Amounts removed from inventory are recorded on an average cost basis.
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Inventories
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September 30,
2012
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December 31,
2011
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Millions
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Fuel
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$31.3
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|
|
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$28.6
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Materials and Supplies
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45.4
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40.5
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Total Inventories
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$76.7
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$69.1
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Prepayments and Other Current Assets
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September 30,
2012
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December 31,
2011
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Millions
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Deferred Fuel Adjustment Clause
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$18.2
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$17.5
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Other
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5.6
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9.6
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Total Prepayments and Other Current Assets
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$23.8
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$27.1
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Other Current Liabilities
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September 30,
2012
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December 31,
2011
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Millions
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Customer Deposits
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$28.8
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$16.3
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Other
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24.3
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29.3
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Total Other Current Liabilities
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$53.1
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$45.6
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Other Non-Current Liabilities
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September 30,
2012
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December 31,
2011
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Millions
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Asset Retirement Obligation
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$61.7
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$57.0
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Other
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47.7
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48.1
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Total Other Non-Current Liabilities
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$109.4
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$105.1
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Supplemental Statement of Cash Flows Information.
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For the Nine Months Ended September 30,
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2012
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2011
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Millions
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Cash Paid During the Period for Interest – Net of Amounts Capitalized
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$32.3
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$32.4
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Cash Paid (Received) During the Period for Income Taxes
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$0.2
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$(11.1)
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Noncash Investing and Financing Activities
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Decrease in Accounts Payable for Capital Additions to Property, Plant and Equipment
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$(13.1)
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$(14.8)
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AFUDC – Equity
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$3.4
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$1.7
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ALLETE Third Quarter 2012 Form 10-Q
10
NOTE 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Accounts Receivable.
Accounts receivable are reported on the Consolidated Balance Sheet net of an allowance for doubtful accounts. The allowance is based on our evaluation of the receivable portfolio under current conditions, overall portfolio quality, review of specific problems and such other factors that, in our judgment, deserve recognition in estimating losses.
In the third quarter of 2011, one of Minnesota Power’s Large Power Customers, NewPage Corporation (NewPage), filed for Chapter 11 bankruptcy protection. Minnesota Power had a pre-bankruptcy petition receivable of
$3.2 million
as of
September 30, 2012
. In September 2012, NewPage submitted a motion to the bankruptcy court to approve amended and restated service agreements and payment of the pre-petition amount, which was approved on October 16, 2012. The agreement is now pending approval by the MPUC, at which time the pre-petition amount will be paid.
Based on our assessment of the facts and circumstances existing as of
September 30, 2012
, we have determined that it is not probable that the pre-petition receivable has been impaired. This customer’s operations have continued without interruption and we continue to provide electric and steam service to this customer. We have received payment of scheduled post-petition receivable balances and we expect continued payment of all other post-petition receivables.
Subsequent Events.
The Company performed an evaluation of subsequent events for potential recognition and disclosure through the time of the financial statements issuance.
New Accounting Standards.
Fair Value.
In May 2011, the FASB issued an accounting standards update on fair value measurement. This update requires disclosure of a sensitivity analysis for fair value measurements within Level 3 and the valuation process used. No retrospective application of this guidance is required. If we utilize Level 3 fair value measurements in the future, this guidance would significantly increase our disclosures in this area. This guidance was effective beginning with the quarter ended March 31, 2012, and did not have a material impact on our consolidated financial position, results of operations or cash flows.
Statement of Comprehensive Income.
In June 2011, the FASB issued an accounting standards update on the presentation of comprehensive income. This guidance was effective beginning with the quarter ended March 31, 2012, and modified our presentation of other comprehensive income, moving it from the footnotes to the face of the financial statements in a separate Consolidated Statement of Comprehensive Income immediately following the Consolidated Statement of Income. The components of net income and other comprehensive income are unchanged and earnings per share continues to be based on net income.
ALLETE Third Quarter 2012 Form 10-Q
11
NOTE 2. BUSINESS SEGMENTS
Regulated Operations includes our regulated utilities, Minnesota Power and SWL&P, as well as our investment in ATC, a Wisconsin-based utility that owns and maintains electric transmission assets in parts of Wisconsin, Michigan, Minnesota and Illinois. Investments and Other is comprised primarily of BNI Coal, our coal mining operations in North Dakota, ALLETE Properties, our Florida real estate investment, and ALLETE Clean Energy, aimed at developing or acquiring capital projects that create energy solutions via wind, solar, biomass, hydro, natural gas/liquids, shale resources, clean coal and other clean energy innovations. The Investments and Other segment also includes a small amount of non-rate base generation, approximately
5,500
acres of land available-for-sale in Minnesota, and earnings on cash and investments.
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Consolidated
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Regulated Operations
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Investments and Other
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Millions
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For the Quarter Ended September 30, 2012
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Operating Revenue
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$248.8
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$226.4
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$22.4
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Fuel and Purchased Power Expense
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79.5
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|
79.5
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—
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Operating and Maintenance Expense
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98.7
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76.4
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22.3
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Depreciation Expense
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25.0
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23.5
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1.5
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Operating Income (Loss)
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45.6
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47.0
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(1.4
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)
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Interest Expense
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(12.3
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)
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(10.2
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)
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(2.1
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)
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Equity Earnings in ATC
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4.9
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4.9
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—
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Other Income
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1.5
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1.5
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—
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Income (Loss) Before Non-Controlling Interest and Income Taxes
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39.7
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43.2
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(3.5
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)
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Income Tax Expense (Benefit)
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10.3
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13.9
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(3.6
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)
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Net Income
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29.4
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|
29.3
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0.1
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Less: Non-Controlling Interest in Subsidiaries
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—
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—
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—
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Net Income Attributable to ALLETE
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$29.4
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$29.3
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$0.1
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Consolidated
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Regulated Operations
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Investments and Other
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Millions
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For the Quarter Ended September 30, 2011
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Operating Revenue
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$226.9
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$207.4
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$19.5
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Fuel and Purchased Power Expense
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74.8
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|
74.8
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—
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Operating and Maintenance Expense
|
90.5
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|
70.4
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|
20.1
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Depreciation Expense
|
22.7
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21.4
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|
1.3
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Operating Income (Loss)
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38.9
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|
40.8
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(1.9
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)
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Interest Expense
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(10.9
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)
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(9.2
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)
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(1.7
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)
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Equity Earnings in ATC
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4.7
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|
4.7
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—
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Other Income (Expense)
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0.5
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|
0.6
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(0.1
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)
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Income (Loss) Before Non-Controlling Interest and Income Taxes
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33.2
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36.9
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(3.7
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)
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Income Tax Expense (Benefit)
|
12.7
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|
13.1
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(0.4
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)
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Net Income (Loss)
|
20.5
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|
23.8
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(3.3
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)
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Less: Non-Controlling Interest in Subsidiaries
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—
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—
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—
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Net Income (Loss) Attributable to ALLETE
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|
$20.5
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|
|
|
$23.8
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|
$(3.3)
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ALLETE Third Quarter 2012 Form 10-Q
12
NOTE 2. BUSINESS SEGMENTS (Continued)
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Consolidated
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Regulated Operations
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Investments and Other
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Millions
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For the Nine Months Ended September 30, 2012
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Operating Revenue
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$705.2
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$642.0
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|
$63.2
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Fuel and Purchased Power Expense
|
228.7
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|
|
228.7
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|
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—
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Operating and Maintenance Expense
|
294.8
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|
|
230.6
|
|
|
64.2
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Depreciation Expense
|
74.4
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|
|
70.1
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|
|
4.3
|
|
Operating Income (Loss)
|
107.3
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|
|
112.6
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|
(5.3
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)
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Interest Expense
|
(33.4
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)
|
|
(29.7
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)
|
|
(3.7
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)
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Equity Earnings in ATC
|
14.3
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|
|
14.3
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|
|
—
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Other Income (Expense)
|
3.4
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|
|
3.5
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|
|
(0.1
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)
|
Income (Loss) Before Non-Controlling Interest and Income Taxes
|
91.6
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|
100.7
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|
|
(9.1
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)
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Income Tax Expense (Benefit)
|
23.4
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|
|
32.6
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|
(9.2
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)
|
Net Income
|
68.2
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|
|
68.1
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|
|
0.1
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|
Less: Non-Controlling Interest in Subsidiaries
|
—
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|
—
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|
|
—
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|
Net Income Attributable to ALLETE
|
|
$68.2
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|
|
|
$68.1
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|
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|
$0.1
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|
As of September 30, 2012
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Total Assets
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|
$3,138.1
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|
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$2,830.9
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|
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$307.2
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Property, Plant and Equipment – Net
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|
$2,239.9
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|
|
|
$2,180.8
|
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|
|
$59.1
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|
Accumulated Depreciation
|
|
$1,146.7
|
|
|
|
$1,091.5
|
|
|
|
$55.2
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Capital Additions
|
|
$318.3
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|
|
|
$312.6
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|
|
|
$5.7
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Consolidated
|
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Regulated Operations
|
|
Investments and Other
|
Millions
|
|
|
|
|
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For the Nine Months Ended September 30, 2011
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Operating Revenue
|
|
$689.0
|
|
|
|
$632.2
|
|
|
|
$56.8
|
|
Fuel and Purchased Power Expense
|
229.8
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|
|
229.8
|
|
|
—
|
|
Operating and Maintenance Expense
|
276.3
|
|
|
218.8
|
|
|
57.5
|
|
Depreciation Expense
|
67.1
|
|
|
63.5
|
|
|
3.6
|
|
Operating Income (Loss)
|
115.8
|
|
|
120.1
|
|
|
(4.3
|
)
|
Interest Expense
|
(32.6
|
)
|
|
(26.9
|
)
|
|
(5.7
|
)
|
Equity Earnings in ATC
|
13.7
|
|
|
13.7
|
|
|
—
|
|
Other Income
|
2.3
|
|
|
1.8
|
|
|
0.5
|
|
Income (Loss) Before Non-Controlling Interest and Income Taxes
|
99.2
|
|
|
108.7
|
|
|
(9.5
|
)
|
Income Tax Expense (Benefit)
|
24.7
|
|
|
28.2
|
|
|
(3.5
|
)
|
Net Income (Loss)
|
74.5
|
|
|
80.5
|
|
|
(6.0
|
)
|
Less: Non-Controlling Interest in Subsidiaries
|
(0.2
|
)
|
|
—
|
|
|
(0.2
|
)
|
Net Income (Loss) Attributable to ALLETE
|
|
$74.7
|
|
|
|
$80.5
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|
|
$(5.8)
|
|
|
|
|
|
|
As of September 30, 2011
|
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|
|
|
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Total Assets
|
|
$2,754.4
|
|
|
|
$2,436.0
|
|
|
|
$318.4
|
|
Property, Plant and Equipment – Net
|
|
$1,902.1
|
|
|
|
$1,847.1
|
|
|
|
$55.0
|
|
Accumulated Depreciation
|
|
$1,079.0
|
|
|
|
$1,028.6
|
|
|
|
$50.4
|
|
Capital Additions
|
|
$143.5
|
|
|
|
$128.4
|
|
|
|
$15.1
|
|
ALLETE Third Quarter 2012 Form 10-Q
13
NOTE 3. INVESTMENTS
Investments.
