PPL 10-Q Quarterly Report June 30, 2012 | Alphaminr
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PPL 10-Q Quarter ended June 30, 2012

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10-Q 1 form10q.htm FORM 10-Q form10q.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
FORM 10-Q
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ended June 30, 2012
OR
[   ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition period from _________ to ___________

Commission File
Number
Registrant; State of Incorporation;
Address and Telephone Number
IRS Employer
Identification No.
1-11459
PPL Corporation
(Exact name of Registrant as specified in its charter)
(Pennsylvania)
Two North Ninth Street
Allentown, PA  18101-1179
(610) 774-5151
23-2758192
1-32944
PPL Energy Supply, LLC
(Exact name of Registrant as specified in its charter)
(Delaware)
Two North Ninth Street
Allentown, PA  18101-1179
(610) 774-5151
23-3074920
1-905
PPL Electric Utilities Corporation
(Exact name of Registrant as specified in its charter)
(Pennsylvania)
Two North Ninth Street
Allentown, PA  18101-1179
(610) 774-5151
23-0959590
333-173665
LG&E and KU Energy LLC
(Exact name of Registrant as specified in its charter)
(Kentucky)
220 West Main Street
Louisville, KY  40202-1377
(502) 627-2000
20-0523163
1-2893
Louisville Gas and Electric Company
(Exact name of Registrant as specified in its charter)
(Kentucky)
220 West Main Street
Louisville, KY  40202-1377
(502) 627-2000
61-0264150
1-3464
Kentucky Utilities Company
(Exact name of Registrant as specified in its charter)
(Kentucky and Virginia)
One Quality Street
Lexington, KY  40507-1462
(502) 627-2000
61-0247570
Indicate by check mark whether the registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days.

PPL Corporation
Yes X
No
PPL Energy Supply, LLC
Yes X
No
PPL Electric Utilities Corporation
Yes X
No
LG&E and KU Energy LLC
Yes X
No
Louisville Gas and Electric Company
Yes X
No
Kentucky Utilities Company
Yes X
No

Indicate by check mark whether the registrants have submitted electronically and posted on their corporate Web site, 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 registrants were required to submit and post such files).

PPL Corporation
Yes X
No
PPL Energy Supply, LLC
Yes X
No
PPL Electric Utilities Corporation
Yes X
No
LG&E and KU Energy LLC
Yes X
No
Louisville Gas and Electric Company
Yes X
No
Kentucky Utilities Company
Yes X
No

Indicate by check mark whether the registrants are large accelerated filers, accelerated filers, non-accelerated filers, 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
Smaller reporting
company
PPL Corporation
[ X ]
[     ]
[     ]
[     ]
PPL Energy Supply, LLC
[     ]
[     ]
[ X ]
[     ]
PPL Electric Utilities Corporation
[     ]
[     ]
[ X ]
[     ]
LG&E and KU Energy LLC
[     ]
[     ]
[ X ]
[     ]
Louisville Gas and Electric Company
[     ]
[     ]
[ X ]
[     ]
Kentucky Utilities Company
[     ]
[     ]
[ X ]
[     ]

Indicate by check mark whether the registrants are shell companies (as defined in Rule 12b-2 of the Exchange Act).

PPL Corporation
Yes
No X
PPL Energy Supply, LLC
Yes
No X
PPL Electric Utilities Corporation
Yes
No X
LG&E and KU Energy LLC
Yes
No X
Louisville Gas and Electric Company
Yes
No X
Kentucky Utilities Company
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.

PPL Corporation
Common stock, $0.01 par value, 580,736,054 shares outstanding at July 31, 2012.
PPL Energy Supply, LLC
PPL Corporation indirectly holds all of the membership interests in PPL Energy Supply, LLC.
PPL Electric Utilities Corporation
Common stock, no par value, 66,368,056 shares outstanding and all held by PPL Corporation at July 31, 2012.
LG&E and KU Energy LLC
PPL Corporation directly holds all of the membership interests in LG&E and KU Energy LLC.
Louisville Gas and Electric Company
Common stock, no par value, 21,294,223 shares outstanding and all held by LG&E and KU Energy LLC at July 31, 2012.
Kentucky Utilities Company
Common stock, no par value, 37,817,878 shares outstanding and all held by LG&E and KU Energy LLC at July 31, 2012.

This document is available free of charge at the Investor Center on PPL Corporation's website at www.pplweb.com.  However, information on this website does not constitute a part of this Form 10-Q.
PPL CORPORATION
PPL ENERGY SUPPLY, LLC
PPL ELECTRIC UTILITIES CORPORATION
LG&E AND KU ENERGY LLC
LOUISVILLE GAS AND ELECTRIC COMPANY
KENTUCKY UTILITIES COMPANY

FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2012


Table of Contents

This combined Form 10-Q is separately filed by the following individual registrants:  PPL Corporation, PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company and Kentucky Utilities Company.  Information contained herein relating to any individual registrant is filed by such registrant solely on its own behalf, and no registrant makes any representation as to information relating to any other registrant, except that information under "Forward-Looking Information" relating to PPL Corporation subsidiaries is also attributed to PPL Corporation and information relating to the subsidiaries of LG&E and KU Energy LLC is also attributed to LG&E and KU Energy LLC.

Unless otherwise specified, references within this Report, individually, to PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU are references to such entities directly or to one or more of their subsidiaries, as the case may be, the financial results of which are consolidated into such Registrants in accordance with GAAP.  This presentation has been applied where identification of particular subsidiaries is not material to the matter being disclosed, and to conform narrative disclosures to the presentation of financial information on a consolidated basis.
Page
PART I.  FINANCIAL INFORMATION
Item 1.  Financial Statements
PPL Corporation and Subsidiaries
PPL Energy Supply, LLC and Subsidiaries
PPL Electric Utilities Corporation and Subsidiaries
LG&E and KU Energy LLC and Subsidiaries
Louisville Gas and Electric Company
Kentucky Utilities Company
Combined Notes to Condensed Financial Statements (Unaudited)
Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations
PART II.  OTHER INFORMATION

GLOSSARY OF TERMS AND ABBREVIATIONS

PPL Corporation and its current and former subsidiaries

Central Networks - collectively Central Networks East plc, Central Networks Limited and certain other related assets and liabilities.  On April 1, 2011, PPL WEM Holdings plc (formerly WPD Investment Holdings Limited) purchased all of the outstanding ordinary share capital of these companies from E.ON AG subsidiaries.  Central Networks West plc (subsequently renamed Western Power Distribution (West Midlands) plc), wholly owned by Central Networks Limited (subsequently renamed WPD Midlands Holdings Limited), and Central Networks East plc (subsequently renamed Western Power Distribution (East Midlands) plc) are British regional electricity distribution utility companies.

KU - Kentucky Utilities Company, a public utility subsidiary of LKE engaged in the regulated generation, transmission, distribution and sale of electricity, primarily in Kentucky.  The subsidiary was acquired by PPL through the acquisition of LKE in November 2010.

LG&E - Louisville Gas and Electric Company, a public utility subsidiary of LKE engaged in the regulated generation, transmission, distribution and sale of electricity and the distribution and sale of natural gas in Kentucky.  The subsidiary was acquired by PPL through the acquisition of LKE in November 2010.

LKE - LG&E and KU Energy LLC (formerly E.ON U.S. LLC), a subsidiary of PPL and the parent of LG&E, KU and other subsidiaries.  PPL acquired E.ON U.S. LLC in November 2010 and changed the name to LG&E and KU Energy LLC.  Within the context of this document, references to LKE also relate to the consolidated entity.

LKS - LG&E and KU Services Company, a subsidiary of LKE that provides services for LKE and its subsidiaries. The subsidiary was acquired by PPL through the acquisition of LKE in November 2010.

PPL - PPL Corporation, the parent holding company of PPL Electric, PPL Energy Funding, LKE and other subsidiaries.

PPL Brunner Island - PPL Brunner Island, LLC, a subsidiary of PPL Generation that owns generating operations in Pennsylvania.

PPL Capital Funding - PPL Capital Funding, Inc., a wholly owned financing subsidiary of PPL.

PPL Electric - PPL Electric Utilities Corporation, a public utility subsidiary of PPL that transmits and distributes electricity in its Pennsylvania service area and provides electric supply to retail customers in this area as a PLR.

PPL Energy Funding - PPL Energy Funding Corporation, a subsidiary of PPL and the parent holding company of PPL Energy Supply, PPL Global (effective January 2011) and other subsidiaries.

PPL EnergyPlus - PPL EnergyPlus, LLC, a subsidiary of PPL Energy Supply that markets and trades wholesale and retail electricity and gas, and supplies energy and energy services in competitive markets.

PPL Energy Supply - PPL Energy Supply, LLC, a subsidiary of PPL Energy Funding and the parent company of PPL Generation, PPL EnergyPlus and other subsidiaries.  In January 2011, PPL Energy Supply distributed its membership interest in PPL Global, representing 100% of the outstanding membership interests of PPL Global, to PPL Energy Supply's parent, PPL Energy Funding.

PPL Generation - PPL Generation, LLC, a subsidiary of PPL Energy Supply that owns and operates U.S. generating facilities through various subsidiaries.

PPL Global - PPL Global, LLC, a subsidiary of PPL Energy Funding that primarily owns and operates a business in the U.K., WPD, that is focused on the regulated distribution of electricity.  In January 2011, PPL Energy Supply, PPL Global's former parent, distributed its membership interest in PPL Global, representing 100% of the outstanding membership interest of PPL Global, to its parent, PPL Energy Funding.

PPL Martins Creek - PPL Martins Creek, LLC, a subsidiary of PPL Generation that owns generating operations in Pennsylvania.

PPL Montana - PPL Montana, LLC, an indirect subsidiary of PPL Generation that generates electricity for wholesale sales in Montana and the Pacific Northwest.
i
PPL Montour - PPL Montour, LLC, a subsidiary of PPL Generation that owns generating operations in Pennsylvania.

PPL Services - PPL Services Corporation, a subsidiary of PPL that provides services for PPL and its subsidiaries.

PPL Susquehanna - PPL Susquehanna, LLC, the nuclear generating subsidiary of PPL Generation.

PPL WEM - PPL WEM Holdings plc (formerly WPD Investment Holdings Limited), an indirect, wholly owned U.K. subsidiary of PPL Global.  PPL WEM indirectly wholly owns both WPD (East Midlands) and WPD (West Midlands).

PPL WW - PPL WW Holdings Limited (formerly Western Power Distribution Holdings Limited), an indirect, wholly owned U.K. subsidiary of PPL Global.  PPL WW Holdings indirectly wholly owns WPD (South Wales) and WPD (South West).

WPD - refers to PPL WW and PPL WEM and their subsidiaries.

WPD (East Midlands) - Western Power Distribution (East Midlands) plc, a British regional electricity distribution utility company.  The company (formerly Central Networks East plc) was acquired and renamed in April 2011.

WPD Midlands - refers to Central Networks, which was renamed after the acquisition.

WPD (South Wales) - Western Power Distribution (South Wales) plc, a British regional electricity distribution utility company.

WPD (South West) - Western Power Distribution (South West) plc, a British regional electricity distribution utility company.

WPD (West Midlands) - Western Power Distribution (West Midlands) plc, a British regional electricity distribution utility company.  The company (formerly Central Networks West plc) was acquired and renamed in April 2011.

WKE - Western Kentucky Energy Corp., a subsidiary of LKE that leased certain non-utility generating plants in western Kentucky until July 2009.  The subsidiary was acquired by PPL through the acquisition of LKE in November 2010.

Other terms and abbreviations

£ - British pound sterling.

2010 Equity Unit(s) - a PPL equity unit, issued in June 2010, consisting of a 2010 Purchase Contract and, initially, a 5.0% undivided beneficial ownership interest in $1,000 principal amount of PPL Capital Funding 4.625% Junior Subordinated Notes due 2018.

2010 Purchase Contract(s) - a contract that is a component of a 2010 Equity Unit that requires holders to purchase shares of PPL common stock on or prior to July 1, 2013.

2011 Bridge Facility - the £3.6 billion Senior Bridge Term Loan Credit Agreement between PPL Capital Funding and PPL WEM, as borrowers, and PPL, as guarantor, and lenders party thereto, used to fund the April 1, 2011 acquisition of Central Networks, as amended by Amendment No. 1 thereto dated April 15, 2011.

2011 Equity Unit(s) - a PPL equity unit, issued in April 2011, consisting of a 2011 Purchase Contract and, initially, a 5.0% undivided beneficial ownership interest in $1,000 principal amount of PPL Capital Funding 4.32% Junior Subordinated Notes due 2019.

2011 Form 10-K - Annual Report to the SEC on Form 10-K for the year ended December 31, 2011.

2011 Purchase Contract(s) - a contract that is a component of a 2011 Equity Unit that requires holders to purchase shares of PPL common stock on or prior to May 1, 2014.

Act 129 - became effective in October 2008.  The law amends the Pennsylvania Public Utility Code and creates an energy efficiency and conservation program and smart metering technology requirements, adopts new PLR electricity supply procurement rules, provides remedies for market misconduct and makes changes to the existing Alternative Energy Portfolio Standard.
ii
AFUDC - Allowance for Funds Used During Construction, the cost of equity and debt funds used to finance construction projects of regulated businesses, which is capitalized as part of construction costs.

AOCI - accumulated other comprehensive income or loss.

ARO - asset retirement obligation.

Baseload generation - includes the output provided by PPL's nuclear, coal, hydroelectric and qualifying facilities.

Basis - when used in the context of derivatives and commodity trading, the commodity price differential between two locations, products or time periods.

Bcf - billion cubic feet.

Bluegrass CTs - three natural gas combustion turbines owned by Bluegrass Generation.  In 2011, LG&E and KU entered into an asset purchase agreement with Bluegrass Generation for the purchase of these combustion turbines, subject to certain conditions including receipt of applicable regulatory approvals and clearances.  In June 2012, LG&E and KU terminated the asset purchase agreement.

Bluegrass Generation - Bluegrass Generation Company, L.L.C., an exempt wholesale electricity generator in LaGrange, Kentucky.

BREC - Big Rivers Electric Corporation, a power-generating rural electric cooperative in western Kentucky.

CAIR - the EPA's Clean Air Interstate Rule.

Clean Air Act - federal legislation enacted to address certain environmental issues related to air emissions, including acid rain, ozone and toxic air emissions.

COLA - license application for a combined construction permit and operating license from the NRC for a nuclear plant.

CPCN - Certificate of Public Convenience and Necessity.  Authority granted by the KPSC pursuant to Kentucky Revised Statute 278.020 to provide utility service to or for the public or the construction of any plant, equipment, property or facility for furnishing of utility service to the public.

CSAPR - Cross-State Air Pollution Rule, the CSAPR implements Clean Air Act requirements concerning the transport of air pollution from power plants across state boundaries.  The CSAPR replaces the 2005 CAIR, which the U.S. Court of Appeals for the D.C. Circuit ordered the EPA to revise in 2008.  The court has granted a stay allowing CAIR to remain in place pending a ruling on the legal challenges to the CSAPR.

Customer Choice Act - the Pennsylvania Electricity Generation Customer Choice and Competition Act, legislation enacted to restructure the state's electric utility industry to create retail access to a competitive market for generation of electricity.

Depreciation not normalized - the flow-through income tax impact related to the state regulatory treatment of depreciation-related timing differences.

Dodd-Frank Act - the Dodd-Frank Wall Street Reform and Consumer Protection Act that was signed into law in July 2010.

DOE - Department of Energy, a U.S. government agency.

DPCR4 - Distribution Price Control Review 4, the U.K. 5-year rate review period applicable to WPD that commenced April 1, 2005.

DPCR5 - Distribution Price Control Review 5, the U.K. 5-year rate review period applicable to WPD that commenced April 1, 2010.

DRIP - Dividend Reinvestment and Direct Stock Purchase Plan.
iii
DSM - Demand Side Management.  Pursuant to Kentucky Revised Statute 278.285, the KPSC may determine the reasonableness of DSM plans proposed by any utility under its jurisdiction.  Proposed DSM mechanisms may seek full recovery of DSM programs and revenues lost by implementing those programs and/or incentives designed to provide financial rewards to the utility for implementing cost-effective DSM programs.  The cost of such programs shall be assigned only to the class or classes of customers which benefit from the programs.

ECR - Environmental Cost Recovery.  Pursuant to Kentucky Revised Statute 278.183, effective January 1993, Kentucky electric utilities are entitled to the current recovery of costs of complying with the Clean Air Act, as amended, and those federal, state or local environmental requirements which apply to coal combustion and by-products from the production of energy from coal.

E.ON AG - a German corporation and the parent of E.ON UK plc, the former parent of Central Networks, and the indirect parent of E.ON US Investments Corp., the former parent of LKE.

EPA - Environmental Protection Agency, a U.S. government agency.

EPS - earnings per share.

Equity Units - refers collectively to the 2011 and 2010 Equity Units.

ESOP - Employee Stock Ownership Plan.

Euro - the basic monetary unit among participating members of the European Union.

FERC - Federal Energy Regulatory Commission, the federal agency that regulates, among other things, interstate transmission and wholesale sales of electricity, hydroelectric power projects and related matters.

Fitch - Fitch, Inc., a credit rating agency.

FTR - financial transmission rights, which are financial instruments established to manage price risk related to electricity transmission congestion.  They entitle the holder to receive compensation or require the holder to remit payment for certain congestion-related transmission charges based on the level of congestion in the transmission grid.

Fundamental Change - as it relates to the terms of the 2011 and 2010 Equity Units, will be deemed to have occurred if any of the following occurs with respect to PPL, subject to certain exceptions:  (i) a change of control; (ii) a consolidation with or merger into any other entity; (iii) common stock ceases to be listed or quoted; or (iv) a liquidation, dissolution or termination.

GAAP - Generally Accepted Accounting Principles in the U.S.

GBP - British pound sterling.

GHG - greenhouse gas(es).

GWh - gigawatt-hour, one million kilowatt-hours.

Intermediate and peaking generation - includes the output provided by PPL's oil- and natural gas-fired units.

Ironwood Acquisition - In April 2012, PPL Ironwood Holdings, LLC, an indirect, wholly owned subsidiary of PPL Energy Supply, completed the acquisition from a subsidiary of The AES Corporation of all of the equity interests of AES Ironwood, L.L.C. (subsequently renamed PPL Ironwood, LLC) and AES Prescott, L.L.C. (subsequently renamed PPL Prescott, LLC), which own and operate, respectively, the Ironwood Facility.

Ironwood Facility - a natural gas-fired power plant in Lebanon, Pennsylvania with a summer rating of 657 MW.

IRS - Internal Revenue Service, a U.S. government agency.

ISO - Independent System Operator.
iv
KPSC - Kentucky Public Service Commission, the state agency that has jurisdiction over the regulation of rates and service of utilities in Kentucky.

LIBOR - London Interbank Offered Rate.

Long Island generation business - includes a 79.9 MW gas-fired plant in the Edgewood section of Brentwood, New York and a 79.9 MW oil-fired plant in Shoreham, New York and related tolling agreements.  This business was sold in February 2010.

Moody's - Moody's Investors Service, Inc., a credit rating agency.

MW - megawatt, one thousand kilowatts.

NDT - PPL Susquehanna's nuclear plant decommissioning trust.

NERC - North American Electric Reliability Corporation.

NGCC - natural gas-fired combined-cycle turbine.

NPDES - National Pollutant Discharge Elimination System.

NPNS - the normal purchases and normal sales exception as permitted by derivative accounting rules.  Derivatives that qualify for this exception receive accrual accounting treatment.

NRC - Nuclear Regulatory Commission, the federal agency that regulates nuclear power facilities.

OCI - other comprehensive income or loss.

Ofgem - Office of Gas and Electricity Markets, the British agency that regulates transmission, distribution and wholesale sales of electricity and related matters.

Opacity - the degree to which emissions reduce the transmission of light and obscure the view of an object in the background.  There are emission regulations that limit the opacity in power plant stack gas emissions.

OVEC - Ohio Valley Electric Corporation, located in Piketon, Ohio, an entity in which LKE indirectly owns an 8.13% interest (consists of LG&E's 5.63% and KU's 2.50% interests), which is accounted for as a cost-method investment.  OVEC owns and operates two coal-fired power plants, the Kyger Creek plant in Ohio and the Clifty Creek plant in Indiana, with combined nameplate capacities of 2,390 MW.

PADEP - the Pennsylvania Department of Environmental Protection, a state government agency.

PJM - PJM Interconnection, L.L.C., operator of the electric transmission network and electric energy market in all or parts of Delaware, Illinois, Indiana, Kentucky, Maryland, Michigan, New Jersey, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia, West Virginia and the District of Columbia.

PLR - Provider of Last Resort, the role of PPL Electric in providing default electricity supply to retail customers within its delivery area who have not chosen to select an alternative electricity supplier under the Customer Choice Act.

PP&E - property, plant and equipment.

Predecessor - refers to the LKE, LG&E and KU pre-acquisition activity covering the time period prior to November 1, 2010.

PUC - Pennsylvania Public Utility Commission, the state agency that regulates certain ratemaking, services, accounting and operations of Pennsylvania utilities.

Purchase Contract(s) - refers collectively to the 2010 and 2011 Purchase Contracts.

RAV - regulatory asset value.  This term is also commonly known as RAB or regulatory asset base.

RECs - renewable energy credits.
v
Registrants - PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU, collectively.

Regulation S-X - SEC regulation governing the form and content of and requirements for financial statements required to be filed pursuant to the federal securities laws.

Rev. Proc(s ). - Revenue Procedure(s), an official published statement by the IRS of a matter of procedural importance to both taxpayers and the IRS concerning administration of the tax laws.

RMC - Risk Management Committee.

S&P - Standard & Poor's Ratings Services, a credit rating agency.

Sarbanes-Oxley - Sarbanes-Oxley Act of 2002, which sets requirements for management's assessment of internal controls for financial reporting.  It also requires an independent auditor to make its own assessment.

SCR - selective catalytic reduction, a pollution control process for the removal of nitrogen oxide from exhaust gases.

Scrubber - an air pollution control device that can remove particulates and/or gases (such as sulfur dioxide) from exhaust gases.

SEC - the U.S. Securities and Exchange Commission, a U.S. government agency whose primary mission is to protect investors and maintain the integrity of the securities markets.

Securities Act of 1933 - the Securities Act of 1933, 15 U.S. Code, Sections 77a-77aa, as amended.

SIFMA Index - the Securities Industry and Financial Markets Association Municipal Swap Index.

SMGT - Southern Montana Electric Generation & Transmission Cooperative, Inc., a Montana cooperative and purchaser of electricity under a long-term supply contract with PPL EnergyPlus that was terminated effective April 1, 2012.
SNCR - selective non-catalytic reduction, a pollution control process for the removal of nitrogen oxide from exhaust gases using ammonia.

Successor - refers to the LKE, LG&E and KU post-acquisition activity covering the time period after October 31, 2010.

Superfund - federal environmental legislation that addresses remediation of contaminated sites; states also have similar statutes.

TC2 - Trimble County Unit 2, a coal-fired plant located in Kentucky with a net summer capacity of 732 MW.  LKE indirectly owns a 75% interest (consists of LG&E's 14.25% and KU's 60.75% interests) in TC2 or 549 MW of the capacity.

Tolling agreement - agreement whereby the owner of an electric generating facility agrees to use that facility to convert fuel provided by a third party into electricity for delivery back to the third party.

TRA - Tennessee Regulatory Authority, the state agency that has jurisdiction over the regulation of rates and service of utilities in Tennessee.

Utilization Factor - a measure reflecting the percentage of electricity actually generated by plants compared with the electricity the plants could produce at full capacity when available.

VaR - value-at-risk, a statistical model that attempts to estimate the value of potential loss over a given holding period under normal market conditions at a given confidence level.

VIE - variable interest entity.

Volumetric risk - the risk that the actual load volumes provided under full-requirement sales contracts could vary significantly from forecasted volumes.

VSCC - Virginia State Corporation Commission, the state agency that has jurisdiction over the regulation of Virginia corporations, including utilities.
vi
VWAP - as it relates to the 2011 and 2010 Equity Units issued by PPL, the per share volume-weighted-average price as displayed under the heading Bloomberg VWAP on Bloomberg page "PPL <EQUITY> AQR" (or its equivalent successor if such page is not available) in respect of the period from the scheduled open of trading on the relevant trading day until the scheduled close of trading on the relevant trading day (or if such volume-weighted-average price is unavailable, the market price of one share of PPL common stock on such trading day determined, using a volume-weighted-average method, by a nationally recognized independent investment banking firm retained for this purpose by PPL).
vii


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viii
FORWARD-LOOKING INFORMATION

Statements contained in this Form 10-Q concerning expectations, beliefs, plans, objectives, goals, strategies, future events or performance and underlying assumptions and other statements which are other than statements of historical fact are "forward-looking statements" within the meaning of the federal securities laws.  Although the Registrants believe that the expectations and assumptions reflected in these statements are reasonable, there can be no assurance that these expectations will prove to be correct.  Forward-looking statements are subject to many risks and uncertainties, and actual results may differ materially from the results discussed in forward-looking statements.  In addition to the specific factors discussed in each Registrant's 2011 Form 10-K and in "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Form 10-Q report, the following are among the important factors that could cause actual results to differ materially from the forward-looking statements.

·
fuel supply cost and availability;
·
continuing ability to recover fuel costs and environmental expenditures in a timely manner at LG&E and KU, and natural gas supply costs at LG&E;
·
weather conditions affecting generation, customer energy use and operating costs;
·
operation, availability and operating costs of existing generation facilities;
·
the length and cost of scheduled and unscheduled outages at our generating facilities;
·
transmission and distribution system conditions and operating costs;
·
expansion of alternative sources of electricity generation;
·
collective labor bargaining negotiations;
·
the outcome of litigation against the Registrants and their subsidiaries;
·
potential effects of threatened or actual terrorism, war or other hostilities, cyber-based intrusions or natural disasters;
·
the commitments and liabilities of the Registrants and their subsidiaries;
·
market demand and prices for energy, capacity, transmission services, emission allowances, RECs and delivered fuel;
·
competition in retail and wholesale power and natural gas markets;
·
liquidity of wholesale power markets;
·
defaults by counterparties under energy, fuel or other power product contracts;
·
market prices of commodity inputs for ongoing capital expenditures;
·
capital market conditions, including the availability of capital or credit, changes in interest rates and certain economic indices, and decisions regarding capital structure;
·
stock price performance of PPL;
·
volatility in the fair value of debt and equity securities and its impact on the value of assets in the NDT funds and in defined benefit plans, and the potential cash funding requirements if fair value declines;
·
interest rates and their effect on pension, retiree medical, and nuclear decommissioning liabilities, and interest payable on certain debt securities;
·
volatility in or the impact of other changes in financial or commodity markets and economic conditions;
·
new accounting requirements or new interpretations or applications of existing requirements;
·
changes in securities and credit ratings;
·
foreign currency exchange rates;
·
current and future environmental conditions, regulations and other requirements and the related costs of compliance, including environmental capital expenditures, emission allowance costs and other expenses;
·
legal, regulatory, political, market or other reactions to the 2011 incident at the nuclear generating facility at Fukushima, Japan, including additional NRC requirements;
·
political, regulatory or economic conditions in states, regions or countries where the Registrants or their subsidiaries conduct business;
·
receipt of necessary governmental permits, approvals and rate relief;
·
new state, federal or foreign legislation or regulatory developments;
·
the outcome of any rate cases or other cost recovery filings by PPL Electric at the PUC or the FERC, by LG&E at the KPSC or the FERC, by KU at the KPSC, VSCC, TRA or the FERC, or by WPD at Ofgem in the U.K.;
·
the impact of any state, federal or foreign investigations applicable to the Registrants and their subsidiaries and the energy industry;
·
the effect of any business or industry restructuring;
·
development of new projects, markets and technologies;
·
performance of new ventures; and
·
business dispositions or acquisitions and our ability to successfully operate such acquired businesses and realize expected benefits from business acquisitions, including PPL's 2011 acquisition of WPD Midlands and 2010 acquisition of LKE.


1

Any such forward-looking statements should be considered in light of such important factors and in conjunction with other documents of the Registrants on file with the SEC.

New factors that could cause actual results to differ materially from those described in forward-looking statements emerge from time to time, and it is not possible for the Registrants to predict all such factors, or the extent to which any such factor or combination of factors may cause actual results to differ from those contained in any forward-looking statement.  Any forward-looking statement speaks only as of the date on which such statement is made, and the Registrants undertake no obligation to update the information contained in such statement to reflect subsequent developments or information.

2

PART I.  FINANCIAL INFORMATION
ITEM 1. Financial Statements
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
PPL Corporation and Subsidiaries
(Unaudited)
(Millions of Dollars, except share data)
Three Months Ended
Six Months Ended
June 30,
June 30,
2012
2011
2012
2011
Operating Revenues
Utility
$
1,605
$
1,484
$
3,319
$
3,020
Unregulated retail electric and gas
179
181
402
328
Wholesale energy marketing
Realized
1,083
732
2,291
1,770
Unrealized economic activity (Note 14)
(458)
(44)
394
13
Net energy trading margins
10
10
18
21
Energy-related businesses
130
126
237
247
Total Operating Revenues
2,549
2,489
6,661
5,399
Operating Expenses
Operation
Fuel
411
414
835
889
Energy purchases
Realized
787
434
1,670
1,105
Unrealized economic activity (Note 14)
(442)
(109)
149
(127)
Other operation and maintenance
739
723
1,445
1,306
Depreciation
271
237
535
445
Taxes, other than income
87
75
178
148
Energy-related businesses
124
120
226
233
Total Operating Expenses
1,977
1,894
5,038
3,999
Operating Income
572
595
1,623
1,400
Other Income (Expense) - net
30
(34)
13
(39)
Other-Than-Temporary Impairments
1
1
1
Interest Expense
236
264
466
438
Income from Continuing Operations Before Income Taxes
365
297
1,169
922
Income Taxes
88
96
347
319
Income from Continuing Operations After Income Taxes
277
201
822
603
Income (Loss) from Discontinued Operations (net of income taxes)
(6)
(1)
(6)
2
Net Income
271
200
816
605
Net Income Attributable to Noncontrolling Interests
4
4
8
Net Income Attributable to PPL Corporation
$
271
$
196
$
812
$
597
Amounts Attributable to PPL Corporation:
Income from Continuing Operations After Income Taxes
$
277
$
197
$
818
$
595
Income (Loss) from Discontinued Operations (net of income taxes)
(6)
(1)
(6)
2
Net Income
$
271
$
196
$
812
$
597
Earnings Per Share of Common Stock:
Income from Continuing Operations After Income Taxes Available to PPL
Corporation Common Shareowners:
Basic
$
0.47
$
0.35
$
1.40
$
1.13
Diluted
$
0.47
$
0.35
$
1.40
$
1.13
Net Income Available to PPL Corporation Common Shareowners:
Basic
$
0.46
$
0.35
$
1.39
$
1.14
Diluted
$
0.46
$
0.35
$
1.39
$
1.14
Dividends Declared Per Share of Common Stock
$
0.36
$
0.35
$
0.72
$
0.70
Weighted-Average Shares of Common Stock Outstanding (in thousands)
Basic
579,881
561,652
579,462
522,897
Diluted
580,593
562,019
580,062
523,184
The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.

3

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
PPL Corporation and Subsidiaries
(Unaudited)
(Millions of Dollars)
Three Months Ended
Six Months Ended
June 30,
June 30,
2012
2011
2012
2011
Net income
$
271
$
200
$
816
$
605
Other comprehensive income (loss):
Amounts arising during the period - gains (losses), net of tax (expense)
benefit:
Foreign currency translation adjustments, net of tax of ($2), $0, $0, $1
(179)
93
(103)
160
Available-for-sale securities, net of tax of $8, ($1), ($20), ($13)
(7)
1
15
13
Qualifying derivatives, net of tax of $7, $21, ($55), ($11)
2
(30)
68
7
Equity investees' other comprehensive income (loss), net of
tax of $0, $0, $2, $0
1
(3)
(1)
Defined benefit plans:
Net actuarial gain (loss), net of tax of $28, $0, $28, $0
(85)
(85)
Reclassifications to net income - (gains) losses, net of tax expense
(benefit):
Available-for-sale securities, net of tax of $1, $0, $3, $5
(1)
(1)
(4)
(8)
Qualifying derivatives, net of tax of $84, $55, $171, $106
(140)
(89)
(262)
(158)
Equity investees' other comprehensive (income) loss, net of
tax of $0, $0, $0, $0
1
3
Defined benefit plans:
Prior service costs, net of tax of ($2), ($1), ($3), ($3)
2
2
5
5
Net actuarial loss, net of tax of ($7), ($6), ($11), ($10)
17
12
37
23
Total other comprehensive income (loss) attributable to PPL
Corporation
(390)
(11)
(332)
44
Comprehensive income (loss)
(119)
189
484
649
Comprehensive income attributable to noncontrolling interests
4
4
8
Comprehensive income (loss) attributable to PPL Corporation
$
(119)
$
185
$
480
$
641
The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.

4

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
PPL Corporation and Subsidiaries
(Unaudited)
(Millions of Dollars)
Six Months Ended June 30,
2012
2011
Cash Flows from Operating Activities
Net income
$
816
$
605
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation
535
446
Amortization
88
126
Defined benefit plans - expense
84
71
Deferred income taxes and investment tax credits
364
337
Unrealized (gains) losses on derivatives, and other hedging activities
(209)
(165)
Other
25
67
Change in current assets and current liabilities
Accounts receivable
21
(36)
Accounts payable
(126)
(60)
Unbilled revenues
72
194
Prepayments
(97)
111
Counterparty collateral
57
(258)
Taxes
29
(63)
Accrued interest
(87)
(9)
Other
(71)
36
Other operating activities
Defined benefit plans - funding
(493)
(550)
Other assets
(16)
(42)
Other liabilities
(45)
4
Net cash provided by operating activities
947
814
Cash Flows from Investing Activities
Expenditures for property, plant and equipment
(1,309)
(1,003)
Proceeds from the sale of certain non-core generation facilities
381
Ironwood Acquisition, net of cash acquired
(84)
Acquisition of WPD Midlands
(5,763)
Purchases of nuclear plant decommissioning trust investments
(85)
(107)
Proceeds from the sale of nuclear plant decommissioning trust investments
79
100
Proceeds from the sale of other investments
21
163
Net (increase) decrease in restricted cash and cash equivalents
54
(22)
Other investing activities
(29)
(48)
Net cash provided by (used in) investing activities
(1,353)
(6,299)
Cash Flows from Financing Activities
Issuance of long-term debt
575
4,350
Issuance of common stock
35
2,266
Payment of common stock dividends
(413)
(340)
Redemption of preference stock of a subsidiary
(250)
Net increase (decrease) in short-term debt
311
(321)
Other financing activities
(67)
(108)
Net cash provided by (used in) financing activities
191
5,847
Effect of Exchange Rates on Cash and Cash Equivalents
(6)
(18)
Net Increase (Decrease) in Cash and Cash Equivalents
(221)
344
Cash and Cash Equivalents at Beginning of Period
1,202
925
Cash and Cash Equivalents at End of Period
$
981
$
1,269
The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.
5
CONDENSED CONSOLIDATED BALANCE SHEETS
PPL Corporation and Subsidiaries
(Unaudited)
(Millions of Dollars, shares in thousands)
June 30,
December 31,
2012
2011
Assets
Current Assets
Cash and cash equivalents
$
981
$
1,202
Short-term investments
16
Restricted cash and cash equivalents
101
152
Accounts receivable (less reserve:  2012, $64; 2011, $54)
Customer
750
736
Other
63
91
Unbilled revenues
754
830
Fuel, materials and supplies
719
654
Prepayments
252
160
Price risk management assets
2,483
2,548
Regulatory assets
17
9
Other current assets
31
28
Total Current Assets
6,151
6,426
Investments
Nuclear plant decommissioning trust funds
681
640
Other investments
68
78
Total Investments
749
718
Property, Plant and Equipment
Regulated utility plant
23,584
22,994
Less:  accumulated depreciation - regulated utility plant
3,813
3,534
Regulated utility plant, net
19,771
19,460
Non-regulated property, plant and equipment
Generation
11,182
10,514
Nuclear fuel
524
457
Other
674
637
Less:  accumulated depreciation - non-regulated property, plant and equipment
5,762
5,676
Non-regulated property, plant and equipment, net
6,618
5,932
Construction work in progress
1,880
1,874
Property, Plant and Equipment, net (a)
28,269
27,266
Other Noncurrent Assets
Regulatory assets
1,335
1,349
Goodwill
4,036
4,114
Other intangibles (a)
909
1,065
Price risk management assets
1,112
920
Other noncurrent assets
947
790
Total Other Noncurrent Assets
8,339
8,238
Total Assets
$
43,508
$
42,648

(a)
Both June 30, 2012 and December 31, 2011 include $416 million of PP&E, consisting primarily of "Generation," including leasehold improvements, and $10 million and $11 million of "Other intangibles" from the consolidation of a VIE that is the owner/lessor of the Lower Mt. Bethel plant.

The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.
6

CONDENSED CONSOLIDATED BALANCE SHEETS
PPL Corporation and Subsidiaries
(Unaudited)
(Millions of Dollars, shares in thousands)
June 30,
December 31,
2012
2011
Liabilities and Equity
Current Liabilities
Short-term debt
$
889
$
578
Long-term debt due within one year
12
Accounts payable
1,037
1,214
Taxes
94
65
Interest
201
287
Dividends
210
207
Price risk management liabilities
1,595
1,570
Regulatory liabilities
58
73
Other current liabilities
1,222
1,261
Total Current Liabilities
5,318
5,255
Long-term Debt
18,698
17,993
Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes
3,638
3,326
Investment tax credits
305
285
Price risk management liabilities
1,016
840
Accrued pension obligations
1,093
1,313
Asset retirement obligations
497
484
Regulatory liabilities
1,003
1,010
Other deferred credits and noncurrent liabilities
960
1,046
Total Deferred Credits and Other Noncurrent Liabilities
8,512
8,304
Commitments and Contingent Liabilities (Notes 6 and 10)
Equity
PPL Corporation Shareowners' Common Equity
Common stock - $0.01 par value (a)
6
6
Additional paid-in capital
6,886
6,813
Earnings reinvested
5,190
4,797
Accumulated other comprehensive loss
(1,120)
(788)
Total PPL Corporation Shareowners' Common Equity
10,962
10,828
Noncontrolling Interests
18
268
Total Equity
10,980
11,096
Total Liabilities and Equity
$
43,508
$
42,648

(a)
780,000 shares authorized; 580,213 and 578,405 shares issued and outstanding at June 30, 2012 and December 31, 2011.

The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.
7
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
PPL Corporation and Subsidiaries
(Unaudited)
(Millions of Dollars)
PPL Corporation Shareowners
Common
stock
Accumulated
shares
Additional
other
Non-
outstanding
Common
paid-in
Earnings
comprehensive
controlling
(a)
stock
capital
reinvested
loss
interests
Total
March 31, 2012
579,520
$
6
$
6,862
$
5,129
$
(730)
$
268
$
11,535
Common stock issued (b)
693
18
18
Stock-based compensation (c)
6
6
Net income
271
271
Dividends, dividend equivalents,
redemptions and distributions (e)
(210)
(250)
(460)
Other comprehensive
income (loss)
(390)
(390)
June 30, 2012
580,213
$
6
$
6,886
$
5,190
$
(1,120)
$
18
$
10,980
December 31, 2011
578,405
$
6
$
6,813
$
4,797
$
(788)
$
268
$
11,096
Common stock issued (b)
1,808
50
50
Stock-based compensation (c)
23
23
Net income
812
4
816
Dividends, dividend equivalents,
redemptions and distributions (e)
(419)
(254)
(673)
Other comprehensive
income (loss)
(332)
(332)
June 30, 2012
580,213
$
6
$
6,886
$
5,190
$
(1,120)
$
18
$
10,980
March 31, 2011
484,618
$
5
$
4,637
$
4,312
$
(424)
$
268
$
8,798
Common stock issued (b)
92,647
1
2,273
2,274
Purchase Contracts (d)
(141)
(141)
Stock-based compensation (c)
5
5
Net income
196
4
200
Dividends, dividend equivalents
and distributions (e)
(202)
(4)
(206)
Other comprehensive
income (loss)
(11)
(11)
June 30, 2011
577,265
$
6
$
6,774
$
4,306
$
(435)
$
268
$
10,919
December 31, 2010
483,391
$
5
$
4,602
$
4,082
$
(479)
$
268
$
8,478
Common stock issued (b)
93,874
1
2,312
2,313
Purchase Contracts (d)
(141)
(141)
Stock-based compensation (c)
1
1
Net income
597
8
605
Dividends, dividend equivalents
and distributions (e)
(373)
(8)
(381)
Other comprehensive
income (loss)
44
44
June 30, 2011
577,265
$
6
$
6,774
$
4,306
$
(435)
$
268
$
10,919

(a)
Shares in thousands.  Each share entitles the holder to one vote on any question presented to any shareowners' meeting.
(b)
Each period includes shares of common stock issued through various stock and incentive compensation plans.  The 2011 periods include the April issuance of 92 million shares of common stock.
(c)
The three and six months ended June 30, 2012 include $6 million and $35 million and the three and six months ended June 30, 2011 include $5 million and $22 million of stock-based compensation expense related to new and existing unvested equity awards.  The six months ended June 30, 2012 and 2011 include $(12) million and $(21) million related primarily to the reclassification from "Stock-based compensation" to "Common stock issued" for the issuance of common stock after applicable equity award vesting periods and tax adjustments related to stock-based compensation.
(d)
The 2011 periods include $123 million for the 2011 Purchase Contracts and $18 million of related fees and expenses, net of tax.
(e)
"Earnings reinvested" includes dividends and dividend equivalents on PPL Corporation common stock and restricted stock units.  "Noncontrolling interests" includes dividends, redemptions and distributions to noncontrolling interests.  In June 2012, PPL Electric redeemed all of its outstanding preference stock at par value, $250 million in the aggregate.  See Note 7 for additional information.

The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.
8
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
PPL Energy Supply, LLC and Subsidiaries
(Unaudited)
(Millions of Dollars)
Three Months Ended
Six Months Ended
June 30,
June 30,
2012
2011
2012
2011
Operating Revenues
Wholesale energy marketing
Realized
$
1,083
$
732
$
2,291
$
1,770
Unrealized economic activity (Note 14)
(458)
(44)
394
13
Wholesale energy marketing to affiliate
17
4
38
10
Unregulated retail electric and gas
180
181
404
328
Net energy trading margins
10
10
18
21
Energy-related businesses
112
114
208
224
Total Operating Revenues
944
997
3,353
2,366
Operating Expenses
Operation
Fuel
196
208
407
468
Energy purchases
Realized
635
226
1,294
540
Unrealized economic activity (Note 14)
(442)
(109)
149
(127)
Energy purchases from affiliate
1
1
2
Other operation and maintenance
294
288
549
533
Depreciation
69
60
133
119
Taxes, other than income
17
16
35
32
Energy-related businesses
109
112
201
220
Total Operating Expenses
878
802
2,769
1,787
Operating Income
66
195
584
579
Other Income (Expense) - net
5
4
10
18
Other-Than-Temporary Impairments
1
1
1
Interest Income from Affiliates
1
1
1
4
Interest Expense
43
51
80
98
Income from Continuing Operations Before Income Taxes
28
149
514
502
Income Taxes
9
59
186
201
Income from Continuing Operations After Income Taxes
19
90
328
301
Income (Loss) from Discontinued Operations (net of income taxes)
(1)
2
Net Income Attributable to PPL Energy Supply
$
19
$
89
$
328
$
303
The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.
9

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
PPL Energy Supply, LLC and Subsidiaries
(Unaudited)
(Millions of Dollars)
Three Months Ended
Six Months Ended
June 30,
June 30,
2012
2011
2012
2011
Net income
$
19
$
89
$
328
$
303
Other comprehensive income (loss):
Amounts arising during the period - gains (losses), net of tax (expense)
benefit:
Available-for-sale securities, net of tax of $8, ($1), ($20), ($13)
(7)
1
15
13
Qualifying derivatives, net of tax of $5, $13, ($52), ($21)
(9)
(21)
47
29
Reclassifications to net income - (gains) losses, net of tax expense
(benefit):
Available-for-sale securities, net of tax of $1, $0, $3, $5
(1)
(1)
(4)
(8)
Qualifying derivatives, net of tax of $75, $49, $168, $103
(108)
(68)
(247)
(147)
Equity investee's other comprehensive (income) loss, net of
tax of $0, $0, $0, $0
1
3
Defined benefit plans:
Prior service costs, net of tax of $0, ($1), ($1), ($2)
2
1
3
2
Net actuarial loss, net of tax of ($2), ($1), $0, ($1)
1
1
6
2
Total other comprehensive income (loss) attributable to
PPL Energy Supply
(122)
(86)
(180)
(106)
Comprehensive income (loss) attributable to PPL Energy Supply
$
(103)
$
3
$
148
$
197
The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.
10

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
PPL Energy Supply, LLC and Subsidiaries
(Unaudited)
(Millions of Dollars)
Six Months Ended June 30,
2012
2011
Cash Flows from Operating Activities
Net income
$
328
$
303
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation
133
120
Amortization
57
50
Defined benefit plans - expense
22
17
Deferred income taxes and investment tax credits
165
186
Unrealized (gains) losses on derivatives, and other hedging activities
(216)
(163)
Other
28
29
Change in current assets and current liabilities
Accounts receivable
(2)
57
Accounts payable
(57)
(104)
Unbilled revenues
61
126
Fuel, materials and supplies
(74)
(26)
Taxes
(58)
31
Counterparty collateral
57
(258)
Other
(40)
(43)
Other operating activities
Defined benefit plans - funding
(69)
(137)
Other assets
(19)
(25)
Other liabilities
(8)
25
Net cash provided by operating activities
308
188
Cash Flows from Investing Activities
Expenditures for property, plant and equipment
(316)
(324)
Proceeds from the sale of certain non-core generation facilities
381
Ironwood Acquisition, net of cash acquired
(84)
Purchases of nuclear plant decommissioning trust investments
(85)
(107)
Proceeds from the sale of nuclear plant decommissioning trust investments
79
100
Net (increase) decrease in notes receivable from affiliates
198
(37)
Net (increase) decrease in restricted cash and cash equivalents
57
(14)
Other investing activities
(22)
(35)
Net cash provided by (used in) investing activities
(173)
(36)
Cash Flows from Financing Activities
Contributions from member
472
168
Distributions to member
(657)
(134)
Cash included in net assets of subsidiary distributed to member
(325)
Net increase (decrease) in short-term debt
120
(100)
Other financing activities
(3)
Net cash provided by (used in) financing activities
(68)
(391)
Net Increase (Decrease) in Cash and Cash Equivalents
67
(239)
Cash and Cash Equivalents at Beginning of Period
379
661
Cash and Cash Equivalents at End of Period
$
446
$
422
The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.
11

CONDENSED CONSOLIDATED BALANCE SHEETS
PPL Energy Supply, LLC and Subsidiaries
(Unaudited)
(Millions of Dollars)
June 30,
December 31,
2012
2011
Assets
Current Assets
Cash and cash equivalents
$
446
$
379
Restricted cash and cash equivalents
93
145
Accounts receivable (less reserve:  2012, $23; 2011, $15)
Customer
181
169
Other
22
31
Accounts receivable from affiliates
89
89
Unbilled revenues
341
402
Note receivable from affiliate
198
Fuel, materials and supplies
372
298
Prepayments
44
14
Price risk management assets
2,471
2,527
Other current assets
12
11
Total Current Assets
4,071
4,263
Investments
Nuclear plant decommissioning trust funds
681
640
Other investments
42
40
Total Investments
723
680
Property, Plant and Equipment
Non-regulated property, plant and equipment
Generation
11,191
10,517
Nuclear fuel
524
457
Other
253
245
Less:  accumulated depreciation - non-regulated property, plant and equipment
5,649
5,573
Non-regulated property, plant and equipment, net
6,319
5,646
Construction work in progress
810
840
Property, Plant and Equipment, net (a)
7,129
6,486
Other Noncurrent Assets
Goodwill
86
86
Other intangibles (a)
244
386
Price risk management assets
1,035
896
Other noncurrent assets
387
382
Total Other Noncurrent Assets
1,752
1,750
Total Assets
$
13,675
$
13,179

(a)
Both June 30, 2012 and December 31, 2011 include $416 million of PP&E, consisting primarily of "Generation," including leasehold improvements, and $10 million and $11 million of "Other intangibles" from the consolidation of a VIE that is the owner/lessor of the Lower Mt. Bethel plant.

The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.
12

CONDENSED CONSOLIDATED BALANCE SHEETS
PPL Energy Supply, LLC and Subsidiaries
(Unaudited)
(Millions of Dollars)
June 30,
December 31,
2012
2011
Liabilities and Equity
Current Liabilities
Short-term debt
$
520
$
400
Long-term debt due within one year
12
Accounts payable
428
472
Accounts payable to affiliates
5
14
Taxes
32
90
Interest
31
30
Price risk management liabilities
1,570
1,560
Counterparty collateral
205
148
Deferred income taxes
296
315
Other current liabilities
209
196
Total Current Liabilities
3,308
3,225
Long-term Debt
3,267
3,024
Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes
1,286
1,223
Investment tax credits
159
136
Price risk management liabilities
958
785
Accrued pension obligations
156
214
Asset retirement obligations
359
349
Other deferred credits and noncurrent liabilities
182
186
Total Deferred Credits and Other Noncurrent Liabilities
3,100
2,893
Commitments and Contingent Liabilities (Note 10)
Equity
Member's equity
3,982
4,019
Noncontrolling interests
18
18
Total Equity
4,000
4,037
Total Liabilities and Equity
$
13,675
$
13,179
The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.
13

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
PPL Energy Supply, LLC and Subsidiaries
(Unaudited)
(Millions of Dollars)
Non-
Member's
controlling
equity
interests
Total
March 31, 2012
$
3,713
$
18
$
3,731
Net income
19
19
Other comprehensive income (loss)
(122)
(122)
Contributions from member
472
472
Distributions
(100)
(100)
June 30, 2012
$
3,982
$
18
$
4,000
December 31, 2011
$
4,019
$
18
$
4,037
Net income
328
328
Other comprehensive income (loss)
(180)
(180)
Contributions from member
472
472
Distributions
(657)
(657)
June 30, 2012
$
3,982
$
18
$
4,000
March 31, 2011
$
3,316
$
18
$
3,334
Net income
89
89
Other comprehensive income (loss)
(86)
(86)
Contributions from member
168
168
Distributions
(53)
(53)
June 30, 2011
$
3,434
$
18
$
3,452
December 31, 2010
$
4,491
$
18
$
4,509
Net income
303
303
Other comprehensive income (loss)
(106)
(106)
Contributions from member
168
168
Distributions
(134)
(134)
Distribution of membership interest in PPL Global (a)
(1,288)
(1,288)
June 30, 2011
$
3,434
$
18
$
3,452

(a)
In January 2011, PPL Energy Supply distributed its entire membership interest in PPL Global to PPL Energy Supply's parent, PPL Energy Funding.  The distribution was made based on the book value of the assets and liabilities of PPL Global with financial effect as of January 1, 2011, and no gains or losses were recognized on the distribution.

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

14


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15

CONDENSED CONSOLIDATED STATEMENTS OF INCOME
PPL Electric Utilities Corporation and Subsidiaries
(Unaudited)
(Millions of Dollars)
Three Months Ended
Six Months Ended
June 30,
June 30,
2012
2011
2012
2011
Operating Revenues
Retail electric
$
403
$
436
$
860
$
990
Electric revenue from affiliate
1
4
2
8
Total Operating Revenues
404
440
862
998
Operating Expenses
Operation
Energy purchases
120
169
273
420
Energy purchases from affiliate
17
4
38
10
Other operation and maintenance
143
126
283
256
Depreciation
39
37
78
70
Taxes, other than income
22
22
48
57
Total Operating Expenses
341
358
720
813
Operating Income
63
82
142
185
Other Income (Expense) - net
1
1
3
1
Interest Expense
24
24
48
48
Income Before Income Taxes
40
59
97
138
Income Taxes
11
19
31
42
Net Income (a)
29
40
66
96
Distributions on Preference Stock
4
4
8
Net Income Available to PPL Corporation
$
29
$
36
$
62
$
88

(a)
Net income approximates comprehensive income.

The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.
16

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
PPL Electric Utilities Corporation and Subsidiaries
(Unaudited)
(Millions of Dollars)
Six Months Ended
June 30,
2012
2011
Cash Flows from Operating Activities
Net income
$
66
$
96
Adjustments to reconcile net income to net cash provided by (used in) operating activities
Depreciation
78
70
Amortization
9
Defined benefit plans - expense
11
9
Deferred income taxes and investment tax credits
59
(19)
Other
5
2
Change in current assets and current liabilities
Accounts receivable
19
(48)
Accounts payable
(37)
(75)
Unbilled revenues
11
47
Prepayments
(18)
38
Regulatory assets and liabilities
(12)
63
Taxes
10
Other
(11)
(16)
Other operating activities
Defined benefit plans - funding
(54)
(102)
Other assets
2
(7)
Other liabilities
(27)
(5)
Net cash provided by (used in) operating activities
101
63
Cash Flows from Investing Activities
Expenditures for property, plant and equipment
(256)
(244)
Other investing activities
(1)
4
Net cash provided by (used in) investing activities
(257)
(240)
Cash Flows from Financing Activities
Redemption of preference stock
(250)
Payment of common stock dividends to parent
(56)
(52)
Net increase (decrease) in note payable to affiliate
37
Net increase (decrease) in short-term debt
195
Distributions on preference stock
(8)
(8)
Net cash provided by (used in) financing activities
(119)
(23)
Net Increase (Decrease) in Cash and Cash Equivalents
(275)
(200)
Cash and Cash Equivalents at Beginning of Period
320
204
Cash and Cash Equivalents at End of Period
$
45
$
4
The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.

17

CONDENSED CONSOLIDATED BALANCE SHEETS
PPL Electric Utilities Corporation and Subsidiaries
(Unaudited)
(Millions of Dollars, shares in thousands)
June 30,
December 31,
2012
2011
Assets
Current Assets
Cash and cash equivalents
$
45
$
320
Accounts receivable (less reserve: 2012, $18; 2011, $17)
Customer
261
271
Other
6
9
Accounts receivable from affiliates
30
35
Unbilled revenues
87
98
Materials and supplies
38
42
Prepayments
96
78
Other current assets
29
30
Total Current Assets
592
883
Property, Plant and Equipment
Regulated utility plant
6,024
5,830
Less: accumulated depreciation - regulated utility plant
2,269
2,217
Regulated utility plant, net
3,755
3,613
Other, net
2
2
Construction work in progress
262
242
Property, Plant and Equipment, net
4,019
3,857
Other Noncurrent Assets
Regulatory assets
734
729
Intangibles
161
155
Other noncurrent assets
80
81
Total Other Noncurrent Assets
975
965
Total Assets
$
5,586
$
5,705
The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.

18

CONDENSED CONSOLIDATED BALANCE SHEETS
PPL Electric Utilities Corporation and Subsidiaries
(Unaudited)
(Millions of Dollars, shares in thousands)
June 30,
December 31,
2012
2011
Liabilities and Equity
Current Liabilities
Short-term debt
$
195
Accounts payable
154
$
171
Accounts payable to affiliates
49
64
Interest
23
24
Regulatory liabilities
42
53
Customer deposits and prepayments
29
39
Vacation
23
22
Other current liabilities
39
47
Total Current Liabilities
554
420
Long-term Debt
1,718
1,718
Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes
1,168
1,115
Investment tax credits
4
5
Accrued pension obligations
139
186
Regulatory liabilities
9
7
Other deferred credits and noncurrent liabilities
113
129
Total Deferred Credits and Other Noncurrent Liabilities
1,433
1,442
Commitments and Contingent Liabilities (Notes 6 and 10)
Shareowners' Equity
Preference stock
250
Common stock - no par value (a)
364
364
Additional paid-in capital
979
979
Earnings reinvested
538
532
Total Equity
1,881
2,125
Total Liabilities and Equity
$
5,586
$
5,705

(a)
170,000 shares authorized; 66,368 shares issued and outstanding at June 30, 2012 and December 31, 2011.

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

19

CONDENSED CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY
PPL Electric Utilities Corporation and Subsidiaries
(Unaudited)
(Millions of Dollars)
Common
stock
shares
Additional
outstanding
Preference
Common
paid-in
Earnings
(a)
stock
stock
capital
reinvested
Total
March 31, 2012
66,368
$
250
$
364
$
979
$
530
$
2,123
Net income
29
29
Redemption of preference stock (b)
(250)
(250)
Cash dividends declared on common stock
(21)
(21)
June 30, 2012
66,368
$
$
364
$
979
$
538
$
1,881
December 31, 2011
66,368
$
250
$
364
$
979
$
532
$
2,125
Net income
66
66
Redemption of preference stock (b)
(250)
(250)
Cash dividends declared on preference stock
(4)
(4)
Cash dividends declared on common stock
(56)
(56)
June 30, 2012
66,368
$
$
364
$
979
$
538
$
1,881
March 31, 2011
66,368
$
250
$
364
$
879
$
485
$
1,978
Net income
40
40
Cash dividends declared on preference stock
(4)
(4)
Cash dividends declared on common stock
(34)
(34)
June 30, 2011
66,368
$
250
$
364
$
879
$
487
$
1,980
December 31, 2010
66,368
$
250
$
364
$
879
$
451
$
1,944
Net income
96
96
Cash dividends declared on preference stock
(8)
(8)
Cash dividends declared on common stock
(52)
(52)
June 30, 2011
66,368
$
250
$
364
$
879
$
487
$
1,980

(a)
Shares in thousands.  All common shares of PPL Electric stock are owned by PPL.
(b)
In June 2012, PPL Electric redeemed all of its outstanding preference stock.  See Note 7 for additional information.

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

20


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21

CONDENSED CONSOLIDATED STATEMENTS OF INCOME
LG&E and KU Energy LLC and Subsidiaries
(Unaudited)
(Millions of Dollars)
Three Months Ended
Six Months Ended
June 30,
June 30,
2012
2011
2012
2011
Operating Revenues
$
658
$
638
$
1,363
$
1,404
Operating Expenses
Operation
Fuel
215
206
428
421
Energy purchases
34
40
108
147
Other operation and maintenance
197
198
403
379
Depreciation
86
84
172
165
Taxes, other than income
12
9
23
18
Total Operating Expenses
544
537
1,134
1,130
Operating Income
114
101
229
274
Other Income (Expense) - net
(7)
(10)
(1)
Interest Expense
37
36
75
72
Income from Continuing Operations Before Income Taxes
70
65
144
201
Income Taxes
20
24
41
73
Income from Continuing Operations After Income Taxes
50
41
103
128
Income (Loss) from Discontinued Operations (net of income taxes)
(6)
(6)
Net Income (a)
$
44
$
41
$
97
$
128
(a)    Net income approximates comprehensive income.
The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.

22

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
LG&E and KU Energy LLC and Subsidiaries
(Unaudited)
(Millions of Dollars)
Six Months Ended June 30,
2012
2011
Cash Flows from Operating Activities
Net income
$
97
$
128
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation
172
165
Amortization
14
13
Defined benefit plans - expense
20
25
Deferred income taxes and investment tax credits
56
146
Other
(2)
(15)
Change in current assets and current liabilities
Accounts receivable
(11)
17
Accounts payable
17
(20)
Unbilled revenues
1
38
Fuel, materials and supplies
1
42
Income tax receivable
2
40
Taxes
33
(6)
Other
(8)
(18)
Other operating activities
Defined benefit plans - funding
(62)
(157)
Other assets
(1)
Other liabilities
24
10
Net cash provided by operating activities
354
407
Cash Flows from Investing Activities
Expenditures for property, plant and equipment
(324)
(180)
Proceeds from the sale of other investments
163
Net (increase) decrease in notes receivable from affiliates
3
(29)
Net (increase) decrease in restricted cash and cash equivalents
(2)
(4)
Net cash provided by (used in) investing activities
(323)
(50)
Cash Flows from Financing Activities
Net increase (decrease) in short-term debt
(163)
Debt issuance and credit facility costs
(1)
(3)
Distributions to member
(60)
(146)
Net cash provided by (used in) financing activities
(61)
(312)
Net Increase (Decrease) in Cash and Cash Equivalents
(30)
45
Cash and Cash Equivalents at Beginning of Period
59
11
Cash and Cash Equivalents at End of Period
$
29
$
56
The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.

23

CONDENSED CONSOLIDATED BALANCE SHEETS
LG&E and KU Energy LLC and Subsidiaries
(Unaudited)
(Millions of Dollars)
June 30,
December 31,
2012
2011
Assets
Current Assets
Cash and cash equivalents
$
29
$
59
Accounts receivable (less reserve: 2012, $19; 2011, $17)
Customer
145
129
Other
13
20
Unbilled revenues
145
146
Fuel, materials and supplies
281
283
Prepayments
28
22
Notes receivable from affiliates
12
15
Income taxes receivable
1
3
Deferred income taxes
104
17
Regulatory assets
17
9
Other current assets
4
3
Total Current Assets
779
706
Investments
21
31
Property, Plant and Equipment
Regulated utility plant
7,758
7,519
Less: accumulated depreciation - regulated utility plant
397
277
Regulated utility plant, net
7,361
7,242
Other, net
2
2
Construction work in progress
574
557
Property, Plant and Equipment, net
7,937
7,801
Other Noncurrent Assets
Regulatory assets
601
620
Goodwill
996
996
Other intangibles
290
314
Other noncurrent assets
113
108
Total Other Noncurrent Assets
2,000
2,038
Total Assets
$
10,737
$
10,576
The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.

24


CONDENSED CONSOLIDATED BALANCE SHEETS
LG&E and KU Energy LLC and Subsidiaries
(Unaudited)
(Millions of Dollars)
June 30,
December 31,
2012
2011
Liabilities and Equity
Current Liabilities
Accounts payable
$
214
$
224
Accounts payable to affiliates
2
2
Customer deposits
47
45
Taxes
58
25
Regulatory liabilities
16
20
Interest
22
23
Salaries and benefits
51
59
Other current liabilities
45
35
Total Current Liabilities
455
433
Long-term Debt
4,074
4,073
Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes
563
413
Investment tax credits
141
144
Accrued pension obligations
313
359
Asset retirement obligations
118
116
Regulatory liabilities
994
1,003
Price risk management liabilities
57
55
Other deferred credits and noncurrent liabilities
248
239
Total Deferred Credits and Other Noncurrent Liabilities
2,434
2,329
Commitments and Contingent Liabilities (Notes 6 and 10)
Member's equity
3,774
3,741
Total Liabilities and Equity
$
10,737
$
10,576
The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.

25

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
LG&E and KU Energy LLC and Subsidiaries
(Unaudited)
(Millions of Dollars)
Member's
Equity
March 31, 2012
$
3,765
Net income
44
Distributions to member
(35)
June 30, 2012
$
3,774
December 31, 2011
$
3,741
Net income
97
Distributions to member
(60)
Other comprehensive income (loss)
(4)
June 30, 2012
$
3,774
March 31, 2011
$
4,042
Net income
41
Distributions to member
(92)
June 30, 2011
$
3,991
December 31, 2010
$
4,011
Net income
128
Distributions to member
(146)
Other comprehensive income (loss)
(2)
June 30, 2011
$
3,991

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

26

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27

CONDENSED STATEMENTS OF INCOME
Louisville Gas and Electric Company
(Unaudited)
(Millions of Dollars)
Three Months Ended
Six Months Ended
June 30,
June 30,
2012
2011
2012
2011
Operating Revenues
Retail and wholesale
$
286
$
280
$
615
$
651
Electric revenue from affiliate
18
17
42
44
Total Operating Revenues
304
297
657
695
Operating Expenses
Operation
Fuel
92
82
181
167
Energy purchases
23
32
92
131
Energy purchases from affiliate
2
7
6
18
Other operation and maintenance
92
91
190
181
Depreciation
38
37
76
73
Taxes, other than income
6
5
11
9
Total Operating Expenses
253
254
556
579
Operating Income
51
43
101
116
Other Income (Expense) - net
(1)
1
Interest Expense
10
12
21
23
Income Before Income Taxes
40
32
80
93
Income Taxes
14
12
29
34
Net Income (a)
$
26
$
20
$
51
$
59
(a)    Net income approximates comprehensive income.
The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.

