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Puget Sound Energy Inc (81100) SEC Filing 10-K Annual report for the fiscal year ending Monday, December 31, 2018

Puget Sound Energy Inc

CIK: 81100
Document And Entity Information
12 Months Ended
Dec. 31, 2018
shares
Jun. 30, 2016
USD ($)
Entity Information [Line Items]  
EBITDA to Interest Expense Denominator1.0 
Dividends, Earnings Before Interest, Tax, Deprecation and Amortization Ratio at Period End1.0 
Entity Registrant NamePUGET ENERGY INC /WA 
Entity Central Index Key0001085392 
Current Fiscal Year End Date--12-31 
Entity Well-known Seasoned IssuerNo 
Entity Voluntary FilersNo 
Entity Current Reporting StatusYes 
Entity Filer CategoryNon-accelerated Filer 
Entity Public Float | $ $ 0
Entity Common Stock, Shares Outstanding | shares200 
Document Fiscal Year Focus2018 
Document Fiscal Period FocusFY 
Document Type10-K 
Amendment Flagfalse 
Entity Emerging Growth Companyfalse 
Entity Small Businessfalse 
Entity Shell Companyfalse 
Document Period End DateDec. 31, 2018 
Subsidiaries [Member]  
Entity Information [Line Items]  
EBITDA to Interest Expense Denominator1.0 
Dividends, Earnings Before Interest, Tax, Deprecation and Amortization Ratio at Period End1.0 
Entity Registrant NamePUGET SOUND ENERGY INC 
Entity Central Index Key0000081100 
Current Fiscal Year End Date--12-31 
Entity Well-known Seasoned IssuerNo 
Entity Voluntary FilersNo 
Entity Current Reporting StatusYes 
Entity Filer CategoryNon-accelerated Filer 
Entity Public Float | $ $ 0
Entity Common Stock, Shares Outstanding | shares85,903,791 
Document Fiscal Year Focus2018 
Document Fiscal Period FocusFY 
Document Type10-K 
Amendment Flagfalse 
Entity Emerging Growth Companyfalse 
Entity Small Businessfalse 
Entity Shell Companyfalse 
Document Period End DateDec. 31, 2018 


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

/X/
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  

For the fiscal year ended December 31, 2018

OR

/  /
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 
For the transition period from ___________ to ___________

 
 
Commission
File Number
Exact name of registrant as specified in its charter,
state of incorporation,
address of principal executive offices, zip code
telephone number
I.R.S.
Employer
Identification
Number

pelogoa03a02a18.jpg
1-16305
PUGET ENERGY, INC.
A Washington Corporation
355 110th Ave NE
Bellevue, Washington 98004
(425) 454-6363
91-1969407
 
  pselogocolorsmalla21.jpg
1-4393
PUGET SOUND ENERGY, INC.
A Washington Corporation
355 110th Ave NE
Bellevue, Washington 98004
(425) 454-6363
91-0374630

Securities registered pursuant to Section 12(b) of the Act:                                                                                                None
 
 
 
 
 

Securities registered pursuant to Section 12(g) of the Act:                               None
 
 
 
 
 







Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Puget Energy, Inc.
Yes
/  /
 
No
/X/
 
Puget Sound Energy, Inc.
Yes
/ /
 
No
/X/

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Puget Energy, Inc.
Yes
/  /
 
No
/X/
 
Puget Sound Energy, Inc.
Yes
/  /
 
No
/X/

Indicate by check mark whether the registrants: (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days.
Puget Energy, Inc.
Yes
/X/
 
No
/  /
 
Puget Sound Energy, Inc.
Yes
/X/
 
No
/  /

Indicate by check mark whether the registrants have submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Puget Energy, Inc.
Yes
/X/
 
No
/  /
 
Puget Sound Energy, Inc.
Yes
/X/
 
No
/  /

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   /X/

Indicate by check mark whether registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Puget Energy, Inc.
Large accelerated filer
/  /
Accelerated filer
/  /
Non-accelerated filer
/X/
Smaller reporting company
/  /
Emerging growth company
/  /
Puget Sound Energy, Inc.
Large accelerated filer
/  /
Accelerated filer
/  /
Non-accelerated filer
/X/
Smaller reporting company
/  /
Emerging growth company
/  /

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. / /


Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Puget Energy, Inc.
Yes
/  /
 
No
/X/
 
Puget Sound Energy, Inc.
Yes
/  /
 
No
/X/

As of February 6, 2009, all of the outstanding shares of voting stock of Puget Energy, Inc. are held by Puget Equico LLC, an indirect wholly-owned subsidiary of Puget Holdings LLC.

All of the outstanding shares of voting stock of Puget Sound Energy, Inc. are held by Puget Energy, Inc.

This Report on Form 10-K is a combined report being filed separately by: Puget Energy, Inc. and Puget Sound Energy, Inc.  Puget Sound Energy, Inc. makes no representation as to the information contained in this report relating to Puget Energy, Inc. and the subsidiaries of Puget Energy, Inc. other than Puget Sound Energy, Inc. and its subsidiaries.






INDEX
 
Page
 
1.         Business
1A.      Risk Factors
2.         Properties
3.         Legal Proceedings
4.         Mine Safety Disclosures
 
 
 
6.         Selected Financial Data
9B.      Other Information
 
 
 
11.       Executive Compensation
 
 
 
 
16.       Form 10-K Summary

3



DEFINITIONS
AFUDC
Allowance for Funds Used During Construction
AOCI
Accumulated Other Comprehensive Income
ARO
Asset Retirement and Environmental Obligations
aMW
Average Megawatt
ASC
Accounting Standards Codification
ASU
Accounting Standards Update
BPA
Bonneville Power Administration
Colstrip
Colstrip, Montana coal-fired steam electric generation facility
Dth
Dekatherm (one Dth is equal to one MMBtu)
EBITDA
Earnings Before Interest, Tax, Depreciation and Amortization 
EPA
Environmental Protection Agency
ERF
Expedited Rate Filing
FASB
Financial Accounting Standards Board
FERC
Federal Energy Regulatory Commission
GAAP
Generally Accepted Accounting Principles
GHG
Greenhouse Gases
GRC
General Rate Case
IRP
Integrated Resource Plan
IRS
Internal Revenue Service
ISDA
International Swaps and Derivatives Association
JPUD
Jefferson County Public Utility District
kW
Kilowatt (one kW equals one thousand watts)
kWh
Kilowatt Hour (one kWh equals one thousand watt hours)
LIBOR
London Interbank Offered Rate
LNG
Liquefied Natural Gas
LTI Plan
Long-Term Incentive Plan
MMBtus
One Million British Thermal Units
MW
Megawatt (one MW equals one thousand kW)
MWh
Megawatt Hour (one MWh equals one thousand kWh)
NAESB
North American Energy Standards Board
NOAA
National Oceanic and Atmospheric Administration
NPNS
Normal Purchase Normal Sale
NWP
Northwest Pipeline, LLC
NYSE
New York Stock Exchange
OCI
Other Comprehensive Income
PCA
Power Cost Adjustment
PCORC
Power Cost Only Rate Case
PGA
Purchased Gas Adjustment
PSE
Puget Sound Energy, Inc.
PTC
Production Tax Credit
PUDs
Washington Public Utility Districts
Puget Energy
Puget Energy, Inc.
Puget Equico
Puget Equico, LLC
Puget Holdings
Puget Holdings, LLC
REC
Renewable Energy Credit
REP
Residential Exchange Program
SEC
United States Securities and Exchange Commission
SERP
Supplemental Executive Retirement Plan
TCJA
Tax Cuts and Jobs Act
Washington Commission
Washington Utilities and Transportation Commission
WSPP
WSPP, Inc.


4



FORWARD-LOOKING STATEMENTS

Puget Energy and PSE include the following cautionary statements in this Form 10-K to make applicable and to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 for any forward-looking statements made by or on behalf of Puget Energy or PSE. This report includes forward-looking statements, which are statements of expectations, beliefs, plans, objectives and assumptions of future events or performance. Words or phrases such as “anticipates,” “believes,” “continues,” “could,” “estimates,” “expects,” “future,” “intends,” “may,” “might,” “plans,” “potential,” “predicts,” “projects,” “should,” “will likely result,” “will continue” or similar expressions are intended to identify certain of these forward-looking statements and may be included in discussion of, among other things, our anticipated operating or financial performance, business plans and prospects, planned capital expenditures and other future expectations. In particular, these include statements relating to future actions, business plans and prospects, future performance expenses, the outcome of contingencies, such as legal proceedings, government regulation and financial results.
Forward-looking statements reflect current expectations and involve risks and uncertainties that could cause actual results or outcomes to differ materially from those expressed. There can be no assurance that Puget Energy’s and PSE’s expectations, beliefs or projections will be achieved or accomplished.
In addition to other factors and matters discussed elsewhere in this report, some important risks that could cause actual results or outcomes for Puget Energy and PSE to differ materially from past results and those discussed in the forward-looking statements include:

Governmental policies and regulatory actions, including those of the Federal Energy Regulatory Commission (FERC) and the Washington Utilities and Transportation Commission (Washington Commission), that may affect our ability to recover costs and earn a reasonable return, including but not limited to disallowance or delays in the recovery of capital investments and operating costs and discretion over allowed return on investment;
Changes in, adoption of and compliance with laws and regulations, including decisions and policies concerning the environment, climate change, greenhouse gas or other emissions or by products of electric generation (including coal ash or other substances), natural resources, and fish and wildlife (including the Endangered Species Act) as well as the risk of litigation arising from such matters, whether involving public or private claimants or regulatory investigative or enforcement measures;
Changes in tax law, related regulations or differing interpretation, including as a result of the Tax Cuts and Jobs Act (TCJA), or enforcement of applicable law by the Internal Revenue Services (IRS) or other taxing jurisdiction and PSE's ability to recover costs in a timely manner arising from such changes;
Inability to realize deferred tax assets and use production tax credits (PTCs) due to insufficient future taxable income;
Accidents or natural disasters, such as hurricanes, windstorms, earthquakes, floods, fires and landslides, and other acts of God, terrorism, asset-based or cyber-based attacks, pandemic or similar significant events, which can interrupt service and lead to lost revenue, cause temporary supply disruptions and/or price spikes in the cost of fuel and raw materials and impose extraordinary costs;
Commodity price risks associated with procuring natural gas and power in wholesale markets from creditworthy counterparties;
Wholesale market disruption, which may result in a deterioration of market liquidity, increase the risk of counterparty default, affect the regulatory and legislative process in unpredictable ways, negatively affect wholesale energy prices and/or impede PSE's ability to manage its energy portfolio risks and procure energy supply, affect the availability and access to capital and credit markets and/or impact delivery of energy to PSE from its suppliers;
Financial difficulties of other energy companies and related events, which may affect the regulatory and legislative process in unpredictable ways, adversely affect the availability of and access to capital and credit markets and/or impact delivery of energy to PSE from its suppliers;
The effect of wholesale market structures (including, but not limited to, regional market designs or transmission organizations) or other related federal initiatives;
PSE electric or natural gas distribution system failure, blackouts or large curtailments of transmission systems (whether PSE's or others'), or failure of the interstate natural gas pipeline delivering to PSE's system, all of which can affect PSE's ability to deliver power or natural gas to its customers and generating facilities;
Electric plant generation and transmission system outages, which can have an adverse impact on PSE's expenses with respect to repair costs, added costs to replace energy or higher costs associated with dispatching a more expensive generation resource;
The ability to restart generation following a regional transmission disruption;
The ability of a natural gas or electric plant to operate as intended;
Changes in climate or weather conditions in the Pacific Northwest, which could have effects on customer usage and PSE's revenue and expenses;

5



Regional or national weather, which could impact PSE's ability to procure adequate supplies of natural gas, fuel or purchased power to serve its customers and the cost of procuring such supplies;
Variable hydrological conditions, which can impact streamflow and PSE's ability to generate electricity from hydroelectric facilities;
Variable wind conditions, which can impact PSE's ability to generate electricity form the wind facilities;
The ability to renew contracts for electric and natural gas supply and the price of renewal;
Industrial, commercial and residential growth and demographic patterns in the service territories of PSE;
General economic conditions in the Pacific Northwest, which may impact customer consumption or affect PSE's accounts receivable;
The loss of significant customers, changes in the business of significant customers or the condemnation of PSE's facilities as a result of municipalization or other government action or negotiated settlement, which may result in changes in demand for PSE's services;
The failure of information systems or the failure to secure information system data, which may impact the operations and cost of PSE's customer service, generation, distribution and transmission;
Opposition and social activism that may hinder PSE's ability to perform work or construct infrastructure;
Capital market conditions, including changes in the availability of capital and interest rate fluctuations;
Employee workforce factors, including strikes, work stoppages, availability of qualified employees or the loss of a key executive;
The ability to obtain insurance coverage, the availability of insurance for certain specific losses, and the cost of such insurance;
The ability to maintain effective internal controls over financial reporting and operational processes;
Changes in Puget Energy's or PSE's credit ratings, which may have an adverse impact on the availability and cost of capital for Puget Energy or PSE generally; and
Deteriorating values of the equity, fixed income and other markets which could significantly impact the value of investments of PSE's retirement plan, post-retirement medical benefit plan trusts and the funding of obligations thereunder.

Any forward-looking statement speaks only as of the date on which such statement is made and, except as required by law, the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events.  New factors emerge from time to time and it is not possible for management to predict all such factors, nor can it assess the impact of any such factor on the business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement.  For further information, see the reports on Form 10-Q and current reports on Form 8-K.

