Document/ExhibitDescriptionPagesSize 1: 10-Q 1st Quarter 2007 Form 10-Q HTML 672K
8: 10-Q 1st Quarter 2007 Form 10-Q PDF -- f10q050307 PDF 244K
9: EX-12.1 Puget Energy Computation of Ratios HTML 89K
10: EX-12.2 Puget Sound Energy Computation of Ratios HTML 88K
2: EX-31.1 Pe Certification Section 302 CEO HTML 13K
3: EX-31.2 Pe Certification Section 302 CFO HTML 13K
4: EX-31.3 Pse Certification Section 302 CEO HTML 13K
5: EX-31.4 Pse Certification Section 302 CFO HTML 13K
6: EX-32.1 Pe and Pse Cerification Section 906 CEO HTML 10K
7: EX-32.2 Pe and Pse Certification Section 906 CFO HTML 10K
Indicate
by check mark whether the registrants: (1) have filed all reports required
to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the registrants were
required to file such reports), and (2) have been subject to such filing
requirements for the past 90 days.
Puget
Energy, Inc.
Yes
/X/
No
/
/
Puget
Sound Energy, Inc.
Yes
/X/
No
/
/
Indicate
by check mark whether registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of “accelerated filer and
large accelerated filer” in Rule 12b-2 of the Exchange Act.
Puget
Energy, Inc.
Large
accelerated filer
/X/
Accelerated
filer
/
/
Non-accelerated
filer
/
/
Puget
Sound Energy, Inc.
Large
accelerated filer
/
/
Accelerated
filer
/
/
Non-accelerated
filer
/X/
Indicate
by check mark whether the registrant is a shell company (as defined in Exchange
Act Rule 12b-2)
Puget
Energy, Inc.
Yes
/
/
No
/X/
Puget
Sound Energy, Inc.
Yes
/
/
No
/X/
As
of
April 26, 2007, (i) the number of shares of Puget Energy, Inc. common stock
outstanding was 116,859,674 ($.01 par value) and (ii) all of the outstanding
shares of Puget Sound Energy, Inc. common stock were held by Puget Energy,
Inc.
This
Report on Form 10-Q is a combined quarterly report filed separately by two
different registrants, Puget Energy, Inc. (Puget Energy) and Puget Sound Energy,
Inc. (PSE). Any references in this report to the “Company” are to Puget Energy
and PSE collectively. PSE makes no representation as to the information
contained in this report relating to Puget Energy and the subsidiaries of Puget
Energy other than PSE and its subsidiaries.
Puget
Energy, Inc. (Puget Energy) and Puget Sound Energy (PSE) are including the
following cautionary statements in this Form 10-Q to make applicable and to
take
advantage of the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995 for any forward-looking statements made by or on behalf
of
Puget Energy or PSE. This report includes forward-looking statements, which
are
statements of expectations, beliefs, plans, objectives and assumptions of future
events or performance. Words or phrases such as “anticipates,”“believes,”“estimates,”“expects,”“future,”“intends,”“plans,”“predicts,”“projects,”“will likely result,”“will continue” or similar expressions identify
forward-looking statements.
Forward-looking
statements involve risks and uncertainties that could cause actual results
or
outcomes to differ materially from those expressed. Puget Energy’s and PSE’s
expectations, beliefs and projections are expressed in good faith and are
believed by Puget Energy and PSE, as applicable, to have a reasonable basis,
including without limitation management’s examination of historical operating
trends, data contained in records and other data available from third parties;
but there can be no assurance that Puget Energy’s and PSE’s expectations,
beliefs or projections will be achieved or accomplished.
In
addition to other factors and matters discussed elsewhere in this report, some
important factors that could cause actual results or outcomes for Puget Energy
and PSE to differ materially from those discussed in forward-looking statements
include:
·
Governmental
policies and regulatory actions, including those of the Federal Energy
Regulatory Commission (FERC) and the Washington Utilities and
Transportation Commission (Washington Commission), with respect to
allowed
rates of return, cost recovery, industry and rate structures, transmission
and generation business structures within PSE, acquisition and disposal
of
assets and facilities, operation, maintenance and construction of
electric
generating facilities, operation of distribution and transmission
facilities (gas and electric), licensing of hydroelectric operations
and
gas storage facilities, recovery of other capital investments, recovery
of
power and gas costs, recovery of regulatory assets and present or
prospective wholesale and retail competition;
·
Changes
in, adoption of and compliance with laws and regulations, including
decisions and policies concerning the environment, climate change,
emissions, natural resources, and fish and wildlife (including the
Endangered Species Act);
·
The
ability to recover changes in enacted federal, state or local tax
laws
through revenue in a timely manner;
·
Natural
disasters, such as hurricanes, earthquakes, floods, fires and landslides,
which can interrupt service and/or cause temporary supply disruptions
and/or price spikes in the cost of fuel and raw materials;
·
Commodity
price risks associated with procuring natural gas and power in wholesale
markets that impact customer loads;
·
Wholesale
market disruption, which may result in a deterioration of market
liquidity, increase the risk of counterparty default, affect the
regulatory and legislative process in unpredictable ways, negatively
affect wholesale energy prices and/or impede PSE’s ability to manage its
energy portfolio risks and procure energy supply, affect the availability
and access to capital and credit markets and/or impact delivery of
energy
to PSE from its suppliers;
·
Financial
difficulties of other energy companies and related events, which
may
affect the regulatory and legislative process in unpredictable ways
and
also adversely affect the availability of and access to capital and
credit
markets and/or impact delivery of energy to PSE from it
suppliers;
·
The
effect of wholesale market structures (including, but not limited
to,
regional market designs or transmission organizations) or other related
federal initiatives;
·
PSE
electric or gas distribution system failure, which may impact PSE’s
ability to deliver energy supply to its customers;
·
Changes
in weather conditions in the Pacific Northwest, which could have
effects
on customer usage and PSE’s revenues, thus impacting net
income;
·
Weather,
which can have a potentially serious impact on PSE’s ability to procure
adequate supplies of gas, fuel or purchased power to serve its customers
and on the cost of procuring such supplies;
·
Variable
hydro conditions, which can impact streamflow and PSE’s ability to
generate electricity from hydroelectric facilities;
·
Plant
outages, which can have an adverse impact on PSE’s expenses with respect
to repair costs, added costs to replace energy or higher costs associated
with dispatching a more expensive resource;
·
The
ability of gas or electric plant to operate as intended;
·
The
ability to renew contracts for electric and gas supply and the price
of
renewal;
·
Blackouts
or large curtailments of transmission systems, whether PSE’s or others’,
which can affect PSE’s ability to deliver power or natural gas to its
customers;
·
The
ability to restart generation following a regional transmission
disruption;
·
Failure
of the interstate gas pipeline delivering to PSE’s system, which may
impact PSE’s ability to adequately deliver gas supply to its customers;
·
The
amount of collection, if any, of PSE’s receivables from the California
Independent System Operator (CAISO) and other parties and the amount
of
refunds found to be due from PSE to the CAISO or other parties;
·
Industrial,
commercial and residential growth and demographic patterns in the
service
territories of PSE;
·
General
economic conditions in the Pacific Northwest, which might impact
customer
consumption or affect PSE’s accounts receivable;
·
The
loss of significant customers or changes in the business of significant
customers, which may result in changes in demand for PSE’s services;
·
The
impact of acts of God, terrorism, flu pandemic or similar significant
events;
·
Capital
market conditions, including changes in the availability of capital
or
interest rate fluctuations;
·
Employee
workforce factors, including strikes, work stoppages, availability
of
qualified employees or the loss of a key executive;
·
The
ability to obtain adequate insurance coverage and the cost of such
insurance;
·
Future
losses related to corporate guarantees provided by Puget Energy as
a part
of the sale of its InfrastruX subsidiary; and
·
The
ability to maintain effective internal controls over financial reporting.
Any
forward-looking statement speaks only as of the date on which such statement
is
made, and, except as required by law, Puget Energy and PSE undertake no
obligation to update any forward-looking statement to reflect events or
circumstances after the date on which such statement is made or to reflect
the
occurrence of unanticipated events. New factors emerge from time to time and
it
is not possible for management to predict all such factors, nor can it assess
the impact of any such factor on the business or the extent to which any factor,
or combination of factors, may cause results to differ materially from those
contained in any forward-looking statement. You are also advised to consult
Item
1A-“Risk Factors” in our report on Form 10-K for the year ended December 31,2006.
Adjustments
to reconcile net income to net cash provided by operating
activities:
Depreciation
and amortization
69,609
63,884
Deferred
income taxes and tax credits, net
11,148
(1,101
)
Net
unrealized (gain) loss on derivative instruments
(5,782
)
975
Amortization
of gas pipeline capacity assignment
(2,690
)
--
Non-cash
return on regulatory assets
(1,823
)
--
Decrease
in residential exchange program
(8,111
)
(12,746
)
Accrual
of contract initiation payments
--
(89,000
)
Power
cost adjustment mechanism
(104
)
(7,499
)
Cash
collateral paid from energy suppliers
--
(14,850
)
Storm
damage deferred costs
(16,759
)
(6,983
)
Other
17,586
7,622
Change
in certain current assets and liabilities:
Accounts
receivable and unbilled revenue
51,487
57,085
Materials
and supplies
(7,633
)
(537
)
Fuel
and gas inventory
56,523
45,085
Prepayments
and other
(1,833
)
(2,128
)
Purchased
gas adjustment receivable/payable
43,666
(5,079
)
Accounts
payable
(94,487
)
(7,310
)
Taxes
payable
31,464
22,016
Accrued
expenses and other
7,298
22,242
Net
cash provided by operating activities
228,336
145,515
Investing
activities:
Construction
expenditures - excluding equity AFUDC
(239,681
)
(101,268
)
Energy
efficiency expenditures
(8,964
)
(6,884
)
Cash
proceeds from property sales
57
--
Restricted
cash
(1
)
(1
)
Refundable
cash received for customer construction projects
4,456
2,554
Other
322
6,273
Net
cash used by investing activities
(243,811
)
(99,326
)
Financing
activities:
Change
in short-term debt, net
133,440
(15,400
)
Loan
from Puget Energy
73
--
Dividends
paid
(26,255
)
(31,356
)
Investment
from Puget Energy
1,705
1,569
Issuance
of bonds and notes
--
161
Redemption
of bonds and notes
(100,000
)
--
Issuance
and redemption cost of bonds and other
5,104
--
Net
cash provided by financing activities
14,067
(45,026
)
Net
increase in cash
(1,408
)
1,163
Cash
at beginning of year
28,092
16,709
Cash
at end of period
$
26,684
$
17,872
Supplemental
cash flow information:
Cash
paid for interest (net of capitalized interest)
$
32,009
$
28,394
Income
taxes paid
--
30,000
The
accompanying notes are an integral part of the financial
statements.
COMBINED
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS
(1)
Summary
of Consolidation Policy
Basis
of Presentation
Puget
Energy, Inc. (Puget Energy) is a holding company that owns Puget Sound Energy
(PSE) and until May 7, 2006, InfrastruX Group, Inc. (InfrastruX). PSE is a
public utility incorporated in the state of Washington that furnishes electric
and gas services in a territory covering 6,000 square miles, primarily in the
Puget Sound region.
The
2007
consolidated financial statements of Puget Energy reflect the accounts of Puget
Energy and its subsidiary, PSE. PSE’s consolidated financial statements include
the accounts of PSE and its subsidiaries. Puget Energy and PSE are collectively
referred to herein as “the Company.” The consolidated financial statements are
presented after elimination of all significant intercompany items and
transactions. Certain amounts previously reported have been reclassified to
conform to current year presentations with no effect on total equity or net
income. The reclassification relates to the income statements of Puget Energy
and PSE, which have been changed from a utility presentation format based on
Federal Energy Regulatory Commission (FERC) guidelines to a presentation based
on generally accepted accounting principles (GAAP).
