** **

**UNITEDSTATES**

**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 endedSept. 30, 2007**

#### ** **

**or**

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

 

#### **For the transition periodfrom               to               **

#### ** **

#### **Commission File Number: 001-03789**

#### ** **

**Southwestern Public Service Company**

**(Exact name of registrant asspecified in its charter)**

** **
| **New Mexico**                  | ** ** | **75-0575400**                       |
|---------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of |       | (I.R.S. Employer Identification No.) |
| incorporation or organization)  |       |                                 |
|                            |       |                                 |
| **Tyler at Sixth,**             | ** ** | ** **                           |
| **Amarillo, Texas**             | ** ** | **79101**                            |
| (Address of principal executive |       | (Zip Code)                           |
| offices)                        |       |                                 |

 

Registrant’stelephone number, including area code **(303)571-7511**

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. xYes   o No

 

Indicate bycheck mark whether the registrant is a large accelerated filer, an acceleratedfiler or a non-accelerated filer. See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

LargeAccelerated Filer o                               AcceleratedFiler o                               Non-AcceleratedFiler x

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act). Yes  o   No  x

 

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

 
| **Class**                  | ** ** | **Outstanding at Oct. 29, 2007** |
|----------------------------|------------|------------------------------------------------------|
| Common Stock, $1 par value |       | 100 shares                                           |

 

SouthwesternPublic Service Company meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is therefore filing this Form 10-Q with the reduceddisclosure format specified in General Instruction H (2) to such Form 10-Q.

 

 

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**Tableof Contents**

 
| ** **                                   | **PART I - FINANCIAL INFORMATION**                                                          | ** ** |
|----------------------------------------------|---------------------------------------------------------------------------------------------|------------|
| ** **                                   | ** **                                                                                  | ** ** |
| Item l.                                      | Financial Statements                                                                        |       |
| Item 2.                                      | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |       |
| Item 4.                                      | Controls and Procedures                                                                     |       |
|                                         |                                                                                        |       |
| ** **                                   | **PART II - OTHER INFORMATION**                                                             | ** ** |
| ** **                                   | ** **                                                                                  | ** ** |
| Item 1.                                      | Legal Proceedings                                                                           |       |
| Item 1A.                                     | Risk Factors                                                                                |       |
| Item 6.                                      | Exhibits                                                                                    |       |
| SIGNATURES                                   |                                                                                        |       |
| Certifications Pursuant to  Section 302 |                                                                                        |
| Certifications Pursuant to  Section 906 |                                                                                        |
| Statement Pursuant to  Private Litigation    |                                                                                        |
|                                              |                                                                                             |            |  |

 

This Form 10-Qis filed by Southwestern Public Service Co. (SPS). SPS is a wholly ownedsubsidiary of Xcel Energy Inc. (Xcel Energy). Additional information on XcelEnergy is available on various filings with the Securities and ExchangeCommission (SEC).

 

2

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**PART 1. FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

**SOUTHWESTERN PUBLIC SERVICECO.**

**STATEMENTS OF INCOME(UNAUDITED)**

**(Thousands of Dollars)**

 
| ** **                                                                                               | ** ** | **Three Months Ended  Sept. 30,** | ** ** | **Nine Months Ended  Sept. 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                                               | ** ** | **2007**                                         | ** ** | **2006**                                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                                                                               | ** ** | ** **                                       | ** ** | ** **                                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Operating revenues**                                                                                   |       | $                                                | 471,521    |                                            | $          | 472,586 |   | $ | 1,238,544 |   | $ | 1,308,575 |   |
|                                                                                                     |       |                                             |       |                                            |       |   |   |   |   |
| **Operating expenses**                                                                                   |       |                                             |       |                                            |       |   |   |   |   |
| Electric fuel and purchased power                                                                        |       | 339,041                                          |       | 333,401                                         |       | 899,962 |   | 937,694 |   |
| Other operating and maintenance expenses                                                                 |       | 49,515                                           |       | 39,509                                          |       | 149,707 |   | 138,244 |   |
| Depreciation and amortization                                                                            |       | 24,115                                           |       | 23,764                                          |       | 73,115 |   | 71,673 |   |
| Taxes (other than income taxes)                                                                          |       | 10,117                                           |       | 12,598                                          |       | 30,920 |   | 39,972 |   |
| Total operating expenses                                                                                 |       | 422,788                                          |       | 409,272                                         |       | 1,153,704 |   | 1,187,583 |   |
|                                                                                                     |       |                                             |       |                                            |       |   |   |   |   |
| **Operating income**                                                                                     |       | 48,733                                           |       | 63,314                                          |       | 84,840 |   | 120,992 |   |
|                                                                                                     |       |                                             |       |                                            |       |   |   |   |   |
| Interest and other income, net (see Note 9)                                                              |       | 834                                              |       | 987                                             |       | 2,164 |   | 3,655 |   |
| Allowance for funds used during  construction — equity                                              |       | —                                           |       | 384                                             |       | — |   | 882 |   |
|                                                                                                     |       |                                             |       |                                            |       |   |   |   |   |
| **Interest charges and financing costs**                                                                 |       |                                             |       |                                            |       |   |   |   |   |
| Interest charges — includes other financing  costs of $587, $1,567, $1,762 and $4,669, respectively |       | 14,119                                           |       | 13,105                                          |       | 40,871 |   | 40,714 |   |
| Allowance for funds used during  construction — debt                                                |       | (660                                             | )          | (685                                            | )          | (1,764 | ) | (2,061 | ) |
| Total interest charges and financing costs                                                               |       | 13,459                                           |       | 12,420                                          |       | 39,107 |   | 38,653 |   |
|                                                                                                     |       |                                             |       |                                            |       |   |   |   |   |
| Income before income taxes                                                                               |       | 36,108                                           |       | 52,265                                          |       | 47,897 |   | 86,876 |   |
| Income taxes                                                                                             |       | 14,956                                           |       | 19,662                                          |       | 19,461 |   | 32,405 |   |
| **Net income**                                                                                           |       | $                                                | 21,152     |                                            | $          | 32,603 |   | $ | 28,436 |   | $ | 54,471 |   |

 

See Notes to Financial Statements

 

3

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**SOUTHWESTERN PUBLIC SERVICE CO.**

**STATEMENTS OF CASH FLOWS (UNAUDITED)**

**(Thousands of Dollars)**

 
| ** **                                                                         | ** ** | **Nine Months Ended  Sept. 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| **Operating activities**                                                           |       |                                            |       |   |   |
| Net income                                                                         |       | $                                               | 28,436     |   | $ | 54,471 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                                            |       |   |   |
| Depreciation and amortization                                                      |       | 75,831                                          |       | 78,438 |   |
| Deferred income taxes                                                              |       | 6,700                                           |       | (28,070 | ) |
| Amortization of investment tax credits                                             |       | (188                                            | )          | (188 | ) |
| Allowance for equity funds used during  construction                               |       | —                                          |       | (882 | ) |
| Net realized and unrealized hedging and derivative  transactions                   |       | 201                                             |       | (827 | ) |
| Changes in operating assets and  liabilities:                                      |       |                                            |       |   |   |
| Accounts receivable                                                                |       | (20,929                                         | )          | 35,707 |   |
| Accrued unbilled revenues                                                          |       | (50,234                                         | )          | 26,561 |   |
| Recoverable electric energy costs                                                  |       | 63,756                                          |       | 44,200 |   |
| Inventories                                                                        |       | 1,197                                           |       | (2,755 | ) |
| Prepayments and other                                                              |       | 1,428                                           |       | 959 |   |
| Accounts payable                                                                   |       | (22,106                                         | )          | (22,792 | ) |
| Net regulatory assets and liabilities                                              |       | (6,923                                          | )          | (4,664 | ) |
| Other current liabilities                                                          |       | (2,854                                          | )          | 11,482 |   |
| Change in other noncurrent assets                                                  |       | (5,758                                          | )          | (12,374 | ) |
| Change in other noncurrent liabilities                                             |       | (2,946                                          | )          | 3,547 |   |
| Net cash provided by operating activities                                          |       | 65,611                                          |       | 182,813 |   |
|                                                                               |       |                                            |       |   |   |
| **Investing activities**                                                           |       |                                            |       |   |   |
| Capital/construction expenditures                                                  |       | (101,584                                        | )          | (77,565 | ) |
| Proceeds from sale of assets                                                       |       | —                                          |       | 24,670 |   |
| Allowance for equity funds used during  construction                               |       | —                                          |       | 882 |   |
| Investments in utility money pool  arrangement                                     |       | (95,000                                         | )          | (47,900 | ) |
| Receipts from utility money pool  arrangement                                      |       | 95,000                                          |       | 47,900 |   |
| Other investments                                                                  |       | 3,212                                           |       | 16 |   |
| Net cash used in investing activities                                              |       | (98,372                                         | )          | (51,997 | ) |
|                                                                               |       |                                            |       |   |   |
| **Financing activities**                                                           |       |                                            |       |   |   |
| Short-term debt repayments — net                                              |       | (1,000                                          | )          | (85,000 | ) |
| Borrowings under utility money pool  arrangement                                   |       | 459,000                                         |       | 324,300 |   |
| Repayments under utility money pool  arrangement                                   |       | (459,000                                        | )          | (324,300 | ) |
| Borrowings under 5-year unsecured credit  facility                                 |       | 125,000                                         |       | — |   |
| Capital contributions from parent                                                  |       | 5,354                                           |       | 7,561 |   |
| Dividends paid to parent                                                           |       | (52,825                                         | )          | (59,495 | ) |
| Net cash provided by (used in) financing  activities                               |       | 76,529                                          |       | (136,934 | ) |
|                                                                               |       |                                            |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                              |       | 43,768                                          |       | (6,118 | ) |
| Cash and cash equivalents at beginning of  period                                  |       | 297                                             |       | 9,407 |   |
| Cash and cash equivalents at end of period                                         |       | $                                               | 44,065     |   | $ | 3,289 |   |
|                                                                               |       |                                            |       |   |   |
| Supplemental disclosure of cash flow  information:                                 |       |                                            |       |   |   |
| Cash paid for interest (net of amounts  capitalized)                               |       | $                                               | 35,499     |   | $ | 29,300 |   |
| Cash paid for income taxes (net of refunds  received)                              |       | 18,376                                          |       | 45,930 |   |
|                                                                               |       |                                            |       |   |   |
| Supplemental disclosure of non-cash  investing transactions:                       |       |                                            |       |   |   |
| Property, plant and equipment additions in  accounts payable                       |       | $                                               | 3,494      |   | $ | 1,525 |   |

 

See the Notes to Financial Statements

 

4

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**SOUTHWESTERN PUBLIC SERVICE CO**.

