Puget Sound Energy. The following are PSE's aggregate contractual obligations and commercial commitments as of March 31, 2004:
| Puget Sound Energy | Payments Due Per Period
|
|---|
Contractual Obligations
(Dollars in millions)
| Total
| 2004
| 2005-
2006
| 2007-
2008
| 2009 and
Thereafter
|
| Long-term debt | | | $ | 2,032 | .9 | $ | 82 | .5 | $ | 112 | .0 | $ | 304 | .5 | $ | 1,533 | .9 |
| Junior subordinated debentures payable | | |
| to a subsidiary trust (1) | | | | 280 | .3 | | | -- | | | -- | | | -- | | 280 | .3 |
| Mandatorily redeemable preferred stock | | | | 1 | .9 | | | -- | | | -- | | | -- | | 1 | .9 |
| Service contract obligations | | | | 161 | .0 | | 14 | .8 | | 41 | .3 | | 43 | .6 | | 61 | .3 |
| Non-cancelable operating leases | | | | 52 | .8 | | 8 | .0 | | 17 | .6 | | 16 | .8 | | 10 | .4 |
| Fredonia combustion turbines lease (2) | | | | 68 | .5 | | 3 | .4 | | 8 | .7 | | 8 | .5 | | 47 | .9 |
| Energy purchase obligations | | | | 4,652 | .1 | | 729 | .3 | | 1,346 | .4 | | 1,057 | .4 | | 1,519 | .0 |
| Financial hedge obligations | | | | 32 | .2 | | 13 | .6 | | 15 | .0 | | 3 | .6 | | | -- |
| Non-qualified pension funding | | | | 29 | .6 | | 2 | .1 | | 3 | .1 | | 4 | .5 | | 19 | .9 |
|
| Total contractual cash obligations | | | $ | 7,311 | .3 | $ | 853 | .7 | $ | 1,544 | .1 | $ | 1,438 | .9 | $ | 3,474 | .6 |
|
| | Amount of Commitment
Expiration Per Period
|
|---|
Commercial Commitments
(Dollars in millions)
| Total
| 2004
| 2005-
2006
| 2007-
2008
| 2009 and
Thereafter
|
| Liquidity facilities - available (3) | | | $ | 362 | .5 | $ | 249 | .5 | $ | 113 | .0 | $ | | -- | $ | | -- |
| Energy operations letter of credit | | | | 0 | .5 | | 0 | .5 | | | -- | | | -- | | | -- |
|
| Total commercial commitments | | | $ | 363 | .0 | $ | 250 | .0 | $ | 113 | .0 | $ | | -- | $ | | -- |
|
Off-Balance Sheet Arrangements
Accounts Receivable Securitization Program. In order to provide a source of liquidity for PSE at attractive cost of capital rates, PSE entered into a Receivables Sales Agreement with Rainier Receivables, Inc., a wholly owned subsidiary of PSE in December 2002. Pursuant to the Receivables Sales Agreement PSE sold all of its utility customers’ accounts receivable and unbilled utility revenues to Rainier Receivables. Concurrently with entering into the Receivables Sales Agreement, Rainier Receivables entered into a Receivables Purchase Agreement with PSE and a third party. The Receivables Purchase Agreement allows Rainier Receivables to sell the receivables purchased from PSE to the third party. The amount of receivables sold by Rainier Receivables is not permitted to exceed $150 million at any time. However, the maximum amount may be less than $150 million depending on the outstanding amount of PSE’s receivables, which fluctuate with the seasonality of energy sales to customers.
The receivables securitization facility is the functional equivalent of a secured revolving line of credit. In the event Rainier Receivables elects to sell receivables under the Receivables Purchase Agreement, Rainier Receivables is required to pay fees to the purchasers that are comparable to interest rates on a revolving line of credit. As receivables are collected by PSE as agent for the receivables purchasers, the outstanding amount of receivables held by the purchasers declines until Rainier Receivables elects to sell additional receivables to the purchasers.
