FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

(Mark One)

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

For the quarterly period ended June 30, 2009

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

For the transition period from  _____  to  _____ 

		Exact Name of Each Registrant as specified in its
Commission File		charter; State of Incorporation; Address; and		IRS Employer
Number		Telephone Number		Identification No.
1-8962		PINNACLE WEST CAPITAL CORPORATION (an Arizona corporation) 400 North Fifth Street, P.O. Box 53999 Phoenix, Arizona 85072-3999 (602) 250-1000		86-0512431
1-4473		ARIZONA PUBLIC SERVICE COMPANY (an Arizona corporation) 400 North Fifth Street, P.O. Box 53999 Phoenix, Arizona 85072-3999 (602) 250-1000		86-0011170

Indicate by check mark whether each registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

PINNACLE WEST CAPITAL CORPORATION		Yes þ No o
ARIZONA PUBLIC SERVICE COMPANY		Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

PINNACLE WEST CAPITAL CORPORATION		Yes o No o
ARIZONA PUBLIC SERVICE COMPANY		Yes o No o

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

PINNACLE WEST CAPITAL CORPORATION
Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o		Smaller reporting company o
ARIZONA PUBLIC SERVICE COMPANY
Large accelerated filer o		Accelerated filer o		Non-accelerated filer þ		Smaller reporting company o

Indicate by check mark whether each registrant is a shell company (as defined in Exchange Act Rule 12b-2).

PINNACLE WEST CAPITAL CORPORATION		Yes o No þ
ARIZONA PUBLIC SERVICE COMPANY		Yes o No þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.

PINNACLE WEST CAPITAL CORPORATION		Number of shares of common stock, no par value, outstanding as of July 29, 2009: 101,200,552
ARIZONA PUBLIC SERVICE COMPANY		Number of shares of common stock, $2.50 par value, outstanding as of July 29, 2009: 71,264,947

Arizona Public Service Company meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is therefore filing this form with the reduced disclosure format allowed under that General Instruction.

This combined Form 10-Q is separately provided by Pinnacle West Capital Corporation and Arizona Public Service Company. Each registrant is providing on its own behalf all of the information contained in this Form 10-Q that relates to such registrant and, where required, its subsidiaries. Except as stated in the preceding sentence, neither registrant is providing any information that does not relate to such registrant, and therefore makes no representation as to any such information.

 

 

TABLE OF CONTENTS

		Page
Glossary			2
Part I			4
Item 1. Financial Statements			4
Pinnacle West Capital Corporation			4
Arizona Public Service Company			42
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			50
Item 3. Quantitative and Qualitative Disclosures About Market Risk			75
Item 4. Controls and Procedures			75
Part II			77
Item 1. Legal Proceedings			77
Item 1A. Risk Factors			77
Item 4. Submission of Matters to a Vote of Security Holders			77
Item 5. Other Information			78
Item 6. Exhibits			82
Signatures			84
Exhibit 12.1
Exhibit 12.2
Exhibit 12.3
Exhibit 31.1
Exhibit 31.2
Exhibit 31.3
Exhibit 31.4
Exhibit 32.1
Exhibit 32.2

GLOSSARY

ACC — Arizona Corporation Commission

ADEQ — Arizona Department of Environmental Quality

ALJ — Administrative Law Judge

APS — Arizona Public Service Company, a subsidiary of the Company

APSES — APS Energy Services Company, Inc., a subsidiary of the Company

Base Fuel Rate — the portion of APS’ retail base rates attributable to fuel and purchased power costs

Clean Air Act — Clean Air Act, as amended

Company — Pinnacle West Capital Corporation

DOE — United States Department of Energy

EITF — FASB’s Emerging Issues Task Force

El Dorado — El Dorado Investment Company, a subsidiary of the Company

EPA — United States Environmental Protection Agency

FASB — Financial Accounting Standards Board

FERC — United States Federal Energy Regulatory Commission

FIN — FASB Interpretation Number

FIP — Federal Implementation Plan

Fitch — Fitch, Inc.

Four Corners — Four Corners Power Plant

FSP — FASB Staff Position

GAAP — accounting principles generally accepted in the United States of America

IRS — United States Internal Revenue Service

kWh — kilowatt-hour, one thousand watts per hour

MMBTU — one million British thermal units

Moody’s — Moody’s Investors Service, Inc.

Native Load — retail and wholesale sales supplied under traditional cost-based rate regulation

Note — a Note to Pinnacle West’s Condensed Consolidated Financial Statements in Item 1 of this report

NRC — United States Nuclear Regulatory Commission

OCI — other comprehensive income

Off-System Sales — sales of electricity from generation owned or contracted by the Company that is over and above the amount required to serve APS’ retail customers and traditional wholesale contracts

Palo Verde — Palo Verde Nuclear Generating Station

Pinnacle West — Pinnacle West Capital Corporation, the Company

Pinnacle West Marketing & Trading — Pinnacle West Marketing & Trading Co., LLC, a subsidiary of the Company

Price Anderson Act — Price Anderson Nuclear Industries Indemnity Act

PRP — potentially responsible parties under Superfund

PSA — power supply adjustor approved by the ACC to provide for recovery or refund of variations in actual fuel and purchased power costs compared with the Base Fuel Rate

Salt River Project — Salt River Project Agricultural Improvement and Power District

SEC — United States Securities and Exchange Commission

Settlement Agreement — Settlement Agreement dated June 12, 2009 between APS and other parties to its general retail rate case

SFAS — Statement of Financial Accounting Standards

Standard & Poor’s — Standard & Poor’s Ratings Services

SunCor — SunCor Development Company, a subsidiary of the Company

SunCor Secured Revolver — SunCor’s principal loan facility

Superfund — Comprehensive Environmental Response, Compensation and Liability Act

2008 Form 10-K — Pinnacle West/APS Annual Report on Form 10-K for the fiscal year ended December 31, 2008

VIE — variable-interest entity

Part I — FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(dollars and shares in thousands, except per share amounts)