6



PART I

ITEM 1.  BUSINESS

General
Puget Energy is an energy services holding company incorporated in the state of Washington in 1999.  Substantially, all of its operations are conducted through its regulated subsidiary, PSE, a utility company.  Puget Energy also has a wholly-owned, non-regulated subsidiary, Puget LNG, LLC (Puget LNG), which was formed in 2016 and has the sole purpose of owning, developing and financing the non-regulated activity of a liquefied natural gas (LNG) facility at the Port of Tacoma, Washington.
Puget Energy is owned through a holding company structure by Puget Holdings, LLC (Puget Holdings).  Puget Holdings is owned by a consortium of long-term infrastructure investors including Macquarie Infrastructure Partners, Macquarie Capital Group Limited, the Canada Pension Plan Investment Board (CPPIB), the British Columbia Investment Management Corporation (BCIMC) and the Alberta Investment Management Corporation (AIMCo).  All of Puget Energy’s common stock is indirectly owned by Puget Holdings. In August 2018, Macquarie Infrastructure Partners and Macquarie Capital Group Limited reached an agreement to sell their shares to Ontario Municipal Employee Retirement System (OMERS), PGGM Vermogensbeheer B.V., AIMCo and BCIMC.  The sale is conditioned upon the approval of various federal and state agencies, including that of the Washington Commission.  Puget Energy and PSE are collectively referred to herein as “the Company.”

Corporate Strategy
Puget Energy is the direct parent company of PSE, the oldest and largest electric and natural gas utility headquartered in the state of Washington, primarily engaged in the business of electric transmission, distribution and generation and natural gas distribution.  Puget Energy’s business strategy is to generate stable earnings and cash flow by offering reliable electric and natural gas service in a cost-effective manner through PSE.

Customers and Revenue Overview
PSE is a public utility incorporated in the state of Washington in 1960.  PSE furnishes electric and natural gas service in a territory covering approximately 6,000 square miles, principally in the Puget Sound region.
The following tables present the number of PSE customers and revenue by customer class for electric and natural gas as of December 31, 2018 and 2017:
 
December 31,
 
 
 
December 31,
 
 
 
2018
 
2017
 
Percent
 
2018
 
2017
 
Percent
Customer Count by Class
Electric
 
Change
 
Natural Gas
 
Change
Residential
1,017,765

 
1,003,984

 
1.4%
 
778,198

 
767,045

 
1.5%
Commercial
129,248

 
127,836

 
1.1
 
56,366

 
55,996

 
0.7
Industrial
3,343

 
3,377

 
(1.0)
 
2,314

 
2,332

 
(0.8)
Other
7,140

 
6,856

 
4.1
 
234

 
226

 
3.5
Total1
1,157,496

 
1,142,053

 
1.4%
 
837,112

 
825,599

 
1.4%
_______________
1 
At December 31, 2018 and 2017, approximately 404,540 and 398,518 customers purchased both electricity and natural gas from PSE, respectively.


7



 
December 31,
 
 
 
December 31,
 
 
Retail Revenue by Class
2018
 
2017
 
Percent
 
2018
 
2017
 
Percent
(Dollars in Thousands)
Electric
 
Change
 
Natural Gas
 
Change
Residential
$
1,147,260

 
$
1,232,075

 
(6.9)%
 
$
598,923

 
$
686,438

 
(12.7)%
Commercial
885,457

 
892,360

 
(0.8)
 
239,552

 
274,907

 
(12.9)
Industrial
110,607

 
112,817

 
(2.0)
 
18,198

 
21,071

 
(13.6)
Other
32,596

 
32,313

 
0.9
 
19,984

 
21,718

 
(8.0)
Total
$
2,175,920

 
$
2,269,565

 
(4.1)%
 
$
876,657

 
$
1,004,134

 
(12.7)%


PSE's revenues and associated expenses are not generated evenly throughout the year, primarily due to seasonal weather patterns, varying wholesale prices for electricity and the amount of hydroelectric energy supplies available to PSE, which make quarter-to-quarter comparisons difficult. Weather conditions in PSE's service territory have an impact on customer energy usage and affect PSE's billed revenue and energy supply expenses. While both PSE's electric and natural gas sales are generally greatest during winter months, variations in energy usage by customers occur from season to season and also month to month within a season, primarily as result of weather conditions. PSE normally experiences its highest retail energy sales, and corresponding higher power costs, during the winter heating season in the first and fourth quarters of the year and its lowest sales and corresponding lower power costs in the third quarter of the year. While fluctuations in weather conditions will continue to affect PSE's billed revenue and energy supply expenses from month to month, PSE's decoupling mechanisms for electric and natural gas operations are expected to normalize the impact of weather on operating revenue and net income. Under the decoupling mechanism, the Washington Commission allows PSE to record a monthly adjustment to its electric and natural gas operating revenues related to electric transmission and distribution, natural gas operations and general administrative costs from residential, commercial and industrial customers. For additional information, see Business, "Regulation and Rates" included in Item 1 of this report and Note 4, "Regulation and Rates" to the consolidated financial statements included in Item 8 of this report.

Capital Expenditures
The following tables present PSE's capital expenditures for the five-year period ended December 31, 2018 and gross utility plant by category and percentages as of December 31, 2018:
Utility Plant Additions/Retirements 5-Year Total
2014 - 2018
(Dollars in Thousands)
Electric
 
Natural Gas
 
Common
Additions
$
1,794,022

 
$
999,900

 
$
664,448

Retirements
(495,286
)
 
(121,870
)
 
(259,506
)
Net Utility Plant
$
1,298,736

 
$
878,030

 
$
404,942


Utility Plant Balance
December 31, 2018
(Dollars in Thousands)
Electric
 
Natural Gas
 
Common
Distribution
$
3,939,924

 
37.2
%
 
$
3,782,100

 
90.8
%
 
$

 
%
Generation
3,965,868

 
37.5

 
8,383

 
0.2

 

 

Transmission
1,550,950

 
14.6

 

 

 

 

General Plant & Other
1,130,489

 
10.7

 
374,006

 
9.0

 
1,052,544

 
100.0

Total
$
10,587,231

 
100.0
%
 
$
4,164,489

 
100.0
%
 
$
1,052,544

 
100.0
%

Employees
At December 31, 2018, PSE had approximately 3,140 full-time equivalent employees.  Approximately 1,070 PSE employees are represented by the International Brotherhood of Electrical Workers Union (IBEW) or the United Association of Plumbers and Pipefitters (UA).  The contracts with the IBEW and the UA were both ratified effective December 2017 and will expire March 31, 2020 and September 30, 2021, respectively.
Puget Energy does not have any employees. PSE's employees provide employment services to Puget Energy and charges for their related salaries and benefits at cost.

8




Corporate Location
PSE’s and Puget Energy's principal executive offices are located at 355 110th Ave NE, Bellevue, Washington 98004 and the telephone number is (425) 454-6363.

Available Information
The Company’s reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available or may be accessed free of charge at the Company’s website, www.pugetenergy.com. SEC maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC and information may also be obtained via the SEC Internet website at www.sec.gov.

Regulation and Rates
PSE is subject to the regulatory authority of: (i) the FERC with respect to the transmission of electricity, the sale of electricity at wholesale, accounting and certain other matters; and (ii) the Washington Commission as to retail rates, accounting, the issuance of securities and certain other matters.  PSE also must comply with mandatory electric system reliability standards developed by the North American Electric Reliability Corporation (NERC), the electric reliability organization certified by the FERC, whose standards are enforced by the Western Electricity Coordinating Council (WECC) in PSE’s operating territory.
Rate mechanisms include: (i) trackers that typically track specific costs during the previous twelve-month period and (ii) riders that project cost recovery during a forward-looking twelve-month period. Both allow recovery of expenditures outside the process of a full general rate case (GRC).
The following table shows PSE’s rate filings for its trackers and riders and whether or not they are included in decoupling rates:
Rate Filings
Electric
 
Natural Gas
Baseline rates
Yes
 
Yes
Annual rate plan increase (only applicable through December 2017)
Yes
 
Yes
Expedited rate filing rider
Yes
 
Yes
Merger credit
No
 
No
Power cost only rates mechanism
No
 
N/A
Federal incentive tracker
No
 
N/A
Low income rates tracker
No
 
No
Pipeline cost recovery mechanism tracker
N/A
 
No
Prior year decoupling deferral tracker
No
 
No
Property tax tracker
No
 
No
Renewable energy credit tracker
No
 
N/A
Residential exchange credits tracker
No
 
N/A
Conservation costs rider
No
 
No
PGA rider
N/A
 
No

Expedited Rate Filing
On November 7, 2018, PSE filed an expedited rate filing (ERF) with the Washington Commission. On January 22, 2019, all parties in the proceeding reached an agreement on settlement terms. The settlement agreement was filed on January 30, 2019. A ruling by the Washington Commission is expected in enough time to implement rates on March 1, 2019. For further details regarding the 2018 ERF filing, see Note 4, "Regulations and Rates" to the consolidated financial statements included in item 8 of this report.

General Rate Case Filing
On January 13, 2017, PSE filed its GRC with the Washington Commission, the settlement agreement was accepted by the Washington Commission on December 5, 2017 and the rates became effective December 19, 2017. For further details regarding the 2017 GRC filing, see Note 4, "Regulation and Rates" to the consolidated financial statements included in Item 8 of this report.

9




Decoupling Filings
While fluctuations in weather conditions will continue to affect PSE's billed revenue and energy supply expenses from month to month, PSE's decoupling mechanisms assist in mitigating the impact of weather on operating revenue and net income. Since July 2013, the Washington Commission has allowed PSE to record a monthly adjustment to its electric and natural gas operating revenues related to electric transmission and distribution, natural gas operations and general administrative costs and beginning December 19, 2017, fixed production costs from most residential, commercial and industrial customers. This monthly adjustment mitigates the effects of abnormal weather, conservation impacts and changes in usage patterns per customer. As a result, these electric and natural gas revenues are recovered on a per customer basis regardless of actual consumption levels. The energy supply costs, which are part of the power cost adjustment (PCA) and purchased gas adjustment (PGA) mechanisms, are not included in the decoupling mechanism. Total electric and natural gas revenue recorded under the decoupling mechanisms will be affected by customer growth and not actual consumption except for fixed production costs, which are held at the level of cost from the most recent rate proceeding and are not impacted by customer growth. Following each calendar year, PSE will recover from, or refund to, customers the difference between allowed decoupling revenue and the corresponding actual revenue during the following May to April time period. For further details regarding decoupling filings, see Note 4, "Regulation and Rates" to the consolidated financial statements included in Item 8 of this report.

Electric Rate Filings
Power Cost Adjustment Mechanism
PSE currently has a PCA mechanism that provides for the deferral of power costs that vary from the “power cost baseline” level of power costs. The “power cost baseline” is set in part, based on normalized assumptions about weather and hydrological conditions.  Excess power costs or savings are apportioned between PSE and its customers pursuant to the graduated scale set forth in the PCA mechanism and will trigger a surcharge or refund when the $20.0 million cumulative deferral trigger is reached.
On August 7, 2015, the Washington Commission issued an order approving changes to the PCA mechanism. The settlement agreement took effect January 1, 2017 and will apply the following graduated scale:
 
Company's Share
 
Customers’ Share
Annual Power Cost Variability
Over
 
Under
 
Over
 
Under
Over or Under Collected by up to $17 million
100%
 
100%
 
—%
 
—%
Over or Under Collected by between $17 million - $40 million
35
 
50
 
65
 
50
Over or Under Collected beyond $40 + million
10
 
10
 
90
 
90

Electric Conservation Rider
The electric conservation rider collects revenue to cover the costs incurred in providing services and programs for conservation. Rates change annually on May 1 to collect the annual budget that started the prior January and to true-up for actual compared to forecast conservation expenditures from the prior year, as well as actual compared to the forecasted load set in rates.

Federal Incentive Tracker Tariff
The Federal Incentive Tracker Tariff passes through to customers the benefits associated with the wind-related treasury grants. The filing results in a credit back to customers for pass-back of treasury grant amortization and pass-through of interest and any related true-ups. The filing is adjusted annually for new Federal benefits, actual versus forecast interest and to true-up for actual load being different than the forecasted load set in rates. Rates change annually on January 1.

Power Cost Only Rate Case
A power cost rate case is a limited-scope proceeding to reset power cost rates.  In addition to providing the opportunity to reset all power costs, the PCORC proceeding also provides for timely review of new resource acquisition costs and inclusion of such costs in rates at the time the new resource goes into service.  To achieve this objective, the Washington Commission is not required to but historically has used an expedited six-month PCORC decision timeline rather than the statutory 11-month timeline for a GRC.

Residential Exchange Benefit
The residential exchange program passes through the residential exchange program benefits that PSE receives from the Bonneville Power Administration (BPA).  Rates change biennially on October 1.


10



Electric Property Tax Tracker Mechanism
The purpose of the property tax tracker mechanism is to pass through the cost of all property taxes incurred by the Company. The mechanism was implemented in 2013 and removed property taxes from general rates and included those costs for recovery in an adjusting tariff rate. After the implementation, the mechanism acts as a tracker rate schedule and collects the total amount of property taxes assessed. The tracker will be adjusted each year in May based on that year's assessed property taxes and true-up from the prior year.

Natural Gas Rate Filings
Natural Gas Cost Recovery Mechanism
The purpose of the CRM is to recover capital costs related to projects included in PSE's pipe replacement program plan on file with the Washington Commission with the intended effect of enhancing the safety of the natural gas distribution system. Rates change annually on November 1.