The
2006
consolidated financial statements of Puget Energy reflect the accounts of Puget
Energy and its subsidiaries, PSE and InfrastruX. Puget Energy holds all the
common shares of PSE and until May 7, 2006, a 90.9% interest in InfrastruX.
The
results of PSE and InfrastruX are presented on a consolidated basis. The
financial position and results of operations for InfrastruX are presented as
discontinued operations. At the time that it was owned by Puget Energy,
InfrastruX was a non-regulated utility construction service company incorporated
in the state of Washington, which provides construction services to the electric
and gas utility industries primarily in the midwest, Texas, south-central and
eastern United States regions.
The
consolidated financial statements contained in this Form 10-Q are unaudited.
In
the respective opinions of the management of Puget Energy and PSE, all
adjustments necessary for a fair statement of the results for the interim
periods have been reflected and were of a normal recurring nature. These
condensed financial statements should be read in conjunction with the audited
financial statements (and the Combined Notes thereto) included in the combined
Puget Energy and PSE Annual Report on Form 10-K for the year ended December31,2006.
The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that
affect the reported amounts of assets and liabilities, disclosure of contingent
assets and liabilities at the date of the financial statements, and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
PSE
collected Washington State excise taxes (which are a component of general retail
rates) and municipal taxes of $74.6 million and $64.7 million for the three
months ended March 31, 2007 and March 31, 2006, respectively. The Company’s
policy is to report such taxes on a gross basis in operating
revenues
and
taxes other than income taxes in the accompanying consolidated statements of
income.
(2)
Earnings
per Common Share (Puget
Energy Only)
Puget
Energy’s basic earnings per common share have been computed based on weighted
average common shares outstanding of 116,479,000 for the three months ended
March 31, 2007 and 115,725,000 for the three months ended March 31, 2006.
Puget
Energy’s diluted earnings per common share have been computed based on weighted
average common shares outstanding and issuable upon exercise of options or
expiration of vesting periods of 116,974,000 for the three months ended March31, 2007 and 116,190,000 for the three months ended March 31, 2006. These shares
include the dilutive effect of securities related to employee and director
equity plans.
(3)
Accounting
for Derivative Instruments and Hedging
Activities
Statement
of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative
Instruments and Hedging Activities,” as amended, requires that all contracts
considered to be derivative instruments be recorded on the balance sheet at
their fair value. The Company enters into contracts to manage its energy
resource portfolio and interest rate exposure including forward physical and
financial contracts, option contracts and swaps. The majority of these contracts
qualify for the normal purchase normal sale (NPNS) exception to derivative
accounting rules if they meet certain criteria. Generally, NPNS applies if
PSE
deems the counterparty creditworthy, has energy resources within the western
region to allow for physical delivery of the energy and if the transaction
is
within PSE’s forecasted load requirements. Those contracts that do not meet NPNS
exception or cash flow hedge criteria are marked-to-market to current earnings
in the income statement, subject to deferral under SFAS No. 71, “Accounting for
the Effects of Certain Types of Regulation,” for energy related derivatives due
to the Power Cost Adjustment (PCA) mechanism and Purchased Gas Adjustment (PGA)
mechanism.
The
nature of serving regulated electric customers with its wholesale portfolio
of
owned and contracted electric generation resources exposes the Company and
its
customers to some volumetric and commodity price risks within the sharing
mechanism of the PCA. The Company’s energy risk portfolio management function
monitors and manages these risks using analytical models and tools. The Company
is not engaged in the business of assuming risk for the purpose of realizing
speculative trading revenues. Therefore, wholesale market transactions are
focused on balancing the Company’s energy portfolio, reducing costs and risks
where feasible and reducing volatility in wholesale costs and margin in the
portfolio. In order to manage risks effectively, the Company enters into
physical and financial transactions which are appropriate for the service
territory of the Company and are relevant to its regulated electric and gas
portfolios.
During
the three months ended March 31, 2007, the Company recorded an increase in
earnings for the change in the market value of derivative instruments not
meeting NPNS or cash flow hedge criteria of approximately $5.8 million compared
to a decrease in earnings of approximately $1.0 million for the three months
ended March 31, 2006. The $5.8 million increase in the first quarter 2007 was
primarily derived from a reversal of a loss reserve related to a physically
delivered gas supply contract for electric generation. The counterparty’s
financial outlook has changed and delivery is now probable through the life
of
the contract. This contract involves monthly delivery of natural gas and will
be
marked-to-market through earnings until its expiration in June 2008. The
mark-to-market gain that was recorded is the difference between the forward
market price of natural gas and the contract price for natural gas based on
volumes purchased. As the contract gets closer to termination in June 2008,
the
gain will reverse due to settlement of the contract on a monthly basis and
the
mark-to-market value will decrease as long as the price for natural gas is
at or
near the current forward market prices of natural gas.
At
March31, 2007, the Company had a net unrealized gain recorded in other comprehensive
income of $11.5 million after-tax related to energy contracts which meet the
criteria for designation as cash flow hedges under SFAS No. 133. The amount
of
cash flow hedges associated with these energy contracts that will reverse and
be
settled into the income statement during 2007 is approximately $6.2 million.
At
March 31, 2007, PSE had a short-term asset of $14.9 million and a long-term
asset of $3.4 million as well as short-term liability of $0.6 million related
to
energy contracts designated as cash flow hedges that represent forward financial
purchases of gas supply for electric generation from PSE-owned electric plants
in future periods. If it is determined that it is uneconomical to run the plants
in the future period, the hedging relationship is ended and the cash flow hedge
is de-designated and any unrealized gains and losses are recorded in the income
statement. Gains and losses when these de-designated cash flow hedges are
settled are recognized in energy costs and are included as part of the PCA
mechanism.
At
March31, 2007, the Company also had a short-term asset of $10.2 million and a
short-term liability of approximately $8.9 million related to the hedge of
gas
contracts to serve natural gas customers. All mark-to-market adjustments
relating to the natural gas business have been reclassified to a deferred
account in accordance with SFAS No. 71 due to the PGA mechanism. The PGA
mechanism passes increases and decreases in the cost of natural gas supply
to
customers. As the gains and losses on the hedges are realized in future periods,
they will be recorded as gas costs under the PGA mechanism.
The
ending balance in other comprehensive income related to previously settled
treasury interest rate swap contracts at March 31, 2007 was a loss of $8.4
million after-tax and accumulated amortization.
(4)
Stock
Compensation
The
Company’s Long-Term Incentive Plan (LTI Plan), which is shareholder approved,
was established in 1995 and amended and restated in 2005 and approved by
shareholders. The LTI Plan applies to officers and key employees of the Company
and awards granted under this plan include stock awards, performance awards
or
other stock-based awards as defined by the plan. Any shares awarded are either
purchased on the open market or newly issued. The 2006 and 2007 LTI Plan cycles
included grants of restricted stock, which was added to reduce the volatility
of
the plans. The maximum number of shares that may be purchased or newly issued
shares for the LTI Plan is 4,200,000.
Performance
Share Grants
The
Company awards performance share grants annually under the LTI Plan which vest
at the end of three years. The number of shares awarded and expense recorded
depends on Puget Energy’s performance as compared to other companies and service
quality indices for customer service. Compensation expense related to
performance share grants was $1.1 million and $(0.6) million for the three
months ended March 31, 2007 and 2006, respectively. The fair value of the 2006
and 2007 performance share grants takes into consideration the historical
performance of the performance share grants and prospective analysis using
the
Capital Asset Pricing Model and expected EPS growth rates. The 2005 performance
shares classified as equity awards were valued using the Black-Scholes option
pricing model and the liability awards were valued using market price of Puget
Energy stock.
Performance
shares activity for the three months ended March 31, 2007 was as
follows:
Plan
participants meeting the Company’s stock ownership guidelines can elect to be
paid up to 50.0% of the share award in cash. The portion of the performance
share grants that can be paid in cash is classified and accounted for as a
liability. As a result, the compensation expense of these liability awards
is
recognized over the performance period based on the fair value (i.e. cash value)
of the award, and is periodically updated based on expected ultimate cash
payout. Compensation cost recognized during the performance period for the
liability portion of the performance grants is based on the closing price of
the
Company’s common stock on the date of measurement and the number of months of
service rendered during the period. The equity portion is valued at the closing
price of the Company’s common stock on the grant date.
Restricted
Stock
In
the
first quarter 2007, the Company granted 96,472 shares of restricted stock under
the LTI Plan. Under the 2007 grant, the shares vest 15.0% on the January 1,2008, 25.0% on January 1, 2009 and the remaining 60.0% on January 1, 2010.
Restricted
stock activity for the three months ended March 31, 2007 was as
follows:
Compensation
expense related to the restricted shares was $0.4 million and $0.5 million
for
the three months ended March 31, 2007 and 2006, respectively. Dividends are
paid
on all outstanding shares of restricted stock and are accounted for as a Puget
Energy common stock dividend, not as compensation expense. The fair value of
the
restricted stock is based on the closing price of the Company’s common stock on
the date of grant.
(5)
Retirement
Benefits
On
September 29, 2006, FASB issued SFAS No. 158, “Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans.” SFAS No. 158 was effective for
fiscal years ending after December 15, 2006, which was the year ended December31, 2006 for the Company. SFAS No. 158 was adopted prospectively as required
by
the statement.
The
Company has a defined benefit pension plan with a cash balance feature covering
substantially all PSE employees. Benefits are a function of age, salary and
service. Puget Energy also maintains a non-qualified supplemental retirement
plan for officers and certain director-level employees.
The
following table summarizes the net periodic benefit cost for the three months
ended March 31:
Pension
Benefits
Other
Benefits
(Dollars
in thousands)
2007
2006
2007
2006
Service
cost
$
3,263
$
3,061
$
91
$
86
Interest
cost
6,570
6,167
379
358
Expected
return on plan assets
(9,750
)
(9,434
)
(205
)
(182
)
Amortization
of prior service cost
511
585
134
134
Recognized
net actuarial (gain) loss
1,173
1,253
(56
)
(127
)
Amortization
of transition obligation
--
--
105
105
Net
periodic benefit cost
$
1,767
$
1,632
$
448
$
374
The
Company previously disclosed in its financial statements for the year ended
December 31, 2006 that it expected contributions by the Company to fund the
pension and other benefits plans for the year ending December 31, 2007 to be
$4.5 million and $0.3 million, respectively. During the three months ended
March31, 2007, the actual cash contributions to the pension plans were $0.5 million.
Based on this activity, the Company anticipates contributing an additional
$4.0
million to the Company’s non-qualified pension plan in 2007. The full amount of
the pension plan funding for 2007 is for the Company’s non-qualified
supplemental retirement plan.
During
the three months ended March 31, 2007, actual other post-retirement medical
benefit plan contributions were less than $0.5 million and the Company does
not
expect to make additional contributions for the remaining period of 2007.
(6)
Income
Taxes
In
July
2006, FASB issued Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in
Income Taxes, an Interpretation of FASB Statement No. 109,” which clarifies the
accounting for uncertainty in income taxes recognized in the financial
statements in accordance with FASB Statement No. 109, “Accounting for Income
Taxes.” FIN 48 requires the use of a two-step approach for recognizing and
measuring tax positions taken or expected to be taken in a tax return. First,
a
tax position should only be recognized when it is more likely than not, based
on
technical merits, that the position will be sustained upon examination by the
taxing authority. Second, a tax position, that meets the recognition threshold,
should be measured at the largest amount that has a greater than 50% likelihood
of being sustained.
FIN
48
was effective for the Company as of January 1, 2007. As of the date of adoption,
the Company had no material unrecognized tax benefits but accrued $6.6 million
in interest expense related to tax deductions for certain capitalized internal
labor and related overhead costs previously deducted before repayment in 2005
and 2006. Additionally, the Company has accrued $0.4 million in
interest expense for the three months
ended March 31, 2007 related
to the tax deductions for the capitalized internal labor and
overheads.
