Attached files

file filename
EX-32.2 - WISCONSIN ELECTRIC EXHIBIT 32.2 - WISCONSIN ELECTRIC POWER COwepco06302016ex322.htm
EX-32.1 - WISCONSIN ELECTRIC EXHIBIT 32.1 - WISCONSIN ELECTRIC POWER COwepco06302016ex321.htm
EX-31.2 - WISCONSIN ELECTRIC EXHIBIT 31.2 - WISCONSIN ELECTRIC POWER COwepco06302016ex312.htm
EX-31.1 - WISCONSIN ELECTRIC EXHIBIT 31.1 - WISCONSIN ELECTRIC POWER COwepco06302016ex311.htm

 


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2016

Commission
 
Registrant; State of Incorporation;
 
IRS Employer
File Number
 
Address; and Telephone Number
 
Identification No.
001-01245
 
WISCONSIN ELECTRIC POWER COMPANY
 
39-0476280
 
 
(A Wisconsin Corporation)
 
 
 
 
231 West Michigan Street
 
 
 
 
P.O. Box 2046
 
 
 
 
Milwaukee, WI 53201
 
 
 
 
(414) 221-2345
 
 

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes [X]     No [ ]

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.
 
Large accelerated filer [ ]  
 
Accelerated filer [  ]
 
 
Non-accelerated filer [X]
 
Smaller reporting company [  ]
 

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

Yes [ ]    No [X]

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:

Common Stock, $10 Par Value,
33,289,327 shares outstanding at
June 30, 2016

All of the common stock of Wisconsin Electric Power Company is owned by WEC Energy Group, Inc.

 



WISCONSIN ELECTRIC POWER COMPANY
QUARTERLY REPORT ON FORM 10-Q
For the Quarter Ended June 30, 2016
TABLE OF CONTENTS
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


06/30/2016 Form 10-Q
i
Wisconsin Electric Power Company


GLOSSARY OF TERMS AND ABBREVIATIONS

The abbreviations and terms set forth below are used throughout this report and have the meanings assigned to them below:
Subsidiaries and Affiliates
ATC
 
American Transmission Company LLC
Bostco
 
Bostco LLC
Integrys
 
Integrys Holding, Inc. (previously known as Integrys Energy Group, Inc.)
WBS
 
WEC Business Services LLC
WEC Energy Group
 
WEC Energy Group, Inc. (previously known as Wisconsin Energy Corporation)
WG
 
Wisconsin Gas LLC
 
 
 
Federal and State Regulatory Agencies
EPA
 
United States Environmental Protection Agency
FERC
 
Federal Energy Regulatory Commission
MDEQ
 
Michigan Department of Environmental Quality
MPSC
 
Michigan Public Service Commission
PSCW
 
Public Service Commission of Wisconsin
SEC
 
United States Securities and Exchange Commission
WDNR
 
Wisconsin Department of Natural Resources
 
 
 
Accounting Terms
AFUDC
 
Allowance for Funds Used During Construction
ASU
 
Accounting Standards Update
FASB
 
Financial Accounting Standards Board
GAAP
 
United States Generally Accepted Accounting Principles
OPEB
 
Other Postretirement Employee Benefits
 
 
 
Environmental Terms
CAIR
 
Clean Air Interstate Rule
CSAPR
 
Cross-State Air Pollution Rule
GHG
 
Greenhouse Gas
MATS
 
Mercury and Air Toxics Standards
NAAQS
 
National Ambient Air Quality Standards
NOx
 
Nitrogen Oxide
SO2
 
Sulfur Dioxide
 
 
 
Measurements
Btu
 
British Thermal Units
Dth
 
Dekatherm (One Dth equals one million Btu)
MW
 
Megawatt (One MW equals one million Watts)
MWh
 
Megawatt-hour
 
 
 
Other Terms and Abbreviations
ALJ
 
Administrative Law Judge
D.C. Circuit Court of Appeals
 
United States Court of Appeals for the District of Columbia Circuit
Exchange Act
 
Securities Exchange Act of 1934, as amended
FTRs
 
Financial Transmission Rights
MCPP
 
Milwaukee County Power Plant
MISO
 
Midcontinent Independent System Operator, Inc.
MISO Energy Markets
 
MISO Energy and Operating Reserves Markets
PIPP
 
Presque Isle Power Plant
ROE
 
Return on Equity
Supreme Court
 
United States Supreme Court
VAPP
 
Valley Power Plant


06/30/2016 Form 10-Q
ii
Wisconsin Electric Power Company


CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

In this report, we make statements concerning our expectations, beliefs, plans, objectives, goals, strategies, and future events or performance. These statements are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act. Readers are cautioned not to place undue reliance on these forward-looking statements. Forward-looking statements may be identified by reference to a future period or periods or by the use of terms such as "anticipates," "believes," "could," "estimates," "expects," "forecasts," "goals," "guidance," "intends," "may," "objectives," "plans," "possible," "potential," "projects," "seeks," "should," "targets," "will," or variations of these terms.

Forward-looking statements include, among other things, statements concerning management's expectations and projections regarding earnings, completion of capital projects, sales and customer growth, rate actions and related filings with regulatory authorities, environmental and other regulations and associated compliance costs, legal proceedings, effective tax rate, pension and OPEB plans, fuel costs, sources of electric energy supply, coal and natural gas deliveries, remediation costs, liquidity and capital resources, and other matters.

Forward-looking statements are subject to a number of risks and uncertainties that could cause our actual results to differ materially from those expressed or implied in the statements. These risks and uncertainties include those described in risk factors as set forth in this report and our Annual Report on Form 10-K for the year ended December 31, 2015, and those identified below:

Factors affecting utility operations such as catastrophic weather-related damage, environmental incidents, unplanned facility outages and repairs and maintenance, and electric transmission or natural gas pipeline system constraints;

Factors affecting the demand for electricity and natural gas, including political developments, unusual weather, changes in economic conditions, customer growth and declines, commodity prices, energy conservation efforts, and continued adoption of distributed generation by customers;

The timing, resolution, and impact of rate cases and negotiations, including recovery of deferred and current costs and adjustments to our and/or ATC's ROE, and other regulatory decisions impacting our regulated operations;

The ability to obtain and retain customers, including wholesale customers, due to increased competition in our electric and natural gas markets from retail choice and alternative electric suppliers, and continued industry consolidation;

The timely completion of capital projects within budgets, as well as the recovery of the related costs through rates;

The impact of federal, state, and local legislative and regulatory changes, including changes in rate-setting policies or procedures, tax law changes, deregulation and restructuring of the electric and/or natural gas utility industries, transmission or distribution system operation, the approval process for new construction, reliability standards, pipeline integrity and safety standards, allocation of energy assistance, and energy efficiency mandates;

Federal and state legislative and regulatory changes relating to the environment, including climate change and other environmental regulations impacting generation facilities and renewable energy standards, the enforcement of these laws and regulations, changes in the interpretation of permit conditions by regulatory agencies, and the recovery of associated remediation and compliance costs;

The risks associated with changing commodity prices, particularly natural gas and electricity, and the availability of sources of fossil fuel, natural gas, purchased power, materials needed to operate environmental controls at our electric generating facilities, or water supply due to high demand, shortages, transportation problems, nonperformance by electric energy or natural gas suppliers under existing power purchase or natural gas supply contracts, or other developments;

Changes in credit ratings, interest rates, and our ability to access the capital markets, caused by volatility in the global credit markets, our capitalization structure, and market perceptions of the utility industry or us;

Costs and effects of litigation, administrative proceedings, investigations, settlements, claims, and inquiries;

The risk of financial loss, including increases in bad debt expense, associated with the inability of our customers, counterparties, and affiliates to meet their obligations;


06/30/2016 Form 10-Q
1
Wisconsin Electric Power Company


Changes in the creditworthiness of the counterparties with whom we have contractual arrangements, including participants in the energy trading markets and fuel suppliers and transporters;

The direct or indirect effect on our business resulting from terrorist incidents, the threat of terrorist incidents, and cyber intrusion, including the failure to maintain the security of personally identifiable information, the associated costs to protect our assets and personal information, and the costs to notify affected persons to mitigate their information security concerns;

The financial performance of ATC and its corresponding contribution to our earnings, as well as the ability of ATC and Duke-American Transmission Company to obtain the required approvals for their transmission projects;

The investment performance of WEC Energy Group's employee benefit plan assets, as well as unanticipated changes in related actuarial assumptions, which could impact future funding requirements;

Factors affecting the employee workforce, including loss of key personnel, internal restructuring, work stoppages, and collective bargaining agreements and negotiations with union employees;

Advances in technology that result in competitive disadvantages and create the potential for impairment of existing assets;

The terms and conditions of the governmental and regulatory approvals of Wisconsin Energy Corporation's acquisition of Integrys that could reduce anticipated benefits and the ability to successfully integrate the operations of the combined company;

The timing and outcome of any audits, disputes, and other proceedings related to taxes;

The effect of accounting pronouncements issued periodically by standard-setting bodies; and

Other considerations disclosed elsewhere herein and in other reports we file with the SEC or in other publicly disseminated written documents.