The receivables securitization facility has a three-year term, but is terminable by PSE and Rainier Receivables upon notice to the receivables purchasers. At March 31, 2004, Rainier Receivables had sold $37.0 million of accounts receivable and the maximum receivables available for sale was $113.0 million.
During the three months ended March 31, 2004, Rainier Receivables sold a cumulative $122.0 million of receivables. No amounts were sold for the same period in 2003.
Fredonia 3 and 4 Operating Lease. PSE leases two combustion turbines for its Fredonia 3 and 4 electric generation facility pursuant to a master lease that was amended for this purpose in April 2001. The lease has a term expiring in 2011, but can be canceled by PSE after August 2004. Payments under the lease vary with changes in the London Interbank Offered Rate (LIBOR). At March 31, 2004, PSE’s outstanding balance under the lease was $58.4 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.
New Generation Resources. In October 2003, PSE completed negotiations to purchase a 49.85% interest in a 275 MW (250 MW capacity with 25 MW planned capital improvements) gas-fired electric generating station located within Western Washington (Fredrickson I). The purchase will add approximately 137 MW of electric generation capacity to serve PSE’s retail customers. PSE submitted a power cost only rate case in October 2003 to the Washington Commission to recover the approximately $80 million cost of the new generating facility and other power costs. The acquisition of Frederickson I was approved by the Washington Commission on April 7, 2004. The acquisition was also approved by FERC under the Federal Power Act on April 23, 2004. Based on these approvals, PSE anticipates completing the acquisition in the second quarter of 2004. In addition, PSE has issued a request for proposals to acquire up to 355 average MW of electric power resources, including generation energy from wind power for its electric-resource portfolio and is currently evaluating responses.
Utility Construction Program. Current 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), were $65.8 million for the three months ended March 31, 2004. PSE expects construction expenditures will total approximately $408 million in 2004, which includes $80 million for acquisition of the 49.85% interest in the Fredrickson I generating facility, $639.7 million in 2005, which includes $280.5 million for new resource acquisitions, and $327 million in 2006. The Fredrickson I acquisition will be funded initially with short-term debt. Construction expenditure estimates are subject to periodic review and adjustment in light of changing economic, regulatory, environmental and conservation factors.
Other Additions. Other property, plant and equipment additions were $5.7 million for the three months ended March 31, 2004. Puget Energy expects InfrastruX’s capital additions to be $16.2 million in 2004, $18.0 million in 2005, and $20.0 million in 2006. Capital addition estimates are subject to periodic review and adjustment in light of changing economic and regulatory factors.
Capital Resources
Cash From Operations.Cash generated from operations for the three months ended March 31, 2004 was $109.1 million. During the period, $22.7 million in cash was used for AFUDC and payment of dividends. Consequently, cash flows available for utility construction expenditures and other capital expenditures were $86.4 million or 115.4% of the $74.9 million in construction expenditures (net of AFUDC) and other capital expenditure requirements for the period. For the same period in 2003, cash generated from operations was $153.0 million, $22.7 million of which was used for AFUDC and payment of dividends. Therefore, cash flows available for utility construction expenditures and other capital expenditures for the three months ended March 31, 2003 were $130.3 million. The reduction in cash generated from operations in the first quarter of 2004 compared to the first quarter of 2003 is primarily due to the utilization of the accounts receivable securization program in December 2003 and March 2004. At December 31, 2003, Rainier Receivables had sold $111.0 million in account receivables, which would have been collected during the first quarter of 2004. Rainier Receivables also sold $37.0 million in accounts receivable at March 31, 2004 compared to no activity for the first quarter of 2003.
Puget Energy and PSE expect to continue financing the utility construction program and other capital expenditure requirements with internally generated funds and externally financed capital.
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. The Company expects to meet capital and operational needs for the balance of 2004 and 2005 with cash generated from operations and borrowings under its liquidity facilities.
