For those of you who have known APS for several years, I hope you found your favorite part of the company in the video. APS has grown with Arizona for 117 years. In every one of those years we’ve taken pride in serving and meeting the energy needs of our customers. But clearly, a handful of those years have been real milestones in our company’s history.
Two-thousand-two (2002) was such a year. We confronted tough markets, navigated a new regulatory structure and resolved liquidity issues. Most importantly, we laid a strong foundation for a diverse and dynamic company that will continue to meet Arizona’s energy needs while providing you – our shareholders – with a strong return on your investment.
I’m delighted to see so many familiar faces in the audience today. Like me, I’m sure that many of you recognized several of the images on the video. They are images that tell an important part of the history and mission of our company. Some of you built these images.
They are images of the role our company has played in building Arizona.
The generating plants pictured in the video were built to meet the growing needs of our state, one of the fastest growing in our country. They were built to meet future needs. They were built to provide lasting value, each and every one of them. And, each time, through each cycle of new construction, they have done that.
During my career here – going back over 30 years now – I, along with many of you, have seen four distinct cycles of power plant construction.
It’s hard to think of APS as a small company. However, in the early 1950s we served only 100,000 customers, primarily with gas-fired plants. Our customer load was almost flat, without the high summer peak demand we have today. We battled the heat with evaporative coolers, if you had one.
By the early 1960s we had nearly doubled the number of customers as Arizona began an era of spectacular growth that continues through today. Air conditioning was new and expensive. Office buildings and new shopping malls were places where people went to avoid the heat. But it was clear new energy demands from air conditioning and population growth were going to increase summer loads, and so we built Four Corners and Cholla. These large coal-fired plants were seen by some at the time as too large and too far away. But they were neither. They diversified our fuel mix and provided our expanding service area with efficient, low-cost base-load capacity.
In the 70s we were growing so rapidly that we rushed to keep up by adding combustion turbines. Air conditioning was becoming widespread. We needed peaking capacity, and we needed it quickly – so we added quick-start gas turbine units at our Ocotillo, Saguaro, West Phoenix and Yucca plants.
By 1980 we were serving more than 420,000 customers, and that level of growth called for more large, base-load power plants. But with the memory of the oil shocks of the 70s still fresh, we couldn’t add oil units. Anticipated natural gas shortages prompted legislation banning the use of natural gas in utility boilers, and coal was a difficult option for environmental reasons.
So we turned to nuclear power and finished Palo Verde, the nation’s largest nuclear energy station at nearly 4,000 megawatts. Thanks to the foresight of executives like Tom Woods and Ed Van Brunt, who are here with us today, Palo Verde gave APS and Arizona the energy foundation to ride out the California energy debacle we’ve experienced over the last few years.
In the 90's, we signed a diversity exchange contract with PacifiCorp, taking advantage of the high amount of base load energy Palo Verde provides. We increased the output of our existing plants and expanded transmission capacity to other markets. Arizona customers don’t realize the jeopardy they could have faced had we not stepped up to the challenge in the late 90's to expand our resources, increase output from our existing plants and take the extraordinary step of acquiring temporary trailer-mounted generating units.
As I have emphasized, our industry, like most things, moves in cycles, particularly when it comes to matching new generation with growing energy requirements. Sometimes I wonder if as an industry we have learned anything from history. Today, the talk is of surpluses and unneeded generation. Nonetheless, I can assure you that in a few years we will be very fortunate to have all the resources we now have on hand.
Through our generation subsidiary, Pinnacle West Energy, we are finishing the latest round of new plants built to serve APS customers, the combined-cycle natural gas-fired plants at Redhawk and West Phoenix and the combustion turbine at Saguaro.
Arizona will need about 17,000 MW of peak electric generating capacity this summer. Existing utility resources total about 13,000 MW, meaning 4,000 MW of the new gas plants, built by others and ourselves over the last few years, will be dedicated to Arizona. The remainder of new gas capacity, about 2,600 MW, has been and will continue to go to California. New plants currently under construction, about 1,300 MW, will be needed to meet future Arizona load growth.