Our long-term investment portfolio includes the real estate assets of ALLETE Properties, debt and equity securities consisting primarily of securities held to fund employee benefits and land available-for-sale in Minnesota.
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Investments
|
September 30,
2012
|
|
|
December 31,
2011
|
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Millions
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|
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|
ALLETE Properties
|
|
$91.1
|
|
|
|
$91.3
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Available-for-sale Securities
|
27.9
|
|
|
24.7
|
|
Other
|
20.7
|
|
|
16.3
|
|
Total Investments
|
|
$139.7
|
|
|
|
$132.3
|
|
|
|
|
|
|
|
|
|
|
ALLETE Properties
|
September 30,
2012
|
|
|
December 31,
2011
|
|
Millions
|
|
|
|
Land Inventory Beginning Balance (January 1, 2012 and 2011, respectively)
|
|
$86.0
|
|
|
|
$86.0
|
|
Deeds to Collateralized Property
|
0.5
|
|
|
1.8
|
|
Land Impairment
|
—
|
|
|
(1.7
|
)
|
Capitalized Improvements and Other
|
0.1
|
|
|
0.2
|
|
Cost of Real Estate Sold
|
(0.2
|
)
|
|
(0.3
|
)
|
Land Inventory Ending Balance
|
86.4
|
|
|
86.0
|
|
Long-Term Finance Receivables (net of allowances of $0.6 and $0.6)
|
1.4
|
|
|
2.0
|
|
Other
|
3.3
|
|
|
3.3
|
|
Total Real Estate Assets
|
|
$91.1
|
|
|
|
$91.3
|
|
Land Inventory.
Land inventory is accounted for as held for use and is recorded at cost, unless the carrying value is determined not to be recoverable in accordance with the accounting standards for property, plant and equipment, in which case the land inventory is written down to fair value. Land values are reviewed for impairment on a quarterly basis and
no
impairments were recorded for the
nine months ended September 30, 2012
(
$1.7 million
as of December 31, 2011). In the fourth quarter of 2011, an impairment analysis of estimated future undiscounted cash flows was conducted and indicated that the cash flows were not adequate to recover the carrying basis of certain properties not strategic to our three major development projects. Consequently, we reduced the cost basis to estimated fair value resulting in a pretax impairment charge of
$1.7 million
. Fair value was determined based on property tax assessed values, discounted cash flow analysis, or a combination thereof.
Long-Term Finance Receivables.
As of
September 30, 2012
, long-term finance receivables were
$1.4 million
net of allowance (
$2.0 million
net of allowance as of
December 31, 2011
). Long-term finance receivables are collateralized by property sold, accrue interest at market-based rates and are net of an allowance for doubtful accounts. As of
September 30, 2012
, we had an allowance for doubtful accounts of
$0.6 million
(
$0.6 million
as of
December 31, 2011
).
ALLETE Third Quarter 2012 Form 10-Q
14
NOTE 4. DERIVATIVES
During the third quarter of 2011, we entered into a variable-to-fixed interest rate swap (Swap), designated as a cash flow hedge, in order to manage the interest rate risk associated with a
$75.0 million
Term Loan. The Term Loan has a variable interest rate equal to the
one-month LIBOR
plus
1.00 percent
, has a maturity of August 25, 2014, and represents approximately
8 percent
of the Company’s outstanding long-term debt as of
September 30, 2012
. (See Note 8. Short-Term and Long-Term Debt.) The Swap agreement has a notional amount equal to the underlying debt principal and matures on August 25, 2014. The Swap agreement involves the receipt of variable rate amounts in exchange for fixed rate interest payments over the life of the agreement without an exchange of the underlying notional amount. The variable rate of the Swap is equal to the
one-month LIBOR
and the fixed rate is equal to
0.825 percent
. Cash flows from the interest rate swap are expected to be highly effective in offsetting the variable interest expense of the debt attributable to fluctuations in the one-month LIBOR interest rate over the life of the Swap. If it is determined that a derivative is not or has ceased to be effective as a hedge, the Company prospectively discontinues hedge accounting with respect to that derivative.
The shortcut method is used to assess hedge effectiveness. At inception, all shortcut method requirements were satisfied; thus changes in the value of the Swap are deemed 100 percent effective. As a result, there was no ineffectiveness recorded for the quarter and nine months ended September 30, 2012.
The mark-to-market fluctuation on the cash flow hedge was recorded in accumulated other comprehensive income on the Consolidated Balance Sheet. As of
September 30, 2012
, the fair value of the Swap was a
$0.8 million
liability (a
$0.4 million
liability as of
December 31, 2011
) and is included in other non-current liabilities on the Consolidated Balance Sheet. Cash flows from derivative activities are presented in the same category as the item being hedged on the Consolidated Statement of Cash Flows. Amounts recorded in other comprehensive income related to cash flow hedges will be recognized in earnings when the hedged transactions occur or when it is probable that the hedged transactions will not occur. Gains or losses on interest rate hedging transactions are reflected as a component of interest expense on the Consolidated Statement of Income.
NOTE 5. FAIR VALUE
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). We utilize market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated or generally unobservable. We primarily apply the market approach for recurring fair value measurements and endeavor to utilize the best available information. Accordingly, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. These inputs, which are used to measure fair value, are prioritized through the fair value hierarchy. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). Descriptions of the three levels of the fair value hierarchy are discussed in Note 9. Fair Value to the consolidated financial statements in our 2011 Form 10-K.
The following tables set forth by level within the fair value hierarchy our assets and liabilities that were accounted for at fair value on a recurring basis as of
September 30, 2012
and
December 31, 2011
. Each asset and liability is classified based on the lowest level of input that is significant to the fair value measurement.
Our assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels. The estimated fair value of cash and cash equivalents listed on the Consolidated Balance Sheet approximates the carrying amount and therefore are excluded from the recurring fair value measures in the table below.
ALLETE Third Quarter 2012 Form 10-Q
15
NOTE 5. FAIR VALUE (Continued)
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|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value as of September 30, 2012
|
Recurring Fair Value Measures
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
Millions
|
|
|
|
|
|
|
|
Assets:
|
|
|
|
|
|
|
|
Investments
|
|
|
|
|
|
|
|
Available-for-sale – Equity Securities
|
|
$19.1
|
|
|
—
|
|
|
—
|
|
|
|
$19.1
|
|
Available-for-sale – Corporate Debt Securities
|
—
|
|
|
|
$8.8
|
|
|
—
|
|
|
8.8
|
|
Cash Equivalents
|
16.6
|
|
|
—
|
|
|
—
|
|
|
16.6
|
|
Total Fair Value of Assets
|
|
$35.7
|
|
|
|
$8.8
|
|
|
—
|
|
|
|
$44.5
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
Deferred Compensation
|
—
|
|
|
|
$14.8
|
|
|
—
|
|
|
|
$14.8
|
|
Derivatives – Interest Rate Swap
|
—
|
|
|
0.8
|
|
|
—
|
|
|
0.8
|
|
Total Fair Value of Liabilities
|
—
|
|
|
|
$15.6
|
|
|
—
|
|
|
|
$15.6
|
|
|
|
|
|
|
|
|
|
Total Net Fair Value of Assets (Liabilities)
|
|
$35.7
|
|
|
$(6.8)
|
|
—
|
|
|
|
$28.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value as of December 31, 2011
|
Recurring Fair Value Measures
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
Millions
|
|
|
|
|
|
|
|
Assets:
|
|
|
|
|
|
|
|
Investments
|
|
|
|
|
|
|
|
Available-for-sale – Equity Securities
|
|
$17.6
|
|
|
—
|
|
|
—
|
|
|
|
$17.6
|
|
Available-for-sale – Corporate Debt Securities
|
—
|
|
|
|
$8.2
|
|
|
—
|
|
|
8.2
|
|
Cash Equivalents
|
11.4
|
|
|
—
|
|
|
—
|
|
|
11.4
|
|
Total Fair Value of Assets
|
|
$29.0
|
|
|
|
$8.2
|
|
|
—
|
|
|
|
$37.2
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
Deferred Compensation
|
—
|
|
|
|
$12.8
|
|
|
—
|
|
|
|
$12.8
|
|
Derivatives – Interest Rate Swap
|
—
|
|
|
0.4
|
|
|
—
|
|
|
0.4
|
|
Total Fair Value of Liabilities
|
—
|
|
|
|
$13.2
|
|
|
—
|
|
|
|
$13.2
|
|
|
|
|
|
|
|
|
|
Total Net Fair Value of Assets (Liabilities)
|
|
$29.0
|
|
|
$(5.0)
|
|
—
|
|
|
|
$24.0
|
|
|
|
|
|
|
|
|
|
|
Recurring Fair Value Measures
Activity in Level 3
|
|
Debt Securities
Issued by States
of the United
States (ARS)
|
Millions
|
|
|
|
|
Balance as of December 31, 2011 and 2010, respectively
|
|
—
|
|
|
|
$6.7
|
|
Redeemed During the Period
(a)
|
|
—
|
|
|
(6.7
|
)
|
Balance as of September 30, 2012 and 2011, respectively
|
|
—
|
|
|
—
|
|
|
|
(a)
|
The remaining ARS were redeemed at carrying value on January 5, 2011.
|
The Company’s policy is to recognize transfers in and transfers out of a given hierarchy level as of the actual date of the event or of the change in circumstances that caused the transfer. For the
nine months ended September 30, 2012 and 2011
, there were
no
transfers in or out of Levels 1, 2 or 3.