		Three Months Ended
		June 30,
		2009				2008
OPERATING REVENUES
Regulated electricity segment		$	812,510			$	829,478
Real estate segment			16,763				23,365
Marketing and trading			—				22,508
Other revenues			10,782				9,162
Total			840,055				884,513
OPERATING EXPENSES
Regulated electricity segment fuel and purchased power			291,699				327,561
Real estate segment operations			23,693				30,594
Real estate impairment charge (Note 21)			632				—
Marketing and trading fuel and purchased power			—				18,687
Operations and maintenance			226,245				193,700
Depreciation and amortization			100,063				97,770
Taxes other than income taxes			32,887				33,251
Other expenses			7,733				6,822
Total			682,952				708,385
OPERATING INCOME			157,103				176,128
OTHER
Allowance for equity funds used during construction			4,730				5,414
Other income (Note 14)			6,587				3,928
Other expense (Note 14)			(4,187	)			(10,055	)
Total			7,130				(713	)
INTEREST EXPENSE
Interest charges			58,951				51,521
Capitalized interest			(3,311	)			(4,938	)
Total			55,640				46,583
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES			108,593				128,832
INCOME TAXES			37,600				16,025
INCOME FROM CONTINUING OPERATIONS			70,993				112,807
INCOME (LOSS) FROM DISCONTINUED OPERATIONS
Net of income tax expense (benefit) of $(1,811) and $13,660 (Note 17)			(2,798	)			21,055
NET INCOME			68,195				133,862
Less: Net loss attributable to noncontrolling interests			(152	)			—
NET INCOME ATTRIBUTABLE TO COMMON SHAREHOLDERS		$	68,347			$	133,862
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING — BASIC			101,109				100,653
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING — DILUTED			101,193				100,917
EARNINGS PER WEIGHTED-AVERAGE COMMON SHARE OUTSTANDING
Income from continuing operations attributable to common shareholders — basic		$	0.70			$	1.12
Net income attributable to common shareholders — basic			0.68				1.33
Income from continuing operations attributable to common shareholders — diluted			0.70				1.12
Net income attributable to common shareholders — diluted			0.68				1.33
DIVIDENDS DECLARED PER SHARE		$	0.525			$	0.525
AMOUNTS ATTRIBUTABLE TO COMMON SHAREHOLDERS:
Income from continuing operations, net of tax		$	71,145			$	112,807
Discontinued operations, net of tax			(2,798	)			21,055
Net income attributable to common shareholders		$	68,347			$	133,862

See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.

PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(dollars and shares in thousands, except per share amounts)

		Six Months Ended
		June 30,
		2009				2008
OPERATING REVENUES
Regulated electricity segment		$	1,415,088			$	1,452,279
Real estate segment			35,129				49,631
Marketing and trading			—				52,960
Other revenues			19,231				17,899
Total			1,469,448				1,572,769
OPERATING EXPENSES
Regulated electricity segment fuel and purchased power			539,087				596,939
Real estate segment operations			53,974				61,551
Real estate impairment charge (Note 21)			211,938				—
Marketing and trading fuel and purchased power			—				42,673
Operations and maintenance			433,776				386,723
Depreciation and amortization			199,984				193,364
Taxes other than income taxes			67,015				66,403
Other expenses			14,200				12,760
Total			1,519,974				1,360,413
OPERATING INCOME (LOSS)			(50,526	)			212,356
OTHER
Allowance for equity funds used during construction			9,722				11,538
Other income (Note 14)			3,568				7,767
Other expense (Note 14)			(10,529	)			(14,951	)
Total			2,761				4,354
INTEREST EXPENSE
Interest charges			114,757				106,223
Capitalized interest			(7,145	)			(10,617	)
Total			107,612				95,606
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES			(155,377	)			121,104
INCOME TAXES			(58,574	)			14,484
INCOME (LOSS) FROM CONTINUING OPERATIONS			(96,803	)			106,620
INCOME (LOSS) FROM DISCONTINUED OPERATIONS
Net of income tax expense (benefit) of $(3,703) and $14,763 (Note 17)			(5,722	)			22,769
NET INCOME (LOSS)			(102,525	)			129,389
Less: Net loss attributable to noncontrolling interests			(14,362	)			—
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON SHAREHOLDERS		$	(88,163	)		$	129,389
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING — BASIC			101,048				100,587
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING — DILUTED			101,048				100,856
EARNINGS PER WEIGHTED-AVERAGE COMMON SHARE OUTSTANDING
Income (loss) from continuing operations attributable to common shareholders — basic		$	(0.82	)		$	1.06
Net income (loss) attributable to common shareholders — basic			(0.87	)			1.29
Income (loss) from continuing operations attributable to common shareholders — diluted			(0.82	)			1.06
Net income (loss) attributable to common shareholders — diluted			(0.87	)			1.28
DIVIDENDS DECLARED PER SHARE		$	1.05			$	1.05
AMOUNTS ATTRIBUTABLE TO COMMON SHAREHOLDERS:
Income (loss) from continuing operations, net of tax		$	(82,441	)		$	106,620
Discontinued operations, net of tax			(5,722	)			22,769
Net income (loss) attributable to common shareholders		$	(88,163	)		$	129,389

See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.

PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(dollars in thousands)

		June 30,				December 31,
		2009				2008
ASSETS
CURRENT ASSETS
Cash and cash equivalents		$	17,595			$	105,245
Trust fund for bond redemption (Note 4)			163,975				—
Customer and other receivables			261,630				292,682
Accrued utility revenues			144,398				100,089
Allowance for doubtful accounts			(2,860	)			(3,383	)
Materials and supplies (at average cost)			184,043				173,252
Fossil fuel (at average cost)			40,589				29,752
Deferred income taxes			101,356				79,729
Income tax receivable (Note 8)			165,353				—
Home inventory (Note 21)			12,910				50,688
Assets held for sale (Note 17)			28,863				—
Assets from risk management and trading activities (Note 10)			43,652				32,581
Other current assets			23,318				21,847
Total current assets			1,184,822				882,482
INVESTMENTS AND OTHER ASSETS
Real estate investments — net (Note 21)			199,470				415,296
Assets from long-term risk management and trading activities (Note 10)			24,720				33,675
Nuclear decommissioning trust (Note 18)			363,221				343,052
Other assets			99,544				117,935
Total investments and other assets			686,955				909,958
PROPERTY, PLANT AND EQUIPMENT
Plant in service and held for future use			12,557,986				12,264,805
Less accumulated depreciation and amortization			4,234,290				4,141,546
Net			8,323,696				8,123,259
Construction work in progress			481,759				572,354
Intangible assets, net of accumulated amortization			140,411				131,722
Nuclear fuel, net of accumulated amortization			138,163				89,323
Total property, plant and equipment			9,084,029				8,916,658
DEFERRED DEBITS
Deferred fuel and purchased power regulatory asset (Note 5)			—				7,984
Other regulatory assets			790,609				787,506
Other deferred debits			116,421				115,505
Total deferred debits			907,030				910,995
TOTAL ASSETS		$	11,862,836			$	11,620,093

See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.

PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(dollars in thousands)

		June 30,				December 31,
		2009				2008
LIABILITIES AND EQUITY
CURRENT LIABILITIES
Accounts payable		$	202,011			$	261,029
Accrued taxes			105,397				109,798
Accrued interest			54,730				40,741
Short-term borrowings			390,498				670,469
Current maturities of long-term debt (Note 4)			331,128				177,646
Customer deposits			76,785				78,745
Liabilities from risk management and trading activities (Note 10)			53,038				69,585
Other current liabilities			82,430				97,915
Total current liabilities			1,296,017				1,505,928
LONG-TERM DEBT LESS CURRENT MATURITIES (NOTE 4)			3,528,987				3,031,603
DEFERRED CREDITS AND OTHER
Deferred income taxes			1,475,278				1,403,318
Deferred fuel and purchased power regulatory liability (Note 5)			71,323				—
Other regulatory liabilities			622,411				587,586
Liability for asset retirements			285,247				275,970
Liabilities for pension and other postretirement benefits (Note 6)			713,445				675,788
Liabilities from risk management and trading activities (Note 10)			109,711				126,532
Other			524,444				520,000
Total deferred credits and other			3,801,859				3,589,194
COMMITMENTS AND CONTINGENCIES (SEE NOTES)
EQUITY (Note 11)
Common stock, no par value			2,147,022				2,151,323
Treasury stock			(4,400	)			(2,854	)
Total common stock			2,142,622				2,148,469
Retained earnings			1,248,086				1,444,208
Accumulated other comprehensive loss:
Pension and other postretirement benefits			(48,530	)			(47,547	)
Derivative instruments			(135,373	)			(99,151	)
Total accumulated other comprehensive loss			(183,903	)			(146,698	)
Total Pinnacle West shareholders’ equity			3,206,805				3,445,979
Noncontrolling real estate interests			29,168				47,389
Total equity			3,235,973				3,493,368
TOTAL LIABILITIES AND EQUITY		$	11,862,836			$	11,620,093

See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.

PINNACLE WEST CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(dollars in thousands)

		Six Months Ended
		June 30,
		2009				2008
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)		$	(102,525	)		$	129,389
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization including nuclear fuel			218,939				209,355
Deferred fuel and purchased power			13,144				(25,867	)
Deferred fuel and purchased power amortization			66,163				114,265
Allowance for equity funds used during construction			(9,722	)			(11,538	)
Real estate impairment charge			222,055				—
Deferred income taxes			77,588				154,249
Change in mark-to-market valuations			(401	)			(29,369	)
Changes in current assets and liabilities:
Customer and other receivables			37,447				23,165
Accrued utility revenues			(44,309	)			(60,492	)
Materials, supplies and fossil fuel			(21,628	)			(3,988	)
Other current assets			(1,432	)			22,531
Accounts payable			(49,711	)			(399	)
Accrued taxes			(169,754	)			(23,337	)
Other current liabilities			(7,977	)			(1,036	)
Expenditures for real estate investments			(1,560	)			(15,614	)
Other changes in real estate assets			7,135				6,357
Change in margin and collateral accounts — assets			(2,457	)			251,299
Change in margin and collateral accounts — liabilities			(91,856	)			6,275
Change in unrecognized tax benefits			14,386				(115,337	)
Change in other long-term assets			(8,025	)			9,088
Change in other long-term liabilities			46,898				39,840
Net cash flow provided by operating activities			192,398				678,836
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures			(393,682	)			(477,269	)
Contributions in aid of construction			33,371				22,970
Capitalized interest			(7,145	)			(10,617	)
Proceeds from nuclear decommissioning trust sales			244,858				188,311
Investment in nuclear decommissioning trust			(255,754	)			(198,682	)
Proceeds from sale of commercial real estate investments			—				94,171
Trust fund for bond redemption			(163,975	)			—
Other			990				1,977
Net cash flow used for investing activities			(541,337	)			(379,139	)
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of long-term debt			840,630				63,127
Repayment and reacquisition of long-term debt			(195,767	)			(147,467	)
Short-term borrowings and payments — net			(279,971	)			(74,210	)
Dividends paid on common stock			(102,439	)			(105,592	)
Common stock equity issuance			1,707				5,562
Other			(2,871	)			(890	)
Net cash flow provided by (used for) financing activities			261,289				(259,470	)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS			(87,650	)			40,227
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD			105,245				56,321
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	17,595			$	96,548
Supplemental disclosure of cash flow information
Cash paid during the period for:
Income taxes, net of refunds		$	17,602			$	10,809
Interest, net of amounts capitalized		$	90,847			$	93,734

See Notes to Pinnacle West’s Condensed Consolidated Financial Statements.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Consolidation and Nature of Operations

The unaudited condensed consolidated financial statements include the accounts of Pinnacle West and our subsidiaries: APS, SunCor, APSES, El Dorado and Pinnacle West Marketing & Trading. By the end of 2008, substantially all of Pinnacle West Marketing & Trading’s contracts were transferred to APS or expired. Intercompany accounts and transactions between the consolidated companies have been eliminated. Our accounting records are maintained in accordance with GAAP. The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In preparing the accompanying unaudited condensed consolidated financial statements, we have evaluated subsequent events that have occurred after June 30, 2009 through the date the financial statements were issued on August 4, 2009.

2. Condensed Consolidated Financial Statements

Our unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments except as otherwise disclosed in the notes) that we believe are necessary for the fair presentation of our financial position, results of operations and cash flows for the periods presented. These condensed consolidated financial statements and notes should be read in conjunction with the consolidated financial statements and related notes included in our 2008 Form 10-K. These condensed consolidated financial statements and notes have been prepared consistently with the 2008 Form 10-K with the exception of the reclassification of certain prior-year amounts on our Condensed Consolidated Statement of Income and Condensed Consolidated Balance Sheets in accordance with SFAS No. 160 (see Note 19) and SFAS No. 144 (see Note 17).

We have presented certain line items in more detail in the Condensed Consolidated Statement of Cash Flows than was presented in the prior year. The prior year amounts were reclassified to conform to the current year presentation. Customer and other receivables and accrued utility revenues are presented as separate line items instead of the previously reported single line item of customer and other receivables. Accrued taxes and other current liabilities are presented as separate line items instead of the previously reported single line item of other current liabilities. The change in collateral and margin account — liabilities and the change in other long-term liabilities are presented separately instead of the previously reported single line item of other long-term liabilities. These reclassifications had no impact on total net cash flow provided by operating activities.

3. Quarterly Fluctuations

Weather conditions cause significant seasonal fluctuations in our revenues. In addition, real estate activities, such as the real estate impairment charges recorded in the first half of 2009 (see Note 21), can have significant impacts on our results for interim periods. For these reasons, results for interim periods do not necessarily represent results expected for the year.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

4. Liquidity Matters

The following table shows principal payments due on Pinnacle West’s and APS’ total long-term debt and capitalized lease requirements as of June 30, 2009 (dollars in millions):

		Consolidated
Year		Pinnacle West				APS
2009		$	211			$	164
2010			316				197
2011			578				401
2012			446				446
2013			34				32
Thereafter			2,283				2,283
Total		$	3,868			$	3,523

The credit and liquidity markets experienced significant stress beginning the week of September 15, 2008. While Pinnacle West’s and APS’ ability to issue commercial paper has been negatively impacted by market conditions, they have both been able to access existing credit facilities, ensuring adequate liquidity.