**BALANCE SHEETS (UNAUDITED)**

**(Thousands of Dollars)**

 
| ** **                                                                              | ** ** | **Sept. 30, 2007** | ** ** | **Dec. 31, 2006** | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                              | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Current assets:                                                                         |       |                         |       |                        |       |
| Cash and cash equivalents                                                               |       | $                            | 44,065     |                        | $          | 297 |   |
| Accounts receivable, net of allowance for  bad debts of $2,875 and $2,686, respectively |       | 80,108                       |       | 56,616                      |       |
| Accounts receivable from affiliates                                                     |       | 6,245                        |       | 8,808                       |       |
| Accrued unbilled revenues                                                               |       | 113,039                      |       | 62,805                      |       |
| Recoverable electric energy costs                                                       |       | 19,344                       |       | 83,100                      |       |
| Materials and supplies inventories                                                      |       | 16,935                       |       | 17,547                      |       |
| Fuel inventories                                                                        |       | 3,510                        |       | 4,095                       |       |
| Derivative instruments valuation                                                        |       | 8,926                        |       | 8,926                       |       |
| Prepayments and other                                                                   |       | 4,899                        |       | 8,326                       |       |
| Total current assets                                                                    |       | 297,071                      |       | 250,520                     |       |
| Property, plant and equipment, at cost:                                                 |       |                         |       |                        |       |
| Electric utility plant                                                                  |       | 3,466,348                    |       | 3,401,108                   |       |
| Construction work in progress                                                           |       | 77,151                       |       | 53,051                      |       |
| Total property, plant and equipment                                                     |       | 3,543,499                    |       | 3,454,159                   |       |
| Less accumulated depreciation                                                           |       | (1,520,067                   | )          | (1,462,787                  | )          |
| Net property, plant and equipment                                                       |       | 2,023,432                    |       | 1,991,372                   |       |
| Other assets:                                                                           |       |                         |       |                        |       |
| Prepaid pension asset                                                                   |       | 114,274                      |       | 106,193                     |       |
| Regulatory assets                                                                       |       | 159,255                      |       | 163,067                     |       |
| Derivative instruments valuation                                                        |       | 87,708                       |       | 94,402                      |       |
| Other investments                                                                       |       | 4,643                        |       | 5,846                       |       |
| Other                                                                                   |       | 7,227                        |       | 7,890                       |       |
| Total other assets                                                                      |       | 373,107                      |       | 377,398                     |       |
| Total assets                                                                            |       | $                            | 2,693,610  |                        | $          | 2,619,290 |   |
|                                                                                    |       |                         |       |                        |       |
| **LIABILITIES AND EQUITY**                                                              |       |                         |       |                        |       |
| Current liabilities:                                                                    |       |                         |       |                        |       |
| Short-term debt                                                                         |       | $                            | 50,000     |                        | $          | 51,000 |   |
| Accounts payable                                                                        |       | 139,121                      |       | 159,672                     |       |
| Accounts payable to affiliates                                                          |       | 14,460                       |       | 14,783                      |       |
| Accrued interest                                                                        |       | 19,045                       |       | 12,099                      |       |
| Dividends payable to parent                                                             |       | 16,284                       |       | 18,581                      |       |
| Taxes accrued                                                                           |       | 23,272                       |       | 33,122                      |       |
| Derivative instruments valuation                                                        |       | 4,357                        |       | 4,307                       |       |
| Deferred income taxes                                                                   |       | 1,490                        |       | 6,849                       |       |
| Other                                                                                   |       | 24,708                       |       | 24,944                      |       |
| Total current liabilities                                                               |       | 292,737                      |       | 325,357                     |       |
| Deferred credits and other liabilities:                                                 |       |                         |       |                        |       |
| Deferred income taxes                                                                   |       | 454,302                      |       | 451,108                     |       |
| Regulatory liabilities                                                                  |       | 139,427                      |       | 143,789                     |       |
| Derivative instruments valuation                                                        |       | 61,249                       |       | 64,187                      |       |
| Pension and employee benefit obligations                                                |       | 53,980                       |       | 54,647                      |       |
| Asset retirement obligations                                                            |       | 4,526                        |       | 4,341                       |       |
| Deferred investment tax credits                                                         |       | 3,027                        |       | 3,215                       |       |
| Other                                                                                   |       | 6,780                        |       | 3,329                       |       |
| Total deferred credits and other  liabilities                                           |       | 723,291                      |       | 724,616                     |       |
| Commitments and contingencies (see Note 5)                                              |       |                         |       |                        |       |
| Capitalization:                                                                         |       |                         |       |                        |       |
| Long-term debt                                                                          |       | 899,001                      |       | 773,903                     |       |
| Common stock – authorized 200 shares of  $1.00 par value, outstanding 100 shares   |       | —                       |       | —                      |       |
| Additional paid in capital                                                              |       | 483,622                      |       | 478,269                     |       |
| Retained earnings                                                                       |       | 300,574                      |       | 323,008                     |       |
| Accumulated other comprehensive loss                                                    |       | (5,615                       | )          | (5,863                      | )          |
| Total common stockholder’s equity                                                  |       | 778,581                      |       | 795,414                     |       |
| Total liabilities and equity                                                            |       | $                            | 2,693,610  |                        | $          | 2,619,290 |   |

** **

**See the Notes to Financial Statements**

 

5

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**NOTES TO FINANCIALSTATEMENTS**

** **

In the opinionof management, the accompanying unaudited financial statements contain alladjustments necessary to present fairly the financial position of SPS as ofSept. 30, 2007, and Dec. 31, 2006; the results of its operations for thethree and nine months ended Sept. 30, 2007 and 2006; and its cash flowsfor the nine months ended Sept. 30, 2007 and 2006. Due to the seasonality ofelectric sales of SPS, interim results are not necessarily an appropriate basefrom which to project annual results.

 

**1.Significant Accounting Policies**

 

Except to theextent updated or described below, the significant accounting policies setforth in Note 1 to the financial statements in SPS’ Annual Report on Form 10-Kfor the year ended Dec. 31, 2006 appropriately represent, in all materialrespects, the current status of accounting policies and are incorporated hereinby reference.

 

***Income Taxes*** —Consistent with prior periods and upon adoption of Financial AccountingStandard Board (FASB) Interpretation No. 48 — “Accounting for Uncertainty inIncome Taxes — an interpretation of FASB Statement No. 109”, SPS recordsinterest and penalties related to income taxes as interest charges in theStatements of Income.

 

***Reclassifications***— Certain amounts in the Statements of Cash Flows have been reclassified fromprior-period presentation to conform to the 2007 presentation. Thereclassifications reflect the presentation of unbilled revenues, recoverablepurchased electric energy costs and regulatory assets and liabilities asseparate items rather than components of other assets and other liabilitieswithin net cash provided by operating activities. In addition, activity relatedto derivative transactions have been combined into net realized and unrealizedhedging and derivative transactions. These reclassifications did not affecttotal net cash provided by (used in) operating, investing or financingactivities within the Statements of Cash Flows.

 

**2.Recently Issued Accounting Pronouncements**

 

***Fair Value Measurements (Statement ofFinancial Accounting Standards (SFAS) 157)****** ***— In September2006, the FASB issued SFAS 157, which provides a single definition of fairvalue, together with a framework for measuring it, and requires additionaldisclosure about the use of fair value to measure assets and liabilities. SFAS157 also emphasizes that fair value is a market-based measurement, and sets outa fair value hierarchy with the highest priority being quoted prices in activemarkets. Fair value measurements are disclosed by level within that hierarchy.SFAS 157 is effective for financial statements issued for fiscal yearsbeginning after Nov. 15, 2007. SPS is evaluating the impact of SFAS 157 on itsfinancial condition and results of operations.

 

***The Fair Value Option for Financial Assetsand Financial Liabilities - Including an Amendment of FASB Statement No. 115(SFAS 159)*** — In February 2007, the FASB issuedSFAS 159, which provides companies with an option to measure, at specifiedelection dates, many financial instruments and certain other items at fairvalue that are not currently measured at fair value. A company that adopts SFAS159 will report unrealized gains and losses on items, for which the fair valueoption has been elected, in earnings at each subsequent reporting date. Thisstatement also establishes presentation and disclosure requirements designed tofacilitate comparisons between entities that choose different measurementattributes for similar types of assets and liabilities. This statement iseffective for fiscal years beginning after Nov. 15, 2007. SPS is evaluating theimpact of SFAS 159 on its financial condition and results of operations.

 

**3.Income Taxes**

 

***Accounting for Uncertainty in Income Taxes —an interpretation of FASB Statement No. 109 (FIN 48)***—In July 2006, the FASB issued FIN 48, which prescribes how a company shouldrecognize, measure, present and disclose uncertain tax positions that thecompany has taken or expects to take in its income tax returns. FIN 48 requiresthat only income tax benefits that meet the “more likely than not” recognitionthreshold be recognized or continue to be recognized on its effective date. Asrequired, SPS adopted FIN 48 as of Jan. 1, 2007 and the initial derecognitionamounts were reported as a cumulative effect of a change in accountingprinciple. The cumulative effect of the change, which is reported as anadjustment to the beginning balance of retained earnings, was not material.Following implementation, the ongoing recognition of changes in measurement ofuncertain tax positions will be reflected as a component of income tax expense.