Purchased Gas Adjustment
PSE has a PGA mechanism that allows PSE to recover expected natural gas supply and transportation costs and defer, as a receivable or liability, any natural gas supply and transportation costs that exceed or fall short of this expected natural gas cost amount in PGA mechanism rates, including accrued interest. PSE is authorized by the Washington Commission to accrue carrying costs on PGA receivable and payable balances. A receivable or payable balance in the PGA mechanism reflects an under recovery or over recovery, respectively, of natural gas cost through the PGA mechanism. Rates change annually on November 1.

Natural Gas Property Tax Tracker Mechanism
The purpose of the property tax tracker mechanism is to pass through the cost of all property taxes incurred by the Company. The mechanism was implemented in 2013 and removed property taxes from general rates and included those costs for recovery in an adjusting tariff rate. After the implementation, the mechanism acts as a tracker rate schedule and collects the total amount of property taxes assessed. The tracker is adjusted each year in May based on that year's assessed property taxes and adjustments to the rate from the prior year.

Natural Gas Conservation Rider
The natural gas conservation rider collects revenue to cover the costs incurred in providing services and programs for conservation. Rates change annually on May 1 to collect the annual budget that started the prior January and to true-up for actual compared to forecast conservation expenditures from the prior year, as well as actual compared to the forecasted load set in rates.

For additional information on electric and natural gas rates, see Management's Discussion and Analysis, "Regulation and Rates" included in Item 7 of this report.


11



ELECTRIC UTILITY OPERATING STATISTICS

 
Year Ended December 31,
 
2018
 
2017
 
2016
Generation and purchased power, MWh
 
 
 
 
 
Company-controlled resources
11,168,286

 
10,825,778

 
11,577,608

Contracted resources
7,654,872

 
8,337,348

 
7,023,786

Non-firm energy purchased
6,490,602

 
6,147,778

 
6,005,797

Total generation and purchased power
25,313,760

 
25,310,904

 
24,607,191

Less: losses and Company use
(1,513,451
)
 
(1,568,599
)
 
(1,547,619
)
Total energy sales, MWh
23,800,309

 
23,742,305

 
23,059,572

Electric energy sales, MWh
 

 
 

 
 

Residential
10,497,389

 
10,931,999

 
10,245,326

Commercial
8,932,681

 
9,089,842

 
8,895,950

Industrial
1,189,828

 
1,214,818

 
1,223,214

Other customers
84,382

 
87,230

 
90,753

Total energy sales to customers
20,704,280

 
21,323,889

 
20,455,243

Sales to other utilities and marketers
3,096,029

 
2,418,416

 
2,604,329

Total energy sales, MWh
23,800,309

 
23,742,305

 
23,059,572

Transportation, including unbilled
2,028,727

 
2,001,244

 
2,085,574

Electric energy sales and transportation, MWh
25,829,036

 
25,743,549

 
25,145,146

Electric operating revenue by classes
 
 
 
 
 
(Dollars in Thousands)
 

 
 

 
 

Residential
$
1,147,260

 
$
1,232,075

 
$
1,138,871

Commercial
885,457

 
892,360

 
872,057

Industrial
110,607

 
112,817

 
113,469

Other customers
18,718

 
19,729

 
20,045

Total operating revenue from customers
2,162,042

 
2,256,981

 
2,144,442

Transportation, including unbilled
13,878

 
12,584

 
10,937

Sales to other utilities and marketers
89,324

 
53,789

 
50,124

Decoupling revenue
13,530

 
9,975

 
29,968

Other decoupling revenue1
(5,475
)
 
(27,706
)
 
(21,168
)
Miscellaneous operating revenue
182,620

 
115,040

 
24,189

Total electric operating revenue
$
2,455,919

 
$
2,420,663

 
$
2,238,492

Number of customers served (average):
 

 
 

 
 

Residential
1,010,574

 
998,078

 
984,739

Commercial
128,845

 
126,829

 
125,067

Industrial
3,362

 
3,399

 
3,425

Other
6,992

 
6,722

 
6,472

Transportation
16

 
16

 
16

Total customers
1,149,789

 
1,135,044

 
1,119,719

_______________
1 
Includes decoupling cash collections, rate of return excess earnings, and decoupling 24-month revenue reserve.



12



ELECTRIC UTILITY OPERATING STATISTICS (Continued)
 
 
Year Ended December 31,
 
 
2018
 
2017
 
2016
Average kWh used per customer:
 
 
 
 

 
 

Residential
 
10,388

 
10,953

 
10,404

Commercial
 
69,329

 
71,670

 
71,129

Industrial
 
353,905

 
357,404

 
357,143

Other
 
12,068

 
12,997

 
14,022

Average revenue per customer:
 
 
 
 
 
 
Residential
 
$
1,135

 
$
1,234

 
$
1,157

Commercial
 
6,872

 
7,036

 
6,973

Industrial
 
32,899

 
33,191

 
33,130

Other
 
2,677

 
2,935

 
3,097

Average retail revenue per kWh sold:
 
 
 
 
 
 
Residential
 
$
0.1093

 
$
0.1127

 
$
0.1112

Commercial
 
0.0991

 
0.0982

 
0.0980

Industrial
 
0.0930

 
0.0929

 
0.0928

Other
 
0.2218

 
0.2262

 
0.2209

Average retail revenue per kWh sold
 
$
0.1044

 
$
0.1058

 
$
0.1048

Heating degree days
 
4,065

 
4,584

 
3,823

Percent of normal - NOAA2 30-year average
 
86.2
%
 
97.2
%
 
81.0
%
Load factor3
 
64.2
%
 
51.6
%
 
56.2
%
_______________
2 
National Oceanic and Atmospheric Administration (NOAA).
3 
Average megawatt (aMW) usage by customers divided by their maximum usage.


13



Electric Supply
At December 31, 2018, PSE’s electric power resources, which include company-owned or controlled resources as well as those under long-term contract, had a total capacity of approximately 4,696 megawatts (MW).  PSE’s historical peak load of approximately 4,912 MW occurred on December 10, 2009.  In order to meet an extreme winter peak load, PSE may supplement its electric power resources with winter-peaking call options and other instruments. When it is more economical for PSE to purchase power than to operate its own generation facilities, PSE will purchase spot market energy when sufficient transmission capacity is available.
The following table shows PSE’s electric energy supply resources and energy production for the years ended December 31, 2018 and 2017:
 
Peak Power Resources
At December 31,
 
Energy Production
At December 31,
 
2018
 
2017
 
2018
 
2017
 
MW
 
%
 
MW
 
%
 
MWh
 
%
 
MWh
 
%
Purchased resources:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Columbia River PUD contracts1
674

 
14.3
%
 
711

 
15.0
%
 
3,468,702

 
13.7
%
 
3,355,134

 
13.3
%
Other hydroelectric
72

 
1.5

 
72

 
1.5

 
315,948

 
1.2

 
281,619

 
1.1

Other producers
284

 
6.2

 
284

 
6.0

 
3,406,627

 
13.6

 
3,679,623

 
14.6

Wind
56

 
1.2

 
56

 
1.2

 
131,270

 
0.5

 
119,690

 
0.5

Short-term wholesale energy purchases

 

 
N/A

 

 
6,822,927

 
26.9

 
7,049,060

 
27.8

Total purchased
1,086

 
23.2
%
 
1,123

 
23.7
%
 
14,145,474

 
55.9
%
 
14,485,126

 
57.3
%
Company-controlled resources:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Hydroelectric
250

 
5.3
%
 
254

 
5.4
%
 
914,540

 
3.6
%
 
864,821

 
3.4
%
Coal
677

 
14.4

 
677

 
14.3

 
4,184,950

 
16.5

 
4,463,705

 
17.6

Natural gas/oil
1,908

 
40.6

 
1,908

 
40.3

 
4,152,359

 
16.4

 
3,822,462

 
15.1

Wind
773

 
16.5

 
773

 
16.3

 
1,932,378

 
7.6

 
1,674,790

 
6.6

Other2
2

 

 
2

 

 

 

 

 

Total company-controlled
3,610

 
76.8
%
 
3,614

 
76.3
%
 
11,184,227

 
44.1
%
 
10,825,778

 
42.7
%
Total resources
4,696

 
100.0
%
 
4,737

 
100.0
%
 
25,329,701

 
100.0
%
 
25,310,904

 
100.0
%
_______________
1
Net of 33 MW capacity delivered to Canada pursuant to the provisions of a treaty between Canada and the United States and Canadian Entitlement Allocation agreements as of December 31, 2018 and 2017.
2.
It is estimated that the Glacier Battery Storage has delivered approximately 1,362.7 and 746.5 MWh as of December 31, 2018 and 2017, respectively.


14



Company–Owned Electric Generation Resources
At December 31, 2018, PSE owns the following plants with an aggregate net generating capacity of 3,610 MW:
Plant Name
 
Plant Type
 
 Net Maximum
Capacity (MW)1
 
Year Installed
Colstrip Units 3 & 4 (25% interest)
 
Coal
 
370
 
1984 & 1986
Colstrip Units 1 & 2 (50% interest)2
 
Coal
 
307
 
1975 & 1976
Mint Farm
 
Natural gas combined cycle
 
297
 
2007; acquired 2008
Goldendale
 
Natural gas combined cycle
 
315
 
2004; acquired 2007; upgraded 2016
Frederickson Unit 1 (49.85% interest)
 
Natural gas combined cycle
 
136
 
2002; added duct firing in 2005
Lower Snake River
 
Wind
 
343
 
2012
Wild Horse
 
Wind
 
273
 
2006 & 2009
Hopkins Ridge
 
Wind
 
157
 
2005 & 2008
Fredonia Units 1 & 2
 
Dual-fuel combustion turbines
 
207
 
1984
Frederickson Units 1 & 2
 
Dual-fuel combustion turbines
 
149
 
1981
Whitehorn Units 2 & 3
 
Dual-fuel combustion turbines
 
149
 
1981
Fredonia Units 3 & 4
 
Dual-fuel combustion turbines
 
107
 
2001
Ferndale
 
Natural gas co-generation
 
253
 
1994; acquired 2012
Encogen
 
Natural gas co-generation
 
165
 
1993; acquired 1999
Sumas
 
Natural gas co-generation
 
127
 
1993; acquired 2008
Upper Baker River
 
Hydroelectric
 
91
 
1959
Lower Baker River
 
Hydroelectric
 
105
 
1925; reconstructed 1960; upgraded 2001 and 2013
Snoqualmie Falls3
 
Hydroelectric
 
54
 
1898 to 1911 & 1957; rebuilt 2013
Crystal Mountain
 
Internal combustion
 
3
 
1969
Glacier Battery Storage
 
Lithium Iron Phosphate
 
2
 
2016
Total net capacity
 
 
 
3,610
 
 
_______________
1 
Net Maximum Capacity is the capacity a unit can sustain over a specified period of time when not restricted by ambient conditions or deratings, less the losses associated with auxiliary loads.
2
In July 2016, PSE reached a settlement with the Sierra Club to retire Colstrip Units 1 and 2 no later than July 1, 2022.
3
The FERC license authorizes the full 54.4 MW; however, the project's water right issued by the State Department of Ecology limits flow to 2,500 cubic feet and therefore output to 47.7MW.


15



Columbia River Electric Energy Supply Contracts
During 2018, approximately 13.7% of PSE’s energy supply was obtained through long-term contracts with three Washington Public Utility Districts (PUDs) that own and operate hydroelectric projects on the Columbia River (Mid-Columbia).   PSE’s payments are not contingent upon the projects being operable.
As of December 31, 2018, PSE's portion of the power output of the PUDs’ projects are set forth below:
 
 
 
 
 
Company’s Annual
Share
(Approximate)
Project
Contract
Expiration Year
 
License
Expiration Year
 
Percent of
Output
 
MW Capacity
Chelan County PUD:
 
 
 
 
 
 
 
Rock Island Project
2031
 
2029
 
25.0
%
 
156

Rocky Reach Project
2031
 
2052
 
25.0
%
 
325

Douglas County PUD:
 
 
 
 
 
 
 
Wells Project1
2028
 
2052
 
25.3
%
 
212

Grant County PUD:
 
 
 
 
 
 
 
Priest Rapids Development
2052
 
2052
 
0.6
%
 
6

Wanapum Development
2052
 
2052
 
0.6
%
 
7

Total
 
 
 
 
 
 
706

_______________
1 
In March 2017, PSE entered a new PPA with Douglas County PUD for Wells Project output that began on August 31, 2018 and continues through September 30, 2028.