Pinnacle West (parent company) has a $283 million revolving credit facility that terminates in December 2010. The revolver is available to support the issuance of up to $250 million in commercial paper or to be used as bank borrowings, including issuances of letters of credit of up to $94 million. At June 30, 2009, the parent company had outstanding $177 million of borrowings under its revolving credit facility and no letters of credit. It also had no commercial paper outstanding at June 30, 2009. At June 30, 2009, the parent company had remaining capacity available under its revolver of approximately $106 million.

On February 26, 2009, APS issued $500 million of 8.75% unsecured senior notes that mature on March 1, 2019. Net proceeds from the sale of the notes were used to repay short-term borrowings under two committed revolving lines of credit incurred to fund capital expenditures and for general corporate purposes.

During the second quarter of 2009, APS refinanced approximately $343 million of its $539 million variable rate pollution control bonds. As a result of these refinancings, which are described in the following three paragraphs, APS no longer has any outstanding debt securities in auction rate mode.

On May 28, 2009, the Navajo County, Arizona Pollution Control Corporation issued approximately $166 million of Navajo County, Arizona Pollution Control Corporation Pollution Control Revenue Refunding Bonds, 2009 Series A-E, due 2034. The bonds were issued to redeem all of approximately $166 million of the Navajo County, Arizona Pollution Control Corporation Pollution Control Revenue Refunding Bonds 2004 Series A-E, due 2034. The 2009 Series A-E bonds are payable solely from revenues obtained from APS pursuant to a loan agreement between APS and the Navajo County, Arizona Pollution Control Corporation. We will be required to purchase the bonds at the applicable interest reset date and have the opportunity to remarket the bonds at that time. These bonds are classified as long-term debt on our Condensed Consolidated Balance Sheets.

Also on May 28, 2009, the Coconino County, Arizona Pollution Control Corporation issued approximately $13 million of 5.50% Coconino County, Arizona Pollution Control Corporation Pollution Control Revenue Refunding Bonds, 2009 Series A, due 2034. The bonds were issued to redeem all of approximately $13 million of the Coconino County, Arizona Pollution Control Corporation Pollution Control Revenue Refunding Bonds 2004 Series A, due 2034. The 2009 Series A bonds are payable solely from revenues obtained from APS pursuant to a loan agreement between APS and the Coconino County, Arizona Pollution Control Corporation. We will be required to purchase the bonds at the interest reset date and have the opportunity to remarket the bonds at that time. These bonds are classified as long-term debt on our Condensed Consolidated Balance Sheets.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

On June 26, 2009, the Maricopa County, Arizona Pollution Control Corporation issued approximately $164 million of Maricopa County, Arizona Pollution Control Corporation Pollution Control Revenue Refunding Bonds, 2009 Series A-E, due 2029. The bonds were issued to redeem all of approximately $164 million of the Maricopa County, Arizona Pollution Control Corporation Pollution Control Revenue Refunding Bonds 2005 Series A-E, due 2029. The 2009 Series A-E bonds are payable solely from revenues obtained from APS pursuant to a loan agreement between APS and Maricopa County, Arizona Pollution Control Corporation. We will be required to purchase the bonds at the applicable interest reset date and have the opportunity to remarket the bonds at that time. These bonds are classified as long-term debt on our Condensed Consolidated Balance Sheets.

Approximately $164 million of the Maricopa 2005 Series A-E bonds, which were redeemed in July 2009, are classified as current maturities of long-term debt on our Condensed Consolidated Balance Sheets. Approximately $164 million was also held in a restricted trust until redemption and is classified as “Trust fund for bond redemption” on the Condensed Consolidated Balance Sheets.

The following table provides details related to the pollution control bonds described above:

		Navajo County, AZ		Coconino County, AZ		Maricopa County, AZ
		Pollution Control		Pollution Control		Pollution Control
Issuer		Corporation		Corporation		Corporation
Issuance Date		May 28, 2009		May 28, 2009		June 26, 2009
Bond series details (series, interest rate, amount, reset date)		Series A — 5.00% $38 million June 1, 2012		Series A — 5.5% $13 million, June 1, 2014		Series A — 6.00% $36 million May 1, 2014
		Series B — 5.50% $32 million June 1, 2014				Series B — 5.50% $32 million May 1, 2012
		Series C — 5.50% $32 million, June 1, 2014				Series C — 5.75% $32 million May 1, 2013
		Series D — 5.75% $32 million, June 1, 2016				Series D — 6.00% $32 million May 1, 2014
		Series E — 5.75%, $32 million, June 1, 2016				Series E — 6.00% $32 million May 1, 2014

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

APS has two committed revolving credit facilities totaling $866 million, of which $377 million terminates in December 2010 and $489 million terminates in September 2011. The revolvers are available either to support the issuance of up to $250 million in commercial paper (see discussion above) or to be used for bank borrowings, including issuances of letters of credit up to $583 million. At June 30, 2009, APS had borrowings of approximately $209 million and no letters of credit under its revolving lines of credit. At June 30, 2009, APS had remaining capacity available under its revolvers of $657 million.

An existing ACC order requires APS to maintain a common equity ratio of at least 40%. As defined in the ACC order, the common equity ratio is common equity divided by the sum of common equity and long-term debt, including current maturities of long-term debt. At June 30, 2009, APS’ common equity ratio, as defined, was 48%. Its total common equity was approximately $3.3 billion, and total capitalization was approximately $6.8 billion. APS would be prohibited from paying dividends if the payment would reduce its common equity below approximately $2.7 billion, assuming APS’ total capitalization remains the same. This restriction does not materially affect Pinnacle West’s ability to meet its ongoing capital requirements.

The SunCor Secured Revolver matures in January 2010 and requires SunCor to reduce its outstanding borrowings by specified amounts over the term of the facility. As of June 30, 2009, approximately $108 million of borrowings were outstanding under the SunCor Secured Revolver and approximately $67 million of debt was outstanding under other SunCor credit facilities. SunCor intends to apply the proceeds of planned asset sales (see Note 21) to the repayment of the SunCor Secured Revolver and SunCor’s other outstanding debt. The impairment charges discussed in Note 21 and the maturity and non-payment of approximately $7 million of project loans resulted in violations of certain covenants contained in the SunCor Secured Revolver and SunCor’s other credit facilities. SunCor has obtained a forbearance agreement from the SunCor Secured Revolver lenders under which those lenders have agreed not to enforce any of their remedies under the SunCor Secured Revolver until August 15, 2009. SunCor remains in discussions with these lenders to modify the SunCor Secured Revolver to resolve the covenant defaults and extend the principal repayment provisions in a manner that more closely corresponds to SunCor’s planned asset sales. SunCor also is seeking extensions, waivers or similar relief from its other lenders and, while doing so, continues to make current interest payments to its lenders. If SunCor is unable to obtain additional extensions, waivers or similar relief from its lenders, SunCor could be required to immediately repay its outstanding indebtedness under the SunCor Secured Revolver and its other credit facilities. Such debt acceleration would have a material adverse impact on SunCor’s business and its financial position. Neither Pinnacle West nor any of its other subsidiaries has guaranteed any SunCor indebtedness. A SunCor debt default would not result in a cross-default of any of the debt of Pinnacle West or any of its other subsidiaries. As a result, Pinnacle West does not believe that SunCor’s inability to obtain waivers or similar relief from SunCor’s lenders would have a material adverse impact on Pinnacle West’s cash flows or liquidity.