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, 2004, PSE could issue:
| • | | approximately $946.4 million of first mortgage bonds, as PSE has approximately $1.6 billion of electric and gas bondable property available for use, subject to the interest coverage ratio limitation of 2.0 times net earnings available for interest. PSE’s interest coverage ratio at March 31, 2004 was 3.0 times net earnings available for interest which would allow issuance of approximately $1.3 billion of additional first mortgage bonds, at an assumed interest rate of approximately 5.6% on a ten-year first mortgage bond; |
| • | | approximately $607.9 million of additional preferred stock at an assumed dividend rate of 7.25%; and |
| • | | approximately $265.1 million of unsecured long-term debt. |
Credit Ratings. Neither Puget Energy nor PSE has any rating downgrade triggers that would accelerate the maturity dates of outstanding debt. However, a downgrade in the credit ratings could adversely affect the Companies’ 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 interest rate spreads over the index and commitment fee increase as PSE’s secured long-term debt ratings decline. An interest rate 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, respectively. A further downgrade in commercial paper ratings could preclude entirely PSE’s ability to issue commercial paper. In addition, downgrades in any or a combination of PSE’s debt ratings may allow counterparties on a contract by contract basis 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 ratings of Puget Energy and PSE as of April 23, 2004 were:
| | 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 | Positive | Stable |
| Puget Energy |
| Corporate credit/issuer rating | BBB- | Ba1 |
* Standard & Poor’s does not rate credit facilities.
Shelf Registrations. In January 2004, Puget Energy and PSE filed a shelf registration statement with the Securities and Exchange Commission for the offering, on a delayed or continuous basis, of up to $500 million principal amount of:
| • | | common stock of Puget Energy, |
| • | | senior notes of PSE, secured by a pledge of PSE’s first mortgage bonds. |
Liquidity Facilities and Commercial Paper. PSE’s short-term borrowings and sales of commercial paper are used to provide working capital and funding of utility construction programs.
PSE has a $250 million unsecured credit agreement with various banks which expires in June 2004 and a $150 million 3-year receivables securitization program which expires in December 2005. The receivables available for sale under the securitization program may be less than $150 million depending on the outstanding amount of PSE’s receivables, which fluctuate with the seasonality of energy sales to customers. At March 31, 2004, PSE had available $250 million in the unsecured credit agreement and $113.0 million available from the receivable securitization facility (net of $37.0 million sold), which provide credit support for outstanding commercial paper and outstanding letters of credit. At March 31, 2004, there were no outstanding amounts under the commercial paper program and $0.5 million under the letters of credit, effectively reducing the available borrowing capacity under the liquidity facilities to $362.5 million. PSE is negotiating with various banks to establish a new unsecured credit facility to replace the facility that will expire in June 2004 and expects the new credit facility to be effective before the existing facility expires.
In May 2003, Puget Energy entered into a $15 million, three-year credit agreement with a bank. Under the terms of the agreement, Puget Energy will pay a floating interest rate on borrowings based on LIBOR. The interest rate is set for one, two, or three-month periods at the option of Puget Energy with interest due at the end of each period. Puget Energy will also pay a commitment fee on any unused portion of the credit facility. Puget Energy has outstanding $5.0 million under the credit agreement at March 31, 2004.
In June 2001, InfrastruX signed a three-year credit agreement with several banks to provide up to $150 million in financing. Puget Energy is the guarantor of the line of credit. In addition, InfrastruX’s subsidiaries have an additional $34.7 million in lines of credit with various banks. Borrowings available for InfrastruX are used to fund acquisitions and working capital requirements of InfrastruX and its subsidiaries. At March 31, 2004, InfrastruX and its subsidiaries had outstanding loans of $147.7 million and letters of credit of $4.7 million, effectively reducing the available borrowing capacity under these lines of credit to $32.3 million.
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’s 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 from the Stock Purchase and Dividend Reinvestment Plan of $3.9 million (175,600 shares) for the three months ended March 31, 2004 compared to $3.8 million (192,800 shares) for the same period in 2003.
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 Licenses
Baker River Project. The Baker River Project is located upstream of the confluence of the Baker and Skagit Rivers in Whatcom and Skagit Counties and consists of the Lower Baker Development (constructed in 1925) and the Upper Baker Development (constructed in 1959). The Baker River Project’s current license expires on April 30, 2006, and PSE intends to submit an application for a new license on or before April 30, 2004.