28

CONDENSED STATEMENTS OF CASH FLOWS
Louisville Gas and Electric Company
(Unaudited)
(Millions of Dollars)
Six Months Ended June 30,
2012
2011
Cash Flows from Operating Activities
Net income
$
51
$
59
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation
76
73
Amortization
6
6
Defined benefit plans - expense
9
11
Deferred income taxes and investment tax credits
28
27
Other
(6)
Change in current assets and current liabilities
Accounts receivable
(11)
24
Accounts payable
11
(11)
Accounts payable to affiliates
(10)
(7)
Unbilled revenues
6
27
Fuel, materials and supplies
6
41
Other
19
(9)
Other operating activities
Defined benefit plans - funding
(25)
(67)
Other assets
(1)
Other liabilities
1
3
Net cash provided by operating activities
160
177
Cash Flows from Investing Activities
Expenditures for property, plant and equipment
(120)
(79)
Proceeds from the sale of other investments
163
Net (increase) decrease in notes receivable from affiliates
(6)
Net (increase) decrease in restricted cash and cash equivalents
(2)
(4)
Net cash provided by (used in) investing activities
(128)
80
Cash Flows from Financing Activities
Net increase (decrease) in notes payable with affiliates
(12)
Net increase (decrease) in short-term debt
(163)
Debt issuance and credit facility costs
(1)
(1)
Payment of common stock dividends to parent
(31)
(42)
Net cash provided by (used in) financing activities
(32)
(218)
Net Increase (Decrease) in Cash and Cash Equivalents
39
Cash and Cash Equivalents at Beginning of Period
25
2
Cash and Cash Equivalents at End of Period
$
25
$
41
The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.

29

CONDENSED BALANCE SHEETS
Louisville Gas and Electric Company
(Unaudited)
(Millions of Dollars, shares in thousands)
June 30,
December 31,
2012
2011
Assets
Current Assets
Cash and cash equivalents
$
25
$
25
Accounts receivable (less reserve: 2012, $2; 2011, $2)
Customer
64
60
Other
6
9
Unbilled revenues
59
65
Accounts receivable from affiliates
21
11
Fuel, materials and supplies
136
142
Prepayments
10
7
Notes receivable from affiliates
6
Income taxes receivable
4
Deferred income taxes
2
2
Regulatory assets
13
9
Other current assets
1
Total Current Assets
343
334
Property, Plant and Equipment
Regulated utility plant
3,077
2,956
Less: accumulated depreciation - regulated utility plant
168
116
Regulated utility plant, net
2,909
2,840
Construction work in progress
182
215
Property, Plant and Equipment, net
3,091
3,055
Other Noncurrent Assets
Regulatory assets
391
403
Goodwill
389
389
Other intangibles
155
166
Other noncurrent assets
42
40
Total Other Noncurrent Assets
977
998
Total Assets
$
4,411
$
4,387
The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.

30


CONDENSED BALANCE SHEETS
Louisville Gas and Electric Company
(Unaudited)
(Millions of Dollars, shares in thousands)
June 30,
December 31,
2012
2011
Liabilities and Equity
Current Liabilities
Accounts payable
$
93
$
94
Accounts payable to affiliates
16
26
Customer deposits
23
22
Taxes
28
13
Regulatory liabilities
7
10
Interest
6
6
Salaries and benefits
13
14
Other current liabilities
20
14
Total Current Liabilities
206
199
Long-term Debt
1,112
1,112
Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes
506
475
Investment tax credits
41
43
Accrued pension obligations
71
95
Asset retirement obligations
55
55
Regulatory liabilities
472
478
Price risk management liabilities
57
55
Other deferred credits and noncurrent liabilities
109
113
Total Deferred Credits and Other Noncurrent Liabilities
1,311
1,314
Commitments and Contingent Liabilities (Notes 6 and 10)
Stockholder's Equity
Common stock - no par value (a)
424
424
Additional paid-in capital
1,278
1,278
Earnings reinvested
80
60
Total Equity
1,782
1,762
Total Liabilities and Equity
$
4,411
$
4,387

(a)
75,000 shares authorized; 21,294 shares issued and outstanding at June 30, 2012 and December 31, 2011.

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

31

CONDENSED STATEMENTS OF EQUITY
Louisville Gas and Electric Company
(Unaudited)
(Millions of Dollars)
Common
stock
shares
Additional
outstanding
Common
paid-in
Earnings
(a)
stock
capital
reinvested
Total
March 31, 2012
21,294
$
424
$
1,278
$
70
$
1,772
Net income
26
26
Cash dividends declared on common stock
(16)
(16)
June 30, 2012
21,294
$
424
$
1,278
$
80
$
1,782
December 31, 2011
21,294
$
424
$
1,278
$
60
$
1,762
Net income
51
51
Cash dividends declared on common stock
(31)
(31)
June 30, 2012
21,294
$
424
$
1,278
$
80
$
1,782
March 31, 2011
21,294
$
424
$
1,278
$
41
$
1,743
Net income
20
20
Cash dividends declared on common stock
(25)
(25)
June 30, 2011
21,294
$
424
$
1,278
$
36
$
1,738
December 31, 2010
21,294
$
424
$
1,278
$
19
$
1,721
Net income
59
59
Cash dividends declared on common stock
(42)
(42)
June 30, 2011
21,294
$
424
$
1,278
$
36
$
1,738

(a)
Shares in thousands.  All common shares of LG&E stock are owned by LKE.

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

32

(THIS PAGE LEFT BLANK INTENTIONALLY.)

33

CONDENSED STATEMENTS OF INCOME
Kentucky Utilities Company
(Unaudited)
(Millions of Dollars)
Three Months Ended
Six Months Ended
June 30,
June 30,
2012
2011
2012
2011
Operating Revenues
Retail and wholesale
$
372
$
358
$
748
$
753
Electric revenue from affiliate
2
7
6
18
Total Operating Revenues
374
365
754
771
Operating Expenses
Operation
Fuel
123
124
247
254
Energy purchases
11
8
16
16
Energy purchases from affiliate
18
17
42
44
Other operation and maintenance
98
100
193
184
Depreciation
48
47
96
92
Taxes, other than income
6
4
12
9
Total Operating Expenses
304
300
606
599
Operating Income
70
65
148
172
Other Income (Expense) - net
(5)
(6)
1
Interest Expense
17
17
34
35
Income Before Income Taxes
48
48
108
138
Income Taxes
18
18
40
50
Net Income (a)
$
30
$
30
$
68
$
88
(a)    Net income approximates comprehensive income.
The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.

34

CONDENSED STATEMENTS OF CASH FLOWS
Kentucky Utilities Company
(Unaudited)
(Millions of Dollars)
Six Months Ended June 30,
2012
2011
Cash Flows from Operating Activities
Net income
$
68
$
88
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation
96
92
Amortization
7
6
Defined benefit plans - expense
5
7
Deferred income taxes and investment tax credits
53
49
Other
(10)
Change in current assets and current liabilities
Accounts receivable
(24)
15
Accounts payable
12
2
Accounts payable to affiliates
1
(19)
Unbilled revenues
(5)
11
Fuel, materials and supplies
(3)
1
Other
15
(15)
Other operating activities
Defined benefit plans - funding
(18)
(45)
Other assets
(1)
Other liabilities
10
4
Net cash provided by operating activities
217
185
Cash Flows from Investing Activities
Expenditures for property, plant and equipment
(203)
(101)
Net cash provided by (used in) investing activities
(203)
(101)
Cash Flows from Financing Activities
Net increase (decrease) in notes payable with affiliates
6
(10)
Debt issuance and credit facility costs
(2)
Payment of common stock dividends to parent
(48)
(68)
Net cash provided by (used in) financing activities
(42)
(80)
Net Increase (Decrease) in Cash and Cash Equivalents
(28)
4
Cash and Cash Equivalents at Beginning of Period
31
3
Cash and Cash Equivalents at End of Period
$
3
$
7
The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.

35

CONDENSED BALANCE SHEETS
Kentucky Utilities Company
(Unaudited)
(Millions of Dollars, shares in thousands)
June 30,
December 31,
2012
2011
Assets
Current Assets
Cash and cash equivalents
$
3
$
31
Accounts receivable (less reserve: 2012, $2; 2011, $2)
Customer
81
69
Other
7
9
Unbilled revenues
86
81
Accounts receivable from affiliates
15
Fuel, materials and supplies
145
141
Prepayments
11
7
Income taxes receivable
1
5
Deferred income taxes
5
5
Regulatory assets
4
Other current assets
5
3
Total Current Assets
363
351
Investments
20
31
Property, Plant and Equipment
Regulated utility plant
4,681
4,563
Less: accumulated depreciation - regulated utility plant
229
161
Regulated utility plant, net
4,452
4,402
Construction work in progress
390
340
Property, Plant and Equipment, net
4,842
4,742
Other Noncurrent Assets
Regulatory assets
210
217
Goodwill
607
607
Other intangibles
135
148
Other noncurrent assets
60
60
Total Other Noncurrent Assets
1,012
1,032
Total Assets
$
6,237
$
6,156
The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.

36

CONDENSED BALANCE SHEETS
Kentucky Utilities Company
(Unaudited)
(Millions of Dollars, shares in thousands)
June 30,
December 31,
2012
2011
Liabilities and Equity
Current Liabilities
Notes payable with affiliates
$
6
Accounts payable
111
$
112
Accounts payable to affiliates
35
33
Customer deposits
24
23
Taxes
23
11
Regulatory liabilities
9
10
Interest
10
11
Salaries and benefits
13
15
Other current liabilities
20
13
Total Current Liabilities
251
228
Long-term Debt
1,842
1,842
Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes
537
484
Investment tax credits
100
101
Accrued pension obligations
71
83
Asset retirement obligations
63
61
Regulatory liabilities
522
525
Other deferred credits and noncurrent liabilities
90
87
Total Deferred Credits and Other Noncurrent Liabilities
1,383
1,341
Commitments and Contingent Liabilities (Notes 6 and 10)
Stockholder's Equity
Common stock - no par value (a)
308
308
Additional paid-in capital
2,348
2,348
Accumulated other comprehensive income (loss)
(4)
Earnings reinvested
109
89
Total Equity
2,761
2,745
Total Liabilities and Equity
$
6,237
$
6,156

(a)
80,000 shares authorized; 37,818 shares issued and outstanding at June 30, 2012 and December 31, 2011.

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

37

CONDENSED STATEMENTS OF EQUITY
Kentucky Utilities Company
(Unaudited)
(Millions of Dollars)
Common
Accumulated
stock
other
shares
Additional
comprehensive
outstanding
Common
paid-in
Earnings
income
(a)
stock
capital
reinvested
(loss)
Total
March 31, 2012
37,818
$
308
$
2,348
$
103
$
(4)
$
2,755
Net income
30
30
Cash dividends declared on common stock
(24)
(24)
June 30, 2012
37,818
$
308
$
2,348
$
109
$
(4)
$
2,761
December 31, 2011
37,818
$
308
$
2,348
$
89
$
2,745
Net income
68
68
Cash dividends declared on common stock
(48)
(48)
Other comprehensive income (loss)
$
(4)
(4)
June 30, 2012
37,818
$
308
$
2,348
$
109
$
(4)
$
2,761
March 31, 2011
37,818
$
308
$
2,348
$
62
$
(1)
$
2,717
Net income
30
30
Cash dividends declared on common stock
(37)
(37)
June 30, 2011
37,818
$
308
$
2,348
$
55
$
(1)
$
2,710
December 31, 2010
37,818
$
308
$
2,348
$
35
$
2,691
Net income
88
88
Cash dividends declared on common stock
(68)
(68)
Other comprehensive income (loss)
$
(1)
(1)
June 30, 2011
37,818
$
308
$
2,348
$
55
$
(1)
$
2,710

(a)
Shares in thousands.  All common shares of KU stock are owned by LKE.

The accompanying Notes to Condensed Financial Statements are an integral part of the financial statements.
38
Combined Notes to Condensed Financial Statements (Unaudited)

1.  Interim Financial Statements

(PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU)

Capitalized terms and abbreviations appearing in the unaudited combined notes to condensed financial statements are defined in the glossary.  Dollars are in millions, except per share data, unless otherwise noted.

The accompanying unaudited condensed financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X and, therefore, do not include all of the information and footnotes required by accounting principles generally accepted in the U.S. for complete financial statements.  In the opinion of management, all adjustments considered necessary for a fair presentation in accordance with accounting principles generally accepted in the U.S. are reflected in the condensed financial statements.  All adjustments are of a normal recurring nature, except as otherwise disclosed.  Each Registrant's Balance Sheet at December 31, 2011 is derived from that Registrant's 2011 audited Balance Sheet.  The financial statements and notes thereto should be read in conjunction with the financial statements and notes contained in each Registrant's 2011 Form 10-K.  The results of operations for the three and six months ended June 30, 2012, are not necessarily indicative of the results to be expected for the full year ending December 31, 2012, or other future periods, because results for interim periods can be disproportionately influenced by various factors, developments and seasonal variations.

The classification of certain prior period amounts has been changed to conform to the presentation in the June 30, 2012 financial statements.

(PPL)

On April 1, 2011, PPL, through its indirect, wholly owned subsidiary PPL WEM, completed its acquisition of all of the outstanding ordinary share capital of Central Networks East plc and Central Networks Limited, the sole owner of Central Networks West plc, together with certain other related assets and liabilities (collectively referred to as Central Networks and subsequently renamed WPD Midlands), from subsidiaries of E.ON AG.  PPL consolidates WPD, including WPD Midlands, on a one-month lag.  Material intervening events, such as debt issuances that occur in the lag period, are recognized in the current period financial statements.  Events that are significant but not material are disclosed.  Therefore, the periods ended June 30, 2012 include three and six months of WPD Midlands' results, compared with two months for the same periods in 2011.  See Note 8 for additional information on the acquisition.

(PPL and PPL Energy Supply)

In April 2012, an indirect, wholly owned subsidiary of PPL Energy Supply completed the Ironwood Acquisition.  See Note 8 for additional information.

2.  Summary of Significant Accounting Policies

(PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU)

The following accounting policy disclosures represent updates to Note 1 in each Registrant's 2011 Form 10-K and should be read in conjunction with those disclosures.

Accounts Receivable (PPL, PPL Energy Supply and PPL Electric)

PPL Electric's customers may choose an alternative supplier for their generation supply.  In accordance with a PUC-approved purchase of accounts receivable program, PPL Electric continues to purchase certain accounts receivable from alternative suppliers at a nominal discount, which reflects a provision for uncollectible accounts.  The alternative suppliers (including PPL Electric's affiliate, PPL EnergyPlus) have no continuing involvement or interest in the purchased accounts receivable.  The purchased accounts receivable are initially recorded at fair value using a market approach based on the purchase price paid and are classified as Level 2 in the fair value hierarchy.  PPL Electric receives a nominal fee for administering its program.  During the three and six months ended June 30, 2012, PPL Electric purchased $184 million and $422 million of accounts receivable from unaffiliated third parties and $74 million and $156 million from its affiliate, PPL EnergyPlus.  During the three and six months ended June 30, 2011, PPL Electric purchased $198 million and $452 million of accounts receivable from unaffiliated third parties and $59 million and $120 million from its affiliate, PPL EnergyPlus.
39
New Accounting Guidance Adopted (PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU)

Fair Value Measurements

Effective January 1, 2012, the Registrants prospectively adopted accounting guidance that was issued to clarify existing fair value measurement guidance and to enhance fair value disclosures.  The additional disclosures required by this guidance include quantitative information about significant unobservable inputs used for Level 3 measurements, qualitative information about the sensitivity of recurring Level 3 measurements, information about any transfers between Levels 1 and 2 of the fair value hierarchy, information about when the current use of a non-financial asset is different from the highest and best use, and the fair value hierarchy classification for assets and liabilities whose fair value is disclosed only in the notes to the financial statements.

The adoption of this standard resulted in additional footnote disclosures but did not have a significant impact on the Registrants.  See Note 13 for additional disclosures required by this guidance.

Testing Goodwill for Impairment

Effective January 1, 2012, the Registrants prospectively adopted accounting guidance which allows an entity to elect the option to first make a qualitative evaluation about the likelihood of an impairment of goodwill.  If, based on this assessment, the entity determines it is not more likely than not that the fair value of a reporting unit is less than the carrying amount, the two-step goodwill impairment test is not necessary.  However, the first step of the impairment test is required if an entity concludes it is more likely than not the fair value of a reporting unit is less than the carrying amount based on the qualitative assessment.

The adoption of this standard did not have a significant impact on the Registrants.

3. Segment and Related Information

(PPL)

See Note 2 in PPL's 2011 Form 10-K for a discussion of reportable segments.  In 2012, the International Regulated segment was renamed the U.K. Regulated segment to more specifically reflect the focus of this segment.  Other than the name change, there were no other changes to this segment.  Because the acquisition of WPD Midlands occurred on April 1, 2011, and PPL consolidates WPD Midlands on a one-month lag, the operating results of the U.K. Regulated segment are not comparable between 2012 and 2011.

Financial data for the segments for the periods ended June 30 are:

Three Months
Six Months
2012
2011
2012
2011
Income Statement Data
Revenues from external customers
Kentucky Regulated
$
658
$
638
$
1,363
$
1,404
U.K. Regulated
557
420
1,119
645
Pennsylvania Regulated
403
436
860
990
Supply (a)
931
995
3,319
2,360
Total
$
2,549
$
2,489
$
6,661
$
5,399
Intersegment electric revenues
Pennsylvania Regulated
$
1
$
4
$
2
$
8
Supply
17
4
38
10
Net Income Attributable to PPL
Kentucky Regulated
$
34
$
31
$
76
$
106
U.K. Regulated
196
38
361
93
Pennsylvania Regulated
29
36
62
88
Supply (a)
12
91
313
310
Total
$
271
$
196
$
812
$
597
40

June 30,
December 31,
2012
2011
Balance Sheet Data
Assets
Kentucky Regulated
$
10,288
$
10,229
U.K. Regulated
13,445
13,364
Pennsylvania Regulated
5,532
5,610
Supply
14,243
13,445
Total assets
$
43,508
$
42,648

(a)
Includes unrealized gains and losses from economic activity.  See Note 14 for additional information.

4.  Earnings Per Share

(PPL)

Basic EPS is computed by dividing income available to PPL common shareowners by the weighted-average number of common shares outstanding during the period.  Diluted EPS is computed by dividing income available to PPL common shareowners by the weighted-average number of shares outstanding that are increased for additional shares that would be outstanding if potentially dilutive non-participating securities were converted to common shares as calculated using the treasury stock method.  In 2012 and 2011, these securities included stock options and performance units granted under incentive compensation plans and the Purchase Contracts associated with Equity Units.  In 2012, these securities also included the PPL common stock forward sale agreements.  See Note 7 for additional information on the forward sale agreements.

The forward sale agreements were dilutive under the treasury stock method for the three and six months ended June 30, 2012 because the average stock price of PPL's common shares exceeded the forward sale price indicated in the forward sale agreements.

The Purchase Contracts will be dilutive under the treasury stock method if the average VWAP of PPL common stock for a certain period exceeds approximately $30.99 and $28.80, for the 2011 and 2010 Purchase Contracts.  The Purchase Contracts were excluded from the diluted EPS calculations for 2012 and 2011 because they did not meet this criterion during the three and six months ended June 30, 2012 and 2011.  Subject to antidilution adjustments at June 30, 2012, the maximum number of shares issuable to settle the Purchase Contracts was 97.8 million shares, including 86.5 million shares that could be issued under standard provisions of the Purchase Contracts and 11.3 million shares that could be issued under make-whole provisions in the event of early settlement upon a Fundamental Change.

Reconciliations of the amounts of income and shares of PPL common stock (in thousands) for the periods ended June 30 used in the EPS calculation are:

Three Months
Six Months
2012
2011
2012
2011
Income (Numerator)
Income from continuing operations after income taxes attributable to PPL
$
277
$
197
$
818
$
595
Less amounts allocated to participating securities
2
1
5
3
Income from continuing operations after income taxes available to PPL
common shareowners
$
275
$
196
$
813
$
592
Income (loss) from discontinued operations (net of income taxes) available
to PPL
$
(6)
$
(1)
$
(6)
$
2
Net income attributable to PPL
$
271
$
196
$
812
$
597
Less amounts allocated to participating securities
2
1
5
3
Net income available to PPL common shareowners
$
269
$
195
$
807
$
594
Shares of Common Stock (Denominator)
Weighted-average shares - Basic EPS
579,881
561,652
579,462
522,897
Add incremental non-participating securities:
Stock options and performance units
444
367
465
287
Forward sale agreements
268
135
Weighted-average shares - Diluted EPS
580,593
562,019
580,062
523,184

41

Three Months
Six Months
2012
2011
2012
2011
Basic EPS
Available to PPL common shareowners:
Income from continuing operations after income taxes
$
0.47
$
0.35
$
1.40
$
1.13
Income (loss) from discontinued operations (net of income taxes)
(0.01)
(0.01)
0.01
Net Income
$
0.46
$
0.35
$
1.39
$
1.14
Diluted EPS
Available to PPL common shareowners:
Income from continuing operations after income taxes
$
0.47
$
0.35
$
1.40
$
1.13
Income (loss) from discontinued operations (net of income taxes)
(0.01)
(0.01)
0.01
Net Income
$
0.46
$
0.35
$
1.39
$
1.14

For the periods ended June 30, 2012, PPL issued common stock related to stock-based compensation plans, ESOP and DRIP as follows:

(Shares in thousands)
Three Months
Six Months
Stock-based compensation plans (a)
76
353
ESOP
280
DRIP
617
1,175

(a)
Includes stock option exercises, vesting of restricted stock and restricted stock units and conversion of stock units granted to directors.

For the periods ended June 30, the following options to purchase PPL common stock and performance units were excluded from the computations of diluted EPS because the effect would have been antidilutive.

Three Months
Six Months
(Shares in thousands)
2012
2011
2012
2011
Stock options
6,250
5,045
5,966
5,829
Performance units
34
1
115
4

5. Income Taxes

Reconciliations of income tax expense for the periods ended June 30 are:

(PPL)
Three Months
Six Months
2012
2011
2012
2011
Reconciliation of Income Tax Expense
Federal income tax on Income from Continuing Operations Before
Income Taxes at statutory tax rate - 35%
$
128
$
104
$
409
$
323
Increase (decrease) due to:
State income taxes, net of federal income tax benefit
7
14
32
39
State valuation allowance adjustments (a)
11
Impact of lower U.K. income tax rates (b)
(24)
(11)
(45)
(19)
U.S. income tax on foreign earnings - net of foreign tax credit (c)
(1)
(11)
1
(17)
Federal and state tax reserve adjustments
(4)
(2)
(5)
(3)
Foreign tax reserve adjustments (d)
(8)
(5)
Federal income tax credits
(3)
(2)
(7)
(7)
Amortization of investment tax credit
(3)
(1)
(5)
(4)
Depreciation not normalized (a)
(2)
(2)
(4)
(6)
State deferred tax rate change (e)
(11)
Net operating loss carryforward adjustments (f)
(3)
(9)
Nondeductible acquisition-related costs (g)
8
8
Other
1
(1)
(4)
(6)
Total increase (decrease)
(40)
(8)
(62)
(4)
Total income taxes from continuing operations
$
88
$
96
$
347
$
319

(a)
In February 2011, the Pennsylvania Department of Revenue issued interpretive guidance on the treatment of bonus depreciation for Pennsylvania income tax purposes.  In accordance with Corporation Tax Bulletin 2011-01, Pennsylvania allows 100% bonus depreciation for qualifying assets in the same year bonus depreciation is allowed for federal tax purposes.  Due to the decrease in projected taxable income related to bonus depreciation, PPL recorded state deferred income tax expense during the six months ended June 30, 2011 related to valuation allowances.

42

Additionally, the 100% Pennsylvania bonus depreciation deduction created a current state income tax benefit for the flow-through impact of Pennsylvania regulated state tax depreciation.  The federal provision for 100% bonus depreciation generally applies to property placed into service before January 1, 2012.  The placed in service deadline is extended to January 1, 2013 for property that exceeds $1 million, has a production period longer than one year and has a tax life of at least ten years.
(b)
The U.K. Finance Act of 2011, enacted in July 2011, reduced the U.K. statutory income tax rate from 27% to 26% retroactive to April 1, 2011 and from 26% to 25% effective April 1, 2012.

The U.K. Finance Act of 2010, enacted in July 2010, reduced the U.K. statutory income tax rate from 28% to 27% effective April 1, 2011.
(c)
During the three and six months ended June 30, 2011, PPL recorded a $7 million and $14 million federal income tax benefit related to U.K. pension contributions.
(d)
During the three and six months ended June 30, 2012, PPL recorded a tax benefit following resolution of a U.K. tax issue related to interest expense.
(e)
During the six months ended June 30, 2012, PPL recorded an adjustment related to state deferred tax liabilities.
(f)
During the three and six months ended June 30, 2012, PPL recorded adjustments to deferred taxes related to net operating loss carryforwards of LKE based on income tax return adjustments.
(g)
During the three and six months ended June 30, 2011, PPL recorded non-deductible acquisition-related costs (primarily the U.K. stamp duty tax) associated with its acquisition of WPD Midlands.

PPL has evaluated the impact of the change in earnings estimates on its projected annual effective tax rate.  The result of the change in estimate reduced income tax expense for the three months ended June 30, 2012 by $13 million ($0.02 per share, basic and diluted).

In July 2012, the U.K. Finance Act of 2012 (the Act) was enacted.  The Act reduced the U.K.'s statutory income tax rate from 25% to 24%, effective April 1, 2012 and from 24% to 23%, effective April 1, 2013.  As a result of these changes, PPL expects to record a deferred tax benefit in the range of $65 million to $75 million in the third quarter of 2012.

(PPL Energy Supply)
Three Months
Six Months
2012
2011
2012
2011
Reconciliation of Income Tax Expense
Federal income tax on Income from Continuing Operations Before
Income Taxes at statutory tax rate - 35%
$
10
$
52
$
180
$
176
Increase (decrease) due to:
State income taxes, net of federal income tax benefit
1
10
24
27
State valuation allowance adjustments (a)
6
Federal income tax credits
(2)
(1)
(6)
(6)
State deferred tax rate change (b)
(11)
Other
(2)
(1)
(2)
Total increase (decrease)
(1)
7
6
25
Total income taxes from continuing operations
$
9
$
59
$
186
$
201

(a)
In February 2011, the Pennsylvania Department of Revenue issued interpretive guidance on the treatment of bonus depreciation for Pennsylvania income tax purposes.  In accordance with Corporation Tax Bulletin 2011-01, Pennsylvania allows 100% bonus depreciation for qualifying assets in the same year bonus depreciation is allowed for federal tax purposes.  Due to the decrease in projected taxable income related to bonus depreciation, PPL Energy Supply recorded state deferred income tax expense during the six months ended June 30, 2011 related to valuation allowances.
(b)
During the six months ended June 30, 2012, PPL Energy Supply recorded an adjustment related to state deferred tax liabilities.

(PPL Electric)
Three Months
Six Months
2012
2011
2012
2011
Reconciliation of Income Tax Expense
Federal income tax on Income Before Income Taxes at statutory
tax rate - 35%
$
14
$
21
$
34
$
48
Increase (decrease) due to:
State income taxes, net of federal income tax benefit
3
3
5
7
Federal and state tax reserve adjustments
(2)
(2)
(3)
(4)
Federal and state income tax return adjustments (a)
(2)
Depreciation not normalized (a)
(3)
(2)
(4)
(5)
Other
(1)
(1)
(1)
(2)
Total increase (decrease)
(3)
(2)
(3)
(6)
Total income taxes
$
11
$
19
$
31
$
42

(a)
In February 2011, the Pennsylvania Department of Revenue issued interpretive guidance on the treatment of bonus depreciation for Pennsylvania income tax purposes.  In accordance with Corporation Tax Bulletin 2011-01, Pennsylvania allows 100% bonus depreciation for qualifying assets in the same year bonus depreciation is allowed for federal tax purposes.  The 100% Pennsylvania bonus depreciation deduction created a current state income tax benefit for the flow-through impact of Pennsylvania regulated state tax depreciation.  The federal provision for 100% bonus depreciation generally applies to property placed in service before January 1, 2012.

43

(LKE)
Three Months
Six Months
2012
2011
2012
2011
Reconciliation of Income Tax Expense
Federal income tax on Income from Continuing Operations Before
Income Taxes at statutory tax rate - 35%
$
25
$
23
$
50
$
70
Increase (decrease) due to:
State income taxes, net of federal income tax benefit
2
2
7
Amortization of investment tax credit
(1)
(1)
(3)
(3)
Net operating loss carryforward adjustments (a)
(3)
(9)
Other
(1)
1
(1)
Total increase (decrease)
(5)
1
(9)
3
Total income taxes from continuing operations
$
20
$
24
$
41
$
73

(a)
During the three and six months ended June 30, 2012, LKE recorded adjustments to deferred taxes related to net operating loss carryforwards based on income tax return adjustments.  The impact of these adjustments was not material to any previously reported financial statements, and is not expected to be material to the financial statements for the full year of 2012.

(LG&E)
Three Months
Six Months
2012
2011
2012
2011
Reconciliation of Income Tax Expense
Federal income tax on Income Before Income Taxes at statutory
tax rate - 35%
$
14
$
11
$
28
$
33
Increase (decrease) due to:
State income taxes, net of federal income tax benefit
1
1
3
3
Other
(1)
(2)
(2)
Total increase (decrease)
1
1
1
Total income taxes
$
14
$
12
$
29
$
34

(KU)
Three Months
Six Months
2012
2011
2012
2011
Reconciliation of Income Tax Expense
Federal income tax on Income Before Income Taxes at statutory
tax rate - 35%
$
17
$
17
$
38
$
48
Increase (decrease) due to:
State income taxes, net of federal income tax benefit
2
2
4
4
Other
(1)
(1)
(2)
(2)
Total increase (decrease)
1
1
2
2
Total income taxes
$
18
$
18
$
40
$
50

Unrecognized Tax Benefits (PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU)

Changes to unrecognized tax benefits for the periods ended June 30 were as follows.

Three Months
Six Months
2012
2011
2012
2011
PPL
Beginning of period
$
121
$
251
$
145
$
251
Additions based on tax positions of prior years
1
4
1
Reductions based on tax positions of prior years
(4)
(31)
Additions based on tax positions related to the current year
1
Reductions based on tax positions related to the current year
(2)
(1)
(2)
(2)
Lapse of applicable statutes of limitations
(2)
(3)
(4)
(5)
Effects of foreign currency translation
2
5
End of period
$
113
$
250
$
113
$
250
PPL Energy Supply
Beginning of period
$
31
$
28
$
28
$
183
Additions based on tax positions of prior years
4
Reductions based on tax positions of prior years
(1)
Derecognize unrecognized tax benefits (a)
(155)
End of period
$
31
$
28
$
31
$
28

44

Three Months
Six Months
2012
2011
2012
2011
PPL Electric
Beginning of period
$
46
$
59
$
73
$
62
Reductions based on tax positions of prior years
(1)
(27)
Additions based on tax positions related to the current year
1
Reductions based on tax positions related to the current year
(1)
Lapse of applicable statutes of limitations
(2)
(3)
(4)
(5)
End of period
$
43
$
56
$
43
$
56

(a)
Represents unrecognized tax benefits derecognized as a result of PPL Energy Supply's distribution of its membership interest in PPL Global to PPL Energy Supply's parent, PPL Energy Funding.  See Note 9 in PPL Energy Supply's 2011 Form 10-K for additional information on the distribution.

LKE's, LG&E's and KU's unrecognized tax benefits and changes in those unrecognized tax benefits are insignificant for the three and six months ended June 30, 2012 and 2011.

At June 30, 2012, it was reasonably possible that during the next 12 months the total amount of unrecognized tax benefits could increase or decrease by the following amounts.  For LKE, LG&E and KU, no significant changes in unrecognized tax benefits are projected over the next 12 months.

Increase
Decrease
PPL
$
21
$
106
PPL Energy Supply
1
31
PPL Electric
22
38

These potential changes could result from subsequent recognition, derecognition and/or changes in the measurement of uncertain tax positions related to the creditability of foreign taxes, the timing and utilization of foreign tax credits and the related impact on alternative minimum tax and other credits, the timing and/or valuation of certain deductions, intercompany transactions and unitary filing groups.  The events that could cause these changes are direct settlements with taxing authorities, litigation, legal or administrative guidance by relevant taxing authorities and the lapse of an applicable statute of limitation.

At June 30, the total unrecognized tax benefits and related indirect effects that, if recognized, would decrease the effective tax rate were as follows.  The amounts for LKE, LG&E and KU were insignificant.

2012
2011
PPL
$
36
$
185
PPL Energy Supply
14
12
PPL Electric
5
10

Other (PPL, PPL Energy Supply and PPL Electric)

PPL changed its method of accounting for repair expenditures for tax purposes effective for its 2008 tax year for the Pennsylvania generation, transmission and distribution operations.  The same change was made for the Montana generation operations for 2009.

In August 2011, the IRS issued Rev. Procs. 2011-42 and 2011-43.  Rev. Proc. 2011-42 provides guidance regarding the use and evaluation of statistical samples and sampling estimates.  Rev. Proc. 2011-43 provides a safe harbor method of determining whether the repair expenditures for electric transmission and distribution property can be currently deducted for tax purposes.  PPL will adopt the safe harbor method with the filing of its 2011 federal income tax return, expected to occur in the third quarter of 2012.  The adoption of the safe harbor method is not expected to result in a material change to income tax expense.

The IRS has not issued guidance to provide a safe harbor method for repair expenditures for generation property.  The IRS may assert and ultimately conclude that PPL's deduction for generation-related expenditures should be disallowed in whole or in part.  PPL believes that it has established an adequate reserve for this contingency.

45

Tax Litigation (PPL)

In 1997, the U.K. imposed a Windfall Profits Tax (WPT) on privatized utilities, including WPD.  PPL filed its tax returns for years subsequent to its 1997 and 1998 claim for refund on the basis that the U.K. WPT was creditable.  In September 2010, the U.S. Tax Court (Tax Court) ruled in PPL's favor in a dispute with the IRS, concluding that the U.K. WPT is a creditable tax for U.S. tax purposes.  As a result, and with finalization of other issues, PPL recorded a $42 million tax benefit in 2010.  In January 2011, the IRS appealed the Tax Court's decision to the U.S. Court of Appeals for the Third Circuit (Third Circuit).  In December 2011, the Third Circuit issued its opinion reversing the Tax Court's decision, holding that the U.K. WPT is not a creditable tax.  As a result of the Third Circuit's adverse determination, PPL recorded a $39 million expense in the fourth quarter of 2011.  In February 2012, PPL filed a petition for rehearing of the Third Circuit's opinion.  In March 2012, the Third Circuit denied PPL's petition.  In June 2012, the U.S. Court of Appeals for the Fifth Circuit issued a contrary opinion in an identical case involving another company.  In July 2012, PPL filed a petition for a writ of certiorari seeking U.S. Supreme Court review of the Third Circuit's opinion.

6.  Utility Rate Regulation

(PPL, PPL Electric, LKE, LG&E and KU)

The following table provides information about the regulatory assets and liabilities of cost-based rate-regulated utility operations.

PPL
PPL Electric
June 30,
December 31,
June 30,
December 31,
2012
2011
2012
2011
Current Regulatory Assets:
Gas supply clause
$
7
$
6
Fuel adjustment clause
10
3
Total current regulatory assets
$
17
$
9
Noncurrent Regulatory Assets:
Defined benefit plans
$
595
$
615
$
270
$
276
Taxes recoverable through future rates
297
289
297
289
Storm costs
148
154
32
31
Unamortized loss on debt
103
110
71
77
Interest rate swaps
71
69
Accumulated cost of removal of utility plant
62
53
62
53
Coal contracts (a)
7
11
AROs
23
18
Other
29
30
2
3
Total noncurrent regulatory assets
$
1,335
$
1,349
$
734
$
729

Current Regulatory Liabilities:
Generation supply charge
$
21
$
42
$
21
$
42
ECR
9
7
Gas supply clause
5
6
Transmission service charge
4
2
4
2
Transmission formula rate
7
7
Universal service rider
7
7
Other
5
16
3
9
Total current regulatory liabilities
$
58
$
73
$
42
$
53
Noncurrent Regulatory Liabilities:
Accumulated cost of removal of utility plant
$
666
$
651
Coal contracts (a)
161
180
Power purchase agreement - OVEC (a)
112
116
Net deferred tax assets
37
39
Act 129 compliance rider
9
7
$
9
$
7
Defined benefit plans
10
9
Other
8
8
Total noncurrent regulatory liabilities
$
1,003
$
1,010
$
9
$
7
46

LKE
LG&E
KU
June 30,
December 31,
June 30,
December 31,
June 30,
December 31,
2012
2011
2012
2011
2012
2011
Current Regulatory Assets:
Gas supply clause
$
7
$
6
$
7
$
6
Fuel adjustment clause
10
3
6
3
$
4
Total current regulatory assets
$
17
$
9
$
13
$
9
$
4
Noncurrent Regulatory Assets:
Defined benefit plans
$
325
$
339
$
215
$
225
$
110
$
114
Storm costs
116
123
63
66
53
57
Unamortized loss on debt
32
33
21
21
11
12
Interest rate swaps
71
69
71
69
Coal contracts (a)
7
11
3
5
4
6
AROs
23
18
12
11
11
7
Other
27
27
6
6
21
21
Total noncurrent regulatory assets
$
601
$
620
$
391
$
403
$
210
$
217

Current Regulatory Liabilities:
ECR
$
9
$
7
$
9
$
7
Gas supply clause
5
6
$
5
$
6
Other
2
7
2
4
3
Total current regulatory liabilities
$
16
$
20
$
7
$
10
$
9
$
10
Noncurrent Regulatory Liabilities:
Accumulated cost of removal
of utility plant
$
666
$
651
$
291
$
286
$
375
$
365
Coal contracts (a)
161
180
70
78
91
102
Power purchase agreement - OVEC (a)
112
116
78
80
34
36
Net deferred tax assets
37
39
30
31
7
8
Defined benefit plans
10
9
10
9
Other
8
8
3
3
5
5
Total noncurrent regulatory liabilities
$
994
$
1,003
$
472
$
478
$
522
$
525

(a)
These regulatory assets and liabilities were recorded as offsets to certain intangible assets and liabilities that were recorded at fair value upon the acquisition of LKE.

Regulatory Matters

Kentucky Activities (PPL, LKE, LG&E and KU)

CPCN Filing

In September 2011, LG&E and KU filed a CPCN with the KPSC requesting approval to build a 640 MW NGCC at the existing Cane Run plant site in Kentucky.  In May 2012, the KPSC issued an order approving the request to build the NGCC.  LG&E will own a 22% undivided interest, and KU will own a 78% undivided interest in the new NGCC.  A formal request for recovery of the costs associated with the NGCC construction was not included in the CPCN filing with the KPSC but is expected to be included in future rate proceedings.  See Note 8 for additional information.

In conjunction with this construction and to meet new, stricter EPA regulations with a 2015 compliance date, LG&E and KU anticipate retiring three coal-fired generating units at LG&E's Cane Run plant, one coal-fired generating unit at KU's Tyrone plant and two coal-fired generating units at KU's Green River plant.  These generating units represent 797 MW of combined summer capacity.

The CPCN application also requested approval to purchase the Bluegrass CTs.  The May 2012 KPSC approval included authority to complete the Bluegrass CT acquisition.  In November 2011, LG&E and KU filed an application with the FERC under the Federal Power Act requesting approval to purchase the Bluegrass CTs.  In May 2012, the FERC issued an order conditionally authorizing the acquisition of the Bluegrass CTs, subject to approval by the FERC of satisfactory mitigation measures to address market-power concerns.  After a review of potentially available mitigation options, LG&E and KU determined that the options were not commercially justifiable.  In June 2012, LG&E and KU terminated the purchase contract for the Bluegrass CTs in accordance with its terms and made applicable filings with the KPSC and FERC.  LG&E and KU are currently assessing the impact of the Bluegrass contract termination and potential future generation capacity options.  See Note 8 for additional information.
47

Kentucky Acquisition Commitments

In connection with the September 2010 approval of PPL's acquisition of LKE, LG&E and KU agreed to implement the Acquisition Savings Sharing Deferral (ASSD) methodology whereby LG&E's and KU's adjusted jurisdictional revenues, expenses, and net operating income are calculated each year.  If LG&E's or KU's actual earned rate of return on common equity exceeds 10.75%, half of the excess amount will be deferred as a regulatory liability and ultimately returned to customers.  The first ASSD filing with the KPSC was made on March 30, 2012 based on the 2011 calendar year.  On July 2, 2012, the KPSC issued an order approving the calculations contained in the 2011 ASSD filing and determined that such calculations produced no deferral amounts for the purpose of establishing regulatory liabilities and are proper and in accordance with the settlement agreement.  The ASSD methodology for each of LG&E's and KU's utility operations will terminate on the earlier of the end of 2015 or the first day of the calendar year during which new base rates go into effect, currently expected to be 2013.  Therefore, due to the timing of the current rate case in Kentucky, no further ASSD filings are expected.

Rate Case Proceedings

In June 2012, LG&E and KU filed requests with the KPSC for increases in annual base electric rates of approximately $62 million at LG&E and approximately $82 million at KU and an increase in annual base gas rates of approximately $17 million at LG&E.  The proposed base rate increases would result in electric rate increases of 6.9% at LG&E and 6.5% at KU and a gas rate increase of 7.0% at LG&E and would be effective in January 2013.  LG&E's and KU's applications include requests for authorized returns-on-equity at LG&E and KU of 11% each.  A hearing on these matters is expected to be scheduled during the fourth quarter of 2012.  LG&E and KU cannot predict the outcome of these proceedings.

Pennsylvania Activities (PPL and PPL Electric)

PUC Investigation of Retail Market

In April 2011, the PUC opened an investigation of Pennsylvania's retail electricity market to be conducted in two phases.  Phase one addressed the status of the existing retail market and explored potential changes.  Questions issued by the PUC for this phase of the investigation focused primarily on default service issues.  Phase two was initiated in July 2011 to develop specific proposals for changes to the retail market and default service model.  In December 2011, the PUC issued a final order providing guidance to EDCs on the design of their next default service procurement plan filings.  In December 2011, the PUC also issued a tentative order proposing an intermediate work plan to address issues raised in the investigation.  In March 2012, the PUC entered a final order on the intermediate work plan.  In March 2012, the PUC Staff issued three possible models for the default service "end state" and the PUC held a hearing regarding those three models.  PPL Electric cannot predict the outcome of the investigation or its impact on PPL Electric's financial condition or results of operation.

Legislation - Regulatory Procedures and Mechanisms

In June 2011, the Pennsylvania House Consumer Affairs Committee approved legislation authorizing the PUC to approve regulatory procedures and mechanisms to provide more timely recovery of a utility's costs.  In the first quarter of 2012, the Governor signed an amended version of the legislation (Act 11 of 2012), which became effective April 14, 2012.  The legislation authorizes the PUC to approve two specific ratemaking mechanisms -- a fully projected future test year and, subject to certain conditions, a distribution system improvements charge.  Such alternative ratemaking procedures and mechanisms are important to PPL Electric as it begins a period of significant capital investment to maintain and enhance the reliability of its delivery system, including the replacement of aging distribution assets.  The PUC staff has initiated a process to develop filing guidelines and a model tariff for the distribution system improvements charge.  In August 2012, the PUC issued a Final Implementation Order adopting procedures, guidelines and a model tariff for the implementation of Act 11 of 2012.  No petition requesting permission to establish a distribution system improvements charge may be filed with the PUC before January 1, 2013.

Rate Case Proceeding

In March 2012, PPL Electric filed a request with the PUC to increase distribution rates by approximately $105 million.  The proposed distribution revenue rate increase would result in a 2.9% increase over PPL Electric's total rates at the time of filing and be effective January 1, 2013.  PPL Electric's application includes a request for an authorized return on equity of 11.25%.   Hearings on this matter are scheduled during August 2012 and a decision is expected in the fourth quarter of 2012.  PPL Electric cannot predict the outcome of this proceeding.
48
ACT 129

Act 129 requires Pennsylvania Electric Distribution Companies (EDCs) to meet specified goals for reduction in customer electricity usage and peak demand by specified dates.  EDCs not meeting the requirements of Act 129 are exposed to significant penalties.

Under Act 129, EDCs must file an energy efficiency and conservation plan (EE&C Plan) with the PUC and contract with conservation service providers to implement all or a portion of the EE&C Plan.  Act 129 requires EDCs to cause reduced overall electricity consumption of 1.0% by May 2011 and 3.0% by May 2013 and reduced peak demand of 4.5% for the 100 hours of highest demand by May 2013 (which will be measured during the June 2012 through September 2012 period).  EDCs will be able to recover the costs (capped at 2% of the EDC's 2006 revenue) of implementing their EE&C Plans.  In October 2009, the PUC approved PPL Electric's EE&C Plan.  To date, PPL Electric has met the 2011 requirement, subject to the PUC's verification.

Act 129 requires the PUC to evaluate the costs and benefits of the EE&C program by November 30, 2012 and adopt additional reductions if the benefits of the program exceed the costs.  In March 2012, the PUC began the process of designing Phase II of the EE&C program.  In August 2012, after receiving input from stakeholders, the PUC issued a Final Implementation Order establishing a three-year Phase II program with consumption reduction targets for each EDC.  PPL Electric's reduction target is 2.1%.  The PUC did not establish any demand reduction targets for the Phase II program.  EDCs must file Phase II plans with the PUC by November 1, 2012.

Act 129 also requires the Default Service Provider (DSP) to provide electric generation supply service to customers pursuant to a PUC-approved competitive procurement plan through auctions, requests for proposal and bilateral contracts at the sole discretion of the DSP.  Act 129 requires a mix of spot market purchases, short-term contracts and long-term contracts (4 to 20 years), with long-term contracts limited to 25% of the load unless otherwise approved by the PUC.  The DSP will be able to recover the costs associated with a competitive procurement plan.

The PUC has approved PPL Electric's procurement plan for the period January 1, 2011 through May 31, 2013, and PPL Electric continues to procure power for its PLR obligations under that plan.

The PUC has directed all EDCs to file default service procurement plans for the period June 1, 2013 through May 31, 2015.   PPL Electric filed its plan in May 2012.  In that plan, PPL Electric proposes a process to obtain supply for its default service customers and it proposes a number of initiatives designed to encourage more customers to purchase electricity from the competitive retail market.  The PUC has assigned PPL Electric's plan to an Administrative Law Judge for hearings and a recommended decision.  The PUC is expected to rule on the plan in 2013.
Federal Matters (PPL and PPL Electric )

FERC Formula Rates

Transmission rates are regulated by the FERC.  PPL Electric's transmission revenues are billed in accordance with a FERC-approved PJM open access transmission tariff that utilizes a formula-based rate recovery mechanism.

In May 2010, PPL Electric initiated its formula rate 2010 Annual Update.  In November 2010, a group of municipal customers taking transmission service in PPL Electric's transmission zone filed a preliminary challenge to the update and, in December 2010, filed a formal challenge.  In August 2011, the FERC issued an order substantially rejecting the formal challenge and accepting PPL Electric's 2010 Annual Update.  The group of municipal customers filed a request for rehearing of that order.

In May 2011, PPL Electric initiated its formula rate 2011 Annual Update.  In October 2011, the group of municipal customers filed a preliminary challenge to the update and, in December 2011, filed a formal challenge.  In January 2012, PPL Electric filed a response to that formal challenge.
49
In May 2012, PPL Electric initiated its formula rate 2012 Annual Update which currently is in the 180-day review and challenge period.  PPL Electric cannot predict the outcome of the foregoing proceedings, which remain pending before the FERC.

In March 2012, PPL Electric filed a request with the FERC seeking recovery, over a 34-year period beginning in June 2012, of its unrecovered regulatory asset related to the deferred state tax liability that existed at the time of the transition from the flow-through treatment of state income taxes to full normalization.  This change in tax treatment occurred in 2008 as a result
of prior FERC initiatives that transferred regulatory jurisdiction of certain transmission assets from the PUC to FERC.  A regulatory asset of approximately $50 million related to this transition, classified as taxes recoverable through future rates, is included in "Other Noncurrent Assets - Regulatory assets" on the Balance Sheets at June 30, 2012 and December 31, 2011.  In May 2012, the FERC issued an order approving PPL Electric's request effective June 1, 2012.

U. K. Activities (PPL)

Ofgem Review of Line Loss Calculation

WPD has a $167 million liability recorded at June 30, 2012 compared with $170 million at December 31, 2011, calculated in accordance with Ofgem's accepted methodology, related to the close-out of line losses for the prior price control period, DPCR4.  Ofgem is currently consulting on the methodology to be used by all network operators to calculate the final line loss incentive/penalty for DPCR4.  In October 2011, Ofgem issued a consultation paper citing two potential changes to the methodology, both of which would result in a reduction of the liability.  In March 2012, Ofgem issued a decision regarding the preferred methodology.  In July 2012, Ofgem issued a consultation paper regarding certain aspects of the preferred methodology as it relates to the DPCR4 line loss incentive/penalty and a proposal to delay the target date for making a final decision until April 2013 together with a proposal to remove the line loss incentive/penalty for DPCR5.  PPL cannot predict the outcome of this matter.

7.  Financing Activities

Credit Arrangements and Short-term Debt

(PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU)

The Registrants maintain credit facilities to enhance liquidity, provide credit support, and provide a backstop to commercial paper programs.  The following credit facilities were in place at:

June 30, 2012
December 31, 2011
Letters of
Letters of
Credit Issued
Credit Issued
and
and
Commercial
Commercial
Expiration
Borrowed
Paper
Unused
Borrowed
Paper
Date
Capacity
(a)
Backstop
Capacity
(a)
Backstop
PPL
WPD Credit Facilities
PPL WW Syndicated
Credit Facility (b)
Jan. 2013
£
150
£
110
n/a
£
40
£
111
n/a
WPD (South West)
Syndicated Credit Facility (c)
Jan. 2017
245
n/a
245
n/a
WPD (East Midlands)
Syndicated Credit Facility
Apr. 2016
300
300
£
70
WPD (West Midlands)
Syndicated Credit Facility
Apr. 2016
300
300
71
Uncommitted Credit Facilities
84
£
4
80
3
Total WPD Credit Facilities (d)
£
1,079
£
110
£
4
£
965
£
111
£
144
PPL Energy Supply (e)
Syndicated Credit Facility
Oct. 2016
$
3,000
$
662
$
2,338
$
541
Letter of Credit Facility
Mar. 2013
200
n/a
128
72
n/a
89
Total PPL Energy Supply
Credit Facilities
$
3,200
$
790
$
2,410
$
630
50
June 30, 2012
December 31, 2011
Letters of
Letters of
Credit Issued
Credit Issued
and
and
Commercial
Commercial
Expiration
Borrowed
Paper
Unused
Borrowed
Paper
Date
Capacity
(a)
Backstop
Capacity
(a)
Backstop
PPL Electric (e)
Syndicated Credit Facility (f)
Oct. 2016
$
300
$
196
$
104
$
1
Asset-backed Credit Facility (g)
July 2012
150
n/a
150
n/a
Total PPL Electric Credit Facilities
$
450
$
196
$
254
$
1
LG&E (e) (h)
Syndicated Credit Facility
Oct. 2016
$
400
$
400
KU (e) (h)
Syndicated Credit Facility
Oct. 2016
$
400
$
400
Letter of Credit Facility
Apr. 2014
198
n/a
$
198
n/a
$
198
Total KU Credit Facilities
$
598
$
198
$
400
$
198
(a)
Amounts borrowed are recorded as "Short-term debt" on the Balance Sheets.

(b)
The borrowing outstanding at June 30, 2012 was a USD-denominated borrowing of $174 million, which equated to £110 million at the time of borrowing and bore interest at approximately 1.458%.

(c)
In January 2012, WPD (South West) entered into a new £245 million 5-year syndicated credit facility to replace the previous £210 million 3-year syndicated credit facility that was set to expire in July 2012.  Under the facility, WPD (South West) has the ability to make cash borrowings but cannot request the lenders to issue letters of credit.  WPD (South West) pays customary commitment fees under this facility and borrowings bear interest at LIBOR-based rates plus a margin.  The credit facility contains financial covenants that require WPD (South West) to maintain an interest coverage ratio of not less than 3.0 times consolidated earnings before income taxes, depreciation and amortization and total net debt not in excess of 85% of its RAV, in each case calculated in accordance with the credit facility.

(d)
At June 30, 2012, the U.S. dollar equivalent of unused capacity under WPD's credit facilities was approximately $1.5 billion.

(e)
All credit facilities at PPL Energy Supply, PPL Electric, LG&E and KU also apply to PPL on a consolidated basis for financial reporting purposes.

(f)
In April 2012, PPL Electric increased the capacity of its syndicated credit facility from $200 million.

(g)
PPL Electric participates in an asset-backed commercial paper program through which PPL Electric obtains financing by selling and contributing its eligible accounts receivable and unbilled revenue to a special purpose, wholly owned subsidiary on an ongoing basis.  The subsidiary has pledged these assets to secure loans from a commercial paper conduit sponsored by a financial institution.

At June 30, 2012 and December 31, 2011, $237 million and $251 million of accounts receivable and $87 million and $98 million of unbilled revenue were pledged by the subsidiary under the credit agreement related to PPL Electric's and the subsidiary's participation in the asset-backed commercial paper program.  Based on the accounts receivable and unbilled revenue pledged at June 30, 2012, the amount available for borrowing under the facility was limited to $87 million.  PPL Electric's sale to its subsidiary of the accounts receivable and unbilled revenue is an absolute sale of assets, and PPL Electric does not retain an interest in these assets.  However, for financial reporting purposes, the subsidiary's financial results are consolidated in PPL Electric's financial statements.  PPL Electric performs certain record-keeping and cash collection functions with respect to the assets in return for a servicing fee from the subsidiary.

In July 2012, PPL Electric and the subsidiary extended this agreement to September 2012 and reduced the capacity to $100 million.

(h)
All credit facilities at LG&E and KU also apply to LKE on a consolidated basis for financial reporting purposes.

(PPL and PPL Energy Supply)

PPL Energy Supply maintains a $500 million Facility Agreement expiring June 2017, whereby PPL Energy Supply has the ability to request up to $500 million of committed letter of credit capacity at fees to be agreed upon at the time of each request, based on certain market conditions.  At June 30, 2012, PPL Energy Supply has not requested any capacity for the issuance of letters of credit under this arrangement.

PPL Energy Supply, PPL EnergyPlus, PPL Montour and PPL Brunner Island maintain an $800 million secured energy marketing and trading facility, whereby PPL EnergyPlus will receive credit to be applied to satisfy collateral posting obligations related to its energy marketing and trading activities with counterparties participating in the facility.  The credit amount is guaranteed by PPL Energy Supply, PPL Montour and PPL Brunner Island.  PPL Montour and PPL Brunner Island have granted liens on their respective generating facilities to secure any amount they may owe under their guarantees.  The facility expires in November 2016, but is subject to automatic one-year renewals under certain conditions.  There were no secured obligations outstanding under this facility at June 30, 2012.
51
In April 2012, PPL Energy Supply increased the capacity of its commercial paper program from $500 million to $750 million to provide an additional financing source to fund its short-term liquidity needs, if and when necessary.  Commercial paper issuances are supported by PPL Energy Supply's Syndicated Credit Facility.  At June 30, 2012, PPL Energy Supply had $520 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheet, at a weighted-average interest rate of approximately 0.48%.

In July 2012, PPL Energy Supply entered into uncommitted letter of credit facilities with available capacity of $75 million and $100 million, respectively, which expire in July 2014 and 2015.  Both facilities contain a financial covenant requiring PPL Energy Supply's debt to capitalization not to exceed 65%, as calculated in accordance with the agreements.  PPL Energy Supply will pay customary fees for letters of credit issued under these facilities.

(PPL and PPL Electric)

In May 2012, PPL Electric increased the capacity of its commercial paper program from $200 million to $300 million to provide an additional financing source to fund its short-term liquidity needs, if and when necessary.  Commercial paper issuances are supported by PPL Electric's Syndicated Credit Facility.  At June 30, 2012, PPL Electric had $195 million of
commercial paper outstanding, included in "Short-term debt" on the Balance Sheet, at a weighted-average interest rate of approximately 0.49%.

(PPL, LKE, LG&E and KU)

In February 2012, LG&E and KU each established a commercial paper program for up to $250 million to provide an additional financing source to fund their short-term liquidity needs.  Commercial paper issuances are supported by LG&E's and KU's Syndicated Credit Facilities.  LG&E and KU had no commercial paper outstanding at June 30, 2012.

(PPL Energy Supply, LKE, LG&E and KU)

See Note 11 for discussion of intercompany borrowings.

Long-term Debt and Equity Securities

(PPL)

In April 2012, PPL made a registered underwritten public offering of 9.9 million shares of its common stock. In conjunction with that offering, the underwriters exercised an option to purchase an additional 591 thousand shares of PPL common stock solely to cover over-allotments.

In connection with the registered public offering, PPL entered into forward sale agreements with two counterparties covering the 9.9 million shares of PPL common stock.  Settlement of these initial forward sale agreements will occur no later than April 2013.  As a result of the underwriters' exercise of the overallotment option, PPL entered into additional forward sale agreements covering the additional 591 thousand shares of PPL common stock.  Settlement of the subsequent forward sale agreements will occur in July 2013.  Upon any physical settlement of any forward sale agreement, PPL will issue and deliver to the forward counterparties shares of its common stock in exchange for cash proceeds per share equal to the forward sale price.  The forward sale price will be calculated based on an initial forward price of $27.02 per share reduced during the period the contracts are outstanding as specified in the forward sale agreements. PPL may, in certain circumstances, elect cash settlement or net share settlement for all or a portion of its rights or obligations under the forward sale agreements.

PPL will not receive any proceeds or issue any shares of common stock until settlement of the forward sale agreements.  PPL intends to use any net proceeds that it receives upon settlement to repay short-term debt obligations and for other general corporate purposes.

The forward sale agreements will be classified as equity transactions.  As a result, no amounts will be recorded in the consolidated financial statements until the settlement of the forward sale agreements.  Prior to those settlements, the only impact to the financial statements will be the inclusion of incremental shares within the calculation of diluted EPS using the treasury stock method.

In April 2012, WPD (East Midlands) issued £100 million aggregate principal amount of 5.25% Senior Notes due 2023.  WPD (East Midlands) received proceeds of approximately £111 million, which equated to $178 million at the time of issuance, net of underwriting fees.  The net proceeds were used for general corporate purposes.
52
In June 2012, PPL Capital Funding issued $400 million of 4.20% Senior Notes due 2022.  The notes may be redeemed at PPL Capital Funding's option any time prior to maturity at make-whole redemption prices.  PPL Capital Funding received proceeds of $396 million, net of a discount and underwriting fees, that will be used for general corporate purposes.
In July 2012, PPL Capital Funding gave notice of its election to redeem at par on August 14, 2012, together with interest accrued to the redemption date, the entire $99 million outstanding principal amount of its 6.85% Senior Notes due 2047.
See Note 7 in PPL's 2011 Form 10-K for information on the 2011 Bridge Facility, 2011 Equity Units and the April 2011 issuance of common stock.
(PPL and PPL Energy Supply)
In April 2012, an indirect, wholly owned subsidiary of PPL Energy Supply completed the Ironwood Acquisition.  See Note 8 for information on the transaction and the debt of PPL Ironwood, LLC assumed through consolidation as part of the acquisition.
(PPL and PPL Electric)

In June 2012, PPL Electric redeemed all 2.5 million shares of its 6.25% Series Preference Stock, par value $100 per share.  The price paid for the redemption was the par value, without premium ($250 million in the aggregate).  At December 31, 2011, the preference stock was reflected in "Noncontrolling Interests" on PPL's Balance Sheet and in "Preference stock" on PPL Electric's Balance Sheet.

(PPL and LKE)

In June 2012, LKE completed an exchange of all its outstanding 4.375% Senior Notes due 2021 issued in September 2011 in a transaction not registered under the Securities Act of 1933, for similar securities that were issued in a transaction registered with the SEC.  See Note 7 in PPL's and LKE's 2011 Form 10-K for additional information.

Legal Separateness

(PPL, PPL Energy Supply, PPL Electric and LKE)

The subsidiaries of PPL are separate legal entities.  PPL's subsidiaries are not liable for the debts of PPL.  Accordingly, creditors of PPL may not satisfy their debts from the assets of PPL's subsidiaries absent a specific contractual undertaking by a subsidiary to pay PPL's creditors or as required by applicable law or regulation.  Similarly, absent a specific contractual undertaking or as required by applicable law or regulation, PPL is not liable for the debts of its subsidiaries, nor are its subsidiaries liable for the debts of one another.  Accordingly, creditors of PPL's subsidiaries may not satisfy their debts from the assets of PPL or its other subsidiaries absent a specific contractual undertaking by PPL or its other subsidiaries to pay the creditors or as required by applicable law or regulation.

Similarly, the subsidiaries of PPL Energy Supply, PPL Electric and LKE are each separate legal entities.  These subsidiaries are not liable for the debts of PPL Energy Supply, PPL Electric and LKE.  Accordingly, creditors of PPL Energy Supply, PPL Electric and LKE may not satisfy their debts from the assets of their subsidiaries absent a specific contractual undertaking by a subsidiary to pay the creditors or as required by applicable law or regulation.  Similarly, absent a specific contractual undertaking or as required by applicable law or regulation, PPL Energy Supply, PPL Electric and LKE are not liable for the debts of their subsidiaries, nor are their subsidiaries liable for the debts of one another.  Accordingly, creditors of these subsidiaries may not satisfy their debts from the assets of PPL Energy Supply, PPL Electric and LKE (or their other subsidiaries) absent a specific contractual undertaking by that parent or other subsidiary to pay such creditors or as required by applicable law or regulation.

Distributions and Capital Contributions

(PPL)

In May 2012, PPL declared its quarterly common stock dividend, payable July 2, 2012, at 36.0 cents per share (equivalent to $1.44 per annum).  Future dividends, declared at the discretion of the Board of Directors, will be dependent upon future earnings, cash flows, financial and legal requirements and other factors.

53
(PPL Energy Supply, PPL Electric, LKE, LG&E and KU)
During the six months ended June 30, 2012, the following distributions and capital contributions occurred:

PPL Energy
Supply
PPL Electric
LKE
LG&E
KU
Dividends/distributions paid to parent/member
$
657
$
56
$
60
$
31
$
48
Capital contributions received from parent/member
472
(PPL, LKE, LG&E and KU)
Since the payment of dividends from jurisdictional public utilities is governed by the Federal Power Act, LG&E and KU petitioned the FERC requesting authorization to pay dividends in the future based on retained earnings balances calculated without giving effect to the impact of purchase accounting adjustments for the acquisition of LKE by PPL.  In May 2012, FERC approved the petitions; however, each utility's adjusted equity ratio must equal or exceed 30% of total capitalization in order to pay dividends.  LG&E and KU do not intend to change their dividend practices as a result of this order.
8. Acquisitions , Development and Divestitures

(PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU)

The Registrants periodically evaluate opportunities for potential acquisitions, divestitures and development projects. Development projects are periodically reexamined based on market conditions and other factors to determine whether to proceed with the projects, sell, cancel or expand them, execute tolling agreements or pursue other options.  Any resulting transactions may impact future financial results.

Acquisitions

Ironwood Acquisition (PPL and PPL Energy Supply)

On April 13, 2012, an indirect, wholly owned subsidiary of PPL Energy Supply completed the acquisition from a subsidiary of The AES Corporation of all of the equity interests of AES Ironwood, L.L.C. (subsequently renamed PPL Ironwood, LLC) and AES Prescott, L.L.C. (subsequently renamed PPL Prescott, LLC), which own and operate, respectively, the Ironwood Facility.  The Ironwood Facility began operation in 2001 and, since 2008, PPL EnergyPlus has supplied natural gas for the operation of the Ironwood Facility and received the facility's full electricity output and capacity value pursuant to a tolling agreement that expires in 2021.  See Note 11 in PPL's and PPL Energy Supply's 2011 Form 10-K for additional information on the tolling agreement.  The acquisition provides PPL Energy Supply, through its subsidiaries, operational control of additional combined-cycle gas generation in PJM.

The consideration paid for this acquisition, subject to finalization of working capital, net indebtedness and fair value adjustments, was as follows.