We expressly disclaim any obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.


06/30/2016 Form 10-Q
2
Wisconsin Electric Power Company


PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

WISCONSIN ELECTRIC POWER COMPANY

CONDENSED CONSOLIDATED INCOME STATEMENTS (Unaudited)
 
Three Months Ended
 
Six Months Ended
 
 
June 30
 
June 30
(in millions)
 
2016
 
2015
 
2016
 
2015
Operating revenues
 
$
877.2

 
$
883.0

 
$
1,852.7

 
$
1,967.6

 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
Cost of sales
 
284.3

 
306.1

 
620.7

 
739.5

Other operation and maintenance
 
336.2

 
343.2

 
684.4

 
685.6

Depreciation and amortization
 
80.8

 
75.6

 
161.2

 
150.3

Property and revenue taxes
 
29.0

 
29.4

 
58.0

 
58.8

Total operating expenses
 
730.3

 
754.3

 
1,524.3

 
1,634.2

 
 
 
 
 
 
 
 
 
Operating income
 
146.9

 
128.7

 
328.4

 
333.4

 
 
 
 
 
 
 
 
 
Equity in earnings of transmission affiliate
 
11.4

 
12.2

 
26.1

 
26.4

Other income, net
 
3.2

 
4.0

 
6.2

 
6.5

Interest expense
 
29.4

 
29.5

 
58.5

 
58.2

Other expense
 
(14.8
)
 
(13.3
)
 
(26.2
)
 
(25.3
)
 
 
 
 
 
 
 
 
 
Income before income taxes
 
132.1

 
115.4

 
302.2

 
308.1

Income tax expense
 
49.2

 
40.5

 
111.7

 
111.5

Net income
 
82.9

 
74.9

 
190.5

 
196.6

 
 
 
 
 
 
 
 
 
Preferred stock dividend requirements
 
0.3

 
0.3

 
0.6

 
0.6

Net income attributed to common shareholder
 
$
82.6

 
$
74.6

 
$
189.9

 
$
196.0


The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these financial statements.


06/30/2016 Form 10-Q
3
Wisconsin Electric Power Company


WISCONSIN ELECTRIC POWER COMPANY

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(in millions, except share and per share amounts)
 
June 30, 2016
 
December 31, 2015
Assets
 
 
 
 
Property, plant, and equipment
 
 
 
 
In service
 
$
11,032.4

 
$
10,917.1

Accumulated depreciation
 
(3,539.7
)
 
(3,461.9
)
 
 
7,492.7

 
7,455.2

Construction work in progress
 
159.6

 
170.6

Leased facilities, net
 
2,104.3

 
2,141.7

Net property, plant, and equipment
 
9,756.6

 
9,767.5

Investments
 
 
 
 
Equity investment in transmission affiliate
 
394.8

 
382.2

Other
 
0.3

 
0.3

Total investments
 
395.1

 
382.5

Current assets
 
 
 
 
Cash and cash equivalents
 
8.5

 
27.1

Accounts receivable and unbilled revenues, net of reserves of $41.9 and $43.0, respectively
 
459.3

 
461.4

Accounts receivable from related parties
 
51.2

 
41.1

Materials, supplies, and inventories
 
263.0

 
301.6

Prepayments
 
179.5

 
171.8

Other
 
14.8

 
19.6

Total current assets
 
976.3

 
1,022.6

Deferred charges and other assets
 
 
 
 
Regulatory assets
 
1,927.5

 
1,855.9

Other
 
94.4

 
111.1

Total deferred charges and other assets
 
2,021.9

 
1,967.0

Total assets
 
$
13,149.9

 
$
13,139.6

 
 
 
 
 
Capitalization and liabilities
 
 
 
 
Capitalization
 
 
 
 
Common stock – $10 par value; 65,000,000 shares authorized; 33,289,327 shares outstanding
 
$
332.9

 
$
332.9

Additional paid in capital
 
1,016.8

 
999.7

Retained earnings
 
2,201.4

 
2,231.4

Preferred stock
 
30.4

 
30.4

Long-term debt
 
2,660.0

 
2,658.8

Capital lease obligations
 
2,764.0

 
2,692.5

Total capitalization
 
9,005.5

 
8,945.7

Current liabilities
 
 
 
 
Current portion of capital lease obligations
 
41.0

 
123.6

Short-term debt
 
146.5

 
144.0

Subsidiary note payable to WEC Energy Group
 
17.1

 
19.6

Accounts payable
 
251.6

 
286.4

Accounts payable to related parties
 
127.4

 
95.7

Accrued payroll and benefits
 
47.9

 
87.5

Other
 
109.6

 
115.7

Total current liabilities
 
741.1

 
872.5

Deferred credits and other liabilities
 
 
 
 
Regulatory liabilities
 
799.1

 
741.2

Deferred income taxes
 
2,229.0

 
2,110.0

Pension and OPEB obligations
 
159.9

 
210.9

Other
 
215.3

 
259.3

Total deferred credits and other liabilities
 
3,403.3

 
3,321.4

 
 
 
 
 
Commitments and contingencies (Note 13)
 

 

 
 
 
 
 
Total capitalization and liabilities
 
$
13,149.9

 
$
13,139.6


The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these financial statements.

06/30/2016 Form 10-Q
4
Wisconsin Electric Power Company


WISCONSIN ELECTRIC POWER COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
 
Six Months Ended
 
 
June 30
(in millions)
 
2016
 
2015
Operating Activities
 
 
 
 
Net income
 
$
190.5

 
$
196.6

Reconciliation to cash provided by operating activities
 
 
 
 
Depreciation and amortization
 
165.1

 
158.7

Deferred income taxes and investment tax credits, net
 
113.4

 
40.0

Contributions and payments related to pension and OPEB plans
 
(4.6
)
 
(104.4
)
Equity income in transmission affiliate, net of distributions
 
(8.1
)
 
(7.8
)
Payments for liabilities transferred to WBS
 
(107.0
)
 

Change in –
 
 
 
 
Accounts receivable and unbilled revenues
 
(8.1
)
 
33.7

Materials, supplies, and inventories
 
38.6

 
28.5

Other current assets
 
24.7

 
13.5

Accounts payable
 
(3.9
)
 
(11.2
)
Accrued taxes, net
 
(13.8
)
 
52.9

Other current liabilities
 
(10.4
)
 
(33.2
)
Other, net
 
(40.3
)
 
(26.7
)
Net cash provided by operating activities
 
336.1

 
340.6

 
 
 
 
 
Investing Activities
 
 
 
 
Capital expenditures
 
(191.9
)
 
(234.8
)
Capital contributions to transmission affiliate
 
(4.6
)
 
(2.3
)
Proceeds from the sale of assets
 
31.7

 

Proceeds from assets transferred to WBS
 
13.1

 

Other, net
 
1.0

 
0.4

Net cash used in investing activities
 
(150.7
)
 
(236.7
)
 
 
 
 
 
Financing Activities
 
 
 
 
Dividends paid on common stock
 
(220.0
)
 
(120.0
)
Dividends paid on preferred stock
 
(0.6
)
 
(0.6
)
Issuance of long-term debt
 

 
250.0

Change in short-term debt
 
2.5

 
(246.8
)
Repayment of subsidiary note to WEC Energy Group
 
(2.5
)
 
(2.3
)
Other, net
 
16.6

 
3.0

Net cash used in financing activities
 
(204.0
)
 
(116.7
)
 
 
 
 
 
Net change in cash and cash equivalents
 
(18.6
)
 
(12.8
)
Cash and cash equivalents at beginning of period
 
27.1

 
24.0

Cash and cash equivalents at end of period
 
$
8.5

 
$
11.2


The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these financial statements.


