Pinnacle West Annual Shareholders Meeting Remarks for Bill Post Chairman and CEO Pinnacle West Capital Corporation

May 22, 2002 Time: 08:30 AM EST

Welcome to our annual meeting and welcome to the Herberger Theatre. I thank you for taking your time to be with us today, to hear about your company, and I’m very pleased to have this opportunity to talk with you about Pinnacle West.

It is very appropriate to have this meeting, here, in this wonderful theater, in the center of Phoenix and the nearly 900,000 customers we serve in our great state. We are very proud to have been a part of Arizona for more than 115 years – even before it became a state – and we are committed to providing the energy needed to support the Arizona lifestyle we all enjoy.

In the early days, APS helped Phoenix into the 20th century. We put in the electric wires and generators while participating with local leaders in a civic vision for our newly emerging city. At Pinnacle West we have a tradition of involvement in the community, and it’s not just a recent development.

We’ve also worked hard to apply the best of our industry’s technology to enhance the lives of our customers. In the 1950's, we were one of the first companies in the country to install solar power facilities to support research and expand into new types of generating resources.

The promise of solar continues to be constrained due to its high cost, over five times more expensive than other power sources. Nonetheless, we continue to support solar and other new methods, including energy efficiency, to help develop innovative research so that some day new technologies will provide a greater proportion of our energy needs. In fact, the cost to harness the power of the sun is just one-quarter of what it was just 20 years ago, thanks in large part to the kind of experience and research taking place here at our facilities.

And we’ve gone beyond solar in our search for promising and environmentally sound new energy technologies.

APS has constructed a hydrogen and compressed natural gas fueling station for vehicles capable of operating on these fuels. This pilot project will help us gain knowledge of how to work with hydrogen for larger applications in the future.

Our work has involved more than technological innovation. In the 1970s, APS was an important partner in putting forward a vision of renewal and an agenda to restore the city’s confidence, revitalize downtown and get it growing again. Many of you here today will remember the "Superblock effort."

I doubt we would be in this facility today if it were not for APS’s leadership to rebuild downtown Phoenix. The Arizona Center, Civic Plaza, the Science Center and many other downtown facilities have benefited from our company’s historical leaders and their leadership.

This APS tradition continues today in downtown Phoenix. APS Energy Services, our unregulated services subsidiary, creatively developed a system to utilize the large unused cooling capacity of Bank One Ballpark to help downtown businesses. Today, more than 8,000 tons of the Ballpark’s air-conditioning system are used to make tons of ice at night when power is cheaper. During the day, as the ice melts, we pipe cold water through a "downtown cooling district" to cool businesses and stores.

The system is more efficient than if each establishment ran its own individual cooling system, it helps downtown development and it reduces the need for new generating resources. It’s another example of how your company’s employees have creatively applied technology to improve the community in which we live.

Outside the Valley, our employees have worked with local leaders to plan for the future.

We have an award-winning program in our Economic Development group called Focused Futures. This program has helped more than 30 communities, such as Flagstaff, Florence and Prescott Valley, to develop strategic economic development plans.

These efforts have been well-received by community residents and are substantiated by the following quote from a recent letter to the editor of the Florence Reminder and Blade Tribune:

"Never in my 54 years . . . have I experienced or even heard of, a corporation that has an organization-wide ethic of service to small communities like I observe at APS. What a wonderfully dynamic partner rural Arizona has in APS." That was Tim Murphy, of Florence, Arizona, on April 25th of this year.

Tim mentioned ethics, and unfortunately ethical problems have become daily business news. Several companies, including Enron and others in our industry, have hurt not only their shareholders but the reputation of business in general.

This is bad for business and bad for our industry. At Pinnacle West, high ethical standards and a strong set of business values are the foundation of our company. Our employees work hard every day to earn the trust of our customers, regulators and you, our owners. We’re not perfect, but we strongly encourage and constantly reinforce appropriate business behavior.

For example, we recently published - and there are copies in the lobby for any of you that would care to have one - a book called WIRED: CREATING OUR CUSTOMER SATISFACTION. It contains stories that highlight exceptional employee performance. It describes for every employee the kind of company we strive to be and what we expect from ourselves.