Aggregate enterprise consideration
$
326
Less: Estimated fair value of long-term debt outstanding assumed through consolidation (a)
258
Plus: Restricted cash debt service reserves
17
Cash consideration paid for equity interests (including estimated working capital adjustments)
$
85

(a)
The estimated long-term debt assumed through consolidation consisted of $226 million aggregate principal amount of 8.857% senior secured bonds to be fully repaid by 2025, plus $8 million of debt service reserve loans, and a $24 million estimated fair value adjustment.

Preliminary Purchase Price Allocation

The following table summarizes the preliminary allocation of the purchase price to the estimated fair value of the major classes of assets acquired and liabilities assumed through consolidation, and the effective settlement of the tolling agreement through consolidation.

PP&E
$
505
Long-term debt (current and noncurrent) (a)
(258)
Tolling agreement assets eliminated (b)
(170)
Other net assets
8
Net identifiable assets acquired (c)
$
85

(a)
Represents non-cash activity excluded from the Statement of Cash Flows for the six months ended June 30, 2012.
54
( b )
Represents PPL EnergyPlus' existing assets, primarily an intangible asset , which represented PPL EnergyPlus' rights to and the related accounting for the tolling agreement with PPL Ironwood, LLC prior to the acquisition.  On the acquisition date, PPL Ironwood, LLC recorded a liability, recognized at estimated fair value, for its obligation to PPL EnergyPlus.  The tolling agreement assets of PPL EnergyPlus and the tolling agreement liability of PPL Ironwood, LLC eliminate in consolidation for PPL and PPL Energy Supply as a result of the acquisition, and therefore the agreement is considered effectively settled.  Any difference between the tolling agreement assets and liability will result in a gain or loss on the effective settlement of the agreement.  That amount is currently estimated to be insignificant.
(c)
Goodwill is currently estimated to be insignificant.

At the date of acquisition, total future minimum lease payments to be made by PPL EnergyPlus to PPL Ironwood, LLC under the tolling agreement were $270 million.  These payments, which were included in the total minimum lease payments disclosed in Note 11 of PPL's and PPL Energy Supply's 2011 Form 10-K, will continue to be made by PPL EnergyPlus to PPL Ironwood, LLC following the acquisition, but will eliminate in consolidation.

In addition, Note 20 of PPL's and PPL Energy Supply's 2011 Form 10-K included annual forecasted amortization expense of $15 million for each of the years 2012 through 2016 related to the PPL EnergyPlus tolling agreement intangible asset.  This amortization will eliminate in consolidation for PPL and PPL Energy Supply as PPL Ironwood, LLC is now a subsidiary of PPL Energy Supply as a result of the acquisition.
The purchase price allocation is preliminary and could change in subsequent periods.  The preliminary purchase price allocation was based on PPL Energy Supply's best estimates using information obtained as of the reporting date.  Any changes to the purchase price allocation that result in material changes to the consolidated financial results will be adjusted retrospectively.  The final purchase price allocation is expected to be completed by the end of 2012.  The items pending finalization include, but are not limited to, the valuation of PP&E, long-term debt, certain contractual liabilities, including the tolling agreement, the resulting gain (loss) and goodwill.

Acquisition of WPD Midlands (PPL)

See Notes 1 and 10 in PPL's 2011 Form 10-K for information on PPL's April 1, 2011 acquisition of WPD Midlands.

Separation Benefits - U.K. Regulated Segment

In connection with the 2011 acquisition, PPL completed a reorganization designed to transition WPD Midlands from a functional operating structure to a regional operating structure requiring a smaller combined support structure, reducing duplication and implementing more efficient procedures.  More than 700 employees of WPD Midlands will have received separation benefits as a result of the reorganization by the end of 2012.

Separation benefits totaling $104 million, pre-tax, were associated with the reorganization, of which $93 million was recorded in the second half of 2011.  Additional severance compensation was recorded during the three and six months ended June 30, 2012, as shown in the table below.  The additional severance compensation is included in "Other operation and maintenance" on the Statement of Income.

The changes in the carrying amounts of accrued severance for the periods ended June 30, 2012 was as follows:

Three Months
Six Months
Accrued severance at the beginning of period
$
19
$
21
Severance compensation
4
10
Severance paid
(15)
(23)
Accrued severance at the end of period
$
8
$
8

In addition, during the second quarter of 2011, WPD recognized $6 million of separation costs associated with the dismissal of eight senior executives of WPD Midlands, which is included in "Other operation and maintenance" on the Statements of Income and were not part of the reorganization discussed above.  Of these costs, $2 million relates to early retirement deficiency costs payable under applicable pension plans and $4 million relates to severance compensation.

Pro forma Information

The pro forma operating revenues and net income attributable to PPL for the periods ended June 30, 2011, which includes WPD Midlands as if the acquisition had occurred January 1, 2010, are as follows.

Three Months
Six Months
Operating Revenues - PPL consolidated pro forma
$
2,587
$
5,802
Net Income Attributable to PPL - PPL consolidated pro forma
288
814

55
The pro forma financial information presented above has been derived from the historical consolidated financial statements of PPL and from the historical combined financial statements of WPD Midlands.  Income (loss) from discontinued operations (net of income taxes), which was not significant, was excluded from the pro forma amounts above.

The pro forma adjustments include adjustments to depreciation, net periodic pension costs, interest expense, nonrecurring adjustments and the related income tax effects.  Nonrecurring adjustments for the periods ended June 30, 2011 include the following pre-tax credits (expenses):

Income Statement
Line Item
Three Months
Six Months
2011 Bridge Facility costs
Interest Expense
$
(36)
$
(43)
Foreign currency loss on 2011 Bridge Facility
Other Income (Expense) - net
(58)
(58)
Net hedge gains associated with the 2011 Bridge Facility
Other Income (Expense) - net
63
56
Hedge ineffectiveness
Interest Expense
(12)
(12)
U.K. stamp duty tax
Other Income (Expense) - net
(21)
(21)
Other acquisition-related adjustments
(a)
(42)
(52)
(a)
Primarily includes advisory, accounting and legal fees recorded to "Other Income (Expense) - net" and certain separation benefits recognized during the second quarter of 2011 as noted above recorded in "Other operation and maintenance" on the Statement of Income.

Terminated Bluegrass CTs Acquisition (PPL, LKE, LG&E and KU)

In September 2011, LG&E and KU entered into an asset purchase agreement with Bluegrass Generation for the purchase of the Bluegrass CTs, aggregating approximately 495 MW, plus limited associated contractual arrangements required for operation of the units, for a purchase price of $110 million, pending receipt of applicable regulatory approvals.  In May 2012, the KPSC issued an order approving the request to purchase the Bluegrass CTs.  Also in May 2012, the FERC issued an order conditionally authorizing the acquisition of the Bluegrass CTs, subject to approval by the FERC of satisfactory mitigation measures to address market-power concerns.  After a review of potentially available mitigation options, LG&E and KU determined that the options were not commercially justifiable.  In June 2012, LG&E and KU terminated the asset purchase agreement for the Bluegrass CTs in accordance with its terms and made applicable filings with the KPSC and FERC.  LG&E and KU are currently assessing the impact of the Bluegrass contract termination and potential future generation capacity options.

Development

NGCC Construction (PPL, LKE, LG&E and KU)

In September 2011, LG&E and KU filed a CPCN with the KPSC requesting approval to build a 640 MW NGCC at the existing Cane Run plant site in Kentucky.  In May 2012, the KPSC issued an order approving the request.  Subject to finalizing contracting agreements and permitting activities, construction is expected to begin in 2012 and be completed during 2015.  The project, which includes building a natural gas supply pipeline and related transmission projects, has an estimated cost of approximately $600 million ($130 million for LG&E and $470 million for KU).

In conjunction with this construction and to meet new, stricter federal EPA regulations with a 2015 compliance date, LG&E and KU anticipate retiring six older coal-fired electric generating units at the Cane Run, Green River and Tyrone plants, which have a combined summer capacity rating of 797 MW.  The Cane Run and Green River coal units are anticipated to remain operational until the NGCC generation and associated transmission project is completed.  See Note 6 for additional information.

(PPL and PPL Energy Supply)

Bell Bend COLA

The NRC continues to review the COLA submitted by a PPL Energy Supply subsidiary, PPL Bell Bend, LLC (PPL Bell Bend) for the proposed Bell Bend nuclear generating unit (Bell Bend) to be built adjacent to the Susquehanna plant.  PPL Bell Bend has made no decision to proceed with construction of Bell Bend and expects that such decision will not be made for several years given the anticipated lengthy NRC license approval process.  Additionally, PPL Bell Bend has announced that it does not expect to proceed with construction absent favorable economics, a joint arrangement with other interested parties and a federal loan guarantee or other acceptable financing.  PPL Bell Bend is currently authorized to spend up to $162 million through 2012 on the COLA and other permitting costs (including land costs) necessary for construction.  At June 30, 2012 and December 31, 2011, $142 million and $131 million of costs, which includes capitalized interest, associated with the
56
licensing application were capitalized and are included on the Balance Sheets in noncurrent "Other intangibles."  PPL Bell Bend believes that the estimated fair value of the COLA currently exceeds the costs expected to be capitalized associated with the licensing application.  PPL Bell Bend remains active in the DOE loan guarantee application process.  See Note 8 in PPL's and PPL Energy Supply's 2011 Form 10-K for additional information.

Susquehanna-Roseland Transmission Line (PPL and PPL Electric)

PPL Electric has experienced delays in obtaining necessary National Park Service (NPS) approvals for the Susquehanna-Roseland transmission line and anticipates a delay of the line's in-service date to 2015.  In March 2012, the NPS announced that the route proposed by PPL Electric and PSE&G, previously approved by the Pennsylvania and New Jersey public utility commissions, is the preferred route for the line under the NPS's National Environmental Policy Act review.  The NPS has stated that it expects to issue its record of decision in October 2012.  An appeal of the New Jersey Board of Public Utilities approval of the line is pending before the New Jersey Superior Court Appellate Division.  PPL Electric cannot predict the ultimate outcome or timing of the NPS approval or any further legal challenges to the project.  PJM has developed a strategy to manage potential reliability problems until the line is built.  PPL Electric cannot predict what additional actions, if any, PJM might take in the event of a further delay to its scheduled in-service date for the new line.

At June 30, 2012, PPL Electric's estimated share of the project cost has increased to $560 million from approximately $500 million at December 31, 2011, mainly due to increased material costs.  In July 2012, PPL Electric began pre-construction activities including tree and vegetation removal from the transmission line's right of way and construction of access roads.

See Note 8 in PPL's and PPL Electric's 2011 Form 10-K for additional information.

9.  Defined Benefits

(PPL, PPL Energy Supply and PPL Electric)

Prior to January 1, 2012, the majority of PPL's Montana and Pennsylvania employees were eligible for pension benefits under PPL Montana's cash balance pension plan or PPL's qualified and non-qualified non-contributory defined benefit pension plans with benefits based on length of service and final average pay, as defined by the plans.  Effective January 1, 2012, these plans were closed to newly hired salaried employees.  Newly hired bargaining unit employees will continue to be eligible under these plans based on their collective bargaining agreements.  Salaried employees hired on or after January 1, 2012 will be eligible to participate in the new PPL Retirement Savings Plan, a 401(k) savings plan with enhanced employer matching.  The changes to the plans are not expected to have a significant near-term cost impact.

(PPL, PPL Energy Supply, LKE and LG&E)

Following are the net periodic defined benefit costs (credits) of the plans sponsored by PPL, PPL Energy Supply, LKE and LG&E for the periods ended June 30:

Pension Benefits
Three Months
Six Months
U.S.
U.K.
U.S.
U.K.
2012
2011
2012
2011
2012
2011
2012
2011
PPL
Service cost
$
26
$
23
$
14
$
12
$
52
$
47
$
27
$
17
Interest cost
54
54
85
73
110
109
169
112
Expected return on plan assets
(64)
(61)
(114)
(88)
(130)
(123)
(225)
(140)
Amortization of:
Prior service cost
6
6
1
1
12
12
2
2
Actuarial (gain) loss
11
8
20
15
21
14
40
29
Net periodic defined benefit
costs (credits) prior to
termination benefits
33
30
6
13
65
59
13
20
Termination benefits
2
2
Net periodic defined benefit
costs (credits)
$
33
$
30
$
6
$
15
$
65
$
59
$
13
$
22
PPL Energy Supply
Service cost
$
2
$
1
$
3
$
2
Interest cost
2
2
4
4
Expected return on plan assets
(3)
(2)
(5)
(4)
Amortization of:
Actuarial (gain) loss
1
1
1
Net periodic defined benefit
costs (credits)
$
1
$
2
$
3
$
3
57

Pension Benefits
Three Months
Six Months
2012
2011
2012
2011
LKE
Service cost
$
5
$
6
$
11
$
12
Interest cost
15
17
32
34
Expected return on plan assets
(17)
(16)
(35)
(32)
Amortization of:
Prior service cost
1
1
2
2
Actuarial (gain) loss
6
6
11
11
Net periodic defined benefit
costs (credits)
$
10
$
14
$
21
$
27
LG&E
Service cost
$
1
$
1
$
1
$
1
Interest cost
3
3
7
7
Expected return on plan assets
(4)
(5)
(9)
(9)
Amortization of:
Prior service cost
1
1
1
Actuarial (gain) loss
2
3
5
6
Net periodic defined benefit
costs (credits)
$
2
$
3
$
5
$
6

Other Postretirement Benefits
Three Months
Six Months
2012
2011
2012
2011
PPL
Service cost
$
3
$
3
$
6
$
6
Interest cost
8
8
16
16
Expected return on plan assets
(5)
(5)
(11)
(11)
Amortization of:
Transition obligation
1
1
1
Actuarial (gain) loss
1
1
2
3
Net periodic defined benefit costs (credits)
$
7
$
8
$
14
$
15
LKE
Service cost
$
1
$
1
$
2
$
2
Interest cost
2
2
4
5
Expected return on plan assets
(1)
(1)
(2)
(2)
Amortization of:
Transition obligation
1
1
1
1
Prior service cost
1
2
1
Actuarial (gain) loss
(1)
(1)
Net periodic defined benefit costs (credits)
$
3
$
3
$
6
$
7

(PPL Energy Supply, PPL Electric, LG&E and KU)

In addition to the specific plans they sponsor, PPL Energy Supply subsidiaries are also allocated costs of defined benefit plans sponsored by PPL Services and LG&E is allocated costs of defined benefit plans sponsored by LKE based on their participation in those plans, which management believes are reasonable.  PPL Electric and KU do not directly sponsor any defined benefit plans.  PPL Electric is allocated costs of defined benefit plans sponsored by PPL Services and KU is allocated costs of defined benefit plans sponsored by LKE based on their participation in those plans, which management believes are reasonable.  For the periods ended June 30, PPL Services allocated the following net periodic benefit costs to PPL Energy Supply subsidiaries and PPL Electric, and LKE allocated the following net periodic benefit costs to LG&E and KU, including amounts applied to accounts that are further distributed between capital and expense.

Three Months
Six Months
2012
2011
2012
2011
PPL Energy Supply
$
9
$
8
$
19
$
15
PPL Electric
7
6
15
12
LG&E
3
4
6
8
KU
5
5
9
11
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Expected Cash Flows - U.K. Pension Plans

(PPL)

At June 30, 2012, WPD's expected pension contributions for 2012 are $323 million compared with $161 million as disclosed in PPL's 2011 Form 10-K.  During the six months ended June 30, 2012, contributions of $275 million were made.  The additional contributions are being made to prepay future contribution requirements to fund pension plan deficits.
10. Commitments and Contingencies

Energy Purchase Commitments

(PPL and PPL Energy Supply)

In 2008, PPL EnergyPlus acquired the rights to an existing long-term tolling agreement associated with the output of the Ironwood Facility.  Under the agreement, PPL EnergyPlus has control over the plant's dispatch into the electricity grid and supplies the natural gas necessary to operate the plant.  The tolling agreement extends through 2021.  In April 2012 an indirect, wholly owned subsidiary of PPL Energy Supply acquired the owner of the Ironwood Facility.  See Note 8 for information on the Ironwood Acquisition.

(PPL and PPL Electric)

In 2009, the PUC approved PPL Electric's procurement plan for the period January 2011 through May 2013.  To date, PPL Electric has conducted 12 of its 14 planned competitive solicitations.  The solicitations include a mix of short-term and long-term purchases ranging from five months to ten years to fulfill PPL Electric's obligation to provide for customer supply as a PLR.  In May 2012, PPL Electric filed a plan with the PUC to purchase its electric supply for default customers for the period June 2013 through May 2015.  The plan proposes to buy this electricity twice a year, beginning in April 2013.

(PPL Energy Supply and PPL Electric)

See Note 11 for information on the power supply agreements between PPL EnergyPlus and PPL Electric.

Legal Matters

(PPL, PPL Energy Supply, PPL Electric LKE, LG&E and KU)

PPL and its subsidiaries are involved in legal proceedings, claims and litigation in the ordinary course of business.  PPL and its subsidiaries cannot predict the outcome of such matters, or whether such matters may result in material liabilities, unless otherwise noted.

TC2 Construction (PPL, LKE, LG&E and KU)

In June 2006, LG&E and KU, as well as the Indiana Municipal Power Agency and Illinois Municipal Electric Agency (collectively, TC2 Owners), entered into a construction contract regarding the TC2 project.  The contract is generally in the form of a turnkey agreement for the design, engineering, procurement, construction, commissioning, testing and delivery of the project, according to designated specifications, terms and conditions.  The contract price and its components are subject to a number of potential adjustments which may increase or decrease the ultimate construction price.  During 2009 and 2010, the TC2 Owners received contractual notices from the TC2 construction contractor asserting historical force majeure and excusable event claims for a number of adjustments to the contract price, construction schedule, commercial operations date, liquidated damages or other relevant provisions.  In September 2010, the TC2 Owners and the construction contractor agreed to a settlement to resolve the force majeure and excusable event claims occurring through July 2010 under the TC2 construction contract, which settlement provided for a limited, negotiated extension of the contractual commercial operations date and/or relief from liquidated damage calculations.  With limited exceptions, the TC2 Owners took care, custody and control of TC2 in January 2011.  Pursuant to certain amendments to the construction agreement, the contractor has made and may be required to make additional modifications to the combustion system to allow operation of TC2 on all specified fuels categories.  The provisions of the construction agreement relating to liquidated damages were also amended.  In September 2011, the TC2 Owners and the construction contractor entered into subsequent adjustments to the construction agreement addressing, among other matters, certain historical change order, labor rate and prior liquidated damages amounts.  The
59
remaining issues, plus certain potential warranty matters, are still under discussion with the contractor.  PPL, LKE, LG&E and KU cannot currently predict the outcome of this matter or the potential impact on the capital costs of this project.

WKE Indemnification (PPL and LKE)

See footnote (o) to the table in "Guarantees and Other Assurances" in this Note 10 for information on an LKE indemnity relating to its former WKE lease, including related legal proceedings.

(PPL and PPL Energy Supply)

Montana Hydroelectric Litigation

In November 2004, PPL Montana, Avista Corporation (Avista) and PacifiCorp commenced an action for declaratory judgment in Montana First Judicial District Court seeking a determination that no lease payments or other compensation for their hydroelectric facilities' use and occupancy of certain riverbeds in Montana can be collected by the State of Montana.  This lawsuit followed dismissal on jurisdictional grounds of an earlier federal lawsuit seeking such compensation in the U.S. District Court of Montana.  The federal lawsuit alleged that the beds of Montana's navigable rivers became state-owned trust property upon Montana's admission to statehood, and that the use of them should, under a 1931 regulatory scheme enacted after all but one of the hydroelectric facilities in question were constructed, trigger lease payments for use of land beneath.  In July 2006, the Montana state court approved a stipulation by the State of Montana that it was not seeking compensation for the period prior to PPL Montana's December 1999 acquisition of the hydroelectric facilities.

Following a number of adverse trial court rulings, in 2007 Pacificorp and Avista each entered into settlement agreements with the State of Montana providing, in pertinent part, that each company would make prospective lease payments for use of the State's navigable riverbeds (subject to certain future adjustments), resolving the State's claims for past and future compensation.

Following an October 2007 trial of this matter on damages, in June 2008, the Montana District Court awarded the State retroactive compensation of approximately $35 million for the 2000-2006 period and approximately $6 million for 2007 compensation.  Those unpaid amounts accrued interest at 10% per year.  The Montana District Court also deferred determination of compensation for 2008 and future years to the Montana State Land Board.  In October 2008, PPL Montana appealed the decision to the Montana Supreme Court, requesting a stay of judgment and a stay of the Land Board's authority to assess compensation for 2008 and future periods.  In March 2010, the Montana Supreme Court substantially affirmed the 2008 Montana District Court decision.

In August 2010, PPL Montana filed a petition for a writ of certiorari with the U.S. Supreme Court requesting review of this matter.  In June 2011, the U.S. Supreme Court granted PPL Montana's petition, and in February 2012 the U.S. Supreme Court issued a decision overturning the Montana Supreme Court decision and remanded the case to the Montana Supreme Court for further proceedings consistent with the U.S. Supreme Court's opinion.  As a result, in the fourth quarter of 2011, PPL Montana reversed its total loss accrual of $89 million ($53 million after-tax) which had been recorded prior to the U.S. Supreme Court decision.  PPL Montana believes the U.S. Supreme Court decision resolves certain questions of liability in this case in favor of PPL Montana and leaves open for reconsideration by Montana courts, consistent with the findings of the U.S. Supreme Court, certain other questions.
In March 2012, the case was returned to the Montana Supreme Court and in April 2012 remanded to the Montana First Judicial District Court.  Further proceedings have not yet been scheduled by the District Court.  PPL Montana has concluded it is no longer probable, but it remains reasonably possible, that a loss has been incurred.  While unable to estimate a range of loss, PPL Montana believes that any such amount should not be material.

Bankruptcy of SMGT

In October 2011, SMGT, a Montana cooperative and purchaser of electricity under a long-term supply contract with PPL EnergyPlus expiring in June 2019 (SMGT Contract), filed for protection under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the District of Montana.  At the time of the bankruptcy filing, SMGT was PPL EnergyPlus' largest unsecured credit exposure.
60
The SMGT Contract provided for fixed volume purchases on a monthly basis at established prices.  Pursuant to a court order and subsequent stipulations entered into between the SMGT bankruptcy trustee and PPL EnergyPlus, since the date of its Chapter 11 filing through January 2012, SMGT continued to purchase electricity from PPL EnergyPlus at the price specified in the SMGT Contract, and made timely payments for such purchases, but at lower volumes than as prescribed in the SMGT Contract.  In January 2012, the trustee notified PPL EnergyPlus that SMGT would not purchase electricity under the SMGT Contract for the month of February.  In March 2012, the U.S. Bankruptcy Court for the District of Montana issued an order approving the request of the SMGT trustee and PPL EnergyPlus to terminate the SMGT Contract.  As a result, the SMGT Contract was terminated effective April 1, 2012, allowing PPL EnergyPlus to resell the electricity previously contracted to SMGT under the SMGT Contract to other customers.

PPL EnergyPlus' receivable under the SMGT Contract totaled approximately $22 million at June 30, 2012, which has been fully reserved.  No assurance can be given as to the collectability of the receivable.

In July 2012, PPL EnergyPlus filed its proof of claim in the SMGT bankruptcy proceeding.  The total claim is approximately $375 million, predominantly an unsecured claim representing the value for energy sales that will not occur as a result of the termination of the SMGT Contract.

PPL Energy Supply cannot predict any amounts that it may recover in connection with the SMGT bankruptcy or the prices and other terms on which it will be able to market to third parties the power that SMGT will not purchase from PPL EnergyPlus due to the termination of the SMGT Contract.

Notice of Intent to Sue Colstrip Owners

On July 30, 2012, PPL Montana received a Notice of Intent to Sue for violations of the Clean Air Act at Colstrip Steam Electric Station (Notice) from counsel on behalf of the Sierra Club and the Montana Environmental Information Center (MEIC).  The Notice was also addressed to the Owner or Managing Agent of Colstrip, and to the other Colstrip co-owners: Avista Corporation, Puget Sound Energy, Portland General Electric Company, Northwest Energy and Pacificorp.  The Notice alleges certain violations of the Clean Air Act, including New Source Review, Title V and opacity requirements.  The Notice states that Sierra Club and MEIC will request a United States District Court to impose injunctive relief and civil penalties, require a beneficial environmental project in the areas affected by the alleged air pollution and require reimbursement of Sierra Club's and MEIC's costs of litigation and attorney's fees.  PPL is evaluating the allegations set forth in the Notice and cannot at this time predict the outcome of this matter.

Regulatory Issues

(PPL, PPL Electric, LKE, LG&E and KU)

See Note 6 for information on regulatory matters related to utility rate regulation.

Enactment of Financial Reform Legislation (PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU)

In July 2010, the Dodd-Frank Act was signed into law.  The Dodd-Frank Act includes provisions that impose derivative transaction reporting requirements and require most over-the-counter derivative transactions to be executed through an exchange and to be centrally cleared.  The Dodd-Frank Act also provides that the U.S. Commodity Futures Trading Commission (CFTC) may impose collateral and margin requirements for over-the-counter derivative transactions, as well as capital requirements for certain entity classifications.  Final rules on major provisions in the Dodd-Frank Act are being established through rulemakings.  The rulemakings are scheduled to become effective at different times following
effectiveness of the definitional rule for the term "swap".  In July 2012, the CFTC approved the rule defining swap, which will become effective 60 days after publication of the rule in the Federal Register.  Additionally, in April 2012, the CFTC approved the Final Rule (Final Rule) defining key terms such as "swap dealer."  The definition of swap dealer, among other things, provides a significantly higher de minimis threshold amount of annual derivative transactions in which a party must have engaged in order to be classified as a swap dealer than was provided for in the CFTC's proposed rule, and is an amount that would not currently result in the Registrants being deemed swap dealers.  There are numerous other provisions in the Final Rule, however, that the Registrants have not yet analyzed that could result in their being subject to the more onerous compliance requirements applicable to swap dealers.  Even if the Registrants are not ultimately subject to the compliance requirements applicable to swap dealers, the Dodd-Frank Act and its implementing regulations nevertheless will impose on them significant additional and potentially costly recordkeeping and reporting requirements.  Also, the Registrants could face significantly higher operating costs or may be required to post additional collateral if they are subject to margin requirements as ultimately adopted in the implementing regulations of the Dodd-Frank Act.  The Registrants will continue to evaluate the provisions of the Dodd-Frank Act and its implementing regulations.  At this time, the Registrants cannot predict the impact
61
that the law or its implementing regulations will have on their businesses or operations, or the markets in which they transact business, but could incur material costs related to compliance with the Dodd-Frank Act.

New Jersey Capacity Legislation (PPL, PPL Energy Supply and PPL Electric)

In January 2011, New Jersey enacted a law that intervenes in the wholesale capacity market exclusively regulated by the FERC:  S. No. 2381, 214th Leg. (N.J. 2011) (the Act).  To create incentives for the development of new, in-state electric generation facilities, the Act implements a "long-term capacity agreement pilot program (LCAPP)."  The Act requires New Jersey utilities to pay a guaranteed fixed price for wholesale capacity, imposed by the New Jersey Board of Public Utilities (BPU), to certain new generators participating in PJM, with the ultimate costs of that guarantee to be borne by New Jersey ratepayers.  PPL believes the intent and effect of the LCAPP is to encourage the construction of new generation in New Jersey even when, under the FERC-approved PJM economic model, such new generation would not be economic.  The Act could depress capacity prices in PJM in the short term, impacting PPL Energy Supply's revenues, and harm the long-term ability of the PJM capacity market to incent necessary generation investment throughout PJM.  In February 2011, the PJM Power Providers Group (P3), an organization in which PPL is a member, filed a complaint before the FERC seeking changes in PJM's capacity market rules designed to ensure that subsidized generation, such as may result from the implementation of the LCAPP, will not be able to set capacity prices artificially low as a result of their exercise of buyer market power.  In April 2011, the FERC issued an order granting in part and denying in part P3's complaint and ordering changes in PJM's capacity rules consistent with a significant portion of P3's requested changes.  Several parties have filed appeals of the FERC's order.  PPL, PPL Energy Supply and PPL Electric cannot predict the outcome of this proceeding or the economic impact on their businesses or operations, or the markets in which they transact business.

In addition, in February 2011, PPL and several other generating companies and utilities filed a complaint in U.S. District Court in New Jersey challenging the Act on the grounds that it violates well-established principles under the Supremacy Clause and the Commerce Clause of the U.S. Constitution.  In this action, the plaintiffs request declaratory and injunctive relief barring implementation of the Act by the Commissioners of the BPU.  In October 2011, the court denied the BPU's motion to dismiss the proceeding and the litigation is continuing.  PPL, PPL Energy Supply and PPL Electric cannot predict the outcome of this proceeding or the economic impact on their businesses or operations, or the markets in which they transact business.

Maryland Capacity Order

In April 2012, the Maryland Public Service Commission (MD PSC) ordered three electric utilities in Maryland to enter into long-term contracts to support the construction of new electric generating facilities in Maryland, specifically a 661 MW natural gas-fired combined-cycle generating facility to be owned by CPV Maryland, LLC.  PPL believes the intent and effect of the action by the MD PSC is to encourage the construction of new generation in Maryland even when, under the FERC-approved PJM economic model, such new generation would not be economic.  The MD PSC action could depress capacity prices in PJM in the short term, impacting PPL Energy Supply's revenues, and harm the long-term ability of the PJM capacity market to encourage necessary generation investment throughout PJM.

In April 2012, PPL and several other generating companies filed a complaint in U.S. District Court in Maryland challenging the MD PSC order on the grounds that it violates well-established principles under the Supremacy and Commerce clauses of the U.S. Constitution.  In this action, the plaintiffs request declaratory and injunctive relief barring implementation of the order by the Commissioners of the MD PSC. In August 2012, the court denied the MD PSC and CPV Maryland, LLC motions to dismiss the proceeding and the litigation is continuing. PPL, PPL Energy Supply, and PPL Electric cannot predict the outcome of this proceeding or the economic impact on their businesses or operations, or the markets in which they transact business.

Pacific Northwest Markets (PPL and PPL Energy Supply)

Through its subsidiaries, PPL Energy Supply made spot market bilateral sales of power in the Pacific Northwest during the period from December 2000 through June 2001.  Several parties subsequently claimed refunds at FERC as a result of these sales.  In June 2003, the FERC terminated proceedings to consider whether to order refunds for spot market bilateral sales made in the Pacific Northwest, including sales made by PPL Montana, during the period December 2000 through June 2001.  In August 2007, the U.S. Court of Appeals for the Ninth Circuit reversed the FERC's decision and ordered the FERC to consider additional evidence.  In October 2011, FERC initiated proceedings to consider additional evidence.  At June 30, 2012, there were two remaining claims against PPL Energy Supply totaling $73 million.  In July 2012, PPL Montana and the City of Tacoma, one of the parties claiming refunds at FERC, reached a settlement whereby PPL Montana would pay $75 thousand to resolve the City of Tacoma's $23 million claim, $9 million of which represents interest.  The settlement does not resolve the remaining claim.
62
Although PPL and its subsidiaries believe that they have not engaged in any improper trading or marketing practices affecting the Pacific Northwest markets, PPL and PPL Energy Supply cannot predict the outcome of the above-described proceedings or whether any subsidiaries will be the subject of any additional governmental investigations or named in other lawsuits or refund proceedings.  Consequently, PPL and PPL Energy Supply cannot estimate a range of reasonably possible losses, if any, related to this matter.

(PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU)

FERC Market-Based Rate Authority

In 1998, the FERC authorized LG&E and KU and PPL EnergyPlus to make wholesale sales of electric power and related products at market-based rates.  In those orders, the FERC directed LG&E, KU and PPL EnergyPlus, respectively, to file an updated market analysis within three years after the order, and every three years thereafter.  Since then, periodic market-based rate filings with the FERC have been made by LG&E, KU, PPL EnergyPlus, PPL Electric, PPL Montana and most of PPL Generation's subsidiaries.  These filings consisted of a Northwest market-based rate filing for PPL Montana and a Northeast market-based rate filing for most of the other PPL subsidiaries in PJM's region.  In June 2011, FERC approved PPL's market-based rate update for the Eastern region and PPL's market-based rate update for the Western region.  Also, in June 2011, PPL filed its market-based rate update for the Southeast region, including LG&E and KU in addition to PPL EnergyPlus.  In June 2011, the FERC issued an order approving LG&E's and KU's request for a determination that they no longer be deemed to have market power in the BREC balancing area and removing restrictions on their market-based rate authority in such region.

Currently, a seller granted FERC market-based rate authority may enter into power contracts during an authorized time period.  If the FERC determines that the market is not workably competitive or that the seller possesses market power or is not charging "just and reasonable" rates, it may institute prospective action, but any contracts entered into pursuant to the FERC's market-based rate authority remain in effect and are generally subject to a high standard of review before the FERC can order changes.  Recent court decisions by the U.S. Court of Appeals for the Ninth Circuit have raised issues that may make it more difficult for the FERC to continue its program of promoting wholesale electricity competition through market-based rate authority.  These court decisions permit retroactive refunds and a lower standard of review by the FERC for changing power contracts, and could have the effect of requiring the FERC in advance to review most, if not all, power contracts.  In June 2008, the U.S. Supreme Court reversed one of the decisions of the U.S. Court of Appeals for the Ninth Circuit, thereby upholding the higher standard of review for modifying contracts.  At this time, PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU cannot predict the impact of these court decisions on the FERC's future market-based rate authority program or on their businesses.

Energy Policy Act of 2005 - Reliability Standards

The NERC is responsible for establishing and enforcing mandatory reliability standards (Reliability Standards) regarding the bulk power system.  The FERC oversees this process and independently enforces the Reliability Standards. The Reliability Standards have the force and effect of law and apply to certain users of the bulk power electricity system, including electric utility companies, generators and marketers.  Under the Federal Power Act, the FERC may assess civil penalties of up to $1 million per day, per violation, for certain violations.

LG&E, KU , PPL Electric and certain subsidiaries of PPL Energy Supply monitor their compliance with the Reliability Standards and continue to self-report potential violations of certain applicable reliability requirements and submit accompanying mitigation plans, as required.  The resolution of a number of potential violations is pending.  Any regional reliability entity determination concerning the resolution of violations of the Reliability Standards remains subject to the approval of the NERC and the FERC.

In the course of implementing their programs to ensure compliance with the Reliability Standards by those PPL affiliates subject to the standards, certain other instances of potential non-compliance may be identified from time to time.  The Registrants cannot predict the outcome of these matters, and cannot estimate a range of reasonably possible losses, if any, other than the amounts currently recorded.
63
Environmental Matters - Domestic

(PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU)

Due to the environmental issues discussed below or other environmental matters, it may be necessary for the Registrants to modify, curtail, replace or cease operating certain facilities or operations to comply with statutes, regulations and other requirements of regulatory bodies or courts.  In addition, legal challenges to new environmental permits or rules add to the uncertainty of estimating the future cost impact of these permits and rules.

(PPL, PPL Energy Supply, LKE, LG&E and KU)

Air

CSAPR (formerly Clean Air Transport Rule)

In July 2011, the EPA adopted the CSAPR, which finalizes and renames the Clean Air Transport Rule (Transport Rule) proposed in August 2010.  The CSAPR replaces the EPA's previous CAIR which was invalidated by the U.S. Court of Appeals for the District of Columbia Circuit (the Court) in July 2008.  CAIR subsequently was effectively reinstated by the Court in December 2008, pending finalization of the Transport Rule.  Like CAIR and the proposed Transport Rule, the CSAPR only applies to PPL's fossil-fueled generating plants located in Kentucky and Pennsylvania.

The CSAPR is meant to facilitate attainment of ambient air quality standards for ozone and fine particulates by requiring reductions in sulfur dioxide and nitrogen oxides.  The CSAPR establishes new sulfur dioxide and nitrogen oxide emission allowance cap and trade programs that are more restrictive than previously under CAIR.  The CSAPR provides for two-phased programs of sulfur dioxide and nitrogen oxide emissions reductions, with initial reductions in 2012 and more stringent reductions in 2014.

In December 2011, the Court stayed implementation of the CSAPR and left CAIR in effect pending a final decision on the validity of the rule.  In February 2012, the EPA made revisions to the rule.  Oral arguments on legal challenges to the CSAPR were held, and a final decision on the validity of the rule is expected in 2012.

With respect to the Kentucky fossil-fueled generating plants, the stay of the CSAPR will initially only impact the unit dispatch order.  With the return of the CAIR and the Kentucky companies' significant number of sulfur dioxide allowances, those units will be dispatched with lower operating cost, but slightly higher sulfur dioxide and nitrogen oxide emissions.  However, a key component of the Court's final decision, even if the CSAPR is upheld, will be whether the ruling delays the implementation of the CSAPR by one year for both Phases I and II, or instead continues to require the significant sulfur dioxide and nitrogen oxide reductions associated with Phase II to begin in 2014.  LG&E's and KU's CSAPR compliance strategy is based on over-compliance during Phase I to generate allowances sufficient to cover the expected shortage during the first two years of Phase II (2014 and 2015) when additional pollution control equipment will be installed.  Should Phase I of the CSAPR be shortened to one year, it will be more difficult and costly to provide enough excess allowances in one year to meet the shortage projected for 2014 and 2015.  LG&E and KU have the ability to recover emission allowance expense through the ECR mechanism; however, actual recovery is subject to the outcome of future review proceedings by the KPSC.

PPL Energy Supply's fossil-fueled generating plants can meet both the CAIR and the stayed CSAPR sulfur dioxide emission requirements with the existing scrubbers that were placed in service in 2008 and 2009.  To meet nitrogen oxide standards, under both the CAIR and the stayed CSAPR, PPL Energy Supply would need to buy allowances or make operational changes, the costs of which are not anticipated to be significant.

National Ambient Air Quality Standards

In addition to the reductions in sulfur dioxide and nitrogen oxide emissions required under the CSAPR for its Pennsylvania and Kentucky plants, PPL's fossil-fueled generating plants, including those in Montana, may face further reductions in sulfur dioxide and nitrogen oxide emissions as a result of more stringent national ambient air quality standards for ozone, nitrogen oxide, sulfur dioxide and/or fine particulates.
64
In 2010, the EPA finalized a new one-hour standard for sulfur dioxide, and states are required to identify areas that meet those standards and areas that are in non-attainment.  For non-attainment areas, states are required to develop plans by 2014 to achieve attainment by 2017.  For areas that are in attainment or are unclassifiable, states are required to develop maintenance plans by mid-2013 that demonstrate continued attainment.  In June 2012, the EPA proposed a rule that strengthens the particulate standards.  The EPA expects that states would identify initial non-attainment areas by the end of 2014 and have until 2020 to achieve attainment status for those areas.  States could request an extension to 2025 to comply with the rule.  Until the rule is finalized, PPL, PPL Energy Supply, LKE, LG&E and KU cannot predict which of their facilities may be located in a non-attainment area and what measures would be required to meet attainment status.

PPL, PPL Energy Supply, LKE, LG&E and KU anticipate that some of the measures required for compliance with the CAIR or the CSAPR such as upgraded or new sulfur dioxide scrubbers at some of their plants or, in the case of LG&E and KU, upgraded or new sulfur dioxide scrubbers at the Mill Creek plant and retirement of the Cane Run, Green River, and Tyrone plants, will also be necessary to achieve compliance with the new one-hour sulfur dioxide standard.  If additional reductions were to be required, the economic impact could be significant.

Mercury and Other Hazardous Air Pollutants

In May 2011, the EPA published a proposed regulation providing for stringent reductions of mercury and other hazardous air pollutants.  In February 2012, the EPA published the final rule, known as the Mercury and Air Toxics Standards (MATS), with an effective date of April 16, 2012.  The rule is being challenged by industry groups and states.

The rule provides for a three-year compliance deadline with the potential for a one-year extension as provided under the statute.  Based on their assessment of the need to install pollution control equipment to meet the provisions of the proposed rule, LG&E and KU filed requests with the KPSC for environmental cost recovery to facilitate moving forward with plans to install environmental controls including chemical additive and fabric-filter baghouses to remove certain hazardous air pollutants.  Recovery of the cost of certain controls was granted by the KPSC order issued in December 2011.  See Note 6 for information on LG&E's and KU's anticipated retirement of certain coal-fired electric generating units in response to this and other environmental regulation.  With the publication of the final MATS rule, LG&E and KU are currently assessing whether changes in the final rule warrant revision of their approved compliance plans.

With respect to PPL Energy Supply's Pennsylvania plants, PPL believes that these plants may require installation of chemical additive systems, the cost of which is not expected to be significant.  With respect to the PPL Montana plants, modifications to the current air pollution controls installed on Colstrip may be required, the cost of which is not expected to be significant.  For the Corette plant, additional controls are being evaluated, the cost of which could be significant.  PPL Energy Supply, LG&E and KU are continuing to conduct in-depth reviews of the MATS.

Regional Haze and Visibility

In January 2012, the EPA proposed limited approval of the Pennsylvania regional haze state implementation plan (SIP).  That proposal would essentially approve PPL's analysis that further particulate controls at PPL Energy Supply's Pennsylvania plants are not warranted.  The limited approval does not address deficiencies of the state plan arising from the remand of the CAIR rule.  Previously, the EPA had determined that implementation of the CAIR requirements would meet regional haze BART (Best Available Retrofit Technology) requirements for sulfur dioxide and nitrogen oxides.  In 2012, the EPA finalized a rule providing that implementation of the CSAPR would also meet the BART.  This rule also addresses the Pennsylvania SIP deficiency arising from the CAIR remand; however the rule is expected to be challenged by environmental groups.

In Montana, the EPA Region 8 is developing the regional haze plan as the Montana Department of Environmental Quality declined to develop a BART SIP at this time.  PPL submitted to the EPA its analyses of the visibility impacts of sulfur dioxide, nitrogen oxides and particulate matter emissions for Colstrip Units 1 and 2 and Corette.  PPL's analyses concluded that further reductions are not warranted.  PPL has also submitted data and a high-level analysis of various air emission control options to reduce air emissions related to the non-BART-affected emission sources of Colstrip Units 3 and 4 under the rules.  The analysis shows that any incremental reductions would not be cost effective and that further analysis is not warranted.

In March 2012, the EPA issued its draft Federal Implementation Plan (FIP) of the regional haze rule for Montana.  The draft FIP identified no additional controls for Corette or Colstrip 3 and 4 but proposed a tighter particulate matter (PM) limit for Corette.  Under the draft FIP, Colstrip Units 1 and 2 would require additional controls to meet the proposed more stringent nitrogen oxide and sulfur dioxide limits.  PPL Energy Supply filed comments to the EPA's proposed FIP in June 2012 opposing the nitrogen oxide and sulfur dioxide limits for Colstrip based upon the installation of an SNCR and spare scrubber
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vessel and the PM limit for Corette.  The final FIP is expected in 2012.  The cost of these potential additional controls could be significant depending on the final outcome of this rulemaking.

LG&E and KU also submitted analyses of the visibility impacts of their Kentucky BART-eligible sources to the Kentucky Division for Air Quality (KDAQ).  Only LG&E's Mill Creek plant was determined to have a significant regional haze impact.  The KDAQ has submitted a regional haze SIP to the EPA which requires the Mill Creek plant to reduce its sulfuric acid mist emissions from Units 3 and 4.  After approval of the Kentucky SIP by the EPA and revision of the Mill Creek plant's Title V air permit, LG&E intends to install sorbent injection controls at the plant to reduce sulfuric acid mist emissions.

New Source Review (NSR)

The EPA has continued its NSR enforcement efforts targeting coal-fired generating plants.  The EPA has asserted that modification of these plants has increased their emissions and, consequently, that they are subject to stringent NSR requirements under the Clean Air Act.  In April 2009, PPL received EPA information requests for its Montour and Brunner Island plants.  The requests are similar to those that PPL received several years ago for its Colstrip, Corette and Martins Creek plants.  PPL and the EPA have exchanged certain information regarding this matter.  In January 2009, PPL and other companies that own or operate the Keystone plant in Pennsylvania received a notice of violation from the EPA alleging that certain projects were undertaken without proper NSR compliance.  In May 2012, PPL Montana received an information request regarding projects undertaken during the Spring 2012 maintenance outage at Colstrip Unit 1.  PPL and PPL Energy Supply cannot predict the outcome of these matters, and cannot estimate a range of reasonably possible losses, if any.

In addition, in August 2007, LG&E and KU received information requests for their Mill Creek, Trimble County, and Ghent plants, but have received no further communications from the EPA since providing their responses.  PPL, LKE, LG&E and KU cannot predict the outcome of these matters, and cannot estimate a range of reasonably possible losses, if any.

In March 2009, KU received a notice alleging that KU violated certain provisions of the Clean Air Act's rules governing NSR and prevention of significant deterioration by installing sulfur dioxide scrubbers and SCR controls at its Ghent plant without assessing potential increased sulfuric acid mist emissions.  KU contends that the work in question, as pollution control projects, was exempt from the requirements cited by the EPA.  In December 2009, the EPA issued an information request on this matter.  KU has exchanged settlement proposals and other information with the EPA regarding imposition of additional permit limits and emission controls and anticipates continued settlement negotiations.  In addition, any settlement or future litigation could potentially encompass a September 2007 notice of violation alleging opacity violations at the plant.  Depending on the provisions of a final settlement or the results of litigation, if any, resolution of this matter could involve significant increased operating and capital expenditures.  PPL, LKE and KU cannot predict the final outcome of this matter, but currently do not expect such outcome to result in material losses above the respective amounts accrued by KU.

If PPL subsidiaries are found to have violated NSR regulations, PPL, PPL Energy Supply, LKE, LG&E and KU would, among other things, be required to meet permit limits reflecting Best Available Control Technology (BACT) for the emissions of any pollutant found to have significantly increased due to a major plant modification.  The costs to meet such limits, including installation of technology at certain units, could be significant.

States and environmental groups also have initiated enforcement actions and litigation alleging violations of the NSR regulations by coal-fired generating plants, and PPL, PPL Energy Supply, LKE, LG&E and KU are unable to predict whether such actions will be brought against any of their plants.  See "Legal Matters" above for information on a notice of intent to sue received in July 2012 by PPL Montana and the other owners of Colstrip.

TC2 Air Permit (PPL, LKE, LG&E and KU)

The Sierra Club and other environmental groups petitioned the Kentucky Environmental and Public Protection Cabinet to overturn the air permit issued for the TC2 baseload generating unit, but the agency upheld the permit in an Order issued in September 2007.  In response to subsequent petitions by environmental groups, the EPA ordered certain non-material changes to the permit which were incorporated into a final revised permit issued by the KDAQ in January 2010.  In March 2010, the environmental groups petitioned the EPA to object to the revised state permit.  Until the EPA issues a final ruling on the pending petition and all available appeals are exhausted, PPL, LKE, LG&E and KU cannot predict the outcome of this matter or the potential impact on the capital costs of this project, if any.
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(PPL, PPL Energy Supply, LKE, LG&E and KU)

Greenhouse Gas Regulations and Tort Litigation

As a result of the April 2007 U.S. Supreme Court decision that the EPA has the authority under the Clean Air Act to regulate GHG emissions from new motor vehicles, in April 2010, the EPA and the U.S. Department of Transportation issued light-duty vehicle emissions standards that apply to 2012 model year vehicles.  The EPA has also clarified that this standard, beginning in 2011, also authorized regulation of GHG emissions from stationary sources under the NSR and Title V operating permit provisions of the Clean Air Act.  As a result, any new sources or major modifications to existing GHG sources causing a net significant emissions increase requires the BACT permit limits for GHGs.  These rules were challenged, and in June 2012 the U.S. Court of Appeals for the D.C. Circuit upheld the EPA's regulations.

In addition, in April 2012, the EPA proposed New Source Performance Standards for carbon dioxide emissions from new coal-fired generating units, combined-cycle natural gas units, and integrated gasification combined-cycle units.  The proposal would require new coal plants to achieve the same stringent limitations on carbon-dioxide emissions as the best performing new gas plants.  There presently is no commercially available technology to allow new coal plants to achieve these limitations and, as a result, the EPA's proposal would effectively preclude construction of new coal-fired generation in the future.

At the regional level, ten northeastern states signed a Memorandum of Understanding (MOU) agreeing to establish a GHG emission cap-and-trade program, called the Regional Greenhouse Gas Initiative (RGGI).  The program commenced in January 2009 and calls for stabilizing carbon dioxide emissions, at base levels established in 2005, from electric power plants with capacity greater than 25 MW.  The MOU also provides for a 10% reduction by 2019 in carbon dioxide emissions from base levels.

Pennsylvania has not stated an intention to join the RGGI, but enacted the Pennsylvania Climate Change Act of 2008 (PCCA).  The PCCA established a Climate Change Advisory Committee to advise the PADEP on the development of a Climate Change Action Plan.  In December 2009, the Advisory Committee finalized its Climate Change Action Report which identifies specific actions that could result in reducing GHG emissions by 30% by 2020.  Some of the proposed actions, such as a mandatory 5% efficiency improvement at power plants, could be technically unachievable.  To date, there have been no regulatory or legislative actions taken to implement the recommendations of the report.  In addition, legislation has been introduced that would, if enacted, accelerate solar supply requirements and restrict eligible solar projects to those located in Pennsylvania.  PPL and PPL Energy Supply cannot predict at this time whether this legislation will be enacted.

Eleven western states and certain Canadian provinces established the Western Climate Initiative (WCI) in 2003.  The WCI established a goal of reducing carbon dioxide emissions 15% below 2005 levels by 2020 and developed GHG emission allocations, offsets, and reporting recommendations.  Montana was once a partner in the WCI, but by 2011 had withdrawn, along with several other western states.

In November 2008, the Governor of Kentucky issued a comprehensive energy plan including non-binding targets aimed at promoting improved energy efficiency, development of alternative energy, development of carbon capture and sequestration projects, and other actions to reduce GHG emissions.  In December 2009, the Kentucky Climate Action Plan Council was established to develop an action plan addressing potential GHG reductions and related measures.  To date, the state has yet to issue a final plan.  The impact of any such plan is not now determinable, but the costs to comply with the plan could be significant.

A number of lawsuits have been filed asserting common law claims including nuisance, trespass and negligence against various companies with GHG emitting plants, and the law remains unsettled on these claims.  In September 2009, the U.S. Court of Appeals for the Second Circuit in the case of AEP v. Connecticut reversed a federal district court's decision and ruled that several states and public interest groups, as well as the City of New York, could sue five electric utility companies under federal common law for allegedly causing a public nuisance as a result of their emissions of GHGs.  In June 2011, the U.S. Supreme Court overturned the lower court and held that such federal common law claims were displaced by the Clean Air Act and regulatory actions of the EPA.  In addition, in Comer v. Murphy Oil, the U.S. Court of Appeals for the Fifth Circuit declined to overturn a district court ruling that plaintiffs did not have standing to pursue state common law claims against companies that emit GHGs.  The complaint in the Comer case named the previous indirect parent of LKE as a defendant based upon emissions from the Kentucky plants.  In January 2011, the Supreme Court denied a petition to reverse the Court of Appeals' ruling.  In May 2011, the plaintiffs in the Comer case filed a substantially similar complaint in federal district court in Mississippi against 87 companies, including KU and three other indirect subsidiaries of LKE, under a Mississippi statute that allows the re-filing of an action in certain circumstances.  In March 2012, the court granted
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defendants' motions to dismiss the state common law claims because plaintiffs had previously raised the same claims, plaintiffs lacked standing, plaintiff's claims were displaced by the Clean Air Act, and other grounds.  In April 2012, plaintiffs filed a notice of appeal in the U.S. Court of Appeals for the Fifth Circuit.  Additional litigation in federal and state courts over these issues is continuing.  PPL, LKE and KU cannot predict the outcome of this litigation or estimate a range of reasonably possible losses, if any.

Renewable Energy Legislation (PPL, PPL Energy Supply, LKE, LG&E and KU)

There has been interest in renewable energy legislation at both the state and federal levels.  At the federal level, House and Senate bills proposed in the 111th Congress would have imposed mandatory renewable energy supply and energy efficiency requirements in the 15% to 20% range by approximately 2020.  Earlier in 2011, there were discussions regarding a Clean Energy Standard (CES) that addressed not only renewables but also encouraged clean energy requirements (as yet to be defined).  At this time, neither the renewable energy debate nor the CES discussion is expected to gain momentum at the federal or state levels (beyond what is otherwise already required in Pennsylvania and Montana) in the near term.

PPL and PPL Energy Supply believe there are financial, regulatory and logistical uncertainties related to GHG reductions and the implementation of renewable energy mandates.  These will need to be resolved before the impact of such requirements on PPL and PPL Energy Supply can be estimated.  Such uncertainties, among others, include the need to provide back-up supply to augment intermittent renewable generation, potential generation oversupply that could result from such renewable generation and back-up, impacts to PJM's capacity market and the need for substantial changes to transmission and distribution systems to accommodate renewable energy.  These uncertainties are not directly addressed by proposed legislation.  PPL and PPL Energy Supply cannot predict at this time the effect on their future competitive position, results of operation, cash flows and financial position of renewable energy mandates that may be adopted, although the costs to implement and comply with any such requirements could be significant.

Water/Waste

Coal Combustion Residuals (CCRs) (PPL, PPL Energy Supply, LKE, LG&E and KU)

In June 2010, the EPA proposed two approaches to regulating the disposal and management of CCRs under the Resource Conservation and Recovery Act (RCRA).  CCRs include fly ash, bottom ash and sulfur dioxide scrubber wastes.  The first approach would regulate CCRs as a hazardous waste under Subtitle C of the RCRA.  This approach would materially increase costs and result in early retirements of many coal-fired plants as it would require plants to retrofit their operations to comply with full hazardous waste requirements for the generation of CCRs and associated waste waters through generation, transportation and disposal.  This would also have a negative impact on the beneficial use of CCRs and could eliminate existing markets for CCRs.  The second approach would regulate CCRs as a solid waste under Subtitle D of the RCRA.  This approach would mainly affect disposal and most significantly affect any wet disposal operations.  Under this approach, many of the current markets for beneficial uses would not be affected.  Currently, PPL expects that several of its plants in Kentucky and Montana could be significantly impacted by the requirements of Subtitle D of the RCRA, as these plants are using surface impoundments for management and disposal of CCRs.

The EPA has issued information requests on CCR management practices at numerous plants throughout the power industry as it considers whether or not to regulate CCRs as hazardous waste.  PPL has provided information on CCR management practices at most of its plants in response to the EPA's requests.  In addition, the EPA has conducted follow-up inspections to evaluate the structural stability of CCR management facilities at several PPL plants and PPL has implemented certain actions in response to recommendations from these inspections.

The EPA is continuing to evaluate the unprecedented number of comments it received on its June 2010 proposed regulations.  In October 2011, the EPA issued a Notice of Data Availability (NODA) that requests comments on selected documents that the EPA received during the comment period for the proposed regulations.  In addition, the U.S. House of Representatives in October 2011 approved a bill to modify Subtitle D of the RCRA to provide for the proper management and disposal of CCRs and to preclude the EPA from regulating CCRs under Subtitle C of the RCRA.  The bill has been introduced in the Senate, and the prospect for passage of this legislation is uncertain.

In January 2012, a coalition of environmental groups filed a 60-day notice of intent to sue the EPA for failure to perform nondiscretionary duties under RCRA, which could require a deadline for EPA to issue strict CCR regulations.  In February 2012, a CCR recycling company also issued a 60-day notice of intent to sue the EPA over its timeliness in issuing CCR regulations, but that company requested that the EPA take a Subtitle D approach that would allow for continued recycling of CCRs.  The coalition filed its lawsuit in April 2012.  The EPA has indicated that it will issue another NODA later in 2012 to request comments on the extensive data that the EPA collected from coal-fired power plant operators as part of the EPA's
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Effluent Limitations Guideline rule modification process which the EPA wants to use in the CCR regulatory development process.

PPL, PPL Energy Supply, LKE, LG&E and KU cannot predict at this time the final requirements of the EPA's CCR regulations or potential changes to the RCRA and what impact they would have on their facilities, but the economic impact could be material, if regulated as a hazardous waste.

Martins Creek Fly Ash Release (PPL and PPL Energy Supply)

In 2005, approximately 100 million gallons of water containing fly ash was released from a disposal basin at the Martins Creek plant used in connection with the operation of the plant's two 150 MW coal-fired generating units.  This resulted in ash being deposited onto adjacent roadways and fields, into a nearby creek and the Delaware River.  PPL determined that the release was caused by a failure in the disposal basin's discharge structure.  PPL conducted extensive clean-up and completed studies, in conjunction with a group of natural resource trustees and the Delaware River Basin Commission, evaluating the effects of the release on the river's sediment, water quality and ecosystem.

The PADEP filed a complaint in Pennsylvania Commonwealth Court against PPL Martins Creek and PPL Generation, alleging violations of various state laws and regulations and seeking penalties and injunctive relief.  PPL and the PADEP have settled this matter.  The settlement also required PPL to submit a report on the completed studies of possible natural resource damages.  PPL subsequently submitted the assessment report to the Pennsylvania and New Jersey regulatory agencies and has continued discussing potential natural resource damages and mitigation options with the agencies.  Subsequently, in August 2011 the PADEP submitted its National Resource Damage Assessment report to the court and to the interveners.  In December 2011, the interveners commented on the PADEP report and in February 2012 the PADEP and PPL filed separate responses with the court.  In March 2012, the court dismissed the interveners' case, but the interveners have appealed the dismissal to the Pennsylvania Supreme Court.  The settlement agreement for the Natural Resources Damage Claim has not yet been submitted for public comments, which is the next phase in the process of finalizing the claim.

Through June 30, 2012, PPL Energy Supply has spent $28 million for remediation and related costs and an insignificant remediation liability remains on the balance sheet.  PPL and PPL Energy Supply cannot be certain of the outcome of the natural resource damage assessment or the associated costs, the outcome of any lawsuit that may be brought by citizens or businesses or the exact nature of any other regulatory or legal actions that may be initiated against PPL, PPL Energy Supply or their subsidiaries as a result of the disposal basin release.  However, PPL and PPL Energy Supply currently do not expect such outcomes to result in significant losses above the amounts currently recorded.

Seepages and Groundwater Infiltration - Pennsylvania, Montana and Kentucky

(PPL, PPL Energy Supply, LKE, LG&E and KU)

Seepages or groundwater infiltration have been detected at active and retired wastewater basins and landfills at various PPL, PPL Energy Supply, LKE, LG&E and KU plants.  PPL, PPL Energy Supply, LKE, LG&E and KU have completed or are completing assessments of seepages or groundwater infiltration at various facilities and have completed or are working with agencies to implement abatement measures, where required.  A range of reasonably possible losses cannot currently be estimated.

(PPL and PPL Energy Supply)

In 2007, six plaintiffs filed a lawsuit in the Montana Sixteenth Judicial District Court against the Colstrip plant owners asserting property damage due to seepage from plant wastewater ponds.  A settlement agreement was reached in July 2010, which would have resulted in a payment by PPL Montana, but certain of the plaintiffs later argued the settlement was not final.  The Colstrip plant owners filed a motion to enforce the settlement and in October 2011, the court granted the motion and ordered the settlement to be completed in 60 days.  The plaintiffs appealed the October 2011 order to the Montana Supreme Court, and the court's decision is expected in the second half of 2012.  Therefore, the settlement ordered by the district court is not final.  PPL and PPL Energy Supply cannot predict the outcome of the appeal, although PPL Montana's share of any final settlement is not expected to be significant.
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Clean Water Act 316(b) (PPL, PPL Energy Supply, LKE, LG&E and KU)

The EPA finalized requirements in 2004 for new or modified cooling water intake structures.  These requirements affect where generating plants are built, establish intake design standards and could lead to requirements for cooling towers at new and modified power plants.  In 2009, however, the U.S. Supreme Court ruled that the EPA has discretion to use cost-benefit analysis in determining the best technology available for minimizing adverse environmental impact to aquatic organisms.  The EPA published the proposed rule in April 2011.  The industry and PPL reviewed the proposed rule and submitted comments.  The EPA is evaluating comments and meeting with industry groups to discuss options.  Two NODAs have been issued on the rule that indicate the EPA may be willing to amend the rule based on certain industry group comments and the EPA's comment period on the NODAs has ended.  The final rule is expected to be issued in 2013.  The proposed rule contains two requirements to reduce impact to aquatic organisms.  The first requires all existing facilities to meet standards for the reduction of mortality of aquatic organisms that become trapped against water intake screens regardless of the levels of mortality actually occurring or the cost of achieving the requirements.  The second requirement is to determine and install the best technology available to reduce mortality of aquatic organisms that are pulled through the plant's cooling water system.  A form of cost-benefit analysis is allowed for this second requirement.  This process involves a site-specific evaluation based on nine factors, including impacts to energy delivery reliability and the remaining useful life of the plant.  PPL, PPL Energy Supply, LKE, LG&E and KU cannot reasonably estimate a range of reasonably possible costs, if any, until a final rule is issued, the required studies have been completed, and each state in which they operate has decided how to implement the rule.

Effluent Limitations Guidelines and Standards (PPL, PPL Energy Supply, LKE, LG&E and KU)

In October 2009, the EPA released its Final Detailed Study of the Steam Electric Power Generating effluent limitations guidelines and standards.  The EPA is expected to issue the final regulations in 2014.  PPL, PPL Energy Supply, LKE, LG&E and KU expect the revised guidelines and standards to be more stringent than the current standards especially for sulfur dioxide scrubber wastewater and ash basin discharges, which could result in more stringent discharge permit limits.  In the interim, states may impose more stringent limits on a case-by-case basis under existing authority as permits are renewed.  PPL, PPL Energy Supply, LKE, LG&E and KU are unable to predict the outcome of this matter or estimate a range of reasonably possible costs, but the costs could be significant.

Other Issues (PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU)

In 2006, the EPA significantly decreased to 10 parts per billion (ppb) the drinking water standards related to arsenic.  In Pennsylvania, Montana and Kentucky, this arsenic standard has been incorporated into the states' water quality standards and could result in more stringent limits in NPDES permits for PPL's Pennsylvania, Montana and Kentucky plants.  Subsequently, the EPA developed a draft risk assessment for arsenic that increases the cancer risk exposure by more than 20 times, which would lower the current standard from 10 ppb to 0.1 ppb.  If the lower standard becomes effective, costly treatment would be required to attempt to meet the standard and, at this time, there is no assurance that it could be achieved.  PPL, PPL Energy Supply, LKE, LG&E and KU cannot predict the outcome of the draft risk assessment and what impact, if any, it would have on their plants, but the costs could be significant.

The EPA is reassessing its polychlorinated biphenyls ( PCB) regulations under the Toxics Substance Control Act, which currently allow certain PCB articles to remain in use.  In April 2010, the EPA issued an Advanced Notice of Proposed Rulemaking for changes to these regulations.  This rulemaking could lead to a phase-out of all PCB-containing equipment.  The EPA is planning to propose the revised regulations in late 2012 or 2013.  PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU cannot predict at this time the outcome of these proposed EPA regulations and what impact, if any, they would have on their facilities, but the costs could be significant.

A PPL Energy Supply subsidiary signed a Consent Order and Agreement (COA) with the PADEP in July 2008 under which it agreed, under certain conditions, to take further actions to minimize the possibility of fish kills at its Brunner Island plant.  Fish are attracted to warm water in the power plant discharge channel, especially during cold weather.  Debris at intake pumps can result in a unit trip or reduction in load, causing a sudden change in water temperature.  A barrier has been constructed to prevent debris from entering the river water intake area at a cost that was not significant.

PPL Energy Supply's subsidiary has also investigated alternatives to exclude fish from the discharge channel and submitted three alternatives to the PADEP.  The subsidiary and the PADEP have now concluded that a barrier method to exclude fish is not workable.  In June 2012, a new COA (the Brunner COA) was signed that allows the subsidiary to study a change in cooling tower operational methods that may keep fish from entering the channel.  Should this approach fail, the Brunner COA requires a retrofit of impingement control technology at the intakes to the cooling towers.
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In March 2012, the subsidiary received a draft NPDES permit (renewed) for the Brunner Island plant from the PADEP. This permit includes new water quality-based limits for the scrubber wastewater plant.  Some of these limits may not be achievable with the existing treatment system.  Several agencies and environmental groups commented on the draft permit, raising issues that must be resolved in order to obtain a final permit for the plant.  PPL Energy Supply cannot predict the outcome of the final resolution of the permit issues at this time or what impact, if any, they would have on this facility, but the costs could be significant.

