Exhibit 99.3
RISK FACTORS
Set forth below and in other documents we file with the Securities and Exchange
Commission ("SEC") are risks and uncertainties that could affect our financial
results.
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 governmental regulation which may have a negative impact on
our business and results of operations. We are a "subsidiary company" of a
"holding company" within the meaning of the Public Utility Holding Company Act
("PUHCA"); however, we are exempt from the provisions of PUHCA by virtue of the
filing of an annual exemption statement with the SEC by our parent company,
Pinnacle West Capital Corporation ("Pinnacle West").
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. 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 believe the
necessary permits, approvals and certificates have been obtained for our
existing operations. However, we are unable to predict the impact on our
business and 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.
WE CANNOT PREDICT THE OUTCOME OF THE GENERAL RATE CASE THAT WE WILL FILE WITH
THE ACC ON OR BEFORE JUNE 30, 2003.
As required by a 1999 settlement agreement among us and various parties (the
"1999 Settlement Agreement"), on or before June 30, 2003, we will file a general
rate case with the ACC. In this rate case, we will update our cost of service
and rate design. In addition, we expect to seek:
* rate base treatment of certain power plants currently owned by
Pinnacle West Energy Corporation, a subsidiary of Pinnacle West
("Pinnacle West Energy") (specifically, Redhawk Units 1 and 2, West
Phoenix Units 4 and 5 and Saguaro Unit 3);
* recovery of the $234 million pretax asset write-off recorded by us as
part of the 1999 Settlement Agreement ($140 million extraordinary
charge recorded on the 1999 Statement of Income); and
* recovery of costs incurred by us in preparation for the previously
required transfer of generation assets to Pinnacle West Energy.
The general rate case will also address the implementation of rate adjustment
mechanisms that were the subject of ACC hearings in April 2003. The rate
adjustment mechanisms, which were authorized as a result of the 1999 Settlement
Agreement, would allow us to recover several types of costs, the most
significant of which are power supply costs (fuel and purchased power costs) and
costs associated with complying with the ACC retail electric competition rules
described below. We assume that the ACC will make a decision in this general
rate case by the end of 2004. We cannot predict the outcome of the rate case and
the resulting levels of regulated revenues.
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 those of
unrelated energy companies; or
* the overall health of the utility industry.
Changes in economic conditions could result in higher interest rates, which
would increase our interest expense on our 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 for more information relating to this discussion.
A SIGNIFICANT 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 in the form of letters of
credit or cash or other 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.
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 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 the 1999 Settlement Agreement, we were required to
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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. Pursuant to an ACC order dated 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
has further established a requirement that we solicit bids for certain estimated
capacity and energy requirements for periods beginning July 1, 2003. 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.
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 PROCUREMENT OF WHOLESALE POWER BY US WITHOUT THE ABILITY TO ADJUST RETAIL
RATES COULD HAVE AN ADVERSE IMPACT ON OUR BUSINESS AND FINANCIAL RESULTS.
The 1999 Settlement Agreement limits our ability to change retail rates until at
least July 1, 2004, which could have a significant adverse financial impact on
us if wholesale power prices significantly exceed the amount included for
generation costs in our current bundled retail rates. Under the ACC's rules, we
are the "provider of last resort" for standard-offer, full-service customers
under rates that have been approved by the ACC. These rates are established
until at least July 1, 2004. The 1999 Settlement Agreement allows us to seek
adjustment of these rates in the event of emergency conditions or circumstances,
such as the inability to secure financing on reasonable terms; material changes
in our cost of service for ACC-regulated services resulting from federal,
tribal, state or local laws; regulatory requirements; or judicial decisions,
actions or orders. Energy prices in the western wholesale market vary and,
during the course of the last two years, have been volatile. At various times,
prices in the spot wholesale market have significantly exceeded the amount of
generation costs per kilowatt hour included in our current retail rates. In the
event of shortfalls due to unforeseen increases in load demand or generation or
transmission outages, we may need to purchase additional supplemental power in
the wholesale spot market. The ACC has further established a requirement that we
solicit bids for certain estimated capacity and energy requirements for periods
beginning July 1, 2003. This competitive procurement process may adversely
affect the cost of our procurement of wholesale power. In sum, there can be no
assurance that we would be able to fully recover the costs of wholesale power
under our present rate structure. Although we could seek to adjust our rates
under the emergency provisions of the settlement agreement discussed above, ACC
approval of such an adjustment also cannot be assured.
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 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
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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 nuclear
decommissioning trust funds and external insurance coverage to minimize our
financial exposure to these risks; however, it is possible that damages could
exceed the amount of 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.
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 pension plan and nuclear
decommissioning trust funds. We are exposed to the impact of market fluctuations
in the price and transportation costs of electricity, natural gas, coal, and
emissions allowances and credits. We have 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 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 plan and nuclear decommissioning trust funds. Our
policy is to manage interest rates through the use of a combination of
fixed-rate and floating-rate debt. The pension plan and nuclear decommissioning
trust funds also have risks associated with changing market values of equity
investments. Most of the pension costs and all of the nuclear decommissioning
costs are recovered in regulated electricity prices.
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 regional transmission
organizations. The characteristics for an acceptable RTO include independence
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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, we and other owners of
electric transmission lines in the Southwest filed with the FERC a request for a
declaratory order confirming that our 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. As
of March 28, 2003, the FERC was considering various aspects of its order as a
result of requests for clarification filed by the WestConnect applicants.
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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