ALLETE Third Quarter 2012 Form 10-Q
16
NOTE 5. FAIR VALUE (Continued)
Fair Value of Financial Instruments.
With the exception of the item listed below, the estimated fair value of all financial instruments approximates the carrying amount. The fair value for the item listed below was based on quoted market prices for the same or similar instruments (Level 2).
|
|
|
|
|
Financial Instruments
|
Carrying Amount
|
|
Fair Value
|
Millions
|
|
|
|
Long-Term Debt, Including Current Portion
|
|
|
|
September 30, 2012
|
$1,014.9
|
|
$1,144.9
|
December 31, 2011
|
$863.3
|
|
$966.4
|
NOTE 6. REGULATORY MATTERS
Electric Rates.
Entities within our Regulated Operations segment file for periodic rate revisions with the MPUC, the FERC or the PSCW.
2010 Minnesota Rate Case.
Minnesota Power’s current retail rates are based on a 2011 MPUC retail rate order, effective
June 1, 2011
, that allowed for a
10.38 percent
return on common equity and a
54.29 percent
equity ratio.
In February 2011, Minnesota Power appealed the MPUC’s interim rate decision in the Company’s 2010 rate case with the Minnesota Court of Appeals. The Company appealed the MPUC’s finding of exigent circumstances in the interim rate decision with the primary arguments that the MPUC exceeded its statutory authority, made its decision without the support of a body of record evidence and that the decision violated public policy. The Company desires to resolve whether the MPUC’s finding of exigent circumstances was lawful for application in future rate cases. In December 2011, the Minnesota Court of Appeals concluded that the MPUC did not err in finding exigent circumstances and properly exercised its discretion in setting interim rates. On January 4, 2012, the Company filed a petition for review at the Minnesota Supreme Court (Court). On February 14, 2012, the Court granted the petition for review and oral arguments were held before the Court on October 9, 2012. A decision is expected in early 2013; however, we cannot predict the outcome at this time.
FERC-Approved Wholesale Rates.
Minnesota Power’s non-affiliated municipal customers consist of
16
municipalities in Minnesota and
1
private utility in Wisconsin. SWL&P, a wholly-owned subsidiary of ALLETE, is also a private utility in Wisconsin and a customer of Minnesota Power. Minnesota Power’s formula-based contract with the City of Nashwauk is effective April 1, 2013 through
June 30, 2024
, and the restated formula-based contracts with the remaining 15 Minnesota municipal customers and SWL&P are effective through June 30, 2019. The rates included in these contracts are calculated using a cost-based formula methodology that is set each July 1, using estimated costs and a rate of return that is equal to our authorized rate of return for Minnesota retail customers (currently
10.38 percent
). The formula-based rate methodology also provides for a yearly true-up calculation for actual costs incurred. The contract terms include a termination clause requiring a
three
-year notice to terminate. Under the City of Nashwauk contract, no termination notice may be given prior to
July 1, 2021
. Under the restated contracts, no termination notices may be given prior to
June 30, 2016
. A
two
-year cancellation notice is required for the one private non-affiliated utility in Wisconsin, and on December 31, 2011, this customer submitted a cancellation notice with termination effective on December 31, 2013. The
17
MW of average monthly demand provided to this customer is expected to be used to supply energy to prospective additional load customers beginning in 2014.
2012 Wisconsin Rate Case.
SWL&P’s current retail rates are based on a 2010 PSCW retail rate order, effective
January 1, 2011
, that allowed for a
10.9 percent
return on common equity. In May 2012, SWL&P filed a rate increase request with the PSCW seeking an average overall increase of
2.5 percent
for retail customers (a
1.2 percent
increase in electric rates, a
0.7 percent
increase in natural gas rates, and a
13.4 percent
increase in water rates). The rate filing seeks an overall return on equity of
10.9 percent
, and a capital structure consisting of approximately
55 percent
equity and
45 percent
debt. On an annualized basis, the requested rate increase would generate approximately
$1.8 million
in additional revenue. Evidentiary and public hearings were held on September 17, 2012. The Company anticipates new rates will take effect during the first quarter of 2013. We cannot predict the level of rates that may be approved by the PSCW.
ALLETE Third Quarter 2012 Form 10-Q
17
NOTE 6. REGULATORY MATTERS (Continued)
ALLETE Clean Energy.
In August 2011, the Company filed with the MPUC for approval of certain affiliated interest agreements between ALLETE and ALLETE Clean Energy. These agreements relate to various relationships between the parties, including the accounting for certain shared services, as well as the transfer of transmission and wind development rights in North Dakota to ALLETE Clean Energy. These transmission and wind development rights are separate and distinct from those needed by Minnesota Power to meet Minnesota’s renewable energy standard requirements. On July 23, 2012, the MPUC issued an order approving certain administrative items related to accounting for shared services as well as the approval of the transfer of meteorological towers, while deferring decisions related to transmission and wind development rights pending the MPUC’s further review of Minnesota Power’s future retail electric service needs.
The Patient Protection and Affordable Care Act of 2010 (PPACA).
In March 2010, the PPACA was signed into law. One of the provisions changed the tax treatment for retiree prescription drug expenses by eliminating the tax deduction for expenses that are reimbursed under Medicare Part D, beginning January 1, 2013. Based on this provision, we are subject to additional taxes in the future and were required to reverse previously recorded tax benefits which resulted in a non-recurring charge to net income of
$4.0 million
in 2010. In October 2010, we submitted a filing with the MPUC requesting deferral of the retail portion of the tax charge taken in 2010 resulting from the PPACA. On May 24, 2011, the MPUC approved our request for deferral until the next rate case and as a result we recorded an income tax benefit of
$2.9 million
and a related regulatory asset of
$5.0 million
in the second quarter of 2011.
Pension.
In December 2011, the Company filed a petition with the MPUC requesting a mechanism to recover the cost of capital associated with the prepaid pension asset (or liability) created by the required contributions under the pension plan in excess of (or less than) annual pension expense. The Company further requested a mechanism to defer pension expenses in excess of (or less than) those currently being recovered in base rates. If our petition is successful, the impact would be deferred in a regulatory asset (or liability) for recovery (or refund) in the Company’s next general rate case. We cannot predict the outcome at this time.
Regulatory Assets and Liabilities.
Our regulated utility operations are subject to the accounting guidance for Regulated Operations. We capitalize incurred costs which are probable of recovery in future utility rates as regulatory assets. Regulatory liabilities
represent amounts expected to be refunded or credited to customers in rates. No regulatory assets or liabilities are currently earning a return.
|
|
|
|
|
|
|
|
|
Regulatory Assets and Liabilities
|
September 30,
2012
|
|
|
December 31,
2011
|
|
Millions
|
|
|
|
Current Regulatory Assets
(a)
|
|
|
|
Deferred Fuel
|
|
$18.2
|
|
|
|
$17.5
|
|
Total Current Regulatory Assets
|
18.2
|
|
|
17.5
|
|
Non-Current Regulatory Assets
|
|
|
|
Future Benefit Obligations Under
|
|
|
|
Defined Benefit Pension and Other Postretirement Benefit Plans
|
276.6
|
|
|
292.8
|
|
Income Taxes
|
28.2
|
|
|
28.6
|
|
Asset Retirement Obligation
|
11.5
|
|
|
9.8
|
|
Cost Recovery Riders
(b)
|
11.4
|
|
|
0.7
|
|
PPACA Income Tax Deferral
|
5.0
|
|
|
5.0
|
|
Other
(c)
|
1.9
|
|
|
9.0
|
|
Total Non-Current Regulatory Assets
|
334.6
|
|
|
345.9
|
|
|
|
|
|
Total Regulatory Assets
|
|
$352.8
|
|
|
|
$363.4
|
|
|
|
|
|
Non-Current Regulatory Liabilities
|
|
|
|
Income Taxes
|
|
$19.8
|
|
|
|
$21.9
|
|
Plant Removal Obligations
|
17.5
|
|
|
15.0
|
|
Wholesale and Retail Contra AFUDC
|
11.1
|
|
|
1.5
|
|
Other
|
6.4
|
|
|
5.1
|
|
Total Non-Current Regulatory Liabilities
|
|
$54.8
|
|
|
|
$43.5
|
|
|
|
(a)
|
Current regulatory assets are included in prepayments and other on the Consolidated Balance Sheet.
|
|
|
(b)
|
The increase in cost recovery rider regulatory assets is primarily due to higher capital expenditures related to our Bison projects.
|
|
|
(c)
|
The decrease in Other is primarily due to the Conservation Improvement Program incentive recorded in 2011 and collected in 2012.
|
ALLETE Third Quarter 2012 Form 10-Q
18
NOTE 7. INVESTMENT IN ATC
Our wholly-owned subsidiary, Rainy River Energy, owns approximately
8 percent
of ATC, a Wisconsin-based utility that owns and maintains electric transmission assets in parts of Wisconsin, Michigan, Minnesota and Illinois. ATC rates are FERC-approved and are based on a
12.2 percent
return on common equity dedicated to utility plant. We account for our investment in ATC under the equity method of accounting.