In May 2010, the Kentucky Waterways Alliance and other environmental groups filed a petition with the Kentucky Energy and Environment Cabinet challenging the Kentucky Pollutant Discharge Elimination System permit issued in April 2010, which covers water discharges from the Trimble County plant.  In November 2010, the Cabinet issued a final order upholding the permit.  In December 2010, the environmental groups appealed the order to the Trimble Circuit Court, but the case was subsequently transferred to the Franklin Circuit Court.  PPL, LKE, LG&E, and KU are unable to predict the outcome of this matter or estimate a range of reasonably possible losses, if any.

The EPA and the Army Corps of Engineers are working on a guidance document that will expand the federal government's interpretation of what constitutes "waters of the United States" subject to regulation under the Clean Water Act.  This change has the potential to affect generation and delivery operations, with the most significant effect being the potential elimination of the existing regulatory exemption for plant waste water treatment systems.  The costs that may be imposed on the Registrants as a result of any eventual expansion of this interpretation cannot reliably be estimated at this time.

Superfund and Other Remediation (PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU)

PPL Electric is potentially responsible for costs at several sites listed by the EPA under the federal Superfund program, including the Columbia Gas Plant site, the Metal Bank site and the Ward Transformer site.  Clean-up actions have been or are being undertaken at all of these sites, the costs of which have not been significant to PPL Electric.  However, should the EPA require different or additional measures in the future, or should PPL Electric's share of costs at multi-party sites increase substantially more than currently expected, the costs could be significant.

PPL Electric, LG&E and KU are remediating or have completed the remediation of several sites that were not addressed under a regulatory program such as Superfund, but for which PPL Electric, LG&E and KU may be liable for remediation.  These include a number of former coal gas manufacturing plants in Pennsylvania and Kentucky previously owned or operated or currently owned by predecessors or affiliates of PPL Electric, LG&E and KU.  There are additional sites, formerly owned or operated by PPL Electric, LG&E and KU predecessors or affiliates, for which PPL Electric, LG&E and KU lack information on current site conditions and are therefore unable to predict what, if any, potential liability they may have.

Depending on the outcome of investigations at sites where investigations have not begun or been completed or developments at sites for which PPL Electric, LG&E and KU currently lack information, the costs of remediation and other liabilities could be material.  PPL, PPL Electric, LKE, LG&E and KU are unable to estimate a range of reasonably possible losses, if any, related to these matters.

The EPA is evaluating the risks associated with polycyclic aromatic hydrocarbons and naphthalene, chemical by-products of coal gas manufacturing.  As a result of the EPA's evaluation, individual states may establish stricter standards for water quality and soil cleanup.  This could require several PPL subsidiaries to take more extensive assessment and remedial actions at former coal gas manufacturing plants.  PPL, PPL Electric, LKE, LG&E and KU cannot estimate a range of reasonably possible losses, if any, related to these matters.

From time to time, PPL Energy Supply, PPL Electric, LG&E and KU undertake remedial action in response to spills or other releases at various on-site and off-site locations, negotiate with the EPA and state and local agencies regarding actions necessary for compliance with applicable requirements, negotiate with property owners and other third parties alleging impacts from PPL's operations, and undertake similar actions necessary to resolve environmental matters which arise in the course of normal operations.  Based on analyses to date, resolution of these environmental matters is not expected to have a significant impact on their operations.

Future cleanup or remediation work at sites currently under review, or at sites not currently identified, may result in significant additional costs for the Registrants.
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Environmental Matters - WPD (PPL)

WPD's distribution businesses are subject to environmental regulatory and statutory requirements.  PPL believes that WPD has taken and continues to take measures to comply with the applicable laws and governmental regulations for the protection of the environment.

Other

Nuclear Insurance (PPL and PPL Energy Supply)

PPL Susquehanna is a member of certain insurance programs that provide coverage for property damage to members' nuclear generating plants.  Facilities at the Susquehanna plant are insured against property damage losses up to $2.75 billion under these programs.  PPL Susquehanna is also a member of an insurance program that provides insurance coverage for the cost of replacement power during prolonged outages of nuclear units caused by certain specified conditions.

Under the property and replacement power insurance programs, PPL Susquehanna could be assessed retroactive premiums in the event of the insurers' adverse loss experience.  At June 30, 2012, this maximum assessment was $48 million.

In the event of a nuclear incident at the Susquehanna plant, PPL Susquehanna's public liability for claims resulting from such incident would be limited to $12.6 billion under provisions of The Price-Anderson Act Amendments under the Energy Policy Act of 2005.  PPL Susquehanna is protected against this liability by a combination of commercial insurance and an industry assessment program.

In the event of a nuclear incident at any of the reactors covered by The Price-Anderson Act Amendments under the Energy Policy Act of 2005, PPL Susquehanna could be assessed up to $235 million per incident, payable at $35 million per year.

Employee Relations (PPL, LKE and KU)

In July 2012, KU and the IBEW Local 2100 ratified a three-year labor agreement containing a 2.5% wage increase through July 2013, a subsequent 2.5% wage increase for July 2013 through July 2014 and a wage reopener for July 2014.  The agreement covers approximately 70 employees.

Guarantees and Other Assurances

(PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU)

In the normal course of business, the Registrants enter into agreements that provide financial performance assurance to third parties on behalf of certain subsidiaries.  Such agreements include, for example, guarantees, stand-by letters of credit issued by financial institutions and surety bonds issued by insurance companies.  These agreements are entered into primarily to support or enhance the creditworthiness attributed to a subsidiary on a stand-alone basis or to facilitate the commercial activities in which these subsidiaries enter.

(PPL)

PPL fully and unconditionally guarantees all of the debt securities of PPL Capital Funding.

(PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU)

The table below details guarantees provided at June 30, 2012.  The total recorded liability at June 30, 2012 and December 31, 2011, was $24 million and $14 million for PPL and $20 million and $11 million for LKE.  The probability of expected payment/performance under each of these guarantees is remote except for "WPD guarantee of pension and other obligations of unconsolidated entities" and "Indemnification of lease termination and other divestitures."

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Exposure at
Expiration
June 30, 2012 (a)
Date
PPL
Indemnifications related to the WPD Midlands acquisition
(b)
WPD indemnifications for entities in liquidation and sales of assets
$
290
(c)
2014 - 2018
WPD guarantee of pension and other obligations of unconsolidated entities
89
(d)
2015
Tax indemnification related to unconsolidated WPD affiliates
(e)
PPL Energy Supply (f)
Letters of credit issued on behalf of affiliates
21
(g)
2012 - 2014
Retrospective premiums under nuclear insurance programs
48
(h)
Nuclear claims assessment under The Price-Anderson Act Amendments under The Energy Policy Act of 2005
235
(i)
Indemnifications for sales of assets
262
(j)
2012 - 2025
Indemnification to operators of jointly owned facilities
6
(k)
Guarantee of a portion of a divested unconsolidated entity's debt
22
(l)
2018
PPL Electric (m)
Guarantee of inventory value
19
(n)
2016
LKE (m)
Indemnification of lease termination and other divestitures
301
(o)
2021 - 2023
LG&E and KU (p)
LG&E and KU guarantee of shortfall related to OVEC
(q)
(a)
Represents the estimated maximum potential amount of future payments that could be required to be made under the guarantee.
(b)
Prior to PPL's acquisition, WPD Midlands Holdings Limited had agreed to indemnify certain former directors of a Turkish entity, in which WPD Midlands Holdings Limited previously owned an interest, for any liabilities that may arise as a result of an investigation by Turkish tax authorities, and PPL WEM has received a cross-indemnity from E.ON AG with respect to these indemnification obligations.  Additionally, PPL subsidiaries agreed to provide indemnifications to subsidiaries of E.ON AG for certain liabilities relating to properties and assets owned by affiliates of E.ON AG that were transferred to WPD Midlands in connection with the acquisition.  The maximum exposure and expiration of these indemnifications cannot be estimated because the maximum potential liability is not capped and the expiration date is not specified in the transaction documents.
(c)
In connection with the liquidation of wholly owned subsidiaries that have been deconsolidated upon turning the entities over to the liquidators, certain affiliates of PPL Global have agreed to indemnify the liquidators, directors and/or the entities themselves for any liabilities or expenses arising during the liquidation process, including liabilities and expenses of the entities placed into liquidation.  In some cases, the indemnifications are limited to a maximum amount that is based on distributions made from the subsidiary to its parent either prior or subsequent to being placed into liquidation.  In other cases, the maximum amount of the indemnifications is not explicitly stated in the agreements.  The indemnifications generally expire two to seven years subsequent to the date of dissolution of the entities.  The exposure noted only includes those cases in which the agreements provide for a specific limit on the amount of the indemnification, and the expiration date was based on an estimate of the dissolution date of the entities.

In connection with their sales of various businesses, WPD and its affiliates have provided the purchasers with indemnifications that are standard for such transactions, including indemnifications for certain pre-existing liabilities and environmental and tax matters.  In addition, in connection with certain of these sales, WPD and its affiliates have agreed to continue their obligations under existing third-party guarantees, either for a set period of time following the transactions or upon the condition that the purchasers make reasonable efforts to terminate the guarantees.  Finally, WPD and its affiliates remain secondarily responsible for lease payments under certain leases that they have assigned to third parties.
(d)
As a result of the privatization of the utility industry in the U.K., certain electric associations' roles and responsibilities were discontinued or modified.  As a result, certain obligations, primarily pension-related, associated with these organizations have been guaranteed by the participating members.  Costs are allocated to the members based on predetermined percentages as outlined in specific agreements.  However, if a member becomes insolvent, costs can be reallocated to and are guaranteed by the remaining members.  At June 30, 2012, WPD has recorded an estimated discounted liability based on its current allocated percentage of the total expected costs for which the expected payment/performance is probable.  Neither the expiration date nor the maximum amount of potential payments for certain obligations is explicitly stated in the related agreements.  Therefore, they have been estimated based on the types of obligations.
(e)
Two WPD unconsolidated affiliates were refinanced during 2005.  Under the terms of the refinancing, WPD indemnified the lender against certain tax and other liabilities.  These indemnifications expired in the second quarter of 2012.
(f)
Other than the letters of credit, all guarantees of PPL Energy Supply, on a consolidated basis, also apply to PPL on a consolidated basis for financial reporting purposes.
(g)
Standby letter of credit arrangements under PPL Energy Supply's credit facilities for the purposes of protecting various third parties against nonperformance by PPL.  This is not a guarantee by PPL on a consolidated basis.
(h)
PPL Susquehanna is contingently obligated to pay this amount related to potential retrospective premiums that could be assessed under its nuclear insurance programs.  See "Nuclear Insurance" above for additional information.
(i)
This is the maximum amount PPL Susquehanna could be assessed for each incident at any of the nuclear reactors covered by this Act.  See "Nuclear Insurance" above for additional information.
(j)
PPL Energy Supply's maximum exposure with respect to certain indemnifications and the expiration of the indemnifications cannot be estimated because, in the case of certain indemnification provisions, the maximum potential liability is not capped by the transaction documents and the expiration date is based on the applicable statute of limitations.  The exposure and expiration dates noted are only for those cases in which the agreements provide for specific limits.  The indemnification provisions described below are in each case subject to certain customary limitations, including thresholds for allowable claims, caps on aggregate liability, and time limitations for claims arising out of breaches of most representations and warranties.
73
A subsidiary of PPL Energy Supply has agreed to provide indemnification to the purchaser of the Long Island generation business for damages arising out of any breach of the representations, warranties and covenants under the related transaction agreement and for damages arising out of certain other matters, including liabilities relating to certain renewable energy facilities which were previously owned by one of the PPL subsidiaries sold in the transaction but which were unrelated to the Long Island generation business.  The indemnification provisions for most representations and warranties expired in the third quarter of 2011.

A subsidiary of PPL Energy Supply has agreed to provide indemnification to the purchasers of the Maine hydroelectric facilities for damages arising out of any breach of the representations, warranties and covenants under the respective transaction agreements and for damages arising out of certain other matters, including liabilities of the PPL Energy Supply subsidiary relating to the pre-closing ownership or operation of those hydroelectric facilities.  The indemnification provisions for certain representations and warranties expired in the second quarter of 2011.

Subsidiaries of PPL Energy Supply have agreed to provide indemnification to the purchasers of certain non-core generation facilities sold in March 2011 for damages arising out of any breach of the representations, warranties and covenants under the related transaction agreements and for damages arising out of certain other matters relating to the facilities that were the subject of the transaction, including certain reduced capacity payments (if any) at one of the facilities in the event specified PJM rule changes are proposed and become effective.  The indemnification provisions for most representations and warranties expired in the first quarter of 2012.
(k)
In December 2007, a subsidiary of PPL Energy Supply executed revised owners agreements for two jointly owned facilities, the Keystone and Conemaugh generating plants.  The agreements require that in the event of any default by an owner, the other owners fund contributions for the operation of the generating plants, based upon their ownership percentages.  The non-defaulting owners, who make up the defaulting owner's obligations, are entitled to the generation entitlement of the defaulting owner, based upon their ownership percentage.  The exposure shown reflects the PPL Energy Supply subsidiary's share of the maximum obligation.  The agreements do not have an expiration date.
(l)
A PPL Energy Supply subsidiary owned a one-third equity interest in Safe Harbor Water Power Corporation (Safe Harbor) that was sold in March 2011.  Beginning in 2008, PPL Energy Supply guaranteed one-third of any amounts payable with respect to certain senior notes issued by Safe Harbor.  Under the terms of the sale agreement, PPL Energy Supply continues to guarantee the portion of Safe Harbor's debt, but received a cross-indemnity from the purchaser, secured by a lien on the purchaser's stock of Safe Harbor, in the event PPL Energy Supply is required to make a payment under the guarantee.  The exposure noted reflects principal only.
(m)
All guarantees of PPL Electric and LKE, on a consolidated basis, also apply to PPL on a consolidated basis for financial reporting purposes.
(n)
PPL Electric entered into a contract with a third party logistics firm that provides inventory procurement and fulfillment services.  Under the contract, the logistics firm has title to the inventory purchased for PPL Electric's use.  Upon termination of the contract, PPL Electric has guaranteed to purchase any remaining inventory that has not been used or sold by the logistics firm at the weighted-average cost at which the logistics firm purchased the inventory, thus protecting the logistics firm from reductions in the fair value of the inventory.
(o)
LKE provides certain indemnifications, the most significant of which relate to the termination of the WKE lease in July 2009.  These guarantees cover the due and punctual payment, performance and discharge by each party of its respective present and future obligations.  The most comprehensive of these guarantees is the LKE guarantee covering operational, regulatory and environmental commitments and indemnifications made by WKE under the WKE Transaction Termination Agreement.  This guarantee has a term of 12 years ending July 2021, and a cumulative maximum exposure of $200 million.  Certain items such as non-excluded government fines and penalties fall outside the cumulative cap.  LKE has contested the applicability of the indemnification requirement relating to one matter presented by a counterparty under this guarantee.  Another guarantee with a maximum exposure of $100 million covering other indemnifications expires in 2023.  In May 2012, LKE received an arbitration panel's decision affecting this matter, which granted LKE's indemnitee certain rights of first refusal to purchase excess power at a market-based price rather than at an absolute fixed price.  In July 2012, LKE's indemnitee filed a judicial action in the Henderson Circuit Court, seeking to vacate the arbitration decision.  LKE believes its indemnification obligations in this matter remain subject to various uncertainties, including the legal status of the court's review of the arbitration decision as well as future prices, availability and demand for the subject excess power.  LKE continues to evaluate various legal and commercial options with respect to this indemnification matter.  The ultimate outcomes of the WKE termination-related indemnifications cannot be predicted at this time.  Additionally, LKE has indemnified various third parties related to historical obligations for other divested subsidiaries and affiliates.  The indemnifications vary by entity and the maximum exposures range from being capped at the sale price to no specified maximum; however, LKE is not aware of formal claims under such indemnities made by any party at this time.  LKE could be required to perform on these indemnifications in the event of covered losses or liabilities being claimed by an indemnified party.  For the three and six months ended June 30, 2012, LKE has adjusted its estimated liability for certain of these indemnifications by $9 million ($5 million after-tax or $0.01 per share, basic and diluted, for PPL), which is reflected in "Income (Loss) from Discontinued Operations (net of income taxes)" on the Statement of Income.  The adjustment was recorded in the Kentucky Regulated segment for PPL.  No additional material loss is anticipated by reason of such indemnifications.
(p)
All guarantees of LG&E and KU also apply to PPL and LKE on a consolidated basis for financial reporting purposes.
(q)
Pursuant to a power purchase agreement with OVEC, LG&E and KU are obligated to pay a demand charge which includes, among other charges, decommissioning costs, postretirement and post employment benefits.  The demand charge is expected to cover LG&E's and KU's shares of the cost of these items over the term of the contract.  However, in the event there is a shortfall in covering these costs, LG&E and KU are obligated to pay their share of the excess.  The maximum exposure and the expiration date of these potential obligations are not presently determinable.
The Registrants provide other miscellaneous guarantees through contracts entered into in the normal course of business.  These guarantees are primarily in the form of indemnification or warranties related to services or equipment and vary in duration.  The amounts of these guarantees often are not explicitly stated, and the overall maximum amount of the obligation under such guarantees cannot be reasonably estimated.  Historically, no significant payments have been made with respect to these types of guarantees and the probability of payment/performance under these guarantees is remote.

PPL, on behalf of itself and certain of its subsidiaries, maintains insurance that covers liability assumed under contract for bodily injury and property damage.  The coverage requires a maximum $4 million deductible per occurrence and provides maximum aggregate coverage of $200 million.  This insurance may be applicable to obligations under certain of these contractual arrangements.

74

11.  Related Party Transactions

PLR Contracts/Purchase of Accounts Receivable (PPL Energy Supply and PPL Electric)

PPL Electric holds competitive solicitations for PLR generation supply.  PPL EnergyPlus has been awarded a portion of the PLR generation supply through these competitive solicitations.  See Note 10 for additional information on the solicitations.  PPL Electric's purchases from PPL EnergyPlus totaled $16 million and $38 million for the three and six months ended June 30, 2012 and $4 million and $10 million during the same periods in 2011.  The sales and purchases are included in the Statements of Income as "Wholesale energy marketing to affiliate" by PPL Energy Supply and as "Energy purchases from affiliate" by PPL Electric.

Under the standard Supply Master Agreement for the solicitation process, PPL Electric requires all suppliers to post collateral once credit exposures exceed defined credit limits.  PPL EnergyPlus is required to post collateral with PPL Electric when the aggregate credit exposure with respect to electricity, capacity and other related products to be delivered by PPL EnergyPlus exceeds a contractual credit limit.  Based on the current credit rating and tangible net worth of PPL Energy Supply, as guarantor, PPL EnergyPlus' credit limit was $35 million at June 30, 2012.  In no instance is PPL Electric required to post collateral to suppliers under these supply contracts.

PPL Electric's customers may choose an alternative supplier for their generation supply.  See Note 2 for additional information regarding PPL Electric's purchases of accounts receivable from alternative suppliers, including PPL EnergyPlus.

At June 30, 2012, PPL Energy Supply had a net credit exposure of $38 million from PPL Electric from its commitment as a PLR supplier and from the sale of its accounts receivable to PPL Electric.

Wholesale Sales and Purchases (LG&E and KU)

LG&E and KU jointly dispatch their generation units with the lowest cost generation used to serve their retail native load.  When LG&E has excess generation capacity after serving its own retail native load and its generation cost is lower than that of KU, KU purchases electricity from LG&E.  When KU has excess generation capacity after serving its own retail native load and its generation cost is lower than that of LG&E, LG&E purchases electricity from KU.  These transactions are reflected in the Statements of Income as "Electric revenue from affiliate" and "Energy purchases from affiliate" and are recorded at a price equal to the seller's fuel cost.  Savings realized from such intercompany transactions are shared equally between the two companies.  The volume of energy each company has to sell to the other is dependent on its native load needs and its available generation.

Allocations of Corporate Service Costs (PPL Energy Supply, PPL Electric and LKE)

PPL Services provides corporate functions such as financial, legal, human resources and information technology services.  PPL Services charges the respective PPL subsidiaries for the cost of such services when they can be specifically identified.  The cost of the services that is not directly charged to PPL subsidiaries is allocated to applicable subsidiaries based on an average of the subsidiaries' relative invested capital, operation and maintenance expenses and number of employees.  PPL Services charged the following amounts for the periods ended June 30, which PPL management believes are reasonable, including amounts applied to accounts that are further distributed between capital and expense:

Three Months
Six Months
2012
2011
2012
2011
PPL Energy Supply
$
53
$
44
$
110
$
94
PPL Electric
39
35
81
74
LKE
3
4
8
9

Intercompany Billings by LKS (LG&E and KU)

LKS provides LG&E and KU with a variety of centralized administrative, management and support services.  The cost of these services is directly charged to the company or, for general costs that cannot be directly attributed, charged based on predetermined allocation factors, including the following measures: number of customers, total assets, revenues, number of employees and/or other statistical information.  LKS charged the amounts in the table below for the periods ended June 30, which LKE management believes are reasonable, including amounts that are further distributed between capital and expense:

75

Three Months
Six Months
2012
2011
2012
2011
LG&E
$
40
$
50
$
81
$
83
KU
35
55
81
104

Intercompany Borrowings

(PPL Energy Supply)

A PPL Energy Supply subsidiary periodically holds revolving demand notes from certain affiliates.  At June 30, 2012, there were no balances outstanding.  At December 31, 2011, a note with PPL Energy Funding had an outstanding balance of $198 million with an interest rate of 3.77% that was reflected in "Note receivable from affiliate" on the Balance Sheet.  Interest earned on these revolving facilities is included in "Interest Income from Affiliates" on the Statements of Income.  The interest rates on borrowings are equal to one-month LIBOR plus a spread.  Interest earned on borrowings was insignificant for the three and six months ended June 30, 2012 and 2011.

(LKE)

LKE maintains a $300 million revolving demand note with a PPL Energy Supply subsidiary whereby LKE can borrow funds on a short-term basis at market-based rates.  The interest rates on borrowings are equal to one-month LIBOR plus a spread.  At June 30, 2012 and December 31, 2011, there were no balances outstanding.  Interest expense incurred on the revolving demand note with the PPL Energy Supply subsidiary was not significant for the three and six months ended June 30, 2012 and 2011.

After PPL's acquisition of LKE in November 2010, LKE held a note receivable from a PPL affiliate that has a $300 million borrowing limit whereby LKE can loan funds on a short-term basis at market-based rates.  At June 30, 2012 and December 31, 2011, $12 million and $15 million were outstanding and were reflected in "Notes receivable from affiliates" on the Balance Sheets.  The interest rates on loans are based on the PPL affiliate's credit rating and are currently equal to one-month LIBOR plus a spread.  The interest rates on the outstanding borrowings at June 30, 2012 and December 31, 2011 were 2.24% and 2.27%.  Interest income on the note receivable was not significant for the three and six months ended June 30, 2012 and 2011.

(LG&E)

LG&E participates in an intercompany money pool agreement whereby LKE and/or KU make available to LG&E funds up to $500 million at an interest rate based on a market index of commercial paper issues.  At June 30, 2012 and December 31, 2011, LG&E had no payable balance outstanding, but at June 30, 2012, LG&E had a $6 million receivable balance outstanding, which was reflected in "Notes receivable from affiliates" on the Balance Sheet.  The interest rate on the outstanding receivable at June 30, 2012 was 0.48%.  Interest expense incurred on the money pool agreement with LKE and/or KU was not significant for the three and six months ended June 30, 2012 and 2011.  Interest income on the money pool agreement with LKE and/or KU was not significant for the three and six months ended June 30, 2012.  There was no interest income on the money pool agreement with LKE and/or KU for the three and six months ended June 30, 2011.

(KU)

KU participates in an intercompany money pool agreement whereby LKE and/or LG&E make available to KU funds up to $500 million at an interest rate based on a market index of commercial paper issues.  At June 30, 2012, $6 million was outstanding and was reflected in "Notes payable with affiliates" on the Balance Sheet.  At December 31, 2011, there was no balance outstanding.  The interest rate on the outstanding borrowings at June 30, 2012 was 0.48%.  Interest expense incurred on the money pool agreement with LKE and/or LG&E was not significant for the three and six months ended June 30, 2012 and 2011.

Trademark Royalties (PPL Energy Supply)

A PPL subsidiary owns PPL trademarks and billed certain affiliates for their use under a licensing agreement.  This agreement was terminated in December 2011.  PPL Energy Supply was charged $10 million and $20 million of license fees for the three and six months ended June 30, 2011.  These charges are primarily included in "Other operation and maintenance" on the Statement of Income.
76

Intercompany Insurance (PPL Electric)

PPL Power Insurance Ltd. (PPL Power Insurance) is a subsidiary of PPL that provides insurance coverage to PPL and its subsidiaries for property damage, general/public liability and workers' compensation.

Due to damages resulting from several PUC-reportable storms that occurred in May 2011, PPL Electric exceeded its deductible for the 2011 policy year.  Probable recoveries on insurance claims with PPL Power Insurance of $15 million were recorded during the three and six months ended June 30, 2011, of which $9 million was included in "Other operation and maintenance" on the Statement of Income, and the remainder was recorded in PP&E on the Balance Sheet.

Other (PPL Energy Supply, PPL Electric, LKE, LG&E and KU)

See Note 7 for a discussion regarding capital transactions by PPL Energy Supply, PPL Electric, LKE, LG&E and KU.  For PPL Energy Supply, PPL Electric, LG&E and KU, refer to Note 9 for discussions regarding intercompany allocations associated with defined benefits.

12.  Other Income (Expense) - net

(PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU)

The breakdown of "Other Income (Expense) - net" for the periods ended June 30 was:

Three Months
Six Months
2012
2011
2012
2011
PPL
Other Income
Earnings on securities in NDT funds
$
4
$
3
$
12
$
18
Interest income
2
2
3
4
AFUDC
3
2
5
3
Net hedge gains associated with the 2011 Bridge Facility (a)
62
55
Equity earnings (losses) from unconsolidated affiliates
(4)
(6)
Miscellaneous - Domestic
3
4
5
7
Miscellaneous - U.K.
2
1
2
1
Total Other Income
10
74
21
88
Other Expense
Economic foreign currency exchange contracts (Note 14)
(25)
(2)
(7)
Charitable contributions
2
2
6
5
WPD Midlands acquisition-related costs (Note 8)
26
36
Foreign currency loss on 2011 Bridge Facility (b)
58
58
U.K. stamp duty tax
21
21
Miscellaneous - Domestic
4
1
8
4
Miscellaneous - U.K.
(1)
2
1
3
Total Other Expense
(20)
108
8
127
Other Income (Expense) - net
$
30
$
(34)
$
13
$
(39)
PPL Energy Supply
Other Income
Earnings on securities in NDT funds
$
4
$
3
$
12
$
18
Interest income
1
2
1
2
Miscellaneous
1
1
2
3
Total Other Income
6
6
15
23
Other Expense
Charitable contributions
1
Miscellaneous
1
2
4
5
Total Other Expense
1
2
5
5
Other Income (Expense) - net
$
5
$
4
$
10
$
18

(a)
Represents a gain on foreign currency contracts that hedged the repayment of the 2011 Bridge Facility borrowing.
(b)
Represents a foreign currency loss related to the repayment of the 2011 Bridge Facility borrowing.

"Other Income (Expense) - net" for the three and six months ended June 30, 2012 and 2011 for PPL Electric is primarily AFUDC.  "Other Income (Expense) - net" for the three and six months ended June 30, 2012 for LKE and KU is primarily equity losses from an unconsolidated affiliate.  The components of "Other Income (Expense) - net" for the three and six months ended June 30, 2012 and 2011 for LG&E are not significant.

77

13.  Fair Value Measurements and Credit Concentration

(PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU)

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 (an exit price).  A market approach (generally, data from market transactions), an income approach (generally, present value techniques and option-pricing models), and/or a cost approach (generally, replacement cost) are used to measure the fair value of an asset or liability, as appropriate.  These valuation approaches incorporate inputs such as observable, independent market data and/or unobservable data that management believes are predicated on the assumptions market participants would use to price an asset or liability.  These inputs may incorporate, as applicable, certain risks such as nonperformance risk, which includes credit risk.  The fair value of a group of financial assets and liabilities is measured on a net basis.  Transfers between levels are recognized at end-of-reporting-period values.  During the three and six months ended June 30, 2012, there were no transfers between Level 1 and Level 2.

Recurring Fair Value Measurements

The assets and liabilities measured at fair value were:

June 30, 2012
December 31, 2011
Total
Level 1
Level 2
Level 3
Total
Level 1
Level 2
Level 3
PPL
Assets
Cash and cash equivalents
$
981
$
981
$
1,202
$
1,202
Restricted cash and cash equivalents (a)
176
176
209
209
Price risk management assets:
Energy commodities
3,506
3
$
3,459
$
44
3,423
3
$
3,390
$
30
Interest rate swaps
3
3
Foreign currency contracts
19
19
18
18
Cross-currency swaps
70
60
10
24
20
4
Total price risk management assets
3,595
3
3,538
54
3,468
3
3,431
34
NDT funds:
Cash and cash equivalents
14
14
12
12
Equity securities
U.S. large-cap
317
219
98
292
202
90
U.S. mid/small-cap
127
94
33
117
87
30
Debt securities
U.S. Treasury
96
96
86
86
U.S. government sponsored agency
10
10
10
10
Municipality
81
81
83
83
Investment-grade corporate
35
35
38
38
Other
2
2
2
2
Receivables (payables), net
(1)
(4)
3
(3)
3
Total NDT funds
681
419
262
640
384
256
Auction rate securities (b)
18
3
15
24
24
Total assets
$
5,451
$
1,579
$
3,803
$
69
$
5,543
$
1,798
$
3,687
$
58
Liabilities
Price risk management liabilities:
Energy commodities
$
2,528
$
3
$
2,515
$
10
$
2,345
$
1
$
2,327
$
17
Interest rate swaps
77
77
63
63
Foreign currency contracts
4
4
Cross-currency swaps
2
2
2
2
Total price risk management liabilities
$
2,611
$
3
$
2,598
$
10
$
2,410
$
1
$
2,392
$
17

78

June 30, 2012
December 31, 2011
Total
Level 1
Level 2
Level 3
Total
Level 1
Level 2
Level 3
PPL Energy Supply
Assets
Cash and cash equivalents
$
446
$
446
$
379
$
379
Restricted cash and cash equivalents (a)
110
110
145
145
Price risk management assets:
Energy commodities
3,506
3
$
3,459
$
44
3,423
3
$
3,390
$
30
Total price risk management assets
3,506
3
3,459
44
3,423
3
3,390
30
NDT funds:
Cash and cash equivalents
14
14
12
12
Equity securities
U.S. large-cap
317
219
98
292
202
90
U.S. mid/small-cap
127
94
33
117
87
30
Debt securities
U.S. Treasury
96
96
86
86
U.S. government sponsored agency
10
10
10
10
Municipality
81
81
83
83
Investment-grade corporate
35
35
38
38
Other
2
2
2
2
Receivables (payables), net
(1)
(4)
3
(3)
3
Total NDT funds
681
419
262
640
384
256
Auction rate securities (b)
15
3
12
19
19
Total assets
$
4,758
$
978
$
3,724
$
56
$
4,606
$
911
$
3,646
$
49
Liabilities
Price risk management liabilities:
Energy commodities
$
2,528
$
3
$
2,515
$
10
$
2,345
$
1
$
2,327
$
17
Total price risk management liabilities
$
2,528
$
3
$
2,515
$
10
$
2,345
$
1
$
2,327
$
17
PPL Electric
Assets
Cash and cash equivalents
$
45
$
45
$
320
$
320
Restricted cash and cash equivalents (c)
13
13
13
13
Total assets
$
58
$
58
$
333
$
333

LKE
Assets
Cash and cash equivalents
$
29
$
29
$
59
$
59
Restricted cash and cash equivalents (c)
31
31
29
29
Total assets
$
60
$
60
$
88
$
88
Liabilities
Price risk management liabilities:
Interest rate swaps (d)
$
62
$
62
$
60
$
60
Total liabilities
$
62
$
62
$
60
$
60
LG&E
Assets
Cash and cash equivalents
$
25
$
25
$
25
$
25
Restricted cash and cash equivalents (c)
31
31
29
29
Total assets
$
56
$
56
$
54
$
54
Liabilities
Price risk management liabilities:
Interest rate swaps (d)
$
62
$
62
$
60
$
60
Total liabilities
$
62
$
62
$
60
$
60
KU
Assets
Cash and cash equivalents
$
3
$
3
$
31
$
31
Total assets
$
3
$
3
$
31
$
31

(a)
Current portion is included in "Restricted cash and cash equivalents" and the long-term portion is included in "Other noncurrent assets" on the Balance Sheets.
(b)
Included in "Other investments" on the Balance Sheets.
(c)
Current portion is included in "Other current assets" and the long-term portion is included in "Other noncurrent assets" on the Balance Sheets.
(d)
Current portion is included in "Other current liabilities" and the long-term portion is included in "Price risk management liabilities" on the Balance Sheets.

79

A reconciliation of net assets and liabilities classified as Level 3 for the periods ended June 30, 2012 is as follows:
Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Three Months
Six Months
Energy
Auction
Cross-
Energy
Auction
Cross-
Commodities,
Rate
Currency
Commodities,
Rate
Currency
net
Securities
Swaps
Total
net
Securities
Swaps
Total
PPL
Balance at beginning of
period
$
19
$
24
$
3
$
46
$
13
$
24
$
4
$
41
Total realized/unrealized
gains (losses)
Included in earnings
(2)
(1)
(3)
16
(1)
15
Included in OCI (a)
(1)
(1)
8
6
1
(1)
10
10
Sales
(5)
(5)
(5)
(5)
Settlements
(5)
(5)
(11)
(11)
Transfers into Level 3
14
14
14
14
Transfers out of Level 3
9
(3)
6
1
(3)
(3)
(5)
Balance at end of period
$
34
$
15
$
10
$
59
$
34
$
15
$
10
$
59
PPL Energy Supply
Balance at beginning of
period
$
19
$
19
$
38
$
13
$
19
$
32
Total realized/unrealized
gains (losses)
Included in earnings
(2)
(2)
16
16
Included in OCI (a)
(1)
(1)
(2)
1
(1)
Sales
(3)
(3)
(3)
(3)
Settlements
(5)
(5)
(11)
(11)
Transfers into Level 3
14
14
14
14
Transfers out of Level 3
9
(3)
6
1
(3)
(2)
Balance at end of period
$
34
$
12
$
46
$
34
$
12
$
46

(a)
"Energy Commodities, net" and "Cross-Currency Swaps" are included in "Qualifying derivatives" and "Auction Rate Securities" are included in "Available-for-sale securities" on the Statements of Comprehensive Income.

A reconciliation of net assets and liabilities classified as Level 3 for the periods ended June 30, 2011 is as follows:
Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Three Months
Six Months
Energy
Auction
Energy
Auction
Commodities,
Rate
Commodities,
Rate
net
Securities
Total
net
Securities
Total
PPL
Balance at beginning of period
$
32
$
25
$
57
$
(3)
$
25
$
22
Total realized/unrealized gains (losses)
Included in earnings
(5)
(5)
(4)
(4)
Included in OCI (a)
3
3
4
4
Purchases
2
2
Sales
(1)
(1)
(4)
(4)
Settlements
3
3
25
25
Transfers out of Level 3
(6)
(6)
6
6
Balance at end of period
$
26
$
25
$
51
$
26
$
25
$
51
PPL Energy Supply
Balance at beginning of period
$
32
$
20
$
52
$
(3)
$
20
$
17
Total realized/unrealized gains (losses)
Included in earnings
(5)
(5)
(4)
(4)
Included in OCI (a)
3
3
4
4
Purchases
2
2
Sales
(1)
(1)
(4)
(4)
Settlements
3
3
25
25
Transfers out of Level 3
(6)
(6)
6
6
Balance at end of period
$
26
$
20
$
46
$
26
$
20
$
46

(a)
"Energy Commodities, net" are included in "Qualifying derivatives" and "Auction Rate Securities" are included in "Available-for-sale securities" on the Statements of Comprehensive Income.
80
The significant unobservable inputs used in the fair value measurement of assets and liabilities classified as Level 3 at June 30, 2012 are as follows:

Quantitative Information about Level 3 Fair Value Measurements
Fair Value, net
Range
Asset
Valuation
Unobservable
(Weighted
(Liability)
Technique
Input(s)
Average) (a)
PPL
Energy commodities
Retail natural gas sales contracts (b)
30
Discounted cash flow
Observable wholesale prices used as proxy for retail delivery points
20% - 100% (69%)
Power sales contracts (c)
(7)
Discounted cash flow
Basis price between delivery points
24% - 61% (25%)
Full-requirement sales contracts (d)
11
Discounted cash flow
Customer migration
13% - 80% (34%)
Auction rate securities (e)
15
Discounted cash flow
Modeled from SIFMA Index
54% - 80% (65%)
Cross-currency swaps (f)
10
Discounted cash flow
Credit valuation adjustment
25% - 37% (32%)
PPL Energy Supply
Energy commodities
Retail natural gas sales contracts (b)
30
Discounted cash flow
Observable wholesale prices used as proxy for retail delivery points
20% - 100% (69%)
Power sales contracts (c)
(7)
Discounted cash flow
Basis price between delivery points
24% - 61% (25%)
Full-requirement sales contracts (d)
11
Discounted cash flow
Customer migration
13% - 80% (34%)
Auction rate securities (e)
12
Discounted cash flow
Modeled from SIFMA Index
61% - 80% (66%)

(a)
For energy commodities and auction rate securities, the range and weighted average represent the percentage of fair value derived from the unobservable inputs.  For cross-currency swaps, the range and weighted average represent the percentage decrease in fair value due to the unobservable inputs used in the model to calculate the credit valuation adjustment.
(b)
Retail natural gas sales contracts extend through 2017.  $14 million of the fair value is scheduled to deliver within the next 12 months.  As the forward price of natural gas increases/(decreases), the fair value of the contracts (decreases)/increases.
(c)
Power sales contracts extend through 2017.  $(4) million of the fair value is scheduled to deliver within the next 12 months.  As the forward price of basis increases/(decreases), the fair value of the contracts (decreases)/increases.
(d)
Full-requirement sales contracts extend through 2013.  $11 million of the fair value is scheduled to deliver within the next 12 months. As customer migration increases/(decreases), the fair value of the contracts decreases/(increases).
(e)
Auction rate securities have a weighted average contractual maturity of 26 years.  The model used to calculate fair value incorporates an assumption that the auctions will continue to fail.  As the modeled forward rates of the SIFMA index increase/(decrease), the fair value of the securities increases/(decreases).
(f)
Cross-currency swaps extend through 2021.  The credit valuation adjustment incorporates projected probabilities of default and estimated recovery rates.  As the credit valuation adjustment increases/(decreases), the fair value of the swaps (decreases)/increases.

Net gains and losses on assets and liabilities classified as Level 3 and included in earnings for the periods ended June 30 are reported in the Statements of Income as follows:

Three Months
Cross-Currency
Energy Commodities, net
Swaps
Unregulated Retail
Wholesale Energy
Net Energy
Energy
Electric and Gas
Marketing
Trading Margins
Purchases
Interest Expense
2012
2011
2012
2011
2012
2011
2012
2011
2012
2011
PPL
Total gains (losses) included in earnings
$
2
$
4
$
(6)
$
(5)
$
1
$
2
$
1
$
(6)
$
(1)
Change in unrealized gains (losses) relating
to positions still held at the reporting date
49
4
(12)
(7)
1
1
(2)
PPL Energy Supply
Total gains (losses) included in earnings
$
2
$
4
$
(6)
$
(5)
$
1
$
2
$
1
$
(6)
Change in unrealized gains (losses) relating
to positions still held at the reporting date
49
4
(12)
(7)
1
1
(2)
81

Six Months
Cross-Currency
Energy Commodities, net
Swaps
Unregulated Retail
Wholesale Energy
Net Energy
Energy
Electric and Gas
Marketing
Trading Margins
Purchases
Interest Expense
2012
2011
2012
2011
2012
2011
2012
2011
2012
2011
PPL
Total gains (losses) included in earnings
$
18
$
5
$
(2)
$
(4)
$
(3)
$
(2)
$
(1)
Change in unrealized gains (losses) relating
to positions still held at the reporting date
39
5
(13)
(6)
$
1
$
1
17
PPL Energy Supply
Total gains (losses) included in earnings
$
18
$
5
$
(2)
$
(4)
$
(3)
$
(2)
Change in unrealized gains (losses) relating
to positions still held at the reporting date
39
5
(13)
(6)
$
1
$
1
17

Price Risk Management Assets/Liabilities - Energy Commodities ( PPL and PPL Energy Supply)

Energy commodity contracts are generally valued using the income approach, except for exchange-traded derivative gas and oil contracts, which are valued using the market approach and are classified as Level 1.  When observable inputs are used to measure all or most of the value of a contract, the contract is classified as Level 2.  Level 2 contracts are valued using quotes obtained from an exchange (where there is insufficient market liquidity to warrant inclusion in Level 1), binding and non-binding broker quotes, prices posted by ISOs or published tariff rates.  Furthermore, independent quotes are obtained from the market to validate the forward price curves.  These contracts include forwards, swaps, options and structured deals for electricity, gas, oil, and/or emission allowances and may be offset with similar positions in exchange-traded markets.  To the extent possible, fair value measurements utilize various inputs that include quoted prices for similar contracts or market-corroborated inputs.  In certain instances, these contracts may be valued using models, including standard option valuation models and standard industry models.  For example, the fair value of a full-requirement sales contract that delivers power to an illiquid delivery point may be measured by valuing the nearest liquid trading point plus the value of the basis between the two points.  The basis input may be from market quotes, FTR prices, or historical prices.

When unobservable inputs are significant to the fair value measurement, a contract is classified as Level 3.  The fair value of contracts classified as Level 3 has been calculated using PPL proprietary models which include significant unobservable inputs such as delivery at a location where pricing is unobservable, assumptions for customer migration or delivery dates that are beyond the dates for which independent quotes are available.  Forward transactions, including forward transactions classified as Level 3, are analyzed by PPL's Risk Management department, which reports to the Chief Financial Officer (CFO).  Accounting personnel, who also report to the CFO, interpret the analysis quarterly to appropriately classify the forward transactions in the fair value hierarchy.  Valuation techniques are evaluated periodically.  Additionally, Level 2 and Level 3 fair value measurements include adjustments for credit risk based on PPL's own creditworthiness (for net liabilities) and its counterparties' creditworthiness (for net assets).  PPL's credit department assesses all reasonably available market information which is used by accounting personnel to calculate the credit valuation adjustment.

In certain instances, energy commodity contracts are transferred between Level 2 and Level 3.  The primary reasons for the transfers during 2012 and 2011 were changes in the availability of market information and changes in the significance of the unobservable portion of the contract.  As the delivery period of a contract becomes closer, market information may become available.  When this occurs, the model's unobservable inputs are replaced with observable market information.

Price Risk Management Assets/Liabilities - Interest Rate Swaps/Foreign Currency Contracts/Cross-Currency Swaps ( PPL, LKE and LG&E)

To manage interest rate risk, PPL, LKE and LG&E use interest rate contracts such as forward-starting swaps, floating-to-fixed swaps and fixed-to-floating swaps.  To manage foreign currency exchange risk, PPL uses foreign currency contracts such as forwards, options and cross-currency swaps that contain characteristics of both interest rate and foreign currency contracts.  An income approach is used to measure the fair value of these contracts, utilizing readily observable inputs, such as forward interest rates (e.g., LIBOR and government security rates) and forward foreign currency exchange rates (e.g.,  GBP and Euro), as well as inputs that may not be observable, such as credit valuation adjustments.  In certain cases, market information cannot practicably be obtained to value credit risk and therefore internal models are relied upon.  These models use projected probabilities of default and estimated recovery rates based on historical observances.  When the credit valuation adjustment is significant to the overall valuation, the contracts are classified as Level 3.  The primary reason for the transfers out of Level 3 for 2012 was the change in the significance of the credit valuation adjustment.  Cross-currency swaps classified as Level 3 are valued by PPL's Corporate Finance department, which reports to the CFO.  Accounting personnel,
82
who also report to the CFO, interpret the analysis quarterly to appropriately classify the contracts in the fair value hierarchy.  Valuation techniques are evaluated periodically.

(PPL and PPL Energy Supply)

NDT Funds

The market approach is used to measure the fair value of equity securities held in the NDT funds.

·
The fair value measurements of equity securities classified as Level 1 are based on quoted prices in active markets and are comprised of securities that are representative of the Wilshire 5000 index, which is invested in approximately 70% large-cap stocks and 30% mid/small-cap stocks.

·
Investments in commingled equity funds are classified as Level 2 and represent securities that track the S&P 500 index and the Wilshire 4500 index.  These fair value measurements are based on firm quotes of net asset values per share, which are not obtained from a quoted price in an active market.

Debt securities are generally measured using a market approach, including the use of matrix pricing.  Common inputs include reported trades, broker/dealer bid/ask prices, benchmark securities and credit valuation adjustments.  When necessary, the fair value of debt securities is measured using the income approach, which incorporates similar observable inputs as well as benchmark yields, credit valuation adjustments, reference data from market research publications, monthly payment data, collateral performance and new issue data.

The debt securities held by the NDT funds at June 30, 2012 have a weighted-average coupon of 4.22% and a weighted-average maturity of 8.3 years.

Auction Rate Securities

Auction rate securities include Federal Family Education Loan Program guaranteed student loan revenue bonds, as well as various municipal bond issues.  The exposure to realize losses on these securities is not significant.

The fair value of auction rate securities is estimated using an income approach that includes readily observable inputs, such as principal payments and discount curves for bonds with credit ratings and maturities similar to the securities, and unobservable inputs, such as future interest rates that are estimated based on the SIFMA Index, creditworthiness, and liquidity assumptions driven by the impact of auction failures.  When the present value of future interest payments is significant to the overall valuation, the auction rate securities are classified as Level 3.  The primary reason for the transfer out of Level 3 in 2012 was the change in the significance of the present value of future interest payments as maturity dates approach.

Auction rate securities are valued by PPL's Treasury department, which reports to the CFO.  Accounting personnel, who also report to the CFO, interpret the analysis quarterly to appropriately classify the contracts in the fair value hierarchy.  Valuation techniques are evaluated periodically.

Financial Instruments Not Recorded at Fair Value (PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU)

The carrying amounts of contract adjustment payments related to the Purchase Contract component of the Equity Units and long-term debt on the Balance Sheets and their estimated fair values are set forth below.  The fair values of these instruments were estimated using an income approach by discounting future cash flows at estimated current cost of funding rates, which incorporate the credit risk of the Registrants.  These instruments are classified as Level 2.  The effect of third-party credit enhancements is not included in the fair value measurement.
83


June 30, 2012
December 31, 2011
Carrying
Carrying
Amount
Fair Value
Amount
Fair Value
PPL
Contract adjustment payments (a)
$
152
$
154
$
198
$
198
Long-term debt
18,710
20,402
17,993
19,392
PPL Energy Supply
Long-term debt
3,279
3,663
3,024
3,397
PPL Electric
Long-term debt
1,718
2,020
1,718
2,012
LKE
Long-term debt
4,074
4,333
4,073
4,306
LG&E
Long-term debt
1,112
1,166
1,112
1,164
KU
Long-term debt
1,842
2,004
1,842
2,000

(a)
Reflected in "Other current liabilities" and "Other deferred credits and noncurrent liabilities" on the Balance Sheets.

The carrying value of short-term debt (including notes between affiliates), when outstanding, represents or approximates fair value due to the variable interest rates associated with the financial instruments and is classified as Level 2.  The carrying value of held-to-maturity, short-term investments at December 31, 2011 approximated fair value due to the liquid nature and short-term duration of these instruments.

Credit Concentration Associated with Financial Instruments

(PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU)

Contracts are entered into with many entities for the purchase and sale of energy.  Many of these contracts qualify for NPNS and, as such, the fair value of these contracts is not reflected in the financial statements.  However, the fair value of these contracts is considered when committing to new business from a credit perspective.  See Note 14 for information on credit policies used to manage credit risk, including master netting arrangements and collateral requirements.

(PPL)

At June 30, 2012, PPL had credit exposure of $2.9 billion from energy trading partners, excluding the effects of netting arrangements and collateral.  As a result of netting arrangements and collateral, PPL's credit exposure was reduced to $843 million.  The top ten counterparties accounted for $429 million, or 51%, of the net exposure and all had investment grade credit ratings from S&P or Moody's.

(PPL Energy Supply)

At June 30, 2012, PPL Energy Supply had credit exposure of $2.9 billion from energy trading partners, excluding exposure from related parties and the effects of netting arrangements and collateral.  As a result of netting arrangements and collateral, this credit exposure was reduced to $842 million.  The top ten counterparties accounted for $429 million, or 51%, of the net exposure and all had investment grade credit ratings from S&P or Moody's.  See Note 11 for information regarding the related party credit exposure.

(PPL Electric)

At June 30, 2012, PPL Electric had no credit exposure under energy supply contracts (including its supply contracts with PPL EnergyPlus).

(LKE, LG&E and KU)

At June 30, 2012, LKE's, LG&E's and KU's credit exposure was not significant.

84

14.  Derivative Instruments and Hedging Activities

Risk Management Objectives

(PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU)

PPL has a risk management policy approved by the Board of Directors to manage market risk and counterparty credit risk.  The RMC, comprised of senior management and chaired by the Chief Risk Officer, oversees the risk management function.  Key risk control activities designed to ensure compliance with the risk policy and detailed programs include, but are not limited to, credit review and approval, validation of transactions and market prices, verification of risk and transaction limits, VaR analyses, portfolio stress tests, gross margin at risk analyses, sensitivity analyses, and daily portfolio reporting, including open positions, determinations of fair value, and other risk management metrics.

Market Risk

Market risk is the potential loss that may be incurred as a result of price changes associated with a particular financial or commodity instrument.  Forward contracts, futures contracts, options, swaps and structured transactions or arrangements, such as tolling agreements, are utilized as part of risk management strategies to minimize unanticipated fluctuations in earnings caused by changes in commodity prices, volumes of full-requirement sales contracts, basis exposure, interest rates and/or foreign currency exchange rates.  Many of the contracts meet the definition of a derivative.  All derivatives are recognized on the Balance Sheets at their fair value, unless they qualify for NPNS.

The table below summarizes the market risks that affect PPL and its subsidiaries.
PPL
PPL
PPL
Energy Supply
Electric
LKE
LG&E
KU
Commodity price risk (including basis and
volumetric risk)
X
X
M
M
M
M
Interest rate risk:
Debt issuances
X
X
M
M
M
M
Defined benefit plans
X
X
M
M
M
M
NDT securities
X
X
Equity securities price risk:
Defined benefit plans
X
X
M
M
M
M
NDT securities
X
X
Future stock transactions
X
Foreign currency risk - WPD investment
X
X
= PPL and PPL Energy Supply actively mitigate market risks through their risk management programs described above.
M
= The regulatory environments for PPL's regulated entities, by definition, significantly mitigate market risk.

Commodity price risk

·
PPL Energy Supply is exposed to commodity price, basis and volumetric risks for energy and energy-related products associated with the sale of electricity from its generating assets and other electricity and gas marketing activities (including full-requirement sales contracts) and the purchase of fuel and fuel-related commodities for generating assets, as well as for proprietary trading activities;
·
PPL Electric is exposed to market and volumetric risks from its obligation as PLR; however, its PUC-approved cost recovery mechanism substantially eliminates its exposure to market risk.  PPL Electric also mitigates its exposure to volumetric risk by entering into full-requirement supply agreements to serve its PLR customers.  These supply agreements transfer the volumetric risk associated with the PLR obligation to the energy suppliers; and
·
LG&E's and KU's rates include certain mechanisms for fuel, gas supply and environmental expenses.  These mechanisms generally provide for timely recovery of market price and volumetric fluctuations associated with these expenses.

Interest rate risk

·
PPL and its subsidiaries are exposed to interest rate risk associated with forecasted fixed-rate and existing floating-rate debt issuances.  WPD holds over-the-counter cross currency swaps to limit exposure to market fluctuations on interest and principal payments from foreign currency exchange rates.  LG&E utilizes over-the-counter interest rate swaps to limit exposure to market fluctuations on floating-rate debt.
85

·
PPL and its subsidiaries are exposed to interest rate risk associated with debt securities held by defined benefit plans.  Additionally, PPL Energy Supply is exposed to interest rate risk associated with debt securities held by the NDT.

Equity securities price risk

·
PPL and its subsidiaries are exposed to equity securities price risk associated with equity securities held by defined benefit plans.  Additionally, PPL Energy Supply is exposed to equity securities price risk in the NDT funds.

·
PPL is exposed to equity securities price risk from future stock sales and/or purchases.
Foreign currency risk
·
PPL is exposed to foreign currency exchange risk primarily associated with its investments in U.K. affiliates.

Credit Risk

Credit risk is the potential loss that may be incurred due to a counterparty's non-performance, including defaults on payments and energy commodity deliveries.

PPL is exposed to credit risk from interest rate and foreign currency derivatives with financial institutions, as well as additional credit risk through certain of its subsidiaries, as discussed below.

PPL Energy Supply is exposed to credit risk from commodity derivatives with its energy trading partners, which include other energy companies, fuel suppliers and financial institutions.

LKE and LG&E are exposed to credit risk from interest rate derivatives with financial institutions.

The majority of credit risk stems from commodity derivatives for multi-year contracts for energy sales and purchases.  If PPL Energy Supply's counterparties fail to perform their obligations under such contracts and PPL Energy Supply could not replace the sales or purchases at the same or better prices as those under the defaulted contracts, PPL Energy Supply would incur financial losses.  Those losses would be recognized immediately or through lower revenues or higher costs in future years, depending on the accounting treatment for the defaulted contracts.  In the event a supplier of LKE (through its subsidiaries LG&E and KU) or PPL Electric defaults on its obligation, those entities would be required to seek replacement power or replacement fuel in the market.  In general, incremental costs incurred by these entities would be recoverable from customers in future rates.

PPL and its subsidiaries have credit policies in place to manage credit risk, including the use of an established credit approval process, daily monitoring of counterparty positions and the use of master netting agreements.  These agreements generally include credit mitigation provisions, such as margin, prepayment or collateral requirements.  PPL and its subsidiaries may request additional credit assurance, in certain circumstances, in the event that the counterparties' credit ratings fall below investment grade or their exposures exceed an established credit limit.  See Note 13 for credit concentration associated with energy trading partners.

Master Netting Arrangements

Net derivative positions are not offset against the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) under master netting arrangements.

PPL's and PPL Energy Supply's obligation to return counterparty cash collateral under master netting arrangements was $205 million and $147 million at June 30, 2012 and December 31, 2011.

PPL Electric, LKE and LG&E had no obligation to return cash collateral under master netting arrangements at June 30, 2012 and December 31, 2011.

PPL, LKE and LG&E had posted cash collateral under master netting arrangements of $31 million and $29 million at June 30, 2012 and December 31, 2011.

PPL Energy Supply and PPL Electric had not posted any cash collateral under master netting arrangements at June 30, 2012 and December 31, 2011.
86

Commodity Price Risk (Non-trading)

(PPL and PPL Energy Supply)

Commodity price risk, including basis and volumetric risk, is among PPL's and PPL Energy Supply's most significant risks due to the level of investment that PPL and PPL Energy Supply maintain in their competitive generation assets, as well as the extent of their marketing and proprietary trading activities.  Several factors influence price levels and volatilities.  These factors include, but are not limited to, seasonal changes in demand, weather conditions, available generating assets within regions, transportation/transmission availability and reliability within and between regions, market liquidity, and the nature and extent of current and potential federal and state regulations.

PPL and PPL Energy Supply enter into financial and physical derivative contracts, including forwards, futures, swaps and options, to hedge the price risk associated with electricity, natural gas, oil and other commodities.  Certain contracts qualify for NPNS or are non-derivatives and are therefore not reflected in the financial statements until delivery.  PPL and PPL Energy Supply segregate their remaining non-trading activities into two categories:  cash flow hedges and economic activity, as discussed below.

Cash Flow Hedges

Certain derivative contracts have qualified for hedge accounting so that the effective portion of a derivative's gain or loss is deferred in AOCI and reclassified into earnings when the forecasted transaction occurs.  The cash flow hedges that existed at June 30, 2012 range in maturity through 2016.  At June 30, 2012, the accumulated net unrecognized after-tax gains (losses) that are expected to be reclassified into earnings during the next 12 months were $260 million for PPL and PPL Energy Supply.  Cash flow hedges are discontinued if it is no longer probable that the original forecasted transaction will occur by the end of the originally specified time periods and any amounts previously recorded in AOCI are reclassified into earnings once it is determined that the hedge transaction is probable of not occurring.  For the three and six months ended June 30, 2012 and 2011, such reclassifications were insignificant.

For the three and six months ended June 30, 2012, hedge ineffectiveness associated with energy derivatives was insignificant.  For the three and six months ended June 30, 2011, hedge ineffectiveness associated with energy derivatives resulted in after-tax gains (losses) of $(10) million and $(14) million.

Certain cash flow hedge positions were dedesignated during the six months ended June 30, 2012.  The fair value of the hedges at December 31, 2011 remained in AOCI because the original forecasted transaction is still expected to occur.  Pre-tax gains (losses) of $123 million, representing the change in fair value of the remaining positions during the six months ended June 30, 2012, were recorded as economic activity in "Wholesale energy marketing - Unrealized" on the Statement of Income.

Economic Activity

Many derivative contracts economically hedge the commodity price risk associated with electricity, natural gas, oil and other commodities but do not receive hedge accounting treatment.  These derivatives hedge a portion of the economic value of PPL Energy Supply's competitive generation assets and unregulated full-requirement and retail contracts, which are subject to changes in fair value due to market price volatility and volume expectations.  Additionally, economic activity includes the ineffective portion of qualifying cash flow hedges (see "Cash Flow Hedges" above).  The derivative contracts in this category that existed at June 30, 2012 range in maturity through 2019.

Examples of economic activity include hedges on sales of baseload generation; dedesignations as discussed in "Cash Flow Hedges" above; certain purchase contracts used to supply full-requirement sales contracts; FTRs or basis swaps used to hedge basis risk associated with the sale of competitive generation or supplying unregulated full-requirement sales contracts; spark spreads (sale of electricity with the simultaneous purchase of fuel); retail electric and natural gas activities; and fuel oil swaps used to hedge price escalation clauses in coal transportation and other fuel-related contracts.  PPL Energy Supply also uses options, which include the sale of call options and the purchase of put options tied to a particular generating unit.  Since the physical generating capacity is owned, price exposure is limited to the cost of the particular generating unit and does not expose PPL Energy Supply to uncovered market price risk.

Unrealized activity associated with monetizing certain full-requirement sales contracts was also included in economic activity during the three and six months ended June 30, 2012 and 2011.
87

The net fair value of economic positions at June 30, 2012 and December 31, 2011 was a net asset (liability) of $796 million and $(63) million for PPL Energy Supply.  The unrealized gains (losses) for economic activity for the periods ended June 30 were as follows.

Three Months
Six Months
2012
2011
2012
2011
PPL Energy Supply
Operating Revenues
Unregulated retail electric and gas
$
(12)
$
1
$
(2)
$
5
Wholesale energy marketing
(458)
(44)
394
13
Operating Expenses
Fuel
(16)
(11)
(14)
12
Energy purchases
442
109
(149)
127

The net gains (losses) recorded in "Wholesale energy marketing" resulted primarily from hedges of baseload generation; certain full-requirement sales contracts for which PPL Energy Supply did not elect NPNS, from hedge ineffectiveness and dedesignations, as discussed in "Cash Flow Hedges" above, and from the monetization of certain full-requirement sales contracts in 2010.  The net gains (losses) recorded in "Energy purchases" resulted primarily from certain purchase contracts to supply the full-requirement sales contracts noted above for which PPL Energy Supply did not elect hedge treatment, from hedge ineffectiveness, and from purchase contracts that no longer hedge the full-requirement sales contracts that were monetized in 2010.

(PPL and PPL Energy Supply)

Commodity Price Risk (Trading)

PPL Energy Supply also executes energy contracts to take advantage of market opportunities.  As a result, PPL Energy Supply may at times create a net open position in its portfolio that could result in significant losses if prices do not move in the manner or direction anticipated.  PPL Energy Supply's trading activity is shown in "Net energy trading margins" on the Statements of Income.

Commodity Volumetric Activity

PPL Energy Supply currently employs four primary strategies to maximize the value of its wholesale energy portfolio.  As further discussed below, these strategies include the sales of competitive baseload generation, optimization of competitive intermediate and peaking generation, marketing activities, and proprietary trading activities.  The tables within this section present the volumes of PPL Energy Supply's derivative activity, excluding those that qualify for NPNS, unless otherwise noted.

Sales of Competitive Baseload Generation

PPL Energy Supply has a formal hedging program for its competitive baseload generation fleet, which includes 7,252 MW of nuclear, coal and hydroelectric generating capacity.  The objective of this program is to provide a reasonable level of near-term cash flow and earnings certainty while preserving upside potential of power price increases over the medium term.  PPL Energy Supply sells its expected generation output on a forward basis using both derivative and non-derivative instruments.  Both are included in the following tables.

The following table presents the expected sales, in GWh, from competitive baseload generation and tolling arrangements that are included in the baseload portfolio based on current forecasted assumptions for 2012-2014.

2012 (a)
2013
2014
25,889
49,602
52,358

(a)
Represents expected sales for the balance of the current year.
88

The following table presents the percentage of expected competitive baseload generation sales shown above that has been sold forward under fixed price contracts and the related percentage of fuel that has been purchased or committed at June 30, 2012.

Derivative
Total Power
Fuel Purchases (c)
Year
Sales (a)
Sales (b)
Coal
Nuclear
2012 (d)
94%
97%
108%
100%
2013
90%
94%
106%
100%
2014 (e)
21%
25%
71%
100%

(a)
Excludes non-derivative contracts and contracts that qualify for NPNS.  Volumes for option contracts factor in the probability of an option being exercised and may be less than the notional amount of the option.
(b)
Amount represents derivative (including contracts that qualify for NPNS) and non-derivative contracts.  Volumes for option contracts factor in the probability of an option being exercised and may be less than the notional amount of the option.  Percentages are based on fixed-price contracts only.
(c)
Coal and nuclear contracts receive accrual accounting treatment, as they are not derivative contracts.  Percentages are based on both fixed- and variable-priced contracts.
(d)
Represents the balance of the current year.
(e)
Volumes for derivative sales contracts that deliver in future periods total 1,737 GWh and 2.0 Bcf.

In addition to the fuel purchases above, PPL Energy Supply attempts to economically hedge the fuel price risk that is within its fuel-related and coal transportation contracts, which are tied to changes in crude oil or diesel prices.  PPL Energy Supply has also entered into contracts to financially hedge the physical sale of oil.  The following table presents the net volumes (in thousands of barrels) of derivative (sales)/purchase contracts and contracts that qualify for NPNS used in support of these strategies at June 30, 2012.

2012 (a)
2013
2014
Oil Swaps
68
393
240

(a)
Represents the balance of the current year.

Optimization of Competitive Intermediate and Peaking Generation

In addition to its competitive baseload generation activities, PPL Energy Supply attempts to optimize the overall value of its competitive intermediate and peaking fleet, which includes 3,256 MW of natural gas and oil-fired generation.  The following table presents the net volumes of derivative (sales)/purchase contracts used in support of this strategy at June 30, 2012.

Units
2012 (a)
2013
2014
Net Power Sales (b)
GWh
(2,188)
(408)
Net Fuel Purchases (b)(c)
Bcf
25.5
2.6
(0.3)

(a)
Represents the balance of the current year.
(b)
Volumes for derivative contracts used in support of these strategies that deliver in future periods are insignificant.
(c)
Included in these volumes are non-options and exercised option contracts that converted to non-option derivative contracts.  Volumes associated with option contracts are insignificant.

Marketing Activities

PPL Energy Supply's marketing portfolio is comprised of full-requirement sales contracts and their related supply contracts, retail natural gas and electricity sales contracts and other marketing activities.  The obligations under the full-requirement sales contracts include supplying a bundled product of energy, capacity, RECs, and other ancillary products.  The full-requirement sales contracts PPL Energy Supply is awarded do not provide for specific levels of load, and actual load could vary significantly from forecasted amounts.  PPL Energy Supply uses a variety of strategies to hedge its full-requirement sales contracts, including purchasing energy at a liquid trading hub or directly at the load delivery zone, purchasing capacity and RECs in the market and supplying the energy, capacity and RECs with its generation.  The following table presents the volume of (sales)/purchase contracts, excluding FTRs, RECs, basis and capacity contracts, used in support of these activities at June 30, 2012.