06/30/2016 Form 10-Q
5
Wisconsin Electric Power Company


WISCONSIN ELECTRIC POWER COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
June 30, 2016

NOTE 1—GENERAL INFORMATION

On June 29, 2015, our parent company, Wisconsin Energy Corporation, acquired Integrys and changed its name to WEC Energy Group, Inc.

As used in these notes, the term "financial statements" refers to the condensed consolidated financial statements. This includes the income statements, balance sheets, and statements of cash flows, unless otherwise noted. In this report, when we refer to "the Company," "us," "we," "our," or "ours," we are referring to Wisconsin Electric Power Company and its subsidiary, Bostco.

We have prepared the unaudited interim financial statements presented in this Form 10-Q pursuant to the rules and regulations of the SEC and GAAP. Accordingly, these financial statements do not include all of the information and footnotes required by GAAP for annual financial statements. These financial statements should be read in conjunction with the consolidated financial statements and footnotes in our Annual Report on Form 10-K for the year ended December 31, 2015. Financial results for an interim period may not give a true indication of results for the year. In particular, the results of operations for the three and six months ended June 30, 2016, are not necessarily indicative of expected results for 2016 due to seasonal variations and other factors.

In management's opinion, we have included all adjustments, normal and recurring in nature, necessary for a fair presentation of our financial results.

Reclassifications

On the income statements for the three and six months ended June 30, 2015, we reclassified $2.2 million and $4.7 million, respectively, from treasury grant to depreciation and amortization. This reclassification was made to be consistent with the current year presentation.

On the statement of cash flows for the six months ended June 30, 2015, we reclassified $0.9 million from depreciation and amortization to other operating activities. In addition, we reclassified $4.4 million of non-qualified pension and OPEB contributions from other operating activities to contributions and payments related to pension and OPEB plans on the statement of cash flows for the six months ended June 30, 2015. We also reclassified $9.4 million from cost of removal, net of salvage to capital expenditures on the statement of cash flows for the six months ended June 30, 2015. These reclassifications were made to be consistent with the current period presentation.

During the second quarter of 2016, we reorganized our business segments to reflect our new internal organization and management structure. All prior period amounts impacted by this change were reclassified to conform to the new presentation. See Note 10, Segment Information, for more information on our business segments.

NOTE 2—DISPOSITIONS

Utility Segment – Sale of Milwaukee County Power Plant

In April 2016, we sold the MCPP steam generation and distribution assets, located in Wauwatosa, Wisconsin. MCPP primarily provides steam to the Milwaukee Regional Medical Center hospitals and other campus buildings. During the second quarter of 2016, we recorded a pre-tax gain on the sale of $10.9 million ($6.5 million after tax), which is netted in other operation and maintenance on our income statements. The assets included in the sale were not material and, therefore, were not presented as held for sale. The results of operations of this plant remained in continuing operations through the sale date as the sale did not represent a shift in our corporate strategy and did not have a major effect on our operations and financial results.


06/30/2016 Form 10-Q
6
Wisconsin Electric Power Company


NOTE 3—COMMON EQUITY

Restrictions

Various financing arrangements and regulatory requirements impose certain restrictions on our ability to transfer funds to WEC Energy Group in the form of cash dividends, loans, or advances. In addition, Wisconsin law prohibits us from making loans to or guaranteeing obligations of WEC Energy Group or its subsidiaries. See Note 9, Common Equity, in our 2015 Annual Report on Form 10-K for additional information on these and other restrictions.

We do not believe that these restrictions will materially affect our operations or limit any dividend payments in the foreseeable future.

NOTE 4—SHORT-TERM DEBT AND LINES OF CREDIT

The following table shows our short-term borrowings and their corresponding weighted-average interest rates:
(in millions, except percentages)
 
June 30, 2016
 
December 31, 2015
Commercial paper
 
 
 
 
Amount outstanding
 
$
146.5

 
$
144.0

Weighted-average interest rate on amounts outstanding
 
0.51
%
 
0.70
%

Our average amount of commercial paper borrowings based on daily outstanding balances during the six months ended June 30, 2016, was $111.8 million with a weighted-average interest rate during the period of 0.49%.

As of June 30, 2016, our subsidiary had a $17.1 million note payable to WEC Energy Group with a weighted-average interest rate of 5.04%.

The information in the table below relates to our revolving credit facility used to support our commercial paper borrowing program, including remaining available capacity under this facility:
(in millions)
 
Maturity
 
June 30, 2016
Revolving credit facility
 
December 2020
 
$
500.0

Total short-term credit capacity
 
 
 
$
500.0

 
 
 
 
 
Less:
 
 
 
 

Letters of credit issued inside credit facility
 
 
 
$
26.0

Commercial paper outstanding
 
 
 
146.5

 
 
 
 
 
Available capacity under existing agreement
 
 
 
$
327.5


NOTE 5—MATERIALS, SUPPLIES, AND INVENTORIES

Our inventory consisted of:
(in millions)
 
June 30, 2016
 
December 31, 2015
Materials and supplies
 
$
150.8

 
$
151.1

Fossil fuel
 
92.5

 
110.5

Natural gas in storage
 
19.7

 
40.0

Total
 
$
263.0

 
$
301.6


Substantially all materials and supplies, fossil fuel, and natural gas in storage inventories are recorded using the weighted-average cost method of accounting.


06/30/2016 Form 10-Q
7
Wisconsin Electric Power Company


NOTE 6—FAIR VALUE MEASUREMENTS

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).

Fair value accounting rules provide a fair value hierarchy that prioritizes the inputs used to measure fair value. 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). The three levels of the fair value hierarchy are defined as follows:

Level 1 – Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

Level 2 – Pricing inputs are observable, either directly or indirectly, but are not quoted prices included within Level 1. Level 2 includes those financial instruments that are valued using external inputs within models or other valuation methods.

Level 3 – Pricing inputs include significant inputs that are generally less observable from objective sources. These inputs may be used with internally developed methods that result in management's best estimate of fair value. Level 3 instruments include those that may be more structured or otherwise tailored to customers' needs.

Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. We use a mid-market pricing convention (the mid-point price between bid and ask prices) as a practical measure for valuing certain derivative assets and liabilities. We primarily use a market approach for recurring fair value measurements and attempt to use valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs.

When possible, we base the valuations of our derivative assets and liabilities on quoted prices for identical assets and liabilities in active markets. These valuations are classified in Level 1. The valuations of certain contracts not classified as Level 1 may be based on quoted market prices received from counterparties and/or observable inputs for similar instruments. Transactions valued using these inputs are classified in Level 2. Certain derivatives are categorized in Level 3 due to the significance of unobservable or internally developed inputs.

We recognize transfers at their value as of the end of the reporting period.

We conduct a thorough review of fair value hierarchy classifications on a quarterly basis.