Snoqualmie Falls Project. The Snoqualmie Falls Project, built in 1898, was the world’s first electric generating facility to be built totally underground. It is located 3.5 miles downstream of the confluence of the north, middle and south forks of the Snoqualmie River. The original license of the project was issued May 13, 1975, effective March 1, 1956, and terminated on December 31, 1993. PSE filed its application to relicense the project on November 25, 1991, and has been operating the project pursuant to annual licenses issued by FERC since the original license expired. The Snoqualmie Tribe appealed the Washington State Department of Ecology’s water quality certification, which the Washington State Pollution Control Hearings Board (PCHB) upheld on April 7, 2004. The Snoqualmie Tribe may appeal the PCHB’s ruling. PSE anticipates that FERC will issue an order concerning its license application during the second quarter 2004.
Electric Rate Matters
On April 5, 2004, PSE filed a general tariff electric rate case with the Washington Commission. The electric rate case proposes a 5.7% or $81.6 million annual increase to electric rates to recover costs associated with extending and upgrading facilities to serve a growing number of electric customers as well as strengthen PSE financially to serve its customers. The resolution of the electric general rate case may be up to an 11-month process from the time the electric general rate case was filed.
On April 23, 2004, the acquisition of a 49.85% interest in the Fredrickson I generating facility was approved by FERC. Prior to that approval, on April 7, 2004, the Washington Commission issued an order in PSE’s power cost only rate case granting approval for the acquisition of the Frederickson I generating facility. As a result of these approvals, PSE anticipates completing the acquisition in the second quarter of 2004. In its order, the Washington Commission found the acquisition to be prudent and the cost associated with the generating facility reasonable. The costs associated with the generating facility, including projected baseline gas costs, are approved for recovery in rates. The Washington Commission, however, reserved its determination of certain issues related to the Tenaska and Encogen generating facilities to a subsequent order. PSE requested clarification on other issues in the power cost only rate case that were not addressed in the April 7, 2004 order, but was denied clarification on these issues until resolution of the Tenaska and Encogen fuel cost proceeding. As described in an exhibit in the rate proceeding, the Washington Commission staff and PSE agreed on all power cost adjustments except those related to Tenaska and Encogen generating facilities. Those items agreed to in the proceeding would increase rates by $54.5 million.
PSE believes that the fuel cost disallowances relating to Encogen and Tenaska proposed by the Washington Commission staff are legally and factually deficient and PSE filed its rebuttal case on February 13, 2004. These costs are currently recovered in rates and PSE believes it is probable that recovery will occur in the future. The Washington Commission staff is independent from the Washington Commission in such a litigated proceeding and their positions do not represent an indication of the final outcome of the proceeding. The hearing was held in late February and the resolution of the final issues of the power cost only rate case is expected by the end of April 2004 barring any unforeseen circumstances.
In December 2003, PSE notified FERC that it rejected the 1997 license for the White River Project, because the 1997 license would have made the White River generation project uneconomical to produce electricity. As a result, generation of electricity ceased at the White River Project on January 15, 2004. In the same proceeding described above, the Washington Commission will be ruling on the accounting treatment that will allow for rate recovery of the unrecovered investment in the White River generating project. The Washington Commission staff’s testimony in PSE’s power cost only rate case supports PSE’s accounting treatment for recovery of the investment in the White River Project. At March 31, 2004, the White River Project net book value totaled $68.2 million, which included $47.5 million of net utility plant, $17.7 million of capitalized FERC licensing costs and $3.0 million of costs related to construction work in progress. The FERC licensing costs and construction work in progress charges have been deferred to a regulatory asset. The Washington Commission’s order on April 7, 2004 did not address the White River accounting treatment. However, PSE will continue to recover in rates the cost of the White River Plant over the period equal to the depreciation rate in effect at the time the plant ceased operations. This accounting treatment is the same as proposed by the Washington Commission Staff in the power cost only rate proceedings. The accounting treatment of the unrecovered White River Plant costs will be resolved at the same time the final order is issued on the Tenaska and Encogen fuel costs issues.
