| PUGET ENERGY INC /WA ITEM 1A RISK FACTORS The following risk factors, in addition to other factors and matters discussed elsewhere in this report, should be carefully considered |
| The risks and uncertainties described below are not the only risks and uncertainties that Puget Energy and PSE may face |
| Additional risks and uncertainties not presently known or currently deemed immaterial also may impair PSE’s business operations |
| If any of the following risks actually occur, Puget Energy’s and PSE’s business, results of operations and financial conditions would suffer |
| RISKS RELATING TO THE UTILITY BUSINESS The actions of regulators can significantly affect PSE’s earnings, liquidity and business activities and are largely outside PSE’s control |
| The rates that PSE is allowed to charge for its services is the single most important item influencing its financial position, results of operations and liquidity |
| PSE is highly regulated and the regulation of the rates that it charges its customers is determined by the Washington Commission |
| PSE is also subject to the regulatory authority of the Washington Commission with respect to accounting, the issuance of securities and certain other matters, and to the regulatory authority of FERC with respect to the transmission of electric energy, the resale of electric energy at wholesale, accounting and certain other matters |
| Policies and regulatory actions by these regulators could have a material impact on PSE’s financial position, results of operations and liquidity, including actions that relate to: · Allowed rates of return; · Financings; · Industry and rate structures; · Transmission and generation business structures within PSE; · Acquisition and disposal of assets and facilities; · Operation, maintenance and construction of generation facilities; · The licensing process with respect to PSE’s hydroelectric generation facilities and gas storage facilities; · Operation of distribution and transmission facilities; · Recovery of capital investments, including investments in new generation facilities, power and gas costs and regulatory assets; and · Present and prospective wholesale and retail competition |
| PSE’s recovery of costs is subject to regulatory review and its operating income may be adversely affected if its costs are disallowed or recovery is delayed |
| The Washington Commission determines the rates PSE may charge to its retail customers based on a normalized cost of producing power |
| If in a specific year PSE’s costs are higher than normal, rates will not be sufficient to permit PSE to earn the allowed return, or to cover its costs and recovery of energy costs will be deferred until subsequent ratemaking proceedings |
| For example, the recent increase in wholesale energy prices could result in an underrecovery of PSE’s costs |
| In addition, the Washington Commission decides what level of expense and investment is necessary, reasonable and prudent in providing service |
| If the Washington Commission decides that part of PSE’s costs do not meet the standard, those costs may be disallowed partially or entirely and not recovered in rates |
| For these reasons, the rates authorized by the Washington Commission may not be sufficient to earn the allowed return or recover the costs incurred by PSE in a given period |
| The mechanism by which variations in PSE’s power costs are apportioned between it and its customers will change in 2006, at which time PSE could experience a significant increase in expenses |
| PSE has a PCA mechanism that is triggered if its costs to provide customers’ electricity fall outside certain bands from a normalized level of power costs |
| PSE’s exposure due to power cost variations over the four-year period ending June 30, 2006 is limited to dlra40 million plus 1prca of the excess costs |
| After June 30, 2006, PSE’s share of power cost variations will be apportioned on an annual basis whereby increases or decreases in power costs will be apportioned between PSE and its customers on a graduated scale |
| (See “PCA Mechanism” under Regulation and Rates section for further details |
| ) Although PSE is required by the Washington Commission to make a power cost only rate case by May 15, 2006 to reset the power cost baseline rates effective July 1, 2006, it is possible that PSE could experience higher expenses associated with excess power under the apportionment arrangement once the cumulative dlra40 million cap expires |
| In addition, PSE was required by the Washington Commission to make a general tariff filing in February 2006 to reset power cost baseline rates effective January 1, 2007 |
| PSE may be unable to acquire energy supply resources to meet projected customer needs or may fail to successfully integrate such acquisitions |
| PSE projects that future energy needs will exceed current purchased and Company-controlled power resources |
| As part of PSE’s business strategy, it plans to acquire additional electric generation and delivery infrastructure to meet customer needs |
| If PSE cannot acquire further additional energy supply resources at a reasonable cost, it may be required to purchase additional power in the open market at a cost that could significantly increase its expenses and reduce earnings and cash flows |
| Additionally, PSE may not be able to timely recover all, if any, of those increased expenses through ratemaking |
| While PSE expects to identify the benefits of new energy supply resources prior to their acquisition and integration, it may not be able to achieve the expected benefits of such energy supply sources due to, among other things: · Delays or difficulties in completing the integration of the acquired energy source; · Higher than anticipated costs or a need to allocate resources to manage unexpected operating difficulties; and · Reliance on inaccurate assumptions in evaluating the expected benefits |
| The Company’s cash flow and earnings could be adversely affected by potential high prices and volatile markets for purchased power, increased customer demand for energy, recurrence of low availability of hydroelectric resources, outages of its generating facilities or a failure to deliver on the part of its suppliers |