 

SPS is amember of the Xcel Energy affiliated group that files consolidated income taxreturns. Xcel Energy has been audited by the Internal Revenue Service (IRS)through tax year 2003, with a limited exception for 2003 research tax credits.The IRS commenced an examination of Xcel Energy’s federal income tax returnsfor 2004 and 2005 (and research credits for 2003) in the third quarter of 2006,and that examination is anticipated to be complete by March 31, 2008. As ofSept. 30, 2007, the IRS had not proposed any material adjustments to tax years2003 through 2005. The statute of limitations applicable to Xcel Energy’s 2000through 2002 federal income tax returns expired as of June 30, 2007.

 

6

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SPS is alsocurrently under examination by the state of Texas for tax years 2003 through2005. A $2.0 million adjustment has been proposed by the state of Texas intheir audit of these years. As of Sept. 30, 2007, SPS’ earliest open tax yearsin which an audit can be initiated by state taxing authorities under applicablestatutes of limitations is 2003.

The amount ofunrecognized tax benefits was $5.0 million and $5.8 million on Jan. 1, 2007 and Sept. 30, 2007, respectively. Of theseamounts, $0.2 million and $0.1 million were offset against the tax benefitsassociated with net tax credit carryovers as of Jan. 1, 2007 and Sept. 30,2007, respectively.

 

Included inthe unrecognized tax benefit balance was $0.2 million and $0.3 million of taxpositions on Jan.1, 2007 and Sept. 30, 2007, respectively, which if recognizedwould affect the annual effective tax rate. In addition the unrecognized tax benefitbalance included $4.8 million and $5.5 million of tax positions on Jan. 1, 2007and Sept. 30, 2007, respectively, for which the ultimate deductibility ishighly certain but for which there is uncertainty about the timing of suchdeductibility. A change in the period of deductibility would not affect theeffective tax rate but would accelerate the payment of cash to the taxingauthority to an earlier period. The increase in the unrecognized tax benefitbalance of $0.9 million from July 1, 2007 to Sept. 30, 2007, was due to theaddition of similar uncertain tax positions relating to third quarter activityand the resolution of certain federal audit matters.

 

SPS’ amount ofunrecognized tax benefits could significantly change in the next 12 months asthe IRS and state tax audits progress. However, at this time due to the natureof the audit process, it is not reasonably possible to estimate a range of thepossible change.

 

The interestexpense liability related to unrecognized tax benefits on Jan. 1, 2007, was notmaterial. The change in the interest expense liability from Jan. 1, 2007, toSept. 30, 2007, was not material. No amounts were accrued for penalties as ofSept. 30, 2007.

 

**4.****     Rate Matters**

 

***Pending and Recently Concluded RegulatoryProceedings — Federal Energy Regulatory Commission (FERC)***

*** ***

***Wholesale RateComplaints*** ***—***InNovember 2004, Golden Spread Electric, Lyntegar Electric, Farmer’sElectric, Lea County Electric, Central Valley Electric and Roosevelt CountyElectric, wholesale cooperative customers of SPS, filed a rate complaint at theFERC. The complaint alleged that SPS’ rates forwholesale service were excessive and that SPS had incorrectly calculatedmonthly fuel cost adjustments contained in SPS’ wholesale rate schedules. Amongother things, the complainants asserted that SPS was not properly calculatingthe fuel costs that are eligible for recovery and that SPS had inappropriatelyallocated average fuel and purchased power costs to its other wholesalecustomers, effectively raising the fuel costs charges to complainants. Cap RockEnergy Corporation (Cap Rock), a full-requirements customer, Public ServiceCompany of New Mexico (PNM) and Occidental Permian Ltd. and Occidental PowerMarketing, L.P. (Occidental) intervened in the proceeding.

 

OnMay 24, 2006, a FERC administrative law judge (ALJ) issued an initialrecommended decision in the proceeding. The FERC will review the initialrecommendation and issue a final order. SPS and others have filed exceptions tothe ALJ’s initial recommendation. The FERC’s order may or may not follow any ofthe ALJ’s recommendation. In the recommended decision, the ALJ found that SPSshould recalculate its wholesale fuel and purchased economic energy costadjustment clause (FCAC) billings for the period beginning Jan. 1, 1999,to reduce the fuel and purchased power costs recovered from the complainingcustomers by allocating incremental fuel costs incurred by SPS in makingwholesale sales of system firm capacity and associated energy to other firmcustomers served under market-based rates during this period based on the viewthat such sales should be treated as opportunity sales.

 

SPSbelieves the ALJ erred on significant and material issues that contradict FERCpolicy or rules of law. Specifically, SPS believes, based on FERCrules and precedent, that it has appropriately applied its FCAC tariff tothe proper classes of customers. These firm market-based sales were of along-term duration under FERC precedent and were made from SPS’ entire system.Accordingly, SPS believes that the ALJ erred in concluding that thesetransactions were opportunity sales, which require the assignment ofincremental costs.

 

TheFERC has approved system average cost allocation treatment in previous filingsby SPS for sales having similar service characteristics and previously acceptedfor filing certain of the challenged agreements with average fuel cost pricing.

 

Moreover,SPS believes that the ALJ’s recommendation constituted a violation of the filedrate doctrine in that it effectively results in a retroactive amendment to theSPS FERC-approved FCAC tariff provisions. Under existing regulations, the FERCmay modify a previously approved FCAC on a prospective basis. Accordingly, SPSbelieves it has applied its FCAC correctly and has sought review of therecommended decision by the FERC by filing a brief on the exceptions.

 

SPSbelieves it should ultimately prevail in this proceeding, however, if the FERCwere to adopt the majority of the ALJ’s recommendations, SPS’ refund exposurecould be approximately $50 million, based on an evaluation of all sales madefrom Jan. 1, 1999 to Dec. 31, 2006. SPS has entered into settlement discussionswith the wholesale cooperative customers. As of Sept. 30, 2007, based uponmanagement’s estimate of this potential liability, SPS believes the appropriateaccrual has been recorded for this matter.

 

7

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Additionally,SPS has entered into settlement discussions with the wholesale cooperativecustomers. As of Sept. 30, 2007, based upon management’s estimate of thispotential liability, SPS believes the appropriate accrual has been recorded forthis matter.

 

In July and September 2007, Golden Spread andSPS filed a joint motion requesting the FERC to defer the final order while thecooperative customers negotiate the complaint case. The case is still pendingfinal FERC action.

 

***Wholesale Power BaseRate Application*** ***—***OnDec. 1, 2005, SPS filed for a $2.5 million increase in wholesale powerrates to certain electric cooperatives. On Jan. 31, 2006, the FERCconditionally accepted the proposed rates for filing, and the $2.5 millionpower rate increase became effective on July 1, 2006, subject to refund.The FERC also set the rate increase request for hearing and settlement judgeprocedures. On Sept. 7, 2006, an offer of settlement with respect to the fivefull-requirements customers was filed for approval and on Sept. 19, 2006, theoffer of settlement with respect to PNM was filed for approval. On Sept. 20,2007, the FERC accepted the settlement with the full-requirements customers. ThePNM settlement is still pending before the FERC.

 

GoldenSpread Electric Cooperative, SPS’ partial requirements wholesale customer, didnot settle and hearings were set for the rate disputes raised by Golden Spread.Subsequent to filing rebuttal testimony, on March 29, 2007, SPS and GoldenSpread entered into additional settlement negotiations. The current hearingschedule has been postponed. The FERC has appointed a settlement judge to facilitatenegotiations.

 

***Pending and Recently Concluded RegulatoryProceedings — Public Utility Commission of Texas (PUCT)***

*** ***

***Texas RetailBase Rate And Fuel Reconciliation Case****** —***On May 31, 2006, SPS filed a Texas retailelectric rate case requesting an increase in annual revenues of approximately$48 million. The rate filing was based on a historical test year, an electricrate base of $943 million, a requested ROE of 11.6 percent and a common equityratio of 51.1 percent.

 

In addition, SPSsubmitted a fuel reconciliation filing, which requested approval ofapproximately $957 million of Texas-jurisdictional fuel and purchased powercosts for 2004 through 2005. As a part of the fuel reconciliation case, fueland purchased energy costs were reviewed.

 

On March 27, 2007, SPS and various intervenors filed a unanimousstipulation agreement related to the Texas retail rate case as well as the fuelreconciliation portion of the proceeding. The agreement includes the followingterms:

 

•                     The settlement provides for an annual baserate increase of $23 million, or approximately 3 percent.

 

•                     The settlement disallows approximately $27million of SPS’ 2004 and 2005 fuel expense.

 

•                     An additional $2.3 million will be deductedfrom SPS’ next fuel reconciliation filing to be made in 2008, associated withthe 2006-2007 fuel reconciliation period.

 

•                     All of SPS’ existing long-term firm andinterruptible capacity wholesale sales are assigned system average costs forpurposes of Texas retail ratemaking, except for sales to El Paso Electric(EPE), which is determined by the PUCT separately.

 

•                     The settlement also creates standards forcost assignment that would apply to future wholesale sale transactions, andestablishes margin sharing of market based wholesale demand revenues.

 

•                     If SPS files a general rate case in 2008, thesettlement would allow for an interim rate increase associated with a purchasedpower agreement with Lea Power Partners of approximately $1.5 million per monthfrom the date of commercial operations. Interim rates would be subject to atrue-up based on the outcome of the rate case proceeding and actual capacitycosts incurred.

 

An estimated settlement allowance and reservewas established in 2006 and prior periods, which approximated the settledamounts of previously deferred or recovered fuel expense.