In
its
2001 tax return, PSE claimed a deduction when it changed its tax accounting
method with respect to capitalized internal labor and overheads. Under the
new
method, the Company could immediately deduct certain costs that it had
previously capitalized. In the IRS audit of the Company’s 2001, 2002 and 2003
federal income tax returns, the IRS disallowed the deduction, citing Revenue
Ruling 2005-53. The Company believes the original deductions were valid as
filed
and has formally appealed the IRS adjustment. The Company repaid the tax
benefits in 2005 and 2006 as provided in the new Regulations, issued on August2, 2005 (Regulation 1.263(a)-1). At December 31, 2006, the full tax benefit
had
been repaid. The IRS national office is in the process of establishing
settlement guidelines which will apply to its settlement offers on this issue.
It is possible that this issue could be resolved in the next 12
months.
Based
on
prior Washington Utilities and Transportation Commission (Washington Commission)
orders on this issue, it is management’s expectation that if the IRS is
ultimately successful in challenging some portion of the deductions the Company
could request rate recovery of the regulatory asset.
For
federal income tax purposes, the Company has open tax years from 2001 through
2007. The Company continues its policy of classifying interest and
penalties as interest and penalties expense in the financial
statements.
(7)
Regulation
and Rates
On
March20, 2007, PSE submitted a Power Cost Only Rate Case (PCORC) filing to request
approval of an updated power cost baseline rate beginning September 2007. The
PCORC filing also requested recovery of Goldendale ownership and operating
costs
through retail electric rates. The requested electric rate increase is $64.7
million or 3.7% annually. PSE estimates that the PCORC order will be issued
in
the third quarter 2007.
On
April11, 2007, the Washington Commission approved PSE’s petition for issuance of an
accounting order that authorizes PSE to defer certain costs the Company will
incur related to its purchase of the Goldendale Generating Station (Goldendale)
during the period prior to the ownership and operating costs are being
considered for inclusion in PSE’s retail electric rates in the PCORC. PSE
established a regulatory asset of $1.1 million at March 31, 2007.
On
January 5, 2007, the Washington Commission issued its order in PSE’s electric
general rate case filed in February 2006, approving a general rate decrease
for
electric customers of $22.8 million or 1.3% annually. The rates for electric
customers are effective beginning January 13, 2007. In its order, the Washington
Commission approved a weighted cost of capital of 8.4%, or 7.06% after-tax,
and
a capital structure that included 44.0% common equity with a return on equity
of
10.4%. The Washington Commission had earlier approved (on June 28, 2006) a
PCORC
increase of $96.1 million annually effective July 1, 2006.
On
June20, 2002, the Washington Commission approved a PCA mechanism that triggers
if
PSE’s costs to provide customers’ electricity falls outside certain bands
established in an electric rate case. The cumulative maximum pre-tax earnings
exposure due to power cost variations over the four-year period ending June30,2006 was limited to $40.0 million plus 1.0% of the excess. In October 2005,
the
Washington Commission approved a shift to an annual PCA measurement period
from
January through December starting in 2007. On January 5, 2007, the Washington
Commission approved the PCA mechanism for continuation under the same annual
graduated scale without a cumulative cap for excess power costs. All significant
variable power supply cost variables (hydroelectric and wind generation, market
price for purchased power and surplus power, natural gas and coal fuel price,
generation unit forced outage risk and transmission cost) are included in the
PCA mechanism.
On
January 5, 2007, the Washington Commission issued its order in PSE’s gas general
rate case, granting an increase for gas customers of $29.5 million or 2.8%
annually, effective beginning January 13, 2007. In its order the Washington
Commission approved the same weighted cost of capital of 8.4% or 7.06% after-tax
and capital structure that included 44.0% common equity with a return on equity
of 10.4%, consistent with the Company’s electric operations.
(8)
Litigation
Residential
Exchange. Petitioners
in several actions in the U.S. Ninth Circuit Court of Appeals (Ninth Circuit)
against Bonneville Power Administration (BPA) asserted that BPA acted contrary
to law or without authority in deciding to enter into, or in entering into
or
performing or implementing, a number of agreements, including the amended
settlement agreement (and the May 2004 agreement) between BPA and PSE regarding
the BPA Residential Purchase and Sale Program. BPA rates used in such agreements
between BPA and PSE for determining the amounts of money to be paid to PSE
by
BPA under such agreements during the period October 1, 2001 through September30, 2006 have been confirmed, approved and allowed to go into effect by FERC.
Petitioners in several actions in the U.S. Ninth Circuit Court of Appeals
against BPA, also asserted that BPA acted contrary to law in adopting or
implementing the rates or rate adjustment clause upon which the benefits
received or to be received from BPA during the October 1, 2001 through September30, 2006 period are based. The parties to these various actions presented oral
arguments to the U.S. Ninth Circuit Court of Appeals in November 2005. A number
of parties have claimed that the BPA rates proposed or adopted in the BPA rate
proceeding to develop BPA rates to be used in the agreements for determining
the
amounts of money to be paid to PSE by BPA during the period October 1, 2006
through September 30, 2009 are contrary to law and that BPA acted contrary
to
law or without authority in deciding to enter into, or in entering into or
performing or implementing such agreements. It is not clear what impact, if
any,
development or review of such rates, review of such agreements and the above
described Ninth Circuit actions may have on PSE.
On
May 3,2007, the Ninth Circuit issued an opinion in Portland
Gen. Elec. v. BPA,
No.
01-70003, in which proceeding the actions of BPA in entering into settlement
agreements, regarding the BPA Residential Purchase and Sale Program, with
PSE
and with other investor-owned utilities were challenged. In this opinion,
the
Ninth Circuit granted petitions for review and held the settlement agreements
entered into between BPA and the investor-owned utilities being challenged
in
that proceeding to be inconsistent with statute. On May 3, 2007, the Ninth
Circuit also issued an opinion in Golden
Northwest Aluminum v. BPA,
No.
03-73426, in which proceeding the petitioners sought review of BPA’s 2002-06
power rates. In this opinion, the Ninth Circuit granted petitions for review
and
held that BPA unlawfully shifted onto its preference customers the costs
of its
settlements with the investor-owned utilities. It is not clear what impact
these
opinions may have on PSE.
Colstrip
Matter.
In May
2003, approximately 50 plaintiffs brought an action against the owners of
Colstrip which has since been amended to add additional claims. The lawsuit
alleges that certain domestic water wells, groundwater and the Colstrip water
supply pond were contaminated by seepage from a Colstrip Units 1 & 2
effluent holding pond, that seepage from Colstrip Units 1 & 2 have decreased
property values and that seepage from the Colstrip water supply pond caused
structural damage to buildings and toxic mold. Discovery is ongoing. On March29, 2007, a second complaint was filed on behalf of three ranchers alleging
damage due to the Units’ 3 & 4 effluent holding pond.
Proceedings
Relating to the Western Power Market.
PSE is
vigorously defending each case in the western power market proceedings.
Litigation is subject to numerous uncertainties and PSE is unable to predict
the
ultimate outcome of these matters. Accordingly, there can be no guarantee that
these proceedings, either individually or in the aggregate, will not materially
and/or adversely affect PSE’s financial condition, results of operations or
liquidity.
California
Receivable and California Refund Proceedings.While
there have been no material litigation events relating to PSE during the first
quarter 2007, FERC has continued to express support for the Ninth Circuit’s
settlement process and several other parties announced settlements during the
quarter. PSE is defending its position while continuing to monitor
developments in these proceedings.
Wah
Chang Suit.This
is
an appeal pending in the United States Court of Appeals for the Ninth Circuit.
Issues include whether the district court correctly dismissed Wah Chang’s
complaint against PSE and other energy sellers alleging market manipulation,
antitrust violations, and breach of contract. Oral argument took place on April10, 2007 and the parties await a decision from the court.
(9)
Related
Party Transaction
On
June1, 2006, PSE entered into a revolving credit facility with its parent, Puget
Energy, in the form of a Demand Promissory Note (Note). Through the Note, PSE
may borrow up to $30.0 million from Puget Energy, subject to approval by Puget
Energy. Under the terms of the Note, PSE pays interest on the outstanding
borrowings based on the lowest of the weighted average interest rate of (a)
PSE’s outstanding commercial paper interest rate; (b) PSE’s senior unsecured
revolving credit facility; or (c) the interest rate available under the
receivable securitization facility of PSE Funding, Inc., a PSE subsidiary,
which
is the London Interbank Offered Rate (LIBOR) plus a marginal rate. At March31,2007, the outstanding balance of the Note was $24.4 million and the interest
rate was 5.52%. The outstanding balance and the related interest under the
Note
are eliminated by Puget Energy upon consolidation of PSE’s financial
statements.
(10)
Financings
In
March
2007, PSE entered into a five-year, $350 million credit agreement with a group
of banks. The agreement is used to support the Company’s energy hedging
activities. Pursuant to the Washington Commission order in PSE’s electric and
gas general rate cases issued on January 5, 2007, the costs of this hedging
credit facility will be recovered through the PCA and PGA mechanisms. Under
the
terms of the credit agreement, PSE pays a floating interest rate on outstanding
borrowings based either on the agent bank’s prime rate or on LIBOR plus a
marginal rate based on PSE’s long-term credit rating at the time of borrowing.
The facility can also be used to provide letters of credit. PSE pays a
commitment fee on any unused portion of the credit agreement also based on
long-term credit ratings of PSE.
In
March
2005, PSE entered into a five-year, $500 million unsecured credit agreement
with
a group of banks. In March 2007, PSE restated this credit agreement to extend
the expiration date to April 2012. The agreement is primarily used to provide
credit support for commercial paper and letters of credit. The terms of this
agreement, as restated, are essentially identical to those contained in the
$350
million facility.
On
April17, 2007, PSE notified the trustee of its 8.231% Capital Trust Preferred
Securities
(classified as Junior Subordinated Debentures of the Corporation Payable to
a
Subsidiary Trust Holding Mandatorily Redeemable Preferred Securities on the
balance sheet) of its intent to redeem the Securities remaining outstanding
on
June 1, 2007. The purpose of the redemption is to help reduce interest costs
by
retiring higher cost debt. The remaining $37.8 million of the Securities
outstanding will be redeemed on June 1, 2007 at a 4.12% premium, or $40.8
million, plus accrued interest on the redemption date.
(11)
Discontinued
Operations and Corporate Guarantees (Puget
Energy Only)
On
May 7,2006, Puget Energy sold InfrastruX to an affiliate of Tenaska Power Fund, L.P.
(Tenaska). Puget Energy accounted for InfrastruX as a discontinued operation
under SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived
Assets” in 2006.
As
part
of the transaction, Puget Energy made certain representations and warranties
concerning InfrastruX. Puget Energy obtained a representation and warranty
insurance policy and deposited $3.7 million into an escrow account to serve
as
retention under the policy At March 31, 2007, restricted cash in the escrow
account was $3.9 million which is included in Puget Energy’s balance sheets,
representing management’s estimate of the aggregate fair value of Puget Energy’s
maximum exposure related to those representations and warranties. Should Tenaska
make any such claims against Puget Energy, payment for the claims would be
made
from the escrow account. The representation and warranty obligation expires
May7, 2008.
Puget
Energy also agreed to indemnify Tenaska for certain costs and expenses incurred
after closing by InfrastruX related to an investigation of one of InfrastruX’s
subsidiary companies. Under the indemnity agreement, Puget Energy is also liable
for refunding a portion of the purchase price paid by Tenaska for InfrastruX
if
the subsidiary does not achieve certain operating results during the measurement
year. The maximum obligation of Puget Energy for defense costs and a refund
of a
portion of the purchase price is capped at $15.0 million. Tenaska has notified
Puget Energy that 2008 will be the measurement year for purposes of calculating
the potential purchase price refund obligation. At March 31, 2007, a liability
in the amount of $5.0 million is included in the accompanying balance sheets;
that amount represents Puget Energy’s estimate of the fair value of the amount
potentially payable using a probability-weighted approach to a range of future
cash flows. The obligation expires May 7, 2011.