89


Units
2012 (a)
2013
2014
Energy sales contracts (b)
GWh
(9,905)
(9,387)
(4,306)
Related energy supply contracts (b)
Energy purchases
GWh
6,904
5,196
1,916
Volumetric hedges (c)
GWh
212
270
74
Generation supply
GWh
1,703
3,049
2,234
Retail natural gas sales contracts
Bcf
(8.4)
(8.0)
(2.3)
Retail natural gas purchase contracts
Bcf
8.4
8.0
2.3

(a)
Represents the balance of the current year.
(b)
Includes NPNS and contracts that are not derivatives, which receive accrual accounting.
(c)
PPL Energy Supply uses power and gas options, swaps and futures to hedge the volumetric risk associated with sales contracts since the demand for power varies hourly.  Volumes for option contracts factor in the probability of an option being exercised and may be less than the notional amount of the option.

Proprietary Trading Activity

At June 30, 2012, PPL Energy Supply's proprietary trading positions, excluding FTR, basis and capacity contract activity that are included in the tables below, were insignificant.

Other Energy-Related Positions

FTRs and Other Basis Positions

PPL Energy Supply buys and sells FTRs and other basis positions to mitigate the basis risk between delivery points related to the sales of its generation, the supply of its full-requirement sales contracts and retail contracts, as well as for proprietary trading purposes.  The following table represents the net volumes of derivative FTR and basis (sales)/purchase contracts at June 30, 2012.

Units
2012 (a)
2013
2014
FTRs
GWh
24,818
19,308
232
Power Basis Positions (b)
GWh
(8,034)
(8,244)
(2,628)
Gas Basis Positions (b)
Bcf
11.7
(4.9)
(5.2)

(a)
Represents the balance of the current year.
(b)
Net volumes that deliver in future periods are (677) GWh and (5.5) Bcf.

Capacity Positions

PPL Energy Supply buys and sells capacity related to the sales of its generation and the supply of its full-requirement sales contracts.  PPL Energy Supply also sells and purchases capacity for proprietary trading purposes.  The following table presents the net volumes of derivative capacity (sales)/purchase contracts at June 30, 2012.

Units
2012 (a)
2013
2014
Capacity (b)
MW-months
(6,184)
(7,075)
(2,786)

(a)
Represents the balance of the current year.
(b)
Net volumes that deliver in future periods are 989 MW-months.

Interest Rate Risk

(PPL, PPL Energy Supply, LKE and LG&E)

PPL and its subsidiaries issue debt to finance their operations, which exposes them to interest rate risk.  Various financial derivative instruments are utilized to adjust the mix of fixed and floating interest rates in their debt portfolio, adjust the duration of the debt portfolio and lock in benchmark interest rates in anticipation of future financing, when appropriate.  Risk limits under PPL's risk management program are designed to balance risk exposure to volatility in interest expense and changes in the fair value of the debt portfolio due to changes in benchmark interest rates.
90

Cash Flow Hedges (PPL and PPL Energy Supply)

Interest rate risks include exposure to adverse interest rate movements for outstanding variable rate debt and for future anticipated financings.  Financial interest rate swap contracts may be entered into to hedge floating interest rate risk associated with both existing and anticipated debt issuances.  For PPL, outstanding interest rate swap contracts range in maturity through 2023 and had a notional amount of $300 million at June 30, 2012.  PPL Energy Supply had no such interest rate swap contracts outstanding at June 30, 2012.

PPL, on behalf of PPL WEM, holds a notional position in cross-currency interest rate swaps totaling $960 million that mature through 2021 to hedge the interest payments and principal of its U.S. dollar-denominated senior notes.  Additionally, PPL WW holds a notional position in cross-currency interest rate swaps totaling $302 million that mature through 2028 to hedge the interest payments and principal of its U.S. dollar-denominated senior notes.

For the three and six months ended June 30, 2012, hedge ineffectiveness associated with interest rate derivatives was insignificant for PPL and PPL Energy Supply.  For the three and six months ended June 30, 2011, hedge ineffectiveness associated with interest rate derivatives was an after-tax gain (loss) of $(9) million for PPL, which included a gain (loss) of $(4) million attributable to certain interest rate swaps that failed hedge effectiveness testing during the second quarter of 2011.  For the three and six months ended June 30, 2011, hedge ineffectiveness associated with interest rate derivatives was insignificant for PPL Energy Supply.

Cash flow hedges are discontinued if it is no longer probable that the original forecasted transaction will occur by the end of the originally specified time period and any amounts previously recorded in AOCI are reclassified into earnings once it is determined that the hedged transaction is probable of not occurring.  PPL and PPL Energy Supply had no such reclassifications for the three and six months ended June 30, 2012 and 2011.

At June 30, 2012, the accumulated net unrecognized after-tax gains (losses) on qualifying derivatives that are expected to be reclassified into earnings during the next 12 months were $(12) million for PPL.  Amounts are reclassified as the hedged interest payments are made.

Fair Value Hedges (PPL and PPL Energy Supply)

PPL and PPL Energy Supply are exposed to changes in the fair value of their debt portfolios.  To manage this risk, financial contracts may be entered into to hedge fluctuations in the fair value of existing debt issuances due to changes in benchmark interest rates.  At June 30, 2012, PPL held contracts that range in maturity through 2047 and had a notional value of $99 million.  In July 2012, these contracts were canceled without penalties by the counterparties.  PPL Energy Supply did not hold any such contracts at June 30, 2012.  PPL and PPL Energy Supply did not recognize gains or losses resulting from the ineffective portion of fair value hedges or from a portion of the hedging instrument being excluded from the assessment of hedge effectiveness or from hedges of debt issuances that no longer qualified as fair value hedges for the three and six months ended June 30, 2012 and 2011.

Economic Activity (PPL, LKE and LG&E)

LG&E enters into interest rate swap contracts that economically hedge interest payments on variable rate debt.  Because realized gains and losses from the swaps, including a terminated swap contract, are recoverable through regulated rates, any subsequent changes in fair value of these derivatives are included in regulatory assets or liabilities until they are realized as interest expense.  Realized gains and losses are recognized in "Interest Expense" on the Statements of Income when the hedged transaction occurs.  At June 30, 2012, LG&E held contracts with a notional amount of $179 million that range in maturity through 2033.  The fair values of these contracts were recorded as liabilities of $62 million and $60 million at June 30, 2012 and December 31, 2011 with equal offsetting amounts recorded as regulatory assets.

Foreign Currency Risk (PPL)

PPL is exposed to foreign currency risk, primarily through investments in U.K. affiliates.  PPL has adopted a foreign currency risk management program designed to hedge certain foreign currency exposures, including net investments, firm commitments, recognized assets or liabilities and anticipated transactions.  In addition, PPL enters into financial instruments to protect against foreign currency translation risk of expected earnings.
91

Net Investment Hedges

PPL enters into foreign currency contracts on behalf of a subsidiary to protect the value of a portion of its net investment in WPD.  The contracts outstanding at June 30, 2012 had a notional amount of £96 million (approximately $153 million based on contracted rates).  The settlement dates of these contracts range from September 2012 through June 2013.  The net fair value of these contracts at June 30, 2012 was insignificant and at December 31, 2011 was an asset (liability) of $7 million.

Additionally, a PPL Global subsidiary that has a U.S. dollar functional currency entered into a GBP intercompany loan payable with a PPL WEM subsidiary that has a GBP functional currency.  The loan qualifies as a net investment hedge for the PPL Global subsidiary.  As such, the foreign currency gains and losses on the intercompany loan for the PPL Global subsidiary are recorded to the foreign currency translation adjustment component of AOCI.  At June 30, 2012, the intercompany loan outstanding was £28 million (approximately $43 million based on spot rates).

For the three and six months ended June 30, 2012 and 2011, PPL recognized insignificant amounts of net investment hedge gains and losses in the foreign currency translation adjustment component of AOCI.  At June 30, 2012, PPL included $19 million of accumulated net investment hedge gains (losses), after tax, in the foreign currency translation adjustment component of AOCI, compared to $19 million of gains (losses), after-tax, recorded by PPL at December 31, 2011.

Cash Flow Hedges

PPL held no foreign currency derivatives that qualified as cash flow hedges during the three and six months ended June 30, 2012 and 2011.

Fair Value Hedges

PPL held no foreign currency derivatives that qualified as fair value hedges during the three and six months ended June 30, 2012 and 2011.

Economic Activity

PPL enters into foreign currency contracts on behalf of a subsidiary to economically hedge GBP-denominated anticipated earnings.  At June 30, 2012, the total exposure hedged by PPL was approximately £1 billion and the net fair value of these positions was an asset (liability) of $12 million.  These contracts had termination dates ranging from July 2012 through June 2014.  Realized and unrealized gains (losses) on these contracts are included in "Other Income (Expense) - net" on the Statements of Income and were $25 million and $7 million for the three and six months ended June 30, 2012.  At December 31, 2011, the total exposure hedged by PPL was £288 million and the net fair value of these positions was an asset (liability) of $11 million.  Realized and unrealized gains (losses) were insignificant for the three and six months ended June 30, 2011.

In anticipation of the repayment of a portion of the borrowings under the 2011 Bridge Facility with U.S. dollar proceeds received from PPL's April 2011 issuance of common stock and 2011 Equity Units and the issuance of senior notes by PPL WEM, PPL entered into forward contracts to purchase GBP to economically hedge the foreign currency exchange rate risk related to the repayment.  These contracts were settled in April 2011.  Realized and unrealized gains (losses) on these contracts are included in "Other Income (Expense) - net" on the Statement of Income.  PPL recorded $62 million and $55 million of pre-tax, net gains (losses) for the three and six months ended June 30, 2011.

Accounting and Reporting

(PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU)

All derivative instruments are recorded at fair value on the Balance Sheet as an asset or liability unless they qualify for NPNS.  NPNS contracts for PPL and PPL Energy Supply include full-requirement sales contracts, other physical sales contracts and certain retail energy and physical capacity contracts, and for PPL Electric include certain full-requirement purchase contracts and other physical purchase contracts.  Changes in the fair value of derivatives not designated as NPNS are recognized currently in earnings unless specific hedge accounting criteria are met, except for the change in fair value of LG&E's interest rate swaps that are recognized as regulatory assets.  See Note 6 for amounts recorded in regulatory assets at June 30, 2012 and December 31, 2011.

See Notes 1 and 19 in each Registrant's 2011 Form 10-K for additional information on accounting policies related to derivative instruments.
92
(PPL)

The following tables present the fair value and location of derivative instruments recorded on the Balance Sheets.

June 30, 2012
December 31, 2011
Derivatives designated as
Derivatives not designated
Derivatives designated as
Derivatives not designated
hedging instruments
as hedging instruments (a)
hedging instruments
as hedging instruments (a)
Assets
Liabilities
Assets
Liabilities
Assets
Liabilities
Assets
Liabilities
Current:
Price Risk Management
Assets/Liabilities (b):
Interest rate swaps
$
15
$
5
$
3
$
3
$
5
Cross-currency swaps
$
1
2
2
Foreign currency
contracts
3
$
8
3
7
$
11
Commodity contracts
91
2,380
1,570
872
3
1,655
1,557
Total current
95
17
2,388
1,578
882
8
1,666
1,562
Noncurrent:
Price Risk Management
Assets/Liabilities (b):
Interest rate swaps
57
55
Cross-currency swaps
69
24
Foreign currency
contracts
8
1
Commodity contracts
34
1
1,001
957
42
2
854
783
Total noncurrent
103
1
1,009
1,015
66
2
854
838
Total derivatives
$
198
$
18
$
3,397
$
2,593
$
948
$
10
$
2,520
$
2,400

(a)
$455 million and $237 million of net gains associated with derivatives that were no longer designated as hedging instruments are recorded in AOCI at June 30, 2012 and December 31, 2011.
(b)
Represents the location on the Balance Sheet.

The after-tax balances of accumulated net gains (losses) (excluding net investment hedges) in AOCI were $333 million and $527 million at June 30, 2012 and December 31, 2011.  The after-tax balances of accumulated net gains (losses) (excluding net investment hedges) in AOCI were $544 million and $695 million at June 30, 2011 and December 31, 2010.

The following tables present the pre-tax effect of derivative instruments recognized in income, OCI or regulatory assets for the periods ended June 30, 2012.

Derivatives in
Hedged Items in
Location of Gain
Gain (Loss) Recognized
Gain (Loss) Recognized
Fair Value Hedging
Fair Value Hedging
(Loss) Recognized
in Income on Derivative
in Income on Related Item
Relationships
Relationships
in Income
Three Months
Six Months
Three Months
Six Months
Interest rate swaps
Fixed rate debt
Interest expense
$
1
$
1
$
1
$
2

Three Months
Six Months
Gain (Loss)
Gain (Loss)
Recognized
Recognized
in Income
in Income
on Derivative
Gain (Loss)
on Derivative
Gain (Loss)
(Ineffective
Reclassified
(Ineffective
Reclassified
Portion and
from AOCI
Portion and
Derivative Gain
Location of
from AOCI
Amount
into
Amount
(Loss) Recognized in
Gain (Loss)
into Income
Excluded from
Income
Excluded from
Derivative
OCI (Effective Portion)
Recognized
(Effective
Effectiveness
(Effective
Effectiveness
Relationships
Three Months
Six Months
in Income
Portion)
Testing)
Portion)
Testing)
Cash Flow Hedges:
Interest rate swaps
$
(25)
$
(22)
Interest expense
$
(5)
$
(9)
Cross-currency swaps
34
46
Interest expense
(1)
Other income
(expense) - net
47
28
Commodity contracts
(14)
99
Wholesale energy
marketing
227
$
(5)
499
$
(1)
Depreciation
1
Energy purchases
(45)
1
(85)
(3)
Total
$
(5)
$
123
$
224
$
(4)
$
433
$
(4)
Net Investment Hedges:
Foreign currency contracts
$
2
$
(1)
93

Derivatives Not Designated as
Location of Gain (Loss) Recognized in
Hedging Instruments:
Income on Derivatives
Three Months
Six Months
Foreign currency contracts
Other income (expense) - net
$
25
$
7
Interest rate swaps
Interest expense
(2)
(4)
Commodity contracts
Unregulated retail electric and gas
1
23
Wholesale energy marketing
33
1,376
Net energy trading margins (a)
13
22
Fuel
(12)
(6)
Energy purchases
(11)
(1,081)
Total
$
47
$
337
Derivatives Not Designated as
Location of Gain (Loss) Recognized as
Hedging Instruments:
Regulatory Liabilities/Assets
Three Months
Six Months
Interest rate swaps
Regulatory assets - noncurrent
$
(9)
$
(3)

(a)
Differs from the Statement of Income due to intra-month transactions that PPL defines as spot activity, which is not accounted for as a derivative.

The following tables present the pre-tax effect of derivative instruments recognized in income or OCI for the periods ended June 30, 2011.

Derivatives in
Hedged Items in
Location of Gain
Gain (Loss) Recognized
Gain (Loss) Recognized
Fair Value Hedging
Fair Value Hedging
(Loss) Recognized
in Income on Derivative
in Income on Related Item
Relationships
Relationships
in Income
Three Months
Six Months
Three Months
Six Months
Interest rate swaps
Fixed rate debt
Interest expense
$
1
$
2
$
8
$
18

Three Months
Six Months
Gain (Loss)
Gain (Loss)
Recognized
Recognized
in Income
in Income
on Derivative
Gain (Loss)
on Derivative
Gain (Loss)
(Ineffective
Reclassified
(Ineffective
Reclassified
Portion and
from AOCI
Portion and
Derivative Gain
Location of
from AOCI
Amount
into
Amount
(Loss) Recognized in
Gain (Loss)
into Income
Excluded from
Income
Excluded from
Derivative
OCI (Effective Portion)
Recognized
(Effective
Effectiveness
(Effective
Effectiveness
Relationships
Three Months
Six Months
in Income
Portion)
Testing)
Portion)
Testing)
Cash Flow Hedges:
Interest rate swaps
$
(9)
$
1
Interest expense
$
(3)
$
(12)
$
(6)
$
(13)
Cross-currency swaps
(8)
(33)
Interest expense
3
Other income
(expense) - net
30
17
Commodity contracts
(34)
50
Wholesale energy
marketing
164
(14)
367
(22)
Energy purchases
(47)
(117)
1
Total
$
(51)
$
18
$
144
$
(26)
$
264
$
(34)
Net Investment Hedges:
Foreign currency contracts
$
(1)

Derivatives Not Designated as
Location of Gain (Loss) Recognized in
Hedging Instruments:
Income on Derivatives
Three Months
Six Months
Foreign currency contracts
Other income (expense) - net
$
64
$
55
Interest rate swaps
Interest expense
(2)
(4)
Commodity contracts
Utility
(3)
(2)
Unregulated retail electric and gas
4
5
Wholesale energy marketing
(71)
(26)
Net energy trading margins (a)
4
11
Fuel
(8)
15
Energy purchases
91
36
Total
$
79
$
90
Derivatives Not Designated as
Location of Gain (Loss) Recognized as
Hedging Instruments:
Regulatory Liabilities/Assets
Three Months
Six Months
Interest rate swaps
Regulatory assets
$
(3)
$
(1)

(a)
Differs from the Statement of Income due to intra-month transactions that PPL defines as spot activity, which is not accounted for as a derivative.
94
(PPL Energy Supply)

The following table presents the fair value and location of derivative instruments recorded on the Balance Sheets.

June 30, 2012
December 31, 2011
Derivatives designated as
Derivatives not designated
Derivatives designated as
Derivatives not designated
hedging instruments
as hedging instruments (a)
hedging instruments
hedging instruments (a)
Assets
Liabilities
Assets
Liabilities
Assets
Liabilities
Assets
Liabilities
Current:
Price Risk Management
Assets/Liabilities (b):
Commodity contracts
$
91
$
2,380
$
1,570
$
872
$
3
$
1,655
$
1,557
Total current
91
2,380
1,570
872
3
1,655
1,557
Noncurrent:
Price Risk Management
Assets/Liabilities (b):
Commodity contracts
34
$
1
1,001
957
42
2
854
783
Total noncurrent
34
1
1,001
957
42
2
854
783
Total derivatives
$
125
$
1
$
3,381
$
2,527
$
914
$
5
$
2,509
$
2,340

(a)
$455 million and $237 million of net gains associated with derivatives that were no longer designated as hedging instruments are recorded in AOCI at June 30, 2012 and December 31, 2011.
(b)
Represents the location on the balance sheet.

The after-tax balances of accumulated net gains (losses) (excluding net investment hedges) in AOCI were $405 million and $605 million at June 30, 2012 and December 31, 2011.  The after-tax balances of accumulated net gains (losses) (excluding net investment hedges) in AOCI were $573 million and $733 million at June 30, 2011 and December 31, 2010.  At June 30, 2011, AOCI reflects the effect of PPL Energy Supply's January 2011 distribution of its membership interest in PPL Global to its parent, PPL Energy Funding.

The following tables present the pre-tax effect of derivative instruments recognized in income or OCI for the six months ended June 30, 2012.

Three Months
Six Months
Gain (Loss)
Gain (Loss)
Recognized
Recognized
in Income
in Income
on Derivative
on Derivative
Gain (Loss)
(Ineffective
Gain (Loss)
(Ineffective
Reclassified
Portion and
Reclassified
Portion and
Derivative Gain
Location of
from AOCI
Amount
from AOCI
Amount
(Loss) Recognized in
Gains (Losses)
into Income
Excluded from
into Income
Excluded from
Derivative
OCI (Effective Portion)
Recognized
(Effective
Effectiveness
(Effective
Effectiveness
Relationships
Three Months
Six Months
in Income
Portion)
Testing)
Portion)
Testing)
Cash Flow Hedges:
Wholesale energy
Commodity contracts
$
(14)
$
99
marketing
$
227
$
(5)
$
499
$
(1)
Depreciation
1
1
Energy purchases
(45)
1
(85)
(3)
Total
$
(14)
$
99
$
183
$
(4)
$
415
$
(4)

Derivatives Not Designated as
Location of Gain (Loss) Recognized in
Hedging Instruments:
Income on Derivatives
Three Months
Six Months
Commodity contracts
Unregulated retail electric and gas
$
1
$
23
Wholesale energy marketing
33
1,376
Net energy trading margins (a)
13
22
Fuel
(12)
(6)
Energy purchases
(11)
(1,081)
Total
$
24
$
334

(a)
Differs from the Statement of Income due to intra-month transactions that PPL Energy Supply defines as spot activity, which is not accounted for as a derivative.

The following tables present the pre-tax effect of derivative instruments recognized in income or OCI for the periods ended June 30, 2011.

95

Derivatives in
Hedged Items in
Location of Gain
Gain (Loss) Recognized
Gain (Loss) Recognized
Fair Value Hedging
Fair Value Hedging
(Loss) Recognized
in Income on Derivative
in Income on Related Item
Relationships
Relationships
in Income
Three Months
Six Months
Three Months
Six Months
Interest rate swaps
Fixed rate debt
Interest expense
$
1
$
1

Three Months
Six Months
Gain (Loss)
Gain (Loss)
Recognized
Recognized
in Income
in Income
on Derivative
on Derivative
Gain (Loss)
(Ineffective
Gain (Loss)
(Ineffective
Reclassified
Portion and
Reclassified
Portion and
Derivative Gain
Location of
from AOCI
Amount
from AOCI
Amount
(Loss) Recognized in
Gains (Losses)
into Income
Excluded from
into Income
Excluded from
Derivative
OCI (Effective Portion)
Recognized
(Effective
Effectiveness
(Effective
Effectiveness
Relationships
Three Months
Six Months
in Income
Portion)
Testing)
Portion)
Testing)
Cash Flow Hedges:
Wholesale energy
Commodity contracts
$
(34)
$
50
marketing
$
164
$
(14)
$
367
$
(22)
Energy purchases
(47)
(117)
1
Total
$
(34)
$
50
$
117
$
(14)
$
250
$
(21)

Derivatives Not Designated as
Location of Gain (Loss) Recognized in
Hedging Instruments:
Income on Derivatives
Three Months
Six Months
Commodity contracts
Unregulated retail electric and gas
$
4
$
5
Wholesale energy marketing
(71)
(26)
Net energy trading margins (a)
4
11
Fuel
(8)
15
Energy purchases
91
36
Total
$
20
$
41

(a)
Differs from the Statement of Income due to intra-month transactions that PPL Energy Supply defines as spot activity, which is not accounted for as a derivative.

(LKE and LG&E)

The following table presents the fair value and location of derivative instruments recorded on the Balance Sheets.

June 30, 2012
December 31, 2011
Derivatives designated as
Derivatives not designated
Derivatives designated as
Derivatives not designated
hedging instruments
as hedging instruments
hedging instruments
as hedging instruments
Assets
Liabilities
Assets
Liabilities
Assets
Liabilities
Assets
Liabilities
Current:
Other Current
Assets/Liabilities (a):
Interest rate swaps
$
5
$
5
Total current
5
5
Noncurrent:
Price Risk Management
Assets/Liabilities (a):
Interest rate swaps
57
55
Total noncurrent
57
55
Total derivatives
$
62
$
60

(a)
Represents the location on the Balance Sheet.
96

The following tables present the pre-tax effect of derivative instruments recognized in income or regulatory assets for the periods ended June 30, 2012.

Derivatives Not Designated as
Location of Gain (Loss) Recognized in
Hedging Instruments:
Income on Derivatives
Three Months
Six Months
Interest rate swaps
Interest expense
$
(2)
$
(4)
Derivatives Not Designated as
Location of Gain (Loss) Recognized as
Hedging Instruments:
Regulatory Liabilities/Assets
Three Months
Six Months
Interest rate swaps
Regulatory assets
$
(9)
$
(3)

The following tables present the pre-tax effect of derivative instruments recognized in income or regulatory assets for the periods ended June 30, 2011.

Derivatives Not Designated as
Location of Gain (Loss) Recognized in
Hedging Instruments:
Income on Derivatives
Three Months
Six Months
Interest rate swaps
Interest expense
$
(2)
$
(4)
Commodity contracts
Operating revenues - retail and wholesale (a)
(3)
(2)
Total
$
(5)
$
(6)
Derivatives Not Designated as
Location of Gain (Loss) Recognized as
Hedging Instruments:
Regulatory Liabilities/Assets
Three Months
Six Months
Interest rate swaps
Regulatory assets
$
(3)
$
(1)

(a)
Amounts are included in "Operating Revenues" for LKE.

Credit Risk-Related Contingent Features (PPL, PPL Energy Supply, LKE and LG&E)

Certain derivative contracts contain credit risk-related contingent provisions which, when in a net liability position, would permit the counterparties to require the transfer of additional collateral upon a decrease in the credit ratings of PPL, PPL Energy Supply, LKE and LG&E, or certain of their subsidiaries.  Most of these provisions would require the transfer of additional collateral or permit the counterparty to terminate the contract if the applicable credit rating were to fall below investment grade.  Some of these provisions also would allow the counterparty to require additional collateral upon each decrease in the credit rating at levels that remain above investment grade.  In either case, if the applicable credit rating were to fall below investment grade (i.e., below BBB- for S&P or Fitch, or Baa3 for Moody's), and assuming no assignment to an investment grade affiliate were allowed, most of these credit contingent provisions require either immediate payment of the net liability as a termination payment or immediate and ongoing full collateralization on derivative instruments in net liability positions.

Additionally, certain derivative contracts contain credit risk-related contingent provisions that require "adequate assurance" of performance be provided if the other party has reasonable grounds for insecurity regarding the performance of PPL's obligation under the contract.  A counterparty demanding adequate assurance could require a transfer of additional collateral or other security, including letters of credit, cash and guarantees from a creditworthy entity.  This would typically involve negotiations among the parties.  However, amounts disclosed below represent assumed immediate payment or immediate and ongoing full collateralization for derivative instruments in net liability positions with "adequate assurance" provisions.

At June 30, 2012, the effect of a decrease in credit ratings below investment grade on derivative contracts that contain credit contingent features and were in a net liability position is summarized as follows:

PPL
PPL
Energy Supply
LKE
LG&E
Aggregate fair value of derivative instruments in a net liability
position with credit contingent provisions
$
211
$
167
$
40
$
40
Aggregate fair value of collateral posted on these derivative instruments
34
3
31
31
Aggregate fair value of additional collateral requirements in the event of
a credit downgrade below investment grade (a)
186
172
9
9

(a)
Includes the effect of net receivables and payables already recorded on the Balance Sheet.

97

(PPL)

The change in the carrying amount of goodwill for the six months ended June 30, 2012 was primarily due to the effect of foreign currency exchange rates on the U.K. Regulated segment.

16 .  Asset Retirement Obligations
(PPL, PPL Energy Supply, LKE, LG&E and KU)
The changes in the carrying amounts of AROs were as follows.
PPL
PPL
Energy Supply
LKE
LG&E
KU
Balance at December 31, 2011
$
497
$
359
$
118
$
57
$
61
Accretion expense
17
13
3
1
2
Changes in estimated cash flow or settlement date
2
2
Obligations settled
(6)
(5)
(1)
(1)
Balance at June 30, 2012
$
510
$
369
$
120
$
57
$
63

Substantially all of the ARO balances are classified as noncurrent at June 30, 2012 and December 31, 2011.

( PPL, LKE, LG&E and KU)

Accretion and depreciation expense recorded by LG&E and KU is offset with a regulatory credit on the income statement, such that there is no earnings impact.

(PPL and PPL Energy Supply)

The most significant ARO recorded by PPL and PPL Energy Supply relates to the decommissioning of the Susquehanna nuclear plant.  The accrued nuclear decommissioning obligation was $304 million and $292 million at June 30, 2012 and December 31, 2011.

Assets in the NDT funds are legally restricted for purposes of settling PPL's and PPL Energy Supply's ARO related to the decommissioning of the PPL Susquehanna nuclear plant.  The aggregate fair value of these assets was $681 million and $640 million at June 30, 2012 and December 31, 2011, and is included in "Nuclear plant decommissioning trust funds" on the Balance Sheets.  See Notes 13 and 17 for additional information on these assets.

17.  Available-for-Sale Securities

(PPL, PPL Energy Supply, LKE and LG&E)

Certain short-term investments, securities held by the NDT funds and auction rate securities are classified as available-for-sale.  Available-for-sale securities are carried on the Balance Sheets at fair value.  Unrealized gains and losses on these securities are reported, net of tax, in OCI or are recognized currently in earnings when a decline in fair value is determined to be other-than-temporary.  The specific identification method is used to calculate realized gains and losses.

(PPL and PPL Energy Supply)

The following table shows the amortized cost, the gross unrealized gains and losses recorded in AOCI, and the fair value of available-for-sale securities.
98

June 30, 2012
December 31, 2011
Gross
Gross
Gross
Gross
Amortized
Unrealized
Unrealized
Amortized
Unrealized
Unrealized
Cost
Gains
Losses
Fair Value
Cost
Gains
Losses
Fair Value
PPL
NDT funds:
Cash and cash equivalents
$
14
$
14
$
12
$
12
Equity securities:
U.S. large-cap
178
$
139
317
173
$
119
292
U.S. mid/small-cap
69
58
127
67
50
117
Debt securities:
U.S. Treasury
86
10
96
76
10
86
U.S. government sponsored
agency
9
1
10
9
1
10
Municipality
77
5
$
1
81
80
4
$
1
83
Investment-grade corporate
32
3
35
35
3
38
Other
2
2
2
2
Receivables/payables, net
(1)
(1)
Total NDT funds
466
216
1
681
454
187
1
640
Auction rate securities
20
2
18
25
1
24
Total
$
486
$
216
$
3
$
699
$
479
$
187
$
2
$
664
PPL Energy Supply
NDT funds:
Cash and cash equivalents
$
14
$
14
$
12
$
12
Equity securities:
U.S. large-cap
178
$
139
317
173
$
119
292
U.S. mid/small-cap
69
58
127
67
50
117
Debt securities:
U.S. Treasury
86
10
96
76
10
86
U.S. government sponsored
agency
9
1
10
9
1
10
Municipality
77
5
$
1
81
80
4
$
1
83
Investment-grade corporate
32
3
35
35
3
38
Other
2
2
2
2
Receivables/payables, net
(1)
(1)
Total NDT funds
466
216
1
681
454
187
1
640
Auction rate securities
17
2
15
20
1
19
Total
$
483
$
216
$
3
$
696
$
474
$
187
$
2
$
659

There were no securities with credit losses at June 30, 2012 and December 31, 2011.

The following table shows the scheduled maturity dates of debt securities held at June 30, 2012.

Maturity
Maturity
Maturity
Maturity
Less Than
1-5
5-10
in Excess
1 Year
Years
Years
of 10 Years
Total
PPL
Amortized cost
$
5
$
84
$
61
$
76
$
226
Fair value
5
87
67
83
242
PPL Energy Supply
Amortized cost
$
5
$
84
$
61
$
73
$
223
Fair value
5
87
67
80
239

The following table shows proceeds from and realized gains and losses on sales of available-for-sale securities for the periods ended June 30.
Three Months
Six Months
2012
2011
2012
2011
PPL
Proceeds from sales of NDT securities (a)
$
45
$
25
$
79
$
100
Other proceeds from sales
5
5
163
Gross realized gains (b)
8
6
13
23
Gross realized losses (b)
5
6
6
11
PPL Energy Supply
Proceeds from sales of NDT securities (a)
$
45
$
25
$
79
$
100
Other proceeds from sales
3
3
Gross realized gains (b)
8
6
13
23
Gross realized losses (b)
5
6
6
11
99
(a)
These proceeds are used to pay income taxes and fees related to managing the trust.  Remaining proceeds are reinvested in the trust.
(b)
Excludes the impact of other-than-temporary impairment charges recognized in the Statements of Income.

(PPL, LKE and LG&E)

At December 31, 2010, LG&E held $163 million aggregate principal amount of tax-exempt revenue bonds issued by Louisville/Jefferson County, Kentucky on behalf of LG&E that were purchased from the remarketing agent in 2008.  During the six months ended June 30, 2011, LG&E received $163 million for its investments in these bonds when they were remarketed to unaffiliated investors.  No realized or unrealized gains (losses) were recorded on these securities, as the difference between carrying value and fair value was not significant.

18.  New Accounting Guidance Pending Adoption

(PPL, PPL Energy Supply, PPL Electric, LKE, LG&E and KU)

Improving Disclosures about Offsetting Balance Sheet Items

Effective January 1, 2013, the Registrants will retrospectively adopt accounting guidance issued to enhance disclosures about financial instruments and derivative instruments that either (1) offset on the balance sheet or (2) are subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset on the balance sheet.

Upon adoption, the enhanced disclosure requirements are not expected to have a significant impact on the Registrants.

Testing Indefinite-Lived Intangible Assets for Impairment

Effective January 1, 2013, the Registrants will prospectively adopt accounting guidance that allows an entity to elect the option to first make a qualitative evaluation about the likelihood of an impairment of an indefinite-lived intangible asset.  If, based on this assessment, the entity determines that it is more likely than not that the fair value of the indefinite-lived intangible asset exceeds the carrying amount, the fair value of that asset does not need to be calculated.  If the entity concludes otherwise, a quantitative impairment test must be performed by determining the fair value of the asset and comparing it with the carrying value.  The entity would record an impairment charge, if necessary.

Upon adoption, this guidance is not expected to have a significant impact on the Registrants.
100

PPL CORPORATION AND SUBSIDIARIES

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations

The following should be read in conjunction with PPL's Condensed Consolidated Financial Statements and the accompanying Notes and with PPL's 2011 Form 10-K.  Capitalized terms and abbreviations are defined in the glossary.  Dollars are in millions, except per share data, unless otherwise noted.

"Management's Discussion and Analysis of Financial Condition and Results of Operations" includes the following information:

·
"Overview" provides a description of PPL and its business strategy, a summary of Net Income Attributable to PPL Corporation and a discussion of certain events related to PPL's results of operations and financial condition.

·
"Results of Operations" provides a summary of PPL's earnings, a review of results by reportable segment and a description of factors by segment expected to impact future earnings.  This section ends with explanations of significant changes in principal items on PPL's Statements of Income, comparing the three and six months ended June 30, 2012 with the same periods in 2011.

·
"Financial Condition - Liquidity and Capital Resources" provides an analysis of PPL's liquidity position and credit profile.  This section also includes a discussion of rating agency actions.

·
"Financial Condition - Risk Management" provides an explanation of PPL's risk management programs relating to market and credit risk.

Overview

Introduction

PPL is an energy and utility holding company with headquarters in Allentown, Pennsylvania.  Through subsidiaries, PPL generates electricity from power plants in the northeastern, northwestern and southeastern U.S., markets wholesale and retail energy primarily in the northeastern and northwestern portions of the U.S., delivers electricity to customers in Pennsylvania, Kentucky, Virginia, Tennessee and the U.K. and delivers natural gas to customers in Kentucky.

PPL's principal subsidiaries are shown below (* denotes an SEC registrant):
PPL Corporation*
PPL Global
● Engages in the regulated operations of electricity distribution businesses in the U.K.
PPL Energy Supply*
PPL Electric*
● Engages in the regulated  transmission and distribution of electricity in Pennsylvania
LKE*
PPL EnergyPlus
● Performs marketing and trading activities
● Purchases fuel
PPL Generation
● Engages in the competitive generation of electricity, primarily in Pennsylvania and Montana
LG&E*
● Engages in the regulated generation, transmission, distribution and sale of electricity in Kentucky, and distribution and sale of natural gas in Kentucky
KU*
● Engages in the regulated generation, transmission, distribution and sale of electricity primarily in Kentucky
U.K. Regulated Segment
Supply Segment
Pennsylvania Regulated Segment
Kentucky Regulated Segment
101
Business Strategy

PPL's overall strategy is to achieve stable, long-term growth in its regulated electricity delivery businesses through efficient operations and strong customer and regulatory relations, and disciplined optimization of energy supply margins in its energy supply business while mitigating volatility in both cash flows and earnings.  In pursuing this strategy, PPL acquired LKE in November 2010 and WPD Midlands in April 2011.  These acquisitions have reduced PPL's overall business risk profile and reapportioned the mix of PPL's regulated and competitive businesses by increasing the regulated portion of its business and enhancing rate-regulated growth opportunities as the regulated businesses make investments to improve infrastructure and customer reliability.

The increase in regulated assets is expected to provide earnings stability through regulated returns and the ability to recover costs of capital investments, in contrast to the competitive energy supply business where earnings and cash flows are subject to commodity market volatility.  Results for periods prior to the acquisition of WPD Midlands are not comparable with, or indicative of, results for periods subsequent to the acquisition.  The pro forma impacts of the acquisition of WPD Midlands on income from continuing operations (after income taxes) attributable to PPL for the six months ended June 30 are as follows.

2011
Pro forma
Actual
Regulated
$
506
62%
$
387
56%
Competitive
308
38%
308
44%
$
814
$
695

Note:  Pro forma and actual amounts exclude non-recurring items identified in Note 8 to the Financial Statements.

With the acquisition of WPD Midlands and the related growth of the portion of PPL's overall earnings translated from British pounds sterling, the related foreign currency risk is more substantial.  The U.K. subsidiaries also have currency exposure to the U.S. dollar associated with their U.S. dollar-denominated debt.  To manage these risks, PPL generally uses contracts such as forwards, options and cross currency swaps that contain characteristics of both interest rate and foreign currency exchange contracts.

PPL's strategy for its competitive energy supply business is to optimize the value from its competitive generation and marketing portfolio.  PPL endeavors to do this by matching energy supply with load, or customer demand, under contracts of varying durations with creditworthy counterparties to capture profits while effectively managing exposure to energy and fuel price volatility, counterparty credit risk and operational risk.

To manage financing costs and access to credit markets, a key objective of PPL's business strategy is to maintain a strong credit profile.  PPL continually focuses on maintaining an appropriate capital structure and liquidity position.  In addition, PPL has adopted financial and operational risk management programs that, among other things, are designed to monitor and manage its exposure to earnings and cash flow volatility related to changes in energy and fuel prices, interest rates, counterparty credit quality and the operating performance of its generating units.

Financial and Operational Developments

Net Income Attributable to PPL Corporation

Net Income Attributable to PPL Corporation for the three and six months ended June 30, 2012 was $271 million and $812 million compared to $196 million and $597 million for the same periods in 2011 representing a 38% and 36% increase over 2011.  Net Income Attributable to PPL Corporation for the periods ended June 30 by segment was:

Three Months
Six Months
2012
2011
2012
2011
Kentucky Regulated
$
34
$
31
$
76
$
106
U.K. Regulated (a)
196
38
361
93
Pennsylvania Regulated
29
36
62
88
Supply
12
91
313
310
Net Income Attributable to PPL Corporation
$
271
$
196
$
812
$
597
EPS - basic
$
0.46
$
0.35
$
1.39
$
1.14
EPS - diluted
$
0.46
$
0.35
$
1.39
$
1.14
102

(a)
WPD Midlands was acquired on April 1, 2011 and its results are recorded on a one-month lag.  Therefore, the 2012 periods include three and six months of WPD Midlands' results while the 2011 periods both include two months of WPD Midlands' results.

The changes in Net Income Attributable to PPL Corporation from period to period were, in part, attributable to certain items that management considers special.  See "Results of Operations" for further discussion of the results of PPL's business segments, details of special items and analysis of the consolidated results of operations.

Economic and Market Conditions

Unregulated gross energy margins associated with PPL Energy Supply's competitive generation and marketing business are impacted by changes in market prices and demand for electricity and natural gas, power plant availability, competition in the markets for retail customers, fuel costs and availability, fuel transportation costs and other costs.  Current depressed wholesale market prices for electricity and natural gas have resulted from general weak economic conditions and other factors, including the impact of expanded domestic shale gas development.  As a result of these factors, PPL Energy Supply has experienced a shift in the dispatching of its competitive generation from coal-fired to combined-cycle gas-fired generation as illustrated in the following table:

Average Utilization Factors (a)
2009 - 2011
2012
Pennsylvania coal plants
90%
63%
Montana coal plants
83%
50%
Combined-cycle gas plants
64%
96%

(a)
All periods reflect the six months ending June 30.

This reduction in coal-fired generation output has resulted in a surplus of coal inventory at certain of PPL Energy Supply's Pennsylvania coal plants.  To mitigate the risk of exceeding available coal storage, PPL Energy Supply incurred pre-tax charges of $12 million during the six months ended June 30, 2012 to reduce its 2012 contracted coal deliveries.  Because coal purchases may also exceed expected fuel needs for 2013, PPL Energy Supply continues to manage its coal inventory to mitigate the financial impact and physical implications of an oversupply, including, but not limited to, contract modifications to reduce 2013 coal deliveries.

In addition, current economic and commodity market conditions indicate a lower value of unhedged future energy margins (primarily in 2014 and forward years) compared to the hedged energy margins in 2012.  As has been PPL Energy Supply's practice in periods of changing business conditions, PPL Energy Supply continues to review its future business and operational plans, including capital and operation and maintenance expenditures, as well as its hedging strategies.

PPL's businesses are also subject to extensive federal, state and local environmental laws, rules and regulations.  Although PPL Energy Supply's competitive generation assets are well positioned to meet these requirements, certain regulated generation assets at LG&E and KU will require substantial capital investment.  See Note 15 to the Financial Statements in PPL's 2011 Form 10-K for additional information on these requirements.  These requirements have resulted in LKE's anticipation of retiring six coal-fired units by 2015.  See Notes 6 and 8 to the Financial Statements for additional information regarding the anticipated retirement of these units as well as certain regulatory approvals to build a NGCC facility.

In light of these economic and market conditions, as well as current and projected environmental regulatory requirements, PPL considered whether certain of its generating assets were impaired, and determined that no impairment charges were required at June 30, 2012.  PPL is unable to predict whether future environmental requirements or market conditions will result in impairment charges or additional retirements.

PPL and its subsidiaries may also be impacted in future periods by the uncertainty in the worldwide financial and credit markets partially caused by the European sovereign debt crisis.  In addition, PPL may be impacted by reductions in the credit ratings of financial institutions and evolving regulations in the financial sector.  Collectively, these factors could reduce availability or restrict PPL and its subsidiaries' ability to maintain sufficient levels of liquidity, reduce capital market activities, change collateral posting requirements and increase the associated costs to PPL and its subsidiaries.

PPL cannot predict the future impact that these economic and market conditions and regulatory requirements may have on its financial condition or results of operations.

Ironwood Acquisition

In April 2012, an indirect, wholly owned subsidiary of PPL Energy Supply completed the acquisition of the equity interests in the owner and operator of the Ironwood Facility.  The Ironwood Facility began operation in 2001 and, since 2008,

103

PPL EnergyPlus has supplied natural gas for the operation of the Ironwood Facility and received the facility's full electricity output and capacity value pursuant to a tolling agreement that expires in 2021.  The acquisition provides PPL Energy Supply, through its subsidiaries, operational control of additional combined-cycle gas generation in PJM.  See Note 8 to the Financial Statements for additional information.

Bankruptcy of SMGT

In October 2011, SMGT, a Montana cooperative and purchaser of electricity under a long-term supply contract with PPL EnergyPlus expiring in June 2019 (SMGT Contract), filed for protection under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the District of Montana.  At the time of the bankruptcy filing, SMGT was PPL EnergyPlus' largest unsecured credit exposure.

The SMGT Contract provided for fixed volume purchases on a monthly basis at established prices.  Pursuant to a court order and subsequent stipulations entered into between the SMGT bankruptcy trustee and PPL EnergyPlus, since the date of its Chapter 11 filing through January 2012, SMGT continued to purchase electricity from PPL EnergyPlus at the price specified in the SMGT Contract, and made timely payments for such purchases, but at lower volumes than as prescribed in the SMGT Contract.  In January 2012, the trustee notified PPL EnergyPlus that SMGT would not purchase electricity under the SMGT Contract for the month of February.  In March 2012, the U.S. Bankruptcy Court for the District of Montana issued an order approving the request of the SMGT bankruptcy trustee and PPL EnergyPlus to terminate the SMGT Contract.  As a result, the SMGT Contract was terminated effective April 1, 2012, allowing PPL EnergyPlus to resell the electricity previously contracted to SMGT under the SMGT Contract to other customers.

PPL EnergyPlus' receivable under the SMGT Contract totaled approximately $22 million at June 30, 2012, which has been fully reserved.  No assurance can be given as to the collectability of the receivable.

In July 2012, PPL EnergyPlus filed its proof of claim in the SMGT bankruptcy proceeding.  The total claim is approximately $375 million, predominantly an unsecured claim representing the value for energy sales that will not occur as a result of the termination of the SMGT Contract.

PPL Energy Supply cannot predict any amounts that it may recover in connection with the SMGT bankruptcy or the prices and other terms on which it will be able to market to third parties the power that SMGT will not purchase from PPL EnergyPlus due to the termination of the SMGT Contract.

Tax Litigation

In 1997, the U.K. imposed a Windfall Profits Tax (WPT) on privatized utilities, including WPD.  PPL filed its tax returns for years subsequent to its 1997 and 1998 claim for refund on the basis that the U.K. WPT was creditable.  In September 2010, the U.S. Tax Court (Tax Court) ruled in PPL's favor in a dispute with the IRS, concluding that the U.K. WPT is a creditable tax for U.S. tax purposes.  As a result, and with finalization of other issues, PPL recorded a $42 million tax benefit in 2010.  In January 2011, the IRS appealed the Tax Court's decision to the U.S. Court of Appeals for the Third Circuit (Third Circuit).  In December 2011, the Third Circuit issued its opinion reversing the Tax Court's decision, holding that the U.K. WPT is not a creditable tax.  As a result of the Third Circuit's adverse determination, PPL recorded a $39 million expense in the fourth quarter of 2011.  In February 2012, PPL filed its petition for rehearing of the Third Circuit's opinion.  In March 2012, the Third Circuit denied PPL's petition.  In June 2012, the U.S. Court of Appeals for the Fifth Circuit issued a contrary opinion in an identical case involving another company.  In July 2012, PPL filed a petition for a writ of certiorari seeking U.S. Supreme Court review of the Third Circuit's opinion.

Terminated Bluegrass CTs Acquisition

In September 2011, LG&E and KU entered into an asset purchase agreement with Bluegrass Generation for the purchase of the Bluegrass CTs, aggregating approximately 495 MW, plus limited associated contractual arrangements required for operation of the units, for a purchase price of $110 million, pending receipt of applicable regulatory approvals.  In May 2012, the KPSC issued an order approving the request to purchase the Bluegrass CTs.  Also, in May 2012, the FERC issued an order conditionally authorizing the acquisition of the Bluegrass CTs, subject to approval by the FERC of satisfactory mitigation measures to address market-power concerns.  After a review of potentially available mitigation options, LG&E and KU determined that the options were not commercially justifiable.  In June 2012, LG&E and KU terminated the asset purchase agreement for the Bluegrass CTs in accordance with its terms and made applicable filings with the KPSC and FERC.  LG&E and KU are currently assessing the impact of the Bluegrass contract termination and potential future generation capacity options.


104

NGCC Construction

In September 2011, LG&E and KU filed a CPCN with the KPSC requesting approval to build a 640 MW NGCC at the existing Cane Run plant site in Kentucky.  In May 2012, the KPSC issued an order approving the request.  Subject to finalizing contracting agreements and permitting activities, construction is expected to begin in 2012 and be completed during 2015.  The project, which includes building a natural gas supply pipeline and related transmission projects, has an estimated cost of approximately $600 million.

In conjunction with this construction and to meet new, stricter federal EPA regulations with a 2015 compliance date, LG&E and KU anticipate retiring six older coal-fired electric generating units at the Cane Run, Green River and Tyrone plants, which have a combined summer capacity rating of 797 MW.  The Cane Run and Green River coal units are anticipated to remain operational until the NGCC generation and associated transmission project is completed.

Regional Transmission Line Expansion Plan

PPL Electric has experienced delays in obtaining necessary National Park Service (NPS) approvals for the Susquehanna-Roseland transmission line and anticipates a delay of the line's in-service date to 2015.  In March 2012, the NPS announced that the route proposed by PPL Electric and PSE&G, previously approved by the Pennsylvania and New Jersey public utility commissions, is the preferred route for the line under the NPS's National Environmental Policy Act review.  The NPS has stated that it expects to issue its record of decision in October 2012.  An appeal of the New Jersey Board of Public Utilities approval of the line is pending before the New Jersey Superior Court Appellate Division.  PPL Electric cannot predict the ultimate outcome or timing of the NPS approval or any further legal challenges to the project.  PJM has developed a strategy to manage potential reliability problems until the line is built.  PPL Electric cannot predict what additional actions, if any, PJM might take in the event of further delay to its scheduled in-service date for the new line.

At June 30, 2012, PPL Electric's estimated share of the project cost has increased to $560 million from approximately $500 million at December 31, 2011, primarily due to increased material costs.  In July 2012, PPL Electric began pre-construction activities including tree and vegetation removal from the transmission line's right of way and construction of access roads.  See Note 8 in PPL's  2011 Form 10-K for additional information.

FERC Formula Rates

In March 2012, PPL Electric filed a request with the FERC seeking recovery, over a 34-year period beginning in June 2012, of its unrecovered regulatory asset related to the deferred state tax liability that existed at the time of the transition from the flow-through treatment of state income taxes to full normalization.  This change in tax treatment occurred in 2008 as a result of prior FERC initiatives that transferred regulatory jurisdiction of certain transmission assets from the PUC to FERC.  A regulatory asset of approximately $50 million related to this transition, classified as taxes recoverable through future rates, is included in "Other Noncurrent Assets - Regulatory assets" on the Balance Sheets at June 30, 2012 and December 31, 2011.  In May 2012, the FERC issued an order approving PPL Electric's request effective June 1, 2012.

U.K. Tax Rate Change

In July 2012, the U.K. Finance Act 2012 (the Act) was enacted.  The Act reduced the U.K.'s statutory income tax rate from 25% to 24%, effective April 1, 2012 and from 24% to 23%, effective April 1, 2013.  As a result of these changes, PPL expects to record a deferred tax benefit in the range of $65 million to $75 million in the third quarter of 2012.

Ofgem Review of Line Loss Calculation

WPD has a $167 million liability recorded at June 30, 2012 compared with $170 million at December 31, 2011, calculated in accordance with Ofgem's accepted methodology, related to the close-out of line losses for the prior price control period, DPCR4.  Ofgem is currently consulting on the methodology to be used by all network operators to calculate the final line loss incentive/penalty for DPCR4.  In October 2011, Ofgem issued a consultation paper citing two potential changes to the methodology, both of which would result in a reduction of the liability.  In March 2012, Ofgem issued a decision regarding the preferred methodology.  In July 2012, Ofgem issued a consultation paper regarding certain aspects of the preferred methodology as it relates to the DPCR4 line loss incentive/penalty and a proposal to delay the target date for making a final decision until April 2013 together with a proposal to remove the line loss incentive/penalty for DPCR5.  PPL cannot predict the outcome of this matter.
105

Equity Forward Contract

In April 2012, PPL made a registered underwritten public offering of 9.9 million shares of its common stock.  In conjunction with that offering, the underwriters exercised an option to purchase an additional 591 thousand shares of PPL common stock solely to cover over-allotments.

In connection with the registered public offering, PPL entered into forward sale agreements with two counterparties covering the 9.9 million shares of PPL's common stock.  Settlement of these initial forward sale agreements will occur no later than April 2013.  As a result of the underwriters' exercise of the overallotment option, PPL entered into additional forward sale agreements covering the additional 591 thousand shares of PPL common stock.  Settlement of the subsequent forward sale agreements will occur in July 2013.

PPL will not receive any proceeds or issue any shares of common stock until settlement of the forward sale agreements.  PPL intends to use any net proceeds that it receives upon settlement to repay short-term debt obligations and for other general corporate purposes.

The forward sale agreements will be classified as equity transactions.  As a result, no amounts will be recorded in the consolidated financial statements until the settlement of the forward sale agreements.  Prior to those settlements, the only impact to the financial statements will be the inclusion of incremental shares within the calculation of diluted EPS using the treasury stock method.  See Note 7 to the Financial Statements for additional information.

Redemption of PPL Electric Preference Stock

In June 2012, PPL Electric redeemed all 2.5 million shares of its 6.25% Series Preference Stock, par value $100 per share.  The price paid for the redemption was the par value, without premium ($250 million in the aggregate).  At December 31, 2011, the preference stock was reflected in "Noncontrolling Interests" on PPL's Balance Sheet.

Results of Operations

The following discussion provides a review of results by reportable segment and a description of factors by segment expected to impact future earnings.  This section ends with "Statement of Income Analysis," which includes explanations of significant changes in principal items on PPL's Statements of Income, comparing the three and six months ended June 30, 2012 with the same periods in 2011.

On April 1, 2011, PPL, through its subsidiary PPL WEM, completed its acquisition of WPD Midlands.  As PPL consolidates WPD Midlands on a one-month lag, consistent with its accounting policy on consolidation of foreign subsidiaries, two months of WPD Midlands' results of operations are included in PPL's results for the 2011 periods.  When discussing PPL's results of operations for 2012 compared with 2011, the results of WPD Midlands (which includes PPL WEM for this purpose) are isolated for purposes of comparability.  WPD Midlands' results are included within the U.K. Regulated segment (formerly the International Regulated segment, renamed in 2012).  See Note 8 to the Financial Statements for additional information regarding the acquisition.

The results for interim periods can be disproportionately influenced by numerous factors and developments and by seasonal variations.  As such, the results of operations for interim periods do not necessarily indicate results or trends for the year or future periods.

Tables analyzing changes in amounts between periods within "Segment Results" and "Statement of Income Analysis" are presented on a constant U.K. foreign currency exchange rate basis, where applicable, in order to isolate the impact of the change in the exchange rate on the item being explained.  Results computed on a constant U.K. foreign currency exchange rate basis are calculated by translating current year results at the prior year weighted-average U.K. foreign currency exchange rate.

Segment Results

Kentucky Regulated Segment

The Kentucky Regulated segment consists primarily of LKE's results from the operation of regulated electricity generation, transmission and distribution assets, primarily in Kentucky, as well as in Virginia and Tennessee.  This segment also includes LKE's results from the regulated distribution and sale of natural gas in Kentucky.

106

Net Income Attributable to PPL Corporation for the periods ended June 30 includes the following results:

Three Months
Six Months
2012
2011
% Change
2012
2011
% Change
Utility revenues
$
658
$
638
3
$
1,363
$
1,404
(3)
Fuel
215
206
4
428
421
2
Energy purchases
34
40
(15)
108
147
(27)
Other operation and maintenance
197
198
(1)
403
379
6
Depreciation
86
84
2
172
165
4
Taxes, other than income
12
9
33
23
18
28
Total operating expenses
544
537
1
1,134
1,130
Other Income (Expense) - net
(7)
n/a
(10)
(1)
900
Interest Expense (a)
54
54
109
108
1
Income Taxes
13
16
(19)
28
59
(53)
Income (Loss) from Discontinued Operations
(6)
n/a
(6)
n/a
Net Income Attributable to PPL Corporation
$
34
$
31
10
$
76
$
106
(28)

(a)
Includes allocated interest expense of $17 million and $34 million for the three and six months ended June 30, 2012 and $17 million and $35 million for the three and six months ended June 30, 2011 related to the 2010 Equity Units and interest rate swaps.

The changes in the components of the Kentucky Regulated segment's results between these periods were due to the following factors, which reflect reclassifications for items included in gross margins and certain items that management considers special.  See additional detail of these special items in the table below.

Three Months
Six Months
Kentucky gross margins
$
12
$
(16)
Other operation and maintenance
4
(17)
Depreciation
(1)
(5)
Taxes, other than income
(3)
(5)
Other Income (Expense) - net
(7)
(9)
Other
(2)
Income Taxes
3
25
Special items, after-tax
(5)
(1)
Total
$
3
$
(30)

·
See "Statement of Income Analysis - Margins - Changes in Non-GAAP Financial Measures" for an explanation of Kentucky Gross Margins.

·
Higher other operation and maintenance for the six-month period, primarily due to $11 million of higher steam maintenance costs resulting from an increased scope of scheduled plant outages.  Also, a $6 million credit was recorded in 2011 to establish a regulatory asset related to 2009 storm costs.

·
Lower other income (expense) - net for the three and six-month periods, primarily due to equity losses from an unconsolidated affiliate.

·
Lower income taxes for the six-month period, primarily due to the change in pre-tax income.

The following after-tax amounts, which management considers special items, also impacted the Kentucky Regulated segment's results during the periods ended June 30.

Income Statement
Three Months
Six Months
Line Item
2012
2011
2012
2011
Special items gains (losses), net of tax (expense) benefit:
LKE acquisition-related adjustments:
Net operating loss carryforward and other tax related adjustments
Income Taxes and Other O&M
$
4
Other:
LKE discontinued operations, net of tax of $4, $0, $4, $0 (a)
Disc. Operations
$
(5)
(5)
Total
$
(5)
$
(1)

(a)
Represents an adjustment to an indemnification liability.
107

Outlook

Excluding special items, PPL projects lower segment earnings in 2012 compared with 2011, primarily driven by higher operation and maintenance expenses, which are expected to be partially offset by higher margins.

In June 2012, LG&E and KU filed requests with the KPSC for increases in annual base electric rates of approximately $62 million at LG&E and approximately $82 million at KU and an increase in annual base gas rates of approximately $17 million at LG&E.  The proposed base rate increases would result in electric rate increases of 6.9% at LG&E and 6.5% at KU and a gas rate increase of 7.0% at LG&E and would be effective in January 2013.  LG&E's and KU's applications include requests for authorized returns-on-equity at LG&E and KU of 11% each.  A hearing on these matters is expected to be scheduled during the fourth quarter of 2012.  LG&E and KU cannot predict the outcome of these proceedings.

Earnings in 2012 are subject to various risks and uncertainties.  See "Forward-Looking Information," the rest of this Item 2 and Notes 6 and 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in PPL's 2011 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.

U.K. Regulated Segment

The U.K. Regulated segment consists primarily of the electric distribution operations of WPD in the U.K.

Net Income Attributable to PPL Corporation for the periods ended June 30 includes the following results:

Three Months
Six Months
2012
2011
% Change
2012
2011
% Change
Utility revenues
$
209
$
203
3
$
437
$
419
4
Energy-related businesses
8
10
(20)
18
19
(5)
Total operating revenues
217
213
2
455
438
4
Other operation and maintenance
52
49
6
107
91
18
Depreciation
33
32
3
64
62
3
Taxes, other than income
12
13
(8)
26
26
Energy-related businesses
6
4
50
11
8
38
Total operating expenses
103
98
5
208
187
11
Other Income (Expense) - net
31
5
520
10
3
233
Interest Expense (a)
46
58
(21)
93
98
(5)
Income Taxes
21
8
163
40
28
43
WPD Midlands, net of tax (b)
118
65
82
241
65
271
WPD Midlands acquisition-related
adjustments, net of tax
(81)
(100)
(4)
(100)
(96)
Net Income Attributable to PPL Corporation
$
196
$
38
416
$
361
$
93
288

(a)
Includes allocated interest expense of $11 million and $23 million for the three and six months ended June 30, 2012 and $14 million for both the three and six months ended June 30, 2011, related primarily to the 2011 Equity Units.
(b)
2012 represents the operations of WPD Midlands for the three and six months ended June 30, 2012 and 2011 represents the operations of WPD Midlands for the period from the April 1, 2011 acquisition date through June 30, 2011, recorded on a one month lag.  These amounts exclude acquisition-related adjustments.  WPD Midlands' revenue from external customers was $340 million and $664 million for the three and six months ended June 30, 2012 and $207 million in the same periods of 2011.

The changes in the components of the U.K. Regulated segment's results between these periods were due to the following factors, which reflect reclassifications for certain items that management considers special.  See additional detail of these special items in the table below.  The amounts for PPL WW and WPD Midlands are presented on a constant U.K. foreign currency exchange rate basis in order to isolate the impact of the change in the exchange rate.

108

Three Months
Six Months
PPL WW
Utility revenues
$
12
$
26
Other operation and maintenance
(9)
(19)
Interest expense
8
11
Other
1
(2)
Income taxes
6
4
WPD Midlands, after-tax
56
184
U.S.
Interest expense
3
(13)
Other
(1)
Income taxes
(11)
(14)
Foreign currency exchange rates, after-tax (a)
(3)
(7)
Special items, after-tax
96
98
Total
$
158
$
268

(a)
Includes the effect of realized gains/(losses) on earnings hedges.
PPL WW
·
Higher utility revenues for the three-month period due to the April 1, 2011 and 2012 price increases which resulted in $19 million of higher utility revenues, partially offset by $4 million of lower regulatory recovery due to a 2012 charge to income for the over-recovery of revenues from customers, compared to a credit to income in 2011.

Higher utility revenues for the six-month period due to the April 1, 2011 and 2012 price increases which resulted in $55 million of higher utility revenues, partially offset by $15 million of lower volumes due primarily to a downturn in the economy and weather and $11 million of lower regulatory recovery due to a 2012 charge to income for the over-recovery of revenues from customers, compared to a credit to income in 2011.

·
Higher other operation and maintenance expense for the three-month period due to $5 million of higher pension expense resulting from an increase in amortization of actuarial losses and $4 million of higher network maintenance expense.

Higher other operation and maintenance expense for the six-month period due to $10 million of higher pension expense resulting from an increase in amortization of actuarial losses and $6 million of higher network maintenance expense.

·
Lower interest expense for the three and six-month periods primarily due to lower interest expense on index-linked notes.

·
Lower income taxes for the three and six-month periods due to $7 million and $5 million of favorable adjustments related to uncertain tax positions.

U.S.

·
Higher interest expense for the six-month period primarily due to $13 million of higher interest expense associated with the 2011 Equity Units issued to finance the WPD Midlands acquisition.

·
Higher income taxes for the three and six-month periods due to a $7 million and $14 million of tax benefits recorded in 2011 as a result of U.K. pension plan contributions.

The following after-tax amounts, which management considers special items, also impacted the U.K. Regulated segment's results during the periods ended June 30.

109


Income Statement
Three Months
Six Months
Line Item
2012
2011
2012
2011
Special items gains (losses), net of tax (expense) benefit:
Foreign currency-related economic hedges, net of tax of ($8), ($1), ($1), $0 (a)
Other Income-net
$
16
$
1
$
2
WPD Midlands acquisition-related adjustments:
2011 Bridge Facility costs, net of tax of $0, $11, $0, $13 (b)
Interest Expense
(25)
$
(30)
Foreign currency loss on 2011 Bridge Facility, net of tax of $0, $19, $0, $19 (c)
Other Income-net
(39)
(39)
Net hedge gains, net of tax of $0, ($20), $0, ($17) (c)
Other Income-net
43
39
Hedge ineffectiveness, net of tax of $0, $3, $0, $3 (d)
Interest Expense
(9)
(9)
U.K. stamp duty tax, net of tax of $0, $0, $0, $0 (e)
Other Income-net
(21)
(21)
Separation benefits, net of tax of $0, $2, $2, $2
Other O&M
(4)
(4)
(8)
(4)
Other acquisition-related adjustments, net of tax of ($1), $10, ($1), $10
(f)
4
(26)
4
(36)
Total
$
16
$
(80)
$
(2)
$
(100)

(a)
Represents unrealized gains (losses) on contracts that economically hedge anticipated earnings denominated in GBP.
(b)
Represents fees incurred in connection with establishing the 2011 Bridge Facility.
(c)
Represents the foreign currency loss on the repayment of the 2011 Bridge Facility, including a pre-tax foreign currency loss of $15 million associated with proceeds received on the U.S. dollar-denominated senior notes issued by PPL WEM in April 2011 that were used to repay a portion of PPL WEM's borrowing under the 2011 Bridge Facility.  The foreign currency risk was economically hedged with forward contracts to purchase GBP, which resulted in pre-tax gains of $63 million and $56 million for the three and six-month periods.  See Note 14 to the Financial Statements for additional information.
(d)
Represents a combination of ineffectiveness associated with closed out interest rate swaps and a charge recorded as a result of certain interest rate swaps failing hedge effectiveness testing.  See Note 14 to the Financial Statements for additional information.
(e)
Tax on the transfer of ownership of property in the U.K. which is not tax deductible for income tax purposes.
(f)
2011 primarily represents advisory, accounting and legal fees which are reflected in "Other Income (Expense) - net" on the Statements of Income.

Outlook

Excluding special items, PPL projects higher segment earnings in 2012 compared with 2011, primarily driven by four additional months of earnings from the Midlands businesses and higher electricity delivery revenue. Partially offsetting these positive earnings drivers are higher income taxes, higher operation and maintenance expense, higher depreciation, higher financing costs and a less favorable currency exchange rate.