As of June 30, 2009, SunCor could not transfer any cash dividends to Pinnacle West as a result of the covenants mentioned above. The restriction does not materially affect Pinnacle West’s ability to meet its ongoing capital requirements.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

5. Regulatory Matters

2008 General Retail Rate Case

Summary of APS Request and Interim Rate Surcharge — On June 2, 2008, APS filed with the ACC updated financial statements, testimony and other data in the general rate case originally filed on March 24, 2008. In its filing, APS requested a net retail rate increase of $278.2 million effective no later than October 1, 2009, which represents a base rate increase of $448.2 million less the reclassification of $170 million of fuel and purchased power revenues from the existing PSA to base rates.

On December 18, 2008, the ACC approved an emergency interim base rate surcharge for APS. This surcharge became effective for retail customer bills issued after December 31, 2008 and will continue in effect until a decision in the general rate case becomes effective. This surcharge increased annual pretax retail revenues by approximately $65.2 million, and is subject to refund with interest pending the final outcome of APS’ general retail rate case.

Proposed Settlement Agreement — APS and other parties to the rate case began settlement discussions on January 30, 2009 and, on June 12, 2009, they entered into an agreement (the “Settlement Agreement”) detailing the terms upon which the parties have agreed to settle the rate case. The Settlement Agreement is conditioned upon approval of the ACC. Testimony filings were made by APS and other parties to the case in July and additional testimony will be filed in early August. The ACC has scheduled an evidentiary hearing on the matter commencing on August 19, 2009.

The Settlement Agreement includes a net retail rate increase of $207.5 million, which represents a base rate increase of $344.7 million less the reclassification of $137.2 million of fuel and purchased power revenues from the existing PSA to base rates.

The parties also agreed to a rate case filing plan in which APS is prohibited from filing its next two general rate cases until on or after June 1, 2011 and June 1, 2013, respectively, unless certain extraordinary events occur. Subject to the foregoing, APS may not request its next general retail rate increase to be effective prior to July 1, 2012. In addition, the parties will use good faith efforts to process these subsequent rate cases within twelve months of sufficiency findings from the ACC staff, which generally occur within 30 days after the filing of a rate case.

Other key provisions of the Settlement Agreement include the following:

•

A non-fuel base rate increase in annual pretax revenues of $196.3 million, which would replace the $65.2 million interim base rate surcharge described above;

•

A net increase in annual pretax revenues of $11.2 million for fuel and purchased power costs reflected in base rates that would not otherwise have been recoverable under the PSA;

•

A Base Fuel Rate of $0.0376 per kWh (compared to the current Base Fuel Rate of $0.0325 per kWh);

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

•

Revenue accounting treatment for line extension payments received for new or upgraded service from January 1, 2010 through year end 2012 (or until new rates are established in APS’ next general rate case, if that is before the end of 2012), resulting in present estimates of increased revenues of $23 million, $25 million and $49 million, respectively;

•

An authorized return on common equity of 11.0%;

•

A capital structure comprised of 46.2% debt and 53.8% common equity;

•

A commitment from APS to reduce average annual operational expenses by at least $30 million from 2010 through 2014 (an increase of $10 million above the $20 million required reductions for 2009 ordered by the ACC in its interim rate decision in this matter);

•

Equity infusions into APS of at least $700 million during the period beginning June 1, 2009 through December 31, 2014; and

•

Various modifications to the existing energy efficiency, demand-side management and renewable energy programs that would require APS to, among other things, expand its conservation and demand-side management programs and its use of renewable energy, as well as allow for concurrent recovery of renewable energy expenses and provide for more concurrent recovery of demand-side management costs and incentives.

If the Settlement Agreement is approved by the ACC, APS expects that its provisions, including the new rates, would become effective on or about January 1, 2010.

Energy Efficiency, Demand-Side Management and Renewable Energy Programs

In 2006, the ACC approved the Arizona Renewable Energy Standard and Tariff (the “RES”). Under the RES, electric utilities that are regulated by the ACC must supply an increasing percentage of their retail electric energy sales from eligible renewable resources, including solar, wind, biomass, biogas and geothermal technologies. In order to achieve these requirements, the ACC allows APS to include an RES surcharge on customer bills to recover the approved amounts for use on renewable energy projects. On July 1, 2009, APS filed its annual RES implementation plan with the ACC, which covers the 2010-2014 timeframe and requests approval for RES funding of $85.5 million for 2010, or an increase of $7.1 million above 2009 levels. We expect to receive a determination from the ACC on this matter by the end of 2009.

On July 15, 2009, APS filed its initial Energy Efficiency Implementation Plan in compliance with certain provisions of the Settlement Agreement. APS is requesting approval by the ACC of programs and program elements for which APS has budgeted $49.9 million for 2010. The Plan is also contingent upon ACC approval of the Settlement Agreement. In order to recover the budgeted amounts for use on certain demand-side management programs, a surcharge would be added to customer bills similar to that described above under the RES. The surcharge will offset energy efficiency expenses and allow for the recovery of any earned incentives. We expect to receive a determination from the ACC on this matter simultaneously with its decision on the Settlement Agreement.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

PSA Balance

The following table shows the changes in the deferred fuel and purchased power regulatory asset (liability) for the six-month period ended June 30, 2009 and 2008 (dollars in millions):

		Six Months Ended
		June 30,
		2009				2008
Beginning balance		$	8			$	111
Deferred fuel and purchased power costs-current period			(13	)			25
Interest on deferred fuel and purchased power			—				1
Amounts recovered through revenues			(66	)			(114	)
Ending balance		$	(71	)		$	23

The PSA annual adjustor rate is reset for a “PSA Year” effective for a twelve-month period beginning February 1 each year. The PSA rate for the PSA Year that began February 1, 2008 was set at $0.004 per kWh. The PSA rate for the PSA year that began February 1, 2009 was set at $0.0053 per kWh. The PSA rate may not be increased more than $0.004 per kWh in a year without permission of the ACC. The $71 million regulatory liability at June 30, 2009 reflects the seasonal nature of fuel and purchased power costs and lower average prices. Any uncollected (overcollected) deferrals during the 2009 PSA Year resulting from this limit will be included in the historical component of the PSA rate for the PSA Year beginning February 1, 2010.