Other Electric Supply, Exchange and Transmission Contracts and Agreements
PSE purchases electric energy under long-term firm purchased power contracts with other utilities and marketers in the Western region.  PSE is generally not obligated to make payments under these contracts unless power is delivered.  PSE also has an agreement with Pacific Gas & Electric Company (PG&E) for 300 MW of capacity which currently has no set expiration. PG&E filed for bankruptcy on January 29, 2019. As of December 31, 2018, there was no outstanding balance due from PG&E related to the energy exchange contract, an agreement in place to supplement peak loads through the transmission of energy from PG&E to PSE in the winter months and from PSE to PG&E in the summer months. During and since emerging from its 2001-2004 bankruptcy proceedings, PG&E delivered on the energy exchange contract and has continued to meet the exchange contract through its current bankruptcy proceedings.
PSE began participating in the Energy Imbalance Market (EIM) operated by the California Independent System Operator on October 1, 2016. PSE has committed 600 MW of existing BPA transmission solely for the EIM market. Participation has resulted in reduced costs for PSE customers of approximately $13.7 million, enhanced system reliability, integration of variable energy resources, and geographic diversity of electricity demand and generation resources. The calculated benefits represent the cost savings of the EIM dispatch compared with a counter-factual dispatch without the EIM. Benefits can take the form of cost savings or profits or their combination. Benefits include greenhouse gas (GHG) revenue, transfer revenues and flexible ramping revenues.
PSE has entered into multiple various-term transmission contracts with other utilities to integrate electric generation and contracted resources into PSE’s system.  These transmission contracts require PSE to pay for transmission service based on the contracted MW level of demand, regardless of actual use. Other transmission agreements provide actual capacity ownership or capacity ownership rights.  PSE’s annual charges under these agreements are also based on contracted MW volumes.  Capacity on these agreements that is not committed to serve PSE’s load is available for sale to third parties.  PSE also purchases short-term transmission services from a variety of providers, including the BPA.
In 2018, PSE had 4,797 MW and 595 MW of total transmission demand contracted with the BPA and other utilities, respectively.  PSE’s remaining transmission capacity needs are met via PSE owned transmission assets.

Natural Gas Supply for Electric Customers
PSE purchases natural gas supplies for its power portfolio to meet demand for its combustion turbine generators. Supplies range from long-term to daily agreements, as the demand for the turbines varies depending on market heat rates.  Purchases are made from a diverse group of major and independent natural gas producers and marketers in the United States and Canada.  PSE also enters into financial hedges to manage the cost of natural gas.  PSE utilizes natural gas storage capacity and transportation that is dedicated to and paid for by the power portfolio to facilitate increased natural gas supply reliability and intra-day dispatch

16



of PSE’s natural gas-fired generation resources.  During 2018, 72.2%, 18.0%, and 9.8% of PSE's natural gas supply for power generation was purchased from British Columbia, Alberta, and the United States, respectively.  

Integrated Resource Plans, Resource Acquisition and Development
PSE is required by Washington Commission regulations to file an electric and natural gas integrated resource plan (IRP) every two years.  The 2017 IRP was filed on November 14, 2017. As part of the IRP, a resource need was identified and, on June 8, 2018, PSE filed an all-source Request for Proposal (RFP). The RFP was approved on June 28, 2018, and identified the following capacity shortfalls and surpluses:

 
 
2019
 
2020
 
2021
 
2022
Projected MW shortfall/(surplus)
 
29
 
1
 
(21)
 
272

The expected capacity needs reflect the mix of energy efficiency programs deemed cost effective in the 2017 IRP. PSE projects that beginning in 2022 its future energy needs will exceed current resources in its supply portfolio because of the retirement of Colstrip Units 1 and 2, approximately 300 MW of capacity.  Therefore, PSE’s IRP sets forth a multi-part strategy of implementing energy efficiency programs and pursuing additional renewable resources and additional capacity resources such as battery storage and generation plants that operate during peak loads.  If PSE cannot acquire needed energy supply resources at a reasonable cost, it may be required to purchase additional power in the wholesale market. These purchases are subject to the sharing bands of the PCA mechanism, at a cost that could, in the absence of regulatory relief, increase its expenses and reduce earnings and cash flows.


17



NATURAL GAS UTILITY OPERATING STATISTICS
 
Year Ended December 31,
 
2018
 
2017
 
2016
Natural gas operating revenue by classes (dollars in thousands):
 
 
 
 
 
Residential
$
598,923

 
$
686,438

 
$
578,955

Commercial firm
219,390

 
251,584

 
213,138

Industrial firm
17,247

 
20,077

 
17,753

Interruptible
21,113

 
24,317

 
24,447

Total retail natural gas sales
856,673

 
982,416

 
834,293

Transportation services
19,984

 
21,718

 
20,322

Decoupling revenue
6,115

 
3,522

 
52,114

Other decoupling revenue1
(37,022
)
 
(22,862
)
 
(28,761
)
Other
4,998

 
12,965

 
12,542

Total natural gas operating revenue
$
850,748

 
$
997,759

 
$
890,510

Number of customers served (average):
 

 
 

 
 

Residential
772,130

 
761,010

 
749,586

Commercial firm
55,716

 
55,372

 
54,992

Industrial firm
2,308

 
2,330

 
2,371

Interruptible
393

 
398

 
410

Transportation
234

 
226

 
227

Total customers
830,781

 
819,336

 
807,586

Natural gas volumes, therms (thousands):
 

 
 

 
 

Residential
571,265

 
621,915

 
521,771

Commercial firm
264,775

 
279,656

 
233,586

Industrial firm
23,890

 
25,500

 
22,783

Interruptible
47,275

 
49,249

 
49,533

Total retail natural gas volumes, therms
907,205

 
976,320

 
827,673

Transportation volumes
230,735

 
236,578

 
230,724

Total volumes
1,137,940

 
1,212,898

 
1,058,397

_______________
1 
Includes decoupling cash collections, rate of return excess earnings, and decoupling 24-month revenue reserve.
  

18



NATURAL GAS UTILITY OPERATING STATISTICS (Continued)
 
Year Ended December 31,
 
2018
 
2017
 
2016
Working natural gas volumes in storage at year end, therms (thousands):
 

 
 

 
 

Jackson Prairie
76,348

 
86,051

 
86,374

Clay Basin
74,420

 
45,854

 
63,136

Average therms used per customer:
 
 
 
 
 

Residential
740

 
817

 
696

Commercial firm
4,752

 
5,050

 
4,248

Industrial firm
10,351

 
10,944

 
9,609

Interruptible
120,293

 
123,742

 
120,812

Transportation
986,045

 
1,046,806

 
1,016,406

Average revenue per customer:
 

 
 

 
 

Residential
$
776

 
$
902

 
$
772

Commercial firm
3,938

 
4,544

 
3,876

Industrial firm
7,473

 
8,617

 
7,488

Interruptible
53,724

 
61,098

 
59,626

Transportation
85,400

 
96,099

 
89,524

Average revenue per therm sold:
 

 
 

 
 

Residential
$
1.048

 
$
1.104

 
$
1.110

Commercial firm
0.829

 
0.900

 
0.912

Industrial firm
0.722

 
0.787

 
0.779

Interruptible
0.447

 
0.494

 
0.494

Average retail revenue per therm sold
$
0.944

 
$
1.006

 
$
1.008

Transportation
0.087

 
0.092

 
0.088

Heating degree days
4,065

 
4,584

 
3,823

Percent of normal - NOAA 30-year average
86.2
%
 
97.2
%
 
81.0
%


19



Natural Gas Supply for Natural Gas Customers
PSE purchases a portfolio of natural gas supplies ranging from long-term firm to daily from a diverse group of major and independent natural gas producers and marketers in the United States and Canada (British Columbia and Alberta).  PSE also enters into physical and financial hedges to manage volatility in the cost of natural gas.  All of PSE’s natural gas supply is ultimately transported through the facilities of Northwest Pipeline, LLC (NWP), the sole interstate pipeline delivering directly into PSE’s service territory.  Accordingly, delivery of natural gas supply to PSE’s natural gas system is dependent upon the reliable operations of NWP.
For base load, peak management and supply reliability purposes, PSE supplements its firm natural gas supply portfolio by purchasing natural gas in periods of lower demand, injecting it into underground storage facilities and withdrawing it during periods of high demand or reduced supply.  Underground storage facilities at Jackson Prairie in western Washington and at Clay Basin in Utah are used for this purpose.  Clay Basin withdrawals are used to supplement purchases from the U.S. Rocky Mountain supply region, while Jackson Prairie provides incremental peak-day resources utilizing firm storage redelivery transportation capacity.  Jackson Prairie is also used for daily balancing of load requirements on PSE’s natural gas system.  Peaking needs are also met by using PSE-owned natural gas held in PSE’s LNG peaking facility located within its distribution system in Gig Harbor, Washington; as well as interrupting service to customers on interruptible service rates, if necessary.
PSE expects to meet its firm peak-day requirements for residential, commercial and industrial markets through its firm natural gas purchase contracts, firm transportation capacity, firm storage capacity and other firm peaking resources.  PSE believes it will be able to acquire incremental firm natural gas supply and transportation capacity to meet anticipated growth in the requirements of its firm customers for the foreseeable future.
During 2018, 49.0%, 17.2%, and 33.8% of PSE's natural gas supply for natural gas customers was purchased from British Columbia, Alberta, and the United States, respectively.  PSE’s firm natural gas supply portfolio has adequate flexibility in its transportation arrangements to enable it to achieve savings when there are regional price differentials between natural gas supply basins.  The geographic mix of suppliers and daily, monthly and annual take requirements permit some degree of flexibility in managing natural gas supplies during periods of lower demand to minimize costs.  Natural gas is marketed outside of PSE’s service territory (off-system sales) to optimize resources when on-system customer demand requirements permit and market economics are favorable; the resulting economics of these transactions are reflected in PSE’s natural gas customer tariff rates through the PGA mechanism.

Natural Gas Storage Capacity
PSE holds storage capacity in the Jackson Prairie and Clay Basin underground natural gas storage facilities adjacent to NWP’s pipeline to serve PSE’s natural gas customers.  The Jackson Prairie facility is operated and one-third owned by PSE, and is used primarily for intermediate peaking purposes due to its ability to deliver a large volume of natural gas in a short time period.  Combined with capacity contracted from NWP’s one-third stake in Jackson Prairie, PSE holds firm withdrawal capacity of 453,800 Dekatherm (Dth) per day, and over 9.8 million Dth of storage capacity at the Jackson Prairie facility. Of this total, PSE designates 397,100 Dth per day of the firm withdrawal capacity and over 9.2 million Dth of storage capacity to serve natural gas customers. The location of the Jackson Prairie facility in PSE’s market area increases supply reliability and provides significant pipeline demand cost savings by reducing the amount of annual pipeline capacity required to meet peak-day natural gas requirements.   
Of the remaining Jackson Prairie storage capacity, 56,700 Dth per day of firm withdrawal capacity and 640,600 Dth of storage capacity is currently designated to PSE's power portfolio, increasing natural gas supply reliability and facilitating intra-day dispatch of PSE's natural gas-fired generation resources. In addition, PSE has temporarily released approximately 6,100 Dth per day of firm withdrawal capacity and 178,500 of Dth of storage capacity to a third party, in exchange for temporary firm pipeline capacity on a constrained portion of NWP's system.
The Clay Basin storage facility is a supply area storage facility that provides operational flexibility and price protection.  PSE holds 12.9 million Dth of Clay Basin storage capacity and approximately 107,400 Dth per day of firm withdrawal capacity under two long-term contracts with remaining terms of one and two years and has rights to extend such agreements.  

LNG and Propane-Air Resources
LNG and propane-air resources provide firm natural gas supply on short notice for short periods of time.  Due to their typically high cost and slow cycle times, these resources are normally utilized as a last resort supply source in extreme peak-demand periods, typically during the coldest hours or days.
PSE holds a contract for LNG storage services of 241,700 Dth of PSE-owned natural gas at Plymouth, with a maximum daily deliverability of 70,500 Dth for use of the PSE generation fleet.  PSE uses the Plymouth contract as an alternate supply source for natural gas required to serve PSE’s generation fleet during peak periods on a daily or intra-day basis. In addition, PSE holds 15,000 Dth/day of firm pipeline capacity from Plymouth for the generation fleet. The balance of the LNG capacity is delivered using firm NWP pipeline transportation service previously acquired to serve PSE’s generation fleet.

20



PSE owns and operates the Swarr vaporized propane-air station located in Renton, Washington which includes storage capacity for approximately 1.5 million gallons of propane.  This vaporized propane-air injection facility delivers the thermal equivalent of 10,000 Dth of natural gas per day for up to 12 days directly into PSE’s distribution system; however, it is temporarily out-of-service pending planned environmental and reliability upgrades.  PSE owns and operates an LNG peaking facility in Gig Harbor, Washington, with total capacity of 10,600 Dth, which is capable of delivering the equivalent of 2,500 Dth of natural gas per day.

Tacoma LNG Facility
Currently under construction at the Port of Tacoma, the Tacoma LNG facility is expected to be operational in late 2020. In January 2018, the Puget Sound Clean Air Agency (PSCAA) determined a Supplemental Environmental Impact Statement (SEIS) is necessary in order to rule on the air quality permit for the facility. As a result of requiring a SEIS, PSCAA's timing and decision on the air quality permit has delayed the Company's construction schedule and, pending the PSCAA's timing and decision on the air quality permit, may further impact the schedule and costs. The Tacoma LNG facility will provide peak-shaving services to PSE’s natural gas customers, and will provide LNG as fuel to transportation customers, particularly in the marine market. Pursuant to the Washington Commission’s order, PSE will be allocated 43.0% of the capital and operating costs, consistent with the regulated portion of the Tacoma LNG facility, and Puget LNG will be allocated the remaining 57.0% of the capital and operating costs. The portion of the Tacoma LNG facility allocated to PSE will be subject to regulation by the Washington Commission.