In June 2002, the Washington Commission approved and adopted the settlement stipulation in the general rate case, putting new rates into effect on July 1, 2002. PSE established an electric PCA mechanism in the rate case settlement. The PCA mechanism will account for differences in PSE’s modified actual power costs relative to a power cost baseline. The mechanism will account for a sharing of costs and benefits that are graduated over four levels of power cost variances, with an overall cap of $40 million (+/-) over the four year period July 1, 2002 through June 30, 2006 plus 1% of the excess over $40 million which was met in 2003. Under the PCA mechanism, all variable power cost rate increases since reaching the $40 million cap are apportioned 99% to customers and 1% to PSE. During the three months ended March 31, 2004, PSE’s excess variable power costs were apportioned $0.1 million to PSE and $13.9 million to customers. For the same period in 2003, PSE was apportioned all of the excess variable power costs of $11.6 million.
Gas Rate Matters
On April 5, 2004, PSE filed a general tariff gas rate case with the Washington Commission. The gas rate case proposes a 6.3% or $47.2 million annual increase to gas rates to recover cost associated with extending and upgrading facilities to serve a growing number of gas customers as well as strengthen PSE financially to serve its customers. The resolution of the gas general rate case may be up to an 11-month process from the time the gas general rate case was filed.
Proceedings Relating to the Western Power Market
California Independent System Operator (CAISO) Receivable and California Proceedings
Puget Energy’s and PSE’s Annual Report on Form 10-K for the year ended December 31, 2003 includes a summary of the Western power market proceedings described below. The following discussion provides a summary of material developments in these proceedings that occurred during the period covered by this report and of any material new proceedings instituted during the last quarter. While PSE cannot predict the outcome of any of the individual ongoing proceedings relating to the Western power markets, in the aggregate, PSE does not expect the ultimate resolution of the issues and cases discussed below to have a material adverse impact on the financial condition, results of operations or liquidity of the Company.
| 1. | CAISO Receivable and California Refund Proceeding. In 2001, PG&E and Southern California Edison defaulted on payment obligations owed to various energy suppliers, including the CAISO and the California PX. The CAISO in turn defaulted on its payment obligations to various energy suppliers, including obligations to PSE relating to sales made by PSE into the California energy market during the fourth quarter of 2000 through the CAISO. The California PX filed bankruptcy in 2001, further constraining PSE’s ability to receive payments due to controls placed on the California PX’s distribution of funds by the California PX bankruptcy court and due to the fact that the vast majority of funds owed directly to the CAISO are owed by the California PX. |
| | a. | California Refund Proceeding. On July 25, 2001, FERC ordered an evidentiary hearing (Docket No. EL00-95) to determine the amount of refunds due to California energy buyers, including the CAISO, for purchases made in the spot markets operated by the CAISO during the period October 2, 2000 through June 20, 2001.
On March 26, 2003, FERC issued an Order on Proposed Findings on Refund Liability in Docket No. EL00-95 that substantially adopted the recommendations made by the Administrative Law Judge on December 12, 2002, except that the Order also substantially adopts the FERC Staff gas price recommendation from the Staff’s August 2002 report. On October 16, 2003, FERC issued its Order on Rehearing that largely leaves the refund calculations established by the March 26 Order unchanged, although the Order allows generators to offset their actual gas costs against their refund liability. The CAISO currently estimates that it will be unable to complete the initial financial clearing as to “who owes what to whom” prior to November 2004.
