Exhibit 99.3
RISK FACTORS
WE ARE SUBJECT TO COMPLEX GOVERNMENT REGULATION WHICH MAY HAVE A NEGATIVE IMPACT
ON OUR BUSINESS AND OUR RESULTS OF OPERATIONS.
We are subject to comprehensive regulation by several federal, state and
local regulatory agencies, which significantly influence our operating
environment and may affect our ability to recover costs from utility customers.
We are required to have numerous permits, approvals and certificates from the
agencies that regulate our business. We believe the necessary permits, approvals
and certificates have been obtained for our existing operations; however, we are
unable to predict the impact on our operating results from the future regulatory
activities of any of these agencies. Changes in regulations or the imposition of
additional regulations could have an adverse impact on our results of
operations.
The Federal Energy Regulatory Commission ("FERC"), the Nuclear Regulatory
Commission ("NRC"), the Environmental Protection Agency ("EPA"), and the Arizona
Corporation Commission ("ACC") regulate many aspects of our utility operations,
including siting and construction of facilities, customer service and the rates
that we can charge customers.
We are unable to predict the impact on our business and operating results
from future regulatory activities of these federal, state and local agencies.
Changes in regulations or the imposition of additional regulations could have a
negative impact on our business and results of operations.
DEREGULATION OR RESTRUCTURING OF THE ELECTRIC INDUSTRY MAY RESULT IN INCREASED
COMPETITION, WHICH COULD HAVE A SIGNIFICANT ADVERSE IMPACT ON OUR BUSINESS AND
OUR FINANCIAL RESULTS.
Retail competition and the unbundling of regulated energy could have a
significant adverse financial impact on us due to an impairment of assets, a
loss of retail customers, lower profit margins or increased costs of capital. In
1999, the ACC approved rules that provide a framework for the introduction of
retail electric competition in Arizona. Under the rules, as modified by a 1999
settlement agreement among us and various parties, we are required to transfer
all of our competitive electric assets and services to an unaffiliated party or
parties or to a separate corporate affiliate or affiliates no later than
December 31, 2002. On September 10, 2002, the ACC unilaterally modified the 1999
settlement agreement and directed us to cancel any plans to divest interests in
any of our generating assets. The ACC further established a requirement that we
competitively procure, at a minimum, any power required for our retail customers
that we cannot produce from our existing generating assets. The ACC ordered the
ACC staff and interested parties to develop a competitive procurement process by
March 1, 2003. On September 16, 2002, APS filed an application with the ACC
requesting the ACC to allow APS to borrow up to $500 million and to lend the
proceeds to Pinnacle West Energy or to Pinnacle West; to gurantee up to $500
million of Pinnacle West Energy's or Pinnacle West's debt; or a combination of
both, not to exceed $500 million in the aggregate. On November 8, 2002, APS
filed an Interim Financing Application with the ACC requesting the ACC to permit
APS to (a) make short-term advances to Pinnacle West in the form of an
inter-affiliate line of credit in the amount of $125 million or (b) guarantee
$125 million of Pinnacle West's short-term debt. These regulatory developments
and legal challenges to the rules have raised considerable uncertainty about the
status and pace of retail electric competition in Arizona. Although some very
limited retail competition existed in our service area in 1999 and 2000, there
are currently no active retail competitors offering unbundled energy or other
utility services to our customers. As a result, we cannot predict when, and the
extent to which, additional competitors will re-enter our service territory.
These matters are discussed in detail in the documents filed by us with the SEC.
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As a result of changes in federal law and regulatory policy, competition in
the wholesale electricity market has greatly increased due to a greater
participation by traditional electricity suppliers, non-utility generators,
independent power producers, and wholesale power marketers and brokers. This
increased competition could affect our load forecasts, plans for power supply
and wholesale energy sales and related revenues. As a result of the changing
regulatory environment and the relatively low barriers to entry, we expect
wholesale competition to increase. As competition continues to increase, our
financial position and results of operations could be adversely affected.
THE UNCERTAIN OUTCOME REGARDING THE CREATION OF REGIONAL TRANSMISSION
ORGANIZATIONS, OR RTOS, MAY MATERIALLY IMPACT OUR OPERATIONS, CASH FLOWS OR
FINANCIAL POSITION.