| If PSE’s operating expenses, including the cost of purchased power and natural gas, significantly exceed the levels recovered from retail customers for an extended period of time, its cash flow and earnings would be negatively affected |
| Factors which could cause purchased power and gas costs to be higher than anticipated include, but are not limited to, high prices in western wholesale markets during periods when PSE has insufficient energy resources to meet its load requirements and/or high volumes of energy purchased in wholesale markets at prices above the amount recovered in retail rates due to: · Increases in demand due, for example, either to weather or customer growth; · Below normal energy generated by PSE-owned hydroelectric resources due to low streamflow conditions; · Extended outages of any of PSE-owned generating facilities or the transmission lines that deliver energy to load centers; · Failure to perform on the part of any party from which PSE purchases capacity or energy; and · The effects of large-scale natural disasters, such as the hurricanes recently experienced in the southern United States |
| PSE’s electric generating facilities are subject to operational risks that could result in unscheduled plant outages, unanticipated operation and maintenance expenses and increased power purchase costs |
| PSE owns and operates coal, gas-fired, hydro, wind-powered and oil-fired generating facilities |
| Operation of electric generating facilities involves risks that can adversely affect energy output and efficiency levels |
| Included among these risks are: · Increased prices for fuel and fuel transportation as existing contracts expire; · Facility shutdowns due to a breakdown or failure of equipment or processes or interruptions in fuel supply; · Disruptions in the delivery of fuel and lack of adequate inventories; · Labor disputes; · Inability to comply with regulatory or permit requirements; · Disruptions in the delivery of electricity; · Operator error; · Terrorist attacks; and · Catastrophic events such as fires, explosions, floods or other similar occurrences affecting the electric generating facilities |
| PSE is subject to the commodity price, delivery and credit risks associated with the energy markets |
| In connection with matching loads and resources, PSE engages in wholesale sales and purchases of electric capacity and energy, and, accordingly, is subject to commodity price risk, delivery, credit risk and other risks associated with these activities |
| Credit risk includes the risk that counterparties owing PSE money or energy will breach their obligations |
| Should the counterparties to these arrangements fail to perform, PSE may be forced to enter into alternative arrangements |
| In that event, PSE’s financial results could be adversely affected and PSE could incur losses |
| Although PSE’s models take into account the expected probability of default by counterparties, actual exposure to a default by a particular counterparty could be greater than the models predict |
| To lower its financial exposure related to commodity price fluctuations, PSE may use forward delivery agreements, swaps and option contracts to hedge commodity price risk with a diverse group of counterparties |
| However, PSE does not always cover the entire exposure of its assets or positions to market price volatility and the coverage will vary over time |
| To the extent PSE has unhedged positions or its hedging procedures do not work as planned, fluctuating commodity prices could adversely impact its results of operations |
| Conditions that may be imposed in connection with hydroelectric license renewals may require large capital expenditures and reduce earnings and cash flows |
| PSE is in the process of renewing the federal licenses for its Baker River hydroelectric project and implementing the federal licensing requirements for the Snoqualmie Falls hydroelectric project |
| The relicensing process is a political and public regulatory process that involves sensitive resource issues |
| PSE cannot predict with certainty the conditions that may be imposed during the relicensing process, the economic impact of those requirements, whether new licenses will ultimately be issued or whether PSE will be willing to meet the relicensing requirements to continue operating these hydroelectric projects |
| Costs of compliance with environmental and endangered species laws are significant and the cost of compliance with new environmental or endangered species laws and the incurrence of environmental liabilities could adversely affect PSE’s results of operations |
| PSE’s operations are subject to extensive federal, state and local regulation relating to environmental and endangered species protection |
| To comply with these legal requirements, PSE must spend significant sums on environmental and endangered species monitoring, pollution control equipment and emission fees |
| New environmental 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 and endangered species expenditures made by it in the future |
| In addition, PSE may not be able to recover all of its costs for environmental expenditures through electric and natural gas rates at current levels in the future |
| PSE has an ownership interest in coal-fired, steam-electric generating plants at Colstrip, Montana, and owns combustion turbine units, which are fueled by natural gas or oil |
| These facilities are subject to the federal Clean Air Act Amendments of 1990 and, although the facilities currently meet emission requirements, there is no assurance that in the future environmental regulations affecting sulfur dioxide, carbon monoxide, particulate matter or nitrogen oxide emissions may not be further restricted, or that restrictions on greenhouse gas emissions, such as carbon dioxide, or other combustion byproducts such as mercury may not be imposed |
| New federal, state and local regulations regarding air quality and emissions, or revisions or reinterpretations of existing regulations, may be adopted or become applicable to PSE or its facilities |