As of September 30, 2012
, our equity investment in ATC was
$105.5 million
(
$98.9 million
at
December 31, 2011
). In the first
nine
months of 2012, we invested
$3.9 million
in ATC, and on October 30, 2012, we invested an additional
$0.8 million
. We do
not
expect to make any additional investments in 2012.
|
|
|
|
|
ALLETE’s Investment in ATC
|
|
Millions
|
|
Equity Investment Balance as of December 31, 2011
|
|
$98.9
|
|
Cash Investments
|
3.9
|
|
Equity in ATC Earnings
|
14.3
|
|
Distributed ATC Earnings
|
(11.6
|
)
|
Equity Investment Balance as of September 30, 2012
|
|
$105.5
|
|
ATC’s summarized financial data for the quarters and
nine months ended September 30, 2012 and 2011
, is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
|
|
Nine Months Ended
|
ATC Summarized Financial Data
|
September 30,
|
|
September 30,
|
Income Statement Data
|
2012
|
|
2011
|
|
2012
|
|
2011
|
Millions
|
|
|
|
|
|
|
|
Revenue
|
$150.3
|
|
$142.8
|
|
|
$450.1
|
|
|
|
$420.6
|
|
Operating Expense
|
68.8
|
|
66.4
|
|
210.1
|
|
|
192.5
|
|
Other Expense
|
21.0
|
|
19.7
|
|
62.1
|
|
|
61.6
|
|
Net Income
|
|
$60.5
|
|
|
$56.7
|
|
|
$177.9
|
|
|
|
$166.5
|
|
|
|
|
|
|
|
|
|
ALLETE’s Equity in Net Income
|
$4.9
|
|
$4.7
|
|
|
$14.3
|
|
|
|
$13.7
|
|
NOTE 8. SHORT-TERM AND LONG-TERM DEBT
Short-Term Debt.
As of
September 30, 2012
, total short-term debt outstanding was
$67.6 million
(
$6.5 million
as of
December 31, 2011
) and consisted of long-term debt due within one year and notes payable. Short-term debt increased from year end primarily due to
$60 million
of long-term debt maturing in April 2013, which is classified as short-term as of
September 30, 2012
.
Long-Term Debt.
As of
September 30, 2012
, total long-term debt outstanding was
$947.6 million
(
$857.9 million
as of
December 31, 2011
).
On July 2, 2012, we issued
$160.0 million
of the Company’s First Mortgage Bonds (Bonds) in the private placement market in two series as follows:
|
|
|
|
|
Issue Date
|
Maturity Date
|
Principal Amount
|
Interest Rate
|
July 2, 2012
|
July 15, 2026
|
$75 Million
|
3.20%
|
July 2, 2012
|
July 15, 2042
|
$85 Million
|
4.08%
|
ALLETE Third Quarter 2012 Form 10-Q
19
NOTE 8. SHORT-TERM AND LONG-TERM DEBT (Continued)
We have the option to prepay all or a portion of the
3.20 percent
Bonds at our discretion at any time prior to January 15, 2026, subject to a make-whole provision, and at any time on or after January 15, 2026, at par, including, in each case, accrued and unpaid interest. We also have the option to prepay all or a portion of the
4.08 percent
Bonds at our discretion at any time prior to January 15, 2042, subject to a make-whole provision, and at any time on or after January 15, 2042, at par, including, in each case, accrued and unpaid interest. The Bonds are subject to the additional terms and conditions of our utility mortgage. In July 2012, we used a portion of the proceeds from the sale of the Bonds to redeem
$6.0 million
of our
6.50 percent
Industrial Development Revenue Bonds and to repay
$14.0 million
in outstanding borrowings on our
$150.0 million
line of credit. The remaining proceeds will be used to fund utility capital expenditures and/or for general corporate purposes. The Bonds were sold in reliance on an exemption from registration under Section 4(a)(2) of the Securities Act of 1933, as amended, to certain institutional accredited investors.
Financial Covenants.
Our long-term debt arrangements contain customary covenants. In addition, our lines of credit and letters of credit supporting certain long-term debt arrangements contain financial covenants. Our compliance with financial covenants is not dependent on debt ratings. The most restrictive financial covenant requires ALLETE to maintain a ratio of Indebtedness to Total Capitalization (as the amounts are calculated in accordance with the respective long-term debt arrangements) of less than or equal to
0.65 to 1.00
, measured quarterly. As of
September 30, 2012
, our ratio was approximately
0.46 to 1.00
. Failure to meet this covenant would give rise to an event of default if not cured after notice from a lender, in which event ALLETE may need to pursue alternative sources of funding. Some of ALLETE’s debt arrangements contain “cross-default” provisions that would result in an event of default if there is a failure under other financing arrangements to meet payment terms or to observe other covenants that would result in an acceleration of payments due. As of
September 30, 2012
, ALLETE was in compliance with its financial covenants.
NOTE 9. OTHER INCOME (EXPENSE)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
September 30,
|
|
|
2012
|
|
2011
|
|
2012
|
|
2011
|
Millions
|
|
|
|
|
|
|
|
|
AFUDC – Equity
|
|
|
$1.5
|
|
|
|
$0.6
|
|
|
|
$3.4
|
|
|
|
$1.7
|
|
Investment and Other Income (Expense)
|
|
—
|
|
|
(0.1
|
)
|
|
—
|
|
|
0.6
|
|
Total Other Income
|
|
|
$1.5
|
|
|
|
$0.5
|
|
|
|
$3.4
|
|
|
|
$2.3
|
|
ALLETE Third Quarter 2012 Form 10-Q
20
NOTE 10. INCOME TAX EXPENSE
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
September 30,
|
|
|
2012
|
|
2011
|
|
2012
|
|
2011
|
Millions
|
|
|
|
|
|
|
|
|
Current Tax Expense
|
|
|
|
|
|
|
|
|
Federal
(a)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
State
(a)
|
|
—
|
|
|
$(0.1)
|
|
—
|
|
|
|
$0.1
|
|
Total Current Tax Expense (Benefit)
|
|
—
|
|
|
(0.1
|
)
|
|
—
|
|
|
0.1
|
|
Deferred Tax Expense (Benefit)
|
|
|
|
|
|
|
|
|
Federal
(b)
|
|
|
$10.5
|
|
|
8.5
|
|
|
|
$24.2
|
|
|
19.3
|
|
State
(b)
|
|
(0.7
|
)
|
|
4.5
|
|
|
(1.9
|
)
|
|
6.0
|
|
Change in Valuation Allowance
(c)
|
|
0.7
|
|
|
—
|
|
|
1.7
|
|
|
—
|
|
Investment Tax Credit Amortization
|
|
(0.2
|
)
|
|
(0.2
|
)
|
|
(0.6
|
)
|
|
(0.7
|
)
|
Total Deferred Tax Expense
|
|
10.3
|
|
|
12.8
|
|
|
23.4
|
|
|
24.6
|
|
Total Income Tax Expense
|
|
|
$10.3
|
|
|
|
$12.7
|
|
|
|
$23.4
|
|
|
|
$24.7
|
|
|
|
(a)
|
For the quarter and
nine
months ended
September 30, 2012
, the federal and state current tax expense of
zero
and
zero
, respectively, (
$(0.1) million
and
$0.1 million
for the quarter and
nine
months ended
September 30, 2011
) is due to a net operating loss (NOL) which resulted primarily from the bonus depreciation provision of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. The 2012 and 2011 federal and state NOLs will be carried forward to offset future taxable income.
|
|
|
(b)
|
For the quarter and
nine
months ended
September 30, 2012
, the state deferred tax benefit of
$0.7 million
and
$1.9 million
, respectively, is due to state renewable tax credits earned which will be carried forward to offset future state tax expense. The
nine
months ended
September 30, 2011
, included a second quarter income tax benefit of
$2.9 million
related to the MPUC approval of our request to defer the retail portion of the tax charge taken in 2010 resulting from the PPACA, and a first quarter benefit for the reversal of a
$6.2 million
deferred tax liability related to a revenue receivable that Minnesota Power agreed to forgo as part of a stipulation and settlement agreement in its 2010 rate case.
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(c)
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For the quarter and
nine
months ended
September 30, 2012
, the valuation allowance is due to state renewable tax credits earned in 2012 which are not expected to be utilized within their allowable tax carryforward period.
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For the
nine months ended September 30, 2012
, the effective tax rate was
25.5 percent
(
24.9 percent
for the
nine months ended September 30, 2011
; the effective tax rate for the
nine months ended September 30, 2011
, was lowered by
6.2
percentage points due to the non-recurring reversal of the deferred tax liability related to a revenue receivable that Minnesota Power agreed to forgo as part of a stipulation and settlement agreement in its 2010 rate case, and by
2.9
percentage points due to the non-recurring income tax benefit related to the MPUC approval of our request to defer the retail portion of the tax charge taken in 2010 resulting from the PPACA). The increase in the effective tax rate from the effective tax rate for the nine months ended
September 30, 2011
, was primarily due to the 2011 non-recurring items above, partially offset by increased renewable tax credits in 2012. The effective tax rate deviated from the statutory rate of approximately
41 percent
primarily due to deductions for AFUDC – Equity, investment tax credits, renewable tax credits and depletion, and in 2011, for the non-recurring items discussed above.
Uncertain Tax Positions.