Natural Gas Transportation Capacity
PSE currently holds firm transportation capacity on pipelines owned by Cascade Natural Gas Company (CNGC), NWP, Gas Transmission Northwest (GTN), Nova Gas Transmission (NOVA), Foothills Pipe Lines (Foothills) and Enbridge Westcoast Energy (Westcoast).  GTN, NOVA, and Foothills are all TransCanada companies.  PSE pays fixed monthly demand charges for the right, but not the obligation, to transport specified quantities of natural gas from receipt points to delivery points on such pipelines each day for the term or terms of the applicable agreements.
PSE holds approximately 542,900 Dth per day of capacity for its natural gas customers on NWP that provides firm year-round delivery to PSE’s service territory.  In addition, PSE holds approximately 447,100 Dth per day of seasonal firm capacity on NWP to provide for delivery of natural gas stored at Jackson Prairie to natural gas customers.  PSE holds approximately 217,900 Dth per day of firm transportation capacity on NWP to supply natural gas to its electric generating facilities.  In addition, PSE holds over 34,200 Dth per day of seasonal firm capacity on NWP to provide for delivery of natural gas stored in Jackson Prairie for its electric generating facilities. PSE’s firm transportation capacity contracts with NWP have remaining terms ranging from one to 26 years.  However, PSE has either the unilateral right to extend the contracts under the contracts’ current terms or the right of first refusal to extend such contracts under current FERC rules.
PSE’s firm transportation capacity for its natural gas customers on Westcoast’s pipeline is 135,800 Dth per day under various contracts, with remaining terms of two to six years.  PSE has other firm transportation capacity on Westcoast’s pipeline, which supplies the electric generating facilities, totaling 88,400 Dth per day, with remaining terms of two to five years and an option for PSE to renew its rights under the Westcoast contract.  PSE has firm transportation capacity for its natural gas customers on NOVA and Foothills pipelines, each totaling approximately 79,000 Dth per day, with remaining terms of two to five years and an option for PSE to renew its rights on the capacity on NOVA and Foothills pipelines.  PSE has other firm transportation capacity on NOVA and Foothills pipelines, which supplies the electric generating facilities, each totaling approximately 41,000 Dth per day, with remaining terms of two to five years. PSE’s firm transportation capacity for its natural gas customers on the GTN pipeline, totaling over 77,000 Dth per day, with remaining terms of five years and PSE has a first right-of-refusal to extend such contracts under current FERC rules. PSE has other firm transportation capacity on GTN pipeline, which supplies the electric generating facilities, totaling 40,600 Dth per day, with remaining terms of two to five years. PSE holds 259,000 decatherms per day of firm capacity on CNGC to connect generating facilities to the pipeline grid with remaining terms of one to three years.

Capacity Release
The FERC regulates the release of firm pipeline and storage capacity for facilities which fall under its jurisdiction.  Capacity releases allow shippers to temporarily or permanently relinquish unutilized capacity to recover all or a portion of the cost of such capacity.  The FERC allows capacity to be released through several methods including open bidding and pre-arrangement.  PSE has acquired some firm pipeline and storage service through capacity release provisions to serve its growing service territory and electric generation portfolio.  PSE also mitigates a portion of the demand charges related to unutilized storage and pipeline capacity through capacity release.  Capacity release benefits derived from the natural gas customer portfolio are passed on to PSE’s natural gas customers through the PGA mechanism.


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Energy Efficiency
PSE is required under Washington state law to pursue all available electric conservation that is cost-effective, reliable and feasible. PSE offers programs designed to help new and existing residential, commercial and industrial customers use energy efficiently.  PSE uses a variety of mechanisms including cost-effective financial incentives, information and technical services to enable customers to make energy efficient choices with respect to building design, equipment and building systems, appliance purchases and operating practices. PSE recovers the actual costs of its electric and natural gas energy efficiency programs through rider mechanisms. However, the rider mechanisms do not provide assistance with gross margin erosion associated with reduced energy sales. To address this issue, PSE received approval in 2017 from the Washington Commission for continuation of electric and natural gas decoupling mechanisms, which mitigates gross margin erosion resulting from the Company's energy efficiency efforts.

Environment
PSE’s operations, including generation, transmission, distribution, service and storage facilities, are subject to environmental laws and regulations by federal, state and local authorities.  See below for the primary areas of environmental law that have the potential to most significantly impact PSE’s operations and costs.

Air and Climate Change Protection
PSE owns numerous thermal generation facilities, including natural gas plants and an ownership percentage of Colstrip.  All of these facilities are governed by the Clean Air Act (CAA), and all have CAA Title V operating permits, which must be renewed every five years.  This renewal process could result in additional costs to the plants. PSE continues to monitor the permit renewal process to determine the corresponding potential impact to the plants. These facilities also emit greenhouse gases (GHG), and thus are also subject to any current or future GHG or climate change legislation or regulation.  The Colstrip plant represents PSE’s most significant source of GHG emissions.

Species Protection
PSE owns hydroelectric plants, wind farms and numerous miles of above ground electric distribution and transmission lines which can be impacted by laws related to species protection.  A number of species of fish have been listed as threatened or endangered under the Endangered Species Act (ESA), which influences hydroelectric operations, and may affect PSE operations, potentially representing cost exposure and operational constraints.  Similarly, there are a number of avian and terrestrial species that have been listed as threatened or endangered under the ESA or are protected by the Migratory Bird Treaty Act or the Bald and Golden Eagle Protection Act.  Designations of protected species under these laws have the potential to influence operation of our wind farms and above ground transmission and distribution systems.

Remediation
PSE and its predecessors are responsible for environmental remediation at various sites.  These include properties currently and formerly owned by PSE (or its predecessors), as well as third-party owned properties where hazardous substances were allegedly generated, transported or released.  The primary cleanup laws to which PSE is subject include the Comprehensive Environmental Response, Compensation and Liability Act (federal) and, in Washington, the Model Toxics Control Act (state).  PSE is also subject to applicable remediation laws in the state of Montana for its ownership interest in Colstrip. These laws may hold liable any current or past owner or operator of a contaminated site, as well as any generator, transporter, arranger, or disposer of regulated substances.

Hazardous and Solid Waste and PCB Handling and Disposal
Related to certain operations, including power generation and transmission and distribution maintenance, PSE must handle and dispose of certain hazardous and solid wastes.  These actions are regulated by the Solid Waste Disposal Act, as amended by the Resource Conservation and Recovery Act (federal), the Toxic Substances Control Act (federal) and hazardous or dangerous waste regulations (state) that impose complex requirements on handling and disposing of regulated substances.

Water Protection
PSE facilities that discharge wastewater or storm water or store bulk petroleum products are governed by the Clean Water Act (federal and state) which includes the Oil Pollution Act amendments.  This includes most generation facilities (and all of those with water discharges and some with bulk fuel storage), and many other facilities and construction projects depending on drainage, facility or construction activities, and chemical, petroleum and material storage.


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Mercury Emissions
Mercury control equipment has been installed at Colstrip and has operated at a level that meets the current Montana requirement.  Compliance, based on a rolling twelve-month average, was first confirmed in January 2011, and PSE continues to meet the requirement.
The EPA published the final Mercury and Air Toxics Standard (MATS) in February 2012. Generating units were given three years, until April 2015, to comply with MATS and could receive up to a 1-year extension from state permitting authorities if necessary for the installation of controls. Colstrip met the MATS limits for mercury and acid gases as of April 2017.
 
Siting New Facilities
In siting new generation, transmission, distribution or other related facilities in Washington, PSE is subject to the State Environmental Policy Act, and may be subject to the federal National Environmental Policy Act, if there is a federal nexus, in addition to other possible local siting and zoning ordinances.  These requirements may potentially require mitigation of environmental impacts as well as other measures that can add significant cost to new facilities.

Recent and Future Environmental Law and Regulation
Recent and future environmental laws and regulations may be imposed at a federal, state or local level and may have a significant impact on the cost of PSE operations.  PSE monitors legislative and regulatory developments for environmental issues with the potential to alter the operation and cost of our generation plants, transmission and distribution system, and other assets.  Described below are the recent, pending and potential future environmental law and regulations with the most significant potential impacts to PSE’s operations and costs.

Climate Change and Greenhouse Gas Emissions
PSE recognizes the growing concern that increased atmospheric concentrations of GHG contribute to climate change.  PSE believes that climate change is an important issue that requires careful analysis and considered responses.  As climate policy continues to evolve at the state and federal levels, PSE remains involved in state, regional and federal policymaking activities. PSE will continue to monitor the development of any climate change or climate change related air emission reduction initiative at the state and western regional level.  PSE has considered the known impact of any future legislation or new government regulation on the cost of generation in its IRP process.

PSE's Greenhouse Gas Emission Reporting
PSE is required to submit, on an annual basis, a report of its GHG emissions to the state of Washington Department of Ecology including a report of emissions from all individual power plants emitting over 10,000 tons per year of GHGs and from certain natural gas distribution operations.  Emissions exceeding 25,000 tons per year of GHGs from these sources must also be reported to the environmental protection agency (EPA). Capital investments to monitor GHGs from the power plants and in the distribution system are not required at this time.  Since 2002, PSE has voluntarily undertaken an annual inventory of its GHG emissions associated with PSE’s total electric retail load served from a supply portfolio of owned and purchased resources.  
The most recent data indicate that PSE’s total GHG emissions (direct and indirect) from its electric supply portfolio in 2017 were 10.2 million metric tons of carbon dioxide equivalents.  Approximately 43.7% of PSE’s total GHG emissions (approximately 4.5 million metric tons) are associated with PSE’s ownership and contractual interests in Colstrip. PSE’s overall emissions strategy demonstrates a concerted effort to manage customers’ needs with an appropriate balance of new renewable generation, existing generation owned and/or operated by PSE and significant energy efficiency efforts.

Federal Greenhouse Gas Rules
In August 2015, the EPA announced a final rule regarding New Source Performance Standard (NSPS) for the control of carbon dioxide (CO2) from new power plants that burn fossil fuels under section 111(b) of the Clean Air Act. The rule was published on October 23, 2015, and separates standards for new power plants fueled by natural gas and coal. New natural gas power plants can emit no more than 1,000 lbs. of CO2/megawatt hour (MWh) which is achievable with the latest combined cycle technology. New coal power plants can emit no more than 1,400 lbs. of CO2/MWh, which is less stringent than the draft rule. The standard for coal plants would not specifically require Carbon Dioxide Capture and Sequestration (CCS) but CCS was reaffirmed by the EPA as the “best system of emission reductions” (BSER). These 111(b) standards are implemented by the states, but states have limited flexibility to alter the standards set by the EPA.
In August 2018, the EPA proposed the Affordable Clean Energy (ACE) rule to replace the 2015 Clean Power Plan. The ACE would require modest efficiency improvements at some coal plants and give states more latitude to set their own carbon emission reduction standards, in contrast to the CPP, which pushed plant owners to invest in less-polluting sources. The

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public comment period closed October 30, 2018 and EPA has stated that it hopes to finalize the rule in early 2019. PSE has reviewed the draft rule but expects that the rule will face legal challenges from environmental groups, clean energy organizations and certain states. PSE cannot yet predict a final outcome.

Washington Clean Air Rule
The Clean Air Rule (CAR) was adopted in September 2016 in Washington State and attempts to reduce greenhouse gas emissions from “covered entities” located within Washington State. Included under the new rule are large manufacturers, petroleum producers and natural gas utilities, including PSE. CAR sets a cap on emissions associated with covered entities, which decreases over time approximately 5.0% every three years. Entities must reduce their carbon emissions, or purchase emission reduction units (ERUs), as defined under the rule, from others.
In September 2016, PSE, along with Avista Corporation, Cascade Natural Gas Corporation and NW Natural, filed a lawsuit in the U.S. District Court for the Eastern District of Washington challenging the CAR. Also in September 2016, the four companies filed a similar challenge to the CAR in Thurston County Superior Court. In March 2018, the Thurston County Superior Court invalidated the CAR. The Department of Ecology appealed the Superior Court decision in May 2018. As a result of the appeal, direct review to the Washington State Supreme Court was granted and oral argument will be in the end of March 2019. The federal court litigation has been held in abeyance pending resolution of the state case.

Regional Haze Rule
In January 2017, the EPA provided revisions to the Regional Haze Rule which were published in the Federal Register. Among other things, these revisions delayed new Regional Haze review from 2018 to 2021, however, the end date will remain 2028. In January 2018, the EPA announced that it would revisit certain aspects of these revisions and PSE is unable to predict the outcome.

Coal Combustion Residuals
In April 2015, the EPA published a final rule, effective October 2015, that regulates Coal Combustion Residuals (CCR's) under the Resource Conservation and Recovery Act, Subtitle D. The EPA issued another rule, effective October 2016, extending certain compliance deadlines under the CCR rule. The CCR rule is self-implementing at a federal level or can be taken over by a state. The rule addresses the risks from coal ash disposal, such as leaking of contaminants into ground water, blowing of contaminants into the air as dust, and the catastrophic failure of coal ash containment structures by establishing technical design, operation and maintenance, closure and post closure care requirements for CCR landfills and surface impoundments, and corrective action requirements for any related leakage. The rule also sets forth recordkeeping and reporting requirements, including posting specific information related to CCR surface impoundments and landfills to publicly-accessible websites.
The CCR rule requires significant changes to the Company's Colstrip operations and those changes were reviewed by the Company and the plant operator in the second quarter of 2015. PSE had previously recognized a legal obligation under the EPA rules to dispose of coal ash material at Colstrip in 2003. Due to the CCR rule, additional disposal costs were added to the Asset Retirement and Environmental Obligations (ARO).