Many of the numerous orders that FERC has issued in Docket No. EL00-95 are now on appeal before the United States Court of Appeals for the Ninth Circuit. On March 23, 2004, the Ninth Circuit consolidated most of these appeals. The now consolidated appeals remain in abeyance pursuant to an August 21, 2002, Ninth Circuit order directing FERC to allow parties to file additional evidence on market manipulation. |
| | b. | CAISO Receivable. PSE has a bad debt reserve and a transaction fee reserve applied to the CAISO receivable, such that PSE has a net receivable from the CAISO at March 31, 2004 of $21.3 million. PSE estimates the range for the receivable to be between $21.3 million and $22.8 million, including interest. In its October 16, 2003 Order on Rehearing in this docket, FERC expressly adopted and approved a stipulation that confirmed that two of PSE’s “non-spot market” transactions are not subject to mitigation in the Refund Proceeding. On October 17, 2003, PSE formally presented CAISO with a request that payment be made on these amounts. The CAISO responded to the letter on November 13, 2003, expressing an unwillingness to take the issue up separately or in advance of its cost re-run activities. PSE continues to pursue the issue in filings before the FERC.
On February 24, 2004, the CAISO issued a market notice that it would distribute more than $40 million in “defaulted receivables” to creditors for the November 2000 transactions in accordance with Tariff Amendment 53. The California Parties filed a motion at FERC seeking to cease distribution of the funds. FERC denied the motion and held that creditors should not have to face further delays in receiving payment and that the defaulted receivables should be timely disbursed. The CAISO distributed payments to creditors on March 25, 2004, including approximately $2.0 million to PSE. |
| 2. | Pacific Northwest Refund Proceeding. On June 25, 2003, FERC issued an order terminating the Pacific Northwest refund proceeding, Docket No. EL01-10, largely on procedural, jurisdictional and equitable grounds. Various parties filed rehearing requests on July 25, 2003. On November 10, 2003, FERC denied the rehearing requests. Seven petitions for review are now pending before the United States Court of Appeals for the Ninth Circuit. The parties now await an order setting a briefing schedule. |
| 3. | Orders to Show Cause. On June 25, 2003, FERC issued two show cause orders pertaining to its Western market investigations that commenced individual proceedings against many sellers. One show cause order (Docket Nos. EL03-180, et seq.) seeks to investigate approximately 26 entities that allegedly had potential “partnerships” with Enron. PSE was not named in that show cause order. In an order dismissing many of the already-named respondents in the “partnerships” proceeding on January 22, 2004, FERC states that it does not intend to proceed further against other parties.
The second show cause order (Docket No. EL03-169) named PSE along with approximately 54 other entities (Docket Nos. EL03-137, et seq.) that allegedly had engaged in potential “gaming” practices in the CAISO and California PX markets. PSE and FERC Staff filed a proposed settlement of all issues pending against PSE in those proceedings on August 28, 2003. The proposed settlement, which admits no wrongdoing on the part of PSE, would result in a payment of $17,092 to settle all claims. The California Parties filed for rehearing of that order repeating arguments that have already been addressed by FERC. On March 17, 2004, PSE filed a motion to dismiss the California Parties’ rehearing request. PSE continues to believe that the orders to show cause do not raise new issues or concerns and will not have a material adverse impact on the financial condition, results of operation or liquidity of the Company. |
| 4. | Anomalous Bidding Investigation. On June 25, 2003, FERC issued an order commencing a new investigatory proceeding (Docket No. IN03-10) to be conducted through its Office of Market Oversight and Investigations (OMOI). OMOI is investigating sellers’ bids into the CAISO or California PX markets that exceeded $250/MWh during the period of May 1, 2000 to October 1, 2000. The OMOI is to determine if each such entity’s bids show a pattern or an effort to manipulate the market, and if they do, to consider whether the entity should be required to disgorge any improper profits earned as a result of such patterns or efforts. PSE received a data request from the OMOI in this proceeding about its bids and responded on July 24, 2003. PSE has not received any further information requests. PSE does not expect any material adverse impacts on the financial condition of the Company from this FERC investigation. |
| 5. | Port of Seattle Suit. On May 21, 2003, the Port of Seattle commenced suit in federal court in Seattle against 22 energy sellers into the California market, alleging that the conduct of those sellers during 2000 and 2001 constituted market manipulation, violated antitrust laws, and damaged the Port of Seattle, which had a contract to purchase its complete energy supply from PSE at the time. The Port’s contract with PSE linked the price of the energy sold to the Port to an index price for energy sold at wholesale at the Mid-Columbia trading hub. The Port alleged that the Mid-Columbia price was intentionally affected improperly by the defendants, including PSE. PSE and other defendants moved to dismiss this case. The court heard oral argument on PSE’s motion to dismiss on March 26, 2004. The parties await an order on the motion to dismiss. |
| 6. | California Litigation.California Class Actions. No material developments have occurred in the two San Diego class actions since previous reports. The plaintiffs allege that all wholesale sellers in the California energy market engaged in anti-competitive behavior in violation of California Business Practices Act. The motions to dismiss, and the appeals of the remand orders, remain pending.Attorney General Case. No material developments have occurred in the California Attorney General suit against PSE since previous reports. The suit filed against a number of sellers, including PSE, alleges that PSE failed to file rates for sales to the CAISO in advance of transactions and thereby violated the California Business Practices Act. Oral argument for the dismissal appeal has been set to commence on June 14, 2004. |
Item 3. Quantitative and Qualitative Disclosure About Market Risk
The Company is exposed to market risks, including changes in commodity prices and interest rates.