As of
September 30, 2012
, we had gross unrecognized tax benefits of
$2.7 million
(
$11.4 million
as of
December 31, 2011
). The
$8.7 million
decrease in the unrecognized tax benefits balance for the
nine
months ended
September 30, 2012
, was primarily due to the resolution of a federal audit matter for prior years’ activity. Of the total gross unrecognized tax benefits,
$0.5 million
represents the amount of unrecognized tax benefits included in the Consolidated Balance Sheet, that, if recognized, would favorably impact the effective income tax rate.
ALLETE’s IRS exam for tax years 2005 through 2009 is currently under review at the IRS appeals office. If the IRS appeals process is completed during the next twelve months, substantially all of the unrecognized tax benefits as of
September 30, 2012
, could be reversed. The unrecognized tax benefits are primarily due to tax positions which are timing in nature and therefore would have an immaterial impact on our effective tax rate if recognized.
ALLETE Third Quarter 2012 Form 10-Q
21
NOTE 11. EARNINGS PER SHARE AND COMMON STOCK
The difference between basic and diluted earnings per share, if any, arises from outstanding stock options and performance share awards granted under our Executive and Director Long-Term Incentive Compensation Plans. For the quarters and
nine months ended September 30, 2012 and 2011
,
0.2 million
and
0.4 million
options, respectively, to purchase shares of common stock were excluded from the computation of diluted earnings per share because the option exercise prices were greater than the average market prices; therefore, their effect would have been anti-dilutive.
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2012
|
|
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2011
|
|
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Reconciliation of Basic and Diluted
|
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|
Dilutive
|
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Dilutive
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Earnings Per Share
|
Basic
|
|
Securities
|
|
Diluted
|
|
Basic
|
|
Securities
|
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Diluted
|
Millions Except Per Share Amounts
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For the Quarter Ended September 30,
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Net Income Attributable to ALLETE
|
|
$29.4
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|
|
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|
$29.4
|
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|
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$20.5
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$20.5
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Average Common Shares
|
37.7
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0.1
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37.8
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35.6
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0.1
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35.7
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Earnings Per Share
|
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$0.78
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$0.78
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|
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$0.57
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|
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$0.57
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For the Nine Months Ended September 30,
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Net Income Attributable to ALLETE
|
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$68.2
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$68.2
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$74.7
|
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|
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$74.7
|
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Average Common Shares
|
37.3
|
|
|
—
|
|
|
37.3
|
|
|
35.1
|
|
|
0.1
|
|
|
35.2
|
|
Earnings Per Share
|
|
$1.83
|
|
|
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|
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$1.83
|
|
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$2.13
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$2.12
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NOTE 12. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS
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Pension
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Other
Postretirement
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Components of Net Periodic Benefit Expense
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2012
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2011
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2012
|
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2011
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Millions
|
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For the Quarter Ended September 30,
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Service Cost
|
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$2.3
|
|
|
|
$1.9
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|
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$1.0
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$1.0
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Interest Cost
|
6.6
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6.8
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2.4
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2.7
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Expected Return on Plan Assets
|
(8.9
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)
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(8.7
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)
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(2.5
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)
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(2.4
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)
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Amortization of Prior Service Costs
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—
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0.1
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(0.4
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)
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(0.4
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)
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Amortization of Net Loss
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4.4
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3.1
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1.9
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2.1
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Net Periodic Benefit Expense
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$4.4
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$3.2
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$2.4
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$3.0
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For the Nine Months Ended September 30,
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Service Cost
|
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$6.9
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$5.7
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$3.1
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$2.9
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Interest Cost
|
19.8
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20.5
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7.1
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8.1
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Expected Return on Plan Assets
|
(26.6
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)
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(26.0
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)
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(7.5
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)
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(7.3
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)
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Amortization of Prior Service Costs
|
0.2
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0.3
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(1.3
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)
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(1.3
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)
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Amortization of Net Loss
|
13.1
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9.1
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5.7
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6.4
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Amortization of Transition Obligation
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—
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—
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0.1
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0.1
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Net Periodic Benefit Expense
|
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$13.4
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$9.6
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$7.2
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$8.9
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Employer Contributions.
For the
nine months ended September 30, 2012
,
no
contributions were made to our defined benefit pension plan (
$6.6 million
for the
nine months ended September 30, 2011
). For the
nine months ended September 30, 2012
,
no
contributions were made to our other postretirement benefit plan (
$10.9 million
for the
nine months ended September 30, 2011
). We do
not
expect to make any contributions to our defined benefit pension plan in
2012
, and we expect to contribute
$8.7 million
to our other postretirement benefit plan in
2012
. In July 2012, Congress passed legislation which included a pension funding stabilization provision. The provision, which is designed to stabilize the discount rate used to determine funding requirements from the effects of interest rate volatility, will not have a material impact on our contributions in 2012.
Accounting and disclosure requirements for the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (Act) provide guidance for employers that sponsor postretirement health care plans that provide prescription drug benefits. We provide postretirement health benefits that include prescription drug benefits, which qualify for the federal subsidy under the Act. For the
nine months ended September 30, 2012
, we received
$0.3 million
in prescription drug reimbursements.
ALLETE Third Quarter 2012 Form 10-Q
22
NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES
Power Purchase Agreements.
Our long-term PPAs have been evaluated under the accounting guidance for variable interest entities. We have determined that either we have no variable interest in the PPAs, or where we do have variable interests, we are not the primary beneficiary; therefore, consolidation is not required. These conclusions are based on the fact that we do not have both control over activities that are most significant to the entity and an obligation to absorb losses or receive benefits from the entity’s performance. Our financial exposure relating to these PPAs is limited to our capacity and energy payments.
Square Butte PPA.
Minnesota Power has a PPA with Square Butte that extends through
2026
(Agreement). It provides a long-term supply of energy to customers in our electric service territory and enables Minnesota Power to meet reserve requirements. Square Butte, a North Dakota cooperative corporation, owns a
455
MW coal-fired generating unit (Unit) near Center, North Dakota. The Unit is adjacent to a generating unit owned by Minnkota Power, a North Dakota cooperative corporation whose Class A members are also members of Square Butte. Minnkota Power serves as the operator of the Unit and also purchases power from Square Butte.
Minnesota Power is obligated to pay its pro rata share of Square Butte’s costs based on Minnesota Power’s entitlement to Unit output. Our output entitlement under the Agreement is
50 percent
for the remainder of the contract, subject to the provisions of the Minnkota Power sales agreement described below. Minnesota Power’s payment obligation will be suspended if Square Butte fails to deliver any power, whether produced or purchased, for a period of one year. Square Butte’s costs consist primarily of debt service, operating and maintenance, depreciation and fuel expenses.
As of September 30, 2012
, Square Butte had total debt outstanding of
$417.4 million
. Annual debt service for Square Butte is expected to be approximately
$44 million
in each of the five years, 2012 through 2016, of which Minnesota Power’s obligation is
50 percent
. Fuel expenses are recoverable through our fuel adjustment clause and include the cost of coal purchased from BNI Coal, under a long-term contract.
Minnkota Power Sales Agreement.
In
December 2009
, Minnesota Power entered into a power sales agreement with Minnkota Power. Under the power sales agreement, Minnesota Power will sell a portion of its output from Square Butte to Minnkota Power, resulting in Minnkota Power’s net entitlement increasing and Minnesota Power’s net entitlement decreasing until Minnesota Power’s share is eliminated at the end of
2025
.
No power will be sold under the 2009 agreement until Minnkota Power has placed in service a new AC transmission line, which is anticipated to occur in late
2013
. This new AC transmission line will allow Minnkota Power to transmit its entitlement from Square Butte directly to its customers, which in turn will enable Minnesota Power the ability to transmit additional wind generation on the existing DC transmission line.
Wind PPAs.
In
2006
and
2007
, Minnesota Power entered into
two
long-term wind PPAs with an affiliate of NextEra Energy, Inc. to purchase the output from Oliver Wind I (
50
MW) and Oliver Wind II (
48
MW)—wind facilities located near Center, North Dakota. Each agreement is for
25
years and provides for the purchase of all output from the facilities at fixed prices. There are
no
fixed capacity charges and we only pay for energy as it is delivered to us.
Hydro PPAs.
Minnesota Power has a PPA with Manitoba Hydro that expires in
April 2015
. Under this agreement Minnesota Power is purchasing
50
MW of capacity and the energy associated with that capacity. Both the capacity price and the energy price are adjusted annually by the change in a governmental inflationary index.
Minnesota Power has a separate PPA with Manitoba Hydro to purchase surplus energy through
April 2022
. This energy-only transaction primarily consists of surplus hydro energy on Manitoba Hydro’s system that is delivered to Minnesota Power on a non-firm basis. The pricing is based on forward market prices. Under this agreement, Minnesota Power will purchase at least
one million
MWh of energy over the contract term. In
March 2011
, the MPUC approved this PPA with Manitoba Hydro.
In
May 2011
, Minnesota Power and Manitoba Hydro signed an additional PPA. The PPA calls for Manitoba Hydro to sell
250
MW of capacity and energy to Minnesota Power for
15
years beginning in
2020
and requires construction of additional transmission capacity between Manitoba and the U.S. The capacity price is adjusted annually until
2020
by a change in a governmental inflationary index. The energy price is based on a formula that includes an annual fixed price component adjusted for a change in a governmental inflationary index and a natural gas index, as well as market prices. On
January 26, 2012
, the MPUC approved this PPA with Manitoba Hydro. In February 2012, Minnesota Power and Manitoba Hydro proposed construction of a
500
kV transmission line between Manitoba and Minnesota’s Iron Range in order to strengthen the electric grid, enhance regional reliability and promote a greater exchange of sustainable energy, which is expected to be in service in
2020
. Total project cost and cost allocations are still to be determined.
ALLETE Third Quarter 2012 Form 10-Q
23
NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (Continued)
North Dakota Wind Development
.