Puget
Energy also provided an environmental guarantee as part of the sale agreement.
Under the terms of the agreement, Tenaska will be responsible for the first
$0.1
million of environmental claims, Tenaska and Puget Energy will share the next
$6.4 million equally and Puget Energy will be responsible for the next $3.5
million. Puget Energy believes it will not have a future loss in connection
with
the environmental guarantee.
The
following table summarizes Puget Energy’s income from discontinued
operations:
Three
Months Ended
March
31,
(Dollars
in Thousands)
2007
2006
Revenues
--
$
92,070
Goodwill
impairment
--
--
Operating
expenses (including interest expense)
--
(87,899
)
Pre-tax
income
--
4,171
Income
tax expense
--
(1,257
)
Puget
Energy carrying value adjustment of InfrastruX
--
7,269
Puget
Energy cost of sale related to InfrastruX, net of tax
--
(937
)
Puget
Energy deferred tax basis adjustment of InfrastruX
--
9,966
Minority
interest in income of discontinued operations
--
(265
)
Income
from discontinued operations
--
$
18,947
In
accordance with SFAS No. 144, InfrastruX discontinued depreciation and
amortization of its assets effective February 8, 2005. This discontinuation
of
depreciation and amortization resulted in $4.8 million ($3.1 million after-tax)
lower depreciation and amortization expense than otherwise would have been
recorded as continuing operations for the three months ended March 31, 2006.
Puget Energy did not record any amortization expense related to the intangible
assets of InfrastruX in 2006.
(12)
Other
FASB
Interpretation No. 46R, “Consolidation of Variable Interest Entities” (FIN 46R)
requires that if a business entity has a controlling financial interest in
a
variable interest entity, the financial statements of the variable interest
entity must be included in the consolidated financial statements of the business
entity. The Company has evaluated its power purchase agreements and determined
that three counterparties may be considered variable interest entities.
Consistent with FIN 46R, PSE submitted requests for information to those
parties; however, the parties have refused to submit to PSE the necessary
information for PSE to determine whether they meet the requirements of a
variable interest entity. PSE also determined that it does not have a
contractual right to such information. PSE will continue to submit requests
for
information to the counterparties in accordance with FIN 46R.
For
the
three power purchase agreements that may be considered variable interest
entities under FIN 46R, PSE is required to buy all the generation from these
plants, subject to displacement by PSE, at rates set forth in the power purchase
agreements. If at any time the counterparties cannot deliver energy to PSE,
PSE
would have to buy energy in the wholesale market at prices which could be higher
or lower than the power purchase agreement prices. PSE’s purchased electricity
expense for the three months ended March 31, 2007 and 2006 for these three
entities was $66.6 million and $58.8 million, respectively.
The
US
Environmental Protection Agency required states to produce regulations by
November 15, 2006 to bring their mercury emissions in line with those mandated
by the Clean Air Mercury Rule. The Montana Board of Environmental Review
approved the state’s regulation to limit mercury emissions from coal-fired
plants on October 16, 2006. The new rule takes a two-tiered approach to reducing
mercury emissions, allowing power plants burning lower-quality lignite coal
to
release more emissions than plants burning cleaner sub-bituminous coal, such
as
Colstrip. The new rule has a more stringent limit than the federal rule (0.9
lbs/Trillion British thermal unit (TBtu), instead of the federal 1.4 lbs/TBtu),
but includes a cap-and-trade provision as well as alternative emission limits
for plants that have tried to meet the new standards but have demonstrated
that
they cannot. The Colstrip owners are still evaluating the potential impact
of
the new rule and have not determined whether the new rule will be
appealed.
In
November 2006, PSE’s Crystal Mountain Generation Station had an accidental
release of approximately 18,000 gallons of diesel oil. PSE crews and consultants
responded and worked with applicable state and federal agencies to control
and
remove the spilled product. Due to snow and other weather conditions, complete
recovery of diesel is not feasible until later in 2007. However, the remaining
recoverable diesel is presumed to be contained within a limited area and largely
embedded in soils under the generator station. Total removal costs as of March31, 2007 were approximately $10.5 million. PSE is currently projecting the
total
remediation cost to be approximately $15.0 million. At March 31, 2007, PSE
had
an insurance receivable recorded in the amount of $12.6 million associated
with
the Crystal Mountain electric generating facility oil spill. PSE management
will
be filing proof of loss claims with insurers once damage repair costs are known
within an acceptable level of precision.
Item
2.Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
The
following discussion of the Company’s financial condition and results of
operations contains forward-looking statements that involve risks and
uncertainties, such as statements of the Company’s plans, objectives,
expectations and intentions. Words such as “anticipates,”“believes,”“estimates,”“expects,”“future,”“intends,”“plans,”“projects,”“predicts,”“will likely result,” and “will continue” and similar expressions are used to
identify forward-looking statements. However, these words are not the exclusive
means of identifying such statements. In addition, any statements that refer
to
expectations, projections or other characterizations of future events or
circumstances are forward-looking statements. The Company’s actual results could
differ materially from those anticipated in these forward-looking statements
for
many reasons, including the factors described below and under the caption
“Forward-Looking Statements” at the beginning of this report. You should not
place undue reliance on these forward-looking statements, which apply only
as of
the date of this Form 10-Q.
Overview
Puget
Energy, Inc. (Puget Energy) is an energy services holding company and all of
its
operations are conducted through its subsidiary Puget Sound Energy (PSE), a
regulated electric and gas utility company. Until May 7, 2006, Puget Energy
owned a 90.9% interest in InfrastruX Group, Inc. (InfrastruX), a utility
construction and services company that was sold to an affiliate of Tenaska
Power
Fund, L.P. (Tenaska). Puget Energy is substantially dependent upon the results
of PSE since PSE is its most significant asset. PSE is the largest electric
and
natural gas utility in the state of Washington, primarily engaged in the
business of electric transmission, distribution, generation and natural gas
distribution. Puget Energy’s business strategy is to generate stable earnings
and cash flow by offering reliable electric and gas service in a cost effective
manner through PSE.
Puget
Sound Energy
PSE
generates revenues from the sale of electric and gas services, mainly to
residential and commercial customers within Washington State. PSE’s operating
revenues and associated expenses are not generated evenly during the year.
Variations in energy usage by consumers occur from season to season and from
month to month within a season, primarily as a result of weather conditions.
PSE
normally experiences its highest retail energy sales and subsequently higher
power costs during the winter heating season in the first and fourth quarters
of
the year and its lowest sales in the third quarter of the year. Varying
wholesale electric prices and the amount of hydroelectric energy supplies
available to PSE also make quarter-to-quarter comparisons difficult.
As
a
regulated utility company, PSE is subject to Federal Energy Regulatory
Commission (FERC) and Washington Utilities and Transportation Commission
(Washington Commission) regulation which may impact a large array of business
activities, including limitation of future rate increases related to retail
rates, transmission rates and wholesale power sales; directed accounting
requirements that could negatively impact earnings; licensing of PSE-owned
generation facilities; and other FERC and Washington Commission directives
that
may impact PSE’s long-term goals. In addition, PSE is subject to risks inherent
to the utility industry as a whole, including weather changes affecting
purchases and sales of energy; outages at owned and non-owned generation plants
where energy is obtained; storms or other events which can damage gas and
electric distribution and transmission lines; wholesale market stability over
time and significant evolving environmental legislation.
PSE’s
main operational objective is to provide reliable, safe and cost-effective
energy to its customers. To help accomplish this objective, PSE is implementing
a strategy to be more self-sufficient in energy generation resources. PSE is
continually exploring new electric-power resource generation and long-term
purchase power agreements to meet this goal on an ongoing basis. On February21,2007, PSE acquired the Goldendale Generating Station (Goldendale), a 277
megawatt (MW) capacity natural gas generating facility in the state of
Washington, from the Calpine Corporation through its bankruptcy proceeding.
PSE
paid $120.0 million for the generating facility and transaction costs totaling
$2.4 million. PSE is seeking recovery of this acquisition in its current Power
Cost Only Rate Case (PCORC) filed March 20, 2007. The resolution of the PCORC
is
expected by September 2007; in the meantime, the Washington Commission has
authorized deferral of certain costs the Company will incur related to its
purchase of Goldendale from March 15, 2007.
In
August
2006, PSE announced the selection of seven projects for further discussion
and
possible negotiation as a result of the 2005 RFP process. In aggregate, these
outside sources, if completed, would generate approximately 1,100 MW of
long-term power supply. The outcome of such discussion and negotiation are
not
known at this time.
Non-GAAP
Financial Measures
The
following discussion includes financial information prepared in accordance
with
generally accepted accounting principles (GAAP), as well as two other financial
measures, Electric Margin and Gas Margin, that are considered “non-GAAP
financial measures.” Generally, a non-GAAP financial measure is a numerical
measure of a Company’s financial performance, financial position or cash flows
that exclude (or include) amounts that are included in (or excluded from) the
most directly comparable measure calculated and presented in accordance with
GAAP. The presentation of Electric Margin and Gas Margin is intended to
supplement investors’ understanding of the Company’s operating performance.
Electric Margin and Gas Margin are used by the Company to determine whether
the
Company is collecting the appropriate amount of energy costs from its customers
to allow recovery of operating costs. PSE’s Electric Margin and Gas Margin
measures may not be comparable to other companies’ Electric Margin and Gas
Margin measures. Furthermore, these measures are not intended to replace
operating income as determined in accordance with GAAP as an indicator of
operating performance.
Results
of Operations
Puget
Energy
All
the
operations of Puget Energy are conducted through PSE and until May 7, 2006,
InfrastruX. Net income for the three months ended March 31, 2007 was $79.1
million on operating revenues of $1.0 billion compared to net income of $92.6
million on operating revenues from continuing operations of $878.1 million
for
the same period in 2006. Net income for 2006 includes the results of
discontinued operations for InfrastruX.
Basic
and
diluted earnings per share for the three months ended March 31, 2007 were $0.68
compared to basic and diluted earnings per share for the three months ended
March 31, 2006 of $0.80 and $0.79, respectively. Net income for the three months
ended March 31, 2006 benefited from income from discontinued operations of
$18.9
million. Net income for the three months ended March 31, 2007 was impacted
by
decreased electric margins of $5.2 million compared to the same period in 2006.
Net income was also negatively impacted by an increase of $10.8 million related
to utility operation and maintenance, a $5.7 million increase in depreciation
and amortization and a $7.2 million increase in interest expense due to higher
debt levels. Offsetting the increase in expenses were increases in gas margins
of $10.2 million compared to the same period in 2006 primarily due to a 2.8%
general rate increase and an increase in gas therm volume sales, a $5.8 million
unrealized gain from a gas supply contract and lower effective tax rate due
to
recovery of PTCs.
Puget
Sound Energy
PSE’s
operating revenues and associated expenses are not generated evenly during
the
year. Variations in energy usage by customers occur from season to season and
from month to month within a season, primarily as a result of weather
conditions. PSE normally experiences its highest retail energy sales and
subsequently higher power costs during the winter heating season in the first
and fourth quarters of the year, and its lowest sales in the third quarter
of
the year. Power costs recovery is seasonal, with underrecovery normally in
the
first and fourth quarters and overrecovery in the second and third quarters.
Varying wholesale electric prices and the amount of hydroelectric energy
supplies available to PSE also make quarter-to-quarter comparisons difficult.
Energy
Margins
The
following table displays the details of electric margin changes for the three
months ended March 31, 2007 compared to the same period in 2006. Electric margin
is electric sales to retail and transportation customers less pass-through
tariff items and revenue-sensitive taxes, and the cost of generating and
purchasing electric energy sold to customers, including transmission costs
to
bring electric energy to PSE’s service territory.
As
reported on PSE’s Consolidated Statement of
Income.
2
Electric
margin does not include any allocation for amortization/depreciation
expense or electric generation operation and maintenance
expense.