PCB Handling and Disposal
In April 2010, the EPA issued an Advanced Notice of Proposed Rulemaking soliciting information on a broad range of questions concerning inventory, management, use, and disposal of polychlorinated biphenyl (PCB) containing equipment.  The EPA is using this Advanced Notice of Proposed Rulemaking to seek data to better evaluate whether to initiate a rulemaking process geared toward a mandatory phase-out of all PCBs.
The rule was scheduled to be published in July 2015, but due to the number of comments received by the EPA, the rule has undergone multiple extensions and revisions. It was anticipated that the rule would be published in November 2017. However, in January 2017, the Trump Administration published the Executive Order on Reducing Regulation and Controlling Regulatory Costs directive which placed the rulemaking on indefinite hold. At this point, PSE cannot determine what impacts this rulemaking will have on its operations, if any, but will continue to work closely with the Utility Solid Waste Activities Group and the American Gas Association (AGA) to monitor developments.


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Executive Officers of the Registrants
The executive officers of Puget Energy as of February 21, 2019 are listed below along with their business experience during the past five years.  Officers of Puget Energy are elected for one-year terms. 
Name
 
Age
 
Offices
K. J. Harris
 
54

 
President and Chief Executive Officer since March 2011
D. A. Doyle
 
60

 
Senior Vice President and Chief Financial Officer since November 2011
S. R. Secrist
 
57

 
Senior Vice President, General Counsel and Chief Ethics and Compliance Officer since January 2014
S. J. King
 
35

 
Controller and Principal Accounting Officer since November 2, 2017. Senior Manager at PricewaterhouseCoopers LLP (PwC), a public accounting firm, July 2016 - November 2017; Manager at PwC July 2013 - July 2016

The executive officers of PSE as of February 21, 2019 are listed below along with their business experience during the past five years.  Officers of PSE are elected for one-year terms.
Name
 
Age
 
Offices
K. J. Harris
 
54

 
President and Chief Executive Officer since March 2011
D. A. Doyle
 
60

 
Senior Vice President and Chief Financial Officer since November 2011
B. K. Gilbertson
 
55

 
Senior Vice President, Operations since March 2015; Vice President, Operations March 2013 – February 2015
M. D. Mellies
 
58

 
Senior Vice President and Chief Administrative Officer since February 2011
D. E. Mills
 
61

 
Senior Vice President, Policy and Energy Supply since February 2018; Senior Vice President, Energy Operations January 2017 - February 2018; Vice President, Energy Operations January 2016 - January 2017; Vice President, Energy Supply Operations January 2012 - January 2015
S. R. Secrist
 
57

 
Senior Vice President, General Counsel and Chief Ethics and Compliance Officer since January 2014
S. J. King
 
35

 
Controller and Principal Accounting Officer since November 2, 2017. Senior Manager at PwC July 2016 - November 2017; Manager at PwC July 2013 - July 2016

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 PSE’s REGULATORY AND RATE-MAKING PROCEDURES
PSE's regulated utility business is subject to various federal and state regulations. PSE's regulatory risks include, but are not limited to, the items discussed below.
 
The actions of regulators can significantly affect PSE’s earnings, liquidity and business activities. The rates that PSE is allowed to charge for its services are the single most important item influencing its financial position, results of operations and liquidity.  PSE is highly regulated and the rates that it charges its wholesale and retail customers are determined by both the Washington Commission and the FERC.
PSE is also subject to the regulatory authority of the Washington Commission with respect to accounting, operations, the issuance of securities and certain other matters, and the regulatory authority of the FERC with respect to the transmission of electric energy, the sale of electric energy at the wholesale level, accounting and certain other matters.  In addition, proceedings with the Washington Commission typically involve multiple stakeholder parties, including consumer advocacy groups and various consumers of energy, who have differing concerns but who have the common objective of limiting rate increases or decreasing rates. Policies and regulatory actions by these regulators could have a material impact on PSE’s financial position, results of operations and liquidity.

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PSE’s recovery of costs is subject to regulatory review and its operating income may be adversely affected if its costs are disallowed. The Washington Commission determines the rates PSE may charge to its electric retail customers based, in part, on historic costs during a particular test year, adjusted for certain normalizing adjustments. Power costs on the other hand, are normalized for market, weather and hydrological conditions projected to occur during the applicable rate year, the ensuing twelve-month period after rates become effective. The Washington Commission determines the rates PSE may charge to its natural gas customers based on historic costs during a particular test year. Natural gas costs are adjusted through the PGA mechanism, as discussed previously. If in a specific year PSE’s costs are higher than the amounts used by the Washington Commission to determine the rates, revenue may not be sufficient to permit PSE to earn its allowed return or to cover its costs. In addition, the Washington Commission has the authority to determine what level of expense and investment is reasonable and prudent in providing electric and natural gas 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 the aforementioned 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.

PSE is currently subject to a Washington Commission order that requires PSE to share its excess earnings above the authorized rate of return with customers. The Washington Commission previously approved an electric and natural gas decoupling mechanism for the recovery of its delivery-system and fixed production costs, along with a rate plan and earnings sharing mechanism that requires PSE and its customers to share in any earnings in excess of the authorized rate of return of 7.60%. The earnings test is done for each service (electric/natural gas) separately, so PSE would be obligated to share the earnings for one service exceeding the authorized rate of return, even if the other service did not exceed the authorized rate of return.

The PCA mechanism, by which variations in PSE’s power costs are apportioned between PSE and its customers pursuant to a graduated scale, could result in significant increases in PSE’s expenses if power costs are significantly higher than the baseline rate. PSE has a PCA mechanism that provides for recovery of power costs from customers or refunding of power cost savings to customers, as those costs vary from the “power cost baseline” level of power costs which are set, in part, based on normalized assumptions about weather and hydrological conditions.  Excess power costs or power cost savings will be apportioned between PSE and its customers pursuant to the graduated scale set forth in the PCA mechanism and will trigger a surcharge or refund when the cumulative deferral trigger is reached.  As a result, if power costs are significantly higher than the baseline rate, PSE’s expenses could significantly increase.

RISKS RELATING TO PSE’s OPERATION

PSE’s cash flow and earnings could be adversely affected by potential high prices and volatile markets for purchased power, recurrence of low availability of hydroelectric resources, outages of its generating facilities or a failure to deliver on the part of its suppliers. The utility business involves many operating risks.  If PSE’s operating expenses, including the cost of purchased power and natural gas, significantly exceed the levels recovered from retail customers, its cash flow and earnings would be negatively affected.  Factors which could cause PSE's purchased power and natural 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 energy supply needs and/or purchases in wholesale markets of high volumes of energy at prices above the amount recovered in retail rates due to:
Below normal levels of generation by PSE-owned hydroelectric resources due to low streamflow conditions or precipitation;
Extended outages of any of PSE-owned generating facilities or the transmission lines that deliver energy to load centers, or the effects of large-scale natural disasters on a substantial portion of distribution infrastructure; and
Failure of a counterparty to deliver capacity or energy purchased by PSE.

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, natural gas-fired, hydroelectric, and wind-powered generating facilities.  Operation of electric generating facilities involves risks that can adversely affect energy output and efficiency levels or increase expenditures, including:
Facility shutdowns due to a breakdown or failure of equipment or processes;
Volatility in prices for fuel and fuel transportation;
Disruptions in the delivery of fuel and lack of adequate inventories;

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Regulatory compliance obligations and related costs, including any required environmental remediation, and any new laws and regulations that necessitate significant investments in our generating facilities;
Labor disputes;
Operator error or safety related stoppages;
Terrorist or other attacks (both cyber-based and/or asset-based); and
Catastrophic events such as fires, explosions or acts of nature.

Cyber-attacks, including cyber-terrorism or other information technology security breaches, or information technology failures may disrupt business operations, increase costs, lead to the disclosure of confidential information and damage PSE's reputation. Security breaches of PSE's information technology infrastructure, including cyber-attacks and cyber-terrorism, or other failures of PSE's information technology infrastructure could lead to disruptions of PSE's production and distribution operations, and otherwise adversely impact PSE's ability to safely and effectively operate electric and natural gas systems and serve customers. In addition, an attack on or failure of information technology systems could result in the unauthorized release of customer, employee or Company data that is crucial to PSE's operational security or could adversely affect PSE's ability to deliver and collect on customer bills. Such security breaches of PSE's information technology infrastructure could adversely affect our business reputation, diminish customer confidence, subject PSE to financial liability or increased regulation, increase costs and expose PSE to material legal claims and liability and adversely affect our operations and financial results. PSE has implemented preventive, detective and remediation measures to manage these risks, and maintains cyber risk insurance to mitigate the effects of these events. Nevertheless, these may not effectively protect all of PSE's systems all of the time. To the extent that the occurrence of any of these cyber-events is not fully covered by insurance, it could adversely affect the PSE’s financial condition and results of operations.
 
Natural disasters and catastrophic events, including terrorist acts, may adversely affect PSE's business.  Events such as fires, earthquakes, explosions, floods, tornadoes, terrorist acts, and other similar occurrences, could damage PSE's operational assets, including utility facilities, information technology infrastructure, distributed generation assets and pipeline assets. Such events could likewise damage the operational assets of PSE's suppliers or customers. These events could disrupt PSE's ability to meet customer requirements, significantly increase PSE's response costs, and significantly decrease PSE's revenues. Unanticipated events or a combination of events, failure in resources needed to respond to events, or a slow or inadequate response to events may have an adverse impact on PSE's operations, financial condition, and results of operations. The availability of insurance covering catastrophic events, sabotage and terrorism may be limited or may result in higher deductibles, higher premiums, and more restrictive policy terms.

PSE is subject to the commodity price, delivery and credit risks associated with the energy markets. In connection with matching PSE's energy needs and available resources, PSE engages in wholesale sales and purchases of electric capacity and energy and, accordingly, is subject to commodity price risk, delivery risk, 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 for delivery of energy supply or contractually required payments related to PSE's energy supply portfolio.  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.  Although PSE takes into account the expected probability of default by counterparties, the actual exposure to a default by a particular counterparty could be greater than predicted.

Costs of compliance with environmental, climate change and endangered species laws are significant and the costs of compliance with new and emerging laws and regulations and the incurrence of associated liabilities could adversely affect PSE’s results of operations. PSE’s operations are subject to extensive federal, state and local laws and regulations relating to environmental issues, including air emissions and climate change, endangered species protection, remediation of contamination, avian protection, waste handling and disposal, decommissioning, water protection and siting new facilities.  To fulfill these legal requirements, PSE must spend significant sums of money to comply with these measures including resource planning, remediation, monitoring, analysis, mitigation measures, pollution control equipment and emissions related abatement and fees.  New environmental 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.  Compliance with these or other future regulations could require significant expenditures by PSE and adversely affect PSE’s financial position, results of operations, cash flows and liquidity.  In addition, PSE may not be able to recover all of its costs for such expenditures through electric and natural gas rates, in a timely manner, at current levels in the future.
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.  The incurrence of a material environmental

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liability or new regulations governing such liability could result in substantial future costs and have a material adverse effect on PSE’s results of operations and financial condition.
Specific to climate change, Washington State has adopted both renewable portfolio standards and GHG legislation, including an emission performance standard provision and the EPA set CO2 emission standards with specific state goals.   
 
PSE's operating results fluctuate on a seasonal and quarterly basis and can be impacted by various impacts of climate change. PSE's business is seasonal and weather patterns can have a material impact on its revenue, expenses and operating results. Demand for electricity is greater in the winter months associated with heating. Accordingly, PSE's operations have historically generated less revenue and income when weather conditions are milder in winter. In the event that the Company experiences unusually mild winters, its results of operations and financial condition could be adversely affected. PSE's hydroelectric resources are also dependent on snow conditions in the Pacific Northwest.

PSE may be adversely affected by extreme events in which PSE is not able to promptly respond, repair and restart the electric and natural gas infrastructure system. PSE must maintain an emergency planning and training program to allow PSE to quickly respond to extreme events.  Without emergency planning, PSE is subject to availability of outside contractors during an extreme event which may impact the quality of service provided to PSE’s customers and also require significant expenditures by PSE.  In addition, a slow or ineffective response to extreme events may have an adverse effect on earnings as customers may be without electricity and natural gas for an extended period of time.

PSE depends on an aging work force and third party vendors to perform certain important services and may be negatively affected by its inability to attract and retain professional and technical employees or the unavailability of vendors. PSE is subject to workforce factors, including but not limited to an aging workforce, loss or retirement of key personnel and availability of qualified personnel. PSE’s ability to implement a workforce succession plan is dependent upon PSE’s ability to employ and retain skilled professional and technical workers.  Without a skilled workforce, PSE’s ability to provide quality service to PSE’s customers and to meet regulatory requirements could affect PSE’s earnings. Also, the costs associated with attracting and retaining qualified employees could reduce earnings and cash flows.
PSE continues to be concerned about the availability and aging of skilled workers for special complex utility functions.  PSE also hires third party vendors to perform a variety of normal business functions, such as power plant maintenance, data warehousing and management, electric transmission, electric and natural gas distribution construction and maintenance, certain billing and metering processes, call center overflow and credit and collections.  The unavailability of skilled workers or unavailability of such vendors could adversely affect the quality and cost of PSE’s natural gas and electric service and accordingly PSE’s results of operations.

Potential municipalization may adversely affect PSE's financial condition. PSE may be adversely affected if we experience a loss in the number of our customers due to municipalization or other related government action.  When a town or city in PSE's service territory establishes its own municipal-owned utility, it acquires PSE's assets and takes over the delivery of energy services that PSE provides.  Although PSE is compensated in connection with the town or city's acquisition of its assets, any such loss of customers and related revenue could negatively affect PSE's future financial condition. 