The following tables summarize our financial assets and liabilities that were accounted for at fair value on a recurring basis, categorized by level within the fair value hierarchy:
 
 
June 30, 2016
(in millions)
 
Level 1
 
Level 2
 
Level 3
 
Total
Derivative assets
 
 
 
 
 
 
 
 
Natural gas contracts
 
$
4.1

 
$
1.1

 
$

 
$
5.2

FTRs
 

 

 
7.5

 
7.5

   Petroleum products contracts
 
0.4

 

 

 
0.4

Coal contracts
 

 
1.3

 

 
1.3

Total derivative assets
 
$
4.5

 
$
2.4

 
$
7.5

 
$
14.4

 
 
 
 
 
 
 
 
 
Derivative liabilities
 
 
 
 
 
 
 
 
Natural gas contracts
 
$
0.2

 
$

 
$

 
$
0.2

   Petroleum products contracts
 
1.3

 

 

 
1.3

Coal contracts
 

 
8.6

 

 
8.6

Total derivative liabilities
 
$
1.5

 
$
8.6

 
$

 
$
10.1



06/30/2016 Form 10-Q
8
Wisconsin Electric Power Company


 
 
December 31, 2015
(in millions)
 
Level 1
 
Level 2
 
Level 3
 
Total
Derivative assets
 
 
 
 
 
 
 
 
Natural gas contracts
 
$
0.5

 
$

 
$

 
$
0.5

FTRs
 

 

 
1.6

 
1.6

   Petroleum products contracts
 
1.2

 

 

 
1.2

Coal contracts
 

 
2.0

 

 
2.0

Total derivative assets
 
$
1.7

 
$
2.0

 
$
1.6

 
$
5.3

 
 
 
 
 
 
 
 
 
Derivative liabilities
 
 
 
 
 
 
 

Natural gas contracts
 
$
9.2

 
$
0.2

 
$

 
$
9.4

   Petroleum products contracts
 
4.4

 

 

 
4.4

Coal contracts
 

 
7.6

 

 
7.6

Total derivative liabilities
 
$
13.6

 
$
7.8

 
$

 
$
21.4


The derivative assets and liabilities listed in the tables above include options, swaps, futures, physical commodity contracts, and other instruments used to manage market risks related to changes in commodity prices. They also include FTRs, which are used to manage electric transmission congestion costs in the MISO Energy Markets.

The following table summarizes the changes to derivatives classified as Level 3 in the fair value hierarchy:
 
 
Three Months Ended June 30
 
Six Months Ended June 30
(in millions)
 
2016
 
2015
 
2016
 
2015
Balance at the beginning of the period
 
$
0.6

 
$
3.3

 
$
1.6

 
$
7.0

Purchases
 
8.1

 
3.9

 
8.1

 
3.9

Settlements
 
(1.2
)
 
(3.6
)
 
(2.2
)
 
(7.3
)
Balance at the end of the period
 
$
7.5

 
$
3.6

 
$
7.5

 
$
3.6


Fair Value of Financial Instruments

The following table shows the financial instruments included on our balance sheets that are not recorded at fair value:
 
 
June 30, 2016
 
December 31, 2015
(in millions)
 
Carrying Amount
 
Fair Value
 
Carrying Amount
 
Fair Value
Preferred stock
 
$
30.4

 
$
29.7

 
$
30.4

 
$
27.3

Long-term debt
 
2,660.0

 
3,085.0

 
2,658.8

 
2,888.2


Due to the short-term nature of cash and cash equivalents, net accounts receivable, accounts payable, and short-term borrowings, the carrying amount of each such item approximates fair value. The fair value of our preferred stock is estimated based on the quoted market value for the same issue, or by using a perpetual dividend discount model. The fair value of our long-term debt is estimated based upon the quoted market value for the same or similar issues. The fair values of our long-term debt and preferred stock are categorized within Level 2 of the fair value hierarchy.

NOTE 7—DERIVATIVE INSTRUMENTS

We use derivatives as part of our risk management program to manage the risks associated with the price volatility of purchased power, generation, and natural gas costs for the benefit of our customers. Our approach is non-speculative and designed to mitigate risk. Regulated hedging programs are approved by the PSCW.

We record derivative instruments on our balance sheets as an asset or liability measured at fair value unless they qualify for the normal purchases and sales exception, and are so designated. We continually assess our contracts designated as normal and will discontinue the treatment of these contracts as normal if the required criteria are no longer met. Changes in the derivative's fair value are recognized currently in earnings unless specific hedge accounting criteria are met or we receive regulatory treatment for the derivative. For most energy-related physical and financial contracts in our regulated operations that qualify as derivatives, our regulators allow the effects of fair value accounting to be offset to regulatory assets and liabilities.


06/30/2016 Form 10-Q
9
Wisconsin Electric Power Company


The following table shows our derivative assets and derivative liabilities:
 
 
June 30, 2016
 
December 31, 2015
(in millions)
 
Derivative Assets
 
Derivative Liabilities
 
Derivative Assets
 
Derivative Liabilities
Other current
 
 
 
 
 
 
 
 
   Natural gas contracts
 
$
4.9

 
$
0.2

 
$
0.5

 
$
8.1

   Petroleum products contracts
 
0.3

 
1.3

 
0.9

 
3.3

   Coal contracts
 
1.3

 
7.1

 
1.7

 
3.4

   FTRs
 
7.5

 

 
1.6

 

   Total other current *
 
14.0

 
8.6

 
4.7

 
14.8

 
 
 
 
 
 
 
 
 
Other long-term
 
 
 
 
 
 
 
 
   Natural gas contracts
 
0.3

 

 

 
1.3

   Petroleum products contracts
 
0.1

 

 
0.3

 
1.1

   Coal contracts
 

 
1.5

 
0.3

 
4.2

  Total other long-term *
 
0.4

 
1.5

 
0.6

 
6.6

Total
 
$
14.4

 
$
10.1

 
$
5.3

 
$
21.4


*
On our balance sheets, we classify derivative assets and liabilities as other current or other long-term based on the maturities of the underlying contracts.

Realized gains (losses) on derivative instruments are primarily recorded in cost of sales on the income statements. Our estimated notional sales volumes and gains (losses) were as follows:
 
 
Three Months Ended June 30, 2016
 
Three Months Ended June 30, 2015
(in millions)
 
Volume
 
Gains (Losses)
 
Volume
 
Gains (Losses)
Natural gas contracts
 
9.6 Dth
 
$
(4.8
)
 
5.9 Dth
 
$
(3.1
)
Petroleum products contracts
 
2.6 gallons
 
(0.8
)
 
0.8 gallons
 
0.1

FTRs
 
5.7 MWh
 
0.5

 
5.9 MWh
 
0.8

Total
 
 
 
$
(5.1
)
 
 
 
$
(2.2
)

 
 
Six Months Ended June 30, 2016
 
Six Months Ended June 30, 2015
(in millions)
 
Volume
 
Gains (Losses)
 
Volume
 
Gains (Losses)
Natural gas contracts
 
20.2 Dth
 
$
(12.0
)
 
12.3 Dth
 
$
(6.9
)
Petroleum products contracts
 
4.2 gallons
 
(1.5
)
 
1.7 gallons
 

FTRs
 
10.9 MWh
 
2.3

 
12.1 MWh
 
2.9

Total
 
 
 
$
(11.2
)
 
 
 
$
(4.0
)

On our balance sheets, the amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral are not offset against the fair value amounts recognized for derivative instruments executed with the same counterparty under the same master netting arrangement. At June 30, 2016, and December 31, 2015, we had posted cash collateral of $1.6 million and $14.9 million, respectively, in our margin accounts. These amounts are recorded on the balance sheets in other current assets.

The following table shows derivative assets and derivative liabilities if derivative instruments by counterparty were presented net on the balance sheet:
 
 
June 30, 2016
 
December 31, 2015
(in millions)
 
Derivative Assets
 
Derivative Liabilities
 
Derivative Assets
 
Derivative Liabilities
Gross amount recognized on the balance sheet
 
$
14.4

 
$
10.1

 
$
5.3

 
$
21.4

Gross amount not offset on the balance sheet *
 
(1.6
)
 
(1.6
)
 
(0.7
)
 
(13.5
)
Net amount
 
$
12.8

 
$
8.5

 
$
4.6

 
$
7.9


*
Includes cash collateral posted of $12.8 million at December 31, 2015. There was no cash collateral included at June 30, 2016.