Formula Transmission Tariff

In July 2008, the FERC approved an Open Access Transmission Tariff for APS to move from fixed rates to a formula rate-setting methodology in order to more accurately reflect the costs that APS incurs in providing transmission services. The formula rate is updated each year effective June 1 on the basis of APS’ actual cost of service, as disclosed in APS’ FERC Form 1 report for the previous fiscal year, and projected capital expenditures. A large portion of the rate represents charges for transmission services to serve APS’ retail customers (“Retail Transmission Charges”). In order to recover the Retail Transmission Charges, APS must file an application with, and obtain approval from, the ACC under the transmission cost adjustor (“TCA”) mechanism, by which changes in Retail Transmission Charges can be reflected in APS’ retail rates.

In 2009, APS was authorized to implement increases in its annual transmission revenues based on calculations filed with the FERC using data for its 2008 fiscal year. Increases in APS’ annual transmission revenues of $22.8 million became effective June 1, 2009. Of this amount, $21 million represents an increase in Retail Transmission Charges which was approved by the ACC on July 29, 2009 and allows APS to reflect the related increased Retail Transmission Charges in its retail rates through the TCA effective August 1, 2009.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Equity Infusion Approval

On May 2, 2008, Pinnacle West filed a notice with the ACC that would allow Pinnacle West to infuse up to $400 million of equity into APS in the event Pinnacle West deems it appropriate to do so to strengthen or maintain APS’ financial integrity. Under Arizona law and implementing regulatory decisions, Pinnacle West is required to give such notice at least 120 days prior to an equity infusion into APS that exceeds $150 million in a single calendar year. On August 6, 2008, the ACC issued an order permitting the infusion to occur on or before December 31, 2009. Pursuant to the terms of the Settlement Agreement, APS would have authorization to obtain equity infusions of up to $700 million during the period beginning June 1, 2009 through December 31, 2014, and such authorization would replace the $400 million authorization described above.

6. Retirement Plans and Other Benefits

Pinnacle West sponsors a qualified defined benefit and account balance pension plan, a non-qualified supplemental excess benefit retirement plan, and other postretirement benefit plans for the employees of Pinnacle West and our subsidiaries. Pinnacle West uses a December 31 measurement date for its pension and other postretirement benefit plans. The market-related value of our plan assets is their fair value at the measurement date.

The following table provides details of the plans’ net periodic benefit costs and the portion of these costs charged to expense (including administrative costs and excluding amounts capitalized as overhead construction or billed to electric plant participants) (dollars in millions):

		Pension Benefits																Other Benefits
		Three Months								Six Months								Three Months								Six Months
		Ended June 30,								Ended June 30,								Ended June 30,								Ended June 30,
		2009				2008				2009				2008				2009				2008				2009				2008
Service cost — benefits earned during the period		$	13			$	13			$	27			$	26			$	4			$	4			$	9			$	9
Interest cost on benefit obligation			30				28				59				55				9				9				19				19
Expected return on plan assets			(29	)			(30	)			(58	)			(59	)			(8	)			(11	)			(17	)			(22	)
Amortization of:
Transition obligation			—				—				—				—				1				1				2				2
Prior service cost			—				—				1				1				—				—				—				—
Net actuarial loss			4				2				7				6				2				—				5				1
Net periodic benefit cost		$	18			$	13			$	36			$	29			$	8			$	3			$	18			$	9
Portion of cost charged to expense		$	9			$	5			$	17			$	12			$	4			$	1			$	9			$	4
APS’ share of cost charged to expense		$	8			$	5			$	16			$	12			$	4			$	1			$	8			$	4

Contributions

In the first quarter of 2009, IRS regulations were modified to allow alternative measurement dates to determine the interest rate used to value the year-end 2008 pension liability for funding purposes. As a result of this change, we estimate our 2009 minimum pension contribution to be zero. The expected contribution to our other postretirement benefit plans in 2009 is estimated to be approximately $15 million. APS and other subsidiaries fund their share of the contributions. APS’ share is approximately 97% of both plans.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

7. Business Segments

Pinnacle West’s two reportable business segments are:

•

our regulated electricity segment, which consists of traditional regulated retail and wholesale electricity businesses (primarily electricity service to Native Load customers) and related activities and includes electricity generation, transmission and distribution; and

•

our real estate segment, which consists of SunCor’s real estate development and investment activities.

Financial data for the three and six months ended June 30, 2009 and 2008 and at June 30, 2009 and December 31, 2008 is provided as follows (dollars in millions):

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2009				2008				2009				2008
Operating revenues:
Regulated electricity segment		$	812			$	829			$	1,415			$	1,452
Real estate segment			17				23				35				50
All other (a)			11				33				19				71
Total		$	840			$	885			$	1,469			$	1,573
Net income (loss) attributable to common shareholders:
Regulated electricity segment		$	78			$	121			$	58			$	114
Real estate segment			(9	)			15				(140	)			14
All other (a)			(1	)			(2	)			(6	)			1
Total		$	68			$	134			$	(88	)		$	129

		As of				As of
		June 30, 2009				December 31, 2008
Assets:
Regulated electricity segment		$	11,369			$	10,951
Real estate segment			361				523
All other (a)			133				146
Total		$	11,863			$	11,620

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

8. Income Taxes

As of June 30, 2009, the tax year ended December 31, 2005 and all subsequent tax years remain subject to examination by the IRS. With few exceptions, we are no longer subject to state income tax examinations by tax authorities for years before 1999. We do not anticipate that there will be any significant increases or decreases in our unrecognized tax benefits within the next 12 months.

Pinnacle West expects to recognize approximately $100 million of cash tax benefits related to SunCor’s strategic asset sales (see Note 21) which will not be realized until the asset sale transactions are completed. Approximately $80 million of these benefits were recorded in the first quarter of 2009 as reductions to income tax expense related to the current impairment charges. The additional $20 million of tax benefits were recorded as reductions to income tax expense related to the SunCor impairment charge recorded in the fourth quarter of 2008.

The $165 million income tax receivable on the Condensed Consolidated Balance Sheets represents the expected tax benefits related to the SunCor strategic asset sales and other anticipated cash refunds related to current income taxes.

9. Variable-Interest Entities

In 1986, APS entered into agreements with three separate VIE lessors in order to sell and lease back interests in Palo Verde Unit 2. The leases are accounted for as operating leases in accordance with GAAP. We are not the primary beneficiary of the Palo Verde VIEs and, accordingly, do not consolidate them.

APS is exposed to losses under the Palo Verde sale leaseback agreements upon the occurrence of certain events that APS does not consider to be reasonably likely to occur. Under certain circumstances (for example, the NRC issuing specified violation orders with respect to Palo Verde or the occurrence of specified nuclear events), APS would be required to assume the debt associated with the transactions, make specified payments to the equity participants, and take title to the leased Unit 2 interests, which, if appropriate, may be required to be written down in value. If such an event had occurred as of June 30, 2009, APS would have been required to assume approximately $167 million of debt and pay the equity participants approximately $161 million. See Note 15 for a discussion of letters of credit that support certain lessors in the Palo Verde sale leaseback transactions.