Portfolio Management. The nature of serving regulated electric customers with its wholesale portfolio of owned and contracted 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 management function monitors and manages these risks using analytical models and tools. The Company manages its energy supply portfolio to achieve three primary objectives:
| • | | Ensure that physical energy supplies are available to serve retail customer requirements; |
| • | | Manage portfolio risks to limit undesired impacts on the Company’s costs; and |
| • | | Maximize the value of the Company’s energy supply assets. |
The portfolio is subject to major sources of variability (e.g., hydro generation, outage risk, regional economic factors, temperature-sensitive retail sales, and market prices for gas and power supplies). At certain times, these sources of variability can mitigate portfolio imbalances; at other times they can exacerbate portfolio imbalances.
The Company’s energy risk management staff develops hedging strategies for the Company’s energy supply portfolio. The first priority is to obtain reliable supply for delivery to the Company’s retail customers. The second priority is to protect against unwanted risk exposure. The third priority is to optimize excess capacity or flexibility within the wholesale portfolio. Most hedges can be implemented in ways that retain the Company’s ability to use its energy supply optimization opportunities. Other hedges are structured similarly to insurance instruments, where PSE pays an insurance premium to protect against certain extreme conditions.
Portfolio exposure is managed in accordance with Company polices and procedures. The Risk Management Committee, which is composed of Company officers, provides policy-level and strategic direction for management of the energy portfolio. The Audit Committee of the Company’s Board of Directors has oversight of the Risk Management Committee.
The prices of energy commodities are subject to fluctuations due to unpredictable factors including weather, generation outages and other factors, which impact supply and demand. The volumetric and commodity price risk is a consequence of purchasing energy at fixed and variable prices and providing deliveries at different tariffs and variable prices. Costs associated with ownership and operation of production facilities are another component of this risk. The Company may use forward physical delivery agreements and financial derivatives for the purpose of hedging commodity price risk. Without jeopardizing the security of supply within its portfolio, the Company will also engage in optimizing the portfolio. Optimization may take the form of utilizing excess capacity, shaping flexible resources to capture their highest value, utilizing transmission capacity or capitalizing on market price movement. As a result, portions of the Company’s energy portfolio are monetized through the use of forward price instruments.
The regulatory mechanisms of the PGA and the PCA mitigate the impact of commodity price volatility upon the Company. The PGA mechanism passes through to customers increases and decreases in the cost of natural gas supply. The PCA mechanism provides for a sharing of costs and benefits that are graduated over four levels of power cost variances with an overall cap of $40 million (+/-) plus 1% of the excess over the $40 million cap over the four-year period ending June 30, 2006.
Transactions that qualify as hedge transactions under SFAS No. 133 are recorded on the balance sheet at fair value. Changes in fair value of the Company’s derivatives are recorded each period in current earnings or other comprehensive income. Short-term derivative contracts for the purchase and sale of electricity are valued based upon daily quoted prices from an independent energy brokerage service. Valuations for short-term and medium-term natural gas financial derivatives are derived from a combination of quotes from several independent energy brokers and are updated daily. Long-term gas financial derivatives are valued based on published pricing from a combination of independent brokerage services and are updated monthly. Option contracts are valued using market quotes and a Monte Carlo simulation-based model approach.