06/30/2016 Form 10-Q
10
Wisconsin Electric Power Company


NOTE 8—EMPLOYEE BENEFITS

The following tables show the components of net periodic pension and OPEB costs for our benefit plans:
 
 
Pension Costs
 
 
Three Months Ended June 30
 
Six Months Ended June 30
(in millions)
 
2016
 
2015
 
2016
 
2015
Service cost
 
$
2.5

 
$
3.6

 
$
5.2

 
$
7.3

Interest cost
 
12.3

 
13.1

 
24.9

 
26.4

Expected return on plan assets
 
(19.4
)
 
(20.8
)
 
(38.8
)
 
(41.8
)
Amortization of prior service cost
 
0.4

 
0.5

 
0.8

 
1.0

Amortization of net actuarial loss
 
8.2

 
8.9

 
16.2

 
17.9

Net periodic benefit cost
 
$
4.0

 
$
5.3

 
$
8.3

 
$
10.8


 
 
OPEB Costs
 
 
Three Months Ended June 30
 
Six Months Ended June 30
(in millions)
 
2016
 
2015
 
2016
 
2015
Service cost
 
$
3.5

 
$
2.1

 
$
3.6

 
$
4.5

Interest cost
 
4.7

 
3.3

 
6.6

 
6.7

Expected return on plan assets
 
(5.8
)
 
(4.0
)
 
(7.0
)
 
(8.0
)
Amortization of prior service credit
 
(0.2
)
 
(0.3
)
 
(0.5
)
 
(0.6
)
Amortization of net actuarial loss
 
0.3

 
0.3

 
0.5

 
0.6

Net periodic benefit cost
 
$
2.5

 
$
1.4

 
$
3.2

 
$
3.2


We did not make any contributions to our qualified pension plans during the first six months of 2016. During the six months ended June 30, 2016, we made payments of $3.1 million related to our non-qualified pension plans and $1.5 million to our OPEB plans. We expect to make payments of $2.1 million related to our pension plans and $3.4 million related to our OPEB plans during the remainder of 2016, dependent upon various factors affecting us, including our liquidity position and possible tax law changes.

NOTE 9—INVESTMENT IN AMERICAN TRANSMISSION COMPANY

We own approximately 23% of ATC, a for-profit, electric transmission company regulated by the FERC and certain state regulatory commissions. The following table shows changes to our investment in ATC:
 
 
Three Months Ended June 30
 
Six Months Ended June 30
(in millions)
 
2016
 
2015
 
2016

2015
Balance at beginning of period
 
$
394.3

 
$
379.0

 
$
382.2

 
$
372.9

Add: Earnings from equity method investment
 
11.4

 
12.2

 
26.1

 
26.4

Add: Capital contributions
 
1.1

 
1.2

 
4.6

 
2.3

Less: Distributions received
 
12.0

 
9.4

 
18.0

 
18.6

Less: Other
 

 
0.1

 
0.1

 
0.1

Balance at end of period
 
$
394.8

 
$
382.9

 
$
394.8

 
$
382.9


We pay ATC for transmission and other related services it provides. In addition, we provide a variety of operational, maintenance, and project management work for ATC, for which we are reimbursed by ATC. We are required to pay the cost of needed transmission infrastructure upgrades for new generation projects while the projects are under construction. ATC reimburses us for these costs when the new generation is placed in service.

The following table summarizes our significant related party transactions with ATC:
 
 
Three Months Ended June 30
 
Six Months Ended June 30
(in millions)
 
2016
 
2015
 
2016
 
2015
Charges to ATC for services and construction
 
$
2.4

 
$
2.5

 
$
4.5

 
$
5.0

Charges from ATC for network transmission services
 
63.3

 
59.6

 
126.6

 
119.2



06/30/2016 Form 10-Q
11
Wisconsin Electric Power Company


Our balance sheets included the following receivables and payables related to ATC:
(in millions)
 
June 30, 2016
 
December 31, 2015
Accounts receivable
 
 
 
 
Services provided to ATC
 
$
0.9

 
$
0.6

Accounts payable
 
 
 
 
Services received from ATC
 
21.1

 
19.9


Summarized financial data for ATC is included in the following tables:
 
 
Three Months Ended June 30
 
Six Months Ended June 30
(in millions)
 
2016
 
2015
 
2016
 
2015
Income statement data
 
 
 
 
 
 
 
 
Revenues
 
$
154.3

 
$
165.1

 
$
318.5

 
$
317.5

Operating expenses
 
81.7

 
80.3

 
160.8

 
160.3

Other expense
 
23.7

 
24.2

 
47.7

 
48.6

Net income
 
$
48.9

 
$
60.6

 
$
110.0

 
$
108.6


(in millions)
 
June 30, 2016
 
December 31, 2015
Balance sheet data
 
 
 
 
Current assets
 
$
83.9

 
$
80.5

Noncurrent assets
 
4,104.6

 
3,948.3

Total assets
 
$
4,188.5

 
$
4,028.8

 
 
 
 
 
Current liabilities
 
$
382.5

 
$
330.3

Long-term debt
 
1,791.0

 
1,790.7

Other noncurrent liabilities
 
293.8

 
245.0

Shareholders' equity
 
1,721.2

 
1,662.8

Total liabilities and shareholders' equity
 
$
4,188.5

 
$
4,028.8


NOTE 10—SEGMENT INFORMATION

During the second quarter of 2016, we reorganized our business segments to reflect our new internal organization and management structure. All prior period amounts impacted by this change were reclassified to conform to the new presentation.
We use operating income to measure segment profitability and to allocate resources to our businesses. At June 30, 2016, we reported two segments, which are described below.
Our utility segment includes our electric and natural gas utility operations. Our electric utility operations are engaged in the generation, distribution, and sale of electricity in southeastern (including metropolitan Milwaukee), east central, and northern Wisconsin and the Upper Peninsula of Michigan. Our electric utility operations also include our steam operations which produce, distribute, and sell steam to space heating and processing customers in metropolitan Milwaukee, Wisconsin. Our natural gas utility operations are engaged in the purchase, distribution, and sale of natural gas to retail customers and the transportation of customer-owned natural gas in our three service areas within southeastern, east central, and northern Wisconsin.
The other segment includes our approximate 23% ownership interest in ATC, a for-profit, electric transmission company regulated by the FERC and certain state regulatory commissions, and Bostco, our non-utility subsidiary, that develops and invests in real estate.

06/30/2016 Form 10-Q
12
Wisconsin Electric Power Company


The following tables show summarized financial information concerning our reportable segments for the three and six months ended June 30, 2016 and 2015:
(in millions)
 
Utility
 
Other
 
Wisconsin Electric Power Company Consolidated
Three Months Ended June 30, 2016
 
 
 
 
 
 
Operating revenues
 
$
877.2

 
$

 
$
877.2

   Other operation and maintenance
 
336.2

 

 
336.2

Depreciation and amortization
 
80.8

 

 
80.8

Operating income
 
146.9

 

 
146.9

   Equity in earnings of transmission affiliate
 

 
11.4

 
11.4

   Interest expense
 
29.1

 
0.3

 
29.4


(in millions)
 
Utility
 
Other
 
Wisconsin Electric Power Company Consolidated
Three Months Ended June 30, 2015
 
 
 
 
 
 
Operating revenues
 
$
883.0

 
$

 
$
883.0

   Other operation and maintenance
 
343.2

 

 
343.2

Depreciation and amortization
 
75.6

 

 
75.6

Operating income
 
128.7

 

 
128.7

   Equity in earnings of transmission affiliate
 

 
12.2

 
12.2

   Interest expense
 
29.2

 
0.3

 
29.5


(in millions)
 
Utility
 
Other
 
Wisconsin Electric Power Company Consolidated
Six Months Ended June 30, 2016
 
 
 
 
 
 
Operating revenues
 
$
1,852.7

 
$

 
$
1,852.7

   Other operation and maintenance
 
684.4

 

 
684.4

Depreciation and amortization
 
161.2

 

 
161.2

Operating income
 
328.4

 

 
328.4

   Equity in earnings of transmission affiliate
 

 
26.1

 
26.1

   Interest expense
 
58.0

 
0.5

 
58.5


(in millions)
 
Utility
 
Other
 
Wisconsin Electric Power Company Consolidated
Six Months Ended June 30, 2015
 
 
 
 
 
 
Operating revenues
 
$
1,967.6

 
$

 
$
1,967.6

   Other operation and maintenance
 
685.6

 

 
685.6

Depreciation and amortization
 
150.3

 

 
150.3

Operating income
 
333.4

 

 
333.4

   Equity in earnings of transmission affiliate
 

 
26.4

 
26.4

   Interest expense
 
57.5

 
0.7

 
58.2


NOTE 11—VARIABLE INTEREST ENTITIES

In February 2015, the FASB issued ASU 2015-02, Amendments to the Consolidation Analysis. This ASU focuses on the consolidation analysis for companies that are required to evaluate whether they should consolidate certain legal entities. It emphasizes the risk of loss when determining a controlling financial interest and amends the guidance for assessing how related party relationships affect the consolidation analysis of variable interest entities. We adopted the standard upon its effective date in the first quarter of 2016, and our adoption resulted in no changes to our disclosures or financial statement presentation.