We have high standards and we’re forging a tradition of meeting and exceeding our ethical, operational and financial goals. To illustrate this, today I would like to comment on three areas:

  • A status report on our performance.
  • An overview of significant industry events. And,
  • Our plan for the future.

Last year our financial and operating performance was one of the best ever.

We achieved the highest earnings in the history of our company. Income from continuing operations was 8.3 percent above our previous high – or $327 million – compared to $302 million in 2000.

We grew our dividend for the eighth year in a row. This is a practice that many electric utilities have abandoned, but it’s a competitive advantage for us. We’ve grown our dividend an average of 8 percent per year over the last five years while the average industry dividend has declined.

We improved our cash flow per share to one of the highest levels in the industry. Last year we produced $8.89 compared to $7.39 just five years ago.

These financial results are particularly remarkable when you consider that we achieved them while providing price decreases for our customers. These price decreases total 13 percent over the last eight years, providing more than $800 million in savings for our customers. And that doesn’t include our next decrease of 1.5 percent this summer.

Compared to the rest of the West, we stand alone in lowering prices and ensuring reliability. California residents are paying, on average, 32 percent more for electricity than they were last year. In Washington State, the increase could average 35 percent and in Nevada 33 percent. The story is similar across the entire region.

And not only did we achieve financial success simultaneously with price decreases, we managed this through a period of strong customer growth while maintaining high reliability in an electric market with the risk of blackouts and enormous price volatility.

Our power marketing group managed this risk in exemplary fashion. If you were to look at just the bottom line you would miss the fact that natural gas prices ranged from a high of $9.70 per million BTUs on January 8 to a low of $1.22 on September 24. Wholesale electric prices varied from $550 per megawatt-hour on May 10 to a low of $16 per megawatt-hour on November 15. Think about that. That’s a variation in price of over 30 times in less than 6 months. Imagine the reaction if our customers had experienced a 30-fold increase, then decrease in their electric bills. No other commodity is that volatile, and our group managed the risk exceptionally well.

We’ve created success in the toughest of environments.

Like our financial performance, our operational performance was also excellent.

At Palo Verde we continue to build on a tradition of superior performance. Our 10-year record in production is unsurpassed, and our average capacity factor for that period ranks among the nation’s very best. In fact, we have generated more electricity at Palo Verde than any plant of any kind in the U.S. in every one of the last 10 years. We have achieved four consecutive INPO 1s, which is the nuclear industry equivalent of a gold medal at four straight Olympics. A very extraordinary achievement.

We set production records at several of our fossil plants, and total fossil production was our best ever at 30 million megawatt-hours. Our new West Phoenix 4 plant operated at 99.8 percent availability after it began operating at mid year. One of our Cholla units operated continuously for 219 straight days, and Cholla, West Phoenix, Ocotillo and Saguaro all established site production records while Four Corners and Navajo came close to previous highs.

Turning to our generation expansion program, last year we completed West Phoenix 4 - our first new generating facility since 1988 - ahead of schedule and on budget. This summer, at our Redhawk plant near Palo Verde, we will bring on line new gas-fired capacity totaling more than 1,000 megawatts.

Our delivery performance was equally impressive. Our employees built seven new distribution and transmission substations last year, more than double that of an average year. They installed 45 substation feeders. In a typical year, that number would be 20.

Moreover, our transmission group won approval from the ACC to construct the Southwest Valley 500KV line, which will come into service in 2003. This line is essential to our ability to deliver to our customers the electricity they need in their day-to-day lives.

SunCor added to our corporate success, as well. Over the past six years, they have contributed $115 million in cash to the company. They’ve built considerable value in a varied portfolio, while creating high quality developments for the residents of their communities.

We continue our commitment to the environment. This commitment is ingrained in our employees and extends from more efficient power operations to waste recycling. From recycling paper in our offices to finding new ways of marketing coal ash, this philosophy has produced significant benefits. Last year, our coal plants sold nearly 500,000 tons of coal ash through a partnership with Phoenix Cement Company. In addition, we sold more than $2.4 million worth of metal, paper, wood pallets and other recyclables that otherwise might have been wasted.

We completed a project that transformed the site of an old manufactured gas plant into the centerpiece of a new park in downtown Prescott. This project included the removal of more than 96,000 tons of soil from the site of the old plant, which operated during the 20s and 30s.