Minnesota Power uses the
465
-mile,
250
kV DC transmission line that runs from Center, North Dakota, to Duluth, Minnesota to transport increasing amounts of wind energy from North Dakota while gradually phasing out coal-based electricity delivered to our system over this transmission line from Square Butte’s lignite coal-fired generating unit.
Bison 1 is an
82
MW wind facility in North Dakota, which was completed in two
phases. The first phase was completed in
2010
, and the second phase was completed in
January 2012
. The project also included construction of a
22
-mile,
230
kV transmission line. Bison 1 had a total project cost of
$174.3 million
through
September 30, 2012
, including additional costs related to land restoration and completion of remaining associated upgrades for the
250
kV DC transmission line. The MPUC has approved cost recovery for Bison 1 investments and expenses, and current customer billing rates for Bison 1 are based on a
November 2011
MPUC order.
Bison 2 and Bison 3 are both
105
MW wind projects in North Dakota which are expected to be completed by the end of
2012
. Construction is currently underway for both projects and the total project costs for Bison 2 and Bison 3 are estimated to be approximately
$160 million
each, of which
$129.2 million
and
$131.0 million
, respectively, was spent through
September 30, 2012
. In
September 2011
and
November 2011
, the MPUC approved Minnesota Power’s petitions seeking cost recovery for investments and expenses related to Bison 2 and Bison 3, respectively. We anticipate filing a petition with the MPUC in the fourth quarter of 2012 to establish customer billing rates for the approved cost recovery.
Coal, Rail and Shipping Contracts.
We have coal supply agreements providing for the purchase of a significant portion of our coal requirements which expire in
2013
. We also have coal transportation agreements in place for the delivery of a significant portion of our coal requirements with expiration dates through
2015
. Our minimum annual payment obligation under these supply and transportation agreements for the remainder of
2012
is
$12.8 million
, and for
2013
is
$26.2 million
. Our minimum annual payment obligations will increase when annual nominations are made for coal deliveries in future years. The delivered costs of fuel for Minnesota Power’s generation are recoverable from Minnesota Power’s utility customers through the fuel adjustment clause.
Leasing Agreements.
BNI Coal is obligated to make lease payments for a dragline totaling
$2.8 million
annually for the lease term, which expires in
2027
. BNI Coal has the option at the end of the lease term to renew the lease at fair market value, to purchase the dragline at fair market value, or to surrender the dragline and pay a
$3 million
termination fee. We lease other properties and equipment under operating lease agreements with terms expiring through
2016
. The aggregate amount of minimum lease payments for all operating leases is
$10.9 million
in
2012
,
$11.1 million
in
2013
,
$11.4 million
in
2014
,
$11.2 million
in
2015
,
$9.2 million
in
2016
and
$43.0 million
thereafter.
Transmission
. We are making investments in Upper Midwest transmission opportunities that strengthen or enhance the regional transmission grid. This includes the CapX2020 initiative, investments in our own transmission assets, investments in other regional transmission assets (individually or in combination with others), and our investment in ATC.
Transmission Investments.
We have an approved cost recovery rider in place for certain transmission expenditures and the continued use of our 2009 billing factor was approved by the MPUC in
May 2011
. The billing factor allows us to charge our retail customers on a current basis for the costs of constructing certain transmission facilities plus a return on the capital invested. In
June 2011
, we filed an updated billing factor that includes additional transmission projects and expenses, which we expect to be approved in late
2012
.
CapX2020.
Minnesota Power is a participant in the CapX2020 initiative which represents an effort to ensure electric transmission and distribution reliability in Minnesota and the surrounding region for the future. CapX2020, which consists of electric cooperatives, municipals and investor-owned utilities, including Minnesota’s largest transmission owners, has assessed the transmission system and projected growth in customer demand for electricity through 2020. Studies show that the region’s transmission system will require major upgrades and expansion to accommodate increased electricity demand as well as support renewable energy expansion through 2020.
ALLETE Third Quarter 2012 Form 10-Q
24
NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (Continued)
Transmission (Continued)
Minnesota Power is participating in
three
CapX2020 projects: the Fargo, North Dakota to St. Cloud, Minnesota project, the Monticello, Minnesota to St. Cloud, Minnesota project, which together total a
238
-mile,
345
kV line from Fargo, North Dakota to Monticello, Minnesota, and the
70
-mile,
230
kV line between Bemidji, Minnesota and Minnesota Power’s Boswell Energy Center near Grand Rapids, Minnesota. The
28
-mile
345
kV line between Monticello and St. Cloud was placed into service in
December 2011
and the
70
-mile
230
kV line between Bemidji, Minnesota and Minnesota Power’s Boswell Energy Center near Grand Rapids, Minnesota was placed into service in September 2012. In
June 2011
, the MPUC approved the route permit for the Minnesota portion of the Fargo to St. Cloud project. The North Dakota permitting process was completed on August 12, 2012. The entire
238
-mile,
345
kV line from Fargo to Monticello is expected to be in service by
2015
.
Based on projected costs of the
three
transmission lines and the allocation agreements among participating utilities, Minnesota Power plans to invest between
$110 million
and
$120 million
in the CapX2020 initiative through 2015. A total of
$45.7 million
was spent through
September 30, 2012
, of which
$33.6 million
was related to the Fargo, North Dakota to Monticello, Minnesota projects and
$12.1 million
was related to the Bemidji, Minnesota to Minnesota Power’s Boswell Energy Center project (
$27.8 million
as of
December 31, 2011
of which
$20.4 million
was related to the Fargo, North Dakota to Monticello, Minnesota projects and
$7.4 million
was related to the Bemidji, Minnesota to Minnesota Power’s Boswell Energy Center project). As future CapX2020 projects are identified, Minnesota Power may elect to participate on a project-by-project basis.
In
November 2010
, the MPUC approved a route permit for the Bemidji to Grand Rapids, Minnesota line and construction for the
230
kV line project commenced in
January 2011
. The Leech Lake Band of Ojibwe (LLBO) subsequently petitioned the MPUC to suspend or revoke the route permit and also served the CapX2020 owners with a complaint filed in Leech Lake Tribal Court. The CapX2020 owners filed a request for declaratory judgment in the United States District Court for the District of Minnesota (District Court) that the project did not require LLBO consent to cross non-tribal land within the reservation. In June 2012, in a letter to the MPUC, the LLBO withdrew its petition to suspend or revoke the route permit issued to the CapX2020 owners. In August 2012, the LLBO executed and approved a consent decree dismissing the federal court actions and the District Court accepted the motion with prejudice.
Environmental Matters
Our businesses are subject to regulation of environmental matters by various federal, state and local authorities. Currently, a number of regulatory changes to the Clean Air Act, the Clean Water Act and various waste management requirements are under consideration by both Congress and the EPA. Minnesota Power’s fossil fuel facilities will likely be subject to regulation under these proposals. Our intention is to reduce our exposure to these requirements by reshaping our generation portfolio over time to reduce our reliance on coal.
We consider our businesses to be in substantial compliance with currently applicable environmental regulations and believe all necessary permits to conduct such operations have been obtained. Due to future restrictive environmental requirements through legislation and/or rulemaking, we anticipate that potential expenditures for environmental matters will be material and will require significant capital investments. Minnesota Power has evaluated various environmental compliance scenarios using possible ranges of future environmental regulations to determine prominent power supply trends and impacts on customers. All coal-fired generating facilities could potentially be impacted, with the possibility that additional environmental control installations will be needed. At Laskin and Taconite Harbor, we will also be considering options such as remissioning, repowering and retirement.
We review environmental matters on a quarterly basis. Accruals for environmental matters are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated, based on current law and existing technologies. Accruals are adjusted as assessment and remediation efforts progress or as additional technical or legal information becomes available. Accruals for environmental liabilities are included in the Consolidated Balance Sheet at undiscounted amounts and exclude claims for recoveries from insurance or other third parties. Costs related to environmental contamination treatment and cleanup are charged to expense unless recoverable in rates from customers.
Air.
The electric utility industry is heavily regulated both at the federal and state level to address air emissions. Minnesota Power’s generating facilities mainly burn low-sulfur western sub-bituminous coal. Square Butte, located in North Dakota, burns lignite coal. All of Minnesota Power’s coal-fired generating facilities are equipped with pollution control equipment such as scrubbers, bag houses and low NO
X
technologies. Under currently applicable environmental regulations, these facilities are substantially compliant with applicable emission requirements.
ALLETE Third Quarter 2012 Form 10-Q
25
NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (Continued)
Environmental Matters (Continued)
New Source Review (NSR)
. In August 2008, Minnesota Power received a Notice of Violation (NOV) from the EPA asserting violations of the NSR requirements of the Clean Air Act at Boswell Units 1, 2, 3 and 4 and Laskin Unit 2. The NOV asserts that seven projects undertaken at these coal-fired plants between the years 1981 and 2000 should have been reviewed under the NSR requirements and that the Boswell Unit 4 Title V permit was violated. In April 2011, Minnesota Power received a NOV alleging that two projects undertaken at Rapids Energy Center in 2004 and 2005 should have been reviewed under the NSR requirements and that the Rapids Energy Center’s Title V permit was violated. Minnesota Power believes the projects specified in the NOVs were in full compliance with the Clean Air Act, NSR requirements and applicable permits. We are engaged in discussions with the EPA regarding resolution of these matters, but we are unable to predict the o
utcome of these discussions.
Resolution of the NOVs could result in civil penalties and the installation of control technology, some of which is already planned or which has been completed to comply with other regulatory requirements.
At this time, the Company cannot reasonably estimate the range of loss (including potential penalties), if any, that may result from this matter. Therefore, the Company has not recorded an accrual in connection with the NOV as of September 30, 2012. Any costs of installing pollution control technology would likely be eligible for recovery in rates over time subject to regulatory approval in a rate proceeding.