Earnings in 2012 are subject to various risks and uncertainties.  See "Forward-Looking Information," the rest of this Item 2, and Notes 6 and 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in PPL's 2011 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.

Pennsylvania Regulated Segment

The Pennsylvania Regulated segment includes the regulated electric delivery operations of PPL Electric.

Net Income Attributable to PPL Corporation for the periods ended June 30 includes the following results:
Three Months
Six Months
2012
2011
% Change
2012
2011
% Change
Operating revenues
External
$
403
$
436
(8)
$
860
$
990
(13)
Intersegment
1
4
(75)
2
8
(75)
Total operating revenues
404
440
(8)
862
998
(14)
Energy purchases
External
120
169
(29)
273
420
(35)
Intersegment
17
4
325
38
10
280
Other operation and maintenance
143
126
13
283
256
11
Depreciation
39
37
5
78
70
11
Taxes, other than income
22
22
48
57
(16)
Total operating expenses
341
358
(5)
720
813
(11)
Other Income (Expense) - net
1
1
3
1
200
Interest Expense
24
24
48
48
Income Taxes
11
19
(42)
31
42
(26)
Net Income
29
40
(28)
66
96
(31)
Net Income Attributable to Noncontrolling Interests
4
(100)
4
8
(50)
Net Income Attributable to PPL Corporation
$
29
$
36
(19)
$
62
$
88
(30)

The changes in the components of the Pennsylvania Regulated segment's results between these periods were due to the following factors, which reflect reclassifications for items included in gross delivery margins.


110


Three Months
Six Months
Pennsylvania gross delivery margins
$
3
$
(10)
Other operation and maintenance
(19)
(25)
Depreciation
(2)
(8)
Other
(1)
2
Income Taxes
8
11
Noncontrolling Interests
4
4
Total
$
(7)
$
(26)

·
See "Statement of Income Analysis - Margins - Changes in Non-GAAP Financial Measures" for an explanation of Pennsylvania Gross Delivery Margins.

·
Higher other operation and maintenance expense for the three-month period, primarily due to $6 million of higher payroll and benefit related costs, $6 million of higher vegetation management costs and $3 million of higher corporate service costs.

Higher other operation and maintenance expense for the six-month period, primarily due to $8 million of higher payroll and benefit related costs, $8 million of higher vegetation management costs and $5 million of higher corporate service costs.

·
Higher depreciation expense for the six-month period, primarily due to the impact of PP&E additions related to the ongoing efforts to ensure the reliability of the delivery system, and replace aging infrastructure.

·
Lower income taxes for the three and six-month periods, primarily due to the change in pre-tax income, which reduced income taxes by $7 million and $16 million.

·
Lower noncontrolling interests for the three and six-month periods due to the preference stock redemption in June 2012.

Outlook

PPL projects lower segment earnings in 2012 compared with 2011, primarily driven by higher operation and maintenance expense, higher depreciation and lower distribution revenue, which are expected to be partially offset by higher transmission revenue, lower financing costs, and lower income taxes.

In March 2012, PPL Electric filed a request with the PUC to increase distribution rates by approximately $105 million.  The proposed distribution revenue rate increase would result in a 2.9% increase over PPL Electric's total rates at the time of filing and be effective January 1, 2013.  PPL Electric's application includes a request for an authorized return-on-equity of 11.25%.  Hearings on this matter are scheduled during August 2012 and a decision is expected in the fourth quarter of 2012.  PPL Electric cannot predict the outcome of this proceeding.

Earnings in 2012 are subject to various risks and uncertainties.  See "Forward-Looking Information," the rest of this Item 2 and Notes 6 and 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A.  Risk Factors" in PPL's 2011 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.

Supply Segment

The Supply segment primarily consists of the energy marketing and trading activities, as well as the competitive generation and development operations of PPL Energy Supply.

111


Net Income Attributable to PPL Corporation for the periods ended June 30 includes the following results:
Three Months
Six Months
2012
2011
% Change
2012
2011
% Change
Energy revenues
External (a)
$
816
$
879
(7)
$
3,106
$
2,132
46
Intersegment
17
4
325
38
10
280
Energy-related businesses
115
116
(1)
213
228
(7)
Total operating revenues
948
999
(5)
3,357
2,370
42
Fuel (a)
196
208
(6)
407
468
(13)
Energy purchases
External (a)
191
116
65
1,438
411
250
Intersegment
n/a
1
1
Other operation and maintenance
287
283
1
535
516
4
Depreciation
76
64
19
148
128
16
Taxes, other than income
17
15
13
35
31
13
Energy-related businesses
113
116
(3)
210
225
(7)
Total operating expenses
880
802
10
2,774
1,780
56
Other Income (Expense) - net
4
4
9
19
(53)
Other-Than-Temporary Impairments
1
n/a
1
1
Interest Expense
53
51
4
101
100
1
Income Taxes
6
58
(90)
177
200
(12)
Income (Loss) from Discontinued Operations
(1)
(100)
2
(100)
Net Income Attributable to PPL Corporation
$
12
$
91
(87)
$
313
$
310
1

(a)
Includes the impact from energy-related economic activity.  See "Commodity Price Risk (Non-trading) - Economic Activity" in Note 14 to the Financial Statements for additional information.

The changes in the components of the Supply segment's results between these periods were due to the following factors, which reflect reclassifications for items included in unregulated gross energy margins and certain items that management considers special.  See additional detail of these special items in the table below.

Three Months
Six Months
Unregulated gross energy margins
$
(87)
Other operation and maintenance
$
(8)
(19)
Depreciation
(12)
(20)
Other Income (Expense) - net
(2)
(12)
Other
(4)
(6)
Income Taxes
8
73
Discontinued operations, after-tax
3
Special items, after-tax
(61)
71
Total
$
(79)
$
3

·
See "Statement of Income Analysis - Margins - Changes in Non-GAAP Financial Measures" for an explanation of Unregulated Gross Energy Margins.

·
Higher other operation and maintenance expense for the three and six-month periods in part due to $11 million and $17 million of higher costs at PPL Susquehanna, including refueling outage costs, payroll-related costs and timing of projects.

·
Higher depreciation expense for the three and six-month periods due to the impact of PP&E additions.

·
Lower other income (expense) - net for the six-month period primarily due to lower earnings on securities in the NDT funds.

·
Lower income taxes for the three and six-month periods primarily due to lower pre-tax income, which reduced income taxes by $5 million and $46 million.  The six-month period was also lower due to an $11 million deferred tax benefit from a state tax rate adjustment recorded in 2012 and $11 million of Pennsylvania net operating loss valuation allowance adjustments which negatively impacted 2011, driven primarily by the impact of bonus depreciation.

The following after-tax amounts, which management considers special items, also impacted the Supply segment's results during the periods ended June 30.

112


Income Statement
Three Months
Six Months
Line Item
2012
2011
2012
2011
Special items gains (losses), net of tax (expense) benefit:
Adjusted energy-related economic activity, net, net of tax of $23, $2, ($79), ($10)
(a)
$
(32)
$
(3)
$
118
$
14
Impairments:
Emission allowances, net of tax of $0, $0, $0, $1
Other O&M
(1)
Renewable energy credits, net of tax of $0, $0, $0, $2
Other O&M
(2)
Adjustments - nuclear decommissioning trust investments, net of tax of ($1), $0, ($2), ($1)
Other Income-net
1
1
LKE acquisition-related adjustments:
Sale of certain non-core generation facilities, net of tax of $0, $1, $0, $0
Disc. Operations
(2)
(3)
Other:
Montana hydroelectric litigation, net of tax of $0, $0, $0, $1
Interest Expense
(1)
(1)
Litigation settlement - spent nuclear fuel storage, net of tax of $0, ($21), $0, ($21) (b)
Fuel
29
29
Counterparty bankruptcy, net of tax of $0, $0, $5, $0 (c)
Other O&M
(6)
Wholesale supply cost reimbursement, net of tax of $0, $0, $0, $0
(d)
1
1
Ash basin leak remediation adjustment, net of tax of $0, $0, ($1), $0
Other O&M
1
Coal contract modification payments, net of tax of $5, $0, $5, $0 (e)
Fuel
(7)
(7)
Total
$
(38)
$
23
$
108
$
37

(a)
See "Reconciliation of Economic Activity" below.
(b)
In May 2011, PPL Susquehanna entered into a settlement agreement with the U.S. Government relating to PPL Susquehanna's lawsuit, seeking damages for the Department of Energy's failure to accept spent nuclear fuel from the PPL Susquehanna plant.  PPL Susquehanna recorded credits to fuel expense to recognize recovery, under the settlement agreement, of certain costs to store spent nuclear fuel at the Susquehanna plant.  This special item represents amounts recorded in 2011 to cover the costs incurred from 1998 through September 2009.
(c)
In October 2011, a wholesale customer, SMGT, filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy code.  In 2012, PPL EnergyPlus recorded an additional allowance for unpaid amounts under the long-term power contract.  In March 2012, the U.S. Bankruptcy Court for the District of Montana approved the request to terminate the contract, effective April 1, 2012.
(d)
Recorded in "Wholesale energy marketing - Realized" on the Statement of Income.
(e)
As a result of lower electricity and natural gas prices, coal unit runtimes have decreased.  Contract modification payments were incurred to reduce the contracted coal quantities scheduled for delivery.

Reconciliation of Economic Activity

The following table reconciles unrealized pre-tax gains (losses) for the periods ended June 30, from the table within "Commodity Price Risk (Non-trading) - Economic Activity" in Note 14 to the Financial Statements to the special item identified as "Adjusted energy-related economic activity, net."

Three Months
Six Months
2012
2011
2012
2011
Operating Revenues
Unregulated retail electric and gas
$
(12)
$
1
$
(2)
$
5
Wholesale energy marketing
(458)
(44)
394
13
Operating Expenses
Fuel
(16)
(11)
(14)
12
Energy Purchases
442
109
(149)
127
Energy-related economic activity (a)
(44)
55
229
157
Option premiums (b)
1
6
1
11
Adjusted energy-related economic activity
(43)
61
230
168
Less:  Economic activity realized, associated with the monetization of
certain full-requirement sales contracts in 2010
12
66
33
144
Adjusted energy-related economic activity, net, pre-tax
$
(55)
$
(5)
$
197
$
24
Adjusted energy-related economic activity, net, after-tax
$
(32)
$
(3)
$
118
$
14

(a)
See Note 14 to the Financial Statements for additional information.
(b)
Adjustment for the net deferral and amortization of option premiums over the delivery period of the item that was hedged or upon realization.  Option premiums are recorded in "Wholesale energy marketing - Realized" and "Energy purchases - Realized" on the Statements of Income.

Outlook

Excluding special items, PPL projects lower segment earnings in 2012 compared with 2011, primarily driven by lower energy margins as a result of lower energy and capacity prices, higher fuel costs, higher operation and maintenance expense, and higher depreciation.  See "Overview" for a discussion on economic and market conditions.

Earnings in 2012 are subject to various risks and uncertainties.  See "Forward-Looking Information," the rest of this Item 2 and Note 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A Risk Factors" in PPL's 2011 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.

113

Statement of Income Analysis --

Margins

Non-GAAP Financial Measures

The following discussion includes financial information prepared in accordance with GAAP, as well as three non-GAAP financial measures:  "Kentucky Gross Margins," "Pennsylvania Gross Delivery Margins" and "Unregulated Gross Energy Margins."  These measures are not intended to replace "Operating Income," which is determined in accordance with GAAP, as an indicator of overall operating performance.  Other companies may use different measures to analyze and to report on the results of their operations.  PPL believes that these measures provide additional criteria to make investment decisions.  These performance measures are used, in conjunction with other information, internally by senior management and the Board of Directors to manage the Kentucky Regulated, Pennsylvania Regulated and Supply segment operations, analyze each respective segment's actual results compared with budget and, in certain cases, to measure certain corporate financial goals used in determining variable compensation.

PPL's three non-GAAP financial measures include:

·
"Kentucky Gross Margins" is a single financial performance measure of the Kentucky Regulated segment's electricity generation, transmission and distribution operations as well as its distribution and sale of natural gas.  In calculating this measure, utility revenues and expenses associated with approved cost recovery tracking mechanisms are offset.  Certain costs associated with these mechanisms, primarily ECR and DSM, are recorded as "Other operation and maintenance" and "Depreciation."  These mechanisms allow for recovery of certain expenses, returns on capital investments and performance incentives.  As a result, this measure represents the net revenues from the Kentucky Regulated segment's operations.

·
"Pennsylvania Gross Delivery Margins" is a single financial performance measure of the Pennsylvania Regulated segment's electric delivery operations, which includes transmission and distribution activities.  In calculating this measure, utility revenues and expenses associated with approved recovery mechanisms, including energy provided as a PLR, are offset with minimal impact on earnings.  Costs associated with these mechanisms are recorded in "Energy purchases," "Other operation and maintenance," which is primarily Act 129 costs, and in "Taxes, other than income," which is primarily gross receipts tax.  This performance measure includes PLR energy purchases by PPL Electric from PPL EnergyPlus, which are reflected in "PLR intersegment utility revenue (expense)" in the table below.  As a result, this measure represents the net revenues from the Pennsylvania Regulated segment's electric delivery operations.

·
"Unregulated Gross Energy Margins" is a single financial performance measure of the Supply segment's competitive energy non-trading and trading activities.  In calculating this measure, the Supply segment's energy revenues, which include operating revenues associated with certain Supply segment businesses that are classified as discontinued operations, are offset by the cost of fuel, energy purchases, certain other operation and maintenance expenses, primarily ancillary charges, gross receipts tax, which is recorded in "Taxes, other than income," and operating expenses associated with certain Supply segment businesses that are classified as discontinued operations.  This performance measure is relevant to PPL due to the volatility in the individual revenue and expense lines on the Statements of Income that comprise "Unregulated Gross Energy Margins."  This volatility stems from a number of factors, including the required netting of certain transactions with ISOs and significant swings in unrealized gains and losses.  Such factors could result in gains or losses being recorded in either "Wholesale energy marketing" or "Energy purchases" on the Statements of Income.  This performance measure includes PLR revenues from energy sales to PPL Electric by PPL EnergyPlus, which are reflected in "PLR intersegment utility revenue (expense)" in the table below.  PPL excludes from "Unregulated Gross Energy Margins" the Supply segment's adjusted energy-related economic activity, which includes the changes in fair value of positions used to economically hedge a portion of the economic value of PPL's competitive generation assets, full-requirement sales contracts and retail activities.  This economic value is subject to changes in fair value due to market price volatility of the input and output commodities (e.g., fuel and power) prior to the delivery period that was hedged.  Also included in this adjusted energy-related economic activity is the ineffective portion of qualifying cash flow hedges, the monetization of certain full-requirement sales contracts and premium amortization associated with options.  This economic activity is deferred, with the exception of the full-requirement sales contracts that were monetized, and included in unregulated gross energy margins over the delivery period that was hedged or upon realization.
114

Reconciliation of Non-GAAP Financial Measures

The following tables reconcile "Operating Income" to PPL's three non-GAAP financial measures for the periods ended June 30.

2012 Three Months
2011 Three Months
Unregulated
Unregulated
Kentucky
PA Gross
Gross
Kentucky
PA Gross
Gross
Gross
Delivery
Energy
Operating
Gross
Delivery
Energy
Operating
Margins
Margins
Margins
Other (a)
Income (b)
Margins
Margins
Margins
Other (a)
Income (b)
Operating Revenues
Utility
$
658
$
403
$
544
(c)
$
1,605
$
639
$
436
$
409
(c)
$
1,484
PLR intersegment utility
revenue (expense) (d)
(17)
$
17
(4)
$
4
Unregulated retail
electric and gas
192
(13)
179
180
1
181
Wholesale energy marketing
Realized
1,075
8
(f)
1,083
716
16
(f)
732
Unrealized economic
activity
(458)
(g)
(458)
(44)
(g)
(44)
Net energy trading margins
10
10
10
10
Energy-related businesses
130
130
126
126
Total Operating Revenues
658
386
1,294
211
2,549
639
432
910
508
2,489
Operating Expenses
Fuel
215
170
26
(e)
411
206
250
(42)
(e)
414
Energy purchases
Realized
34
120
617
16
(f)
787
40
169
150
75
(f)
434
Unrealized economic
activity
(442)
(g)
(442)
(109)
(g)
(109)
Other operation and
maintenance
24
26
7
682
739
21
29
9
664
723
Depreciation
13
258
271
12
225
237
Taxes, other than income
20
7
60
87
20
7
48
75
Energy-related businesses
124
124
120
120
Intercompany eliminations
(1)
1
(4)
1
3
Total Operating Expenses
286
165
801
725
1,977
279
214
417
984
1,894
Total
$
372
$
221
$
493
$
(514)
$
572
$
360
$
218
$
493
$
(476)
$
595

2012 Six Months
2011 Six Months
Unregulated
Unregulated
Kentucky
PA Gross
Gross
Kentucky
PA Gross
Gross
Gross
Delivery
Energy
Operating
Gross
Delivery
Energy
Operating
Margins
Margins
Margins
Other (a)
Income (b)
Margins
Margins
Margins
Other (a)
Income (b)
Operating Revenues
Utility
$
1,363
$
860
$
1,096
(c)
$
3,319
$
1,404
$
990
$
626
(c)
$
3,020
PLR intersegment utility
revenue (expense) (d)
(38)
$
38
(10)
$
10
Unregulated retail
electric and gas
406
(4)
402
323
5
328
Wholesale energy marketing
Realized
2,279
12
(f)
2,291
1,738
32
(f)
1,770
Unrealized economic
activity
394
(g)
394
13
(g)
13
Net energy trading margins
18
18
21
21
Energy-related businesses
237
237
247
247
Total Operating Revenues
1,363
822
2,741
1,735
6,661
1,404
980
2,092
923
5,399
Operating Expenses
Fuel
428
385
22
(e)
835
421
534
(66)
(e)
889
Energy purchases
Realized
108
273
1,251
38
(f)
1,670
147
420
377
161
(f)
1,105
Unrealized economic
activity
149
(g)
149
(127)
(g)
(127)
Other operation and
maintenance
46
49
11
1,339
1,445
41
47
13
1,205
1,306
Depreciation
26
509
535
24
421
445
Taxes, other than income
44
16
118
178
53
14
81
148
Energy-related businesses
226
226
233
233
Intercompany eliminations
(2)
1
1
(8)
2
6
Total Operating Expenses
608
364
1,664
2,402
5,038
633
512
940
1,914
3,999
Discontinued operations
12
(12)
(h)
Total
$
755
$
458
$
1,077
$
(667)
$
1,623
$
771
$
468
$
1,164
$
(1,003)
$
1,400

115


(a)
Represents amounts that are excluded from Margins.
(b)
As reported on the Statement of Income.
(c)
Primarily represents WPD's utility revenue.
(d)
Primarily related to PLR supply sold by PPL EnergyPlus to PPL Electric.
(e)
Includes economic activity related to fuel as described in "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements.  The three and six months ended June 30, 2012, includes a pre-tax loss of $12 million related to coal contract modification payments.  The three and six months ended June 30, 2011 includes a pre-tax credit of $50 million for the spent nuclear fuel litigation settlement.
(f)
Represents energy-related economic activity as described in "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements.  For the three and six months ended June 30, 2012, "Wholesale energy marketing - Realized" and "Energy purchases - Realized" include net pre-tax losses of $12 million and $33 related to the monetization of certain full-requirement sales contracts and net pre-tax gains of $1 million and $1 million related to the amortization of option premiums.  The three and six months ended June 30, 2011 include net pre-tax losses of $66 million and $144 million related to the monetization of certain full-requirement sales contracts and net pre-tax gains of $6 million and $11 million related to the amortization of option premiums.
(g)
Represents energy-related economic activity, which is subject to fluctuations in value due to market price volatility, as described in "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements.
(h)
Represents the net of certain revenues and expenses associated with certain businesses that are classified as discontinued operations.  These revenues and expenses are not reflected in "Operating Income" on the Statements of Income.

Changes in Non-GAAP Financial Measures

The following table shows PPL's three non-GAAP financial measures for the periods ended June 30 as well as the change between periods.  The factors that gave rise to the changes are described below the table.

Three Months
Six Months
2012
2011
Change
2012
2011
Change
Kentucky Gross Margins
$
372
$
360
$
12
$
755
$
771
$
(16)
PA Gross Delivery Margins by Component
Distribution
$
170
$
173
$
(3)
$
359
$
381
$
(22)
Transmission
51
45
6
99
87
12
Total
$
221
$
218
$
3
$
458
$
468
$
(10)
Unregulated Gross Energy Margins by Region
Non-trading
Eastern U.S.
$
407
$
395
$
12
$
896
$
972
$
(76)
Western U.S.
76
88
(12)
163
171
(8)
Net energy trading
10
10
18
21
(3)
Total
$
493
$
493
$
$
1,077
$
1,164
$
(87)

Kentucky Gross Margins

Margins increased for the three-month period ended June 30, 2012, compared with 2011, due to $12 million of higher retail margins, as volumes were impacted by increases in production levels at some of LKE's larger industrial customers and warmer weather during the three months ended June 30, 2012.  Total cooling degree days increased 9% compared to the same period in 2011.

Margins decreased for the six-month period ended June 30, 2012, compared with 2011, primarily due to $13 million of lower retail margins, as volumes were impacted by unseasonably mild weather during the first four months of 2012, and $3 million of lower wholesale margins, as volumes were impacted by lower market prices.  Total heating degree days decreased 24% compared to the same period in 2011.

Pennsylvania Gross Delivery Margins

Distribution

Margins decreased for the three and six month periods ended June 30, 2012, compared with 2011, due primarily to the effects of weather.
Transmission

Margins increased for the three and six month periods ended June 30, 2012, compared with 2011, primarily due to increased investment in plant and the recovery of additional costs through the FERC formula-based rates.

116

Unregulated Gross Energy Margins

Eastern U.S.
The changes in non-trading margins for the periods ended June 30, 2012 compared with 2011 were due to:
Three Months
Six Months
Baseload energy and capacity prices (a)
$
(51)
$
(137)
Intermediate and peaking energy and capacity (b)
(5)
(26)
Full-requirement sales contracts
(9)
(14)
Impact of non-core generation facilities sold in the first quarter of 2011
(12)
Ironwood Acquisition which eliminates tolling expense (c)
13
13
Net coal and hydroelectric unit availability (d)
9
19
Nuclear generation volume (e)
57
82
Other
(2)
(1)
$
12
$
(76)

(a)
Energy prices and capacity prices were lower in both periods of 2012.
(b)
Capacity prices were lower in both periods of 2012.
(c)
See Note 8 to the Financial Statements for additional information.
(d)
Coal unit availability was higher in both periods allowing the capture of additional margins.
(e)
For the three and six month periods, volumes were higher due to a shorter outage period for blade inspections and an uprate in the third quarter of 2011.  For the six month period, volumes were also higher due to an unplanned outage in March 2011.

Western U.S.

Non-trading margins for the three and six months ended June 30, 2012, compared with the same periods in 2011 were lower primarily due to $14 million related to the bankruptcy of SMGT.

Utility Revenues
The increase (decrease) in utility revenues for the periods ended June 30, 2012 compared with 2011 was due to:
Three Months
Six Months
Domestic:
PPL Electric (a)
$
(33)
$
(130)
LKE (b)
20
(41)
Total Domestic
(13)
(171)
U.K.:
PPL WW
Price (c)
19
55
Volume (d)
(2)
(15)
Recovery of allowed revenues (e)
(4)
(11)
Foreign currency exchange rates
(5)
(8)
Other
(2)
(3)
Total PPL WW
6
18
WPD Midlands (f)
128
452
Total U.K.
134
470
Total
$
121
$
299

(a)
See "Pennsylvania Gross Delivery Margins" for further information.
(b)
See "Kentucky Gross Margins" for further information.
(c)
The increase for the three and six-month periods is primarily due to price increases effective April 1, 2012 and 2011.
(d)
The decrease for the six-month period is primarily due to the downturn in the economy and weather.
(e)
The decrease for the three and six-month periods is primarily due to a 2012 charge to income for the over-recovery of revenues from customers, compared to a credit to income in 2011.
(f)
Periods are not comparable.  The periods ended June 30, 2012 include three and six months of WPD Midlands' results, compared with two months for the same periods in 2011.

117

Other Operation and Maintenance
The increase (decrease) in other operation and maintenance expense for the periods ended June 30, 2012 compared with 2011 were due to:
Three Months
Six Months
Domestic:
Uncollectible accounts (a)
$
4
$
18
LKE steam maintenance plant costs (b)
11
LKE storm costs (c)
6
PPL Susquehanna nuclear plant costs (d)
11
17
Vegetation management
6
9
Stock based compensation
8
Other
8
U.K.:
PPL WW (e)
7
17
WPD Midlands (f)
(12)
45
Total
$
16
$
139

(a)
In October 2011, SMGT filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code.  The increase for the six-month period reflects an $11 million increase to a reserve on unpaid amounts.
(b)
Increase primarily due to steam maintenance costs, resulting from an increased scope of scheduled outages.
(c)
A credit to establish a regulatory asset was recorded in the first quarter of 2011 related to 2009 storm costs.
(d)
Primarily due to refueling outage costs, payroll costs and timing of projects.
(e)
Increase for the three and six-month periods includes $5 million and $10 million of higher pension expense resulting from the amortization of actuarial losses and $4 million and $6 million of higher network maintenance expense.
(f)
Periods are not comparable.  The periods ended June 30, 2012 include three and six months of WPD Midlands' results, compared with two months for the same periods in 2011.  The decrease for the three-month period was primarily due to the impact of acquisition-related adjustments.

Depreciation
The increase (decrease) in depreciation expense for the periods ended June 30, 2012 compared with 2011 was due to:
Three Months
Six Months
Additions to PP&E
$
13
$
33
WPD Midlands (a)
17
53
Ironwood Acquisition
4
4
Total
$
34
$
90

(a)
Periods are not comparable.  The periods ended June 30, 2012 include three and six months of WPD Midlands' results, compared with two months for the same periods in 2011.

Taxes, Other Than Income
The increase (decrease) in taxes, other than income for the periods ended June 30, 2012 compared with 2011 was due to:
Three Months
Six Months
Pennsylvania gross receipts tax (a)
$
(5)
$
(12)
Domestic property tax
5
5
WPD Midlands (b)
8
30
Other
4
7
Total
$
12
$
30

(a)
The decrease for the three and six month periods was primarily due to a decrease in taxable electric revenue.  This tax is included in "Unregulated Gross Energy Margins" and "Pennsylvania Gross Delivery Margins".
(b)
Periods are not comparable.  The periods ended June 30, 2012 include three and six months of WPD Midlands' results, compared with two months for the same periods in 2011.

Other Income (Expense) - net

The $64 million increase in other income (expense) - net for the three months ended June 30, 2012 compared with 2011 was primarily due to:

·
$47 million of other WPD Midlands acquisition-related adjustments in 2011;
·
a $23 million increase in gains from economic foreign currency exchange contracts; and

118

·
a $58 million foreign currency loss related to the repayment of the 2011 Bridge Facility borrowing offset by a $62 million gain on foreign currency contracts that hedged the repayment of such borrowings, both in 2011.

The $52 million increase in other income (expense) - net for the six months ended June 30, 2012 compared with 2011 was primarily due to:

·
$57 million of other WPD Midlands acquisition-related adjustments in 2011;
·
a $7 million increase in gains from economic foreign currency exchange contracts; and
·
a $58 million foreign currency loss related to the repayment of the 2011 Bridge Facility borrowing partially offset by a $55 million gain on foreign currency contracts that hedged the repayment of such borrowings, both in 2011.

See Note 12 to the Financial Statements for further details.

Interest Expense
The increase (decrease) in interest expense for the periods ended June 30, 2012 compared with 2011 was due to:
Three Months
Six Months
2011 Bridge Facility costs related to financing the acquisition of WPD Midlands
$
(36)
$
(43)
2011 Equity Units (a)
1
13
Interest rates (excluding 2011 Equity Units) (b)
(15)
(26)
Debt balances (excluding 2011 Equity Units) (c)
13
17
WPD Midlands (d)
12
68
Inflation adjustment on U.K. Index-linked Senior Unsecured Notes
(5)
(8)
Hedging activity and ineffectiveness
10
19
Ironwood Acquisition (Note 8)
4
4
Other
(12)
(16)
Total
$
(28)
$
28
(a)
Interest related to the issuance in April 2011 to support the WPD Midlands acquisition.
(b)
Short-term weighted average rates were 0.69% and 0.73% for the three and six months ended June 30, 2012, compared with 1.82% and 2.02% for the same periods in 2011.  Long-term weighted average rates of 4.69% at June 30, 2012, compared with 4.94% at June 30, 2011.
(c)
Short-term debt balances were $420 million and $83 million higher for the three and six months ended June 30, 2012, compared with the same periods in 2011.  The long-term debt balance (excluding $255 million of long-term debt balance from the April 2012 Ironwood Acquisition) was $520 million higher at June 30, 2012, compared with the same period in 2011.
(d)
Periods are not comparable.  The periods ended June 30, 2012 include three and six months of WPD Midlands' results, compared with two months for the same periods in 2011.

Income Taxes
The increase (decrease) in income taxes for the periods ended June 30, 2012 compared with 2011 was due to:
Three Months
Six Months
Lower pre-tax book income
$
(30)
$
(23)
State valuation allowance adjustments (a)
(11)
Federal and state tax reserve adjustments
(2)
(2)
Federal and state tax return adjustments
(1)
2
U.S. income tax on foreign earnings net of foreign tax credit (b)
10
18
Foreign tax reserve adjustments (c)
(8)
(5)
Net operating loss carryforward adjustments (d)
(3)
(9)
Depreciation not normalized (a)
2
WPD Midlands (e)
27
61
State deferred tax rate change (f)
(11)
Other
(1)
6
Total
$
(8)
$
28

(a)
In February 2011, the Pennsylvania Department of Revenue issued interpretive guidance on the treatment of bonus depreciation for Pennsylvania income tax purposes.  In accordance with Corporation Tax Bulletin 2011-01, Pennsylvania allows 100% bonus depreciation for qualifying assets in the same year bonus depreciation is allowed for federal income tax purposes.  Due to the decrease in projected taxable income related to bonus depreciation, PPL recorded state deferred income tax expense during the six months ended June 30, 2011 related to valuation allowances.

Additionally, the 100% Pennsylvania bonus depreciation deduction created a current state income tax benefit for the flow-through impact of Pennsylvania regulated state tax depreciation.  The federal provision for 100% bonus depreciation generally applies to property placed in service before January 1, 2012.  The placed in service deadline is extended to January 1, 2013 for property that exceeds $1 million, has a production period longer than one year and has a tax life of at least 10 years.
(b)
During the three and six months ended June 30, 2011, PPL recorded a $7 million and $14 million federal income tax benefit related to U.K. pension contributions.

119

(c)
During the three and six months ended June 30, 2012, PPL recorded a tax benefit following resolution of a U.K. tax issue related to interest expense.
(d)
During the three and six months ended June 30, 2012, PPL recorded adjustments to deferred taxes related to net operating loss carryforwards of LKE based on income tax return adjustments.
(e)
Periods are not comparable.  The periods ended June 30, 2012 include three and six months of WPD Midlands' results compared with two months for the same periods in 2011.
(f)
During the six months ended June 30, 2012, PPL recorded an adjustment related to state deferred tax liabilities.

See Note 5 to the Financial Statements for additional information on income taxes.

Noncontrolling Interests

"Net Income Attributable to Noncontrolling Interests" decreased by $4 million for the three and six months ended June 30, 2012 compared with 2011.  The decrease is due to PPL Electric's June 2012 redemption of all 2.5 million shares of its preference stock.  The price paid was the par value, without premium ($250 million in the aggregate).

Financial Condition
Liquidity and Capital Resources
PPL had the following at:
June 30, 2012
December 31, 2011
Cash and cash equivalents
$
981
$
1,202
Short-term investments
16
$
981
$
1,218
Short-term debt
$
889
$
578

At June 30, 2012, $357 million of cash and cash equivalents were denominated in GBP.  If these amounts would be remitted as dividends, PPL may be subject to additional U.S. taxes, net of allowable foreign tax credits.  Historically, dividends paid by foreign subsidiaries have been distributions of the current year's earnings.  See Note 5 to the Financial Statements in PPL's 2011 Form 10-K for additional information on undistributed earnings of WPD.

The $221 million decrease in PPL's cash and cash equivalents position was primarily the net result of:

·
capital expenditures of $1.3 billion;
·
the payment of $413 million of common stock dividends;
·
the redemption of preference stock of a subsidiary of $250 million;
·
the Ironwood Acquisition for $84 million, net of cash acquired;
·
net cash provided by operating activities of $947 million;
·
proceeds of $575 million from the issuance of long-term debt; and
·
a net increase in short-term debt of $311 million.

PPL's cash provided by operating activities increased by $133 million for the six months ended June 30, 2012 compared with 2011.  The increase was the net effect of:

·
an increase of $211 million in net income (primarily from the U.K. Regulated segment); and
·
a decrease of $57 million in defined benefit plan funding; partially offset by
·
an increase in cash used by components of working capital of $117 million.

Credit Facilities

PPL maintains credit facilities to provide liquidity and to backstop commercial paper issuances.  At June 30, 2012, PPL's total committed borrowing capacity under its credit facilities and the use of this borrowing capacity were:

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Letters of
Credit Issued
and
Committed
Commercial
Unused
Capacity
Borrowed
Paper Backstop
Capacity
PPL Energy Supply Credit Facilities
$
3,200
$
790
$
2,410
PPL Electric Credit Facilities (a)
450
196
254
LG&E Credit Facility
400
400
KU Credit Facilities
598
198
400
Total Domestic Credit Facilities (b)
$
4,648
$
1,184
$
3,464
PPL WW Credit Facility (c)
£
150
£
110
n/a
£
40
WPD (South West) Credit Facility (d)
245
n/a
245
WPD (East Midlands) Credit Facility
300
300
WPD (West Midlands) Credit Facility
300
300
Total WPD Credit Facilities (e)
£
995
£
110
£
885

(a)
In April 2012, PPL Electric increased the capacity of its syndicated credit facility from $200 million to $300 million.

Committed capacity includes a $150 million credit facility related to an asset-backed commercial paper program through which PPL Electric obtains financing by selling and contributing its eligible accounts receivable and unbilled revenue to a special purpose, wholly owned subsidiary on an ongoing basis.  The subsidiary pledges these assets to secure loans of up to an aggregate of $150 million from a commercial paper conduit sponsored by a financial institution.  At June 30, 2012, based on accounts receivable and unbilled revenue pledged, the amount available for borrowing under the facility was limited to $87 million.  In July 2012, PPL Electric and the subsidiary extended this agreement to September 2012 and reduced the capacity to $100 million.
(b)
The commitments under PPL's domestic credit facilities are provided by a diverse bank group, with no one bank and its affiliates providing an aggregate commitment of more than 9% of the total committed capacity.
(c)
The borrowing outstanding at June 30, 2012 was a USD-denominated borrowing of $174 million, which equated to £110 million at the time of borrowing and bore interest at approximately 1.458%.
(d)
In January 2012, WPD (South West) entered into a new £245 million syndicated credit facility to replace its previous £210 million syndicated credit facility.  Under the new facility, WPD (South West) has the ability to make cash borrowings but cannot request the lenders to issue letters of credit.  WPD (South West) pays customary commitment fees under this facility, and borrowings bear interest at LIBOR-based rates plus a margin.  The facility contains financial covenants that require WPD (South West) to maintain an interest coverage ratio of not less than 3.0 times consolidated earnings before income taxes, depreciation and amortization and total net debt not in excess of 85% of its RAV, in each case calculated in accordance with the credit facility.
(e)
At June 30, 2012, the U.S. dollar equivalent of unused capacity under WPD's committed credit facilities was approximately $1.4 billion.  The commitments under WPD's credit facilities are provided by a diverse bank group with no one bank providing more than 16% of the total committed capacity.

See Note 7 to the Financial Statements for further discussion of PPL's credit facilities.

Commercial Paper

In February 2012, LG&E and KU each established a commercial paper program for up to $250 million to provide an additional financing source to fund their short-term liquidity needs.  Commercial paper issuances are supported by LG&E's and KU's Syndicated Credit Facilities.  LG&E and KU had no commercial paper outstanding at June 30, 2012.

In April 2012, PPL Energy Supply increased the capacity of its commercial paper program from $500 million to $750 million to provide an additional financing source to fund its short-term liquidity needs, if and when necessary.  Commercial paper issuances are supported by PPL Energy Supply's Syndicated Credit Facility.  At June 30, 2012, PPL Energy Supply had $520 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheet, at a weighted-average interest rate of approximately 0.48%.

In May 2012, PPL Electric increased the capacity of its commercial paper program from $200 million to $300 million to provide an additional financing source to fund its short-term liquidity needs, if and when necessary.  Commercial paper issuances are supported by PPL Electric's Syndicated Credit Facility.  At June 30, 2012, PPL Electric had $195 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheet, at a weighted-average interest rate of approximately 0.49%.

Long-term Debt and Equity Securities

In April 2012, PPL made a registered underwritten public offering of 9.9 million shares of its common stock.  In conjunction with that offering, the underwriters exercised an option to purchase an additional 591 thousand shares of PPL common stock solely to cover over-allotments.
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In connection with the registered public offering, PPL entered into forward sale agreements with two counterparties covering the 9.9 million shares of PPL's common stock.  Settlement of these initial forward sale agreements will occur no later than April 2013.  As a result of the underwriters' exercise of the overallotment option, PPL entered into additional forward sale agreements covering the additional 591 thousand shares of common stock.  Settlement of the subsequent forward sale agreements will occur in July 2013.  Upon any physical settlement of any forward sale agreement, PPL will issue and deliver to the forward counterparties shares of its common stock in exchange for cash proceeds per share equal to the forward sale price.  The forward sale price will be calculated based on an initial forward price of $27.02 per share reduced during the period the contracts are outstanding as specified in the forward sale agreements. PPL may, in certain circumstances, elect cash settlement or net share settlement for all or a portion of its rights or obligations under the forward sale agreements.

PPL will not receive any proceeds or issue any shares of common stock until settlement of the forward sale agreements.  PPL intends to use any net proceeds that it receives upon settlement to repay short-term debt obligations and for other general corporate purposes.

The forward sale agreements will be classified as equity transactions.  As a result, no amounts will be recorded in the consolidated financial statements until the settlement of the forward sale agreements.  Prior to those settlements, the only impact to the financial statements will be the inclusion of incremental shares within the calculation of diluted EPS using the treasury stock method.

In April 2012, an indirect, wholly owned subsidiary of PPL Energy Supply completed the Ironwood Acquisition.  See Note 8 for information on the transaction and the debt of PPL Ironwood, LLC assumed through consolidation as part of the acquisition.

In April 2012, WPD (East Midlands) issued £100 million aggregate principal amount of 5.25% Senior Notes due 2023.  WPD (East Midlands) received proceeds of approximately £111 million, which equated to $178 million at the time of issuance, net of underwriting fees.  The net proceeds were used for general corporate purposes.

In June 2012, LKE completed an exchange of all its outstanding 4.375% Senior Notes due 2021 issued in September 2011 in a transaction not registered under the Securities Act of 1933, for similar securities that were issued in a transaction registered with the SEC.  See Note 7 in PPL's and LKE's 2011 Form 10-K for additional information.

In June 2012, PPL Capital Funding issued $400 million of 4.20% Senior Notes due 2022.  The notes may be redeemed at PPL Capital Funding's option any time prior to maturity at make-whole redemption prices.  PPL Capital Funding received proceeds of $396 million, net of a discount and underwriting fees, that will be used for general corporate purposes.

In June 2012, PPL Electric redeemed all 2.5 million shares of its 6.25% Series Preference Stock, par value $100 per share.  The price paid for the redemption was the par value, without premium ($250 million in the aggregate).  At December 31, 2011, the preference stock was reflected in "Noncontrolling Interests" on PPL's Balance Sheet.

In July 2012, PPL Capital Funding gave notice of its election to redeem at par on August 14, 2012, together with interest accrued to the redemption date, the entire $99 million outstanding principal amount of its 6.85% Senior Notes due 2047.

See Note 7 in PPL's 2011 Form 10-K for information on the 2011 Bridge Facility, 2011 Equity Units and the April 2011 issuance of common stock.

Common Stock Dividends

In May 2012, PPL declared its quarterly common stock dividend, payable July 2, 2012, at 36.0 cents per share (equivalent to $1.44 per annum).  Future dividends, declared at the discretion of the Board of Directors, will be dependent upon future earnings, cash flows, financial and legal requirements and other factors.

Rating Agency Actions

Moody's, S&P and Fitch periodically review the credit ratings on the debt of PPL and its subsidiaries.  Based on their respective independent reviews, the rating agencies may make certain ratings revisions or ratings affirmations.

A credit rating reflects an assessment by the rating agency of the creditworthiness associated with an issuer and particular securities that it issues.  The credit ratings of PPL and its subsidiaries are based on information provided by PPL and other sources.  The ratings of Moody's, S&P and Fitch are not a recommendation to buy, sell or hold any securities of PPL or its subsidiaries.  Such ratings may be subject to revisions or withdrawal by the agencies at any time and should be evaluated

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independently of each other and any other rating that may be assigned to the securities.  A downgrade in PPL's or its subsidiaries' credit ratings could result in higher borrowing costs and reduced access to capital markets.

As a result of the passage of the Dodd-Frank Act, PPL is limiting its credit rating disclosure to a description of the actions taken by the rating agencies with respect to PPL's ratings, but without stating what ratings have been assigned to PPL or its subsidiaries, or their securities.  The ratings assigned by the rating agencies to PPL and its subsidiaries and their respective securities may be found, without charge, on each of the respective rating agencies' websites, which ratings together with all other information contained on such rating agency websites is, hereby, explicitly not incorporated by reference in this report.

The rating agencies took the following actions related to PPL and its subsidiaries:

In January 2012, S&P affirmed its rating and revised its outlook for PPL Montana's Pass Through Certificates due 2020.

In February 2012, Fitch assigned ratings to the two newly established commercial paper programs for LG&E and KU.

In March 2012, Moody's affirmed the following ratings:
·
the long-term ratings of the First Mortgage Bonds for LG&E and KU;
·
the issuer ratings for LG&E and KU; and
·
the bank loan ratings for LG&E and KU.

Also in March 2012, Moody's and S&P each assigned short-term ratings to the two newly established commercial paper programs for LG&E and KU.

In March and May 2012, Moody's, S&P and Fitch affirmed the long-term ratings for LG&E's 2003 Series A and 2007 Series B pollution control bonds.

Following the announcement of the then-pending acquisition of AES Ironwood, L.L.C. in February 2012, the rating agencies took the following actions:
·
In March 2012, Moody's placed AES Ironwood, L.L.C.'s senior secured bonds under review for possible ratings upgrade.
·
In April 2012, S&P affirmed the rating of AES Ironwood, L.L.C.'s senior secured bonds.

In May 2012, Fitch downgraded its rating and revised its outlook for PPL Montana's Pass Through Certificates due 2020.

In June 2012, Fitch assigned a rating and outlook to PPL Capital Funding's Senior Notes.

Ratings Triggers

PPL and PPL Energy Supply have various derivative and non-derivative contracts, including contracts for the sale and purchase of electricity and fuel, commodity transportation and storage, tolling agreements and interest rate and foreign currency instruments, which contain provisions that require PPL and PPL Energy Supply to post additional collateral or permit the counterparty to terminate the contract, if PPL's or PPL Energy Supply's credit rating were to fall below investment grade.  See Note 14 to the Financial Statements for a discussion of "Credit Risk-Related Contingent Features," including a discussion of the potential additional collateral that would have been required for derivative contracts in a net liability position at June 30, 2012.  At June 30, 2012, if PPL's and its subsidiaries' credit ratings had been below investment grade, PPL would have been required to prepay or post an additional $531 million of collateral to counterparties for both derivative and non-derivative commodity and commodity-related contracts used in its generation, marketing and trading operations and interest rate and foreign currency contracts.

Capital Expenditures

Capital expenditure plans are revised periodically to reflect changes in operational, market and regulatory conditions.  PPL has lowered its projected capital spending for 2012 by approximately $325 million from the previously disclosed $3.8 billion projection included in PPL's 2011 Form 10-K.  The lower projected capital spending is due mainly to the terminated Bluegrass CT acquisition discussed in Notes 6 and 8 to the Financial Statements and the status of environmental projects.

For additional information on PPL's liquidity and capital resources, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," in PPL's 2011 Form 10-K.
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Risk Management

Market Risk

See Notes 13 and 14 to the Financial Statements for information about PPL's risk management objectives, valuation techniques and accounting designations.

The forward-looking information presented below provides estimates of what may occur in the future, assuming certain adverse market conditions and model assumptions.  Actual future results may differ materially from those presented.  These disclosures are not precise indicators of expected future losses, but only indicators of possible losses under normal market conditions at a given confidence level.

Commodity Price Risk (Non-trading)

PPL segregates its non-trading activities into two categories:  hedge activity and economic activity.  Transactions that are accounted for as hedge activity qualify for hedge accounting treatment.  The economic activity category includes transactions that address a specific risk, but were not eligible for hedge accounting or for which hedge accounting was not elected.  This activity includes the changes in fair value of positions used to hedge a portion of the economic value of PPL's generation assets, full-requirement sales contracts and retail contracts.  This economic activity is subject to changes in fair value due to market price volatility of the input and output commodities (e.g., fuel and power).  Although they do not receive hedge accounting treatment, these transactions are considered non-trading activity.  The fair value of economic positions at June 30, 2012 and December 31, 2011 was a net asset/(liability) of $796 million and $(63) million.  The change in fair value is largely attributable to the dedesignation of cash flow hedges that are now classified as economic hedges.  See Note 14 to the Financial Statements for additional information.

To hedge the impact of market price volatility on PPL's energy-related assets, liabilities and other contractual arrangements, PPL both sells and purchases physical energy at the wholesale level under FERC market-based tariffs throughout the U.S. and enters into financial exchange-traded and over-the-counter contracts.  PPL's non-trading commodity derivative contracts mature at various times through 2019.

The following table sets forth the change in net fair value of PPL's non-trading commodity derivative contracts for the periods ended June 30.  See Notes 13 and 14 to the Financial Statements for additional information.

Gains (Losses)
Three Months
Six Months
2012
2011
2012
2011
Fair value of contracts outstanding at the beginning of the period
$
1,215
$
997
$
1,082
$
947
Contracts realized or otherwise settled during the period
(261)
(85)
(540)
(128)
Fair value of new contracts entered into during the period (a)
13
31
12
15
Other changes in fair value
(6)
(49)
407
60
Fair value of contracts outstanding at the end of the period
$
961
$
894
$
961
$
894

(a)
Represents the fair value of contracts at the end of the quarter of their inception.

The following table segregates the net fair value of PPL's non-trading commodity derivative contracts at June 30, 2012, based on the level of observability of the information used to determine the fair value.

Net Asset (Liability)
Maturity
Maturity
Less Than
Maturity
Maturity
in Excess
Total Fair
1 Year
1-3 Years
4-5 Years
of 5 Years
Value
Source of Fair Value
Prices based on significant other observable inputs
$
703
$
237
$
(21)
$
8
$
927
Prices based on significant unobservable inputs
21
9
4
34
Fair value of contracts outstanding at the end of the period
$
724
$
246
$
(17)
$
8
$
961

PPL sells electricity, capacity and related services and buys fuel on a forward basis to hedge the value of energy from its generation assets.  If PPL were unable to deliver firm capacity and energy or to accept the delivery of fuel under its agreements, under certain circumstances it could be required to pay liquidating damages.  These damages would be based on the difference between the market price and the contract price of the commodity.  Depending on price changes in the wholesale energy markets, such damages could be significant.  Extreme weather conditions, unplanned power plant outages, transmission disruptions, nonperformance by counterparties (or their own counterparties) with which it has energy contracts

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and other factors could affect PPL's ability to meet its obligations, or cause significant increases in the market price of replacement energy.  Although PPL attempts to mitigate these risks, there can be no assurance that it will be able to fully meet its firm obligations, that it will not be required to pay damages for failure to perform, or that it will not experience counterparty nonperformance in the future.  In connection with its bankruptcy proceedings, a significant counterparty, SMGT, had been purchasing lower volumes of electricity than prescribed in the contract and effective April 1, 2012 the contract was terminated.  At this time, PPL Energy Supply cannot predict the prices or other terms on which it will be able to market to third parties the power that SMGT will not purchase from PPL EnergyPlus due to the termination of this contract.  See Note 10 to the Financial Statements for additional information.

Commodity Price Risk (Trading)

PPL's trading commodity derivative contracts mature at various times through 2017.  The following table sets forth changes in the net fair value of PPL's trading commodity derivative contracts for the periods ended June 30.  See Notes 13 and 14 to the Financial Statements for additional information.

Gains (Losses)
Three Months
Six Months
2012
2011
2012
2011
Fair value of contracts outstanding at the beginning of the period
$
2
$
7
$
(4)
$
4
Contracts realized or otherwise settled during the period
(1)
1
(1)
3
Fair value of new contracts entered into during the period (a)
(1)
5
5
8
Other changes in fair value
17
2
17
Fair value of contracts outstanding at the end of the period
$
17
$
15
$
17
$
15

(a)
Represents the fair value of contracts at the end of the quarter of their inception.

Unrealized gains of approximately $1 million will be reversed over the next three months as the transactions are realized.

The following table segregates the net fair value of trading commodity derivative contracts at June 30, 2012, based on the level of observability of the information used to determine the fair value.

Net Asset (Liability)
Maturity
Maturity
Less Than
Maturity
Maturity
in Excess
Total Fair
1 Year
1-3 Years
4-5 Years
of 5 Years
Value
Source of Fair Value
Prices based on significant other observable inputs
$
8
$
8
$
1
$
17
Fair value of contracts outstanding at the end of the period
$
8
$
8
$
1
$
17

VaR Models

A VaR model is utilized to measure commodity price risk in domestic gross energy margins for the non-trading and trading portfolios.  VaR is a statistical model that attempts to estimate the value of potential loss over a given holding period under normal market conditions at a given confidence level.  VaR is calculated using a Monte Carlo simulation technique based on a five-day holding period at a 95% confidence level.  Given the company's conservative hedging program, the non-trading VaR exposure is expected to be limited in the short-term.  The VaR for portfolios using end-of-month results for the period was as follows.

Trading VaR
Non-Trading VaR
Six Months
Twelve Months
Six Months
Twelve Months
Ended
Ended
Ended
Ended
June 30,
December 31,
June 30,
December 31,
2012
2011
2012
2011
95% Confidence Level, Five-Day Holding Period
Period End
$
5
$
1
$
11
$
6
Average for the Period
2
3
9
5
High
5
6
11
7
Low
1
1
7
4

The trading portfolio includes all speculative positions, regardless of the delivery period.  All positions not considered speculative are considered non-trading.  The non-trading portfolio includes the entire portfolio, including generation, with delivery periods through the next 12 months.  Both the trading and non-trading VaR computations exclude FTRs due to the

125

absence of reliable spot and forward markets.  The fair value of the non-trading and trading FTR positions was insignificant at June 30, 2012.

Interest Rate Risk

PPL and its subsidiaries issue debt to finance their operations, which exposes them to interest rate risk.  PPL utilizes various financial derivative instruments to adjust the mix of fixed and floating interest rates in its debt portfolio, adjust the duration of its debt portfolio and lock in benchmark interest rates in anticipation of future financing, when appropriate.  Risk limits under the risk management program are designed to balance risk exposure to volatility in interest expense and changes in the fair value of PPL's debt portfolio due to changes in the absolute level of interest rates.

At June 30, 2012, PPL's potential annual exposure to increased interest expense, based on a 10% increase in interest rates, was not significant.

PPL is also exposed to changes in the fair value of its domestic and international debt portfolios.  PPL estimated that a 10% decrease in interest rates at June 30, 2012 would increase the fair value of its debt portfolio by $601 million.

At June 30, 2012, PPL had the following interest rate hedges outstanding:

Effect of a
Fair Value,
10% Adverse
Exposure
Net - Asset
Movement
Hedged
(Liability) (a)
in Rates (b)
Cash flow hedges
Interest rate swaps (c)
$
300
$
(15)
$
(6)
Cross-currency swaps (d)
1,262
68
(177)
Fair value hedges
Interest rate swaps (e)
99
1
Economic hedges
Interest rate swaps (f)
179
(62)
(3)
(a)
Includes accrued interest, if applicable.
(b)
Effects of adverse movements decrease assets or increase liabilities, as applicable, which could result in an asset becoming a liability.
(c)
PPL utilizes various risk management instruments to reduce its exposure to the expected future cash flow variability of its debt instruments.  These risks include exposure to adverse interest rate movements for outstanding variable rate debt and for future anticipated financing.  While PPL is exposed to changes in the fair value of these instruments, any changes in the fair value of such cash flow hedges are recorded in equity.  The changes in fair value of these instruments are then reclassified into earnings in the same period during which the item being hedged affects earnings.  Sensitivities represent a 10% adverse movement in interest rates.  The positions outstanding at June 30, 2012 mature through 2023.
(d)
PPL WEM, through PPL, and PPL WW use cross-currency swaps to hedge the interest payments and principal of their U.S. dollar-denominated senior notes.  While PPL is exposed to changes in the fair value of these instruments, any change in the fair value of these instruments is recorded in equity and reclassified into earnings in the same period during which the item being hedged affects earnings.  Sensitivities represent a 10% adverse movement in both interest rates and foreign currency exchange rates.  The positions outstanding at June 30, 2012 mature through 2028.
(e)
PPL utilizes various risk management instruments to adjust the mix of fixed and floating interest rates in its debt portfolio.  The change in fair value of these instruments, as well as the offsetting change in the value of the hedged exposure of the debt, is reflected in earnings.  Sensitivities represent a 10% adverse movement in interest rates.  In July 2012, these contracts were canceled without penalties by the counterparties.
(f)
PPL utilizes various risk management instruments to reduce its exposure to the expected future cash flow variability of its debt instruments.  These   risks include exposure to adverse interest rate movements for outstanding variable rate debt and for future anticipated financing.  While PPL is exposed to changes in the fair value of these instruments, any realized changes in the fair value of such economic hedges are recoverable through regulated rates and any subsequent changes in fair value of these derivatives are included in regulatory assets or liabilities.  Sensitivities represent a 10% adverse movement in interest rates.  The positions outstanding at June 30, 2012 mature through 2033.
Foreign Currency Risk

PPL is exposed to foreign currency risk, primarily through investments in U.K. affiliates.  In addition, PPL's domestic operations may make purchases of equipment in currencies other than U.S. dollars.

PPL has adopted a foreign currency risk management program designed to hedge certain foreign currency exposures, including firm commitments, recognized assets or liabilities, anticipated transactions and net investments.  In addition, PPL enters into financial instruments to protect against foreign currency translation risk of expected earnings.
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At June 30, 2012, PPL had the following foreign currency hedges outstanding:

Effect of a
10%
Adverse
Movement
in Foreign
Fair Value,
Currency
Exposure
Net - Asset
Exchange
Hedged
(Liability)
Rates (a)
Net investment hedges (b)
£
96
$
3
$
(15)
Economic hedges (c)
1,022
12
(153)

(a)
Effects of adverse movements decrease assets or increase liabilities, as applicable, which could result in an asset becoming a liability.
(b)
To protect the value of a portion of its net investment in WPD, PPL executes forward contracts to sell GBP.  The positions outstanding at June 30, 2012 mature through 2013.  Excludes the amount of an intercompany loan classified as a net investment hedge.  See Note 14 to the Financial Statements for additional information.
(c)
To economically hedge the translation of expected income denominated in GBP to U.S. dollars, PPL enters into a combination of average rate forwards and average rate options to sell GBP.  The positions outstanding at June 30, 2012 mature through 2014.

NDT Funds - Securities Price Risk

In connection with certain NRC requirements, PPL Susquehanna maintains trust funds to fund certain costs of decommissioning the PPL Susquehanna nuclear plant (Susquehanna).  At June 30, 2012, these funds were invested primarily in domestic equity securities and fixed-rate, fixed-income securities and are reflected at fair value on the Balance Sheet.  The mix of securities is designed to provide returns sufficient to fund Susquehanna's decommissioning and to compensate for inflationary increases in decommissioning costs.  However, the equity securities included in the trusts are exposed to price fluctuation in equity markets, and the values of fixed-rate, fixed-income securities are primarily exposed to changes in interest rates.  PPL actively monitors the investment performance and periodically reviews asset allocation in accordance with its NDT policy statement.  At June 30, 2012, a hypothetical 10% increase in interest rates and a 10% decrease in equity prices would have resulted in an estimated $47 million reduction in the fair value of the trust assets.  See Notes 13 and 17 to the Financial Statements for additional information regarding the NDT funds.

Credit Risk

See Notes 13 and 14 to the Financial Statements in this Form 10-Q and "Risk Management - Energy Marketing & Trading and Other - Credit Risk" in PPL's 2011 Form 10-K for additional information.

Foreign Currency Translation

The value of the British pound sterling fluctuates in relation to the U.S. dollar.  Changes in these exchange rates resulted in a foreign currency translation loss of $104 million for the six months ended June 30, 2012, which primarily reflected a $196 million reduction to PP&E offset by a reduction of $92 million to net liabilities.  Changes in these exchange rates resulted in a foreign currency translation gain of $162 million for the six months ended June 30, 2011, which primarily reflected a $336 million increase to PP&E offset by an increase of $174 million to net liabilities.  The impact of foreign currency translation is recorded in AOCI.

Related Party Transactions

PPL is not aware of any material ownership interests or operating responsibility by senior management of PPL, PPL Energy Supply, PPL Electric, LKE, LG&E or KU in outside partnerships, including leasing transactions with variable interest entities or other entities doing business with PPL.  See Note 11 to the Financial Statements for additional information on related party transactions.

Acquisitions, Development and Divestitures

See Note 8 to the Financial Statements for information on the April 2012 Ironwood Acquisition and LG&E's and KU's June 2012 termination of the asset purchase agreement for the Bluegrass CTs.

See Note 10 to the Financial Statements in PPL's 2011 Form 10-K and Note 8 to the Financial Statements for information on PPL's April 2011 acquisition of WPD Midlands.


127

Development projects are continuously reexamined based on market conditions and other factors to determine whether to proceed with the projects, sell, cancel or expand them, execute tolling agreements or pursue other options.  See Note 8 to the Financial Statements for additional information on the more significant activities.

Environmental Matters

Extensive federal, state and local environmental laws and regulations are applicable to PPL's air emissions, water discharges and the management of hazardous and solid waste, among other areas; and the cost of compliance or alleged non-compliance cannot be predicted with certainty but could be material.  In addition, costs may increase significantly if the requirements or scope of environmental laws or regulations, or similar rules, are expanded or changed by the relevant regulatory agencies.  Costs may take the form of increased capital or operating and maintenance expenses; monetary fines, penalties or other restrictions.  Many of these environmental law considerations are also applicable to the operations of key suppliers, or customers, such as coal producers and industrial power users, and may impact the cost of their products or their demand for PPL's services.  See Note 10 to the Financial Statements in this Form 10-Q and "Item 1. Business - Environmental Matters" in PPL's 2011 Form 10-K for a discussion of environmental matters.

New Accounting Guidance

See Notes 2 and 18 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.

Application of Critical Accounting Policies

Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies.  The following accounting policies are particularly important to the financial condition or results of operations, and require estimates or other judgments of matters inherently uncertain: price risk management, defined benefits, asset impairment, loss accruals, AROs, income taxes, regulatory assets and liabilities and business combinations - purchase price allocation.  See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in PPL's 2011 Form 10-K for a discussion of each critical accounting policy.
128
PPL ENERGY SUPPLY, LLC AND SUBSIDIARIES

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations

The following should be read in conjunction with PPL Energy Supply's Condensed Consolidated Financial Statements and the accompanying Notes and with PPL Energy Supply's 2011 Form 10-K.  Capitalized terms and abbreviations are defined in the glossary.  Dollars are in millions, unless otherwise noted.

"Management's Discussion and Analysis of Financial Condition and Results of Operations" includes the following information:

·
"Overview" provides a description of PPL Energy Supply and its business strategy, a summary of Net Income Attributable to PPL Energy Supply and a discussion of certain events related to PPL Energy Supply's results of operations and financial condition.

·
"Results of Operations" provides a summary of PPL Energy Supply's earnings and a description of factors expected to impact future earnings.  This section ends with explanations of significant changes in principal items on PPL Energy Supply's Statements of Income, comparing the three and six months ended June 30, 2012 with the same periods in 2011.

·
"Financial Condition - Liquidity and Capital Resources" provides an analysis of PPL Energy Supply's liquidity position and credit profile.  This section also includes a discussion of rating agency actions.

·
"Financial Condition - Risk Management" provides an explanation of PPL Energy Supply's risk management programs relating to market and credit risk.

Overview

Introduction

PPL Energy Supply is an energy company with headquarters in Allentown, Pennsylvania.  Through its subsidiaries, PPL Energy Supply is primarily engaged in the generation and marketing of electricity in two key markets - the northeastern and northwestern U.S.

Business Strategy

PPL Energy Supply's overall strategy is to achieve disciplined optimization of energy supply margins while mitigating volatility in both cash flows and earnings.  More specifically, PPL Energy Supply's strategy is to optimize the value from its competitive generation and marketing portfolio.  PPL Energy Supply endeavors to do this by matching energy supply with load, or customer demand, under contracts of varying durations with creditworthy counterparties to capture profits while effectively managing exposure to energy and fuel price volatility, counterparty credit risk and operational risk.

To manage financing costs and access to credit markets, a key objective of PPL Energy Supply's business is to maintain a strong credit profile.  PPL Energy Supply continually focuses on maintaining an appropriate capital structure and liquidity position.  In addition, PPL Energy Supply has financial and operational risk management programs that, among other things, are designed to monitor and manage its exposure to earnings and cash flow volatility related to changes in energy and fuel prices, interest rates, counterparty credit quality and the operating performance of its generating units.

Financial and Operational Developments

Net Income Attributable to PPL Energy Supply

Net Income Attributable to PPL Energy Supply for the three and six months ended June 30, 2012 was $19 million and $328 million compared to $89 million and $303 million for the same periods in 2011 representing a 79% decrease and an 8% increase over the same periods in 2011.

See "Results of Operations" for details of special items and analysis of the consolidated results of operations.
129
Economic and Market Conditions

Unregulated gross energy margins associated with PPL Energy Supply's competitive generation and marketing business are impacted by changes in market prices and demand for electricity and natural gas, power plant availability, competition in the markets for retail customers, fuel costs and availability, fuel transportation costs and other costs.  Current depressed wholesale market prices for electricity and natural gas have resulted from general weak economic conditions and other factors, including the impact of expanded domestic shale gas development.  As a result of these factors, PPL Energy Supply has experienced a shift in the dispatching of its competitive generation from coal-fired to combined-cycle gas-fired generation as illustrated in the following table:

Average Utilization Factors (a)
2009 - 2011
YTD 2012
Pennsylvania coal plants
90%
63%
Montana coal plants
83%
50%
Combined-cycle gas plants
64%
96%

(a)
All periods reflect the six months ending June 30.

This reduction in coal-fired generation output has resulted in a surplus of coal inventory at certain of PPL Energy Supply's Pennsylvania coal plants.  To mitigate the risk of exceeding available coal storage, PPL Energy Supply incurred pre-tax charges of $12 million during the six months ended June 30, 2012 to reduce its 2012 contracted coal deliveries.  Because coal purchases may also exceed expected fuel needs for 2013, PPL Energy Supply continues to manage its coal inventory to mitigate the financial impact and physical implications of an oversupply, including, but not limited to, contract modifications to reduce 2013 coal deliveries.

In addition, current economic and commodity market conditions indicated a lower value of unhedged future energy margins (primarily in 2014 and forward years) compared to the hedged energy margins in 2012.  As has been PPL Energy Supply's practice in periods of changing business conditions, PPL Energy Supply continues to review its future business and operational plans, including capital and operation and maintenance expenditures, as well as its hedging strategies.

PPL Energy Supply's businesses are also subject to extensive federal, state and local environmental laws, rules and regulations.  PPL Energy Supply's competitive generation assets are well positioned to meet these requirements.  See Note 15 to the Financial Statements in PPL Energy Supply's Form 2011 10-K for additional information on these requirements.

In light of these economic and market conditions, as well as current and projected environmental regulatory requirements, PPL Energy Supply considered whether certain of its generating assets were impaired, and determined that no impairment charges were required at June 30, 2012.  PPL Energy Supply is unable to predict whether future environmental requirements or market conditions will result in impairment charges or retirements.