These and many other efforts have been acknowledged by a number of independent groups that evaluate the environmental stewardship of companies. We were one of the early supporters, first utility company, of the CERES principles – standards of environmental performance by businesses – and have received recognition from both financial and environmental organizations for our participation.

Whether it’s the environment, operations or financial results, the people of Pinnacle West performed exceptionally well.

Our people care about our customers. Our increasingly positive customer satisfaction ratings validate our performance. Earlier this year, J.D. Powers ranked us second in the West Region among utilities surveyed for overall customer satisfaction of commercial customers. Our own numbers paint a similar picture.

Our people are proud of their results, and they deserve to be. They make Pinnacle West. They give us the ability to successfully challenge the future.

Our future will continue to present any number of challenges. That’s increasingly the nature of our industry. But I am confident that we will continue to turn challenges into opportunities. We did last year. And we will in the future.

The challenges started early in 2001 with the California struggle - mixing high prices, low supplies and politics – a dangerous recipe. By mid-year the Federal Energy Regulatory Commission caused short-term havoc by imposing price caps in the West. Then later in the year Enron imploded, with all its implications for accounting, business standards and the derivatives market.

The California regulatory debacle will hang over our industry for some time. It has created substantial regulatory backlash, with many states abandoning or postponing their plans for competition. It unleashed a whirlwind of market price volatility and reliability issues, not just in California but all through the West.

But that’s not the story here in Arizona. We kept control of our prices and kept the lights on for our customers. We met the growing needs of our state by adding the largest addition in generating capacity we have had since Palo Verde came on line in the mid 80's. We added more than 500 MWs last year, and we needed every one of them, when, on July 2 with a temperature of 116 degrees, we satisfied the highest electric demand in the history of our company.

That’s what customer reliability is all about – keeping customers cool in the summer and warm in the winter. It is about day-to-day life for people everywhere, and it is about our commitment to meet the needs of our customers.

The California lesson is clear to anyone who takes the trouble to learn it: Customers will not tolerate high prices, nor can our economy endure, anything but the highest levels of reliability. And our customers look to us to maintain those standards.

That’s why we started the process now under way at the Arizona Corporation Commission. It’s critical to our future, and competition rules developed back in 1999 cannot be implemented as originally expected due to a lack of development in the wholesale electric market. At the time, it was anticipated that the wholesale electric market would expand sufficiently to meet a majority of the need in the West. It has not – which is not surprising given the California debacle. Ignoring this reality and pushing the market beyond its limits will drive prices up and reliability down. Here’s the situation:

The ACC approved competition rules in 1999 that required APS to transfer its generation to an unregulated entity. As many of you will remember from my earlier presentations in these meetings, the ACC originally wanted us to sell our generation, but we adamantly refused. We didn’t see how we could meet the needs of our customers reliably and economically in an unproven wholesale market.

We kept our generation, and avoided the price spikes and outages that sent California into a tailspin. We also protected our customers through the aggressive actions taken in our power marketing group.

Now we’re dealing with another real market issue. Under the ACC rules, we’re required to buy all of our power needs on the open market beginning next year. At least 50 percent of that power has to come from "competitive bidding." We believe this cannot be done in today’s market with any acceptable or reasonable result.

If we have to carry out this requirement, the repercussions could be severe – for our customers, for the state of Arizona and for the future of competition in our region.

We cannot permit political agendas to overwhelm the importance of Arizona’s energy future as they did in California. We will – and we have – aggressively urged the ACC to make timely and responsible decisions concerning the transition to competition.

Last year we identified the potential for this trouble and filed our regulatory plan to protect customers from price volatility and ensure reliability for years to come.

To date, the ACC has been evaluating the legal and market issues; however, serious and substantive decisions must be made in the next few months. We are committed to aggressively pursue this effort to make sure that these tough decisions are timely and responsible.

We will not allow our customers’ energy needs to be compromised. And for you, our shareholders, we will not allow your assets to be devalued.

The future of Arizona’s energy supply as well as our own company’s role in the marketplace rests with these decisions.

Across the country movement to customer choice and retail competition has not been successful. Original promises promoted by opportunistic new participants were unrealistic, and the results have actually increased prices and decreased reliability in many states here in the West.