Electric
margin decreased $5.2 million for the three months ended March 31, 2007 compared
to the same period in 2006 primarily due to underrecovery of net power costs
under the PCA mechanism which decreased margin by $13.4 million and to PTCs
provided to customers which decreased revenue by $4.8 million. PTCs that are
provided to customers through lower rates are recovered through a lower
effective tax rate. These decreases were partially offset by a $6.8 million
increase in margin due to the PCORC rate increase of 5.9% effective July 1,2006
and variance in customer class mix usage and a $6.3 million increase in margin
due to a 2.9% increase in retail kWh sales.
The
following table displays the details of gas margin changes for the three months
ended March 31, 2007 compared to the same period in 2006. Gas margin is gas
sales to retail and transportation customers less pass-through tariff items
and
revenue-sensitive taxes, and the cost of gas purchased, including gas
transportation costs to bring gas to PSE’s service territory.
As
reported on PSE’s Consolidated Statement of
Income.
2
Gas
margin does not include any allocation for amortization/depreciation
expense or electric generation operations and maintenance
expense.
Gas
margin increased $10.2 million for the three months ended March 31, 2007
compared to the same period in 2006 primarily due to a 2.8% general rate
increase effective January 13, 2007 which increased margin $7.2 million, a
3.9%
increase in gas therm volume sales which contributed $3.9 million to margin
and
customer mix and pricing which decreased margin by $0.9 million.
Electric
Operating Revenues
The
table
below sets forth changes in electric operating revenues for PSE for the three
months ended March 31, 2007 compared to the same period in 2006.
Electric
retail sales increased $59.9 million for the three months ended March 31, 2007
compared to the same period in 2006 due primarily to rate increases related
to
the PCORC rate increase of July 1, 2006 offset by the electric general rate
decrease of January 13, 2007 and increased retail sales volumes. The electric
tariff changes provided $18.3 million to electric operating revenues for the
three months ended March 31, 2007 compared to the same period in 2006. Retail
electricity usage increased 171,802 megawatt hours (MWh) or 2.9% for the three
months ended March 31, 2007 compared to the same period in 2006, which resulted
in an approximate $12.7 million increase in electric operating revenue. The
increase in electricity usage was related to 2.2% higher average number of
customers served in 2007 compared to 2006. During the three month period ended
March 31, 2007, the benefits of the Residential and Farm Energy Exchange Benefit
credited to customers reduced electric operating revenues by $36.1 million
compared to $59.3 million for the same period in 2006. During the three months
ended March 31, 2007, PTCs credited to customers reduced electric operating
revenues by $8.7 million compared to $3.9 million for the same period in 2006.
The PTCs also lower the effective federal tax rate with no impact on earnings.
This credit also reduced power costs by a corresponding amount with no impact
on
earnings. Transportation sales decreased by $0.4 million for the three months
ended March 31, 2007 compared to the same period in 2006 due to a decrease
in
sales volume of 6,672 MWh or 1.3%.
Sales
to
other utilities and marketers increased $3.4 million for the three months ended
March 31, 2007 compared to the same period in 2006 due to an increase in sales
volume of 96,816 MWh or 30.3% and an increase in wholesale market prices in
2007
compared to 2006.
Other
electric revenues decreased $2.7 million for the three months ended March 31,2007 compared to the same period in 2006, primarily due to gains from Tenaska
and other non-core gas financial hedges in 2006 that did not recur in 2007.
The
following electric rate changes were approved by the Washington Commission
in
2007 and 2006:
Gas
retail sales increased $60.4 million for the three months ended March 31, 2007
compared to the same period in 2006 due to higher purchased gas adjustment
(PGA)
mechanism rates, the approval of a 2.8% general gas rate increase effective
January 13, 2007 and increased customer gas usage. The Washington Commission
approved a PGA mechanism rate increase effective September 27, 2006 that
increased rates 10.2% annually. The PGA mechanism passes through to customers
increases or decreases in the gas supply portion of the natural gas service
rates based upon changes in the price of natural gas purchased from producers
and wholesale marketers or changes in gas pipeline transportation costs. PSE’s
gas margin and net income are not affected by changes under the PGA mechanism.
For the three months ended March 31, 2007, the effects of the PGA mechanism
rate
increases provided an increase of $36.6 million in gas operating revenues.
The
gas general rate case provided an additional $7.2 million in gas revenues for
the three months ended March 31, 2007 as compared to the same period in 2006.
The remaining increase in gas retail revenues was primarily due to higher gas
sales of 15.3 million therms or $15.7 million for the three months ended March31, 2007 compared to the same period in 2006, which was related to a 2.7%
increase in customers.
The
following gas rate adjustments were approved by the Washington Commission in
2007 and 2006:
The
table
below sets forth significant changes in operating expenses for PSE and its
subsidiaries for the three months ended March 31, 2007 compared to the same
period in 2006.
Purchased
electricity
expenses
increased $30.0 million for the three months ended March 31, 2007 compared
to
the same period in 2006. The increase for the three months ended March 31,2007
was primarily the result of higher wholesale market prices and increased
purchase volumes which caused underrecovery of power costs of $13.6 million
due
to the PCA sharing bands being reset at January 2007. For the three months
ended
March 31, 2006, power cost did not impact costs as PSE was at the maximum
exposure under the PCA mechanism. PSE is allowed to recover power cost through
the PCA mechanism on a shared basis with customers if actual costs are higher
than the normalized level established in rates. Total purchased power for the
three months ended March 31, 2007 increased 136,941 MWh or 2.9% compared to
the
same period in 2006. Increases in purchases contributed $19.3 million to the
increase for the three months ended March 31, 2007. The increase also reflects
the deferral of excess power costs of $7.2 million in 2006. Increase in
transmission and other expenses contributed $3.3 million due in part to
increased kWh sales to customers.
The
April
mid-month Runoff Forecast published by the National Weather Service Northwest
River Forecast Center indicated that the total forecasted runoff above Grand
Coulee Reservoir for the period January through July 2007 would be at 105%
of
normal. PSE’s hydroelectric production and related power costs in 2006 were
positively impacted by above-normal precipitation and snow pack in the Pacific
Northwest region, which resulted in the runoff above Grand Coulee Reservoir
to
be 106% of normal.
To
meet
customer demand, PSE economically dispatches resources in its power supply
portfolio such as fossil-fuel generation, owned and contracted hydroelectric
capacity and energy and long-term contracted power. However, depending
principally upon availability of hydroelectric energy, plant availability,
fuel
prices and/or changing load as a result of weather, PSE may sell surplus power
or purchase deficit power in the wholesale market. PSE manages its regulated
power portfolio through short-term and intermediate-term off-system physical
purchases and sales and through other risk management techniques.
Electric
generation fuel
expense
increased $4.5 million for the three months ended March 31, 2007 compared to
the
same period in 2006. The increase for the three months ended March 31, 2007
was
primarily the result of an increase of $2.3 million in the cost of natural
gas
and due to higher volumes of electricity generated at PSE-controlled combustion
turbine generating facilities and an increase in the cost of coal at Colstrip
generating facilities of $2.2 million compared to the same period in 2006.
Residential
exchange credits
associated with the Residential Purchase and Sale Agreement with BPA decreased
$22.1 million for the three months ended March 31, 2007 compared to the same
period in 2006 as a result of lower residential and small farm customer electric
credit in rates effective October 1, 2006. The residential exchange credit
is a
pass-through tariff item with a corresponding credit in electric operating
revenue; thus, it has no impact on electric margin or net income.
Purchased
gas
expenses
increased $43.9 million for the three months ended March 31, 2007 compared
to
the same period in 2006 primarily due to an increase in PGA rates as approved
by
the Washington Commission and higher customer therm sales. The PGA mechanism
allows PSE to recover expected gas costs, and defer, as a receivable or
liability, any gas costs that exceed or fall short of this expected gas cost
amount in PGA mechanism rates, including accrued interest. The PGA mechanism
payable balance at March 31, 2007 was $3.8 million compared to a receivable
balance at December 31, 2006 of $39.8 million. PSE is authorized by the
Washington Commission to accrue carrying costs on PGA receivable balances.
A
receivable balance in the PGA mechanism reflects an underrecovery of market
gas
cost through rates. A payable balance reflects overrecovery of market gas cost
through rates.
Unrealized
(gain) loss on derivative instruments increased
$6.8 million forthe
three
months ended March 31, 2007 compared to the same period in 2006 primarily as
a
result of the reversal of a loss reserve related to a physical gas supply
contract for PSE’s electric generating facilities. The mark-to-market gain that
was recorded is the difference between the forward market price of natural
gas
and the contract price for natural gas based on volumes purchased. As the
contract gets closer to termination in June 2008, the gain will reverse due
to
settlement of the contract on a monthly basis and the mark-to-market value
will
decrease as long as the price for natural gas is at or near the current forward
market prices of natural gas.
Utility
operations and maintenance expense
increased $10.8 million for the three months ended March 31, 2007 compared
to
the same period in 2006. The increase was a result of higher operating and
maintenance costs at PSE’s generating facilities, due to the addition of the
Wild Horse wind project (Wild Horse) which began operations on December 22,2006
and higher expenses related to operating and maintaining PSE’s energy delivery
system. Wild Horse operations and maintenance expense is fully recovered in
rates. For the three months ended March 31, 2007 and 2006, electric storm damage
costs were higher than historical averages and in both periods PSE exceeded
the
$7.0 million operation and maintenance expense threshold. As a result, PSE
will
defer any qualifying electric storm damage costs during the remainder of 2007
for future recovery in rates.
Non-utility
expense and other
increased $1.7 million for the three months ended March 31, 2007 compared to
the
same period in 2006 primarily due to an increase in PSE’s long-term incentive
plan costs of $1.7 million.
Depreciation
and amortization
expense
increased $5.7 million for the three months ended March 31, 2007, compared
to
the same period in 2006 primarily as a result of placing Wild Horse into service
on December 22, 2006 and additional utility plant placed in service over the
last 12 months.
Conservation
amortization
increased $2.3 million for the three months ended March 31, 2007, compared
to
the same period in 2006 due to higher authorized recovery of electric
conservation expenditures. Conservation amortization is a pass-through tariff
item with no impact on earnings.
Taxes
other than income taxes
increased $7.4 million for the three months ended March 31, 2007, compared
to
the same period in 2006 due primarily to increases in revenue-based Washington
State excise tax and municipal tax due to increased operating revenues. Revenue
sensitive Washington State excise and municipal taxes have no impact on
earnings. Excluding the impact of revenue sensitive taxes, taxes other than
income taxes decreased $2.6 million primarily as a result of updating 2006
levy
rates based on property tax billings.
Other
Income, Interest Charges and Income Tax Expense
The
table
below sets forth significant changes in other income, interest charges and
income taxes for PSE and its subsidiaries for the three months ended March31,2007 compared to the same period in 2006.
Other
income increased
$1.5 million for the three months ended March 31, 2007 compared to the same
period in 2006 primarily due to an increase on the return of the Chelan PUD
regulatory asset offset by a decrease in the return on capitalized overhead
tax
payments.
Interest
expense increased
$7.5 million due primarily to an increase in outstanding debt. At March 31,2007, debt outstanding totaled $3.2 billion compared to March 31, 2006 debt
level of $2.5 billion which reflected additional borrowing related to Wild
Horse
wind project, Goldendale Generating Station, pre-payment associated with the
Chelan PUD long-term purchase power agreement and system restoration expense
incurred as a result of a severe December 2006 wind storm.
Income
tax expense decreased
$6.5 million for the three months ended March 31, 2007 compared to the same
period in 2006 due primarily to higher tax credits associated with the
production of wind-powered energy. The PTCs for the three months ended March31,2007 were $8.1 million compared to $3.8 million for the same period in 2006.
These additional credits were made available due to the addition of Wild Horse,
which was placed in service in December 2006.
Capital
Requirements
Contractual
Obligations and Commercial Commitments
Puget
Energy.