| 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 |
| 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 |
| The Company’s business is dependent on its ability to successfully access capital markets |
| The Company relies on access to both short-term money markets as a source of liquidity and longer-term capital markets to fund its utility construction program and other capital expenditure requirements not satisfied by cash flow from its operations |
| If the Company is unable to access capital at competitive rates, its ability to pursue improvements or acquisitions, including generating capacity, that may be relied on for future growth, and to otherwise implement its strategy, could be adversely affected |
| Certain market disruptions or a downgrade of the Company’s credit rating may increase the Company’s cost of borrowing or adversely affect the ability to access one or more financial markets |
| In addition to further economic downturns and the overall health of the utility industry, such disruptions could include: · The bankruptcy of an unrelated energy company; · Capital market conditions generally; · Market prices for electricity and natural gas; or · Terrorist attacks or threatened attacks |
| A downgrade in the Company’s credit rating could negatively affect its ability to access capital and the ability to hedge in wholesale markets |
| Standard and Poor’s and Moody’s Investor Services rate PSE’s senior secured debt at “BBB” with a stable outlook and “Baa2” with a stable outlook, respectively |
| Although the Company is not aware of any current plans of S&P or Moody’s to lower their respective ratings on PSE’s debt, the Company cannot be assured that such credit ratings will not be downgraded |
| Although neither Puget Energy nor PSE has any rating downgrade triggers that would accelerate the maturity dates of outstanding debt, a downgrade in the Companies’ credit ratings could adversely affect their 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 spreads over the index and commitment fee increase as PSE’s corporate credit ratings decline |
| A downgrade in commercial paper ratings could preclude PSE’s ability to issue commercial paper under its current programs |
| Any downgrade below investment grade of PSE’s senior secured debt could allow counterparties in the wholesale electric, wholesale gas and financial derivative markets to require PSE to post a letter of credit or other collateral, make cash prepayments, obtain a guarantee agreement or provide other mutually agreeable security |
| The Company’s operating results fluctuate on a seasonal and quarterly basis |
| PSE’s business is seasonal and weather patterns can have a material impact on its operating performance |
| Because natural gas is heavily used for residential and commercial heating, demand depends heavily on weather patterns in PSE’s service territory, and a significant amount of natural gas revenues are recognized in the first and fourth quarters related to the heating season |
| However, the recent increase in the price of natural gas may result in decreased customer demand, despite normal or lower than normal temperatures |
| Demand for electricity is also greater in the winter months associated with heating |
| Accordingly, PSE’s operations have historically generated less revenues and income when weather conditions are milder in the winter |
| In the event that the Company experiences unusually mild winters, results of operations and financial condition could be adversely affected |
| The Company may be adversely affected by legal proceedings arising out of the electricity supply situation in the western power markets, which could result in refunds or other liabilities |
| The Company is involved in a number of legal proceedings and complaints with respect to power markets in the western United States |
| Most of these proceedings relate to the significant increase in the spot market price of energy in western power markets in 2000 and 2001, which allegedly contributed to or caused unjust and unreasonable prices and allegedly may have been the result of manipulations by certain other parties |
| These proceedings include, but are not limited to, refund proceedings and hearings in California and the Pacific Northwest and complaints and cross-complaints filed by various parties with respect to alleged misconduct by other parties in western power markets |
| 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 adversely affect PSE’s financial condition, results of operations or liquidity |
| RISKS RELATING TO DISPOSITION OF DISCONTINUED OPERATIONS Until InfrastruX is sold, Puget Energy may be required to reduce the carrying value of InfrastruX ownership interest, which could have a negative effect on the Company’s financial position |
| Puget Energy’s plan to dispose of its interest in InfrastruX meets the criteria established for recognition of InfrastruX as a discontinued operation under SFAS Nodtta 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” and is accounted for as such in the Company’s consolidated financial statements in 2005 |
| Pursuant to SFAS Nodtta 144, the Company is required to re-assess the carrying value of its investment in InfrastruX at the end of each fiscal quarter and the carrying value could be significantly reduced in future periods due to a deterioration in InfrastruX’s financial performance or market conditions in the utility construction services sector generally |