Technological developments may have an adverse impact on PSE's financial condition. Advances in power generation, energy efficiency and other alternative energy technologies, such as solar generation, could lead to more wide-spread use of these technologies, thereby reducing customer demand for the energy supplied by PSE which could negatively impact PSE's revenue and financial condition. 

RISKS RELATING TO PUGET ENERGY'S AND PSE'S FINANCING

The Company's business is dependent on its ability to successfully access capital. The Company relies on access to internally generated funds, bank borrowings through multi-year committed credit facilities and short-term money markets as sources of liquidity and longer-term debt markets to fund PSE's utility construction program and other capital expenditure requirements of PSE.  If Puget Energy or PSE are unable to access capital on reasonable terms, their ability to pursue improvements or acquisitions, including generating capacity, which may be necessary for future growth, could be adversely affected.  Capital and credit market disruptions, a downgrade of Puget Energy's or PSE's credit rating or the imposition of restrictions on borrowings under their credit facilities in the event of a deterioration of financial ratios, may increase Puget Energy's and PSE’s cost of borrowing or adversely affect the ability to access one or more financial markets.

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The amount of the Company's debt could adversely affect its liquidity and results of operations. Puget Energy and PSE have short-term and long-term debt, and may incur additional debt (including secured debt) in the future.  Puget Energy has access to a multi-year $800.0 million revolving credit facility, secured by substantially all of its assets, which has a maturity date of October 25, 2022. There was $11.9 million outstanding under the facility as of December 31, 2018.  Puget Energy's credit facility includes an expansion feature that could, upon the banks' approval, increase the size of the facility to $1.3 billion. Separately, Puget Energy entered into a 3 year, $150.0 million term loan agreement with a small group of banks in October, 2018. PSE also has a separate credit facility, which provides PSE with access to $800.0 million in short-term borrowing capability, and includes an expansion feature that could, upon the banks' approval, increase the size of the facility to $1.4 billion. The PSE credit facility matures on October 25, 2022. As of December 31, 2018, no amounts were drawn and outstanding under the PSE credit facility. In addition, Puget Energy has issued $1.8 billion in senior secured notes, whereas PSE, as of December 31, 2018, had approximately $3.8 billion outstanding under first mortgage bonds, pollution control bonds and senior notes. The Company's debt level could have important effects on the business, including but not limited to:
Making it difficult to satisfy obligations under the debt agreements and increasing the risk of default on the debt obligations;
Making it difficult to fund non-debt service related operations of the business; and
Limiting the Company's financial flexibility, including its ability to borrow additional funds on favorable terms or at all.

A downgrade in Puget Energy’s or PSE’s credit rating could negatively affect the ability to access capital, the ability to hedge in wholesale markets and the ability to pay dividends. Although neither Puget Energy nor PSE has any rating downgrade provisions in its credit facilities that would accelerate the maturity dates of outstanding debt, a downgrade in the Companies’ credit ratings could adversely affect the ability to renew existing or obtain access to new credit facilities and could increase the cost of such facilities.  For example, under Puget Energy’s and PSE’s facilities, the borrowing spreads over the London Interbank Offered Rate (LIBOR) and commitment fees increase if their respective corporate credit ratings decline.  A downgrade in commercial paper ratings could increase the cost of commercial paper and limit or preclude PSE’s ability to issue commercial paper under its current programs.
Any downgrade below investment grade of PSE’s corporate credit rating could cause counterparties in the wholesale electric, wholesale natural gas and financial derivative markets to request PSE to post a letter of credit or other collateral, make cash prepayments, obtain a guarantee agreement or provide other mutually agreeable security, all of which would expose PSE to additional costs.
PSE may not declare or make any dividend distribution unless on the date of distribution PSE’s corporate credit/issuer rating is investment grade, or if its credit ratings are below investment grade, PSE’s ratio of earnings before interest, tax, depreciation and amortization (EBITDA) to interest expense for the most recently ended four fiscal quarter periods prior to such date is equal to or greater than 3.0 to 1.0.  

Changes in the method for determining LIBOR and the potential replacement of LIBOR may affect our credit facilities and the interest rates on such borrowings. LIBOR, the London interbank offered rate, is the basic rate of interest used in lending between banks on the London interbank market and is widely used as a reference for setting the interest rate on loans globally. Puget Energy and PSE’s credit facilities allow Puget Energy or PSE, respectively to borrow at the bank's prime rate or to make floating rate advances at LIBOR plus a spread that is based upon Puget Energy’s or PSE's credit rating, respectively.
    On July 27, 2017, the United Kingdom’s Financial Conduct Authority, which regulates LIBOR announced that it intends to phase out LIBOR by the end of 2021. It is unclear if at that time LIBOR will cease to exist or if new methods of calculating LIBOR will be established such that it continues to exist after 2021. If the method for calculation of LIBOR changes, if LIBOR is no longer available or if lenders have increased costs due to changes in LIBOR, Puget Energy or PSE may suffer from potential increases in interest rates on any borrowings. Further, Puget Energy or PSE may need to renegotiate our credit facilities that utilize LIBOR as a factor in determining the interest rate to replace LIBOR with the new standard that is established.] Note to Company: Company to consider whether the LIBOR phase-out could be material. If so, include this risk factor.

The Company may be negatively affected by unfavorable changes in the tax laws or their interpretation. The Company’s tax obligations include income, real estate, public utility, municipal, sales and use, business and occupation and employment-related taxes and ongoing audits related to these taxes.  Changes in tax law, related regulations or differing interpretation or enforcement of applicable law by the IRS or other taxing jurisdiction could have a material adverse impact on the Company’s financial statements.  The tax law, related regulations and case law are inherently complex.  The Company must make judgments and interpretations about the application of the law when determining the provision for taxes.  These judgments may include reserves for potential adverse outcomes regarding tax positions that may be subject to challenge by the taxing authorities. Disputes over interpretations of tax laws may be settled with the taxing authority in examination, upon appeal or through litigation.

29



In particular, the Tax Cuts and Jobs Act which was enacted in December 2017 introduced significant permanent and temporary changes to the federal tax code. These changes include a tax rate change from 35.0% to 21.0%, the exclusion of utility businesses from claiming bonus depreciation, the limitation of interest deductibility by non-utility businesses, in addition to numerous other changes.

Poor performance of pension and postretirement benefit plan investments and other factors impacting plan costs could unfavorably impact PSE’s cash flow and liquidity. PSE provides a defined benefit pension plan and postretirement benefits to certain PSE employees and former employees.  Costs of providing these benefits are based, in part, on the value of the plan’s assets and the current interest rate environment and therefore, adverse market performance or low interest rates could result in lower rates of return for the investments that fund PSE’s pension and postretirement benefits plans and could increase PSE’s funding requirements related to the pension plans.  Changes in demographics, including increased numbers of retirements or changes in life expectancy assumptions, may also increase PSE's funding requirements related to the pension plans. Any contributions to PSE’s plans in 2019 and beyond as well as the timing of the recovery of such contributions in GRCs could impact PSE’s cash flow and liquidity.

Potential legal proceedings and claims could increase the Company’s costs, reduce the Company’s revenue and cash flow, or otherwise alter the way the Company conducts business. The Company is, from time to time, subject to various legal proceedings and claims, either asserted or unasserted. Any such claims, whether with or without merit, could be time-consuming and expensive to defend and could divert management’s attention and resources. While management believes the Company has reasonable and prudent insurance coverage and accrues loss contingencies for all known matters that are probable and can be reasonably estimated, the Company cannot assure that the outcome of all current or future litigation will not have a material adverse effect on the Company and/or its results of operations.
  
RISKS RELATING TO PUGET ENERGY'S CORPORATE STRUCTURE

Puget Energy's ability to pay dividends may be limited. As a holding company with no significant operations of its own, the primary source of funds for the repayment of debt and other expenses, as well as payment of dividends to its shareholder, is cash 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 or repay debt or other expenses, will depend on PSE’s earnings, capital requirements and general financial condition.  If Puget Energy does not receive adequate distributions from PSE, it may not be able to meet its obligations or pay dividends.
The payment of dividends by PSE to Puget Energy is restricted by provisions of certain covenants applicable to long-term debt contained in PSE’s electric and natural gas mortgage indentures.  In addition, beginning February 2009, pursuant to the terms of the Washington Commission merger order, PSE may not declare or pay dividends if PSE’s common equity ratio calculated on a regulatory basis is 44.0% or below, except to the extent a lower equity ratio is ordered by the Washington Commission.  Also, pursuant to the merger order, PSE's ability to declare or make any distribution is limited by its' corporate credit/issuer rating and EBITDA to interest ratio, as previously discussed above.  The common equity ratio, calculated on a regulatory basis, was 47.6% at December 31, 2018 and the EBITDA to interest expense was 5.6 to 1.0 for the twelve-months ended December 31, 2018.
PSE’s ability to pay dividends is also limited by the terms of its credit facilities, pursuant to which PSE is not permitted to pay dividends during any Event of Default (as defined in the facilities), or if the payment of dividends would result in an Event of Default, such as failure to comply with certain financial covenants.

Challenges relating to the construction or future operation of the Tacoma LNG facility could adversely affect the Company’s operations.  PSE and Puget Energy’s subsidiary, Puget LNG, currently are constructing the Tacoma LNG facility at the Port of Tacoma, a jointly owned facility intended to provide peak-shaving services to PSE’s natural gas customers, and to provide LNG as fuel primarily to the maritime market.  Puget LNG has entered into one fuel supply agreement with a maritime customer, and is marketing the facility’s expected output to other potential customers.  Scheduled to be completed in 2020, delays in the facility’s construction and operation or in its ability to timely deliver fuel to customers could expose Puget LNG to damages under one or more fuel supply contracts, which could unfavorably impact Puget Energy’s return on investment.


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ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

The principal electric generating plants and underground natural gas storage facilities owned by PSE are described under Item 1, Business – Electric Supply and Natural Gas Supply.  PSE owns its transmission and distribution facilities and various other properties.  Substantially all properties of PSE are subject to the liens of PSE’s mortgage indentures.  The Company’s corporate headquarters is housed in a leased building located in Bellevue, Washington.

ITEM 3. LEGAL PROCEEDINGS

For information on litigation or legislative rulemaking proceedings, see Note 15, "Litigation" to the consolidated financial statements included in Item 8 of this report.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

All of the outstanding shares of Puget Energy’s common stock, the only class of common equity of Puget Energy, are held by its direct parent Puget Equico LLC (Puget Equico), which is an indirect wholly-owned subsidiary of Puget Holdings, and are not publicly traded.  The outstanding shares of PSE’s common stock, the only class of common equity of PSE, are held by Puget Energy and are not publicly traded.
The payment of dividends on PSE common stock to Puget Energy is restricted by provisions of certain covenants applicable to long-term debt contained in PSE’s mortgage indentures in addition to terms of the Washington Commission merger order.  Puget Energy’s ability to pay dividends is also limited by the merger order issued by the Washington Commission as well as by the terms of its credit facilities.  For further discussion, see Item 1A, "Risk Factors"- Risks Relating to Puget Energy’s Corporate Structure and Item 7, "Management’s Discussion and Analysis of Financial Condition and Results of Operations" included in this report.
From time to time, when deemed advisable and permitted, PSE and Puget Energy pay dividends on its common stock. During 2018, 2017 and 2016, PSE paid dividends to its parent, Puget Energy, and Puget Energy paid dividends to its parent, Puget Equico, in the amounts shown in Puget Energy's and PSE's Consolidated Statements of Common Shareholder's Equity, included in this Form 10-K.



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ITEM 6. SELECTED FINANCIAL DATA

The following tables show selected financial data.  This information should be read in conjunction with the audited consolidated financial statements and the related notes found in Item 8, "Financial Statements and Supplementary Data" along with the information included in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operation" of this Form 10-K.
Puget Energy
 
 
 
 
 
 
 
 
 
Summary of Operations
Year Ended December 31,
(Dollars in Thousands)
2018
 
2017
 
2016
 
2015
 
2014
Operating revenue
$
3,346,496

 
$
3,460,276

 
$
3,164,301

 
$
3,092,700

 
$
3,113,171

Operating income
554,058

 
739,106

 
765,474

 
671,925

 
577,851

Net income
235,622

 
175,194

 
312,899

 
241,179

 
171,835

 
 
 
 
 
 
 
 
 
 
Total assets at year-end
$
14,098,861

 
$
13,690,789

 
$
13,266,380

 
$
12,814,254

 
$
12,637,946

Long-term debt
5,672,491

 
5,207,929

 
5,104,073

 
5,077,518

 
4,957,951

Junior subordinated notes

 
250,000

 
250,000

 
250,000

 
250,000

Capital lease obligations
1,315

 
1,129

 
645

 
378

 
9,473


Puget Sound Energy
 
 
 
 
 
 
 
 
 
Summary of Operations
Year Ended December 31,
(Dollars in Thousands)
2018
 
2017
 
2016
 
2015
 
2014
Operating revenue
$
3,346,496

 
$
3,460,276

 
$
3,164,618

 
$
3,093,258

 
$
3,116,123

Operating income
557,136

 
740,595

 
770,552

 
656,138

 
568,693

Net income
317,162

 
320,054

 
380,581

 
304,189

 
236,614

 
 
 
 
 
 
 
 
 
 
Total assets at year-end
$
12,097,523

 
$
11,731,706

 
$
11,297,080

 
$
10,799,513

 
$
10,552,727

Long-term debt
3,894,860

 
3,499,911

 
3,497,298

 
3,494,362

 
3,484,571

Junior subordinated notes

 
250,000

 
250,000

 
250,000

 
250,000

Capital lease obligations
1,315

 
1,129

 
645

 
378

 
9,473




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ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with the financial statements and related notes thereto included elsewhere in this report on Form 10-K. The discussion contains forward-looking statements that involve risks and uncertainties, such as Puget Energy, Inc. (Puget Energy) and Puget Sound Energy, Inc. (PSE) objectives, expectations and intentions. Words or phrases such as “anticipates,” “believes,” “continues,” “could,” “estimates,” “expects,” “future,” “intends,” “may,” “might,” “plans,” “potential,” “predicts,” “projects,” “should,” “will likely result,” “will continue” and similar expressions are intended to identify certain of these forward-looking statements. However, these words are not the exclusive means of identifying such statements.  In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements.  Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report.  Puget Energy’s and PSE’s actual results could differ materially from results that may be anticipated by such forward-looking statements.  Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section entitled “Forward-Looking Statements” and “Risk Factors” included elsewhere in this report.  Except as required by law, neither Puget Energy nor PSE undertakes any obligation to revise any forward-looking statements in order to reflect events or circumstances that may subsequently arise.  Readers are urged to carefully review and consider the various disclosures made in this report and in Puget Energy’s and PSE’s other reports filed with the U.S. Securities and Exchange Commission (SEC) that attempt to advise interested parties of the risks and factors that may affect Puget Energy’s and PSE’s business, prospects and results of operations.