I know that’s a lot of numbers. What it means is that if all the construction currently under way can be financed and construction is completed, we will have about two years of new capacity available. In our business two years is not a long time. Historically, we have seen significant wholesale price swings long before they were expected. Although I don’t see wholesale electric prices changing quickly in the near term, I predict the discussion will turn to the need for new generation faster than most believe.
Planning for the needs of Arizona is our job. We did it with Four Corners, Cholla, Navajo, Palo Verde, Redhawk and West Phoenix. We’re proud of our record of meeting the energy needs of our fast growing state. Unlike companies in other states, we did not turn reliability over to the politicians or state agencies. We did not succumb to short term fads or convenient regulatory scenarios. We did not sell our generating units, and we kept our focus on our core business.
We have a long-term perspective that incorporates the cycles of our business and utilizes them to our advantage on behalf of our customers and our shareholders. Nobody protected customers from a California-style debacle like we did, nobody cut prices like we did and nobody took steps in 1999 to protect their shareholders from the volatility of the marketplace like we did. Our intent is to provide value over time. This perspective provides a clear vision and is our foundation for the future.
Our customers, regulators and shareholders expect us to face the unexpected and perform well in unusual circumstances. They expect us to manage risk.
To do that, we must have resources we can count on. We need generating plants, not just promises of a new deregulated generating market. And we need something even more important than that. We need people willing to face the challenge of high expectations. Fortunately, we have them.
Customers themselves will tell you the kind of job our employees are doing. Bob Johnson, CEO of Honeywell Aerospace here in Phoenix, told me that he has never seen a company perform the way we performed after a severe monsoon – our own perfect storm – destroyed much of the electric infrastructure in the vicinity of Sky Harbor Airport last summer. Honeywell engineers feared their operations would be shut down for weeks. Terry Yoakum, Marshall Rose and John Strickland of our T&D group along with 30 system crews and 20 metro crews tackled the damaged area right away, and within 56 hours, the Honeywell facility was back in operation. That’s effective dedication and commitment.
Customers expect us to deliver value – which they define as reliable power at an affordable price. To meet the highest reliability standards, we’ve built new power plants, to be sure, but our people have done much more. In the last 10 years they have added more than 5,200 miles of "wires". That’s like building a line from Phoenix to Chicago, New York, Miami and then back to Phoenix. These new transmission and distribution wires were needed to serve nearly 300,000 new customers.
While we were serving more customers, we were also serving them better by objective measures of reliability and by the evidence of satisfaction surveys. Perhaps even more significantly, while California and other states endured rolling blackouts and brownouts, our customers did not experience a single capacity-related outage.
Moreover, we are working safer. Two-thousand-and-two (2002) was our safest year ever. For the second year in a row, the total number of preventable accidents decreased. Energy Delivery and Sales reduced injuries by more than 15 percent. In our business, that is essential and often life-saving.
Best of all for customers, during the last decade our retail electric prices have fallen by 16 percent, a record unmatched by any other utility in the nation during this period. When you consider that on average the price of electricity in the West has increased by 43 percent, it’s even more dramatic.
In the area of customer information, we’ve taken "on demand" customer service to new levels. With the information and technology explosion that has occurred in the past decade, the expectations of our customers have grown. The demand and need for timely and accurate information about electric outages has greatly increased. With better training and computer technology, we are now able to satisfy this need for outage information "on demand."
Our customer web site has been recognized with national honors, and our call center performance has been one of the anchors of our improved customer satisfaction. We’ve found that it is just as important for customers to have quick access to timely information about outages, for example, as it is to restore power quickly.
Customers like what they’re seeing. In our latest satisfaction surveys, we’ve achieved a continuous improvement in customer satisfaction over the last four years. Our statistics have improved 30 percent since 1999. The most recent J.D. Power study placed us second in commercial customer satisfaction in the West and first for investor-owned utilities.