 

On March 27, 2007, the ALJ approved SPS’ requestto implement the $23 million base rate increase, effective April 2007, on aninterim basis until the PUCT acts on the stipulation. The $23 million base rateincrease includes approximately $14 million of coal cost that was previouslyrecovered through the fuel cost recovery mechanism, and approximately $6.2million that results from interruptible customers converting to firm service.

 

OnJuly 27, 2007, the PUCT issued a written order adopting the settlement andassigning incremental costs to the EPE sale. The effect of this decision underthe terms of the settlement is an additional $3 million in fuel costs assignedto EPE, which SPS will not recover either through its FCA or its contract. For2008, this amount will reach $6.3 million. SPS has previously given notice toEPE to terminate the agreement based on a regulatory provision and Xcel Energyexpects that the termination will be effective in 2009.

 

***Pending and Recently Concluded RegulatoryProceedings —***New Mexico Public Regulation Commission(NMPRC)

*** ***

***New Mexico Fuel Factor Continuation Filing***** —**On Aug. 18, 2005, SPS filedwith the NMPRC requesting continuation of the use of SPS’ fuel and purchasedpower cost adjustment clause (FPPCAC) and current monthly factor cost recoverymethodology. This filing was required by NMPRC rule.

 

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Testimony wasfiled in the case by staff and intervenors objecting to SPS’ assignment of systemaverage fuel costs to certain wholesale sales and the inclusion of certainpurchased power capacity and energy payments in the FPPCAC. The testimony alsoproposed limits on SPS’ future use of the FPPCAC. Related to these issues someintervenors requested disallowances for past periods, which in the aggregatetotal approximately $45 million. This claim was for the period from Oct. 1,2001 through May 31, 2005 and does not include the value of incremental costassigned for wholesale transactions from that date forward. Other issues in thecase include the treatment of renewable energy certificates and sulfur dioxide(SO2) allowance credit proceeds in relation to SPS’ New Mexicoretail fuel and purchased power recovery clause.

 

On May 2,2007, the hearing examiner issued his recommended decision in which hedetermined the following:

 

•                     The NMPRC isbarred from granting the retroactive refunds or financial penalties requestedby the parties.

 

•                     The issuesrelated to the assignment of system average fuel cost to SPS’ firm wholesalesales, subsequent to March 7, 2006, should be litigated in SPS’ next rate casewhich was filed in July 2007, or in a separate parallel proceeding with theresults to be incorporated into the next rate case.

 

•                     The NMPRClacked legal authority to apply any change in cost assignment methodologyretroactively until such date that SPS was put on notice of any concern withits longstanding assignment practice.

 

•                     March 7, 2006was the first time that SPS was put on notice with respect to any change in NewMexico’s assignment practice.

 

•                     The futurelitigation recommendation would determine both the proper allocation andassignment of fixed and fuel costs and examine the prudence of SPS’ firmwholesale contracts and affiliate transactions related to those wholesalesales.

 

•                     Chargescollected through the FPPCAC since March 7, 2006, should be subject to refundpending further order of the NMPRC.  The hearing examiner also noted thatspecific allegations regarding affiliate transactions could also be resolved inthese proceedings.

 

Underthe recommended decision, SPS would also be ordered to refund approximately$1.6 million of long-term purchased power capacity costs that it acknowledgedwere erroneously collected through the FPPCAC.  SPS would be authorized tocontinue its use of the FPPCAC pending a final order in the next ratecase.  The hearing examiner also determined that no action was required onrenewable energy certificates and that SPS should seek a determination ofproper treatment of SO2 allowances in a separate proceeding. Although there is no deadline for NMPRC action, SPS expects the NMPRC will actduring the fourth quarter of 2007. As of Sept. 30, 2007, based upon management’sestimate of this potential liability, SPS believes the appropriate accrual hasbeen recorded for this matter.

 

***New Mexico Electric Rate Case -***On July 30, 2007, SPS filed with the NMPRCrequesting a New Mexico retail electric general rate increase of $17.3 millionannually or a 6.6 percent increase. The rate filing is based on a 2006 calendaryear base period adjusted for known and measurable changes and includes arequested rate of return on equity of 11.0 percent, an electric rate base ofapproximately $307.3 million allocated to the New Mexico retail jurisdictionand an equity ratio of 51.2 percent. The NMPRC suspended the requestedeffective date for an additional nine months beyond the requested effectivedate. Intervenor testimony is due Dec. 21, 2007 and hearings are scheduled forJan. 28-Feb. 1, 2008. A decision on the request is expected in the secondquarter of 2008, and final rates are expected to be implemented in mid-2008.

 

***Investigation of SPS Participation in SPP*** - On Oct. 16, 2007, the PRC issued an orderinitiating an investigation to consider the prudence and reasonableness of SPS’participation in the Southwest Power Pool, Inc. (SPP) regional transmissionorganization (RTO). The investigation will consider the costs and benefits ofRTO participation to SPS customers in New Mexico. The order required SPS tofile direct testimony no later than 75 days after the completion of the hearingin the New Mexico electric rate case.

 

**5.Commitments and Contingent Liabilities**

 

Except to the extentnoted below, the circumstances set forth in Note 10 and 11 to the financialstatements in SPS’ Annual Report on Form 10-K for the year ended Dec. 31, 2006and Note 4 to the financial statements in this Quarterly Report on Form 10-Q,appropriately represent, in all material respects, the current status ofcommitments and contingent liabilities and are incorporated herein byreference. The following include unresolved contingencies that are material toSPS’ financial position.

 

## **EnvironmentalContingencies**

## ** **

SPS has been,or is currently, involved with the cleanup of contamination from certainhazardous substances at several sites. In many situations, SPS believes it willrecover some portion of these costs through insurance claims. Additionally,where applicable, SPS is pursuing, or intends to pursue, recovery from otherpotentially responsible parties and through the rate regulatory process. Newand changing federal and state environmental mandates can also create addedfinancial liabilities for SPS, which are normally recovered through the rateregulatory process. To the extent any costs are not recovered through theoptions listed above, SPS would be required to recognize an expense.

 

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***Site Remediation****—*SPSmust pay all or a portion of the cost to remediate sites where past activitiesof SPS and some other parties have caused environmental contamination. At Sept.30, 2007, SPS was a party to third party and other sites, such as landfills, towhich SPS is alleged to be a potentially responsible party (PRP) that sent hazardousmaterials and wastes.

 

SPS records a liabilitywhen enough information is obtained to develop an estimate of the cost ofenvironmental remediation and revises the estimate as information is received. Theestimated remediation cost may vary materially.

 

To estimate the cost toremediate these sites, assumptions are made when facts are not fully known. Forinstance, assumptions may be made about the nature and extent of sitecontamination, the extent of required cleanup efforts, costs of alternative cleanupmethods and pollution-control technologies, the period over which remediationwill be performed and paid for, changes in environmental remediation andpollution-control requirements, the potential effect of technologicalimprovements, the number and financial strength of other PRPs and theidentification of new environmental cleanup sites.

 

Estimates are revised asfacts become known. At Sept. 30, 2007, the liability for the cost ofremediating these sites was estimated to be $0.1 million. Some of the cost ofremediation may be recovered from:

 

•                     Insurance coverage;

 

•                     Other parties that have contributed to the contamination; and

 

•                     Customers.

 

Neither the totalremediation cost nor the final method of cost allocation among all PRPs of theunremediated sites has been determined. Estimates have been recorded for SPS’future costs for these sites.

 

***Third Party and Other Environmental Site Remediation***

 

***Asbestos Removal*****—**Someof SPS’ facilities contain asbestos. Most asbestos will remain undisturbeduntil the facilities that contain it are demolished or renovated. SPS hasrecorded an estimate for final removal of the asbestos as an asset retirementobligation. See additional discussion of asset retirement obligations in Note11 to the SPS Annual Report on Form 10-K for the year ended Dec. 31, 2006. Itmay be necessary to remove some asbestos to perform maintenance or makeimprovements to other equipment. The cost of removing asbestos as part of otherwork is immaterial and is recorded as incurred as operating expenses formaintenance projects, capital expenditures for construction projects or removalcosts for demolition projects.

 

***Cunningham andMaddox Station Groundwater***— Cunningham Station isa natural gas-fired power plant constructed in the 1960’s by SPS and has 28water wells installed on its water rights. The well field provides water forboiler makeup, cooling water and potable water. Following an acid release in2002, groundwater samples revealed elevated concentrations of inorganic saltcompounds not related to the release. The contamination was identified in wellslocated near the plant buildings. The source of contamination is thought to beleakage from ponds that receive blow down water from the plant.

 

In response to a request by the New Mexico Environment Department(NMED), SPS prepared a corrective action plan to address the groundwatercontamination. Under the plan submitted to the NMED, SPS agreed to controlleakage from the plant blow down ponds through construction of a new linedpond, additional irrigation areas to minimize percolation, and installation ofadditional wells to monitor groundwater quality. On June 23, 2005, NMED issueda letter approving the corrective action plan. The action plan was subject tocontinued compliance with New Mexico regulations and oversight by the NMED. TheCunningham wastewater management project has been completed at a final costof  $3.5 million. Upon completion of theproject, NMED finalized the wastewater permit. SPS began theimplementation of a similar process at the Maddox Station in 2007. The permitting process for Maddox Station hasbegun and is estimated to cost approximately $1.3 million through 2008 and willbe capitalized or expensed as incurred.