| InfrastruX’s operations may be affected by various factors, including: · The inability to generate internal growth, which could be affected by, among other factors, InfrastruX’s ability to maintain current key customer relationships, expand the range of services offered to customers, attract new customers, increase the number of projects performed for existing customers, hire and retain employees and open additional facilities; · The effect of competition in the industry in which InfrastruX competes, including from competitors that may have greater resources than InfrastruX, which may enable them to develop expertise, experience and resources to provide services that are superior in quality or lower in price; · The extent to which existing electric power and gas companies or prospective customers will continue to outsource services in the future, which may be impacted by, among other things, regional and general economic conditions in the markets InfrastruX serves; · Delinquencies, including those associated with the financial conditions of InfrastruX’s customers; · The impact of any impairments on the carrying value of the investment in InfrastruX; · The impact of adverse weather conditions that negatively affect operating conditions and results; · The ability to obtain adequate bonding coverage and the cost of such bonding; · The perception of risk associated with its business due to a challenging business environment; · Risks related to regulatory compliance issues; and · Pending or threatened litigation or government investigations, relatively common in the utility construction industry, may create uncertainty and expose InfrastruX to potential liabilities |
| Puget Energy may be unable to complete the sale of its interest in InfrastruX on reasonable terms |
| Puget Energy is committed to a sale of InfrastruX Puget Energy has retained an investment banking firm to assist Puget Energy to complete a sale, although a sale is not assured |
| Puget Energy’s carrying value at December 31, 2005 reflects Puget Energy’s best estimate of the fair value of its InfrastruX investment |
| Net proceeds on the ultimate sale could vary from this estimate |
| Puget Energy’s liquidity and financial condition could be adversely impacted if InfrastruX is unable to satisfy its obligations under its revolving credit facility |
| In May 2004, InfrastruX secured a three-year credit agreement with several banks to provide up to dlra150 million in financing |
| Puget Energy is the guarantor of this line of credit |
| If InfrastruX is unable to generate cash flow from operations or to access other financing sources in an amount sufficient to service its obligations under the credit agreement, Puget Energy, as the guarantor, may be required to satisfy these obligations |
| Currently, Puget Energy does not have a liquidity facility in place to support its guarantor obligations, and there can be no assurance that such a facility could be obtained on favorable terms, if at all |
| In the event Puget Energy is required, as guarantor, to repay amounts owed under the credit agreement, its liquidity and access to capital could be negatively impacted |
| RISKS RELATING TO PUGET ENERGY’S CORPORATE STRUCTURE As a holding company, Puget Energy is subject to restrictions on its ability to pay dividends |
| As a holding company with no significant operations of its own, the primary source of funds for the payment of dividends to its shareholders is dividends PSE pays to Puget Energy |
| PSE is a separate and distinct legal entity and has no obligation to pay any amounts to Puget Energy, whether by dividends, loans or other payments |
| The ability of PSE to pay dividends or make distributions to Puget Energy, and accordingly, Puget Energy’s ability to pay dividends on its common stock, will depend on its earnings, capital requirements and general financial condition |
| If Puget Energy does not receive adequate distributions from PSE, then it may not be able to make or may have to reduce dividend payments on its common stock |
| PSE’s payment of common stock dividends to Puget Energy is restricted by provisions of covenants applicable to its preferred stock and long-term debt contained in its articles of incorporation and electric and gas mortgage indentures |
| Puget Energy’s Board of Directors reviews the dividend policy periodically in light of the factors referred to above, and cannot assure you of the amount of dividends, if any, that may be paid in the future |
| Future sales of Puget Energy’s common stock on the public market could lower the stock price |
| Puget Energy may sell additional shares of common stock in public offerings, through the stock purchase and dividend reinvestment plan or through common stock offering programs which it has entered into with two financial institutions |
| Puget Energy cannot predict the size of future issuances of common stock, or the effect, if any, that future issuances and sales of shares of common stock will have on the market price of common stock |
| Sales of substantial amounts of common stock, or the perception that such sales could occur, may adversely affect the prevailing market price of common stock |
| The market price for common stock is uncertain and may fluctuate significantly |
| Puget Energy cannot predict whether the market price of its common stock will rise or fall |
| Numerous factors influence the trading price of its common stock |
| These factors may include changes in financial condition, results of operations and prospects, legal and administrative proceedings and political, economic, financial and other factors that can affect the capital markets generally, the stock exchanges on which Puget Energy’s common stock is traded and its business segments |
| Certain provisions of law, as well as provisions in the restated articles of incorporation, bylaws and shareholders rights plan, may make it more difficult for others to obtain control of Puget Energy, even though some shareholders might consider this favorable |
| Puget Energy is a Washington corporation and certain anti-takeover provisions of Washington laws apply and create various impediments to the acquisition of control of Puget Energy or to the consummation of certain business combinations |
| In addition, Puget Energy’s restated articles of incorporation, bylaws and shareholders rights plan contain provisions which may make it more difficult to remove incumbent directors or effect certain business combinations with Puget Energy without the approval of the Board of Directors |
| These provisions of law and of Puget Energy’s corporate documents, individually or in the aggregate, could discourage a future takeover attempt which individual shareholders might deem to be in their best interests or in which shareholders would receive a premium for their shares over current prices |