Cross-State Air Pollution Rule (CSAPR)
. In July 2011, the EPA issued the CSAPR, which went into effect in October 2011. The final rule replaced the EPA’s 2005 Clean Air Interstate Rule (CAIR). However, on August 21, 2012, a three judge panel of the District of Columbia Circuit Court of Appeals vacated the CSAPR, ordering that the CAIR remain in effect while a CSAPR replacement rule is promulgated. The EPA and other parties to the case have requested that the matter be reheard by the full circuit court. The CSAPR would have required states in the CSAPR region, including Minnesota, to significantly improve air quality by reducing power plant emissions that contribute to ozone and/or fine particle pollution in other states. The CSAPR did not directly require the installation of controls. Instead, the rule would have required facilities to have sufficient emission allowances to cover their emissions on an annual basis. These allowances would have been allocated to facilities from each state’s annual budget and would also have been able to be bought and sold.
The CAIR regulations similarly require certain states to improve air quality by reducing power plant emissions that contribute to ozone and/or fine particle pollution in other states. The CAIR also created an allowance allocation and trading program rather than specifying pollution controls. Minnesota participation in the CAIR was stayed by EPA administrative action while the EPA completed a review of air quality modeling issues in conjunction with the development of a final replacement rule. While the CAIR remains in effect, Minnesota participation in the CAIR will continue to be stayed. It remains uncertain if emission restrictions similar to those contained in the CSAPR will become effective for Minnesota utilities due to the August 2012 District of Columbia Circuit Court of Appeals decision.
Since 2006, we have significantly reduced emissions at our Laskin, Taconite Harbor and Boswell generating units. Based on our expected generation rates, these emission reductions would have satisfied Minnesota Power’s SO
2
and NO
X
emission compliance obligations with respect to the EPA-allocated CSAPR allowances for 2012. Minnesota Power will continue to track the EPA activity related to promulgation of a CSAPR replacement rule. We are unable to predict any additional compliance costs we might incur if the CSAPR is reinstated or if a CSAPR replacement rule is promulgated.
Regional Haze
. The federal Regional Haze Rule requires states to submit SIPs to the EPA to address regional haze visibility impairment in 156 federally-protected parks and wilderness areas. Under the first phase of the Regional Haze Rule, certain large stationary sources, put in place between 1962 and 1977, with emissions contributing to visibility impairment, are required to install emission controls, known as Best Available Retrofit Technology (BART). We have two steam units, Boswell Unit 3 and Taconite Harbor Unit 3, that are subject to BART requirements.
The MPCA requested that companies with BART-eligible units complete and submit a BART emissions control retrofit study, which was completed for Taconite Harbor Unit 3 in November 2008. The retrofit work completed in 2009 at Boswell Unit 3 meets the BART requirements for that unit. In December 2009, the MPCA approved the Minnesota SIP for submittal to the EPA for its review and approval. The Minnesota SIP incorporates information from the BART emissions control retrofit studies that were completed as requested by the MPCA.
ALLETE Third Quarter 2012 Form 10-Q
26
NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (Continued)
Environmental Matters (Continued)
In December 2011, the EPA published in the Federal Register a proposal to approve the trading program in the CSAPR as an alternative to determining BART. However, as a result of the August 2012 District of Columbia Circuit Court of Appeals decision to vacate the CSAPR (See
Cross-State Air Pollution Rule)
, Minnesota Power is now evaluating whether significant additional expenditures at Taconite Harbor Unit 3 will be required to comply with BART requirements under the Regional Haze Rule. If additional regional haze related controls are ultimately required, Minnesota Power will have up to five years from the final rule promulgation to bring Taconite Harbor Unit 3 into compliance with the Regional Haze Rule requirements. It is uncertain what controls would ultimately be required at Taconite Harbor Unit 3 under this scenario.
Mercury and Air Toxics Standards (MATS) Rule (formerly known as the Electric Generating Unit Maximum Achievable Control Technology (MACT) Rule).
Under Section 112 of the Clean Air Act, the EPA is required to set emission standards for hazardous air pollutants (HAPs) for certain source categories. The EPA published the final MATS rule in the Federal Register on February 16, 2012, addressing such emissions from coal-fired utility units greater than 25 MW. There are currently 188 listed HAPs that the EPA is required to evaluate for establishment of MACT standards. In the final MATS rule, the EPA established categories of HAPs, including mercury, trace metals other than mercury, acid gases, dioxin/furans, and organics other than dioxin/furans. The EPA also established emission limits for the first three categories of HAPs, and work practice standards for the remaining categories. Affected sources must be in compliance with the rule by April 2015. States have the authority to grant sources a one-year extension and the EPA is assessing other means for granting additional extensions when justified. Compliance at our Boswell Unit 4 to address the final MATS rule is expected to result in capital expenditures totaling between
$350 million
to
$400 million
through 2016. Some additional controls for complying with the rule at our remaining coal-fired generating units may be required, the costs of which cannot be estimated at this time.
EPA National Emission Standards for Hazardous Air Pollutants for Major Sources: Industrial, Commercial and Institutional Boilers and Process Heaters
. In March 2011, a final rule was published in the Federal Register for industrial boiler maximum achievable control technology (Industrial Boiler MACT). The rule was stayed by the EPA in May 2011, to allow the EPA time to consider additional comments received. The EPA re-proposed the rule in December 2011. On January 9, 2012, the United States District Court for the District of Columbia ruled that the EPA stay of the Industrial Boiler MACT was unlawful, effectively reinstating the March 2011 rule and associated compliance deadlines. A final rule based on the December 2011 proposal, which will supersede the March 2011 rule, is expected in late 2012. Major sources are expected to have three years to achieve compliance with the final rule. Costs for complying with the final rule cannot be estimated at this time.
Minnesota Mercury Emission Reduction Act
. Under a 2006 statute, Minnesota Power is required to implement a mercury reduction project for Boswell Unit 4 by December 31, 2018. On August 31, 2012, Minnesota Power filed its mercury emission reduction plan for Boswell Unit 4 with the MPUC and the MPCA. The plan proposes that Minnesota Power install pollution controls to address both the Minnesota mercury reduction requirements and the MATS rule, which also regulates mercury, by the end of 2015. Costs to implement the Boswell Unit 4 emission reduction plan are included in the estimated capital expenditures required for compliance with the MATS rule discussed above.
Proposed and Finalized National Ambient Air Quality Standards (NAAQS).
The EPA is required to review the NAAQS every five years. If the EPA determines that a state’s air quality is not in compliance with a NAAQS, the state is required to adopt plans describing how it will reduce emissions to attain the NAAQS. These state plans often include more stringent air emission limitations on sources of air pollutants than the NAAQS require. Four NAAQS have either recently been revised or are currently proposed for revision, as described below.
Ozone NAAQS.
The EPA has proposed to more stringently control emissions that result in ground level ozone. In January 2010, the EPA proposed to revise the 2008 eight-hour ozone standard and to adopt a secondary standard for the protection of sensitive vegetation from ozone-related damage. The EPA was scheduled to decide upon the 2008 eight-hour ozone standard in July 2011, but has since announced that it is deferring revision of this standard until 2013.
ALLETE Third Quarter 2012 Form 10-Q
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NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (Continued)
Environmental Matters (Continued)
Particulate Matter NAAQS.
The EPA finalized the NAAQS Particulate Matter standards in September 2006. Since then, the EPA has established a more stringent 24-hour average fine particulate matter (PM
2.5
) standard and kept the annual average fine particulate matter standard and the 24-hour coarse particulate matter standard unchanged. The United States Court of Appeals for the District of Columbia Circuit has remanded the PM
2.5
standard to the EPA, requiring consideration of lower annual average standard values. The EPA proposed a new PM
2.5
standard on June 14, 2012, with a goal of finalizing the standard by December 14, 2012. The EPA has proposed a decrease to the current annual average fine particulate standard, which has been in place since 1997. The EPA’s proposal also includes a separate fine particulate standard to improve visibility (see
Regional Haze
). State attainment status determination with these new NAAQS will occur after the rule is finalized. It is not known when affected sources would have to take additional control measures if modeling demonstrates non-compliance.
SO
2
and NO
2
NAAQS.
During 2010, the EPA finalized new one-hour NAAQS for SO
2
and NO
2
. Ambient monitoring data indicates that Minnesota will likely be in compliance with these new standards; however, the one-hour SO
2
NAAQS also require the EPA to evaluate modeling data to determine attainment. The EPA has notified states that their SIPs for attainment of the standard will be required to be submitted to the EPA for approval by June 2013 but will not be required to include the evaluation of modeling data until 2017.
In late 2011, the MPCA initiated modeling activities that included approximately 65 sources within Minnesota that emit greater than 100 tons of SO
2
per year.
However, on April 12, 2012, the MPCA notified Minnesota Power that such modeling had been suspended as a result of the EPA’s announcement that the June 2013 SIP submittals would no longer require modeling demonstrations for states, such as Minnesota, where ambient monitors indicate compliance with the new standard. The MPCA is awaiting updated EPA guidance and will communicate with affected sources once the MPCA has more information on how the state will meet the EPA’s SIP requirements. Currently, compliance with these new NAAQS is expected to be required as early as 2017. The costs for complying with the final standards cannot be estimated at this time.
Climate Change.
The scientific community generally accepts that emissions of GHGs are linked to global climate change. Climate change creates physical and financial risk. Physical risks could include, but are not limited to: increased or decreased precipitation and water levels in lakes and rivers; increased temperatures; and the intensity and frequency of extreme weather events. These all have the potential to affect the Company’s business and operations. We are addressing climate change by taking the following steps that also ensure reliable and environmentally compliant generation resources to meet our customers’ requirements:
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Expand our renewable energy supply;
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Improve the efficiency of our coal-based generation facilities, as well as other process efficiencies;
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Provide energy conservation initiatives for our customers and engage in other demand side efforts; and
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Support research of technologies to reduce carbon emissions from generation facilities and support carbon sequestration efforts.