 

***Clean Air Interstate Rule***- In March 2005, the Environmental Protection Agency (EPA) issued the Clean AirInterstate Rule (CAIR) to further regulate SO2 and nitrogen oxide(NOx) emissions. The objective of CAIR is to cap emissions of SO2 and NOx in the eastern United States,including Minnesota, Texas and Wisconsin, which are within Xcel Energy’sservice territory. Xcel Energy generating facilities in other states are notaffected. CAIR addresses the transportation of fine particulates, ozone andemission precursors to nonattainment downwind states. CAIR has a two-phasecompliance schedule, beginning in 2009 for NOx and 2010 for SO2,with a final compliance deadline in 2015 for both emissions. Under CAIR, eachaffected state will be allocated an emissions budget for SO2 and NOX that will result in significantemission reductions. It will be based on stringent emission controls and formsthe basis for a cap-and-trade program. State emission budgets or caps declineover time. States can choose to implement an emissions reduction program basedon the EPA’s proposed model program, or they can propose another method, whichthe EPA would need to approve.

 

OnJuly 11, 2005, SPS, the City of Amarillo, Texas and Occidental Permian LTDfiled a lawsuit against the EPA and a request for reconsideration with theagency to exclude West Texas from the CAIR. El Paso Electric Co. joined in therequest for reconsideration. Xcel Energy and SPS advocated that West Texasshould be excluded from CAIR because it does not contribute significantly tononattainment with the fine particulate matter standards in any downwindjurisdiction.

 

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OnMarch 15, 2006, the EPA denied the petition for reconsideration. On June 27,2006, Xcel Energy and the other parties filed a petition for review of thedenial of the petition for reconsideration, as well as a petition for review ofthe Federal Implementation Plan, with the D.C. Court of Appeals. Pursuant tothe court’s scheduling order, briefing has been finalized, but no court datehas been set to hear oral arguments.

 

Under CAIR’s cap-and-trade structure, SPS can comply through capitalinvestments in emission controls or purchase of emission “allowances” fromother utilities making reductions on their systems. Based on the preliminaryanalysis of various scenarios of capital investment and allowance purchase, SPScurrently believes that following the installation of low NOx burners onHarrington 3 in 2006, additional capital investments, estimated at $12 million,will be remaining for NOx controls in the SPS region. Purchases of NOxallowances in the first phase are estimated at $1.4 million. Annual purchasesof SO2 allowances are estimated in the range of $13million to $25 million each year, beginning in 2012 for phase I, based onallowance costs and fuel quality as of March 2007.

 

These cost estimates representone potential scenario on complying with CAIR, if West Texas is not excluded. Thereis uncertainty concerning implementation of CAIR. States are required todevelop implementation plans within 18 months of the issuance of the newrules and have a significant amount of discretion in the implementationdetails. Legal challenges to CAIR rules could alter their requirementsand/or schedule. The uncertainty associated with the final CAIRrules makes it difficult to project the ultimate amount and timing ofcapital expenditures and operating expenses.

 

While SPS expects to complywith the new rules through a combination of additional capital investmentsin emission controls at various facilities and purchases of emissionallowances, it is continuing to review the alternatives. Xcel Energy believesthe cost of any required capital investment or allowance purchases will berecoverable from customers.

 

***Clean Air MercuryRule*** — In March 2005, the EPA issued theClean Air Mercury Rule (CAMR), which regulates mercury emissions from powerplants for the first time. The EPA’s CAMR uses a national cap-and-tradesystem, where compliance may be achieved by either adding mercury controls orpurchasing allowances or a combination of both and is designed to achieve a 70percent reduction in mercury emissions. It affects all coal- and oil-firedgenerating units across the country that are greater than 25 MW. Compliancewith this rule occurs in two phases, with the first phase beginning in2010 and the second phase in 2018. The Texas Commission on EnvironmentalQuality (TCEQ) has adopted by reference the EPA model program. States will beallocated mercury allowances based on coal type and their baseline heat inputrelative to other states. Each electric generating unit will be allocatedmercury allowances based on its percentage of total coal heat input for thestate.

 

Under CAMR, SPS can comply through capital investments in emissioncontrols or purchase of emission “allowances” from other utilities makingreductions on their systems. SPS’ preliminary analysis for phase I compliancesuggests capital costs of approximately $14.5 million and increased operatingand maintenance expenses of approximately $7.9 million, beginning in 2010. Testingat Harrington Station near Amarillo is complete pending a final report andadditional testing at Tolk Station is planned during the fourth quarter of 2007to confirm these costs or determine whether different measures will benecessary, which could result in higher costs. Additional costs will beincurred to meet phase II requirements in 2018.

 

***Regional Haze Rules***— On June 15, 2005, the EPA finalized amendments to the July 1999 regional hazerules. These amendments apply to the provisions of the regional haze rule thatrequire emission controls, known as best available retrofit technology (BART),for industrial facilities emitting air pollutants that reduce visibility bycausing or contributing to regional haze. Some of SPS’ generating facilitieswill be subject to BART requirements. Some of these facilities are located inregions where CAIR is effective. The TCEQ has determined that facilities mayuse CAIR as a substitute for BART for NOx and SO2.If West Texas is excluded from CAIR by the D.C. Court of Appeals, then thesefacilities will be subject to BART requirements for NOx, SO2,and particulate matter. Due to the uncertainties of the litigation outcome, SPSis not able to estimate the cost impact at this time.

 

**Legal Contingencies**

** **

In the normalcourse of business, SPS is party to routine claims and litigation arising fromprior and current operations. SPS is actively defending these matters and hasrecorded a liability related to the probable cost of settlement or otherdisposition, when it can be reasonably estimated.

 

***Carbon Dioxide Emissions Lawsuit***—On July 21, 2004, the attorneys general of eight states and New York City, aswell as several environmental groups, filed lawsuits in U.S. District Court forthe Southern District of New York against five utilities, including XcelEnergy, to force reductions in carbon dioxide (CO2)emissions. Although SPS is not named as a party to this litigation, therequested relief that Xcel Energy cap and reduce its CO2 emissions could have a material adverse effecton SPS. The other utilities include American Electric Power Co., Southern Co.,Cinergy Corp. and Tennessee Valley Authority. CO2 is emitted whenever fossil fuel is combusted,such as in automobiles, industrial operations and coal- or natural gas-firedpower plants. The lawsuits allege that CO2 emitted by each company is a public nuisance asdefined under state and federal common law because it has contributed to globalwarming. The lawsuits do not demand monetary damages. Instead, the lawsuits askthe court to order each utility to cap and reduce its CO2 emissions. In October 2004, Xcel Energy andthe other defendants filed a motion to dismiss the lawsuit. On Sept. 19, 2005,the 

 

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judge granted the motion to dismiss on constitutional grounds.Plaintiffs filed an appeal to the Second Circuit Court of Appeals. On June 21,2007 the Second Circuit Court of Appeals issued an order requesting the partiesto file a letter brief regarding the impact of the United States SupremeCourt’s decision in Massachusetts v. EPA, 127 S.Ct. 1438 (April 2, 2007) on theissues raised by the parties on appeal. Among other things, in its decision inMassachusetts v. EPA, the United States Supreme Court held that CO2 emissions are a “pollutant” subject to regulation by the EPA under the Clean Air Act. In responseto the request of the Second Circuit Court of Appeals, the defendant utilitiesfiled a letter brief on July 6, 2007, stating the position that the UnitedStates Supreme Court’s decision supports the arguments raised by the utilitieson appeal. It is unknown when the Second Circuit Court of Appeals will rule onthe appeal.

 

***Lamb County Electric Cooperative***- On July 24, 1995, Lamb County Electric Cooperative, Inc. (LCEC) petitionedthe PUCT for a cease and desist order against SPS alleging that SPS was unlawfullyproviding service to oil field customers in LCEC’s certificated area. On May23, 2003, the PUCT issued an order denying LCEC’s petition based on itsdetermination that SPS was granted a certificate in 1976 to serve the disputedcustomers. LCEC appealed the decision to the District Court in Travis County,Texas and on Aug. 12, 2004, the District Court affirmed the decision of thePUCT. On Sept. 9, 2004, LCEC appealed the District Court’s decision to theCourt of Appeals for the Third Supreme Judicial District of the state of Texas,which appeal is currently pending. Oral arguments in the case were heard March23, 2005. SPS is awaiting the Court of Appeals decision.

 

On Oct. 18,1996, LCEC filed a suit for damages against SPS in the District Court in LambCounty, Texas, based on the same facts as alleged in its petition for a ceaseand desist order at the PUCT. This suit has been dormant since it was filed,awaiting a final determination at the PUCT of the legality of SPS providingelectric service to the disputed customers. The PUCT order of May 23, 2003,found that SPS was legally serving the disputed customers thus collaterallydetermining the issue of liability contrary to LCEC’s position in the suit. Anadverse ruling on the appeal of the May 23, 2003 PUCT order could result in are-determination of the legality of SPS’ service to the disputed customers.

 

***Comer vs. Xcel Energy Inc. et al.*****— On April 25, 2006, Xcel Energy received notice of apurported class action lawsuit filed in United States District Court for theSouthern District of Mississippi. Although SPS is not named as a party to thislitigation, if the litigation ultimately results in an unfavorable outcome forXcel Energy, it could have a material adverse effect on SPS. The lawsuit names morethan 45 oil, chemical and utility companies, including Xcel Energy, asdefendants and alleges that defendants’ CO2 emissions “were a proximate and direct causeof the increase in the destructive capacity of Hurricane Katrina.”  Plaintiffs allege in support of their claim,several legal theories, including negligence and public and private nuisanceand seek damages related to the loss resulting from the hurricane. Xcel Energybelieves this lawsuit is without merit and intends to vigorously defend itselfagainst these claims. On July 19, 2006, Xcel Energy filed a motion to dismissthe lawsuit in its entirety. On Aug. 30, 2007, the court dismissed the lawsuitin its entirety against all defendants on constitutional grounds. On Sept. 17,2007, plaintiffs filed a notice of appeal to the Fifth Circuit.

 

**6.Short-Term Borrowings and Other Financing Instruments**

 

As ofSept. 30, 2007, SPS had $50.0 million of short-term debt outstanding at aweighted average interest rate of 5.43 percent.