In a December 1999 order, the FERC set minimum characteristics and
functions that must be met by utilities that participate in RTOs. The
characteristics for an acceptable RTO include independence from market
participants, operational control over a region large enough to support
efficient and nondiscriminatory markets, and exclusive authority to maintain
short-term reliability. On October 16, 2001, APS and other owners of electric
transmission lines in the Southwest filed with the FERC a request for a
declaratory order confirming that their proposal to form WestConnect RTO, LLC
would satisfy the FERC's requirements for the formation of an RTO. On October
10, 2002, the FERC issued an order finding that the WestConnect proposal, if
modified to address specified issues, could meet the FERC's RTO requirements and
provide the basic framework for a standard market design for the Southwest . In
its order, the FERC also stated that its approval of various WestConnect
provisions addressed in the order would not be overturned or affected by the
final rule the FERC intends to ultimately adopt in response to its July 31, 2002
Notice of Proposed Rulemaking regarding a standard market design for the
electric utility industry. FERC did not address all of the proposed WestConnect
provisions in its order and some could still be affected by a final rule in the
pending rulemaking proceeding. We cannot currently predict what, if any, impact
there may be to the WestConnect proposal or to us if the FERC adopts the
proposed rule. On November 12, 2002, APS and other owners filed a request for
rehearing and clarification on portions of the October 10 order.
WE ARE SUBJECT TO NUMEROUS ENVIRONMENTAL LAWS AND REGULATIONS WHICH MAY INCREASE
OUR COST OF OPERATIONS, IMPACT OUR BUSINESS PLANS, OR EXPOSE US TO ENVIRONMENTAL
LIABILITIES.
We are subject to numerous environmental regulations affecting many aspects
of our present and future operations, including air emissions, water quality,
wastewater discharges, solid waste, and hazardous waste. These laws and
regulations can result in increased capital, operating, and other costs,
particularly with regard to enforcement efforts focused on power plant emissions
obligations. These laws and regulations generally require us to obtain and
comply with a wide variety of environmental licenses, permits, inspections and
other approvals. Both public officials and private individuals may seek to
enforce applicable environmental laws and regulations. We cannot predict the
outcome (financial or operational) of any related litigation that may arise.
In addition, we may be a responsible party for environmental clean up at
sites identified by a regulatory body. We cannot predict with certainty the
amount and timing of all future expenditures related to environmental matters
because of the difficulty of estimating clean-up costs. There is also
uncertainty in quantifying liabilities under environmental laws that impose
joint and several liability on all potentially responsible parties.
We cannot be sure that existing environmental regulations will not be
revised or that new regulations seeking to protect the environment will not be
adopted or become applicable to us. Revised or additional regulations that
result in increased compliance costs or additional operating restrictions,
particularly if those costs are not fully recoverable from our customers, could
have a material adverse effect on our results of operations.
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RECENT EVENTS IN THE ENERGY MARKETS THAT ARE BEYOND OUR CONTROL MAY HAVE
NEGATIVE IMPACTS ON OUR BUSINESS.
As a result of the energy crisis in California during the summer of 2001,
the recent volatility of natural gas prices in North America, the filing of
bankruptcy by the Enron Corporation, and investigations by governmental
authorities into energy trading activities, companies generally in the regulated
and unregulated utility businesses have been under an increased amount of public
and regulatory scrutiny. The capital markets and ratings agencies also have
increased their level of scrutiny. We believe that we are complying with all
applicable laws, but it is difficult or impossible to predict or control what
effect these or related issues may have on our business or our access to the
capital markets.
OUR RESULTS OF OPERATIONS CAN BE ADVERSELY AFFECTED BY MILDER WEATHER.
Weather conditions in our service territory directly influence the demand
for electricity and affect the price of energy commodities. Electric power
demand is generally a seasonal business. In Arizona, demand for power peaks
during the hot summer months, with market prices also peaking at that time. As a
result, our overall operating results fluctuate substantially on a seasonal
basis. In addition, we have historically sold less power, and consequently
earned less income, when weather conditions are milder. As a result, unusually
mild weather could diminish our results of operations and harm our financial
condition.
THERE ARE INHERENT RISKS IN THE OPERATION OF NUCLEAR FACILITIES, SUCH AS
ENVIRONMENTAL, HEALTH AND FINANCIAL RISKS AND THE RISK OF TERRORIST ATTACK.
We have an ownership interest in and operate the Palo Verde Nuclear
Generating Station ("Palo Verde"). Palo Verde is subject to environmental,
health and financial risks such as the ability to dispose of spent nuclear fuel,
the ability to maintain adequate reserves for decommissioning, potential
liabilities arising out of the operation of these facilities, and the costs of
securing the facilities against possible terrorist attacks. We maintain
decommissioning trusts and external insurance coverage to minimize our financial
exposure to these risks; however, it is possible that damages could exceed the
amount of our insurance coverage.
The NRC has broad authority under federal law to impose licensing and
safety-related requirements for the operation of nuclear generation facilities.