The
following are Puget Energy’s aggregate consolidated (including PSE) contractual
obligations and commercial commitments as of March 31, 2007:
Puget Energy
Payments
Due Per Period
Contractual
Obligations
(Dollars
in Millions)
Total
2007
2008-
2009
2010-
2011
2012
&
Thereafter
Long-term
debt including interest
$
5,343.7
$
194.3
$
654.8
$
740.9
$
3,753.7
Short-term
debt including interest
461.6
461.6
--
--
--
Junior subordinated debentures payable to a subsidiary trust including
interest1
In
1997, PSE formed Puget Sound Energy Capital Trust I for the sole
purpose
of issuing and selling preferred securities (Trust Securities)
to
investors and issuing common securities to PSE. The proceeds from
the sale
of Trust Securities were used by the Trust to purchase Junior Subordinated
Debentures (Debentures) from PSE. The Debentures are the sole assets
of
the Trusts and PSE owns all common securities of the Trusts. The
Company
will redeem the outstanding Debentures on June 1,2007.
2
See
“Fredonia 3 and 4 Operating Lease” under “Off-Balance Sheet Arrangements”
below.
3
Under
the InfrastruX sale agreement, Puget Energy is obligated for certain
representations and warranties concerning InfrastruX’s business and
anti-trust inquiries. The fair value of the business warranty is
$3.9
million at March 31, 2007 and the obligation expires on May 7,2008.
Puget Energy also agreed
to
indemnify the buyer relating to an inquiry of an InfrastruX subsidiary
and
the fair value of the warranty was $5.0 million at March 31, 2007.
See
“InfrastruX” above for further discussion.
4
At
March 31, 2007, PSE had available a $500.0 million and a $350.0
unsecured
credit agreement expiring in April 2012. The credit agreements
provide
credit support for letters of credit and commercial paper. At March31,2007, PSE had $8.3 million for an outstanding letter of credit
and $299.5
million commercial paper outstanding, effectively reducing the
available
borrowing capacity to $542.2 million.
5
At
March 31, 2007, PSE had available a $200.0 million receivables
securitization facility that expires in December 2010. $162.0 million
was
outstanding under the receivables securitization facility at March31,2007 thus leaving $38.0 million available. The facility allows
receivables
to be used as collateral to secure short-term loans, not exceeding
the
lesser of $200.0 million or the borrowing base of eligible receivables,
which fluctuate with the seasonality of energy sales to customers.
See
“Receivables Securitization Facility” below for further discussion.
Puget
Sound Energy.
The
following are PSE’s aggregate contractual obligations and commercial commitments
as of March 31, 2007:
Puget
Sound Energy
Payments
Due Per Period
Contractual
Obligations
(Dollars
in Millions)
Total
2007
2008-
2009
2010-
2011
2012
&
Thereafter
Long-term
debt including interest
$
5,343.7
$
194.3
$
654.8
$
740.9
$
3,753.7
Short-term
debt including interest
486.0
486.0
--
--
--
Junior subordinated debentures payable to a subsidiary trust
including
interest1
Fredonia
3 and 4 Operating Lease.
PSE
leases two combustion turbines for its Fredonia 3 and 4 electric generating
facility pursuant to a master operating lease that was amended for this lease
in
April 2001. The lease has a term expiring in 2011, but can be canceled by PSE
at
any time. Payments under the lease vary with changes in the London Interbank
Offered Rate (LIBOR). At March 31, 2007, PSE’s outstanding balance under the
lease was $50.4 million. The expected residual value under the lease is the
lesser of $37.4 million or 60% of the cost of the equipment. In the event the
equipment is sold to a third party upon termination of the lease and the
aggregate sales proceeds are less than the unamortized value of the equipment,
PSE would be required to pay the lessor contingent rent in an amount equal
to
the deficiency up to a maximum of 87% of the unamortized value of the equipment.
Utility
Construction Program
Utility
construction expenditures for generation, transmission and distribution are
designed to meet continuing customer growth and to improve efficiencies of
PSE’s
energy delivery systems. Construction expenditures, excluding equity Allowance
for Funds Used during Construction (AFUDC) and customer refundable
contributions, were $239.7 million for the three months ended March 31, 2007.
Utility construction expenditures, excluding AFUDC and excluding new generation
resources other than the Wild Horse project (which will be determined as the
Company proceeds through the integrated resource planning process) are
anticipated to be as follows in 2007, 2008 and 2009:
Capital
Expenditure Estimates
(Dollars
in Millions)
2007
2008
2009
Energy
delivery, technology and facilities
$
530
$
555
$
640
New
resources
120
70
210
Total
expenditures
$
650
$
625
$
850
The
proposed utility construction expenditures and any new generation resource
expenditures that may be incurred are anticipated to be funded with a
combination of cash from operations, short-term debt, long-term debt and equity.
Construction expenditure estimates, including any new generation resources,
are
subject to periodic review and adjustment in light of changing economic,
regulatory, environmental and efficiency factors.
Capital
Resources
Cash
From Operations
Cash
generated from operations for the quarter ended March 31, 2007 was $228.4
million which is 91.9% of the $248.6 million used for utility construction
expenditures and other capital expenditures. For the three months ended March31, 2006, cash generated from operations was $138.4 million which is 123.2%
of
the $112.3 million used for utility construction expenditures and other capital
expenditures.
The
overall cash generated from operating activities for the three months ended
March 31, 2007 increased $90.0 million compared to the same period in 2006.
The
increase was primarily the result of costs incurred in 2006 that did not recur
in 2007, including the Chelan PUD contract initiation payment of $89.0 million
and cash collateral repaid to energy suppliers of $14.9 million. Also
contributing to the increase were collection of the purchased gas receivable
of
$48.7 million and $30.0 million in income taxes paid in the first quarter 2006
compared to none paid in the same period in 2007. The increase was partially
offset by a decrease in accounts payable of $89.5 million.
Financing
Program
Financing
utility construction requirements and operational needs are dependent upon
the
cost and availability of external funds through capital markets and from
financial institutions. Access to funds is dependent upon factors such as
general economic conditions, regulatory authorizations and policies, and Puget
Energy’s and PSE’s credit ratings.
Restrictive
Covenants
In
determining the type and amount of future financing, PSE may be limited by
restrictions contained in its electric and gas mortgage indentures, articles
of
incorporation and certain loan agreements. Under the most restrictive tests,
at
March 31, 2007, PSE could issue:
·
approximately
$362 million of additional first mortgage bonds under PSE’s electric
mortgage indenture based on approximately $603 million of electric
bondable property available for issuance, subject to an interest
coverage
ratio limitation of 2.0 times net earnings available for interest
(as
defined in the electric utility mortgage), which PSE exceeded at
March 31,2007;
·
approximately
$365 million of additional first mortgage bonds under PSE’s gas mortgage
indenture based on approximately $608 million of gas bondable property
available for issuance, subject to interest coverage ratio limitations
of
1.75 times and 2.0 times net earnings available for interest (as
defined
in the gas utility mortgage), which PSE exceeded at March 31,2007;
·
approximately
$841 million of additional preferred stock at an assumed dividend
rate of
6.9%; and
·
approximately
$686 million of unsecured long-term
debt.
At
March31, 2007, PSE had approximately $4.2 billion in electric and gas ratebase to
support the interest coverage ratio limitation test for net earnings available
for interest.
Credit
Ratings
Neither
Puget Energy nor PSE has any debt outstanding that would accelerate debt
maturity upon a credit rating downgrade. A ratings downgrade could adversely
affect the ability to renew existing, or obtain access to new credit facilities
and could increase the cost of such facilities. For example, under PSE’s
revolving credit facility, the borrowing costs and commitment fee increase
as
PSE’s secured long-term debt ratings decline. A downgrade in commercial paper
ratings could preclude PSE’s ability to issue commercial paper under its current
programs. The marketability of PSE commercial paper is currently limited by
the
A-3/P-2 ratings by Standard & Poor’s and Moody’s Investors Service. In
addition, downgrades in PSE’s debt ratings may prompt counterparties to require
PSE to post a letter of credit or other collateral, make cash prepayments,
obtain a guarantee or provide other security.
The
ratings of Puget Energy and PSE, as of April 26, 2007, were as
follows:
Ratings
Standard
& Poor’s
Moody’s
Puget
Sound Energy
Corporate
credit/issuer rating
BBB-
Baa3
Senior
secured debt
BBB
Baa2
Shelf
debt senior secured
BBB
(P)Baa2
Trust
preferred securities
BB
Ba1
Preferred
stock
BB
Ba2
Commercial
paper
A-3
P-2
Revolving
credit facility
*
Baa3
Ratings
outlook
Stable
Stable
Puget
Energy
Corporate
credit/issuer rating
BBB-
Ba1
__________________
*
Standard
& Poor’s does not rate credit facilities.
Shelf
Registrations, Long-Term Debt and Common Stock Activity
On
April17, 2007, PSE notified the trustee of its 8.231% Capital Trust Preferred
Securities
(classified as Junior Subordinated Debentures of the Corporation Payable to
a
Subsidiary Trust Holding Mandatorily Redeemable Preferred Securities on the
balance sheet) of its intent to redeem the remaining $37.8 million of the
Securities on June 1, 2007 at a 4.12% premium, or $40.8 million, plus accrued
interest on the redemption date.
Liquidity
Facilities and Commercial Paper
PSE’s
short-term borrowings and sales of commercial paper are used to provide working
capital fund utility construction programs and support the Company’s energy
hedging activities.
PSE
Credit Facilities
The
Company has three committed credit facilities that provide, in aggregate, $1.05
billion in short-term borrowing capability. These include a $500.0 million
credit agreement, a $200.0 million accounts receivable securitization facility
and a $350.0 million credit agreement to support hedging activity.
Credit
Agreements.
In March
2007, PSE entered into a five-year, $350.0 million credit agreement with a
group
of banks. The agreement is used to support the Company’s energy hedging
activities and may also be used to provide letters of credit. The interest
rate
on outstanding borrowings is based either on the agent bank’s prime rate or on
LIBOR plus a marginal rate related to PSE’s long-term credit rating at the time
of borrowing. PSE pays a commitment fee on any unused portion of the credit
agreement also related to on long-term credit ratings of PSE. At March 31,2007,
there were no borrowings or letters of credit outstanding under the credit
facility.
In
March
2005, PSE entered into a five-year, $500.0 million unsecured credit agreement
with a group of banks. In March 2007, PSE restated this credit agreement to
extend the expiration date to April 2012. The agreement is primarily used to
provide credit support for commercial paper and letters of credit. The terms
of
this agreement as restated, are essentially identical to those contained in
the
$350.0 million facility. At March 31, 2007, there was $8.3 million outstanding
under a letter of credit and $299.5 million commercial paper outstanding,
effectively reducing the available borrowing capacity under the credit
agreements to $542.2 million.
Receivables
Securitization Facility.
PSE
entered into a five-year Receivable Sales Agreement with PSE Funding, Inc.
(PSE
Funding), a wholly owned subsidiary, on December 20, 2005. Pursuant to the
Receivables Sales Agreement, PSE sells all of its utility customer accounts
receivable and unbilled utility revenues to PSE Funding. In addition, PSE
Funding entered into a Loan and Servicing Agreement with PSE and two banks.
The
Loan and Servicing Agreement allows PSE Funding to use the receivables as
collateral to secure short-term loans, not exceeding the lesser of $200.0
million or the borrowing base of eligible receivables which fluctuate with
the
seasonality of energy sales to customers. All loans from this facility will
be
reported as short-term debt in the financial statements. The PSE Funding
facility expires in December 2010, and is terminable by PSE and PSE Funding
upon
notice to the banks. During the three months ended March 31, 2007, PSE Funding
borrowed a cumulative amount of $236.0 million secured by accounts receivable.
There was $162.0 million in loans that were secured by accounts receivable
pledged at March 31, 2007. The borrowing base of eligible receivables at March31, 2007 was $38.0 million.
Demand
Promissory Note.