 

**7. Long-Term Borrowings and Other FinancingInstruments**

 

On Aug. 29, 2007, SPS borrowed $125 million against its $250 millionfive-year unsecured credit facility. The weighted average interest rate on theborrowing was 5.91 percent. The borrowing was repaid on Oct. 1, 2007.

 

**8.****     DerivativeValuation and Financial Impacts**

 

SPS uses anumber of different derivative instruments in connection with its utilitycommodity price, interest rate, and limited short-term wholesale and commoditytrading activities, including forward contracts, futures, swaps and options.

 

All derivative instruments not qualifying for the normal purchases andnormal sales exception, as defined by SFAS 133-”Accounting for DerivativeInstruments and Hedging Activities,” as amended (SFAS 133), are recorded atfair value. The presentation of these derivative instruments is dependent onthe designation of a qualifying hedging relationship. The adjustment to fairvalue of derivative instruments not designated in a qualifying hedgingrelationship is reflected in current earnings or as a regulatory balance.

 

SPS records the fair value of its derivative instruments in its BalanceSheets as separate line items identified as Derivative Instruments Valuation inboth current and noncurrent assets and liabilities.

 

Qualifying hedgingrelationships are designated as either a hedge of a forecasted transaction orfuture cash flow (cash flow hedge), or a hedge of a recognized asset, liabilityor firm commitment (fair value hedge). The types of qualifying hedgingtransactions that SPS is currently engaged in are discussed below.

 

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** **

**CashFlow Hedges**

 

SPS enters intoderivative instruments to manage variability of future cash flows from changesin commodity prices and interest rates.

 

As of Sept. 30, 2007, SPShad no commodity-related contracts classified as cash flow hedges.

 

SPS enters into****variousinstruments that effectively fix the interest payments on certain floating ratedebt obligations or effectively fix the yield or price on a specified benchmarkinterest rate for a specific period. These derivative instruments aredesignated as cash flow hedges for accounting purposes, and the changein the fair value of these instruments is recorded as a component of OtherComprehensive Income.

 

As of Sept. 30, 2007, SPS had net losses of approximately $0.7 millionin Accumulated Other Comprehensive Income related to interest rate cash flowhedge contracts that are expected to be recognized in earnings during the next12 months.

 

Gains or losseson hedging transactions for the sales of energy or energy-related products areprimarily recorded as a component of revenue, hedging transactions for fuelused in energy generation are recorded as a component of fuel costs andinterest rate hedging transactions are recorded as a component of interestexpense. SPS is allowed to recover in electric rates the costs of certainfinancial instruments purchased to reduce commodity cost volatility. There wasan immaterial amount of hedge ineffectiveness in the third quarter of 2007.

 

The impact ofqualifying cash flow hedges on SPS’ Accumulated Other Comprehensive Income,included as a component of common stockholders’ equity, are detailed in thefollowing table:

 
| ** **                                                                           | ** ** | **Nine months ended Sept. 30,** | ** ** |
|--------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(Millions of dollars)**                                                  | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
| Accumulated other comprehensive loss  related to cash flow hedges at Jan. 1          |       | $                                                   | (5.9       | ) | $ | (4.8 | ) |
| After-tax net unrealized gains related to  derivatives accounted for as hedges       |       | 0.1                                                 |       | — |   |
| After-tax net realized losses on derivative  transactions reclassified into earnings |       | 0.2                                                 |       | 0.2 |   |
| Accumulated other comprehensive loss  related to cash flow hedges at Sept. 30        |       | $                                                   | (5.6       | ) | $ | (4.6 | ) |

 

**DerivativesNot Qualifying for Hedge Accounting**

 

SPS entersinto certain commodity-based derivative transactions, not included in tradingoperations, which do not qualify for hedge accounting treatment. Thesederivative instruments are accounted for on a mark-to-market basis inaccordance with SFAS 133. The results of these transactions are reported in theStatements of Income.

 

**NormalPurchases or Normal Sales Contracts**

 

SPS enters into contracts forthe purchase and sale of various commodities for use in its businessoperations. SFAS 133 requires a company to evaluate these contracts todetermine whether the contracts are derivatives. Certain contracts that meetthe definition of a derivative may be exempted from SFAS 133 as normalpurchases or normal sales.

 

SPS evaluatesall of its contracts when such contracts are entered to determine if they arederivatives and, if so, if they qualify and meet the normal designationrequirements under SFAS 133. None of the derivative contracts entered intowithin the commodity trading operations qualify for a normal designation.

 

**9.Detail of Interest and Other Income, Net**

 

Interest and other income, netof nonoperating expenses, for the three and nine months ended Sept. 30consisted of the following:

 
| ** **                           | ** ** | **Three months ended  Sept. 30,** | ** ** | **Nine months ended  Sept. 30,** | ** ** |
|--------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| **(Thousands of dollars)** | ** ** | **2007**                                         | ** ** | **2006**                                        | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                 |       |                                             |       |                                            |       |   |   |   |   |
| Interest income                      |       | $                                                | 730        |                                            | 936        |   | $ | 2,184 |   | $ | 2,888 |   |
| Other nonoperating income            |       | 158                                              |       | 64                                              |       | 205 |   | 895 |   |
| Other nonoperating expense           |       | (54                                              | )          | (13                                             | )          | (225 | ) | (128 | ) |
| Total interest and other income, net |       | $                                                | 834        |                                            | $          | 987 |   | $ | 2,164 |   | $ | 3,655 |   |
|                                      |            |                                                  |            |                                                 |            |  |  |  |  |  |  |  |  |

 

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**10. Segment Information**

 

SPS has onereportable segment. SPS operates in the Regulated Electric Utility industry,providing wholesale and retail electric service in the states of Texas and NewMexico. Revenues from external customers were $1,238.5 million and $1,308.6million for the nine months ended Sept. 30, 2007 and 2006, respectively.

 

**11. Comprehensive Income**

 

The componentsof total comprehensive income are shown below:

 
| ** **                                                                                           | ** ** | **Three months ended  Sept. 30,** | ** ** | **Nine months ended  Sept. 30,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| **(Millions of dollars)**                                                                  | ** ** | **2007**                                         | ** ** | **2006**                                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net income                                                                                           |       | $                                                | 21.2       |                                            | $          | 32.6 |   | $ | 28.4 |   | $ | 54.5 |   |
| Other comprehensive income:                                                                          |       |                                             |       |                                            |       |   |   |   |   |
| After-tax net unrealized gains (losses)  related to derivatives accounted for as hedges (see Note 8) |       | (0.4                                             | )          | (0.6                                            | )          | 0.1 |   | — |   |
| After-tax net realized losses on derivative  transactions reclassified into earnings (see Note 8)    |       | 0.1                                              |       | 0.1                                             |       | 0.2 |   | 0.2 |   |
| Other comprehensive income                                                                           |       | (0.3                                             | )          | (0.5                                            | )          | 0.3 |   | 0.2 |   |
| Comprehensive income                                                                                 |       | $                                                | 20.9       |                                            | $          | 32.1 |   | $ | 28.7 |   | $ | 54.7 |   |

 

**12.Benefit Plans and Other Postretirement Benefits**

 

Pension and otherpostretirement benefit disclosures below generally represent Xcel Energyconsolidated information unless specifically identified as being attributableto SPS.

 

**Componentsof Net Periodic Benefit Cost**

 
| ** **                                                    | ** ** | **Three months ended Sept. 30,** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                    | ** ** | **2007 (1)**                                    | ** ** | **2006** | ** ** | **2007** | ** ** | **2006** | ** ** |
| **(Thousands of dollars)**                          | ** ** | **Pension Benefits**                            | ** ** | **Postretirement Health  Care Benefits** | ** ** |
| **Xcel Energy Inc.**                                          | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service cost                                                  |       | $                                                    | 15,520     |   | $ | 15,406 |   | $ | 1,453 |   | $ | 1,659 |   |
| Interest cost                                                 |       | 41,313                                               |       | 38,854 |   | 12,619 |   | 13,234 |   |
| Expected return on plan assets                                |       | (66,208                                              | )          | (67,017 | ) | (7,600 | ) | (6,690 | ) |
| Amortization of transition obligation                         |       | —                                               |       | — |   | 3,644 |   | 3,611 |   |
| Amortization of prior service cost (credit)                   |       | 6,487                                                |       | 7,424 |   | (545 | ) | (544 | ) |
| Amortization of net loss                                      |       | 4,211                                                |       | 4,339 |   | 3,550 |   | 6,200 |   |
| Net periodic benefit cost (credit)                            |       | 1,323                                                |       | (994 | ) | 13,121 |   | 17,470 |   |
| Credits not recognized due to the effects  of regulation      |       | 2,787                                                |       | 3,159 |   | — |   | — |   |
| Additional cost recognized due to the  effects of regulation  |       | —                                               |       | — |   | 972 |   | 972 |   |
| Net benefit cost recognized for financial  reporting          |       | $                                                    | 4,110      |   | $ | 2,165 |   | $ | 14,093 |   | $ | 18,442 |   |
| **SPS**                                                       |       |                                                 |       |   |   |   |   |   |   |
| Net benefit cost (credit) recognized for  financial reporting |       | $                                                    | (1,909     | ) | $ | (1,734 | ) | $ | 1,560 |   | $ | 1,676 |   |

 