The primary beneficiary of a variable interest entity must consolidate the entity's assets and liabilities. In addition, certain disclosures are required for significant interest holders in variable interest entities.


06/30/2016 Form 10-Q
13
Wisconsin Electric Power Company


We assess our relationships with potential variable interest entities, such as our coal suppliers, natural gas suppliers, coal and natural gas transporters, and other counterparties related to power purchase agreements, investments, and joint ventures. In making this assessment, we consider, along with other factors, the potential that our contracts or other arrangements provide subordinated financial support, the obligation to absorb the entity's losses, the right to receive residual returns of the entity, and the power to direct the activities that most significantly impact the entity's economic performance.

American Transmission Company

We own approximately 23% of ATC, a for-profit, electric transmission company regulated by the FERC and certain state regulatory commissions. We have determined that ATC is a variable interest entity but that consolidation is not required since we are not ATC's primary beneficiary. We do not have the power to direct the activities that most significantly impact ATC's economic performance. We account for ATC as an equity method investment. See Note 9, Investment in American Transmission Company, for more information.

The significant assets and liabilities related to ATC recorded on our balance sheets included our equity investment and accounts payable. At June 30, 2016 and December 31, 2015, our equity investment was $394.8 million and $382.2 million, respectively, which approximates our maximum exposure to loss as a result of our involvement with ATC. In addition, we had $21.1 million and $19.9 million of accounts payable due to ATC at June 30, 2016 and December 31, 2015, respectively, for network transmission services.

Purchased Power Agreement

We have identified a purchased power agreement that represents a variable interest. This agreement is for 236 MW of firm capacity from a natural gas-fired cogeneration facility, and we account for it as a capital lease. The agreement includes no minimum energy requirements over the remaining term of approximately six years. We have examined the risks of the entity, including operations and maintenance, dispatch, financing, fuel costs, and other factors, and have determined that we are not the primary beneficiary of the entity. We do not hold an equity or debt interest in the entity, and there is no residual guarantee associated with the purchased power agreement.

We have approximately $107.9 million of required payments over the remaining term of this agreement. We believe that the required lease payments under this contract will continue to be recoverable in rates. Total capacity and lease payments under this contract for the six months ended June 30, 2016 and 2015 were $26.9 million and $26.8 million, respectively. Our maximum exposure to loss is limited to the capacity payments under the contract.

NOTE 12—RELATED PARTIES

We and our consolidated subsidiary, Bostco, routinely enter into transactions with related parties, including WEC Energy Group, its subsidiaries, ATC, and other entities in which we have material interests.

Bostco has a note payable to our parent company, WEC Energy Group. At June 30, 2016 and December 31, 2015, the balance of this note payable was $17.1 million and $19.6 million, respectively.


06/30/2016 Form 10-Q
14
Wisconsin Electric Power Company


The following table shows activity associated with our related party transactions:
 
 
Three Months Ended June 30
 
Six Months Ended June 30
(in millions)
 
2016
 
2015
 
2016
 
2015
Lease agreements
 
 

 
 

 
 

 
 

Lease payments to W.E. Power, LLC (1)
 
$
110.0

 
$
104.3

 
$
217.4

 
$
204.6

Construction work in progress billed to W.E. Power, LLC
 
16.4

 
1.8

 
17.7

 
13.9

 
 
 
 
 
 
 
 
 
Transactions with WBS
 
 
 
 
 
 
 
 
Billings to WBS (2)
 
53.1

 

 
109.8

 

Billings from WBS (3)
 
62.2

 

 
225.6

 

 
 
 
 
 
 
 
 
 
Transactions with WG
 
 
 
 

 
 
 
 
Natural gas purchases from WG
 
1.3

 
1.3

 
2.7

 
2.7

Services received from WG
 
5.6

 
5.9

 
10.5

 
11.5

Services provided to WG
 
15.8

 
20.3

 
29.9

 
40.2


(1) 
We make lease payments to W.E. Power, LLC, another subsidiary of WEC Energy Group, for Port Washington Generating Station Units 1 and 2 and Oak Creek Expansion Units 1 and 2.

(2) 
Included in the amount of billings to WBS, for the three and six months ended June 30, 2016, was $3.2 million and $13.1 million, respectively, for the transfer of certain software to WBS.

(3) 
Included in the amount of billings from WBS, for the six months ended June 30, 2016, was $107.0 million for the transfer of certain benefit-related liabilities to WBS. There were no transfers of liabilities to WBS during the three months ended June 30, 2016.

NOTE 13—COMMITMENTS AND CONTINGENCIES

We have significant commitments and contingencies arising from our operations, including those related to unconditional purchase obligations, environmental matters, and enforcement and litigation matters.

Energy Related Purchased Power Agreements

We have obligations to distribute and sell electricity and natural gas to our customers and expect to recover costs related to these obligations in future customer rates. In order to meet these obligations, we routinely enter into long-term purchase and sale commitments for various quantities and lengths of time. Our minimum future commitments related to these purchase obligations as of June 30, 2016, were $10,442.2 million.

Environmental Matters

Consistent with other companies in the energy industry, we face significant ongoing environmental compliance and remediation obligations related to current and past operations. Specific environmental issues affecting us include, but are not limited to, current and future regulation of air emissions such as SO2, NOx, fine particulates, mercury, and GHGs; water discharges; disposal of coal combustion products such as fly ash; and remediation of impacted properties, including former manufactured gas plant sites.

Air Quality

Sulfur Dioxide National Ambient Air Quality Standards

The EPA issued a revised 1-Hour SO2 NAAQS that became effective in August 2010. The EPA issued a final rule in August 2015 describing the implementation requirements and established a compliance timeline for the revised standard. The final rule affords state agencies some latitude in rule implementation. A nonattainment designation could have negative impacts for a localized geographic area, including additional permitting requirements for new or existing sources in the area.

In March 2015, a federal court entered a consent decree between the EPA and the Sierra Club and others agreeing to specific actions related to implementing the revised standard for areas containing large sources emitting above a certain threshold level of SO2. The consent decree required the EPA to complete attainment designations for certain areas with large sources by no later than July 2016.

06/30/2016 Form 10-Q
15
Wisconsin Electric Power Company


SO2 emissions from PIPP are above the consent decree emission threshold, which means that the Marquette area required action earlier than would otherwise have been required under the revised NAAQS. However, we were able to show through modeling that the area should be designated as attainment. Based upon this modeling, the state of Michigan recommended to the EPA that the Marquette area be designated as attainment. In July 2016, the EPA finalized its recommendation and published a notice in the Federal Register designating Marquette County, Michigan, as unclassified/attainment, effective in September 2016.

We believe our fleet overall is well positioned to meet the new regulation.

8-Hour Ozone National Ambient Air Quality Standards

The EPA completed its review of the 2008 8-hour ozone standard in November 2014, and announced a proposal to tighten (lower) the NAAQS. In October 2015, the EPA released the final rule, which lowered the limit for ground-level ozone. This is expected to cause nonattainment designations for some counties in Wisconsin with potential future impacts for our fossil-fueled power plant fleet. For nonattainment areas, the state will have to develop a state implementation plan to bring the areas back into attainment. We will be required to comply with this state implementation plan no earlier than 2020 and are in the process of reviewing and determining potential impacts resulting from this rule.