However, wholesale competition -- the sale of energy between energy companies – is real. Although the size of the market has not expanded as anticipated to cover a majority of retail sales, companies remain dependent on this market to fully meet customer loads. And they can pay, as I said earlier, prices that can swing as much as 30 times over short periods. Customer growth, particularly important here in the Southwest, is almost totally dependent on the wholesale market. The Federal Government and the Federal Energy Regulatory Commission require that companies participate and support the expansion of the wholesale market through regional transmission organizations. State Regulators have and will continue to use wholesale electric prices as benchmarks for generation prices charged to retail customers. And, as you know, in our own state the Arizona Corporation Commission continues to approve the construction of new power plants beyond those needed to serve the energy needs of our State. In short, wholesale markets are here to stay and they will continue to grow, albeit at a slower pace than envisioned in 1999.

The attendant risk of fluctuating wholesale electric prices is the most significant structural change in our industry’s history. Which is why it’s so important for our own State to get the transition to wholesale competition right, giving consideration to practical market realities while preserving commitments and responsibilities.

Wholesale markets are replacing the old command and control regulation, along with their prudence audits and least-cost planning procedures. This is good. However, it puts great value on managing generating risk. Which is why we’ve built our future plan around maintaining control over our own generation and using our power marketing group to control the impact of wholesale market volatility.

It’s been the key structural ingredient to our success over the last two years, and it’s fundamental to our future success. Without a power marketing group to manage customer and shareholder risk, industry volatility will overwhelm the regulatory structure. And we cannot have a fully functioning power marketing group with our generating resources bound by traditional regulation and compound decision making.

Managing this risk is the foundation of our future plan, which we believe will benefit our customers and our shareholders. Let me take just a few minutes to describe our plan.

First, we will continue to optimize growth opportunities in Arizona and the West. Pinnacle West is not – and has not aspired to be – a national company. We will continue to focus on our core business. We have the people with the experience and the knowledge to seize new opportunities as they develop, in the area of the country we know here in Arizona and the West.

Second, we will expand our generation business. We have the operational excellence in this area that makes generation one of our core strengths, and by adding more natural gas generation to our nuclear and coal capacity, we will have a balanced fuel mix that provides a strategic advantage over our competitors and price stability for our customers.

Third, as I said, we must manage risk. We must avoid short-term price volatility for our customers. We must avoid earnings volatility for our shareholders. For us, power marketing is a risk management imperative, not a short-term speculative bet.

And as I emphasized in my comments about our current proceeding before the ACC, managing regulatory risk is a continuing priority.

Fourth, we will continue to focus on creating customer value by providing stable prices and high reliability. We’ve seen power disruptions create mayhem in California. Customers want their lights on without significant increases in their energy bills.

Fifth, we will continue to focus on tomorrow and adjust our performance today to anticipate the future. Here are some examples:

At APS we’re never satisfied, we’re always looking to improve our operations. So we’ve launched a business analysis of the business by the business. It’s simply the business turning to look at itself and fine tune our performance.

We believe the current situation in California may not be as stable as it currently appears, and we’re prepared to act upon Western power market opportunities as they develop.

And we’re mining the potential of internet and computer technologies to improve communications with our suppliers and customers, cut costs, improve service and enhance productivity.

Sixth, we are working to decrease our capital leverage. Over the past couple of years, due to the generation expansion to provide reliable service to Arizona customers, our debt ratio – as expected – has increased to 60 percent. Our goal is to reduce this ratio to below 55 percent by the end of 2004, and we have a process in place to achieve this goal.

Seventh, and finally, we will continue to target combined earnings per share and dividend growth that exceeds the industry average. That is our definition of creating shareholder value. Over the last five years we have grown these two prime value indicators at a combined average compounded rate of 17.6 percent per year, ranking us in the top 10 percent in our industry.

That, in summary, is our plan for the future – a plan for providing service and value for customers, steady growth for shareholders and commitment and leadership for our communities. It is not an easy task. We face uncertainties in the regulatory arena and we face a tough economy. We move forward with discipline, but also with confidence in our own abilities and in the future of Arizona and the West.

Our outstanding results and our confidence in the future is based on the creativity and ability of our employees. Our employees have a history and a commitment to Arizona. They care about our State, and they have the knowledge, experience, focus and dedication to produce excellent operating results and superior shareholder returns.

We’ve made that kind of performance a tradition and we have every intention of keeping it that way.

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