On
June1, 2006, PSE entered into an uncommitted revolving credit facility with its
parent, Puget Energy, pursuant to which PSE may borrow up to $30 million from
Puget Energy. Under the terms of the Note, PSE pays interest on the outstanding
borrowings based on the lowest of the weighted average interest rate of (a)
PSE’s outstanding commercial paper interest rate; (b) PSE’s senior unsecured
revolving credit facility; or (c) the interest rate available under the
receivable securitization facility of PSE Funding, Inc., a PSE subsidiary.
At
March 31, 2007, the outstanding balance of the Note was $24.4 million. The
outstanding balance and the related interest under the Note are eliminated
by
Puget Energy upon consolidation of PSE’s financial statements.
Stock
Purchase and Dividend Reinvestment Plan
Puget
Energy has a Stock Purchase and Dividend Reinvestment Plan pursuant to which
shareholders and other interested investors may invest cash and cash dividends
in shares of Puget Energy common stock. Since new shares of common stock may
be
purchased directly from Puget Energy, funds received may be used for general
corporate purposes. Puget Energy issued common stock under the Stock Purchase
and Dividend Reinvestment Plan of $3.2 million (130,896 shares) for the three
months ended March 31, 2007, compared to $3.5 million (166,900 shares) for
the
three months ended March 31, 2006.
Common
Stock Offering Programs
To
provide additional financing options, Puget Energy entered into agreements
in
July 2003 with two financial institutions under which Puget Energy may offer
and
sell shares of its common stock from time to time through these institutions
as
sales agents, or as principals. Sales of the common stock, if any, may be made
by means of negotiated transactions or in transactions that may be deemed to
be
“at-the-market” offerings as defined in Rule 415 promulgated under the
Securities Act of 1933, including in ordinary brokers’ transactions on the New
York Stock Exchange at market prices.
Other
FERC
Hydroelectric Projects and Licenses
Baker
River project. The
Baker
River project’s current annual license expires on April 30, 2007, and PSE
submitted an application for a new license to FERC on April 30, 2004. On
November 30, 2004, PSE and 23 parties, (federal, state and local governmental
organizations, Native American Indian tribes, environmental and other
non-governmental entities) filed a proposed comprehensive settlement agreement
on all issues relating to the relicensing of the Baker River project. The
proposed settlement includes a set of proposed license articles and, if approved
by FERC without material modification, would allow for a new license of 45
years
or more. The proposed settlement would require an investment of approximately
$360.0 million over the next 30 years (capital expenditures and operations
and
maintenance cost) in order to implement the conditions of the new license.
The
proposed settlement is subject to additional regulatory approvals yet to be
attained from various agencies and other contingencies that have yet to be
resolved. FERC has not yet ruled on the proposed settlement and its ultimate
outcome remains uncertain.
White
River project. The
White
River project was operated as a hydropower facility until 2004. PSE is actively
seeking to sell the project and the municipal water rights associated with
the
project to one or more entities. In June 2003, the Washington State Department
of Ecology (Ecology) approved an application for new municipal water rights
related to the White River project reservoir. After an appeal in July 2004,
this
decision was remanded back to Ecology for further analysis of non-hydropower
operations. On December 21, 2006, PSE entered into a Purchase and Sale Agreement
with the Cascade Land Conservancy to sell certain rights and interests in a
portion of former project properties; the closing of the sale is subject to
contingencies that have yet to be resolved. On April 7, 2004, the Washington
Commission approved PSE’s recovery on the unamortized White River plant
investment. At March 31, 2007, the White River project net book value totaled
$70.1 million, which included $43.0 million of net utility plant, $17.0 million
of capitalized FERC licensing costs, $5.4 million of costs related to
construction work in progress and $2.1 million related to dam operations and
safety. On February 18, 2005, the Washington Commission approved the recovery
of
the White River net utility plant costs but did not allow current recovery
of
FERC licensing costs and other related costs until all costs associated with
selling the White River plant and any sales proceeds are known. Any proceeds
from the sale of the White River assets and water rights will reduce the balance
of the deferred regulatory asset. Neither the outcome of this matter nor any
potential associated financial impacts can be predicted at this
time.
Snoqualmie
Falls project. The
Snoqualmie Falls project was granted a new 40-year operating license by FERC
on
June 29, 2004. On July 29, 2004, the Snoqualmie Tribe filed a request for
rehearing of the new license and a request to stay the FERC license. On March1,2005, FERC issued an Order on Rehearing and Dismissing Stay Request. Appeals
to
the U.S. Court of Appeals by the Snoqualmie Tribe and by PSE have been
consolidated. Oral arguments were held on February 8, 2007. An adverse ruling
from the Court or adverse action by FERC if the license issuance is remanded
could impact PSE’s future use of this generating asset.
Electric
Regulation and Rates
Power
Cost Only Rate Case.
On March20, 2007, PSE submitted a Power Cost Only Rate Case (PCORC) filing to request
approval of an updated power cost baseline rate beginning September 2007. The
PCORC filing also requested recovery of Goldendale ownership and operating
costs
through retail electric rates. The requested electric rate increase is $64.7
million or 3.7% annually. PSE estimates that the PCORC order will be issued
in
the third quarter 2007.
Accounting
Petition.
On April11, 2007, the Washington Commission approved PSE’s petition for issuance of an
accounting order that authorizes PSE to defer certain costs the Company will
incur related to its purchase of the Goldendale Generating Station (Goldendale)
before the ownership and operating costs are included in PSE’s electric retail
customer rates. PSE established a regulatory asset of $1.1 million at March31,2007.
Electric
General Rate Case.
On
January 5, 2007, the Washington Commission issued its order in PSE’s electric
general rate case filed in February 2006, approving a general rate decrease
for
electric customers of $22.8 million or 1.3% annually. The rates for electric
customers are effective beginning January 13, 2007. In its order, the Washington
Commission approved a weighted cost of capital of 8.4%, or 7.06% after-tax,
and
a capital structure that included 44.0% common equity with a return on equity
of
10.4%. The Washington Commission had earlier approved (on June 28, 2006) a
power
cost only rate case (PCORC) increase of $96.1 million annually effective July1,2006.
Production
Tax Credit.
On
October 30, 2006, PSE revised its PTC electric tariff to increase the credit
to
customers from $13.1 million to $28.8 million, effective January 1, 2007. The
credit is based on expected wind generation and reflects the true-up of prior
years’ credits provided to customers versus credits for actual wind generation
taken for federal income taxes and the addition of Wild Horse to the wind
portfolio.
PCA
Mechanism.
On June20, 2002, the Washington Commission approved a PCA mechanism that triggers
if
PSE’s costs to provide customers’ electricity falls outside certain bands
established in an electric rate case. The cumulative maximum pre-tax earnings
exposure due to power cost variations over the four-year period ending June30,2006 was limited to $40.0 million plus 1.0% of the excess. On January 5, 2007,
the Washington Commission approved the PCA mechanism for continuation under
the
same annual graduated scale without a cumulative cap for excess power costs.
All
significant variable power supply cost variables (hydroelectric and wind
generation, market price for purchased power and surplus power, natural gas
and
coal fuel price, generation unit forced outage risk and transmission cost)
are
included in the PCA mechanism. The PCA mechanism apportions increases or
decreases in power costs, on a calendar year basis, between PSE and its
customers on a graduated scale:
Annual
Power
Cost
Variability
Customers’
Share
Company’s
Share1
+/-
$20 million
0
%
100
%
+/-
$20 - $40 million
50
%
50
%
+/-
$40 - $120 million
90
%
10
%
+/-
$120 million
95
%
5
%
_____________________
1
Over
the four-year period July 1, 2002 through June 30, 2006, the Company’s
share of pre-tax power cost variations is capped at a cumulative
$40
million plus 1% of the excess. Power cost variation after June30, 2006
will be apportioned on an annual basis, on the graduated scale
without a
cumulative cap.
Gas
Regulation and Rates
Gas
General Rate Case.
On
January 5, 2007, the Washington Commission issued its order in PSE’s gas general
rate case, granting an increase for gas customers of $29.5 million or 2.8%
annually, effective January 13, 2007. In its order the Washington Commission
approved the same weighted cost of capital of 8.4% or 7.06% after-tax and
capital structure that included 44.0% common equity with a return on equity
of
10.4%, consistent with the Company’s electric operations.
Proceedings
Relating to the Western Power Market
Puget
Energy’s and PSE’s Report on Form 10-K for the year ended December 31, 2006
include a summary relating to the western power market proceedings. The
following discussion provides a summary of material developments in these
proceedings that occurred during and subsequent to the period covered by this
report. PSE is vigorously defending each of these cases. Litigation is subject
to numerous uncertainties and PSE is unable to predict the ultimate outcome
of
these matters. Accordingly, there can be no guarantee that these proceedings,
either individually or in the aggregate, will not materially and/or adversely
affect PSE’s financial condition, results of operations or
liquidity.
California
Receivable and California Refund Proceedings. While
there have been no material litigation events relating to PSE during the
first
quarter 2007, FERC has continued to express support for the Ninth Circuit’s
settlement process and several other parties announced settlements during
the
quarter. PSE is defending its position while continuing to monitor
developments in these proceedings.
Wah
Chang Suit.This
is
an appeal pending in the United States Court of Appeals for the Ninth Circuit.
Issues include whether the district court correctly dismissed Wah Chang’s
complaint against PSE and other energy sellers alleging market manipulation,
antitrust violations, and breach of contract. Oral argument took place on April10, 2007 and the parties await a decision from the court.
Colstrip
Matters
In
May
2003, approximately 50 plaintiffs brought an action against the owners of
Colstrip which has since been amended to add additional claims. The lawsuit
alleges that certain domestic water wells, groundwater and the Colstrip water
supply pond were contaminated by seepage from a Colstrip Units 1 & 2
effluent holding pond, that seepage from Colstrip Units 1 & 2 have decreased
property values and that seepage from the Colstrip water supply pond caused
structural damage to buildings and toxic mold. Discovery is ongoing. On March29, 2007, a second complaint was filed on behalf of three ranchers alleging
damage due to the Units’ 3 & 4 effluent holding pond.
On
May18, 2005, the Environmental Protection Agency (EPA) enacted the Clean Air
Mercury Rule (CAMR) that will permanently cap and reduce mercury emissions
from
coal-fired power plants. The Montana Board of Environmental Review approved
the
state’s regulation to limit mercury emissions from coal-fired plants on October16, 2006. The new rule has a more stringent limit than the federal rule
(0.9 lbs/TBtu, instead of the federal 1.4 lbs/TBtu), but includes a
cap-and-trade provision as well as alternative emission limits for plants that
have tried to meet the new standards but have demonstrated that they cannot.
The
Colstrip owners are still evaluating the potential impact of the new rule and
it
is still unknown whether the new rule will be appealed. Preliminary treatment
technology studies undertaken by the Colstrip owners estimate that PSE’s portion
of the capital costs to comply with the new rule could be as much as
$75.0 million, but this number could change as new information becomes
available.
In
December 2003, the EPA issued an Administrative Consent Order (ACO) which
alleged violation of the Clean Air Act permit at Colstrip since 1980. The permit
required Colstrip to submit, for review and approval by the EPA, an analysis
and
proposal for reducing emissions of nitrogen oxide to address visibility concerns
upon the occurrence of certain triggering events. The EPA asserts that
regulations it promulgated in 1980 triggered this requirement. Although Colstrip
owners believe that the ACO is unfounded, the Colstrip owners entered into
negotiations with the EPA and the Northern Cheyenne Tribe, and in March 2007,
a
proposed Consent Decree was lodged with the Montana Federal District Court.
The
agreement requires installation of low nitrogen oxide equipment on Colstrip
Units 3 & 4, payment of a non-material penalty and financing of an energy
efficient project on the Northern Cheyenne reservation. The estimated total
additional cost to PSE is $2.65 million.
On
June15, 2005, the EPA issued the Clean Air Visibility Rule to address regional
haze
or regionally-impaired visibility caused by multiple sources over a wide area.