PPL Energy Supply and its subsidiaries may also be impacted in future periods by the uncertainty in the worldwide financial and credit markets partially caused by the European sovereign debt crisis.  In addition, PPL Energy Supply may be impacted by reductions in the credit ratings of financial institutions and evolving regulations in the financial sector.  Collectively, these factors could reduce availability or restrict PPL Energy Supply and its subsidiaries' ability to maintain sufficient levels of liquidity, reduce capital market activities, change collateral posting requirements and increase the associated costs to PPL Energy Supply and its subsidiaries.

PPL Energy Supply cannot predict the future impact that these economic and market conditions and regulatory requirements may have on its financial condition or results of operations.

Ironwood Acquisition

In April 2012, an indirect, wholly owned subsidiary of PPL Energy Supply completed the acquisition of the equity interests in the owner and operator of the Ironwood Facility.  The Ironwood Facility began operation in 2001 and, since 2008, PPL EnergyPlus has supplied natural gas for the operation of the Ironwood Facility and received the facility's full electricity output and capacity value pursuant to a tolling agreement that expires in 2021.  The acquisition provides PPL Energy Supply, through its subsidiaries, operational control of additional combined-cycle gas generation in PJM.  See Note 8 to the Financial Statements for additional information.
130
Bankruptcy of SMGT

In October 2011, SMGT, a Montana cooperative and purchaser of electricity under a long-term supply contract with PPL EnergyPlus expiring in June 2019 (SMGT Contract), filed for protection under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the District of Montana.  At the time of the bankruptcy filing, SMGT was PPL EnergyPlus' largest unsecured credit exposure.

The SMGT Contract provided for fixed volume purchases on a monthly basis at established prices.  Pursuant to a court order and subsequent stipulations entered into between the SMGT bankruptcy trustee and PPL EnergyPlus, since the date of its Chapter 11 filing through January 2012, SMGT continued to purchase electricity from PPL EnergyPlus at the price specified in the SMGT Contract, and made timely payments for such purchases, but at lower volumes than as prescribed in the SMGT Contract.  In January 2012, the trustee notified PPL EnergyPlus that SMGT would not purchase electricity under the SMGT Contract for the month of February.  In March 2012, the U.S. Bankruptcy Court for the District of Montana issued an order approving the request of the SMGT bankruptcy trustee and PPL EnergyPlus to terminate the SMGT Contract.  As a result, the SMGT Contract was terminated effective April 1, 2012, allowing PPL EnergyPlus to resell the electricity previously contracted to SMGT under the SMGT Contract to other customers.

PPL EnergyPlus' receivable under the SMGT Contract totaled approximately $22 million at June 30, 2012, which has been fully reserved.  No assurance can be given as to the collectability of the receivable.

In July 2012, PPL EnergyPlus filed its proof of claim in the SMGT bankruptcy proceeding.  The total claim is approximately $375 million, predominantly an unsecured claim representing the value for energy sales that will not occur as a result of the termination of the SMGT Contract.

PPL Energy Supply cannot predict any amounts that it may recover in connection with the SMGT bankruptcy or the prices and other terms on which it will be able to market to third parties the power that SMGT will not purchase from PPL EnergyPlus due to the termination of the SMGT Contract.

Results of Operations

The following discussion provides a summary of PPL Energy Supply's earnings and a description of factors that are expected to impact future earnings.  This section ends with "Statement of Income Analysis," which includes explanations of significant changes in principal items on PPL Energy Supply's Statements of Income, comparing the three and six months ended June 30, 2012 with the same periods in 2011.

The results for interim periods can be disproportionately influenced by numerous factors and developments and by seasonal variations.  As such, the results of operations for interim periods do not necessarily indicate results or trends for the year or future periods.

Earnings
Net Income Attributable to PPL Energy Supply for the periods ended June 30 was:
Three Months
Six Months
2012
2011
2012
2011
Net Income Attributable to PPL Energy Supply
$
19
$
89
$
328
$
303

The changes in the components of Net Income Attributable to PPL Energy Supply between these periods were due to the following factors, which reflect reclassifications for items included in unregulated gross energy margins and certain items that management considers special.  See additional detail of these special items in the tables below.

Three Months
Six Months
Unregulated gross energy margins
$
(87)
Other operation and maintenance
$
(10)
(16)
Depreciation
(9)
(14)
Other Income (Expense) - net
(1)
(10)
Interest Expense
7
16
Other
(2)
(3)
Income Taxes
6
65
Discontinued operations, after-tax
3
Special items, after-tax
(61)
71
Total
$
(70)
$
25

131


·
See "Statement of Income Analysis - Unregulated Gross Energy Margins - Changes in Non-GAAP Financial Measures" for an explanation of Unregulated Gross Energy Margins.

·
Higher other operation and maintenance expense for the three-month period primarily due to $11 million of higher costs at PPL Susquehanna, including refueling outage costs, payroll-related costs and timing of projects, and $7 million from higher system-related costs and timing of projects, partially offset by $8 million of trademark royalties with an affiliate in 2011 for which the agreement was terminated December 31, 2011.

Higher other operation and maintenance expense for the six-month period primarily due to $17 million of higher costs at PPL Susquehanna, including refueling outage costs, payroll-related costs and timing of projects, and $14 million from higher system-related costs and timing of projects, partially offset by $17 million of trademark royalties with an affiliate in 2011 for which the agreement was terminated December 31, 2011.

·
Higher depreciation expense for the three and six-month periods due to the impact of PP&E additions.

·
Lower other income (expense) - net for the six-month period primarily due to lower earnings on securities in the NDT funds.

·
Lower interest expense for the three and six-month period, reflecting a $5 million and $10 million impact of lower interest rates, as a result of the redemption of 7.00% Senior Unsecured Notes in July 2011.

·
Lower income taxes for the six-month period primarily due to lower pre-tax income, which reduced income taxes by $48 million.  The six-month period was also lower due to an $11 million deferred tax benefit from a state tax rate adjustment recorded in 2012 and $6 million of Pennsylvania net operating loss valuation allowance adjustments recorded in 2011, driven primarily by the impact of bonus depreciation.


The following after-tax amounts, which management considers special items, also impacted the results during the periods ended June 30.

Income Statement
Three Months
Six Months
Line Item
2012
2011
2012
2011
Special items gains (losses), net of tax (expense) benefit:
Adjusted energy-related economic activity, net, net of tax of $23, $2, ($79), ($10)
(a)
$
(32)
$
(3)
$
118
$
14
Impairments:
Emission allowances, net of tax of $0, $0, $0, $1
Other O&M
(1)
Renewable energy credits, net of tax of $0, $0, $0, $2
Other O&M
(2)
Adjustments - nuclear decommissioning trust investments, net of tax of ($1), $0, ($2), ($1)
Other Income-net
1
1
LKE acquisition-related adjustments:
Sale of certain non-core generation facilities, net of tax of $0, $1, $0, $0
Disc. Operations
(2)
(3)
Other:
Montana hydroelectric litigation, net of tax of $0, $0, $0, $1
Interest Expense
(1)
(1)
Litigation settlement - spent nuclear fuel storage, net of tax of $0, ($21), $0, ($21) (b)
Fuel
29
29
Counterparty bankruptcy, net of tax of $0, $0, $5, $0 (c)
Other O&M
(6)
Wholesale supply cost reimbursement, net of tax of $0, $0, $0, $0
(d)
1
1
Ash basin leak remediation adjustment, net of tax of $0, $0, ($1), $0
Other O&M
1
Coal contract modification payments, net of tax of $5, $0, $5, $0 (e)
Fuel
(7)
(7)
Total
$
(38)
$
23
$
108
$
37

(a)
See "Reconciliation of Economic Activity" below.
(b)
In May 2011, PPL Susquehanna entered into a settlement agreement with the U.S. Government relating to PPL Susquehanna's lawsuit, seeking damages for the Department of Energy's failure to accept spent nuclear fuel from the PPL Susquehanna plant.  PPL Susquehanna recorded credits to fuel expense to recognize recovery, under the settlement agreement, of certain costs to store spent nuclear fuel at the Susquehanna plant.  This special item represents amounts recorded in 2011 to cover the costs incurred from 1998 through September 2009.
(c)
In October 2011, a wholesale customer, SMGT, filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy code.  In 2012, PPL EnergyPlus recorded an additional allowance for unpaid amounts under the long-term power contract.  In March 2012, the U.S. Bankruptcy Court for the District of Montana approved the request to terminate the contract, effective April 1, 2012.
(d)
Recorded in "Wholesale energy marketing - Realized" on the Statement of Income.
(e)
As a result of lower electricity and  natural gas prices, coal unit runtimes have decreased.  Contract modification payments were incurred to reduce the contracted coal quantities scheduled for delivery.


132

Reconciliation of Economic Activity

The following table reconciles unrealized pre-tax gains (losses) for the periods ended June 30, from the table within "Commodity Price Risk (Non-trading) - Economic Activity" in Note 14 to the Financial Statements to the special item identified as "Adjusted energy-related economic activity, net."

Three Months
Six Months
2012
2011
2012
2011
Operating Revenues
Unregulated retail electric and gas
$
(12)
$
1
$
(2)
$
5
Wholesale energy marketing
(458)
(44)
394
13
Operating Expenses
Fuel
(16)
(11)
(14)
12
Energy Purchases
442
109
(149)
127
Energy-related economic activity (a)
(44)
55
229
157
Option premiums (b)
1
6
1
11
Adjusted energy-related economic activity
(43)
61
230
168
Less:  Economic activity realized, associated with the monetization of
certain full-requirement sales contracts in 2010
12
66
33
144
Adjusted energy-related economic activity, net, pre-tax
$
(55)
$
(5)
$
197
$
24
Adjusted energy-related economic activity, net, after-tax
$
(32)
$
(3)
$
118
$
14

(a)
See Note 14 to the Financial Statements for additional information.
(b)
Adjustment for the net deferral and amortization of option premiums over the delivery period of the item that was hedged or upon realization.  Option premiums are recorded in "Wholesale energy marketing - Realized" and "Energy purchases - Realized" on the Statements of Income.

Outlook

Excluding special items, PPL Energy Supply projects lower earnings in 2012 compared with 2011, primarily driven by lower energy margins as a result of lower energy and capacity prices, higher fuel costs, higher operation and maintenance expense, and higher depreciation.  See "Overview" for a discussion on economic and market conditions.

Earnings in 2012 are subject to various risks and uncertainties.  See "Forward-Looking Information," the rest of this Item 2 and Note 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in PPL Energy Supply's 2011 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.

Statement of Income Analysis --

Unregulated Gross Energy Margins

Non-GAAP Financial Measure

The following discussion includes financial information prepared in accordance with GAAP, as well as a non-GAAP financial measure, "Unregulated Gross Energy Margins."  "Unregulated Gross Energy Margins" is a single financial performance measure of PPL Energy Supply's competitive energy non-trading and trading activities.  In calculating this measure, PPL Energy Supply's energy revenues, which include operating revenues associated with certain PPL Energy Supply businesses that are classified as discontinued operations, are offset by the cost of fuel, energy purchases, certain other operation and maintenance expenses, primarily ancillary charges, gross receipts tax, which is recorded in "Taxes, other than income," and operating expenses associated with certain PPL Energy Supply businesses that are classified as discontinued operations.  This performance measure is relevant to PPL Energy Supply due to the volatility in the individual revenue and expense lines on the Statements of Income that comprise "Unregulated Gross Energy Margins."  This volatility stems from a number of factors, including the required netting of certain transactions with ISOs and significant swings in unrealized gains and losses.  Such factors could result in gains or losses being recorded in either "Wholesale energy marketing" or "Energy purchases" on the Statements of Income.  This performance measure includes PLR revenues from energy sales to PPL Electric by PPL EnergyPlus, which are recorded in "Wholesale energy marketing to affiliate" revenue.  PPL Energy Supply excludes from "Unregulated Gross Energy Margins" energy-related economic activity, which includes the changes in fair value of positions used to economically hedge a portion of the economic value of PPL Energy Supply's competitive generation assets, full-requirement sales contracts and retail activities.  This economic value is subject to changes in fair value due to market price volatility of the input and output commodities (e.g., fuel and power) prior to the delivery period that was hedged.  Also included in this energy-related economic activity is the ineffective portion of qualifying cash flow hedges, the monetization of certain full-requirement sales contracts and premium amortization associated with options.  This economic activity is deferred, with the exception of the full-requirement sales contracts that were monetized, and included in
133
"Unregulated Gross Energy Margins" over the delivery period that was hedged or upon realization.  This measure is not intended to replace "Operating Income," which is determined in accordance with GAAP, as an indicator of overall operating performance.  Other companies may use different measures to analyze and to report on the results of their operations.  PPL Energy Supply believes that "Unregulated Gross Energy Margins" provides another criterion to make investment decisions.  This performance measure is used, in conjunction with other information, internally by senior management and PPL's Board of Directors to manage PPL Energy Supply's operations, analyze actual results compared with budget and measure certain corporate financial goals used in determining variable compensation.

Reconciliation of Non-GAAP Financial Measures

The following table reconciles "Operating Income" to "Unregulated Gross Energy Margins" as defined by PPL Energy Supply for the periods ended June 30.

2012 Three Months
2011 Three Months
Unregulated
Unregulated
Gross Energy
Operating
Gross Energy
Operating
Margins
Other (a)
Income (b)
Margins
Other (a)
Income (b)
Operating Revenues
Wholesale energy marketing
Realized
$
1,075
$
8
(c)
$
1,083
$
716
$
16
(c)
$
732
Unrealized economic activity
(458)
(d)
(458)
(44)
(d)
(44)
Wholesale energy marketing
to affiliate
17
17
4
4
Unregulated retail electric and gas
192
(12)
180
180
1
181
Net energy trading margins
10
10
10
10
Energy-related businesses
112
112
114
114
Total Operating Revenues
1,294
(350)
944
910
87
997
Operating Expenses
Fuel
170
26
(e)
196
250
(42)
(e)
208
Energy purchases
Realized
617
18
(c)
635
150
76
(c)
226
Unrealized economic activity
(442)
(d)
(442)
(109)
(d)
(109)
Energy purchases from affiliate
1
1
Other operation and maintenance
7
287
294
9
279
288
Depreciation
69
69
60
60
Taxes, other than income
7
10
17
7
9
16
Energy-related businesses
109
109
112
112
Total Operating Expenses
801
77
878
417
385
802
Total
$
493
$
(427)
$
66
$
493
$
(298)
$
195

2012 Six Months
2011 Six Months
Unregulated
Unregulated
Gross Energy
Operating
Gross Energy
Operating
Margins
Other (a)
Income (b)
Margins
Other (a)
Income (b)
Operating Revenues
Wholesale energy marketing
Realized
$
2,279
$
12
(c)
$
2,291
$
1,738
$
32
(c)
$
1,770
Unrealized economic activity
394
(d)
394
13
(d)
13
Wholesale energy marketing
to affiliate
38
38
10
10
Unregulated retail electric and gas
406
(2)
404
323
5
328
Net energy trading margins
18
18
21
21
Energy-related businesses
208
208
224
224
Total Operating Revenues
2,741
612
3,353
2,092
274
2,366
Operating Expenses
Fuel
385
22
(e)
407
534
(66)
(e)
468
Energy purchases
Realized
1,251
43
(c)
1,294
377
163
(c)
540
Unrealized economic activity
149
(d)
149
(127)
(d)
(127)
Energy purchases from affiliate
1
1
2
2
Other operation and maintenance
11
538
549
13
520
533
Depreciation
133
133
119
119
Taxes, other than income
16
19
35
14
18
32
Energy-related businesses
201
201
220
220
Total Operating Expenses
1,664
1,105
2,769
940
847
1,787
Discontinued Operations
12
(12)
(f)
Total
$
1,077
$
(493)
$
584
$
1,164
$
(585)
$
579

134

(a)
Represents amounts excluded from Margins.
(b)
As reported on the Statements of Income.
(c)
Represents energy-related economic activity as described in "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements.  For the three and six months ended June 30, 2012, "Wholesale energy marketing - Realized" and "Energy purchases - Realized" include net pre-tax losses of $12 million and $33 related to the monetization of certain full-requirement sales contracts and net pre-tax gains of $1 million and $1 million related to the amortization of option premiums.  The three and six months ended June 30, 2011 include net pre-tax losses of $66 million and $144 million related to the monetization of certain full-requirement sales contracts and net pre-tax gains of $6 million and $11 million related to the amortization of option premiums.
(d)
Represents energy-related economic activity, which is subject to fluctuations in value due to market price volatility, as described in "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements.
(e)
Includes economic activity related to fuel as described in "Commodity Price Risk (Non-trading) - Economic Activity" within Note 14 to the Financial Statements.  The three and six months ended June 30, 2012, includes a pre-tax loss of $12 million related to coal contract modification payments.  The three and six months ended June 30, 2011 includes a pre-tax credit of $50 million for the spent nuclear fuel litigation settlement.
(f)
Represents the net of certain revenues and expenses associated with certain businesses that are classified as discontinued operations.  These revenues and expenses are not reflected in "Operating Income" on the Statements of Income.

Changes in Non-GAAP Financial Measures

Unregulated Gross Energy Margins are generated through PPL Energy Supply's competitive non-trading and trading activities.  PPL Energy Supply's non-trading energy business is managed on a geographic basis that is aligned with its generation fleet.  The following table shows PPL Energy Supply's non-GAAP financial measure, Unregulated Gross Energy Margins, for the periods ended June 30, as well as the change between periods.  The factors that gave rise to the changes are described below the table.

Three Months
Six Months
2012
2011
Change
2012
2011
Change
Non-trading
Eastern U.S.
$
407
$
395
$
12
$
896
$
972
$
(76)
Western U.S.
76
88
(12)
163
171
(8)
Net energy trading
10
10
18
21
(3)
Total
$
493
$
493
$
$
1,077
$
1,164
$
(87)

Eastern U.S.
The changes in non-trading margins for the periods ended June 30, 2012 compared with 2011 were due to:
Three Months
Six Months
Baseload energy and capacity prices (a)
$
(51)
$
(137)
Intermediate and peaking energy and capacity (b)
(5)
(26)
Full-requirement sales contracts
(9)
(14)
Impact of non-core generation facilities sold in the first quarter of 2011
(12)
Ironwood Acquisition which eliminates tolling expense (c)
13
13
Net coal and hydroelectric unit availability (d)
9
19
Nuclear generation volume (e)
57
82
Other
(2)
(1)
$
12
$
(76)

(a)
Energy prices and capacity prices were lower in both periods of 2012.
(b)
Capacity prices were lower in both periods of 2012.
(c)
See Note 8 to the Financial Statements for additional information.
(d)
Coal unit availability was higher in both periods allowing the capture of additional margins.
(e)
For the three and six month periods, volumes were higher due to a shorter outage period for blade inspections and an uprate in the third quarter of 2011.  For the six month period, volumes were also higher due to an unplanned outage in March 2011.

Western U.S.

Non-trading margins for the three and six months ended June 30, 2012, compared with the same periods in 2011 were lower primarily due to $14 million related to the bankruptcy of SMGT.
135

Other Operation and Maintenance
The increase (decrease) in other operation and maintenance expense for the periods ended June 30, 2012 compared with 2011 was due to:
Three Months
Six Months
Susquehanna nuclear plant costs (a)
$
11
$
17
Uncollectible accounts (b)
11
Costs at Western fossil and hydroelectric plants
(3)
(5)
Trademark royalties (c)
(8)
(17)
Corporate service costs (d)
7
14
Other
(1)
(4)
Total
$
6
$
16

(a)
Primarily due to refueling outage costs, payroll-related costs and timing of projects.
(b)
In October 2011, SMGT filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code.  The increase for the six-month period reflects an $11 million increase to a reserve on unpaid amounts.
(c)
In 2011, PPL Energy Supply was charged trademark royalties by an affiliate.  The agreement was terminated December 31, 2011.
(d)
Primarily due to systems-related costs and timing of projects.

Depreciation
The increase (decrease) in depreciation expense for the periods ended June 30, 2012 compared with 2011 was due to:
Three Months
Six Months
Additions to PP&E
$
5
$
10
Ironwood Acquisition
4
4
Total
$
9
$
14

Other Income (Expense) - net

The $8 million decrease in other income (expense) - net for the six months ended June 30, 2012 compared with 2011 was primarily due to a $6 million decrease in earnings on securities in the NDT funds.

See Note 12 to the Financial Statements for further details.

Interest Expense
The increase (decrease) in interest expense for the periods ended June 30, 2012 compared with 2011 was due to:
Three Months
Six Months
Interest rates (a)
$
(5)
$
(10)
Debt balances
(2)
(5)
Ironwood Acquisition (Note 8)
4
4
Other
(5)
(7)
Total
$
(8)
$
(18)

(a)
Long-term weighted average rates of 5.88% at June 30, 2012 compared with 6.24% at June 30, 2011.

Income Taxes
The increase (decrease) in income taxes for the periods ended June 30, 2012 compared with 2011 was due to:
Three Months
Six Months
Higher (lower) pre-tax book income
$
(50)
$
2
State valuation allowance adjustments (a)
(6)
State deferred tax rate change (b)
(11)
Total
$
(50)
$
(15)

136

(a)
In February 2011, the Pennsylvania Department of Revenue issued interpretive guidance on the treatment of bonus depreciation for Pennsylvania income tax purposes.  In accordance with Corporation Tax Bulletin 2011-01, Pennsylvania allows 100% bonus depreciation for qualifying assets in the same year bonus depreciation is allowed for Federal tax purposes.  Due to the decrease in projected taxable income related to bonus depreciation, PPL Energy Supply recorded state deferred income tax expense during the six months ended June 30, 2011 related to valuation allowances.
(b)
During the six months ended June 30, 2012, PPL Energy Supply recorded an adjustment related to state deferred tax liabilities.

See Note 5 to the Financial Statements for additional information on income taxes.

Financial Condition
Liquidity and Capital Resources
PPL Energy Supply had the following at:
June 30, 2012
December 31, 2011
Cash and cash equivalents
$
446
$
379
Short-term debt
$
520
$
400

The $67 million increase in PPL Energy Supply's cash and cash equivalents position was primarily the net result of:

· contributions from Member of $472 million;
·
net cash provided by operating activities of $308 million;
·
a net decrease in note receivable from affiliate of $198 million;
·
a net increase in short-term debt of $120 million;
·
distributions to Member of $657 million;
·
capital expenditures of $316 million; and
·
the Ironwood Acquisition for $84 million, net of cash acquired.

PPL Energy Supply's cash provided by operating activities increased by $120 million for the six months ended June 30, 2012, compared with 2011.  This was primarily due to a $68 million decrease in defined benefit plan funding and a $104 million increase in cash from components of working capital (primarily due to changes in counterparty collateral, partially offset by changes in accounts receivable, unbilled revenue and accrued taxes).

Credit Facilities

PPL Energy Supply maintains credit facilities to provide liquidity and to backstop commercial paper issuances.  At June 30, 2012, PPL Energy Supply's total committed borrowing capacity under its credit facilities and the use of this borrowing capacity were:

Letters of
Credit Issued
and
Committed
Commercial
Unused
Capacity
Borrowed
Paper Backstop
Capacity
Syndicated Credit Facility
$
3,000
$
662
$
2,338
Letter of Credit Facility
200
n/a
128
72
Total PPL Energy Supply Credit Facilities (a)
$
3,200
$
790
$
2,410

(a)
The commitments under PPL Energy Supply's credit facilities are provided by a diverse bank group, with no one bank and its affiliates providing an aggregate commitment of more than 11% of the total committed capacity.

See Note 7 to the Financial Statements for further discussion of PPL Energy Supply's credit facilities.

Commercial Paper

In April 2012, PPL Energy Supply increased the capacity of its commercial paper program from $500 million to $750 million to provide an additional financing source to fund its short-term liquidity needs, if and when necessary.  Commercial paper issuances are supported by PPL Energy Supply's Syndicated Credit Facility.  At June 30, 2012, PPL Energy Supply had $520 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheet, at a weighted-average interest rate of approximately 0.48%.
137
Long-term Debt Securities

In April 2012, an indirect, wholly owned subsidiary of PPL Energy Supply completed the Ironwood Acquisition.  See Note 8 to the Financial Statements for information on the transaction and the debt of PPL Ironwood, LLC assumed through consolidation as part of the acquisition.

Rating Agency Actions

Moody's, S&P and Fitch periodically review the credit ratings on the debt securities of PPL Energy Supply and its subsidiaries.  Based on their respective independent reviews, the rating agencies may make certain ratings revisions or ratings affirmations.

A credit rating reflects an assessment by the rating agency of the creditworthiness associated with an issuer and particular securities that it issues.  The credit ratings of PPL Energy Supply and its subsidiaries are based on information provided by PPL Energy Supply and other sources.  The ratings of Moody's, S&P and Fitch are not a recommendation to buy, sell or hold any securities of PPL Energy Supply or its subsidiaries.  Such ratings may be subject to revisions or withdrawal by the agencies at any time and should be evaluated independently of each other and any other rating that may be assigned to the securities.  A downgrade in PPL Energy Supply's or its subsidiaries' credit ratings could result in higher borrowing costs and reduced access to capital markets.

As a result of the passage of the Dodd-Frank Act, PPL Energy Supply is limiting its credit rating disclosure to a description of the actions taken by the rating agencies with respect to PPL Energy Supply's ratings, but without stating what ratings have been assigned to PPL Energy Supply or its subsidiaries, or their securities.  The ratings assigned by the rating agencies to PPL Energy Supply and its subsidiaries and their respective securities may be found, without charge, on each of the respective rating agencies' websites, which ratings together with all other information contained on such rating agency websites is, hereby, explicitly not incorporated by reference in this report.

The rating agencies took the following actions related to PPL Energy Supply and its subsidiaries.

In January 2012, S&P affirmed its rating and revised its outlook for PPL Montana's Pass Through Certificates due 2020.

Following the announcement of the then-pending acquisition of AES Ironwood, L.L.C. in February 2012, the rating agencies took the following actions:

·
In March 2012, Moody's placed AES Ironwood, L.L.C.'s senior secured bonds under review for possible ratings upgrade.

·
In April 2012, S&P affirmed the rating of AES Ironwood, L.L.C.'s senior secured bonds.

In May 2012, Fitch downgraded its rating and revised its outlook for PPL Montana's Pass Through Certificates due 2020.

Ratings Triggers

PPL Energy Supply has various derivative and non-derivative contracts, including contracts for the sale and purchase of electricity and fuel, commodity transportation and storage, tolling agreements and interest rate instruments, which contain provisions that require PPL Energy Supply to post additional collateral or permit the counterparty to terminate the contract, if PPL Energy Supply's credit rating were to fall below investment grade.  See Note 14 to the Financial Statements for a discussion of "Credit Risk-Related Contingent Features," including a discussion of the potential additional collateral that would have been required for derivative contracts in a net liability position at June 30, 2012.  At June 30, 2012, if PPL Energy Supply's credit rating had been below investment grade, PPL Energy Supply would have been required to prepay or post an additional $427 million of collateral to counterparties for both derivative and non-derivative commodity and commodity-related contracts used in its generation, marketing and trading operations and interest rate contracts.

For additional information on PPL Energy Supply's liquidity and capital resources, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," in PPL Energy Supply's 2011 Form 10-K.
138
Risk Management

Market Risk

See Notes 13 and 14 to the Financial Statements for information about PPL Energy Supply's risk management objectives, valuation techniques and accounting designations.

The forward-looking information presented below provides estimates of what may occur in the future, assuming certain adverse market conditions and model assumptions.  Actual future results may differ materially from those presented.  These disclosures are not precise indicators of expected future losses, but only indicators of possible losses under normal market conditions at a given confidence level.

Commodity Price Risk (Non-trading)

PPL Energy Supply segregates its non-trading activities into two categories:  hedge activity and economic activity.  Transactions that are accounted for as hedge activity qualify for hedge accounting treatment.  The economic activity category includes transactions that address a specific risk, but were not eligible for hedge accounting or for which hedge accounting was not elected.  This activity includes the changes in fair value of positions used to hedge a portion of the economic value of PPL Energy Supply's competitive generation assets, full-requirement sales contracts and retail contracts.  This economic activity is subject to changes in fair value due to market price volatility of the input and output commodities (e.g., fuel and power).  Although they do not receive hedge accounting treatment, these transactions are considered non-trading activity.  The fair value of economic positions at June 30, 2012 and December 31, 2011 was a net asset/(liability) of $796 million and $(63) million.  The change in fair value is largely attributable to the dedesignation of cash flow hedges that are now classified as economic hedges.  See Note 14 to the Financial Statements for additional information.

To hedge the impact of market price volatility on PPL Energy Supply's energy-related assets, liabilities and other contractual arrangements, PPL Energy Supply both sells and purchases physical energy at the wholesale level under FERC market-based tariffs throughout the U.S. and enters into financial exchange-traded and over-the-counter contracts.  PPL Energy Supply's non-trading commodity derivative contracts range in maturity through 2019.

The following table sets forth the changes in net fair value of PPL Energy Supply's non-trading commodity derivative contracts for the periods ended June 30.  See Notes 13 and 14 to the Financial Statements for additional information.

Gains (Losses)
Three Months
Six Months
2012
2011
2012
2011
Fair value of contracts outstanding at the beginning of the period
$
1,215
$
998
$
1,082
$
958
Contracts realized or otherwise settled during the period
(261)
(83)
(540)
(135)
Fair value of new contracts entered into during the period (a)
13
32
12
15
Other changes in fair value
(6)
(51)
407
58
Fair value of contracts outstanding at the end of the period
$
961
$
896
$
961
$
896

(a)
Represents the fair value of contracts at the end of the quarter of their inception.

The following table segregates the net fair value of non-trading commodity derivative contracts at June 30, 2012, based on the level of observability of the information used to determine the fair value.

Net Asset (Liability)
Maturity
Maturity
Less Than
Maturity
Maturity
in Excess
Total Fair
1 Year
1-3 Years
4-5 Years
of 5 Years
Value
Source of Fair Value
Prices based on significant other observable inputs
$
703
$
237
$
(21)
$
8
$
927
Prices based on significant unobservable inputs
21
9
4
34
Fair value of contracts outstanding at the end of the period
$
724
$
246
$
(17)
$
8
$
961

PPL Energy Supply sells electricity, capacity and related services and buys fuel on a forward basis to hedge the value of energy from its generation assets.  If PPL Energy Supply were unable to deliver firm capacity and energy or to accept the delivery of fuel under its agreements, under certain circumstances it could be required to pay liquidating damages.  These damages could be based on the difference between the market price and the contract price of the commodity.  Depending on price changes in the wholesale energy markets, such damages could be significant.  Extreme weather conditions, unplanned power plant outages, transmission disruptions, nonperformance by counterparties (or their own counterparties) with which it
139
has energy contracts and other factors could affect PPL Energy Supply's ability to meet its obligations, or cause significant increases in the market price of replacement energy.  Although PPL Energy Supply attempts to mitigate these risks, there can be no assurance that it will be able to fully meet its firm obligations, that it will not be required to pay damages for failure to perform, or that it will not experience counterparty nonperformance in the future.  In connection with its bankruptcy proceedings, a significant counterparty, SMGT, had been purchasing lower volumes of electricity than prescribed in the contract and effective April 1, 2012 the contract was terminated.  PPL Energy Supply cannot predict the prices or other terms on which it will be able to market to third parties the power that SMGT will not purchase from PPL EnergyPlus due to the termination of this contract.  See Note 10 to the Financial Statements for additional information.

Commodity Price Risk (Trading)

PPL Energy Supply's trading commodity derivative contracts range in maturity through 2017.  The following table sets forth changes in the net fair value of PPL Energy Supply's trading commodity derivative contracts for the periods ended June 30.  See Notes 13 and 14 to the Financial Statements for additional information.

Gains (Losses)
Three Months
Six Months
2012
2011
2012
2011
Fair value of contracts outstanding at the beginning of the period
$
2
$
7
$
(4)
$
4
Contracts realized or otherwise settled during the period
(1)
1
(1)
3
Fair value of new contracts entered into during the period (a)
(1)
5
5
8
Other changes in fair value
17
2
17
Fair value of contracts outstanding at the end of the period
$
17
$
15
$
17
$
15

(a)
Represents the fair value of contracts at the end of the quarter of their inception.

Unrealized gains of approximately $1 million will be reversed over the next three months as the transactions are realized.

The following table segregates the net fair value of trading commodity derivative contracts at June 30, 2012, based on the level of observability of the information used to determine the fair value.

Net Asset (Liability)
Maturity
Maturity
Less Than
Maturity
Maturity
in Excess
Total Fair
1 Year
1-3 Years
4-5 Years
of 5 Years
Value
Source of Fair Value
Prices based on significant other observable inputs
$
8
$
8
$
1
$
17
Fair value of contracts outstanding at the end of the period
$
8
$
8
$
1
$
17

VaR Models

A VaR model is utilized to measure commodity price risk in domestic gross energy margins for the non-trading and trading portfolios.  VaR is a statistical model that attempts to estimate the value of potential loss over a given holding period under normal market conditions at a given confidence level.  VaR is calculated using a Monte Carlo simulation technique based on a five-day holding period at a 95% confidence level.  Given the company's conservative hedging program, the non-trading VaR exposure is expected to be limited in the short-term.  The VaR for portfolios using end-of-month results for the period was as follows.

Trading VaR
Non-Trading VaR
Six Months
Twelve Months
Six Months
Twelve Months
Ended
Ended
Ended
Ended
June 30,
December 31,
June 30,
December 31,
2012
2011
2012
2011
95% Confidence Level, Five-Day Holding Period
Period End
$
5
$
1
$
11
$
6
Average for the Period
2
3
9
5
High
5
6
11
7
Low
1
1
7
4

The trading portfolio includes all speculative positions, regardless of the delivery period.  All positions not considered speculative are considered non-trading.  The non-trading portfolio includes the entire portfolio, including generation, with delivery periods through the next 12 months.  Both the trading and non-trading VaR computations exclude FTRs due to the
140
absence of reliable spot and forward markets.  The fair value of the non-trading and trading FTR positions was insignificant at June 30, 2012.

Interest Rate Risk

PPL Energy Supply and its subsidiaries issue debt to finance their operations, which exposes them to interest rate risk.  PPL and PPL Energy Supply utilize various financial derivative instruments to adjust the mix of fixed and floating interest rates in PPL Energy Supply's debt portfolio, adjust the duration of its debt portfolio and lock in benchmark interest rates in anticipation of future financing, when appropriate.  Risk limits under the risk management program are designed to balance risk exposure to volatility in interest expense and changes in the fair value of PPL Energy Supply's debt portfolio due to changes in the absolute level of interest rates.  PPL Energy Supply had no interest rate hedges outstanding at June 30, 2012.

At June 30, 2012, PPL Energy Supply's potential annual exposure to increased interest expense, based on a 10% increase in interest rates, was not significant.

PPL Energy Supply is also exposed to changes in the fair value of its debt portfolio.  PPL Energy Supply estimated that a 10% decrease in interest rates at June 30, 2012 would increase the fair value of its debt portfolio by $56 million.

NDT Funds - Securities Price Risk

In connection with certain NRC requirements, PPL Susquehanna maintains trust funds to fund certain costs of decommissioning the PPL Susquehanna nuclear plant (Susquehanna).  At June 30, 2012, these funds were invested primarily in domestic equity securities and fixed-rate, fixed-income securities and are reflected at fair value on the Balance Sheet.  The mix of securities is designed to provide returns sufficient to fund Susquehanna's decommissioning and to compensate for inflationary increases in decommissioning costs.  However, the equity securities included in the trusts are exposed to price fluctuation in equity markets, and the values of fixed-rate, fixed-income securities are primarily exposed to changes in interest rates.  PPL actively monitors the investment performance and periodically reviews asset allocation in accordance with its NDT policy statement.  At June 30, 2012, a hypothetical 10% increase in interest rates and a 10% decrease in equity prices would have resulted in an estimated $47 million reduction in the fair value of the trust assets.  See Notes 13 and 17 to the Financial Statements for additional information regarding the NDT funds.

Credit Risk

See Notes 11, 13 and 14 to the Financial Statements in this Form 10-Q and "Risk Management - Energy Marketing & Trading and Other - Credit Risk" in PPL Energy Supply's 2011 Form 10-K for additional information.

Related Party Transactions

PPL Energy Supply is not aware of any material ownership interests or operating responsibility by senior management of PPL Energy Supply in outside partnerships, including leasing transactions with variable interest entities or other entities doing business with PPL Energy Supply.  See Note 11 to the Financial Statements for additional information on related party transactions.

Acquisitions, Development and Divestitures

Development projects are continuously reexamined based on market conditions and other factors to determine whether to proceed with the projects, sell, cancel or expand them, execute tolling agreements or pursue other options.  See Note 8 to the Financial Statements for information on the more significant activities, including the April 2012 Ironwood Acquisition.

Environmental Matters

Extensive federal, state and local environmental laws and regulations are applicable to PPL Energy Supply's air emissions, water discharges and the management of hazardous and solid waste, among other areas; and the costs of compliance or alleged non-compliance cannot be predicted with certainty but could be material.  In addition, cost may increase significantly if the requirements or scope of environmental laws or regulations, or similar rules, are expanded or changed by the relevant regulatory agencies.  Costs may take the form of increased capital or operating and maintenance expenses; monetary fines, penalties or other restrictions.  Many of these environmental law considerations are also applicable to the operations of key suppliers, or customers, such as coal producers and industrial power users, and may impact the costs of their products or their demand for PPL Energy Supply's services.  See Note 10 to the Financial Statements in this Form 10-Q and "Item 1. Business - Environmental Matters" in PPL Energy Supply's 2011 Form 10-K for a discussion of environmental matters.

141


New Accounting Guidance

See Notes 2 and 18 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.

Application of Critical Accounting Policies

Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies.  The following accounting policies are particularly important to the financial condition or results of operations, and require estimates or other judgments of matters inherently uncertain: price risk management, defined benefits, asset impairment, loss accruals, AROs and income taxes.  See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in PPL Energy Supply's 2011 Form 10-K for a discussion of each critical accounting policy.

142

PPL ELECTRIC UTILITIES CORPORATION AND SUBSIDIARIES

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations


The following should be read in conjunction with PPL Electric's Condensed Consolidated Financial Statements and the accompanying Notes and with PPL Electric's 2011 Form 10-K.  Capitalized terms and abbreviations are defined in the glossary.  Dollars are in millions, unless otherwise noted.

"Management's Discussion and Analysis of Financial Condition and Results of Operations" includes the following information:

·
"Overview" provides a description of PPL Electric and its business strategy, a summary of Net Income Available to PPL Corporation and a discussion of certain events related to PPL Electric's results of operations and financial condition.

·
"Results of Operations" provides a summary of PPL Electric's earnings and a description of factors expected to impact future earnings.  This section ends with explanations of significant changes in principal items on PPL Electric's Statements of Income, comparing the three and six months ended June 30, 2012 with the same periods in 2011.

·
"Financial Condition - Liquidity and Capital Resources" provides an analysis of PPL Electric's liquidity position and credit profile.  This section also includes a discussion of rating agency actions.

·
"Financial Condition - Risk Management" provides an explanation of PPL Electric's risk management programs relating to market and credit risk.

Overview

Introduction

PPL Electric is an electricity delivery service provider in eastern and central Pennsylvania with headquarters in Allentown, Pennsylvania.  PPL Electric is subject to regulation as a public utility by the PUC, and certain of its transmission activities are subject to the jurisdiction of FERC under the Federal Power Act.  PPL Electric delivers electricity in its Pennsylvania service area and provides electricity supply to retail customers in that area as a PLR under the Customer Choice Act.

Business Strategy

PPL Electric's strategy and principal challenge is to own and operate its electricity delivery business at the most efficient cost while maintaining high quality customer service and reliability.  PPL Electric anticipates that it will have significant capital expenditure requirements in the future.  In order to manage financing costs and access to credit markets, a key objective for PPL Electric's business is to maintain a strong credit profile.  PPL Electric continually focuses on maintaining an appropriate capital structure and liquidity position.

Timely recovery of costs to maintain and enhance the reliability of its delivery system including the replacement of aging distribution assets is required in order to maintain strong cash flows and a strong credit profile.  Traditionally, such cost recovery would be pursued through periodic base rate case proceedings with the PUC.  As such costs continue to increase, more frequent rate case proceedings may be required or an alternative rate making process would need to be implemented in order to achieve more timely recovery.  See "Regulatory Matters - Pennsylvania Activities - Legislation - Regulatory Procedures and Mechanisms" in Note 6 to the Financial Statements for information on Pennsylvania's new alternative rate-making mechanism.

Transmission costs are recovered through a FERC Formula Rate mechanism, which is updated annually for costs incurred and assets placed in service.  Accordingly, increased costs including those related to the replacement of aging transmission assets and the PJM-approved Regional Transmission Line Expansion Plan are recovered on a timely basis.


143

Financial and Operational Developments

Net Income Available to PPL Corporation

Net Income Available to PPL Corporation for the three and six months ended June 30, 2012 was $29 million and $62 million compared to $36 million and $88 million for the same periods in 2011 representing a 19% and 30% decrease from the same periods in 2011.

See "Results of Operations" for a discussion and analysis of PPL Electric's earnings.

Redemption of Preference Stock

In June 2012, PPL Electric redeemed all 2.5 million shares of its 6.25% Series Preference Stock, par value $100 per share.  The price paid for the redemption was the par value, without premium ($250 million in the aggregate).  At December 31, 2011, the preference stock was reflected on PPL Electric's Balance Sheets in "Preference stock."

Regional Transmission Line Expansion Plan

PPL Electric has experienced delays in obtaining necessary National Park Service (NPS) approvals for the Susquehanna-Roseland transmission line and anticipates a delay of the line's in-service date to 2015.  In March 2012, the NPS announced that the route proposed by PPL Electric and PSE&G, previously approved by the Pennsylvania and New Jersey public utility commissions, is the preferred route for the line under the NPS's National Environmental Policy Act review.  The NPS has stated that it expects to issue its record of decision in October 2012.  An appeal of the New Jersey Board of Public Utilities approval of the line is pending before the New Jersey Superior Court Appellate Division.  PPL Electric cannot predict the ultimate outcome or timing of the NPS approval or any further legal challenges to the project.  PJM has developed a strategy to manage potential reliability problems until the line is built.  PPL Electric cannot predict what additional actions, if any, PJM might take in the event of a further delay to its scheduled in-service date for the new line.

At June 30, 2012, PPL Electric's estimated share of the project cost has increased to $560 million from approximately $500 million at December 31, 2011, mainly due to increased material costs.  In July 2012, PPL Electric began pre-construction activities including tree and vegetation removal from the transmission line's right of way and construction of access roads.  See Note 8 in PPL Electric's 2011 Form 10-K for additional information.

FERC Formula Rates

In March 2012, PPL Electric filed a request with the FERC seeking recovery, over a 34-year period beginning in June 2012, of its unrecovered regulatory asset related to the deferred state tax liability that existed at the time of the transition from the flow-through treatment of state income taxes to full normalization.  This change in tax treatment occurred in 2008 as a result of prior FERC initiatives that transferred regulatory jurisdiction of certain transmission assets from the PUC to FERC.  A regulatory asset of approximately $50 million related to this transition, classified as taxes recoverable through future rates, is included in "Other Noncurrent Assets - Regulatory assets" on the Balance Sheets at June 30, 2012 and December 31, 2011.  In May 2012, the FERC issued an order approving PPL Electric's request effective June 1, 2012.

Results of Operations

The following discussion provides a summary of PPL Electric's earnings and a description of factors that management expects may impact future earnings.  This section ends with "Statement of Income Analysis," which includes explanations of significant changes in principal items on PPL Electric's Statements of Income, comparing the three and six months ended June 30, 2012 with the same periods in 2011.

The results for interim periods can be disproportionately influenced by numerous factors and developments and by seasonal variations.  As such, the results of operations for interim periods do not necessarily indicate results or trends for the year or future periods.

144


Earnings
Net Income Available to PPL Corporation for the periods ended June 30 was:
Three Months
Six Months
2012
2011
2012
2011
Net Income Available to PPL Corporation
$
29
$
36
$
62
$
88

The changes in the components of Net Income Available to PPL Corporation between these periods were due to the following factors which reflect reclassifications for items included in gross delivery margins.

Three Months
Six Months
Pennsylvania gross delivery margins
$
3
$
(10)
Other operation and maintenance
(19)
(25)
Depreciation
(2)
(8)
Other
(1)
2
Income Taxes
8
11
Distributions on preference stock
4
4
Total
$
(7)
$
(26)

·
See "Statement of Income Analysis - Pennsylvania Gross Delivery Margins - Changes in Non-GAAP Financial Measures" for an explanation of Pennsylvania Gross Delivery Margins.

·
Higher other operation and maintenance expense for the three-month period, primarily due to $6 million of higher payroll and benefit related costs, $6 million of higher vegetation management costs and $3 million of higher corporate service costs.

Higher other operation and maintenance expense for the six-month period, primarily due to $8 million of higher payroll and benefit related costs, $8 million of higher vegetation management costs and $5 million of higher corporate service costs.

·
Higher depreciation expense for the six-month period, primarily due to the impact of PP&E additions related to the ongoing efforts to ensure the reliability of the delivery system, and replace aging infrastructure.

·
Lower income taxes for the three and six-month periods, primarily due to the change in pre-tax income, which reduced income taxes by $7 million and $16 million.

·
Lower distributions on preference stock for the three and six-month periods due to the preference stock redemption in June 2012.

Outlook

PPL Electric projects lower earnings in 2012 compared with 2011, primarily driven by higher operation and maintenance expense, higher depreciation and lower distribution revenue, which are expected to be partially offset by higher transmission revenue, lower financing costs, and lower income taxes.

In March 2012, PPL Electric filed a request with the PUC to increase distribution rates by approximately $105 million.  The proposed distribution revenue rate increase would result in a 2.9% increase over PPL Electric's total rates at the time of filing and be effective January 1, 2013.  PPL Electric's application includes a request for an authorized return-on-equity of 11.25%.  Hearings on this matter are scheduled during August 2012 and a decision is expected in the fourth quarter of 2012.  PPL Electric cannot predict the outcome of this proceeding.

Earnings in 2012 are subject to various risks and uncertainties.  See "Forward-Looking Information," the rest of this Item 2 and Notes 6 and 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in PPL Electric's 2011 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.


145

Statement of Income Analysis --

Pennsylvania Gross Delivery Margins

Non-GAAP Financial Measure

The following discussion includes financial information prepared in accordance with GAAP, as well as a non-GAAP financial measure, "Pennsylvania Gross Delivery Margins."  "Pennsylvania Gross Delivery Margins" is a single financial performance measure of PPL Electric's Pennsylvania regulated electric delivery operations, which includes transmission and distribution activities.  In calculating this measure, utility revenues and expenses associated with approved recovery mechanisms, including energy provided as a PLR, are offset with minimal impact on earnings.  Costs associated with these mechanisms are recorded in "Energy purchases," "Energy purchases from affiliate," "Other operation and maintenance" expense, which is primarily Act 129 costs, and "Taxes, other than income" which is primarily gross receipts tax.  As a result, this measure represents the net revenues from PPL Electric's Pennsylvania regulated electric delivery operations.  This measure is not intended to replace "Operating Income," which is determined in accordance with GAAP, as an indicator of overall operating performance.  Other companies may use different measures to analyze and to report on the results of their operations.  PPL Electric believes that "Pennsylvania Gross Delivery Margins" provides another criterion to make investment decisions.  This performance measure is used, in conjunction with other information, internally by senior management and PPL's Board of Directors to manage PPL Electric's operations and analyze actual results to budget.

Reconciliation of Non-GAAP Financial Measures

The following tables reconcile "Operating Income" to "Pennsylvania Gross Delivery Margins" as defined by PPL Electric for the periods ended June 30.

2012 Three Months
2011 Three Months
PA Gross
PA Gross
Delivery
Operating
Delivery
Operating
Margins
Other (a)
Income (b)
Margins
Other (a)
Income (b)
Operating Revenues
Retail electric
$
403
$
403
$
436
$
436
Electric revenue from affiliate
1
1
4
4
Total Operating Revenues
404
404
440
440
Operating Expenses
Energy purchases
120
120
169
169
Energy purchases from affiliate
17
17
4
4
Other operation and maintenance
26
$
117
143
29
$
97
126
Depreciation
39
39
37
37
Taxes, other than income
20
2
22
20
2
22
Total Operating Expenses
183
158
341
222
136
358
Total
$
221
$
(158)
$
63
$
218
$
(136)
$
82

2012 Six Months
2011 Six Months
PA Gross
PA Gross
Delivery
Operating
Delivery
Operating
Margins
Other (a)
Income (b)
Margins
Other (a)
Income (b)
Operating Revenues
Retail electric
$
860
$
860
$
990
$
990
Electric revenue from affiliate
2
2
8
8
Total Operating Revenues
862
862
998
998
Operating Expenses
Energy purchases
273
273
420
420
Energy purchases from affiliate
38
38
10
10
Other operation and maintenance
49
$
234
283
47
$
209
256
Depreciation
78
78
70
70
Taxes, other than income
44
4
48
53
4
57
Total Operating Expenses
404
316
720
530
283
813
Total
$
458
$
(316)
$
142
$
468
$
(283)
$
185

(a)
Represents amounts that are excluded from Margins.
(b)
As reported on the Statement of Income.


146

Changes in Non-GAAP Financial Measures

The following table shows PPL Electric's non-GAAP financial measure, "Pennsylvania Gross Delivery Margins" for the periods ended June 30, as well as the change between periods.  The factors that gave rise to the change are described below the table.
Three Months
Six Months
2012
2011
Change
2012
2011
Change
PA Gross Delivery Margins by Component
Distribution
$
170
$
173
$
(3)
$
359
$
381
$
(22)
Transmission
51
45
6
99
87
12
Total
$
221
$
218
$
3
$
458
$
468
$
(10)

Distribution

Margins decreased for the three and six month periods ended June 30, 2012, compared with 2011, due primarily to the effects of weather.

Transmission

Margins increased for the three and six month periods ended June 30, 2012, compared with 2011, primarily due to increased investment in plant and the recovery of additional costs through the FERC formula-based rates.

Other Operation and Maintenance
The increase (decrease) in other operation and maintenance expense for the periods ended June 30, 2012 compared with 2011 was due to:
Three Months
Six Months
Payroll-related costs
$
4
$
7
Vegetation management
6
8
PUC-reportable storm costs, net of insurance recovery
(2)
(7)
Uncollectible accounts
2
4
Allocation of certain corporate support group costs
2
5
Other
5
10
Total
$
17
$
27

Depreciation

Depreciation increased by $8 million for the six months ended June 30, 2012 compared with 2011, primarily due to PP&E additions related to PPL Electric's ongoing efforts to ensure the reliability of its delivery system and replace aging infrastructure.

Taxes, Other Than Income

Taxes, other than income for the six months ended June 30, 2012 compared with 2011 decreased by $9 million, primarily due to lower Pennsylvania gross receipts tax expense due to a decrease in taxable electric revenue.  This tax is included in "Pennsylvania Gross Delivery Margins."

Financing Costs
The increase (decrease) in financing costs for the periods ended June 30, 2012 compared with 2011 was due to:
Three Months
Six Months
Long-term debt balances
$
4
$
7
Interest rates
(5)
(9)
Distributions on preference stock (a)
(4)
(4)
Amortization of debt issuance costs
1
2
Total
$
(4)
$
(4)

(a)      Decreases for both periods are due to the June 2012 redemption of all 2.5 million shares of preference stock.

147


Income Taxes
The increase (decrease) in income taxes for the periods ended June 30, 2012 compared with 2011 was due to:
Three Months
Six Months
Lower pre-tax book income
$
(7)
$
(16)
Federal and state tax reserve adjustments
1
Federal and state tax return adjustments (a)
2
Depreciation not normalized (a)
(1)
1
Other
1
Total
$
(8)
$
(11)

(a)
In February 2011, the Pennsylvania Department of Revenue issued interpretive guidance on the treatment of bonus depreciation for Pennsylvania income tax purposes.  In accordance with Corporation Tax Bulletin 2011-01, Pennsylvania allows 100% bonus depreciation for qualifying assets in the same year bonus depreciation is allowed for Federal income tax purposes.  The 100% Pennsylvania bonus depreciation deduction created a current state income tax benefit for the flow-through impact of Pennsylvania regulated state tax depreciation.  The federal provision for 100% bonus depreciation generally applies to property placed in service before January 1, 2012.

See Note 5 to the Financial Statements for additional information on income taxes.

Financial Condition
Liquidity and Capital Resources
PPL Electric had the following at:
June 30, 2012
December 31, 2011
Cash and cash equivalents
$
45
$
320
Short-term debt
$
195
$

The $275 million decrease in PPL Electric's cash and cash equivalents position was primarily the net result of:

·
capital expenditures of $256 million;
·
redemption of preference stock of $250 million;
·
the payment of $56 million of common stock dividends to parent;
·
the net increase in short-term debt of $195 million; and
·
net cash provided by operating activities of $101 million.

PPL Electric's cash provided by operating activities increased by $38 million for the six months ended June 30, 2012, compared with 2011, primarily due to a $48 million decrease in defined benefit plan funding.

Credit Facilities

PPL Electric maintains credit facilities to provide liquidity and to backstop commercial paper issuances.  At June 30, 2012, PPL Electric's total committed borrowing capacity under its credit facilities and the use of this borrowing capacity were:

Letters of
Credit Issued
and
Committed
Commercial
Unused
Capacity
Borrowed
Paper Backstop
Capacity
Syndicated Credit Facility (a)
$
300
$
196
$
104
Asset-backed Credit Facility (b)
150
n/a
150
Total PPL Electric Credit Facilities
$
450
$
196
$
254

(a)
The commitments under this credit facility are provided by a diverse bank group, with no one bank and its affiliates providing an aggregate commitment of more than 7% of the total committed capacity.
(b)
PPL Electric obtains financing by selling and contributing its eligible accounts receivable and unbilled revenue to a special purpose, wholly owned subsidiary on an ongoing basis.  The subsidiary pledges these assets to secure loans of up to an aggregate of $150 million from a commercial paper conduit sponsored by a financial institution.  At June 30, 2012, based on accounts receivable and unbilled revenue pledged, the amount available for borrowing under this facility was limited to $87 million.  In July 2012, PPL Electric and the subsidiary extended this agreement from July 2012 to September 2012 and reduced the capacity to $100 million.

148
See Note 7 to the Financial Statements for further discussion of PPL Electric's credit facilities.

Commercial Paper

In May 2012, PPL Electric increased the capacity of its commercial paper program from $200 million to $300 million to provide an additional financing source to fund its short-term liquidity needs, if and when necessary.  Commercial paper issuances are supported by PPL Electric's Syndicated Credit Facility.  At June 30, 2012, PPL Electric had $195 million of commercial paper outstanding, included in "Short-term debt" on the Balance Sheet, at a weighted-average interest rate of approximately 0.49%.

Equity Securities

In June 2012, PPL Electric redeemed all 2.5 million shares of its 6.25% Series Preference Stock, par value $100 per share.  The price paid for the redemption was the par value, without premium ($250 million in the aggregate).  At December 31, 2011, the preference stock was reflected in "Preference stock" on PPL Electric's Balance Sheet.

Rating Agency Actions

Moody's, S&P and Fitch periodically review the credit ratings on the debt of PPL Electric.  Based on their respective independent reviews, the rating agencies may make certain ratings revisions or ratings affirmations.

A credit rating reflects an assessment by the rating agency of the creditworthiness associated with an issuer and particular securities that it issues.  The credit ratings of PPL Electric are based on information provided by PPL Electric and other sources.  The ratings of Moody's, S&P and Fitch are not a recommendation to buy, sell or hold any securities of PPL Electric.  Such ratings may be subject to revisions or withdrawal by the agencies at any time and should be evaluated independently of each other and any other rating that may be assigned to the securities.  A downgrade in PPL Electric's credit ratings could result in higher borrowing costs and reduced access to capital markets.

As a result of the passage of the Dodd-Frank Act, PPL Electric is limiting its credit rating disclosure to a description of the actions taken by the rating agencies with respect to PPL Electric's ratings, but without stating what ratings have been assigned to PPL Electric or its securities.  The ratings assigned by the rating agencies to PPL Electric and its respective securities may be found, without charge, on each of the respective rating agencies' websites, which ratings together with all other information contained on such rating agency websites is, hereby, explicitly not incorporated by reference in this report.

The rating agencies did not take any actions related to PPL Electric in 2012.

For additional information on PPL Electric's liquidity and capital resources, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," in PPL Electric's 2011 Form 10-K.

Risk Management

Market Risk and Credit Risk

PPL Electric issues debt to finance its operations, which exposes it to interest rate risk.  PPL Electric had no potential annual exposure to increased interest expense, based on a 10% increase in interest rates, at June 30, 2012.  PPL Electric estimated that a 10% decrease in interest rates at June 30, 2012 would increase the fair value of its debt portfolio by $77 million.

See Notes 13 and 14 to the Financial Statements in this Form 10-Q and "Risk Management" in PPL Electric's 2011 Form 10-K for additional information on market and credit risk.

Related Party Transactions

PPL Electric is not aware of any material ownership interests or operating responsibility by senior management of PPL Electric in outside partnerships, including leasing transactions with variable interest entities or other entities doing business with PPL Electric.  See Note 11 to the Financial Statements for additional information on related party transactions.
149
Environmental Matters

See Note 10 to the Financial Statements in this Form 10-Q and "Item 1. Business - Environmental Matters" in PPL Electric's 2011 Form 10-K for a discussion of environmental matters.

New Accounting Guidance

See Notes 2 and 18 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.

Application of Critical Accounting Policies

Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies.  The following accounting policies are particularly important to the financial condition or results of operations, and require estimates or other judgments of matters inherently uncertain: defined benefits, loss accruals, income taxes, regulatory assets and liabilities and revenue recognition - unbilled revenue.  See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in PPL Electric's 2011 Form 10-K for a discussion of each critical accounting policy.

150

LG&E AND KU ENERGY LLC AND SUBSIDIARIES

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations


The following should be read in conjunction with LKE's Condensed Consolidated Financial Statements and the accompanying Notes and with LKE's 2011 Form 10-K.  Capitalized terms and abbreviations are defined in the glossary.  Dollars are in millions, unless otherwise noted.

"Management's Discussion and Analysis of Financial Condition and Results of Operations" includes the following information:

·
"Overview" provides a description of LKE and its business strategy, a summary of Net Income and a discussion of certain events related to LKE's results of operations and financial condition.

·
"Results of Operations" provides a summary of LKE's earnings and a description of factors expected to impact future earnings.  This section ends with explanations of significant changes in principal items on LKE's Statements of Income, comparing the three and six months ended June 30, 2012 with the same periods in 2011.

·
"Financial Condition - Liquidity and Capital Resources" provides an analysis of LKE's liquidity position and credit profile.  This section also includes a discussion of rating agency actions.

·
"Financial Condition - Risk Management" provides an explanation of LKE's risk management programs relating to market and credit risk.

Overview

Introduction

LKE, headquartered in Louisville, Kentucky, is a holding company with utility operations through its subsidiaries, LG&E and KU.  LG&E and KU, which constitute substantially all of LKE's operations, are regulated utilities engaged in the generation, transmission, distribution and sale of electricity, in Kentucky, Virginia and Tennessee.  LG&E also engages in the distribution and sale of natural gas in Kentucky.

Business Strategy

LKE's overall strategy is to provide reliable, safe and competitively priced energy to its customers.

A key objective for LKE is to maintain a strong credit profile through managing financing costs and access to credit markets.  LKE continually focuses on maintaining an appropriate capital structure and liquidity position.

Financial and Operational Developments

Net Income
Net Income for the three and six months ended June 30, 2012 was $44 million and $97 million compared to $41 million and $128 million for the same periods in 2011 representing a 7% increase and a 24% decrease over the same periods in 2011.

See "Results of Operations" for a discussion and analysis of LKE's earnings.

Terminated Bluegrass CTs Acquisition

In September 2011, LG&E and KU entered into an asset purchase agreement with Bluegrass Generation for the purchase of the Bluegrass CTs, aggregating approximately 495 MW, plus limited associated contractual arrangements required for operation of the units, for a purchase price of $110 million, pending receipt of applicable regulatory approvals.  In May 2012, the KPSC issued an order approving the request to purchase the Bluegrass CTs.  Also in May 2012, the FERC issued an order conditionally authorizing the acquisition of the Bluegrass CTs, subject to approval by the FERC of satisfactory mitigation measures to address market-power concerns.  After a review of potentially available mitigation options, LG&E and KU determined that the options were not commercially justifiable.  In June 2012, LG&E and KU terminated the asset purchase agreement for the Bluegrass CTs in accordance with its terms and made applicable filings with

151

the KPSC and FERC.  LG&E and KU are currently assessing the impact of the Bluegrass contract termination and potential future generation capacity options.

NGCC Construction

In September 2011, LG&E and KU filed a CPCN with the KPSC requesting approval to build a 640 MW NGCC at the existing Cane Run plant site in Kentucky.  In May 2012, the KPSC issued an order approving the request.  Subject to finalizing contracting agreements and permitting activities, construction is expected to begin in 2012 and be completed during 2015.  The project, which includes building a natural gas supply pipeline and related transmission projects, has an estimated cost of approximately $600 million ($130 million for LG&E and $470 million for KU).

In conjunction with this construction and to meet new, stricter federal EPA regulations with a 2015 compliance date, LG&E and KU anticipate retiring six older coal-fired electric generating units at the Cane Run, Green River and Tyrone plants, which have a combined summer capacity rating of 797 MW.  The Cane Run and Green River coal units are anticipated to remain operational until the NGCC generation and associated transmission project is completed.

Registered Debt Exchange Offer by LKE

In June 2012, LKE completed an exchange of all its outstanding 4.375% Senior Notes due 2021 issued in September 2011 in a transaction not registered under the Securities Act of 1933, for similar securities that were issued in a transaction registered with the SEC.  See Note 7 in LKE's 2011 Form 10-K for additional information.

Commercial Paper

In February 2012, LG&E and KU each established a commercial paper program for up to $250 million to provide an additional financing source to fund their short-term liquidity needs.  Commercial paper issuances will be supported by LG&E's and KU's Syndicated Credit Facilities.  LG&E and KU had no commercial paper outstanding at June 30, 2012.

Results of Operations

The following discussion provides a summary of LKE's earnings and a description of factors that management expects may impact future earnings.  This section ends with "Statement of Income Analysis," which includes explanations of significant changes in principal items on LKE's Statements of Income, comparing the three and six months ended June 30, 2012 with the same periods in 2011.

The results for interim periods can be disproportionately influenced by numerous factors and developments and by seasonal variations.  As such, the results of operations for interim periods do not necessarily indicate results or trends for the year or future periods.

Earnings
Net Income for the periods ended June 30 was:
Three Months
Six Months
2012
2011
2012
2011
Net Income
$
44
$
41
$
97
$
128

The changes in the components of Net Income between these periods were due to the following factors, which reflect reclassifications for items included in margins and certain items that management considers special.  See additional detail of these special items in the table below.

Three Months
Six Months
Margins
$
12
$
(16)
Other operation and maintenance
4
(17)
Depreciation
(1)
(5)
Taxes, other than income
(3)
(5)
Other
(1)
(4)
Other Income (Expense) - net
(7)
(9)
Income Taxes
4
26
Special items
(5)
(1)
Total
$
3
$
(31)


152

·
See "Statement of Income Analysis - Margins - Changes in Non-GAAP Financial Measures" for an explanation of margins.

·
Higher other operation and maintenance for the six-month period, primarily due to $11 million of higher steam maintenance costs resulting from an increased scope of scheduled plant outages.  Also, a $6 million credit was recorded in 2011 to establish a regulatory asset related to 2009 storm costs.

·
Lower other income (expense) - net for the three and six-month periods primarily due to equity losses from an unconsolidated affiliate.

·
Lower income taxes for the six-month period, primarily due to the change in pre-tax income.

The following after-tax amounts, which management considers special items, also impacted earnings during the periods ended June 30:

Income Statement
Three Months
Six Months
Line Item
2012
2011
2012
2011
Special items gains (losses), net of tax (expense) benefit:
Acquisition-related adjustments:
Net operating loss carryforward and other tax related adjustments
Income Taxes and Other O&M
$
4
Other:
Discontinued Operations, net of tax of $4, $0, $4, $0 (a)
Discontinued Operations
$
(5)
(5)
Total
$
(5)
$
(1)

(a)
Represents an adjustment to an indemnification liability.