As I said, this is possible only through the dedicated actions of our people. The people of APS tackle more and more every day. Technology helps, but our improving efficiency comes primarily from their personal dedication. Last year we had nearly 500 employees take early retirement as a result of an enhanced retirement plan. Consider that 15 years ago we had more than 9,000 employees, and today our total employee count is about 6,000. During the same period our customer market grew 70 percent, making even more remarkable the improvement we’ve seen in customer satisfaction.
Of course, when customers are happy, it’s easier to keep regulators happy. Easier, but not easy. Meeting the expectations of regulators will never be easy, and 2002 was a difficult regulatory time. After 10 years of preparation for competition, they’re moving us back to a fully integrated world of regulation. Although it’s not that simple. We’re in a constantly shifting regulatory arena trying to satisfy the frequently conflicting expectations of state and federal regulators.
The result will be a paradoxical mix of more regulation side by side with competition. With FERC continuing to push for deregulation and the ACC pursuing vertical integration, we must deal with incompatibilities and live in different universes at the same time.
With our price decrease next month, we will have fulfilled our commitment to reduce retail electric prices as part of the 1999 regulatory agreement with the Arizona Corporation Commission. However, the competitive world produced something different than we all expected in 1999. Yet, we kept our part of the bargain, and we think it’s appropriate and essential that our regulators recognize our efforts and resolve inconsistencies established by their rules.
As I said in my letter to investors, we acted responsibly in protecting our customers during the power market debacle. We avoided the turmoil of blackouts and the price shocks that swept through our region. We expect a regulatory solution that is fair to our customers and shareholders, and we will be filing our request by the end of June. In it we will be asking that our new plants be placed in rate base where they are best positioned to continue serving APS customers for many years to come.
Since APS was 1,500 MW s short to the market when the rules were established in 1999, we had no choice but to build these plants under Pinnacle West Energy to serve APS customers. The recently completed Track ‘B’ effort ordered by the Commission confirms and validates that position. It also shows that in a competitive bidding process, monitored by the ACC with an independent consultant that they selected, our plants provide the most economic summer supply for APS customers.
We’ll also be asking the Commission to reverse the $234 million write-off our shareholders took in 1999. That write-off was a part of the package to move all our generating units out from under regulation. That write-off is no longer appropriate since the Commission changed direction and retained the existing units in APS.
In addition, we will seek recovery of all the costs associated with our preparation for and the reversal of the movement toward competition.
Although it may appear to some that APS has recently been supporting Pinnacle West and Pinnacle West Energy, actually the reverse is true. Without the Pinnacle West Energy units, APS would not be able to meet this summer’s electric load in Phoenix. Without Pinnacle West, these new generating assets would not have been financed the way they are today – with rates three to five hundred basis points below comparable merchant company costs. This will benefit not only Pinnacle West shareholders but APS customers as well.
The fact that we’ve preserved our financial health through these tumultuous times is not a basis for negative regulatory decisions. We will make it clear that a favorable regulatory outcome is essential to maintaining a healthy company, which is a prerequisite for top performance in an industry where managing risk is essential to both customer and shareholder success.
The good news for shareholders is this: despite the regulatory changes, our business strategy is fundamentally the same.
We focus on superior long-term returns for shareholders.
We achieve that by providing Arizona electric customers with reliable power at stable prices and by capturing growth opportunities in our electricity markets.
We concentrate on our core business.
We actively manage our costs and business risks while maximizing the long-term value of our assets.
We maintain a disciplined focus on our long-term goals while remaining agile in our approach to achieving those goals.
As our customer growth continues, we will expand our supply portfolio consistent with customer demand growth, cash flow and market conditions to assure that Arizona has the future energy it needs.
That’s our strategy in a nutshell. A strategy matched by operational performance as impressive on the generation side of the business as it is on the customer service side. Highlights of that performance can be found on the handouts in your chairs.