14

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| ** **                                                    | ** ** | **Nine months ended Sept. 30,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                    | ** ** | **2007 (1)**                                   | ** ** | **2006** | ** ** | **2007** | ** ** | **2006** | ** ** |
| **(Thousands of dollars)**                          | ** ** | **Pension Benefits**                           | ** ** | **Postretirement Health  Care Benefits** | ** ** |
| **Xcel Energy Inc.**                                          | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service cost                                                  |       | $                                                   | 46,560     |   | $ | 46,220 |   | $ | 4,359 |   | $ | 4,975 |   |
| Interest cost                                                 |       | 123,939                                             |       | 116,560 |   | 37,857 |   | 39,704 |   |
| Expected return on plan assets                                |       | (198,624                                            | )          | (201,049 | ) | (22,800 | ) | (20,068 | ) |
| Amortization of transition obligation                         |       | —                                              |       | — |   | 10,932 |   | 10,833 |   |
| Amortization of prior service cost (credit)                   |       | 19,461                                              |       | 22,272 |   | (1,635 | ) | (1,634 | ) |
| Amortization of net loss                                      |       | 12,633                                              |       | 13,015 |   | 10,650 |   | 18,598 |   |
| Net periodic benefit cost (credit)                            |       | 3,969                                               |       | (2,982 | ) | 39,363 |   | 52,408 |   |
| Credits not recognized due to the effects  of regulation      |       | 8,361                                               |       | 9,477 |   | — |   | — |   |
| Additional cost recognized due to the  effects of regulation  |       | —                                              |       | — |   | 2,918 |   | 2,918 |   |
| Net benefit cost recognized for financial  reporting          |       | $                                                   | 12,330     |   | $ | 6,495 |   | $ | 42,281 |   | $ | 55,326 |   |
| **SPS**                                                       |       |                                                |       |   |   |   |   |   |   |
| Net benefit cost (credit) recognized for  financial reporting |       | $                                                   | (5,728     | ) | $ | (5,796 | ) | $ | 4,679 |   | $ | 5,029 |   |

 

----

(1)     Includes qualified and non-qualifiedpension net periodic benefit cost.

 

**Item 2. MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

** **

Discussion offinancial condition and liquidity for SPS is omitted per conditions set forthin general instructions H (1) (a) and (b) of Form 10-Q for wholly ownedsubsidiaries. It is replaced with management’s narrative analysis and theresults of operations set forth in general instructions H (2) (a) of Form 10-Qfor wholly owned subsidiaries (reduced disclosure format).

 

**Forward-LookingInformation**

 

The followingdiscussion and analysis by management focuses on those factors that had amaterial effect on the financial condition and results of operations of SPSduring the periods presented, or are expected to have a material impact in thefuture. It should be read in conjunction with the accompanying unauditedfinancial statements and notes.

 

Except for the historical statements contained in this report, thematters discussed in the following discussion and analysis are forward-lookingstatements that are subject to certain risks, uncertainties and assumptions.Such forward-looking statements are intended to be identified in this documentby the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “objective,”“outlook,” “plan,” “project,” “possible,” “potential,” “should” and similarexpressions. Actual results may vary materially. Forward-lookingstatements speak only as of the date they are made, and we do not undertake anyobligation to update them to reflect changes that occur after that date. Factors that could cause actual results todiffer materially include, but are not limited to: general economic conditions,including the availability of credit and its impact on capital expenditures andthe ability of SPS to obtain financing on favorable terms; business conditionsin the energy industry; actions of credit rating agencies; competitive factors,including the extent and timing of the entry of additional competition in themarkets served by SPS; unusual weather; effects of geopolitical events,including war and acts of terrorism; state, federal and foreign legislative andregulatory initiatives that affect cost and investment recovery, have an impacton rates or have an impact on asset operation or ownership; structures thataffect the speed and degree to which competition enters the electric market;costs and other effects of legal and administrative proceedings, settlements,investigations and claims; actions of accounting regulatory bodies; the itemsdescribed under Factors Affecting Results of Continuing Operations; and theother risk factors listed from time to time by SPS in reports filed with theSEC, including “Risk Factors” in Item 1A of SPS’ Form 10-K for the yearended Dec. 31, 2006 and Exhibit 99.01 to this report onForm 10-Q for the quarter ended Sept. 30, 2007.

 

**MarketRisks**

 

SPS is exposedto market risks, including changes in commodity prices and interest rates, asdisclosed in Item 7A — Quantitative and Qualitative Disclosures About MarketRisk in its Annual Report on Form 10-K for the year ended Dec. 31, 2006.Commodity price and interest rate risks for SPS are mitigated in mostjurisdictions due to cost-based rate regulation. At Sept. 30, 2007, therewere no material changes to the financial market risks that affect thequantitative and qualitative disclosures presented as of Dec. 31, 2006.

 

**RESULTSOF OPERATIONS**

 

SPS’ netincome was approximately $28.4 million for the first nine months of 2007,compared with approximately $54.5 million for the first nine months of 2006. Thedecrease was due to lower electric margin, primarily as the result of accrualsfor potential fuel contingencies, partially offset by lower property taxes, andlower income taxes as a result of the lower pre-tax income.

 

15

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**ElectricUtility, Short-term Wholesale and Commodity Trading Margins**

 

Electric fuel and purchased power expenses tend to vary with changing retail and wholesale requirements and unit cost changes in fuel and purchased power. Due to fuel and purchased energy cost recovery mechanisms for customers, most fluctuations in these costs do not materially affect electric utility margin.

 

SPS has two distinct forms of wholesalesales:  short-term wholesale andcommodity trading. Short-term wholesale refers to energy related purchase andsales activity and the use of certain financial instruments associated with thefuel required for and energy produced from SPS’ generation assets and energyand capacity purchased to serve native load. Commodity trading is notassociated with SPS’ generation assets or the energy and capacity purchased toserve native load.

 

SPSconducts an inconsequential amount of commodity trading. Margins from commoditytrading activity are partially redistributed to Northern States Power Company,a Minnesota corporation, and Public Service Company of Colorado, both whollyowned subsidiaries of Xcel Energy, pursuant to the joint operating agreement(JOA) approved by the FERC. Margins received pursuant to the JOA are reflectedas part of base electric utility revenues. Short-term wholesale and commoditytrading margins reflect the impact of regulatory sharing, if applicable.Commodity trading revenues are reported net of trading costs (i.e., on a marginbasis) in the Statements of Income. Commodity trading costs include purchasedpower, transmission, broker fees and other related costs.

 

The following table details base electricutility and short-term wholesale activities:

 
| **(Millions of Dollars)**                      | ** ** | **Base  Electric  Utility** | ** ** | **Short-Term  Wholesale** | ** ** | **Commodity  Trading** | ** ** | **Total** | ** ** |
|----------------------------------------------------------|------------|-----------------------------|------------|---------------------------|------------|------------------------|------------|-----------|------------|
| **Nine months ended Sept. 30, 2007**                     |       |                        |       |                      |       |                   |       |      |       |
| Electric utility revenues (excluding  commodity trading) |       | $                           | 1,220      |                      | $          | 19                     |       | $         | —     |   | $ | 1,239 |   |
| Fuel and purchased power                                 |       | (882                        | )          | (18                       | )          | —                 |       | (900      | )          |
| Commodity trading revenues                               |       | —                      |       | —                    |       | —                 |       | —    |       |
| Commodity trading costs                                  |       | —                      |       | —                    |       | —                 |       | —    |       |
| Gross margin before operating expenses                   |       | $                           | 338        |                      | $          | 1                      |       | $         | —     |   | $ | 339 |   |
| Margin as a percentage of revenues                       |       | 27.7                        | %          | 5.3                       | %          | —                 | %          | 27.4      | %          |
|                                                     |       |                        |       |                      |       |                   |       |      |       |
| **Nine months ended Sept. 30, 2006**                     |       |                        |       |                      |       |                   |       |      |       |
| Electric utility revenues (excluding  commodity trading) |       | $                           | 1,302      |                      | $          | 6                      |       | $         | —     |   | $ | 1,308 |   |
| Fuel and purchased power                                 |       | (932                        | )          | (6                        | )          | —                 |       | (938      | )          |
| Commodity trading revenues                               |       | —                      |       | —                    |       | 1                      |       | 1         |       |
| Commodity trading costs                                  |       | —                      |       | —                    |       | (1                     | )          | (1        | )          |
| Gross margin before operating expenses                   |       | $                           | 370        |                      | $          | —                 |       | $         | —     |   | $ | 370 |   |
| Margin as a percentage of revenues                       |       | 28.4                        | %          | —                    | %          | —                 | %          | 28.3      | %          |

 

The followingsummarizes the components of the changes in base electric revenues and baseelectric margin for the nine months ended Sept. 30:

 

***Base Electric Revenues***

 
| **(Millions of dollars)**              | ** ** | **2007 vs. 2006** | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|
| Fuel and purchased power cost recovery           |       | $                           | (78        | ) |
| SPS potential regulatory settlements             |       | (14                         | )          |
| Retail sales decline (excluding weather  impact) |       | (3                          | )          |
| Estimated impact of weather                      |       | (1                          | )          |
| Firm wholesale                                   |       | 8                           |       |
| Transmission revenue                             |       | 6                           |       |
| Total decrease in base electric revenues         |       | $                           | (82        | ) |

 

16

 

##### ***Base ElectricMargin***

 
| **(Millions of dollars)**              | ** ** | **2007 vs. 2006** | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|
| SPS potential regulatory settlements             |       | $                           | (14        | ) |
| Purchased capacity costs                         |       | (9                          | )          |
| Fuel handling and procurement                    |       | (9                          | )          |
| Retail sales decline (excluding weather  impact) |       | (3                          | )          |
| Estimated impact of weather                      |       | (1                          | )          |
| Firm wholesale                                   |       | 7                           |       |
| Other                                            |       | (3                          | )          |
| Total decrease in base electric margin           |       | $                           | (32        | ) |

 

## **Non-FuelOperating Expense and Other Costs**

## ** **

***Other Operating and Maintenance Expenses -***Thefollowing summarizes the components of the changes in other operating and maintenanceexpense for the nine months ended Sept. 30:

 
| **(Millions of dollars)**                         | ** ** | **2007 vs. 2006** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------|------------|
| Higher combustion/hydro plant costs          |       | $                           |  7    | ** ** |
| Higher labor costs                                |       | 1                           | ** ** |
| Higher uncollectible receivable costs                       |       | 1                           |       |
| Higher material costs                                       |       | 1                           |       |
| Lower employee benefit costs                                |       | (2                          | )          |
| Other                                                       |       | 3                           |       |
| Total increase in other operating and  maintenance expenses |       | $                           | 11         |   |

 

***Taxes (other than income taxes) -***Taxes(other than income taxes) decreased by approximately $9.1 million, or 22.6percent, for the first nine months of 2007, compared with the first nine monthsof 2006. The decrease was primarily due to a reduction in Texas property taxesand the discontinuation of the Texas franchise fee.