Mercury and Other Hazardous Air Pollutants

In December 2011, the EPA issued the final MATS rule, which imposes stringent limitations on emissions of mercury and other hazardous air pollutants from coal and oil-fired electric generating units beginning in April 2015. In addition, both Wisconsin and Michigan have state mercury rules that require a 90% reduction of mercury; however, these rules are not in effect as long as MATS is in place. In June 2015, the Supreme Court ruled on a challenge to the MATS rule and remanded the case back to the D.C. Circuit Court of Appeals, ruling that the EPA failed to appropriately consider the cost of the regulation. The MATS rule remains in effect until the D.C. Circuit Court of Appeals takes action on the EPA's April 2016 updated cost evaluation.

We believe that our fleet is well positioned to comply with this regulation. In April 2013, we received a one year MATS compliance extension from the MDEQ for PIPP through April 2016. The addition of a dry sorbent injection system for further control of mercury and acid gases at PIPP was placed into service in March 2016, and PIPP is now in compliance with MATS.

Climate Change

In 2015, the EPA issued the Clean Power Plan, a final rule regulating GHG emissions from existing generating units, a proposed federal plan and model trading rules as alternatives or guides to state compliance plans, and final performance standards for modified and reconstructed generating units and new fossil-fueled power plants. In October 2015, following publication of the final rule for existing fossil-fueled generating units, numerous states (including Wisconsin and Michigan), trade associations, and private parties filed lawsuits challenging the final rule, including a request to stay the implementation of the final rule pending the outcome of these legal challenges. The D.C. Circuit Court of Appeals denied the stay request, but in February 2016, the Supreme Court stayed the effectiveness of the rule until disposition of the litigation in the D.C. Circuit Court of Appeals and to the extent that review is sought, at the Supreme Court. In addition, in February 2016, the Governor of Wisconsin issued Executive Order 186, which prohibits state agencies, departments, boards, commissions, or other state entities from developing or promoting the development of a state plan.

The final rule for existing fossil-fueled generating units seeks to achieve state-specific GHG emission reduction goals by 2030, and would have required states to submit plans by September 6, 2016. States submitting initial plans and requesting an extension would have been required to submit final plans by September 2018, either alone or in conjunction with other states. The timelines for the 2022 through 2029 interim goals and the 2030 final goal for states, as well as all other aspects of the rule, may be changed due to the stay and subsequent legal proceedings.

The goal of the final rule is to reduce nationwide GHG emissions by 32% from 2005 levels. The rule is seeking GHG emission reductions in Wisconsin and Michigan of 41% and 39%, respectively, below 2012 levels by 2030. Interim goals starting in 2022 would require states to achieve about two-thirds of the 2030 required reduction. The building blocks used by the EPA to determine each state's emission reduction requirements include a combination of improving power plant efficiency, increasing reliance on combined cycle natural gas units, and adding new renewable energy resources. We are in the process of reviewing the final rule for existing fossil-fueled generating units to determine the potential impacts to our operations. The rule could result in significant additional

06/30/2016 Form 10-Q
16
Wisconsin Electric Power Company


compliance costs, including capital expenditures, could impact how we operate our existing fossil-fueled power plants and biomass facility, and could have a material adverse impact on our operating costs.

Draft Federal Plan and Model Trading Rules were also published in October 2015 for use in developing state plans or for use in states where a plan is not submitted or approved. In December 2015, the state of Wisconsin submitted petitions for reconsideration of the EPA's final standards for existing, as well as new, modified, and reconstructed generating units. A petition for reconsideration of the EPA's final standards for existing generating units was also submitted jointly by the Wisconsin utilities. Among other things, the petitions narrowly ask the EPA to consider revising the state goal for existing units to reflect the 2013 retirement of the Kewaunee Power Station, which could lower the state's carbon dioxide equivalent reduction goal by about 10%. In May 2016, the EPA denied the state of Wisconsin's petition for reconsideration related to new, modified, and reconstructed generating units, except that the EPA deferred the portion related to the treatment of biomass. In addition, the EPA has not issued decisions yet regarding the above referenced petitions for reconsideration of the final EPA standards for existing generating units. In December 2015, Michigan state agencies announced modeling results that suggest that the state will be able to meet existing source requirements until 2025, based on planned coal plant retirements, along with a continuation of state renewable standards and current levels of energy efficiency.

Water Quality

Clean Water Act Cooling Water Intake Structure Rule

In August 2014, the EPA issued a final regulation under Section 316(b) of the Clean Water Act, which requires that the location, design, construction, and capacity of cooling water intake structures at existing power plants reflect the Best Technology Available (BTA) for minimizing adverse environmental impacts from both impingement and entrainment. The rule became effective in October 2014, and applies to all of our existing generating facilities with cooling water intake structures, except for the Oak Creek expansion units, which were permitted under the rules governing new facilities.

Facility owners must select from seven compliance options available to meet the impingement mortality (IM) reduction standard. The rule requires state permitting agencies to make BTA determinations, subject to EPA oversight, for IM reduction over the next several years as facility permits are reissued. Based on our assessment, we believe that existing technologies at our generating facilities, except for VAPP Unit 1, satisfy the IM BTA requirements. For VAPP Unit 2, a project to install fish protection screens to meet the IM BTA standard was completed in 2015. The same types of screens are scheduled to be installed on VAPP Unit 1 starting in the third quarter of 2016.

BTA determinations must also be made by the WDNR and MDEQ to address entrainment mortality (EM) reduction on a site-specific basis taking into consideration several factors. We have received an EM BTA determination by the WDNR, with EPA concurrence, for our proposed intake modification at VAPP. BTA determinations for EM will be made in future permit reissuances for Port Washington Generating Station, Pleasant Prairie Power Plant, PIPP, and Oak Creek Power Plant Units 5 through 8. 

During 2016–2018, we will be completing studies and evaluating options to address the EM BTA requirements at our plants. With the exception of Pleasant Prairie Power Plant (which has existing cooling towers that meet EM BTA requirements), and VAPP, we cannot yet determine what, if any, intake structure or operational modifications will be required to meet the new EM BTA requirements at our facilities. In addition, the rule allows the EM BTA requirements to be waived in cases of pending facility retirements, which we are currently considering for PIPP. Based on discussions with the MDEQ, if we submit a signed certification with our next National Pollutant Discharge Elimination System permit application stating that PIPP will be retired no later than the end of the next permit cycle (assumed to be October 1, 2022), we believe the EM BTA requirements will be waived. Entrainment studies are currently underway at PIPP.

Steam Electric Effluent Guidelines

The EPA's final steam electric effluent guidelines rule took effect in January 2016 and applies to discharges of wastewater from our power plant processes in Wisconsin and Michigan. Unless pending challenges to the final guidelines are successful, the WDNR and MDEQ will modify the state rules and incorporate the new requirements into our facility permits, which are renewed every five years. We expect the new requirements to be phased in between 2018 and 2023 as our permits are renewed. Our power plant facilities already have advanced wastewater treatment technologies installed that meet many of the discharge limits established by this rule. However, these standards will require additional wastewater treatment retrofits as well as installation of other equipment to minimize process water use. The final rule phases in new or more stringent requirements related to limits of arsenic, mercury, selenium, and nitrogen in wastewater discharged from wet scrubber systems. New requirements for wet scrubber wastewater treatment will require additional zero liquid discharge or other advanced treatment capital improvements for the Oak Creek and

06/30/2016 Form 10-Q
17
Wisconsin Electric Power Company


Pleasant Prairie facilities. The rule also requires dry fly ash handling, which is already in place at all of our power plants. Dry bottom ash transport systems are required by the new rule, and modifications will be required at Oak Creek Units 7 and 8, the Pleasant Prairie units, and the PIPP units. We are beginning preliminary engineering for compliance with the rule and estimate a total cost range of $70 million to $95 million for these advanced treatment and bottom ash transport systems.