SunCor has certain land development arrangements that are required to be consolidated under FIN 46R, “Consolidation of Variable Interest Entities.” The assets and non-controlling interests reflected in our Condensed Consolidated Balance Sheets related to these arrangements were approximately $29 million at June 30, 2009 and December 31, 2008.

In addition, see Note 19 for a discussion of SFAS No. 167, “Amendments to FASB Interpretation No. 46(R).”

10. Derivative and Energy Trading Accounting

Our derivative instruments are accounted for at fair value in accordance with SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities,” as amended and interpreted. See Note 20 for a discussion of fair value measurements. We adopted SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities,” on January 1, 2009. This new standard requires enhanced disclosures about derivative instruments and hedging activities. The adoption of SFAS No. 161 did not have a material impact on our financial statements.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

We are exposed to the impact of market fluctuations in the commodity price and transportation costs of electricity, natural gas, coal, emissions allowances and in interest rates. We manage risks associated with these market fluctuations by utilizing various derivative instruments, including futures, forwards, options and swaps. As part of our overall risk management program, we may use such instruments to hedge purchases and sales of electricity, fuels, and emissions allowances and credits. Derivative instruments that are designated as cash flow hedges are used to limit our exposure to cash flow variability on forecasted transactions. As of June 30, 2009, we hedged the majority of certain exposures to the price variability of commodities for a maximum of 39 months. The changes in market value of such contracts have a high correlation to price changes in the hedged transactions.

We enter into derivative instruments for economic hedging purposes. While we believe the economic hedges mitigate exposure to fluctuations in commodity prices, some of these instruments are not designated as accounting hedges. Economic hedges not designated as accounting hedges are recorded at fair value on our balance sheet with changes in fair value recognized in the statement of income as incurred. These instruments are included in the “non-designated hedges” discussion and disclosure below.

Accounting hedges must meet specific hedging requirements for designation. Accounting hedges, which do not meet the normal purchase and sales scope exception (as discussed below), are recognized at fair value as either assets or liabilities on the balance sheet.

Hedge effectiveness is the degree to which the derivative instrument contract and the hedged item are correlated and is measured based on the relative changes in fair value between the derivative instrument contract and the hedged item over time. We assess hedge effectiveness both at inception and on a continuing basis. These assessments exclude the time value of certain options. For accounting hedges that are deemed an effective hedge, the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same period during which the hedged transaction affects earnings. We recognize in current earnings the gains and losses representing hedge ineffectiveness, and the gains and losses on any hedge components which are excluded from our effectiveness assessment.

Derivative instruments for the physical delivery of purchase and sale quantities transacted in the normal course of business qualify for the normal purchase and sales scope exception and are accounted for under the accrual method of accounting. Due to the scope exception, these derivative instruments are excluded from our derivative instrument discussion and disclosures below.

We may also invest in derivative instruments for trading purposes; however, for the six months ended June 30, 2009, there was no material trading activity.

In the electricity business, some contracts to purchase energy are netted against other contracts to sell energy. This is called “book-out” and usually occurs in contracts that have the same terms (quantities and delivery points) and for which power does not flow. We net these book-outs, which reduces both revenues and fuel and purchased power costs in our Condensed Consolidated Statements of Income, but this does not impact our financial condition, net income or cash flows.

For its regulated operations, APS defers for future rate treatment approximately 90% of gains and losses on certain derivatives that would otherwise be recognized in income pursuant to the PSA mechanism. Unless otherwise noted, gains and losses from derivatives in the following tables represent the amounts reflected as income after the effect of PSA deferrals.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of June 30, 2009 we had the following outstanding gross notional amount of derivatives, which represent both purchases and sales (does not reflect net position):

Commodity		Quantity
Power		15,042,878 MWh
Gas		197,259,000 MMBTU

Derivative Instruments in Designated Accounting Hedging Relationships

The following table provides information about gains and losses from derivative instruments in designated accounting hedging relationships and their impact on our Condensed Consolidated Statements of Income during the three and six months ended June 30, 2009 (dollars in thousands):

		Financial Statement		Three Months Ended				Six Months Ended
Commodity Contracts		Location		June 30, 2009				June 30, 2009
Amount of Gain (Loss) Recognized in OCI on Derivative Instruments (Effective Portion)		Accumulated other comprehensive loss-derivative instruments		$	5,554			$	(132,994	)
Amount of Loss Reclassified from OCI into Income (Effective Portion Realized)		Regulated electricity segment fuel and purchased power			47,964				73,330
Amount of Loss Recognized in Income from Derivative Instruments (Ineffective Portion and Amount Excluded from Effectiveness Testing) (a) (b)		Regulated electricity segment fuel and purchased power			141				42

During the next twelve months, we estimate that a net loss of $134 million before income taxes will be reclassified from accumulated other comprehensive income as an offset to the effect of market price changes for the related hedged transactions. In accordance with the PSA, at least 90% of these amounts will be recorded as either a regulatory asset or liability and have no effect on earnings (see Note 5).

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Derivative Instruments Not Designated as Accounting Hedges

The following table provides information about gains and losses from derivative instruments not designated as accounting hedging instruments and their impact on our Condensed Consolidated Statements of Income during the three and six months ended June 30, 2009 (dollars in thousands):

		Financial Statement		Three Months Ended				Six Months Ended
Commodity Contracts		Location		June 30, 2009				June 30, 2009
Amount of Gain (Loss) Recognized in Income from Derivative Instruments		Regulated electricity segment revenue		$	(97	)		$	11
Amount of Gain Recognized in Income from Derivative Instruments		Regulated electricity segment fuel and purchased power expense			4,462				431
Total (a)				$	4,365			$	442

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Fair Values of Derivative Instruments in the Condensed Consolidated Balance Sheets

The following table provides information about the fair value of our derivative instruments. These amounts are located in the asset or liability from risk management and trading activities lines of our Condensed Consolidated Balance Sheets. Amounts are as of June 30, 2009 (dollars in thousands):

		Current				Investments				Current				Deferred Credits				Total Assets
Commodity Contracts		Assets				and Other Assets				Liabilities				and Other				(Liabilities)
Derivatives designated as accounting hedging instruments:
Assets		$	—			$	379			$	8,839			$	736			$	9,954
Liabilities			(2,877	)			(318	)			(131,237	)			(93,949	)			(228,381	)
Total hedging instruments			(2,877	)			61				(122,398	)			(93,213	)			(218,427	)
Derivatives not designated as accounting hedging instruments:
Assets			31,140				31,248				49,811				38,909				151,108
Liabilities			(890	)			(6,589	)			(181,463	)			(84,944	)			(273,886	)
Total non-hedging instruments			30,250				24,659				(131,652	)			(46,035	)			(122,778	)
Total derivatives			27,373				24,720				(254,050	)			(139,248	)			(341,205	)
Margins and options at cost			16,279				—				64,022				1,906				82,207
Collateral provided to counterparties			—				—				137,240				27,631				164,871
Collateral provided from counterparties			—				—				(250	)			—				(250	)
Balance Sheet Total		$	43,652			$	24,720			$	(53,038	)		$	(109,711	)		$	(94,377	)

Derivative instrument assets and liabilities in the table are reported on a gross basis and exclude cash collateral and margin accounts. Transactions with counterparties that have master netting arrangements are reported net on the balance sheet, including cash collateral and margin in accordance with FSP FIN 39-1.