 

***Income taxes***- Income tax expense decreased byapproximately $12.9 million for the first nine months of 2007 compared with thefirst nine months of 2006. The decrease was primarily due to lower pretaxincome. The effective tax rate was 40.6 percent for the first nine months of2007, compared with 37.3 percent for the same period in 2006. The increase inthe effective tax rate was primarily due to an increase in the forecastedeffective tax rate for 2007 as compared to 2006.

 

***Regulation***

** **

**Summary of Recent Federal Regulatory Developments**

 

TheFERC has jurisdiction over rates for electric transmission service ininterstate commerce and electric energy sold at wholesale, hydro facilitylicensing, accounting practices and certain other activities of SPS. State andlocal agencies have jurisdiction over many of SPS’ activities, includingregulation of retail rates and environmental matters. In addition to the matters discussed below,see Note 4 to the financial statements for a discussion of other regulatorymatters.

 

***FERC Rules Implementing Energy PolicyAct of 2005 (Energy Act) —*** The Energy Act repealed the Public Utility Holding Company Act of1935, effective Feb. 8, 2006. In addition, the Energy Act required theFERC to conduct several rulemakings to adopt new regulations to implementvarious aspects of the Energy Act. Since Aug. 2005, the FERC has completedor initiated proceedings to modify its regulations on a number of subjects. Inaddition to the previous disclosure in Item 1 of SPS’ Form 10-K forthe year ended Dec. 31, 2006, the FERC issued final rules making certain reliability standards mandatory andsubject to potential financial penalties up to $1 million per day per violationfor non-compliance effective June 18, 2007.

 

WhileSPS cannot predict the ultimate impact the new regulations will have on itsoperations or financial results, SPS is taking actions that are intended tocomply with and implement these new rules and regulations as they becomeeffective.

 

***Electric Transmission RateRegulation —*** The FERC also regulates therates charged and terms and conditions for electric transmission services. FERCpolicy encourages utilities to turn over the functional control over theirelectric transmission assets and the related responsibility for the sale ofelectric transmission services to a RTO. SPS is a member of the SPP. Each RTOseparately files regional transmission tariff rates for approval by the FERC.All members within that RTO are then subjected to those rates.

 

OnFeb. 15, 2007, the FERC issued final rules adopting revisions to its 1996 openaccess transmission rules. SPS submitted the initial required revisions to itsOpen Access Transmission Tariff (OATT) on July 13, 2007 and Sept. 11, 2007, asrequired.

 

17

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Inaddition, in January 2007, the FERC issued interim and proposed rules to modifythe current FERC rules governing the functional separation of the SPS electrictransmission function from the wholesale sales and marketing function. Theproposed rules are pending final FERC action.

 

WhileSPS cannot predict the ultimate impact the new regulations will have on itsoperations or financial results, SPS is taking actions that are intended tocomply with and implement these new rules and regulations as they becomeeffective.

 

***Market Based RateRules******—***OnJune 21, 2007, the FERC issued a final order amending its regulations governingits market-based rate authorizations to electric utilities such as SPS. TheFERC reemphasized its commitment to market-based pricing, but is revising thetests it’s using to assess whether a utility has market power and hasemphasized that it intends to exercise greater oversight where it hasmarket-based rate authorizations. SPS has been granted market-based rateauthority and will be subject to the new rule. SPS is presently analyzing thenew rule.

 

An aspect of FERC’s market-based rate requirements is the requirementto charge mitigated rates in markets where a utility is found to have marketpower or where a utility cannot establish the absence of market power. SPS hasbeen authorized by the FERC to charge market-based rates outside of theircontrol areas, but is generally limited to charging mitigated rates withintheir control areas. Consistent with the approach followed by many otherutilities subject to the FERC’s mitigation requirement, SPS uses cost-based ratecaps set out in the Western Systems Power Pool (WSPP) agreement as theirapplicable mitigated rates, an approach expressly approved by the FERC. However,concurrently with the issuance of the final order, the FERC initiated aproceeding to investigate whether the use of the WSPP rate caps for thispurpose is just and reasonable. An outcome of this proceeding may be to lowerthe mitigated rates that SPS may charge in their control areas.

 

**Other Regulatory Matters — SPS**

 

***New Mexico RenewablePortfolio Standard*** - The 2007 New Mexicolegislature enacted a renewable portfolio standard in which renewable energymust comprise no less than 5 percent of retail sales by 2006; 10 percent by2011; 15 percent by 2015; and 20 percent by 2020. The legislation also allowsperformance-based incentives to encourage the acquisition of renewable energysupplies beyond the requirements. The NMPRC has implemented revised rulesrelated to the increased requirements. The NMPRC has interpreted thediversification requirement to mean no less than 20 percent of the standard ismet using wind energy, no less than 20 percent using central solar, no lessthan 10 percent other (e.g., biomass, geothermal), and no less than 1.5 percentusing renewable distributed generation (increasing to 3 percent by 2015). Theeffective date of the diversification requirements is 2011.

 

***Texas Renewable Energy Zone*s**- The PUCT designated competitive renewable energyzones (CREZs) this summer. CREZs are regions of the state in which renewableenergy resources and suitable land areas are sufficient to develop electricgenerating capacity from renewable energy technologies, such as wind. SeveralCREZ areas within the SPS service region were designated for potentialdevelopment. The PUCT considered the availability of renewable resources in acandidate CREZ, the financial commitment of generators and the majortransmission improvements necessary to deliver the energy generated byrenewable resources. A statewide study conducted by the Electric ReliabilityCouncil of Texas (ERCOT) identifies the Texas panhandle as having the top fourof the state’s primary areas for wind energy expansion. Several transmissionproposals have been filed in the CREZ proceeding, including plans tointerconnect CREZs with the SPP and plans that would collect wind energy frompanhandle CREZs and deliver it into ERCOT.

 

***Texas Retail Base Rate And FuelReconciliation Case*** - As more fully described inNote 4 to the financial statements, on July 27, 2007, the PUCT issued a writtenorder adopting a settlement, which in part provided for an annual base rateincrease of $23 million.  However, thisrate increase will not have a material effect on the financial statements dueto differences in certain assumptions used in developing the test year revenuerequirement versus actual performance. The changes are related largely to assumptions associated with firmversus interruptible customer loads and the appropriate demand billingdeterminants when converting a rate structure based primarily on energy chargesto one based primarily on demand charges.

 

**Item 4. CONTROLS AND PROCEDURES**

 

**Disclosure Controls andProcedures**

** **

SPS maintainsa set of disclosure controls and procedures designed to ensure that informationrequired to be disclosed in reports that it files or submits under theSecurities Exchange Act of 1934 is recorded, processed, summarized and reportedwithin the time periods specified in Securities and Exchange Commissionrules and forms. In addition, the disclosure controls and procedures ensurethat information required to be disclosed is accumulated and communicated tomanagement, including the chief executive officer (CEO) and chief financialofficer (CFO), allowing timely decisions regarding required disclosure. As ofthe end of the period covered by this report, based on an evaluation carriedout under the supervision and with the participation of SPS’ management,including the CEO and CFO, of the effectiveness of our disclosure controls andprocedures, the CEO and CFO have concluded that SPS’ disclosure controls andprocedures are effective.

 

**Internal Control Over FinancialReporting**

** **

No change inSPS’ internal control over financial reporting has occurred during the mostrecent fiscal quarter that has materially affected, or is reasonably likely tomaterially affect, its internal control over financial reporting.

 

18

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#### ** **

#### **Part II. OTHERINFORMATION**

#### ** **

## **Item 1. LegalProceedings**

## ** **

In the normal course ofbusiness, various lawsuits and claims have arisen against SPS. Management,after consultation with legal counsel, has recorded an estimate of the probablecost of settlement or other disposition for such matters. See Notes 4 and 5 ofthe Financial Statements in this Quarterly Report on Form 10-Q for furtherdiscussion of legal proceedings, including Regulatory Matters and Commitmentsand Contingent Liabilities, which are hereby incorporated by reference.Reference also is made to Item 3 and Note 11 of SPS’ Annual Report on Form10-K for the year ended Dec. 31, 2006 for a description of certain legalproceedings presently pending.

 

**Item1A. Risk Factors**

 

SPS’ risk factors are documented in Item 1A of Part I of its 2006Annual Report on Form 10-K, which is incorporated herein by reference. Therehave been no material changes to the risk factors.

 

## **Item 6.Exhibits**

## ** **

The followingExhibits are filed with this report:

 
| 31.01 |   | Principal  Executive Officer’s and Principal Financial Officer’s certifications pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002 |
|-------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 32.01 |   | Certification  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002                                                                             |
| 99.01 |   | Statement  pursuant to Private Securities Litigation Reform Act of 1995.                                                                                                                                       |

 

19

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SIGNATURES

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized on Oct 29, 2007.

 
| Southwestern  Public Service Co.            |
|---------------------------------------------|
| (Registrant)                                |
|                                        |
|                                        |
| /s/ TERESA  S. MADDEN                       |   |
| Teresa S.  Madden                           |   |
| Vice  President and Controller              |   |
|                                        |   |
|                                        |   |
| /s/ BENJAMIN  G.S. FOWKE III                |   |
| Benjamin G.S. Fowke III                     |   |
| Vice  President and Chief Financial Officer |   |

 

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