That performance includes – for the 11th consecutive year – Palo Verde as the number one electric producer in our country, and fossil plant operations placing us in the top quartile in plant availability while meeting high environmental standards.
We were among the first to add scrubbers to our major coal-fired units. We were the first utility to endorse the CERES code of conduct, committing us to the highest environmental standards. We’re closing down our hydro plant, Childs-Irving, and restoring its stream to pristine condition. We’re a worldwide leader in the practical application in solar power. Because of our solar and environmental reputation, DOE has turned to us for one of the nation’s largest tests of clean hydrogen technology.
Environmentally, APS performs very well compared to our peers. This was highlighted in June 2002 with the release of the Innovest Strategic Value Advisors report on the U.S. Electric Industry where Pinnacle West was one of two (out of 28 utilities) to receive the highest rating for environmental performance and risk management.
We have a strong environmental ethic, and we continue to look for ways to improve our performance. This year we implemented a Compliance Assurance Program, which provided a four-tier review of our environmental performance – ranging from self-assessment to independent audits and emphasizing environmental ownership at the operational level.
All of this has been accomplished with integrity – a core value for Pinnacle West and an attribute, unfortunately, in far too short supply in our industry the last few years. At our company, we believe that employees, shareholders, regulators, customers and, indeed, any other stakeholder should expect the truth properly and fairly told. I’m proud of the fact that our employees identified unfair trading practices early and took action to make them known to the California ISO. We’ve built an atmosphere in which doing the right thing is paramount, and we do not and will not tolerate inappropriate or unethical dealings.
Our outstanding performance meant that last year’s operating earnings were relatively strong despite a sub par economy and some one-time charges that position us well for the future. Our voluntary staffing reduction, in particular, will begin providing benefits to the bottom line this year. NAC, a company that is owned by Pinnacle West investment subsidiary El Dorado, experienced difficulty with two nuclear fuel contracts last year. NAC has settled one and is on the way to completing the other next month. I do not believe we will see any significant losses from NAC this year.
We have a sound liquidity situation, having taken prudent steps such as obtaining loans for our power plant financings, canceling Redhawk 3 and 4 and carrying out a successful equity offering. We’re also making significant headway at Suncor, our real estate subsidiary, to increase earnings and cash distributions to the parent. We are on track this year to double Suncor’s earnings from last year and provide $80 to $100 million in cash to the parent.
Our company moved in one direction for nearly a decade – toward a new competitive industry. In 2002, that direction reversed. Such sudden change is not easy, and it caused disruptions. Nonetheless, it did not change expectations.
Our shareholders expect us to deliver strong performance in the form of share appreciation and dividends over time. Last year our stock performance mirrored the industry, and we have held our own against our peers and the broader indexes over the last five years. But, unlike many utilities that have decreased or even eliminated their dividend, we’ve continued to set ourselves apart by steadily increasing ours.
Over the last five years, our dividend has increased faster than any other utility in the industry. Going forward, we will continue to emphasize dividends. This fall our board will again consider the dividend level, giving consideration to cash flow, market conditions and payout ratios.
Our financial health remains strong. We preserved our investment grade credit ratings with all three agencies throughout last year’s regulatory restructuring. Our industry saw 12 percent of utility companies fall to below investment grade, with approximately 60 percent receiving downgrades.
The many things that make us a great company and a strong investment, position us well to continue to meet your expectations. Our customer growth is powerful, and our customer satisfaction has never been higher. Our power plants and wires networks are operating beyond our previous high performance standards. We understand the opportunities here in the Southwest.
We remain on course. Arizona – with its intense climate, aesthetic beauty and nearly limitless potential – has never seemed more attractive. Our Arizona roots go deep, and we expect to continue to plan for and meet the energy needs of our customers in order to provide you, our shareholders, a strong return on your investment.
As I wrote in our annual report, this is our home, this is our future, this is our element.