The rule defines Best Available Retrofit Technology requirements for electric
generating units, including presumptive limits for sulfur dioxide, particulate
matter and nitrogen oxide controls for large units. In February 2007 Colstrip
was notified by EPA that Colstrip Units 1 & 2 were determined to be subject
to the BART requirements and was required to submit a BART engineering analysis
for Colstrip 1 & 2 by May 2007. PSE cannot yet determine the need for or
costs of additional controls to comply with this rule, but they could be
significant.
Critical
Accounting Policies and Estimates
In
July
2006, Financial Accounting Standards Board (FASB) issued Interpretation No.
48
(FIN 48), “Accounting for Uncertainty in Income Taxes, an Interpretation of FASB
Statement No. 109,” which clarifies the accounting for uncertainty in income
taxes recognized in the financial statements in accordance with FASB Statement
No. 109, “Accounting for Income Taxes.” FIN 48 provides guidance on recognition
threshold and measurement attributed to a tax position taken or expected to
be
taken in a tax return. The tax positions should only be recognized when it
is
more likely than not, based on technical merits, that the position will be
sustained upon examination by the taxing authority. FIN 48 was effective for
the
Company as of January 1, 2007. The Company has performed a review of all open
tax years (2001 through 2007) and identified one tax position that must be
reported under the provisions of FIN 48. The Company has determined that the
proper amount of interest to accrue under FIN 48 is $6.6 million as of January1, 2007. See discussion at Note 6, “Income Taxes.”
Item
3. Quantitative
and Qualitative Disclosure About Market Risk
Energy
Portfolio Management
The
Company has energy risk policies and procedures to manage commodity and
volatility risks. The Company’s Energy Management Committee establishes the
Company’s energy risk management policies and procedures, and monitors
compliance. The Energy Management Committee is comprised of certain Company
officers and is overseen by the Audit Committee of the Company’s Board of
Directors.
The
Company is focused on commodity price exposure and risks associated with
volumetric variability in the gas and electric portfolios. It is not engaged
in
the business of assuming risk for the purpose of speculative trading. The
Company hedges open gas and electric positions to reduce both the portfolio
risk
and the volatility risk in prices. The exposure position is determined by using
a probabilistic risk system that models 100 scenarios of how the Company’s gas
and power portfolios will perform under various weather, hydro and unit
performance conditions. The objective of the hedging strategy is
to:
·
ensure
physical energy supplies are available to reliably and cost-effectively
serve retail load;
·
prudent
management of energy portfolio risks to serve retail load at overall
least
cost and limit undesired impacts on PSE’s customers and shareholders;
and
·
reduce
power costs by extracting the value of the Company’s
assets.
At
March31, 2007, the Company had a short-term asset of $14.9 million and a long-term
asset of $3.4 million as well as a short-term liability of $0.6 million related
to energy contracts designated as cash flow hedges that represent forward
financial purchases of gas supply for electric generation from PSE-owned
electric plants in future periods. These
contracts were designated as qualifying cash flow hedges and a corresponding
unrealized gain of $11.5 million, net of tax, was recorded in other
comprehensive income. If
it is
determined that it is uneconomical to run the plants in the future period,
the
hedging relationship is ended and the cash flow hedge is de-designated and
any
unrealized gains and losses are recorded in the income statement. Gains and
losses, when these de-designated cash flow hedges are settled, are recognized
in
energy costs and are included as part of the PCA mechanism.
At
March31, 2007, the Company had a short-term asset of $10.2 million and a short-term
liability of $8.9 million related to the hedges of gas contracts to serve
natural gas customers. All mark-to-market adjustments relating to the natural
gas business have been reclassified to a deferred account due to the PGA
mechanism. All increases and decreases in the cost of natural gas supply are
passed on to customers with the PGA mechanism. As the gains and losses on the
hedges are realized in future periods, they will be recorded as gas costs under
the PGA mechanism.
During
the three months ended March 31, 2007, the Company recorded an increase in
earnings of $5.8 million related to the reversal of a loss reserve for a
physical delivered gas supply contract for electric generation that did not
meet
Normal Purchase Normal Sales (NPNS) or cash flow hedge criteria. The
mark-to-market gain that was recorded is the difference between the forward
market price of natural gas and the contract price for natural gas based on
volumes purchased. As the contract gets closer to termination in June 2008,
the
gain will reverse due to settlement of the contract on a monthly basis and
the
mark-to-market value will decrease as long as the price for natural gas is
at or
near the current forward market prices of natural gas. A
hypothetical 10.0% decrease in the market prices of natural gas and electricity
would decrease the fair value of qualifying cash flow hedges and comprehensive
income by $7.1 million after tax and would decrease the fair value of those
contracts marked-to-market in earnings by $0.9 million after tax.
Credit
Risk
The
Company is exposed to credit risk primarily through buying and selling
electricity and gas to serve its customers. Credit risk is the potential loss
resulting from counterparty’s non-performance under an agreement. The Company
manages credit risk with policies and procedures for, among other things,
counterparty analysis, exposure measurement, exposure monitoring and exposure
mitigation.
It
is
possible that extreme volatility in energy commodity prices could cause the
Company to have sub-optimal credit risk exposures with one or more
counterparties. If such counterparties fail to perform their obligations under
one or more agreements, the Company could suffer a material financial loss.
However, as of March 31, 2007, approximately 99% of the Company’s energy
portfolio was rated investment grade or higher by Standard & Poor's Ratings
Services and/or Moody's Investor Services, Inc.
Interest
Rate Risk
The
Company believes its interest rate risk primarily relates to the use of
short-term debt instruments, variable-rate notes and leases and anticipated
long-term debt financing needed to fund capital requirements. The Company
manages its interest rate risk through the issuance of mostly fixed-rate debt
of
various maturities. The Company utilizes commercial paper, line of credit
facilities and accounts receivable securitization to meet short-term cash
requirements. These short-term obligations are commonly refinanced with
fixed-rate bonds or notes when needed and when interest rates are considered
favorable. The Company may enter into swap instruments or other financial hedge
instruments to manage the interest rate risk associated with these debts.
The
ending balance in other comprehensive income related to the forward starting
swaps and previously settled treasury lock contracts at March 31, 2007 was
a net
loss of $8.4 million after-tax and accumulated amortization. All financial
hedge
contracts of this type are reviewed by senior management and presented to the
Securities Pricing Committee of the Board of Directors and are approved prior
to
execution.
Under
the
supervision and with the participation of Puget Energy’s management, including
the Chairman, President and Chief Executive Officer and the Senior Vice
President Finance and Chief Financial Officer, Puget Energy has evaluated the
effectiveness of its disclosure controls and procedures (as defined in Rule
13a-15(e) under the Securities Exchange Act of 1934) as of March 31, 2007,
the
end of the period covered by this report. Based upon that evaluation, the
Chairman, President and Chief Executive Officer and the Senior Vice President
Finance and Chief Financial Officer of Puget Energy concluded that these
disclosure controls and procedures are effective.
Changes
in Internal Control Over Financial Reporting
There
have been no changes in Puget Energy’s internal control over financial reporting
during the quarter ended March 31, 2007 that have materially affected, or are
reasonably likely to materially affect, Puget Energy’s internal control over
financial reporting.
Puget
Sound Energy
Evaluation
of Disclosure Controls and Procedures
Under
the
supervision and with the participation of PSE’s management, including the
Chairman, President and Chief Executive Officer and the Senior Vice President
Finance and Chief Financial Officer, PSE has evaluated the effectiveness of
its
disclosure controls and procedures (as defined in Rule 13a-15(e) under the
Securities Exchange Act of 1934) as of March 31, 2007, the end of the period
covered by this report. Based upon that evaluation, the Chairman, President
and
Chief Executive Officer and the Senior Vice President Finance and Chief
Financial Officer of PSE concluded that these disclosure controls and procedures
are effective.
Changes
in Internal Control Over Financial Reporting
There
have been no changes in PSE’s internal control over financial reporting during
the quarter ended March 31, 2007, that have materially affected, or are
reasonably likely to materially affect, PSE’s internal control over financial
reporting.
See
the
section titled “Proceedings Relating to the Western Power Market” under Item 2
“Management’s Discussion and Analysis of Financial Conditions and Results of
Operations” of this Report on Form 10-Q. Contingencies arising out of the normal
course of the Company’s business exist at March 31, 2007. The ultimate
resolution of these issues in part or in the aggregate is not expected to have
a
material adverse impact on the financial condition, results of operations or
liquidity of the Company.
The
following risk factor is an update to the previously disclosed risk factors
by
Puget Energy and PSE in their Form 10-K, Item 1A for the period ending December31, 2006.
Costs
of compliance with environmental, climate change, and endangered species laws
are significant and the cost of compliance with new laws and regulations and
the
incurrence of associated liabilities could adversely affect PSE’s results of
operations.
PSE’s
operations are subject to extensive federal, state and local laws and
regulations relating to environmental, climate change, and endangered species
protection. To comply with these legal requirements, PSE must spend significant
sums on measures including resource planning, remediation, monitoring, pollution
control equipment, and emissions related abatement and fees. New environmental,
climate change, and endangered species laws and regulations affecting PSE’s
operations may be adopted, and new interpretations of existing laws and
regulations could be adopted or become applicable to PSE or its facilities,
which may substantially increase environmental, climate change, and endangered
species expenditures made by PSE in the future. Compliance with these or other
future regulations could require significant capital expenditures by PSE and
adversely affect PSE’s financial position, results of operations, cash flows and
liquidity. In addition, PSE may not be able to recover all of its costs for
such
expenditures through electric and natural gas rates at current levels in the
future.
With
respect to endangered species laws, the listing or proposed listing of several
species of salmon in the Pacific Northwest is causing a number of changes to
the
operations of hydroelectric generating facilities on Pacific Northwest rivers,
including the Columbia River. These changes could reduce the amount, and
increase the cost, of power generated by hydroelectric plants owned by PSE
or in
which PSE has an interest and increase the cost of the permitting process for
these facilities.
Under
current law, PSE is also generally responsible for any on-site liabilities
associated with the environmental condition of the facilities that it currently
owns or operates or has previously owned or operated, regardless of whether
the
liabilities arose before, during or after the time the facility was owned or
operated. The incurrence of a material environmental liability or the new
regulations governing such liability could result in substantial future costs
and have a material adverse effect on PSE’s results of operations and financial
condition.
Specific
to climate change, Washington State has adopted both a renewable portfolio
standard and greenhouse gas legislation (Governor Gregoire has indicated she
intends to sign this bill), including a performance standard provision. Recent
U.S. Supreme Court decisions related to climate change have also drawn greater
attention to this issue at the federal, state, and local level. PSE cannot
yet
determine the costs of compliance with the recently enacted legislation.
Pursuant
to the requirements of the Securities Exchange Act of 1934, each registrant
has
duly caused this report to be signed on their behalf by the undersigned
thereunto duly authorized.
PUGET
ENERGY, INC.
PUGET
SOUND ENERGY, INC.
/s/
James W. Eldredge
James
W. Eldredge
Vice
President, Corporate Secretary and Chief Accounting
Officer
Statement
setting forth computation of ratios of earnings to fixed charges
(2002
through 2006 and 12 months ended March 31, 2007) for Puget
Energy.
12.2
Statement
setting forth computation of ratios of earnings to fixed charges
(2002
through 2006 and 12 months ended March 31, 2007) for
PSE.
31.1
Chief
Executive Officer certification of Puget Energy pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act
of 2002.
31.2
Chief
Financial Officer certification of Puget Energy pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act
of 2002.
31.3
Chief
Executive Officer certification of Puget Sound Energy pursuant to
18
U.S.C. Section 1350, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.4
Chief
Financial Officer certification of Puget Sound Energy pursuant to
18
U.S.C. Section 1350, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1
Chief
Executive Officer certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32.2
Chief
Financial Officer certification pursuant to 18 U.S.C. Section 1350,
as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
Dates Referenced Herein and Documents Incorporated by Reference