Overview

Puget Energy is an energy services holding company and substantially all of its operations are conducted through its subsidiary PSE, a regulated electric and natural gas utility company. PSE is the largest electric and natural gas utility in the state of Washington, primarily engaged in the business of electric transmission, distribution and generation and natural gas distribution. Puget Energy's business strategy is to generate stable cash flows by offering reliable electric and natural gas service in a cost-effective manner through PSE. Puget Energy also has a wholly-owned non-regulated subsidiary, Puget LNG, LLC (Puget LNG), which has the sole purpose of owning, developing and financing the non-regulated activity of the Tacoma liquefied natural gas (LNG) facility, currently under construction. All of Puget Energy's common stock is indirectly owned by Puget Holdings, LLC (Puget Holdings). Puget Holdings is owned by a consortium of long-term infrastructure investors including Macquarie Infrastructure Partners, Macquarie Capital Group Limited, the Canada Pension Plan Investment Board, the British Columbia Investment Management Corporation (BCIMC), and the Alberta Investment Management Corporation (AIMCo). In August 2018, Macquarie Infrastructure Partners and Macquarie Capital Group Limited reached an agreement to sell their shares to Ontario Municipal Employee Retirement System (OMERS), PGGM Vermogensbeheer B.V. and current owners, AIMCo and BCIMC.  The sale is conditioned upon the approval of various federal and state agencies, including that of the Washington Utilities and Transportation Commission (Washington Commission).  Puget Energy and PSE are collectively referred to herein as “the Company.”
PSE generates revenue and cash flow primarily from the sale of electric and natural gas services to residential and commercial customers within a service territory covering approximately 6,000 square miles, principally in the Puget Sound region of the state of Washington. PSE continually balances its load requirements, generation resources, purchase power agreements, and market purchases to meet customer demand. The Company's external financing requirements principally reflect the cash needs of its construction program, its schedule of maturing debt and certain operational needs. PSE requires access to bank and capital markets to meet its financing needs.
Factors affecting PSE's performance are set forth in this “Overview” section, as well as in other sections of the Management's Discussion and Analysis.

Non-GAAP Financial Measures
The following discussion includes financial information prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP), as well as return on equity (ROE) excluding unrealized gains and losses on derivative instruments (net income plus unrealized losses and/or minus unrealized gains on derivative instruments divided by average common equity) that is considered a “non-GAAP financial measure.”  Generally, a non-GAAP financial measure is a numerical measure of a company’s financial performance, financial position or cash flows that includes adjustments that result in a departure from GAAP presentation. The Company believes that its return on average of monthly averages (AMA) equity, also a non-GAAP measure, is a more suitable metric for comparing ROE across years and is a more accurate metric for assessing and evaluating ROE performance against the Company's authorized regulated ROE.  The AMA equity is not intended to represent the regulated equity. PSE's ROE may not

33



be comparable to other companies' ROE measures.  Furthermore, this measure is not intended to replace ROE (GAAP net income divided by GAAP average common equity) as an indicator of operating performance.
The following table presents PSE’s ROE, its return on AMA equity and its authorized regulated ROE for 2018 and 2017:
 
2018
 
 
 
2017
(Dollars in Thousands)
 
Earnings
 
Average Common Equity
 
Return on Equity
 
Earnings
 
Average Common Equity
 
Return on Equity
Return on equity  
$317,162
 
$3,654,524
 
8.7%
 
$320,054
 
$3,545,686
 
9.0%
Less/Plus: Unrealized gains and losses on derivative instruments, after-tax
(32,913)
 
 
*
 
20,014
 
 
*
Less/Plus: Equity adjustments1
 
179,852
 
*
 
 
169,298
 
*
Plus: Impact of average of monthly average (AMA)
 
18,075
 
*
 
 
78,793
 
*
Return on AMA equity
$284,249
 
$3,852,451
 
7.4%
 
$340,068
 
$3,793,777
 
9.0%
Authorized regulated return on equity2
 
 
 
 
9.5%
 
 
 
 
 
9.8%
_______________
1 
Equity adjustments are related to removing the impacts of accumulated other comprehensive income (AOCI), subsidiary retained earnings, retained earnings of derivative instruments, and decoupling 24-month revenue reserve.
2 
The authorized regulated return on equity rate changed to 9.5% effective December 19, 2017, per the approved general rate case (GRC).
* 
Not meaningful and/or applicable.

The Company’s 2018 return on AMA equity was 7.4%, which is lower than the authorized regulated ROE primarily due to the following:
Regulated equity (rate base multiplied by equity percent) was $379.9 million lower than AMA equity for the year ended December 31, 2018. The impact on ROE for this variance was negative 0.9%. The variance was primarily driven by investment in items that do not earn a return or earn a return that is less than the authorized ROE. Such items include investment in construction work in progress and growth in rate base since the last general rate case (GRC).
Depreciation expense was $50.7 million higher than the amount allowed in rates on a pre-tax basis for the year ended December 31, 2018 for an impact on ROE of negative 1.3%.

The Company’s 2017 return on AMA equity was 9.0%, which is lower than the authorized regulated ROE primarily due to the following:
Regulated equity (rate base multiplied by equity percent) was $478.0 million lower than AMA equity for the year ended December 31, 2017. The variance was primarily driven by the impact on rate base of the deferred tax liability for utility, plant and equipment. The impact on ROE for this variance was negative 1.2%.
Rates are based on an assumption of normal weather. The amount of variance due to weather was $13.2 million, which resulted in an impact on ROE of positive 0.3%.
Depreciation expense was $24.8 million higher than the amount allowed in rates for the year ended December 31, 2017 for an impact on ROE of negative 0.7%.
Partially offsetting the above was net revenue from below the line activities and interest savings which totaled $28.2 million for an impact on ROE of positive 0.7%.


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Factors and Trends Affecting PSE’s Performance  
PSE’s ongoing regulatory requirements and operational needs necessitated the investment of substantial capital in 2018 and will continue to do so in future years.  Because PSE intends to seek recovery of such investments through the regulatory process, its financial results depend heavily upon favorable outcomes from that process.  The principal business, economic and other factors that affect PSE’s operations and financial performance include:
The rates PSE is allowed to charge for its services;
PSE’s ability to recover power costs that are included in rates which are based on volume;
Weather conditions, including the impact of temperature on customer load; the impact of extreme weather events on budgeted maintenance costs; meteorological conditions such as snow-pack, stream-flow and wind-speed which affect power generation, supply and price;
Regulatory decisions allowing PSE to recover purchased power and fuel costs, on a timely basis;
PSE’s ability to supply electricity and natural gas, either through company-owned generation, purchase power contracts or by procuring natural gas or electricity in wholesale markets;
Equal sharing between PSE and its customers of earnings which exceed PSE's authorized rate of return (ROR);
Availability and access to capital and the cost of capital;
Regulatory compliance costs, including those related to new and developing federal regulations of electric system reliability, state regulations of natural gas pipelines and federal, state and local environmental laws and regulations;
Wholesale commodity prices of electricity and natural gas;
Increasing capital expenditures with additional depreciation and amortization;
Tax reform, the effect of lower tax rates, and regulatory treatment of excess deferred tax balances on rate base and customer rates;
General economic conditions in PSE's service territory and its effects on customer growth and use-per-customer; and
Federal, state, and local taxes.

Regulation of PSE Rates and Recovery of PSE Costs
PSE's regulatory requirements and operational needs require the investment of substantial capital in 2018 and future years. As PSE intends to seek recovery of these investments through the regulatory process, its financial results depend heavily upon outcomes from that process. The rates that PSE is allowed to charge for its services influence its financial condition, results of operations and liquidity. PSE is highly regulated and the rates that it charges its retail customers are approved by the Washington Commission. The Washington Commission has traditionally required these rates be determined based, to a large extent, on historic test year costs plus weather normalized assumptions about hydroelectric conditions and power costs in the relevant rate year. Incremental customer growth and sales typically have not provided sufficient revenue to cover general cost increases over time due to the combined effects of regulatory lag and attrition. Accordingly, the Company will need to seek rate relief through a rate case on a regular and frequent basis in the foreseeable future after the investment is made. In addition, the Washington Commission determines whether the Company's expenses and capital investments are reasonable and prudent for the provision of cost-effective, reliable and safe electric and natural gas service. If the Washington Commission determines that a capital investment is not reasonable or prudent, the costs (including return on any resulting rate base) related to such capital investment may be disallowed, partially or entirely, and not recovered in rates.
Washington state law also requires PSE to pursue electric conservation that is cost-effective, reliable and feasible. PSE’s mandate to pursue electric conservation initiatives may have a negative impact on the electric business financial performance due to lost margins from lower sales volumes as variable power costs are not part of the decoupling mechanism. Although not specified by Washington state law, the Washington Commission also sets natural gas conservation achievement standards for PSE. The effects of achieving these standards will, however, have only a slight negative impact on natural gas business financial performance due to the natural gas business being almost fully decoupled.

Expedited Rate Filing
On November 7, 2018, PSE filed an expedited rate filing (ERF) with the Washington Commission. On January 22, 2019, all parties in the proceeding reached an agreement on settlement terms. The settlement agreement was filed on January 30, 2019. A ruling by the Washington Commission is expected in enough time to implement rates on March 1, 2019. For further details regarding the 2018 ERF filing, see Note 4, "Regulations and Rates" to the consolidated financial statements included in item 8 of this report.


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Washington Commission Tax Deferral Filing
The TCJA was signed into law in December 2017. As a result of this change, PSE re-measured its deferred tax balances under the new corporate tax rate.  PSE filed an accounting petition on December 29, 2017 requesting deferred accounting treatment for the impacts of tax reform.  The deferred accounting treatment results in the tax rate change being captured in the deferred income tax balance with an offset to the regulatory liability for deferred income taxes.  Additionally, on March 30, 2018, PSE filed for a rate change for electric and natural gas customers associated with TCJA to reflect the decrease in the federal corporate income tax rate from 35% to 21%.
The Washington Commission approved the following PSE requests to change rates to reflect the new corporate tax rates:
Effective Date
Average Percentage Increase (Decrease) in Rates
 
Increase (Decrease) in Revenue (Dollars in Millions)
Electric:
 
 
 
May 1, 2018
 
(3.4)%
 
$(72.9)
Natural Gas:
 
 
 
 
 
May 1, 2018
 
(2.7)
 
(23.6)

General Rate Case Filing
On January 13, 2017, PSE filed its GRC with the Washington Commission, the settlement agreement was accepted by the Washington Commission on December 5, 2017 and the rates became effective December 19, 2017. For further details regarding the 2017 GRC filing, see Note 4, "Regulation and Rates" to the consolidated financial statements included in Item 8 of this report.

Decoupling Filings
On December 5, 2017, the Washington Commission approved PSE’s request within the 2017 GRC to extend the decoupling mechanism with some changes to the methodology that took effect on December 19, 2017. Electric and natural gas delivery revenues will continue to be recovered on a per customer basis and electric fixed production energy costs will now be decoupled and recovered on the basis of a fixed monthly amount. Approved revenue per customer costs can only be changed in a GRC or ERF. Approved electric fixed production energy costs can also be changed in a power cost only rate case (PCORC). Other changes to the decoupling methodology approved by the Washington Commission include regrouping of electric and natural gas non-residential customers and the exclusion of certain electric schedules from the decoupling mechanism going forward. The rate cap which limits the amount of previously deferred revenues PSE can collect in its annual filings increased from 3.0% to 5.0% for natural gas customers but will remain at 3.0% for electric customers. The decoupling mechanism is to be reviewed again in PSE's first GRC filed in or after 2021, or in a separate proceeding, if appropriate. PSE’s decoupling mechanism over- and under- collections will still be collectible or refundable after this effective date even if the decoupling mechanism is not extended.

36



The Washington Commission approved the following PSE requests to change rates for prior deferrals under its electric and natural gas decoupling mechanisms:
Effective Date
 
Average
Percentage
Increase (Decrease)
in Rates
 
Increase (Decrease)
in Revenue
(Dollars in Millions)1
Electric:
 
 
 
 
May 1, 2018
 
(1.1)%