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EPA Regulation of GHG Emissions.
In May 2010, the EPA issued the final Prevention of Significant Deterioration (PSD) and Title V Greenhouse Gas Tailoring Rule (Tailoring Rule). The Tailoring Rule establishes permitting thresholds required to address GHG emissions for new facilities, at existing facilities that undergo major modifications and at other facilities characterized as major sources under the Clean Air Act’s Title V program. For our existing facilities, the rule does not require amending our existing Title V operating permits to include GHG requirements. However, GHG requirements are likely to be added to our existing Title V operating permits by the MPCA as these permits are renewed or amended.
In late 2010, the EPA issued guidance to permitting authorities and affected sources to facilitate incorporation of the Tailoring Rule permitting requirements into the Title V and PSD permitting programs. The guidance stated that the project-specific, top-down BACT determination process used for other pollutants will also be used to determine BACT for GHG emissions. Through sector-specific white papers, the EPA also provided examples and technical summaries of GHG emission control technologies and techniques the EPA considers available or likely to be available to sources. It is possible that these control technologies could be determined to be BACT on a project-by-project basis.
On March 28, 2012, the EPA announced its proposed rule to apply CO
2
emission New Source Performance Standards (NSPS) to new fossil fuel-fired electric generating units. The proposed NSPS apply only to new or re-powered units and were open for public comment through June 25, 2012. It is anticipated that the EPA will issue NSPS for existing fossil fuel-fired generating units in the future. We cannot predict what CO
2
control measures, if any, may be required by such NSPS.
ALLETE Third Quarter 2012 Form 10-Q
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NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (Continued)
Environmental Matters (Continued)
Legal challenges have been filed with respect to the EPA’s regulation of GHG emissions, including the Tailoring Rule. On June 26, 2012, the United States District Court for the District of Columbia upheld most of the EPA’s proposed regulations, including the Tailoring Rule criteria, finding that the Clean Air Act compels the EPA to regulate in the manner the EPA proposed. Comments to the permitting guidance were submitted by Minnesota Power and others and may be addressed by the EPA in the form of revised guidance documents.
We are unable to predict the GHG emission compliance costs we might incur; however, the costs could be material. We would seek recovery of any additional costs through cost recovery riders or in a general rate case.
Water.
The Clean Water Act requires NPDES permits be obtained from the EPA (or, when delegated, from individual state pollution control agencies) for any wastewater discharged into navigable waters. We have obtained all necessary NPDES permits, including NPDES storm water permits for applicable facilities, to conduct our operations.
Clean Water Act – Aquatic Organisms.
In April 2011, the EPA published in the Federal Register proposed regulations under Section 316(b) of the Clean Water Act that set standards applicable to cooling water intake structures for the protection of aquatic organisms. The proposed regulations would require existing large power plants and manufacturing facilities that withdraw greater than 25 percent of water from adjacent water bodies for cooling purposes and have a design intake flow of greater than 2 million gallons per day to limit the number of aquatic organisms that are killed when they are pinned against the facility’s intake structure or that are drawn into the facility’s cooling system. The Section 316(b) standards would be implemented through NPDES permits issued to the covered facilities. The Section 316(b) proposed rule comment period ended in August 2011 and the EPA is obligated to finalize the rule by June 27, 2013. We are unable to predict the compliance costs we might incur under the final rule; however, the costs could be material. We would seek recovery of any additional costs through cost recovery riders or in a general rate case.
Steam Electric Power Generating Effluent Guidelines.
In late 2009, the EPA announced that it will be reviewing and reissuing the federal effluent guidelines for steam electric stations. These are the underlying federal water discharge rules that apply to all steam electric stations. The EPA has indicated that the new rule promulgating these guidelines will be proposed in late 2012 and finalized in 2014. As part of the review phase for this new rule, the EPA issued an Information Collection Request (ICR) in June 2010, to most thermal electric generating stations in the country, including all five of Minnesota Power’s generating stations. The ICR was completed and submitted to the EPA in September 2010, for Boswell, Laskin, Taconite Harbor, Hibbard, and Rapids Energy Center. The ICR was designed to gather extensive information on the nature and extent of all water discharge and related wastewater handling at power plants. The information gathered through the ICR will form a basis for development of the eventual new rule, which could include more restrictive requirements on wastewater discharge, flue gas desulfurization, and wet ash handling operations. We are unable to predict the costs we might incur to comply with potential future water discharge regulations at this time.
Solid and Hazardous Waste.
The Resource Conservation and Recovery Act of 1976 regulates the management and disposal of solid and hazardous wastes. We are required to notify the EPA of hazardous waste activity and, consequently, routinely submit the necessary reports to the EPA.
Coal Ash Management Facilities
.
Minnesota Power generates coal ash at all five of its coal-fired electric generating facilities. Two facilities store ash in onsite impoundments (ash ponds) with engineered liners and containment dikes. Another facility stores dry ash in a landfill with an engineered liner and leachate collection system. Two facilities generate a combined wood and coal ash that is either land applied as an approved beneficial use or trucked to state permitted landfills. In June 2010, the EPA proposed regulations for coal combustion residuals generated by the electric utility sector. The proposal sought comments on three general regulatory schemes for coal ash. Comments on the proposed rule were due in November 2010. It is estimated that the final rule will be published in late 2012 or early 2013. We are unable to predict the compliance costs we might incur; however, the costs could be material. We would seek recovery of any additional costs through cost recovery riders or in a general rate case.
Manufactured Gas Plant Site.
We are reviewing and addressing environmental conditions at a former manufactured gas plant site in the City of Superior, Wisconsin, and formerly operated by SWL&P. We have been working with the WDNR to determine the extent of contamination and the remediation of contaminated locations. As of
September 30, 2012
, we had a
$0.5 million
liability for this site and a corresponding regulatory asset as we expect recovery of remediation costs to be allowed by the PSCW.
ALLETE Third Quarter 2012 Form 10-Q
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NOTE 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES (Continued)
Other Matters
BNI Coal.
As of
September 30, 2012
, BNI Coal had surety bonds outstanding of
$29.8 million
related to the reclamation liability for closing costs associated with its mine and mine facilities. Although the coal supply agreements obligate the customers to provide for the closing costs, additional assurance is required by federal and state regulations. In addition to the surety bonds, BNI Coal has secured a letter of credit with CoBANK ACB for an additional
$2.6 million
to provide for BNI Coal’s total reclamation liability, which is currently estimated at
$32.4 million
. BNI Coal does not believe it is likely that any of these outstanding surety bonds or the letter of credit will be drawn upon.
ALLETE Properties.
As of
September 30, 2012
, ALLETE Properties, through its subsidiaries, had surety bonds outstanding and letters of credit to governmental entities totaling
$10.2 million
primarily related to development and maintenance obligations for various projects. The estimated cost of the remaining development work is approximately
$7.4 million
, of which
$0.6 million
is the contractual obligation of land purchasers. ALLETE Properties does not believe it is likely that any of these outstanding surety bonds or letters of credit will be drawn upon.
Community Development District Obligations.
In
March 2005
, the Town Center District issued
$26.4 million
of tax-exempt,
6
percent capital improvement revenue bonds and in
May 2006
, the Palm Coast Park District issued
$31.8 million
of tax-exempt,
5.7 percent
special assessment bonds. The capital improvement revenue bonds and the special assessment bonds are payable over
31
years (by May 1, 2036 and 2037, respectively) and secured by special assessments on the benefited land. The bond proceeds were used to pay for the construction of a portion of the major infrastructure improvements in each district and to mitigate traffic and environmental impacts. The assessments were billed to the landowners beginning in November 2006 for Town Center and November 2007 for Palm Coast Park. To the extent that we still own land at the time of the assessment, we will incur the cost of our portion of these assessments, based upon our ownership of benefited property. At
September 30, 2012
, we owned
73 percent
of the assessable land in the Town Center District (
73 percent
at
December 31, 2011
) and
93 percent
of the assessable land in the Palm Coast Park District (
93 percent
at
December 31, 2011
). At these ownership levels, our annual assessments are approximately
$1.5 million
for Town Center and
$2.2 million
for Palm Coast Park. As we sell property, the obligation to pay special assessments will pass to the new landowners. In accordance with accounting guidance, these bonds are not reflected as debt on our Consolidated Balance Sheet.
Legal Proceedings.
In January 2011, the Company was named as a defendant in a lawsuit in the Sixth Judicial District for the State of Minnesota by one of our customer’s (United Taconite, LLC) property and business interruption insurers. In October 2006, United Taconite experienced a fire as a result of the failure of certain electrical protective equipment. The equipment at issue in the incident was not owned, designed, or installed by Minnesota Power, but Minnesota Power had provided testing and calibration services related to the equipment. The lawsuit alleges approximately
$20.0 million
in damages related to the fire. The Company believes that it has strong defenses to the lawsuit and intends to vigorously assert such defenses. An accrual related to any damages that may result from the lawsuit has not been recorded as of
September 30, 2012
, because a potential loss is not currently probable or reasonably estimable; however, the Company believes it has adequate insurance coverage for any potential loss.
Other.
We are involved in litigation arising in the normal course of business. Also in the normal course of business, we are involved in tax, regulatory and other governmental audits, inspections, investigations and other proceedings that involve state and federal taxes, safety, and compliance with regulations, rate base and cost of service issues, among other things. While the resolution of such matters could have a material effect on earnings and cash flows in the year of resolution, none of these matters are expected to materially change our present liquidity position, or have a material adverse effect on our financial condition.
ALLETE Third Quarter 2012 Form 10-Q
30