In the event of noncompliance, the NRC has the authority to impose fines or shut
down a unit, or both, depending upon its assessment of the severity of the
situation, until compliance is achieved. In addition, although we have no reason
to anticipate a serious nuclear incident at Palo Verde, if an incident did
occur, it could materially and adversely affect our results of operations or
financial condition. A major incident at a nuclear facility anywhere in the
world could cause the NRC to limit or prohibit the operation or licensing of any
domestic nuclear unit.
The operation of Palo Verde requires licenses that need to be periodically
renewed and/or extended. We do not anticipate any problems renewing these
licenses. However, as a result of potential terrorist threats and increased
public scrutiny of utilities, the licensing process could result in increased
licensing or compliance costs that are difficult or impossible to predict.
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THE USE OF DERIVATIVE CONTRACTS IN THE NORMAL COURSE OF OUR BUSINESS COULD
RESULT IN FINANCIAL LOSSES THAT NEGATIVELY IMPACT OUR RESULTS OF OPERATIONS.
Our operations include managing market risks related to commodity prices,
changes in interest rates, and investments held by our nuclear decommissioning
trust fund. We are exposed to the impact of market fluctuations in the price and
transportation costs of electricity, natural gas, coal, and emissions
allowances. We employ established procedures to manage risks associated with
these market fluctuations by utilizing various commodity derivatives, including
exchange-traded futures and options and over-the-counter forwards, options, and
swaps. As part of our overall risk management program, we enter into derivative
transactions to hedge purchases and sales of electricity, fuels, and emissions
allowances and credits. The changes in market value of such contracts have a
high correlation to price changes in the hedged commodity.
We are exposed to losses in the event of nonperformance or nonpayment by
counterparties. We use a risk management process to assess and monitor the
financial exposure of all counterparties. Despite the fact that the great
majority of trading counterparties are rated as investment grade by the credit
rating agencies, there is still a possibility that one or more of these
companies could default, resulting in a material adverse impact on our earnings
for a given period.
Changing interest rates will affect interest paid on variable-rate debt and
interest earned by our pension and nuclear decommissioning trust fund. Our
policy is to manage interest rates through the use of a combination of
fixed-rate and floating-rate debt. The pension and nuclear decommissioning fund
also has risks associated with changing market values of equity investments.
Pension and nuclear decommissioning costs are recovered in regulated electricity
prices.
IF WE ARE NOT ABLE TO ACCESS CAPITAL AT COMPETITIVE RATES, OUR ABILITY TO
IMPLEMENT OUR FINANCIAL STRATEGY WILL BE ADVERSELY AFFECTED.
We rely on access to both short-term money markets and longer-term capital
markets as a significant source of liquidity and for capital requirements not
satisfied by the cash flow from our operations. We believe that we will maintain
sufficient access to these financial markets based upon current credit ratings.
However, certain market disruptions or a downgrade of our credit rating may
increase our cost of borrowing or adversely affect our ability to access one or
more financial markets. Such disruptions could include:
* an economic downturn;
* capital market conditions generally;
* the bankruptcy of an unrelated energy company;
* market prices for electricity and gas;
* terrorist attacks or threatened attacks on our facilities or unrelated
energy companies; or
* the overall health of the utility industry.
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Changes in economic conditions could result in higher interest rates, which
would increase our interest expense on our floating rate debt and reduce funds
available to us for our current plans. Additionally, an increase in our leverage
could adversely affect us by:
* increasing the cost of future debt financing;
* increasing our vulnerability to adverse economic and industry
conditions;
* requiring us to dedicate a substantial portion of our cash flow from
operations to payments on our debt, which would reduce funds available
to us for operations, future business opportunities or other purposes;
and
* placing us at a competitive disadvantage compared to our competitors
that have less debt.
See the following Risk Factor.
ANY REDUCTION IN OUR CREDIT RATINGS COULD MATERIALLY AND ADVERSELY AFFECT OUR
BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
We cannot be sure that any of our current ratings will remain in effect for
any given period of time or that a rating will not be lowered or withdrawn
entirely by a rating agency if, in its judgment, circumstances in the future so
warrant. Any downgrade could increase our borrowing costs which would diminish
our financial results. We would likely be required to pay a higher interest rate
in future financings, and our potential pool of investors and funding sources
could decrease. A downgrade could require additional support from letters of
credit or cash collateral and otherwise have a material adverse effect on our
business, financial condition and results of operations. If our short-term
ratings were to be lowered, it could limit our access to the commercial paper
market. We note that the ratings from credit agencies are not recommendations to
buy, sell or hold our securities and that each rating should be evaluated
independently of any other rating. On November 4, 2002, Standard & Poor's
Corporation lowered the Company's corporate credit rating from BBB+ to BBB and
lowered Pinnacle West Capital Corporation's senior unsecured debt rating from
BBB to BBB-. See the preceding Risk Factor.
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