Valley Power Plant Wisconsin Pollutant Discharge Elimination System Permit

The WDNR issued a Wisconsin Pollutant Discharge Elimination System (WPDES) permit for VAPP that became effective in January 2013. The permit contains several additional requirements including effluent toxicity testing and monitoring for additional parameters (phosphorous, mercury, and ammonia-nitrogen), and a new heat addition limit from the cooling water discharges that all took effect immediately. Other long-term compliance requirements include thermal discharge studies, phosphorous evaluation and feasibility for reduction, mercury minimization planning, and the installation of new cooling water intake fish protection screens. Installation of wedge wire screens for fish protection on the VAPP Unit 2 cooling water intake structure was completed in 2015. An identical modification for VAPP Unit 1 is scheduled to begin in 2016. We are also working on updating the WPDES permit to reflect acceptance of VAPP process wastewater by the Milwaukee Metropolitan Sewage District, which addresses the permit conditions for phosphorous, mercury, and ammonia-nitrogen.

Manufactured Gas Plant Remediation

We have identified sites at which we or a predecessor company owned or operated a manufactured gas plant or stored manufactured gas. We have also identified other sites that may have been impacted by historical manufactured gas plant activities. We are responsible for the environmental remediation of these sites. We are also working with various state jurisdictions in our investigation and remediation planning. These sites are at various stages of investigation, monitoring, remediation, and closure.

The future costs for detailed site investigation, future remediation, and monitoring are dependent upon several variables including, among other things, the extent of remediation, changes in technology, and changes in regulation. Historically, our regulators have allowed us to recover incurred costs, net of insurance recoveries and recoveries from potentially responsible parties, associated with the remediation of manufactured gas plant sites. Accordingly, we have established regulatory assets for costs associated with these sites.

We have established the following regulatory assets and reserves related to manufactured gas plant sites:
(in millions)
 
June 30, 2016
 
December 31, 2015
Regulatory assets
 
$
17.0

 
$
16.9

Reserves for future remediation
 
5.6

 
5.6


Enforcement and Litigation Matters

We are involved in legal and administrative proceedings before various courts and agencies with respect to matters arising in the ordinary course of business. Although we are unable to predict the outcome of these matters, management believes that appropriate reserves have been established and that final settlement of these actions will not have a material effect on our financial condition or results of operations.

Consent Decree

In April 2003, we entered into a Consent Decree with the EPA, in which we agreed to significantly reduce air emissions from our coal-fired power plants. Under the terms of the Consent Decree, we could request its termination after December 31, 2015. We made this termination request in March 2016. In July 2016, the United States informed us that neither the EPA nor the State of Michigan objected to the termination request. We, along with the United States and the State of Michigan, intend to request formal termination of the Consent Decree by the court shortly.


06/30/2016 Form 10-Q
18
Wisconsin Electric Power Company


NOTE 14—SUPPLEMENTAL CASH FLOW INFORMATION
 
 
Six Months Ended June 30
(in millions)
 
2016
 
2015
Cash (paid) for interest, net of amount capitalized
 
$
(58.1
)
 
$
(56.2
)
Cash received (paid) for income taxes, net of (payments) refunds
 
0.6

 
(20.9
)
Significant noncash transactions:
 
 
 
 
Accounts payable related to construction costs
 
12.4

 
3.4


NOTE 15—REGULATORY ENVIRONMENT

Upper Michigan Energy Resources Corporation

In June 2016, WEC Energy Group filed a proposal with the MPSC and the PSCW to form Upper Michigan Energy Resources Corporation, a stand-alone utility in the Upper Peninsula of Michigan. This utility will include our and Wisconsin Public Service Corporation's electric and natural gas distribution assets located in the Upper Peninsula. The proposal was filed pursuant to the MPSC's approval of the acquisition of Integrys, whereby WEC Energy Group agreed to form a separate Michigan utility company. If approved, it is anticipated that the new utility will be created effective January 1, 2017.

NOTE 16—NEW ACCOUNTING PRONOUNCEMENTS

Revenue Recognition

In May 2014, the FASB and the International Accounting Standards Board issued their joint revenue recognition standard, ASU 2014-09, Revenue from Contracts with Customers. This guidance is effective for fiscal years and interim periods beginning after December 15, 2017, and can either be applied retrospectively or as a cumulative-effect adjustment as of the date of adoption. We are currently assessing the effects this guidance may have on our financial statements.

Classification and Measurement of Financial Instruments

In January 2016, the FASB issued ASU 2016-01, Classification and Measurement of Financial Assets and Liabilities. This guidance is effective for fiscal years and interim periods beginning after December 15, 2017, and will be recorded with a cumulative-effect adjustment to beginning retained earnings as of the beginning of the fiscal year in which the guidance is effective. We are currently assessing the effects this guidance may have on our financial statements.

Leases

In February 2016, the FASB issued ASU 2016-02, Leases. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, and will be applied using a modified retrospective approach. We are currently assessing the effects this guidance may have on our financial statements.

Stock-Based Compensation

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. We are currently assessing the effects this guidance may have on our financial statements.

Financial Instruments Credit Losses

In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. We are currently assessing the effects this guidance may have on our financial statements.


06/30/2016 Form 10-Q
19
Wisconsin Electric Power Company


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

CORPORATE DEVELOPMENTS

The following discussion should be read in conjunction with the accompanying financial statements and related notes and our Annual Report on Form 10-K for the year ended December 31, 2015.

Introduction

We are a wholly owned subsidiary of WEC Energy Group, and are primarily engaged in the business of generating and distributing electricity in Wisconsin and the Upper Peninsula of Michigan and distributing natural gas in Wisconsin. We have combined common functions with WG, an affiliated public utility, and operate under the trade name of "We Energies."

Corporate Strategy

Our goal is to continue to create long-term value for WEC Energy Group's shareholders and our customers by focusing on the following:

Reliability

We have made significant reliability related investments in recent years, and plan to continue making significant capital investments to strengthen and modernize the reliability of our generation and distribution networks.

Operating Efficiency

We continually look for ways to optimize the operating efficiency of our company. For example, we received approval from the PSCW to make changes at the Oak Creek Expansion plant to enable the facility to burn coal from the Powder River Basin (PRB) located in the western United States. The coal plant was originally designed to burn coal mined from the eastern United States. This project is expected to create flexibility and should enable the plant to operate at lower costs, placing it in a better position to be called upon in the MISO Energy Markets, resulting in lower fuel costs for our customers.

Financial Discipline

A strong adherence to financial discipline is essential to earning our authorized ROE and maintaining a strong balance sheet, stable cash flows, and quality credit ratings.

We follow an asset management strategy that focuses on investing in and acquiring assets consistent with our strategic plans, as well as disposing of assets, including property, plant, and equipment, that are no longer performing as intended or have an unacceptable risk profile. See Note 2, Dispositions, for information on the sale of the MCPP.

Exceptional Customer Care

Our approach is driven by an intense focus on delivering exceptional customer care every day. We strive to provide the best value for our customers by embracing constructive change, leveraging our capabilities and expertise, and using creative solutions to meet or exceed our customers’ expectations.

One example of how we obtain feedback from our customers is through our "We Care" calls, where our employees contact customers after a completed service call. Customer satisfaction is a priority, and making "We Care" calls is one of the main methods we use to gauge our performance in order to improve customer satisfaction and minimize customer dissatisfaction.


06/30/2016 Form 10-Q
20
Wisconsin Electric Power Company


RESULTS OF OPERATIONS

THREE MONTHS ENDED JUNE 30, 2016

Consolidated Earnings

Our consolidated earnings for the three months ended June 30, 2016 were $82.6 million, compared to $74.6 million for the same period in 2015. See below for additional information on the $8.0 million increase in earnings.

Utility Segment Contribution to Operating Income

The following table compares our utility segment's contribution to operating income for the second quarter of 2016 with the second quarter of 2015, including favorable or better, "B", and unfavorable or worse, "W", variances:
 
 
Three Months Ended June 30
(in millions)
 
2016
 
2015
 
B (W)
Electric revenues
 
$
815.1

 
$
821.7

 
$
(6.6
)
Fuel and purchased power
 
253.4

 
273.9

 
20.5

Total electric margins
 
561.7

 
547.8

 
13.9

 
 
 
 
 
 
 
Natural gas revenues
 
62.1

 
61.3

 
0.8

Cost of natural gas sold
 
30.9

 
32.2

 
1.3

Total natural gas margins
 
31.2