At March 31, 2004, the Company had an after-tax net asset of approximately $21.0 million of energy contracts designated as qualifying cash flow hedges and a corresponding unrealized gain recorded in other comprehensive income. Of the amount in other comprehensive income, 99% has been reclassified out of other comprehensive income to a deferred account due to the Company reaching the $40 million cap under the PCA mechanism. The Company also had energy contracts that were marked-to-market at a gain through current earnings for the three months ended March 31, 2004 of $0.1 million as a result of 99% being reclassified to a deferred account due to the Company reaching the $40 million cap under the PCA mechanism. A hypothetical 10% increase in the market prices of natural gas and electricity would increase the fair value of qualifying cash flow hedges by approximately $5.8 million after-tax and would increase current earnings for those contracts marked-to-market in earnings by an insignificant amount as a result of applying the $40 million PCA mechanism cap.
Counterparty Credit Risk. The Company is subject to credit risk from counterparties based on transactions it enters into during the normal course of business. The Company is exposed to risk to the extent that counterparties fail to perform on their contractual obligations. These counterparties include other utilities, energy trading companies, financial institutions and natural gas production companies. The Company mitigates its exposure by transacting with counterparties that meet minimum credit thresholds, setting credit limits and obtaining master agreements. Credit limits are reviewed daily to ensure transactions continually meet the Company’s standards.
Interest Rate Risk. The Company believes its interest rate risk primarily relates to the use of short-term debt instruments, variable rate leases and 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 bank borrowings, 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 to manage the interest rate risk associated with these debts. The Company did not have any swap instruments outstanding as March 31, 2004.
Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures. Under the supervision and with the participation of Puget Energy’s and PSE’s management, including the Companies’ President and Chief Executive Officer and Senior Vice President and Chief Financial Officer, Puget Energy and PSE have evaluated the effectiveness of the Companies’ disclosure controls and procedures (as defined in Rule 13a-15(e)(c) under the Securities Exchange Act of 1934) as of the end of the fiscal quarter covered by this report. Based upon that evaluation, the President and Chief Executive Officer and Senior Vice President and Chief Financial Officer of Puget Energy and PSE concluded that these disclosure controls and procedures are effective as of the end of the quarter.
Changes in internal controls over financial reporting.There have been no significant changes in Puget Energy’s or PSE’s internal control over financial reporting during the quarter covered by this report that have materially affected, or are reasonably likely to materially affect, Puget Energy’s or PSE’s internal control over financial reporting.
PART II OTHER INFORMATION
Item 1. Legal Proceedings
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 Quarterly Report on Form 10-Q.
Contingencies arising out of the normal course of the Company’s business exist at March 31, 2004. 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.
| Item | 6. | | Exhibits and Reports on Form 8-K |
| | | | |
| | (a) | | See Exhibit Index for list of exhibits. |
| | | | |
| | (b) | | Reports on Form 8-K |
| | | | |
| | | | Filed by Puget Energy & Puget Sound Energy: |
| | | | |
| | | | Form 8-K dated February 4, 2004, Item 5 - Other Events, related to Washington Utilities and Transportation Commission Staff testimony of PSE's Power Cost Only Rate Case. |
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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/ Donald E. Gaines
|
| | Donald E. Gaines
Vice President Finance and Treasurer |
| | |
| Date: April 27, 2004 | Officer duly authorized to sign this report on behalf
of each registrant |
The following exhibits are filed herewith:
| | 12.1 | | Statement setting forth computation of ratios of earnings to fixed charges (1998 through 2003 and 12 months ended March 31, 2004) for Puget Energy. |
| | 12.2 | | Statement setting forth computation of ratios of earnings to fixed charges (1998 through 2003 and 12 months ended March 31, 2004) 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. 31.1 |
| | 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. |