Credit Risk and Credit Related Contingent Features

We are exposed to losses in the event of nonperformance or nonpayment by counterparties. We have risk management and trading contracts with many counterparties, including one counterparty for which our exposure represents approximately 42% of Pinnacle West’s $68 million of risk management and trading assets as of June 30, 2009. This exposure relates to a long-term traditional wholesale contract with a counterparty that has very high credit quality. Our risk management process assesses and monitors the financial exposure of all counterparties. Despite the fact that the great majority of trading counterparties’ debt is rated as investment grade by the credit rating agencies, there is still a possibility that one or more of these companies could default, resulting in a material impact on consolidated earnings for a given period. Counterparties in the portfolio consist principally of financial institutions, major energy companies, municipalities and local distribution companies. We maintain credit policies that we believe minimize overall credit risk to within acceptable limits. Determination of the credit quality of our counterparties is based upon a number of factors, including credit ratings and our evaluation of their financial condition. To manage credit risk, we employ collateral requirements and standardized agreements that allow for the netting of positive and negative exposures associated with a single counterparty. Valuation adjustments are established representing our estimated credit losses on our overall exposure to counterparties.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Certain of our derivative instrument contracts contain credit-risk-related contingent features including, among other things, investment grade credit rating provisions, credit-related cross default provisions, and adequate assurance provisions. Adequate assurance provisions allow a counterparty with reasonable grounds for uncertainty to demand additional collateral based on subjective events and/or conditions. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a liability position on June 30, 2009 was $417 million for which we had posted collateral of $165 million in the normal course of business.

For those derivative instruments in a net liability position, with investment grade credit contingencies, the counterparties could demand additional collateral if our debt were to fall below investment grade (below BBB- for S&P or Fitch, or Baa3 for Moody’s), which would be a violation of the credit rating provisions. If the investment grade contingent features underlying these agreements had been triggered on June 30, 2009, after off-setting asset positions under master netting arrangements we would have been required to post approximately an additional $140 million of collateral to our counterparties; this amount includes those contracts which qualify for scope exceptions, which are excluded from the derivative details in the above footnote. We also have energy related non-derivative instrument contracts with investment grade credit-related contingent features which could also require us to post additional collateral of approximately $200 million if our debt were to fall below investment grade.

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

11. Changes in Equity

The following tables shows the Company’s changes in common stock equity and changes in equity of noncontrolling interests for the three and six months ended June 30, 2009 and 2008 (dollars in thousands):

		Three Months Ended June 30, 2009												Three Months Ended June 30, 2008
		Common				Noncontrolling								Common				Noncontrolling
		Shareholders				Interests				Total				Shareholders				Interests				Total
Beginning balance, March 31		$	3,162,902			$	34,366			$	3,197,268			$	3,544,201			$	54,247			$	3,598,448
Net income (loss)			68,347				(152	)			68,195				133,862				—				133,862
Other comprehensive income (loss):
Net unrealized gains on derivative instruments (a)			5,554				—				5,554				240,986				—				240,986
Net reclassification of realized (gains) losses to income (b)			47,964				—				47,964				(36,705	)			—				(36,705	)
Reclassification of pension and other postretirement benefits to income			1,253				—				1,253				1,304				—				1,304
Net unrealized losses related to pension and other postretirement benefits			(4,204	)			—				(4,204	)			(10,595	)			—				(10,595	)
Income tax expense related to items of other comprehensive income			(19,844	)			—				(19,844	)			(76,344	)			—				(76,344	)
Total other comprehensive income			30,723				—				30,723				118,646				—				118,646
Total comprehensive income (loss)			99,070				(152	)			98,918				252,508				—				252,508
Issuance of capital stock			2,717				—				2,717				2,747				—				2,747
Purchase of treasury stock, net of reissuances			5				—				5				—				—				—
Other (primarily stock compensation)			(4,820	)			(41	)			(4,861	)			1,188				(382	)			806
Common stock dividends			(53,069	)			—				(53,069	)			(52,831	)			—				(52,831	)
Net capital activities by noncontrolling interests			—				(5,005	)			(5,005	)			—				—				—
Ending balance, June 30		$	3,206,805			$	29,168			$	3,235,973			$	3,747,813			$	53,865			$	3,801,678

PINNACLE WEST CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

		Six Months Ended June 30, 2009												Six Months Ended June 30, 2008
		Common				Noncontrolling								Common				Noncontrolling
		Shareholders				Interests				Total				Shareholders				Interests				Total
Beginning balance, January 1		$	3,445,979			$	47,389			$	3,493,368			$	3,531,611			$	54,569			$	3,586,180
Net income (loss)			(88,163	)			(14,362	)			(102,525	)			129,389				—				129,389
Other comprehensive income (loss):
Net unrealized gains (losses) on derivative instruments (a)			(132,994	)			—				(132,994	)			360,792				—				360,792
Net reclassification of realized (gains) losses to income (b)			73,330				—				73,330				(38,771	)			—				(38,771	)
Reclassification of pension and other postretirement benefits to income			2,506				—				2,506				2,347				—				2,347
Net unrealized losses related to pension and other postretirement benefits			(4,204	)			—				(4,204	)			(10,595	)			—				(10,595	)
Income tax (expense) benefit related to items of other comprehensive income			24,157				—				24,157				(122,825	)			—				(122,825	)
Total other comprehensive income (loss)			(37,205	)			—				(37,205	)			190,948				—				190,948
Total comprehensive income (loss)			(125,368	)			(14,362	)			(139,730	)			320,337				—				320,337
Issuance of capital stock			5,346				—				5,346				5,562				—				5,562
Purchase of treasury stock, net of reissuances			(1,546	)			—				(1,546	)			(1,344	)			—				(1,344	)
Other (primarily stock compensation)			(11,527	)			(170	)			(11,697	)			(2,763	)			(704	)			(3,467	)
Common stock dividends			(106,079	)			—				(106,079	)			(105,590	)			—				(105,590	)
Net capital activities by noncontrolling interests			—				(3,689	)			(3,689	)			—				—				—
Ending balance, June 30		$	3,206,805			$	29,168			$	3,235,973			$	3,747,813			$	53,865			$	3,801,678