Outlook

Excluding special items, LKE projects lower earnings in 2012 compared with 2011, as margin increases are not expected to offset operating expense increases, including depreciation.  Actual results will be dependent on the effects of the economy and the impact of weather on retail sales among other variables .

In June 2012, LG&E and KU filed requests with the KPSC for increases in annual base electric rates of approximately $62 million at LG&E and approximately $82 million at KU and an increase in annual base gas rates of approximately $17 million at LG&E.  The proposed base rate increases would result in electric rate increases of 6.9% at LG&E and 6.5% at KU and a gas rate increase of 7.0% at LG&E and would be effective in January 2013.  LG&E's and KU's applications include requests for authorized returns-on-equity at LG&E and KU of 11% each. A hearing on these matters is expected to be scheduled during the fourth quarter of 2012.  LG&E and KU cannot predict the outcome of these proceedings.

Earnings in 2012 are subject to various risks and uncertainties.  See "Forward-Looking Information," the rest of this Item 2, Notes 6 and 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in LKE's 2011 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.

Statement of Income Analysis --

Margins

Non-GAAP Financial Measure

The following discussion includes financial information prepared in accordance with GAAP, as well as a non-GAAP financial measure, "Margins." Margins is not intended to replace "Operating Income," which is determined in accordance with GAAP as an indicator of overall operating performance.  Other companies may use different measures to analyze and to report on the results of their operations.  Margins is a single financial performance measure of LKE's operations.  In calculating this measure, utility revenues and expenses associated with approved cost recovery tracking mechanisms are offset.  These mechanisms allow for recovery of certain expenses, returns on capital investments associated with environmental regulations and performance incentives.  Certain costs associated with these mechanisms, primarily ECR and DSM, are recorded as "Other operation and maintenance" and "Depreciation."  As a result, this measure represents the net revenues from LKE's operations.  This performance measure is used, in conjunction with other information, internally by senior management to manage LKE's operations and analyze actual results compared to budget.


153

Reconciliation of Non-GAAP Financial Measures

The following tables reconcile "Operating Income" to "Margins" as defined by LKE for the periods ended June 30.

2012 Three Months
2011 Three Months
Operating
Operating
Margins
Other (a)
Income (b)
Margins
Other (a)
Income (b)
Operating Revenues
$
658
$
658
$
639
$
(1)
$
638
Operating Expenses
Fuel
215
215
206
206
Energy purchases
34
34
40
40
Other operation and maintenance
24
$
173
197
21
177
198
Depreciation
13
73
86
12
72
84
Taxes, other than income
12
12
9
9
Total Operating Expenses
286
258
544
279
258
537
Total
$
372
$
(258)
$
114
$
360
$
(259)
$
101

2012 Six Months
2011 Six Months
Operating
Operating
Margins
Other (a)
Income (b)
Margins
Other (a)
Income (b)
Operating Revenues
$
1,363
$
1,363
$
1,404
$
1,404
Operating Expenses
Fuel
428
428
421
421
Energy purchases
108
108
147
147
Other operation and maintenance
46
$
357
403
41
$
338
379
Depreciation
26
146
172
24
141
165
Taxes, other than income
23
23
18
18
Total Operating Expenses
608
526
1,134
633
497
1,130
Total
$
755
$
(526)
$
229
$
771
$
(497)
$
274

(a)
Represents amounts that are excluded from Margins.
(b)
As reported on the Statements of Income.

Changes in Non-GAAP Financial Measures

Margins increased by $12 million for the three-month period due to higher retail margins, as volumes were impacted by increases in production levels at some of LKE's larger industrial customers and warmer weather during the three months ended June 30, 2012.  Total cooling degree days increased 9% compared to the same period in 2011.

Margins decreased by $16 million for the six-month period primarily due to $13 million of lower retail margins, as volumes were impacted by unseasonably mild weather during the first four months of 2012, and $3 million of lower wholesale margins, as volumes were impacted by lower market prices.  Total heating degree days decreased 24% compared to the same period in 2011.

Other Operation and Maintenance
The increase (decrease) in other operation and maintenance expense for the periods ended June 30, 2012, compared with 2011, was due to:
Three Months
Six Months
Steam maintenance (a)
$
11
Distribution maintenance (b)
$
(1)
8
DSM
2
3
Other
(2)
2
Total
$
(1)
$
24

(a)
Steam maintenance costs increased $11 million during the six months ended June 30, 2011, primarily resulting from an increased scope of scheduled outages.
(b)
A $6 million credit to establish a regulatory asset was recorded in the first quarter of 2011 related to 2009 storm costs.

Depreciation

Depreciation increased by $2 million and $7 million for the three and six months ended June 30, 2012 compared with 2011, primarily due to PP&E additions.


154

Other Income (Expense) - net

The increase (decrease) in other income (expense) - net for the periods ended June 30, 2012, compared with 2011, was due to:

Three Months
Six Months
Equity losses from an unconsolidated affiliate
$
(4)
$
(6)
Other
(3)
(3)
Total
$
(7)
$
(9)

Income Taxes
The increase (decrease) in income taxes for the periods ended June 30, 2012, compared with 2011, was due to:
Three Months
Six Months
Higher (lower) pre-tax book income
$
2
$
(22)
Net operating loss carryforward adjustments (a)
(3)
(9)
Other
(3)
(1)
Total
$
(4)
$
(32)

(a)
During the three and six months ended June 30, 2012, LKE recorded adjustments to deferred taxes related to net operating loss carryforwards based on income tax return adjustments.

See Note 5 to the Financial Statements for additional information on income taxes.

Income (Loss) from Discontinued Operations (net of income taxes)

Loss from discontinued operations increased by $6 million for the three and six months ended June 30, 2012, compared with 2011.  The increase was primarily related to an adjustment to the estimated liability for indemnifications.

Financial Condition
Liquidity and Capital Resources
LKE had the following at:
June 30, 2012
December 31, 2011
Cash and cash equivalents
$
29
$
59

The $30 million decrease in LKE's cash and cash equivalents position was primarily the net result of:

·
capital expenditures of $324 million and
·
the payment of $60 million of distributions to PPL, partially offset by
·
cash provided by operating activities of $354 million.

LKE's cash provided by operating activities decreased by $53 million for the six months ended June 30, 2012, compared with 2011, primarily due to:

·
a decrease in net income of $31 million due to unseasonably mild weather during the first four months of 2012 and higher operation and maintenance expenses, adjusted for non-cash effects of $74 million (deferred income taxes and investment tax credits of $90 million and defined benefit plans - expense of $5 million, partially offset by depreciation of $7 million and other noncash items of $14 million) and
·
a decrease in coal consumption resulting from lower coal-fired generation due to the mild winter weather and an increase in combustion turbine generation that led to an increase of $34 million in coal inventory, along with an increase in price per ton of coal in comparison to 2011; partially offset by
·
a decrease in cash outflows of $95 million due to a reduction in discretionary defined benefit plan contributions.

LKE's cash used in investing activities increased by $273 million for the six months ended June 30, 2012, compared with 2011, primarily due to proceeds from the sale of other investments of $163 million in 2011 and an increase in capital
155
expenditures of $144 million as a result of increased environmental spending, primarily related to landfills, and infrastructure improvements at generation, distribution and transmission facilities.

LKE's cash used in financing activities decreased by $251 million for the six months ended June 30, 2012, compared with 2011, primarily due to a repayment on a revolving line of credit of $163 million in 2011 and lower distributions to PPL of $86 million in 2012.

Credit Facilities

At June 30, 2012, LKE's total committed borrowing capacity under its credit facilities and the use of this borrowing capacity were:
Committed
Letters of
Unused
Capacity
Borrowed
Credit Issued
Capacity
LKE Credit Facility with a subsidiary of PPL Energy Supply
$
300
$
300
LG&E Credit Facility
400
400
KU Credit Facilities
598
$
198
400
Total Credit Facilities (a)
$
1,298
$
198
$
1,100

(a)
The commitments under LKE's domestic credit facilities are provided by a diverse bank group, with no one bank and its affiliates providing an aggregate commitment of more than 10% of the total committed capacity; however, the PPL affiliate provides a commitment of approximately 23% of the total facilities listed above.

See Note 7 to the Financial Statements for further discussion of LKE's credit facilities and long-term debt securities.

LKE's long-term debt securities activity through June 30, 2012 was:
Debt
Issuances
Retirement
Non-cash Exchanges (a)
LKE Senior Unsecured Notes
$
250
$
(250)

(a)
In June 2012, LKE completed an exchange of all of its outstanding 4.375% Senior Notes due 2021 issued in September 2011 in a transaction not registered under the Securities Act of 1933, for similar securities that were issued in a transaction registered with the SEC.

See Note 7 to the Financial Statements for additional information about long-term debt securities.

Rating Agency Actions

Moody's, S&P and Fitch periodically review the credit ratings on the debt securities of LKE and its subsidiaries.  Based on their respective independent reviews, the rating agencies may make certain ratings revisions or ratings affirmations.

A credit rating reflects an assessment by the rating agency of the creditworthiness associated with an issuer and particular securities that it issues.  The credit ratings of LKE and its subsidiaries are based on information provided by LKE and other sources.  The ratings of Moody's, S&P and Fitch are not a recommendation to buy, sell or hold any securities of LKE or its subsidiaries.  Such ratings may be subject to revisions or withdrawal by the agencies at any time and should be evaluated independently of each other and any other rating that may be assigned to the securities.  A downgrade in LKE's or its subsidiaries' credit ratings could result in higher borrowing costs and reduced access to capital markets.

As a result of the passage of the Dodd-Frank Act and the attendant uncertainties relating to the extent to which issuers of non-asset backed securities may disclose credit ratings without being required to obtain rating agency consent to the inclusion of such disclosure, or incorporation by reference of such disclosure, in a registrant's registration statement or section 10(a) prospectus, LKE is limiting its credit rating disclosure to a description of the actions taken by the rating agencies with respect to LKE's ratings, but without stating what ratings have been assigned to LKE or its subsidiaries, or their securities.  The ratings assigned by the rating agencies to LKE and its subsidiaries and their respective securities may be found, without charge, on each of the respective rating agencies' websites, which ratings together with all other information contained on such rating agency websites is, hereby, explicitly not incorporated by reference in this report.

The rating agencies took the following actions related to LKE and its subsidiaries:

In February 2012, Fitch assigned ratings to the two newly established commercial paper programs for LG&E and KU.


156

In March 2012, Moody's affirmed the following ratings:
·
the long-term ratings of the First Mortgage Bonds for LG&E and KU;
·
the issuer ratings for LG&E and KU; and
·
the bank loan ratings for LG&E and KU.

Also in March 2012, Moody's and S&P each assigned short-term ratings to the two newly established commercial paper programs for LG&E and KU.

In March and May 2012, Moody's, S&P and Fitch affirmed the long-term ratings for LG&E's 2003 Series A and 2007 Series B pollution control bonds.

Ratings Triggers

LKE and its subsidiaries have various derivative and non-derivative contracts, including contracts for the sale and purchase of electricity, fuel, commodity transportation and storage and interest rate instruments, which contain provisions requiring LKE and its subsidiaries to post additional collateral, or permitting the counterparty to terminate the contract, if LKE's or its subsidiaries' credit ratings were to fall below investment grade.  See Note 14 to the Financial Statements for a discussion of "Credit Risk-Related Contingent Features," including a discussion of the potential additional collateral that would have been required for derivative contracts in a net liability position at June 30, 2012.  At June 30, 2012, if LKE and its subsidiaries' credit ratings had been below investment grade, the maximum amount that LKE would have been required to post as additional collateral to counterparties was $100 million for both derivative and non-derivative commodity and commodity-related contracts used in its generation and marketing operations, gas supply and interest rate contracts.

Capital Expenditures

LKE has lowered its projected capital spending for 2012 by approximately $325 million from the previously disclosed $1.2 billion projection included in LKE's 2011 Form 10-K.  The lower projected capital spending is due mainly to the terminated Bluegrass CTs acquisition discussed in Notes 6 and 8 to the Financial Statements and the status of environmental projects.

Risk Management

Market Risk

See Notes 13 and 14 to the Financial Statements for information about LKE's risk management objectives, valuation techniques and accounting designations.

The forward-looking information presented below provides estimates of what may occur in the future, assuming certain adverse market conditions and model assumptions.  Actual future results may differ materially from those presented.  These disclosures are not precise indicators of expected future losses, but only indicators of possible losses under normal market conditions at a given confidence level.

Commodity Price Risk

LG&E's and KU's rates are set by regulatory commissions and the fuel costs incurred are directly recoverable from customers.  As a result, LG&E and KU are subject to commodity price risk for only a small portion of on-going business operations.  LKE conducts energy trading and risk management activities to maximize the value of the physical assets at times when the assets are not required to serve LG&E's and KU's customers.  See Note 14 to the Financial Statements for additional disclosures.

Interest Rate Risk

LKE and its subsidiaries issue debt to finance their operations, which exposes them to interest rate risk.  LKE utilizes various financial derivative instruments to adjust the mix of fixed and floating interest rates in its debt portfolio when appropriate.  Risk limits under LKE's risk management program are designed to balance risk, exposure to volatility in interest expense and changes in the fair value of LKE's debt portfolio due to changes in the absolute level of interest rates.

At June 30, 2012, LKE's potential annual exposure to increased interest expense, based on a 10% increase in interest rates, was not significant.


157

LKE is also exposed to changes in the fair value of its debt portfolio.  LKE estimated that a 10% decrease in interest rates at June 30, 2012, would increase the fair value of its debt portfolio by $120 million.

At June 30, 2012, LKE had the following interest rate hedges outstanding:
Effect of a
Fair Value,
10% Adverse
Exposure
Net - Asset
Movement
Hedged
(Liability) (a)
in Rates
Economic hedges
Interest rate swaps  (b)
$
179
$
(63)
$
(3)

(a)
Includes accrued interest.
(b)
LKE utilizes various risk management instruments to reduce its exposure to the expected future cash flow variability of its debt instruments.  These risks include exposure to adverse interest rate movements for outstanding variable rate debt and for future anticipated financing.  While LKE is exposed to changes in the fair value of these instruments, any realized changes in the fair value of such economic hedges are recoverable through regulated rates and any subsequent changes in fair value of these derivatives are included in regulatory assets or liabilities.  Sensitivities represent a 10% adverse movement in interest rates.  The positions outstanding at June 30, 2012 mature through 2033.

Credit Risk

See Notes 13 and 14 to the Financial Statements in this Form 10-Q and "Risk Management - Energy Marketing & Trading and Other - Credit Risk" in PPL's and LKE's 2011 Form 10-K for additional information.

Related Party Transactions

LKE is not aware of any material ownership interest or operating responsibility by senior management of LKE, LG&E or KU in outside partnerships, including leasing transactions with variable interest entities, or other entities doing business with LKE.  See Note 11 to the Financial Statements for additional information on related party transactions.

Environmental Matters

Protection of the environment is a major priority for LKE and a significant element of its business activities.  Extensive federal, state and local environmental laws and regulations are applicable to LKE's air emissions, water discharges and the management of hazardous and solid waste, among other areas, and the costs of compliance or alleged non-compliance cannot be predicted with certainty but could be material.  In addition, costs may increase significantly if the requirements or scope of environmental laws or regulations, or similar rules, are expanded or changed from prior versions by the relevant agencies.  Costs may take the form of increased capital or operating and maintenance expenses; monetary fines, penalties or forfeitures; or other restrictions.  Many of these environmental law considerations are also applicable to the operations of key suppliers, or customers, such as coal producers, industrial power users, etc. and may impact the costs for their products or their demand for LKE's services.  See "Item 1. Business - Environmental Matters" in LKE's 2011 Form 10-K and Note 10 to the Financial Statements for a discussion of environmental matters.

New Accounting Guidance

See Notes 2 and 18 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.

Application of Critical Accounting Policies

Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies.  The following accounting policies are particularly important to the financial condition or results of operations and require estimates or other judgments of matters inherently uncertain: revenue recognition - unbilled revenue, price risk management, defined benefits, asset impairment, loss accruals, AROs, income taxes, and regulatory assets and liabilities.  See "Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations" in LKE's 2011 Form 10-K for a discussion of each critical accounting policy.

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LOUISVILLE GAS AND ELECTRIC COMPANY

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations


The following should be read in conjunction with LG&E's Condensed Financial Statements and the accompanying Notes and with LG&E's 2011 Form 10-K.  Capitalized terms and abbreviations are defined in the glossary.  Dollars are in millions, unless otherwise noted.

"Management's Discussion and Analysis of Financial Condition and Results of Operations" includes the following information:

·
"Overview" provides a description of LG&E and its business strategy, a summary of Net Income and a discussion of certain events related to LG&E's results of operations and financial condition.

·
"Results of Operations" provides a summary of LG&E's earnings and a description of factors expected to impact future earnings.  This section ends with explanations of significant changes in principal items on LG&E's Statements of Income, comparing the three and six months ended three and six months ended June 30, 2012 with the same periods in 2011.

·
"Financial Condition - Liquidity and Capital Resources" provides an analysis of LG&E's liquidity position and credit profile.  This section also includes a discussion of rating agency actions.

·
"Financial Condition - Risk Management" provides an explanation of LG&E's risk management programs relating to market and credit risk.

Overview

Introduction

LG&E, headquartered in Louisville, Kentucky, is a regulated utility engaged in the generation, transmission, distribution and sale of electricity and the distribution and sale of natural gas in Kentucky.

Business Strategy

LG&E's overall strategy is to provide reliable, safe and competitively priced energy to its customers.

A key objective for LG&E is to maintain a strong credit profile through managing financing costs and access to credit markets.  LG&E continually focuses on maintaining an appropriate capital structure and liquidity position.

Financial and Operational Developments

Net Income
Net Income for the three and six months ended June 30, 2012 was $26 million and $51 million compared to $20 million and $59 million for the same periods in 2011 representing a 30% increase and a 14% decrease over the same periods in 2011.

See "Results of Operations" for a discussion and analysis of LG&E's earnings.

Terminated Bluegrass CTs Acquisition

In September 2011, LG&E and KU entered into an asset purchase agreement with Bluegrass Generation for the purchase of the Bluegrass CTs, aggregating approximately 495 MW, plus limited associated contractual arrangements required for operation of the units, for a purchase price of $110 million, pending receipt of applicable regulatory approvals.  In May 2012, the KPSC issued an order approving the request to purchase the Bluegrass CTs.  Also in May 2012, the FERC issued an order conditionally authorizing the acquisition of the Bluegrass CTs, subject to approval by the FERC of satisfactory mitigation measures to address market-power concerns.  After a review of potentially available mitigation options, LG&E and KU determined that the options were not commercially justifiable.  In June 2012, LG&E and KU terminated the asset purchase agreement for the Bluegrass CTs in accordance with its terms and made applicable filings with

159

the KPSC and FERC.  LG&E and KU are currently assessing the impact of the Bluegrass contract termination and potential future generation capacity options.

NGCC Construction

In September 2011, LG&E and KU filed a CPCN with the KPSC requesting approval to build a 640 MW NGCC at the existing Cane Run plant site in Kentucky.  In May 2012, the KPSC issued an order approving the request.  Subject to finalizing contracting agreements and permitting activities, construction is expected to begin in 2012 and be completed during 2015.  The project, which includes building a natural gas supply pipeline and related transmission projects, has an estimated cost of approximately $600 million ($130 million for LG&E and up to $470 million for KU).

In conjunction with this construction and to meet new, stricter federal EPA regulations with a 2015 compliance date, LG&E and KU anticipate retiring six older coal-fired electric generating units at the Cane Run, Green River and Tyrone plants, which have a combined summer capacity rating of 797 MW.  The Cane Run and Green River coal units are anticipated to remain operational until the NGCC generation and associated transmission project is completed.

Commercial Paper

In February 2012, LG&E established a commercial paper program for up to $250 million to provide an additional financing source to fund its short-term liquidity needs.  Commercial paper issuances will be supported by LG&E's Syndicated Credit Facility.  LG&E had no commercial paper outstanding at June 30, 2012.

Results of Operations

The following discussion provides a summary of LG&E's earnings and a description of factors that management expects may impact future earnings.  This section ends with "Statement of Income Analysis," which includes explanations of significant changes in principal items on LG&E's Statements of Income, comparing the three and six months ended June 30, 2012 with the same periods in 2011.

The results for interim periods can be disproportionately influenced by numerous factors and developments and by seasonal variations.  As such, the results of operations for interim periods do not necessarily indicate results or trends for the year or for future periods.

Earnings
Net Income for the periods ended June 30 was:
Three Months
Six Months
2012
2011
2012
2011
Net Income
$
26
$
20
$
51
$
59

The changes in the components of Net Income between these periods were due to the following factors, which reflect reclassification for items included in margins.

Three Months
Six Months
Margin
$
8
$
(3)
Other operation and maintenance
2
(7)
Depreciation
(1)
(3)
Taxes, other than income
(1)
(2)
Other Income (Expense) - net
(2)
Interest Expense
2
2
Income Taxes
(2)
5
Total
$
6
$
(8)

·
See "Statement of Income Analysis - Margins - Changes in Non-GAAP Financial Measures" for an explanation of margins.

·
Higher other operation and maintenance for the six-month period, due to $7 million of higher steam maintenance costs primarily resulting from an increased scope of scheduled plant outages.


160

Outlook

LG&E projects lower earnings in 2012 compared with 2011, as margin increases are not expected to offset operating expense increases, including depreciation.  Actual results will be dependent on the effects of the economy and the impact of weather on retail sales among other variables.

In June 2012, LG&E filed a request with the KPSC for an increase in annual base electric rates of approximately $62 million and an increase in annual base gas rates of approximately $17 million.  The proposed request would result in a 6.9% increase in the base electric rates and a 7.0% increase in the base gas rates, and would be effective in January 2013.  LG&E's application includes a request for authorized return-on-equity of 11%.  A hearing on these matters is expected to be scheduled during the fourth quarter of 2012.  LG&E cannot predict the outcome of this proceeding.

Earnings in 2012 are subject to various risks and uncertainties.  See "Forward-Looking Information," the rest of this Item 2, Notes 6 and 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in LG&E's 2011 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.

Statement of Income Analysis --

Margins

Non-GAAP Financial Measure

The following discussion includes financial information prepared in accordance with GAAP, as well as a non-GAAP financial measure, "Margins."  Margins is not intended to replace "Operating Income," which is determined in accordance with GAAP as an indicator of overall operating performance.  Other companies may use different measures to analyze and to report on the results of their operations.  Margins is a single financial performance measure of LG&E's operations.  In calculating this measure, utility revenues and expenses associated with approved cost recovery tracking mechanisms are offset.  These mechanisms allow for recovery of certain expenses, returns on capital investments associated with environmental regulations and performance incentives.  Certain costs associated with these mechanisms, primarily ECR and DSM, are recorded as "Other operation and maintenance" and "Depreciation".  As a result, this measure represents the net revenues from LG&E's operations.  This performance measure is used, in conjunction with other information, internally by senior management to manage operations and analyze actual results compared to budget.

Reconciliation of Non-GAAP Financial Measures

The following tables reconcile "Operating Income" to "Margins" as defined by LG&E for the periods ended June 30.

2012 Three Months
2011 Three Months
Operating
Operating
Margins
Other (a)
Income (b)
Margins
Other (a)
Income (b)
Operating Revenues
$
304
$
304
$
297
$
297
Operating Expenses
Fuel
92
92
82
82
Energy purchases
25
25
39
39
Other operation and maintenance
11
$
81
92
8
$
83
91
Depreciation
1
37
38
1
36
37
Taxes, other than income
6
6
5
5
Total Operating Expenses
129
124
253
130
124
254
Total
$
175
$
(124)
$
51
$
167
$
(124)
$
43

2012 Six Months
2011 Six Months
Operating
Operating
Margins
Other (a)
Income (b)
Margins
Other (a)
Income (b)
Operating Revenues
$
657
$
657
$
695
$
695
Operating Expenses
Fuel
181
181
167
167
Energy purchases
98
98
149
149
Other operation and maintenance
21
$
169
190
19
$
162
181
Depreciation
1
75
76
1
72
73
Taxes, other than income
11
11
9
9
Total Operating Expenses
301
255
556
336
243
579
Total
$
356
$
(255)
$
101
$
359
$
(243)
$
116

161

(a)
Represents amounts excluded from Margins.
(b)
As reported on the Statement of Income.

Changes in Non-GAAP Financial Measures

Margins increased by $8 million and decreased by $3 million during the three and six months ended June 30, 2012, compared with the same periods in 2011.  The positive impact during the three-month period primarily resulted from $8 million of higher retail margins, as volumes were impacted by increases in production levels at some of LG&E's larger industrial customers and warmer weather during the three months ended June 30, 2012.  Total cooling degree days increased by 14% compared to the same period in 2011.  The negative impact during the six-month period primarily resulted from $3 million of lower wholesale margins, as volumes were impacted by lower market prices.

Other Operation and Maintenance
The increase (decrease) in other operation and maintenance expense for the periods ended June 30, 2012, compared with 2011, was due to:
Three Months
Six Months
Steam maintenance (a)
$
(2)
$
7
Other
3
2
Total
$
1
$
9

(a)
Higher steam maintenance costs of $7 million for the six-month period due to an increased scope of scheduled outages.

Income Taxes
The increase (decrease) in income taxes for the periods ended June 30, 2012, compared with 2011, was due to:
Three Months
Six Months
Higher (lower) pre-tax book income
$
3
$
(5)
Other
(1)
Total
$
2
$
(5)

See Note 5 to the Financial Statements for additional information on income taxes.

Financial Condition
Liquidity and Capital Resources
LG&E had the following at:
June 30, 2012
December 31, 2011
Cash and cash equivalents
$
25
$
25

LG&E's cash and cash equivalents position was primarily the net result of:

·
cash provided by operating activities of $160 million, partially offset by
·
capital expenditures of $120 million;
·
the payment of $31 million of common stock dividends; and
·
notes receivable from affiliates of $6 million.

LG&E's cash provided by operating activities decreased by $17 million for the six months ended June 30, 2012, compared with 2011, primarily due to:

·
a net increase in cash outflows related to working capital, excluding fuel, materials and supplies, of $37 million due to the timing of cash receipts and payments, including an $8 million increase in accounts payable invoices paid on behalf of KU and an $8 million increase in tax settlements with LKE;
·
a decrease in coal consumption resulting from lower coal-fired generation due to the mild winter weather and an increase in combustion turbine generation that led to an increase of $30 million in coal inventory, along with an increase in price per ton of coal in comparison to 2011; and

162

·
a decrease in net income of $8 million due to unseasonably mild weather during the first four months of 2012, lower off-system sales and higher operation and maintenance expenses, adjusted for non-cash effects of $4 million (defined benefit plans - expense of $2 million and other noncash items of $6 million, partially offset by depreciation of $3 million and deferred income taxes and investment tax credits of $1 million); partially offset by
·
a decrease in cash outflows of $42 million due to a reduction in discretionary defined benefit plan contributions and
·
a decrease in cash outflows related to accrued taxes of $15 million primarily due to the timing of property tax payments.

LG&E's cash used in investing activities increased by $208 million for the six months ended June 30, 2012, compared with 2011, primarily due to proceeds from the sale of other investments of $163 million in 2011 and an increase in capital expenditures of $41 million as a result of increased environmental spending, primarily related to landfills, and infrastructure improvements at generation, distribution, transmission and gas storage facilities.

LG&E's cash used in financing activities decreased by $186 million for the six months ended June 30, 2012, compared with 2011, primarily due to a repayment on a revolving line of credit of $163 million and a net decrease in notes payable with affiliates of $12 million in 2011, along with lower common stock dividends paid to LKE of $11 million in 2012.

Credit Facilities

At June 30, 2012, LG&E's committed borrowing capacity under its credit facilities and the use of this borrowing capacity were:
Committed
Letters of
Unused
Capacity
Borrowed
Credit Issued
Capacity
Syndicated Credit Facility (a)
$
400
$
400

(a)
The commitments under LG&E's Syndicated Credit Facility are provided by a diverse bank group, with no one bank and its affiliates providing an aggregate commitment of more than 6% of the total committed capacity available to LG&E.

LG&E participates in an intercompany money pool agreement whereby LKE and/or KU make available to LG&E funds up to $500 million at an interest rate based on a market index of commercial paper issues.  At June 30, 2012 and December 31, 2011, there was no balance outstanding.

See Note 7 to the Financial Statements for further discussion of LG&E's credit facilities.

Rating Agency Actions

Moody's, S&P and Fitch periodically review the credit ratings on the debt securities of LG&E.  Based on their respective independent reviews, the rating agencies may make certain ratings revisions or ratings affirmations.

A credit rating reflects an assessment by the rating agency of the creditworthiness associated with an issuer and particular securities that it issues.  The credit ratings of LG&E are based on information provided by LG&E and other sources.  The ratings of Moody's, S&P and Fitch are not a recommendation to buy, sell or hold any securities of LG&E.  Such ratings may be subject to revisions or withdrawal by the agencies at any time and should be evaluated independently of each other and any other rating that may be assigned to the securities.  A downgrade in LG&E's credit ratings could result in higher borrowing costs and reduced access to capital markets.

As a result of the passage of the Dodd-Frank Act and the attendant uncertainties relating to the extent to which issuers of non-asset backed securities may disclose credit ratings without being required to obtain rating agency consent to the inclusion of such disclosure, or incorporation by reference of such disclosure, in a registrant's registration statement or section 10(a) prospectus, LG&E is limiting its credit rating disclosure to a description of the actions taken by the rating agencies with respect to LG&E's ratings, but without stating what ratings have been assigned to LG&E's securities.  The ratings assigned by the rating agencies to LG&E and its securities may be found, without charge, on each of the respective rating agencies' websites, which ratings together with all other information contained on such rating agency websites is, hereby, explicitly not incorporated by reference in this report.

The rating agencies took the following actions related to LG&E:

In February 2012, Fitch assigned ratings to LG&E's newly established commercial paper program.

In March 2012, Moody's affirmed the following ratings:
·
the long-term ratings of the First Mortgage Bonds for LG&E;

163

·
the issuer ratings for LG&E; and
·
the bank loan ratings for LG&E.

Also in March 2012, Moody's and S&P each assigned short-term ratings to LG&E's newly established commercial paper programs.

In March and May 2012, Moody's, S&P and Fitch affirmed the long-term ratings for LG&E's 2003 Series A and 2007 Series B pollution control bonds.

Ratings Triggers

LG&E has various derivative and non-derivative contracts, including contracts for the sale and purchase of electricity, fuel, commodity transportation and storage and interest rate instruments, which contain provisions requiring LG&E to post additional collateral, or permitting the counterparty to terminate the contract, if LG&E's credit rating were to fall below investment grade.  See Note 14 to the Financial Statements for a discussion of "Credit Risk-Related Contingent Features," including a discussion of the potential additional collateral that would have been required for derivative contracts in a net liability position at June 30, 2012.  At June 30, 2012, if LG&E's credit ratings had been below investment grade, the maximum amount that LG&E would have been required to post as additional collateral to counterparties was $79 million for both derivative and non-derivative commodity and commodity-related contracts used in its generation and marketing operations, gas supply and interest rate contracts.

Capital Expenditures

LG&E has lowered its projected capital spending for 2012 by approximately $215 million from the previously disclosed $554 million projection included in LG&E's 2011 Form 10-K.  The lower projected capital spending is due mainly to the terminated Bluegrass CTs acquisition discussed in Notes 6 and 8 to the Financial Statements and the status of environmental projects.

Risk Management

Market Risk

See Notes 13 and 14 to the Financial Statements for information about LG&E's risk management objectives, valuation techniques and accounting designations.

The forward-looking information presented below provides estimates of what may occur in the future, assuming certain adverse market conditions and model assumptions.  Actual future results may differ materially from those presented.  These disclosures are not precise indicators of expected future losses, but only indicators of possible losses under normal market conditions at a given confidence level.

Commodity Price Risk

LG&E's rates are set by a regulatory commission and the fuel costs incurred are directly recoverable from customers.  As a result, LG&E is subject to commodity price risk for only a small portion of on-going business operations.  LG&E conducts energy trading and risk management activities to maximize the value of the physical assets at times when the assets are not required to serve LG&E's or KU's customers.  See Note 14 to the Financial Statements for additional disclosures.

Interest Rate Risk

LG&E issues debt to finance its operations, which exposes it to interest rate risk.  LG&E utilizes various financial derivative instruments to adjust the mix of fixed and floating interest rates in its debt portfolio when appropriate.  Risk limits under LG&E's risk management program are designed to balance risk, exposure to volatility in interest expense and changes in the fair value of LG&E's debt portfolio due to changes in the absolute level of interest rates.

At June 30, 2012, LG&E's potential annual exposure to increased interest expense, based on a 10% increase in interest rates, was not significant.

LG&E is also exposed to changes in the fair value of its debt portfolio.  LG&E estimated that a 10% decrease in interest rates at June 30, 2012, would increase the fair value of its debt portfolio by $28 million.

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At June 30, 2012, LG&E had the following interest rate hedges outstanding:
Effect of a
Fair Value,
10% Adverse
Exposure
Net - Asset
Movement
Hedged
(Liability) (a)
in Rates
Economic hedges
Interest rate swaps  (b)
$
179
$
(63)
$
(3)

(a)
Includes accrued interest.
(b)
LG&E utilizes various risk management instruments to reduce its exposure to the expected future cash flow variability of its debt instruments.  These risks include exposure to adverse interest rate movements for outstanding variable rate debt and for future anticipated financing.  While LG&E is exposed to changes in the fair value of these instruments, any realized changes in the fair value of such economic hedges are recoverable through regulated rates and any subsequent changes in fair value of these derivatives are included in regulatory assets or liabilities.  Sensitivities represent a 10% adverse movement in interest rates.  The positions outstanding at June 30, 2012 mature through 2033.

Credit Risk

See Notes 13 and 14 to the Financial Statements in this Form 10-Q and "Risk Management - Energy Marketing & Trading and Other - Credit Risk" in PPL's and LG&E's 2011 Form 10-K for additional information.

Related Party Transactions

LG&E is not aware of any material ownership interest or operating responsibility by senior management of LG&E in outside partnerships, including leasing transactions with variable interest entities, or other entities doing business with LG&E.  See Note 11 to the Financial Statements for additional information on related party transactions.

Environmental Matters

Protection of the environment is a major priority for LG&E and a significant element of its business activities.  Extensive federal, state and local environmental laws and regulations are applicable to LG&E's air emissions, water discharges and the management of hazardous and solid waste, among other areas, and the costs of compliance or alleged non-compliance cannot be predicted with certainty but could be material.  In addition, costs may increase significantly if the requirements or scope of environmental laws or regulations, or similar rules, are expanded or changed from prior versions by the relevant agencies.  Costs may take the form of increased capital or operating and maintenance expenses; monetary fines, penalties or forfeitures; or other restrictions.  Many of these environmental law considerations are also applicable to the operations of key suppliers, or customers, such as coal producers, industrial power users, etc. and may impact the costs for their products or their demand for LG&E's services.  See "Item 1. Business - Environmental Matters" in LG&E's 2011 Form 10-K and Note 10 to the Financial Statements for a discussion of environmental matters.

New Accounting Guidance

See Notes 2 and 18 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.

Application of Critical Accounting Policies

Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies.  The following accounting policies are particularly important to the financial condition or results of operations and require estimates or other judgments of matters inherently uncertain: revenue recognition - unbilled revenue, price risk management, defined benefits, asset impairment, loss accruals, AROs, income taxes, and regulatory assets and liabilities.  See "Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations" in LG&E's 2011 Form 10-K for a discussion of each critical accounting policy.

165

KENTUCKY UTILITIES COMPANY

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations


The following should be read in conjunction with KU's Condensed Financial Statements and the accompanying Notes and with KU's 2011 Form 10-K.  Capitalized terms and abbreviations are defined in the glossary.  Dollars are in millions, unless otherwise noted.

"Management's Discussion and Analysis of Financial Condition and Results of Operations" includes the following information:

·
"Overview" provides a description of KU and its business strategy, a summary of Net Income and a discussion of certain events related to KU's results of operations and financial condition.

·
"Results of Operations" provides a summary of KU's earnings and a description of factors expected to impact future earnings.  This section ends with explanations of significant changes in principal items on KU's Statements of Income, comparing the three and six months ended June 30, 2012 with the same periods in 2011.

·
"Financial Condition - Liquidity and Capital Resources" provides an analysis of KU's liquidity position and credit profile.  This section also includes a discussion of rating agency actions.

·
"Financial Condition - Risk Management" provides an explanation of KU's risk management programs relating to market and credit risk.

Overview

Introduction

KU, headquartered in Lexington, Kentucky, is a regulated utility engaged in the generation, transmission, distribution and sale of electricity, in Kentucky, Virginia and Tennessee.

Business Strategy

KU's overall strategy is to provide reliable, safe and competitively priced energy to its customers.

A key objective for KU is to maintain a strong credit profile through managing financing costs and access to credit markets.  KU continually focuses on maintaining an appropriate capital structure and liquidity position.

Financial and Operational Developments

Net Income
Net Income for the three and six months ended June 30, 2012 was $30 million and $68 million compared to $30 million and $88 million for the same periods in 2011 representing a 23% decrease for the six-month period.

See "Results of Operations" for a discussion and analysis of KU's earnings.

Terminated Bluegrass CTs Acquisition

In September 2011, KU and LG&E entered into an asset purchase agreement with Bluegrass Generation for the purchase of the Bluegrass CTs, aggregating approximately 495 MW, plus limited associated contractual arrangements required for operation of the units, for a purchase price of $110 million, pending receipt of applicable regulatory approvals.  In May 2012, the KPSC issued an order approving the request to purchase the Bluegrass CTs.  Also in May 2012, the FERC issued an order conditionally authorizing the acquisition of the Bluegrass CTs, subject to approval by the FERC of satisfactory mitigation measures to address market-power concerns.  After a review of potentially available mitigation options, KU and LG&E determined that the options were not commercially justifiable.  In June 2012, KU and LG&E terminated the asset purchase agreement for the Bluegrass CTs in accordance with its terms and made applicable filings with the KPSC and FERC.  KU and LG&E are currently assessing the impact of the Bluegrass contract termination and potential future generation capacity options.

166


NGCC Construction

In September 2011, KU and LG&E filed a CPCN with the KPSC requesting approval to build a 640 MW NGCC at the existing Cane Run plant site in Kentucky.  In May 2012, the KPSC issued an order approving the request.  Subject to finalizing contracting agreements and permitting activities, construction is expected to begin in 2012 and be completed during 2015.  The project, which includes building a natural gas supply pipeline and related transmission projects, has an estimated cost of approximately $600 million ($470 million for KU and up to $130 million for LG&E).

In conjunction with this construction and to meet new, stricter federal EPA regulations with a 2015 compliance date, KU and LG&E anticipate retiring six older coal-fired electric generating units at the Cane Run, Green River and Tyrone plants, which have a combined summer capacity rating of 797 MW.  The Cane Run and Green River coal units are anticipated to remain operational until the NGCC generation and associated transmission project is completed.

Commercial Paper

In February 2012, KU established a commercial paper program for up to $250 million to provide an additional financing source to fund its short-term liquidity needs.  Commercial paper issuances will be supported by KU's Syndicated Credit Facility.  KU had no commercial paper outstanding at June 30, 2012.

Results of Operations


The following discussion provides a summary of KU's earnings and a description of factors that management expects may impact future earnings.  This section ends with "Statement of Income Analysis," which includes explanations of significant changes in principal items on KU's Statements of Income, comparing the three and six months ended June 30, 2012 with the same periods in 2011.

The results for interim periods can be disproportionately influenced by numerous factors and developments and by seasonal variations.  As such, the results of operations for interim periods do not necessarily indicate results or trends for the year or future periods.

Earnings
Net Income for the periods ended June 30 was:
Three Months
Six Months
2012
2011
2012
2011
Net Income
$
30
$
30
$
68
$
88

The changes in the components of Net Income between these periods were due to the following factors, which reflect reclassifications for items included in margins.

Three Months
Six Months
Margin
$
5
$
(12)
Other operation and maintenance
2
(6)
Depreciation
(1)
(3)
Taxes, other than income
(2)
(3)
Other
1
1
Other Income (Expense) - net
(5)
(7)
Income Taxes
10
Total
$
$
(20)

·
See "Statement of Income Analysis - Margins - Changes in Non-GAAP Financial Measures" for an explanation of margins.

·
Higher other operation and maintenance for the six-month period primarily due to a $6 million credit recorded in 2011 to establish a regulatory asset related to 2009 storm costs.

·
Higher other income (expense) - net for the three and six-month periods primarily due to equity losses from an unconsolidated affiliate.

167


·
Lower income taxes for the six-month period primarily due to the change in pre-tax income.

Outlook

KU projects lower earnings in 2012 compared with 2011, as margin increases are not expected to offset operating expense increases, including depreciation.  Actual results will be dependent on the effects of the economy and the impact of weather on retail sales among other variables.

In June 2012, KU filed a request with the KPSC for an increase in annual base electric rates of approximately $82 million.  The proposed base electric rate increase would result in a 6.5% increase over KU's present rate and would be effective in January 2013.  KU's application includes a request for authorized return-on-equity of 11%.  A hearing on these matters is expected to be scheduled during the fourth quarter of 2012.  KU cannot predict the outcome of this proceeding.

Earnings in 2012 are subject to various risks and uncertainties.  See "Forward-Looking Information," the rest of this Item 2, Notes 6 and 10 to the Financial Statements in this Form 10-Q and "Item 1. Business" and "Item 1A. Risk Factors" in KU's 2011 Form 10-K for a discussion of the risks, uncertainties and factors that may impact future earnings.

Statement of Income Analysis --

Margins

Non-GAAP Financial Measure

The following discussion includes financial information prepared in accordance with GAAP, as well as a non-GAAP financial measure, "Margins." Margins is not intended to replace "Operating Income," which is determined in accordance with GAAP as an indicator of overall operating performance.  Other companies may use different measures to analyze and to report on the results of their operations.  Margins is a single financial performance measure of KU's operations.  In calculating this measure, utility revenues and expenses associated with approved cost recovery tracking mechanisms are offset.  These mechanisms allow for recovery of certain expenses, returns on capital investments associated with environmental regulations and performance incentives.  Certain costs associated with these mechanisms, primarily ECR and DSM, are recorded as "Other operation and maintenance" and "Depreciation".  As a result, this measure represents the net revenues from KU's operations.  This performance measure is used, in conjunction with other information, internally by senior management to manage operations and analyze actual results compared to budget.

Reconciliation of Non-GAAP Financial Measures

The following tables reconcile "Operating Income" to "Margins" as defined by KU for the periods ended June 30.

2012 Three Months
2011 Three Months
Operating
Operating
Margins
Other (a)
Income (b)
Margins
Other (a)
Income (b)
Operating Revenues
$
374
$
374
$
366
$
(1)
$
365
Operating Expenses
Fuel
123
123
124
124
Energy purchases
29
29
25
25
Other operation and maintenance
12
$
86
98
12
88
100
Depreciation
12
36
48
12
35
47
Taxes, other than income
6
6
4
4
Total Operating Expenses
176
128
304
173
127
300
Total
$
198
$
(128)
$
70
$
193
$
(128)
$
65


168


2012 Six Months
2011 Six Months
Operating
Operating
Margins
Other (a)
Income (b)
Margins
Other (a)
Income (b)
Operating Revenues
$
754
$
754
$
771
$
771
Operating Expenses
Fuel
247
247
254
254
Energy purchases
58
58
60
60
Other operation and maintenance
25
$
168
193
22
$
162
184
Depreciation
24
72
96
23
69
92
Taxes, other than income
12
12
9
9
Total Operating Expenses
354
252
606
359
240
599
Total
$
400
$
(252)
$
148
$
412
$
(240)
$
172

(a)
Represents amounts excluded from Margins.
(b)
As reported on the Statement of Income.

Changes in Non-GAAP Financial Measures

Margins increased by $5 million and decreased by $12 million during the three and six months ended June 30, 2012, compared with the same periods in 2011.  The positive impact during the three-month period primarily resulted from $4 million of higher retail margins, as volumes were impacted by increases in production levels at some of KU's larger industrial customers and warmer weather during the three months ended June 30, 2012.  Total cooling degree days increased 2% compared to the same period in 2011.  The negative impact during the six-month period primarily resulted from $12 million of lower retail margins, as volumes were impacted by unseasonably mild weather during the first four months of 2012.  Total heating degree days decreased 21% compared to the same period in 2011.

Other Operation and Maintenance
The increase (decrease) in other operation and maintenance expense for the periods ended June 30, 2012, compared with 2011, was due to:
Three Months
Six Months
Distribution maintenance (a)
$
7
Other
$
(2)
2
Total
$
(2)
$
9

(a)
Higher distribution maintenance primarily due to a $6 million credit to establish a regulatory asset that was recorded in the first quarter of 2011 related to 2009 storm costs.

Other Income (Expense) - net

The increase (decrease) in Other Income (Expense) for the periods ended June 30, 2012, compared with 2011, was due to:

Three Months
Six Months
Equity losses from an unconsolidated affiliate
$
(4)
$
(6)
Other
(1)
(1)
Total
$
(5)
$
(7)

Income Taxes

Income taxes decreased by $10 million for the six months ended June 30, 2012, compared with 2011, primarily due to the change in pre-tax income.

See Note 5 to the Financial Statements for additional information on income taxes.

Financial Condition
Liquidity and Capital Resources
KU had the following at:
June 30, 2012
December 31, 2011
Cash and cash equivalents
$
3
$
31

169

The $28 million decrease in KU's cash and cash equivalents position was the net result of:

·
capital expenditures of $203 million and
·
the payment of $48 million of common stock dividends, partially offset by
·
cash provided by operating activities of $217 million and
·
notes payable with affiliates of $6 million.

KU's cash provided by operating activities increased by $32 million for the six months ended June 30, 2012, compared with 2011, primarily due to a decrease in cash outflows of $27 million due to a reduction in discretionary defined benefit plan contributions.

KU's cash used in investing activities increased by $102 million for the six months ended June 30, 2012, compared with 2011, due to an increase in capital expenditures of $102 million as a result of increased environmental spending, primarily related to landfills, and infrastructure improvements at generation, distribution and transmission facilities.

KU's cash used in financing activities decreased by $38 million for the six months ended June 30, 2012, compared with 2011, primarily due to lower common stock dividends paid to LKE of $20 million in 2012 and a higher notes payable with affiliates.

Credit Facilities

At June 30, 2012, KU's committed borrowing capacity under its credit facilities and the use of this borrowing capacity were:
Committed
Letters of
Unused
Capacity
Borrowed
Credit Issued
Capacity
Syndicated Credit Facility
$
400
$
400
Letter of Credit Facility
198
$
198
Total Credit Facilities (a)
$
598
$
198
$
400

(a)
The commitments under KU's credit facilities are provided by a diverse bank group, with no one bank and its affiliates providing an aggregate commitment of more than 19% of the total committed capacity available to KU.

KU participates in an intercompany money pool agreement whereby LKE and/or LG&E make available to KU funds up to $500 million at an interest rate based on a market index of commercial paper issues.  At June 30, 2012, KU owed $6 million and at December 31, 2011, there was no balance outstanding.

See Notes 7 and 11 to the Financial Statements for further discussion of KU's credit facilities.

Rating Agency Actions

Moody's, S&P and Fitch periodically review the credit ratings on the debt securities of KU.  Based on their respective independent reviews, the rating agencies may make certain ratings revisions or ratings affirmations.

A credit rating reflects an assessment by the rating agency of the creditworthiness associated with an issuer and particular securities that it issues.  The credit ratings of KU are based on information provided by KU and other sources.  The ratings of Moody's, S&P and Fitch are not a recommendation to buy, sell or hold any securities of KU.  Such ratings may be subject to revisions or withdrawal by the agencies at any time and should be evaluated independently of each other and any other rating that may be assigned to the securities.  A downgrade in KU's credit ratings could result in higher borrowing costs and reduced access to capital markets.

As a result of the passage of the Dodd-Frank Act and the attendant uncertainties relating to the extent to which issuers of non-asset backed securities may disclose credit ratings without being required to obtain rating agency consent to the inclusion of such disclosure, or incorporation by reference of such disclosure, in a registrant's registration statement or section 10(a) prospectus, KU is limiting its credit rating disclosure to a description of the actions taken by the rating agencies with respect to KU's ratings, but without stating what ratings have been assigned to KU's securities.  The ratings assigned by the rating agencies to KU and its securities may be found, without charge, on each of the respective rating agencies' websites, which ratings together with all other information contained on such rating agency websites is, hereby, explicitly not incorporated by reference in this report.


170

The rating agencies took the following actions related to KU:

In February 2012, Fitch assigned ratings to KU's newly established commercial paper program.

In March 2012, Moody's affirmed the following ratings:
·
the long-term ratings of the First Mortgage Bonds for KU;
·
the issuer ratings for KU; and
·
the bank loan ratings for KU.

Also in March 2012, Moody's and S&P each assigned short-term ratings to KU's newly established commercial paper programs.

Ratings Triggers

KU has various derivative and non-derivative contracts, including contracts for the sale and purchase of electricity, fuel, and commodity transportation and storage, which contain provisions requiring KU to post additional collateral, or permitting the counterparty to terminate the contract, if KU's credit rating were to fall below investment grade.  See Note 14 to the Financial Statements for a discussion of "Credit Risk-Related Contingent Features," including a discussion of the potential additional collateral that would have been required for derivative contracts in a net liability position at June 30, 2012.  At June 30, 2012, if KU's credit ratings had been below investment grade, the maximum amount that KU would have been required to post as additional collateral to counterparties was $21 million for both derivative and non-derivative commodity and commodity-related contracts used in its generation and marketing operations.

Capital Expenditures

KU has lowered its projected capital spending for 2012 by approximately $110 million from the previously disclosed $656 million projection included in KU's 2011 Form 10-K.  The lower projected capital spending is due mainly to the terminated Bluegrass CTs acquisition discussed in Notes 6 and 8 to the Financial Statements and the status of environmental projects.

Risk Management

Market Risk

See Notes 13 and 14 to the Financial Statements for information about KU's risk management objectives, valuation techniques and accounting designations.

The forward-looking information presented below provides estimates of what may occur in the future, assuming certain adverse market conditions and model assumptions.  Actual future results may differ materially from those presented.  These disclosures are not precise indicators of expected future losses, but only indicators of possible losses under normal market conditions at a given confidence level.

Commodity Price Risk

KU's rates are set by regulatory commissions and the fuel costs incurred are directly recoverable from customers.  As a result, KU is subject to commodity price risk for only a small portion of on-going business operations.  KU conducts energy trading and risk management activities to maximize the value of the physical assets at times when the assets are not required to serve KU's or LG&E's customers.  See Note 14 to the Financial Statements for additional disclosures.

Interest Rate Risk

KU issues debt to finance its operations, which exposes it to interest rate risk.  At June 30, 2012, KU's potential annual exposure to increased interest expense, based on a 10% increase in interest rates, was not significant.

KU is also exposed to changes in the fair value of its debt portfolio.  KU estimated that a 10% decrease in interest rates at June 30, 2012, would increase the fair value of its debt portfolio by $71 million.
171

Credit Risk

See Notes 13 and 14 to the Financial Statements in this Form 10-Q and "Risk Management - Energy Marketing & Trading and Other - Credit Risk" in PPL's and KU's 2011 Form 10-K for additional information.

Related Party Transactions

KU is not aware of any material ownership interest or operating responsibility by senior management of KU in outside partnerships, including leasing transactions with variable interest entities, or other entities doing business with KU.  See Note 11 to the Financial Statements for additional information on related party transactions.

Environmental Matters

Protection of the environment is a major priority for KU and a significant element of its business activities.  Extensive federal, state and local environmental laws and regulations are applicable to KU's air emissions, water discharges and the management of hazardous and solid waste, among other areas, and the costs of compliance or alleged non-compliance cannot be predicted with certainty but could be material.  In addition, costs may increase significantly if the requirements or scope of environmental laws or regulations, or similar rules, are expanded or changed from prior versions by the relevant agencies.  Costs may take the form of increased capital or operating and maintenance expenses; monetary fines, penalties or forfeitures; or other restrictions.  Many of these environmental law considerations are also applicable to the operations of key suppliers, or customers, such as coal producers, industrial power users, etc. and may impact the costs for their products or their demand for KU's services.  See "Item 1. Business - Environmental Matters" in KU's 2011 Form 10-K and Note 10 to the Financial Statements for a discussion of environmental matters.

New Accounting Guidance

See Notes 2 and 18 to the Financial Statements for a discussion of new accounting guidance adopted and pending adoption.

Application of Critical Accounting Policies

Financial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies.  The following accounting policies are particularly important to the financial condition or results of operations and require estimates or other judgments of matters inherently uncertain: revenue recognition - unbilled revenue, price risk management, defined benefits, asset impairment, loss accruals, AROs, income taxes, and regulatory assets and liabilities.  See "Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations" in KU's 2011 Form 10-K for a discussion of each critical accounting policy.

172

PPL Corporation
PPL Energy Supply, LLC
PPL Electric Utilities Corporation
LG&E and KU Energy LLC
Louisville Gas and Electric Company
Kentucky Utilities Company

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

Reference is made to "Risk Management" in each Registrant's "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations."

Item 4.  Controls and Procedures

(a)           Evaluation of disclosure controls and procedures.

PPL Corporation, PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company, and Kentucky Utilities Company

The registrants' principal executive officers and principal financial officers, based on their evaluation of the registrants' disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934) have concluded that, as of June 30, 2012, the registrants' disclosure controls and procedures are effective to ensure that material information relating to the registrants and their consolidated subsidiaries is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms, particularly during the period for which this quarterly report has been prepared.  The aforementioned principal officers have concluded that the disclosure controls and procedures are also effective to ensure that information required to be disclosed in reports filed under the Exchange Act is accumulated and communicated to management, including the principal executive and principal financial officers, to allow for timely decisions regarding required disclosure.

(b)           Change in internal controls over financial reporting.

PPL Corporation

The registrant's principal executive officer and principal financial officer have concluded that there were no changes in the registrant's internal control over financial reporting during the registrant's second fiscal quarter that have materially affected, or are reasonably likely to materially affect, the registrant's internal control over financial reporting.
As reported in the 2011 Form 10-K, PPL's principal executive officer and principal financial officer concluded that a systems migration related to the WPD Midlands acquisition created a material change to its internal control over financial reporting.  Specifically, on December 1, 2011, the use of legacy information technology systems at WPD Midlands was discontinued and the related data, processes and internal controls were migrated to the systems, processes and controls currently in place at PPL WW.

Risks related to the system migration were partially mitigated by PPL's expanded internal control over financial reporting that were implemented subsequent to the acquisition and PPL's existing policy of consolidating foreign subsidiaries on a one-month lag, which provided management additional time for review and analysis of WPD Midlands' results and their incorporation into PPL's consolidated financial statements.

PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company, and Kentucky Utilities Company

The registrants' principal executive officers and principal financial officers have concluded that there were no changes in the registrants' internal control over financial reporting during the registrants' second fiscal quarter that have materially affected, or are reasonably likely to materially affect, the registrants' internal control over financial reporting.

173

PART II.  OTHER INFORMATION

Item 1. Legal Proceedings

For additional information regarding various pending administrative and judicial proceedings involving regulatory, environmental and other matters, which information is incorporated by reference into this Part II, see:

·
"Item 3. Legal Proceedings" in each Registrant's 2011 Form 10-K; and
·
Notes 5, 6 and 10 to the Financial Statements.

Item 1A. Risk Factors

There have been no material changes in the Registrant's risk factors from those disclosed in "Item 1A. Risk Factors" of the 2011 Form 10-K.


Item 4. Mine Safety Disclosures

Not applicable.

174

Item 6. Exhibits

The following Exhibits indicated by an asterisk preceding the Exhibit number are filed herewith.  The balance of the Exhibits have heretofore been filed with the Commission and pursuant to Rule 12(b)-32 are incorporated herein by reference.  Exhibits indicated by a [_] are filed or listed pursuant to Item 601(b)(10)(iii) of Regulation S-K.

-
Amendment No. 7 to PPL Employee Stock Ownership Plan, dated May 30, 2012
-
Amendment No. 8 to PPL Employee Stock Ownership Plan, dated July 17, 2012
4(c)
-
Supplemental Indenture No. 8, dated as of June 14, 2012, among PPL Capital Funding, Inc., PPL Corporation and The Bank of New York Mellon (as successor to JPMorgan Chase Bank, N. A. (formerly known as The Chase Manhattan Bank)), as Trustee (Exhibit 4(b) to PPL Corporation Form 8-K Report (File No. 1-11459) dated June 14, 2012)
[_]10(a)
-
PPL Corporation 2012 Stock Incentive Plan (Annex A to Proxy Statement of PPL Corporation, dated April 3, 2012)
-
Uncommitted Line of Credit Letter Agreement, dated as of July 1, 2012, between PPL Energy Supply, LLC, the Borrower, and Banco Bilbao Vizcaya Argentaria, S.A., the Bank
-
Reimbursement Agreement, dated as of July 1, 2012, between PPL Energy Supply, LLC and Banco Bilbao Vizcaya Argentaria, S.A.
-
PPL Corporation Executive Severance Plan, effective as of July 26, 2012
*10(e) -
Letter of Credit Issuance and Reimbursement Agreement, dated as of July 27, 2012, between PPL Energy Supply, LLC and Canadian Imperial Bank of Commerce, New York Agency
-
PPL Corporation and Subsidiaries Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends
-
PPL Energy Supply, LLC and Subsidiaries Computation of Ratio of Earnings to Fixed Charges
-
PPL Electric Utilities Corporation and Subsidiaries Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends
-
LG&E and KU Energy LLC and Subsidiaries Computation of Ratio of Earnings to Fixed Charges
-
Louisville Gas and Electric Company Computation of Ratio of Earnings to Fixed Charges
-
Kentucky Utilities Company Computation of Ratio of Earnings to Fixed Charges
Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, for the quarterly period ended June 30, 2012, filed by the following officers for the following companies:
-
PPL Corporation's principal executive officer
-
PPL Corporation's principal financial officer
-
PPL Energy Supply, LLC's principal executive officer
-
PPL Energy Supply, LLC's principal financial officer
-
PPL Electric Utilities Corporation's principal executive officer
-
PPL Electric Utilities Corporation's principal financial officer
-
LG&E and KU Energy LLC's principal executive officer
-
LG&E and KU Energy LLC's principal financial officer
-
Louisville Gas and Electric Company's principal executive officer
-
Louisville Gas and Electric Company's principal financial officer
-
Kentucky Utilities Company's principal executive officer
-
Kentucky Utilities Company's principal financial officer

175


Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, for the quarterly period ended June 30, 2012, furnished by the following officers for the following companies:
-
PPL Corporation's principal executive officer
-
PPL Corporation's principal financial officer
-
PPL Energy Supply, LLC's principal executive officer
-
PPL Energy Supply, LLC's principal financial officer
-
PPL Electric Utilities Corporation's principal executive officer
-
PPL Electric Utilities Corporation's principal financial officer
-
LG&E and KU Energy LLC's principal executive officer
-
LG&E and KU Energy LLC's principal financial officer
-
Louisville Gas and Electric Company's principal executive officer
-
Louisville Gas and Electric Company's principal financial officer
-
Kentucky Utilities Company's principal executive officer
-
Kentucky Utilities Company's principal financial officer
101.INS
-
XBRL Instance Document for PPL Corporation, PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company and Kentucky Utilities Company
101.SCH
-
XBRL Taxonomy Extension Schema for PPL Corporation, PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company and Kentucky Utilities Company
101.CAL
-
XBRL Taxonomy Extension Calculation Linkbase for PPL Corporation, PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company and Kentucky Utilities Company
101.DEF
-
XBRL Taxonomy Extension Definition Linkbase for PPL Corporation, PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company and Kentucky Utilities Company
101.LAB
-
XBRL Taxonomy Extension Label Linkbase for PPL Corporation, PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company and Kentucky Utilities Company
101.PRE
-
XBRL Taxonomy Extension Presentation Linkbase for PPL Corporation, PPL Energy Supply, LLC, PPL Electric Utilities Corporation, LG&E and KU Energy LLC, Louisville Gas and Electric Company and Kentucky Utilities Company

176


Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrants have duly caused this report to be signed on their behalf by the undersigned thereunto duly authorized.  The signature for each undersigned company shall be deemed to relate only to matters having reference to such company or its subsidiaries.

PPL Corporation
(Registrant)
PPL Energy Supply, LLC
(Registrant)
Date:  August 8, 2012
/s/  Vincent Sorgi
Vincent Sorgi
Vice President and Controller
(Principal Accounting Officer)
PPL Electric Utilities Corporation
(Registrant)
Date:  August 8, 2012
/s/  Vincent Sorgi
Vincent Sorgi
Vice President and
Chief Accounting Officer
(Principal Financial and Accounting Officer)


LG&E and KU Energy LLC
(Registrant)
Louisville Gas and Electric Company
(Registrant)
Kentucky Utilities Company
(Registrant)
Date:  August 8, 2012
/s/  Kent W. Blake
Kent W. Blake
Chief Financial Officer
(Principal Financial Officer and Principal Accounting Officer)
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TABLE OF CONTENTS
Part I. Financial InformationprintItem 1. Financial StatementsprintItem 2. Management's Discussion and Analysis Of Financial Condition and Results Of OperationsprintItem 3. Quantitative and Qualitative Disclosures About Market RiskprintItem 4. Controls and ProceduresprintPart II. Other InformationprintItem 1. Legal ProceedingsprintItem 1A. Risk FactorsprintItem 4. Mine Safety DisclosuresprintItem 6. Exhibitsprint

Exhibits

*4(a) - Amendment No. 7 to PPL Employee Stock Ownership Plan, dated May 30, 2012 *4(b) - Amendment No. 8 to PPL Employee Stock Ownership Plan, dated July 17, 2012 *10(b) - Uncommitted Line of Credit Letter Agreement, dated as of July 1, 2012, between PPL Energy Supply, LLC, the Borrower, and Banco Bilbao Vizcaya Argentaria, S.A., the Bank *10(c) - Reimbursement Agreement, dated as of July 1, 2012, between PPL Energy Supply, LLC and Banco Bilbao Vizcaya Argentaria, S.A. *[_]10(d) - PPL Corporation Executive Severance Plan, effective as of July 26, 2012 *10(e) - Letter of Credit Issuance and Reimbursement Agreement, dated as of July 27, 2012, between PPL Energy Supply, LLC and Canadian Imperial Bank of Commerce, New York Agency *12(a) - PPLCorporation and Subsidiaries Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends *12(b) - PPL Energy Supply, LLC and Subsidiaries Computation of Ratio of Earnings to Fixed Charges *12(c) - PPL Electric Utilities Corporation and Subsidiaries Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends *12(d) - LG&E and KU Energy LLC and Subsidiaries Computation of Ratio of Earnings to Fixed Charges *12(e) - Louisville Gas and Electric Company Computation of Ratio of Earnings to Fixed Charges *12(f) - Kentucky Utilities Company Computation of Ratio of Earnings to Fixed Charges *31(a) - PPL Corporation's principal executive officer *31(b) - PPL Corporation's principal financial officer *31(c) - PPL Energy Supply, LLC's principal executive officer *31(d) - PPL Energy Supply, LLC's principal financial officer *31(e) - PPL Electric Utilities Corporation's principal executive officer *31(f) - PPL Electric Utilities Corporation's principal financial officer *31(g) - LG&E and KU Energy LLC's principal executive officer *31(h) - LG&E and KU Energy LLC's principal financial officer *31(i) - Louisville Gas and Electric Company's principal executive officer *31(j) - Louisville Gas and Electric Company's principal financial officer *31(k) - Kentucky Utilities Company's principal executive officer *31(l) - Kentucky Utilities Company's principal financial officer *32(a) - PPL Corporation's principal executive officer *32(b) - PPL Corporation's principal financial officer *32(c) - PPL Energy Supply, LLC's principal executive officer *32(d) - PPL Energy Supply, LLC's principal financial officer *32(e) - PPL Electric Utilities Corporation's principal executive officer *32(f) - PPL Electric Utilities Corporation's principal financial officer *32(g) - LG&E and KU Energy LLC's principal executive officer *32(h) - LG&E and KU Energy LLC's principal financial officer *32(i) - Louisville Gas and Electric Company's principal executive officer *32(j) - Louisville Gas and Electric Company's principal financial officer *32(k) - Kentucky Utilities Company's principal executive officer *32(l) - Kentucky Utilities Company's principal financial officer