Remarks of Bill Post at the Pinnacle West Capital Corporation Annual Meeting

May 21, 2008 Time: 08:30 AM EST

Thank you for attending today’s meeting.

For 123 years, our company has proudly served Arizona. Arizona is our home, our passion and our focus. Powering our state’s future is a commitment embraced by each of our employees.

Our people work in the most demanding and quickly expanding region in the country.

Yet, amid these demands and expectations, each year our people set new high standards of performance, earn positive recognition and incorporate new technologies to make our system run more smoothly.

In the last decade, they have connected more than 300,000 new customers, added more than 7,500 miles of transmission and distribution wire and have seen our peak energy demand increase 64 percent, while customer outages have decreased 67 percent.

Those numbers reflect a pride in performance that runs throughout our company. In 2007, our coal units set new records, reaching an 88 percent combined capacity factor, well above the national average of 71 percent.

At the Palo Verde Nuclear Generating Station, our people have put the plant on a steady path to recovery. Last year, the plant logged an 11-percent improvement in capacity factor over 2006. We’re seeing more positive signs in 2008. With new steam generators running in all three units, Palo Verde set an all time production record until Unit 2 started its scheduled refueling in March. Through April, the Palo Verde capacity factor was 86 percent, while Units 1 and 3 continue to perform with 173 and 123 days of continuous performance.

Improvements to our delivery system have made possible dramatic increases in the dependability of our product. A decade ago, a typical customer would experience nearly three outages in a year. By comparison, last year the average APS customer experienced about half that, and we’ve cut the duration of those outages by 38 percent. Put another way, in 2007, despite adding another 34,000 customers, we kept the power flowing 99.98 percent of the time, even with our summer storms.

Our people are also creatively developing and applying new industry-changing technologies. For example, our employees have created a real-time system which will revolutionize the accuracy and timeliness of how we analyze the oil in our transformers. The result is a safer, more economical and far more effective process that will drastically reduce the likelihood of catastrophic transformer failures, and may set a new standard for our industry.

And our people are pioneering new ways to reduce carbon-dioxide emissions at our power plants by feeding those emissions to algae and bacteria while producing bio‑energy which also improves our carbon footprint.

This hard work and ingenuity has earned our company considerable third-party recognition such as the Energy Star Award for our work with energy-efficient homes, the Better Business Bureau ethics award, and a place on the Global 100, a list of the world’s most sustainable corporations.

Most important, our people have a positive attitude and a commitment to succeed no matter what challenges lie before them. They relish the opportunity to put their fingerprints on the Arizona of tomorrow, and help ensure this is an even better place to live 10, 20 or 40 years from now.

The infrastructure investments we’re making today and over the next decade will shape the future of Arizona’s communities, its environment and its economy. We’re working to ensure a bigger Arizona is, in fact, a better Arizona.

That means just doing things faster or better won’t be enough. We are committed to doing new things, in new ways for a new and growing generation of customers.

For example, we are committed to a future that is cleaner: We recently announced the Solana Solar Generating Station, which if operating today would be the world’s largest solar plant. Solana will give APS more solar power per customer than any other electric utility in the nation.

We’re committed to a future that is more efficient: Our energy efficiency programs – including discounts on compact fluorescent bulbs, and substantial rebates on solar rooftop systems and efficient appliances – are saving our customers money and helping to reduce growth in demand.

We’re committed to a future that offers our customers more control over how they use energy: The smart meters we’re installing on our customers’ homes at a pace of 7,000 per month, will create a platform for our customers to control their energy use in Arizona from a cell phone anywhere in the world.

We’re committed to a future that is more intuitive and responsive: We’ve added new, state-of-the-art distribution technologies with new process control computers and information systems which allow us to instantaneously monitor electrical needs and reduce outage minutes.

And, we’re committed to a future that is more reliable: We plan to invest a billion dollars in new electric infrastructure each year for the foreseeable future to ensure our energy system will meet our state’s growing demands.

As we sit here in cool comfort today, with temperatures this week hitting 110 degrees outside, I assume we are all thankful for air conditioning. In fact, I can safely say that anything that makes it possible – even comfortable – to live in the middle of the Sonoran Desert during the hottest months of summer, is of critical importance. So is electricity. Compared to any other energy source, electricity is, by far, the greatest value. In the last 20 years, APS’ actual electric prices have gone up 10 percent. Inflation was up 82 percent and, by comparison, natural gas has increased 146 percent, gasoline has grown 292 percent, and oil has risen 695 percent.

Part of keeping electricity a great value is attributable to efficiency gains in household appliances. These efficiency gains have helped ensure each kilowatt we produce accomplishes more. Today’s air conditioning units are 100 percent more efficient than they were 40 years ago, meaning they can run twice as long using the same amount of energy. Similarly, today’s refrigerators are 240 percent more efficient than their predecessors of 40 years ago.

Efficiency is important. However, added efficiency has not actually contributed to a decrease in electricity consumption. Although appliances have improved, we simply use them more. While our customers are more efficient than they were ten years ago, on average they use 20 percent more energy per household, than they did ten years ago.

Reliable, affordable electric power is the key energy cornerstone in our dynamic, modern economy. The tie between growth in the economy and growth in dependable electricity is inarguable and mutually enabling. In Arizona, electricity usage has risen at almost the same rate as employment. Since 1980, employment in Arizona is up 165 percent…electricity usage is up 180 percent. As the old song goes, “you can’t have one without the other.”

The growth of electricity has made our state more prosperous. Consider that 40 years ago, there were roughly 475,000 jobs in Arizona, and an average household income of $10,600. Today, there are 2.7 million jobs, while income has increased six and one‑half times.ى Even more telling, the average annual growth in household income has been 15ىpercent above the rate of inflation. ى And 40 years from now? Our projections estimate, with the right amount of infrastructure investment, Arizona jobs could hit 5.1 million, with real annual incomes continuing to grow at their historic levels.

As vital as electricity has been in Arizona, it will likely be more so in the future. APS will add customers at or near the fastest rate of any utility in the country, and as a result we will need to add about 4,500 megawatts of new generating capacity by 2020. That means even with the increasing efficiencies of our customers, an aggressive demand side management program and high performance from our existing plants, we’ll still need to expand our system by more than 50 percent in the next 12 years.

Meeting growth is what we do and what we have always done. In the seventies, we built Palo Verde to get ahead of future growth. It was a tough decision – an investment greater than our company’s net worth at the time. But what would Arizona look like today if our company had not been willing to make that tough decision? Could we have powered the expansion of the fastest growing region in the United States?

We will continue to meet our customers’ electricity demands – that’s our job. To do so, we will invest $10 billion in electric infrastructure over the next 10 years to power Arizona’s future. However, the specifics of how we build and pay for this future are key pieces of the puzzle we must solve soon. Our growth means APS faces a need for new base load energy capacity within the next five to eight years. More tough decisions will have to be made. To build consensus on the best path for the future, we are seeking broad input from our customers, investors, regulators, government officials and others on the best energy alternatives for Arizona.

We’ve had three public meetings so far and expect to have at least six more throughout the state. These stakeholder meetings look at the future of our state, focusing on issues such as growth, economic development, energy efficiency, alternative energy sources, fuel risks and diversity. We consider it our role to include all interested parties in the discussion of how to meet future energy demands. The meetings have been well attended and we expect to complete this process by year end.

We know our plan will focus on cleaner, more sustainable technologies. To this end, we’re rapidly increasing our use of renewable energy resources. This year we expect to see a six-fold increase in renewable energy production compared with just two years ago. But that’s just the beginning.

We will continue to push the development of sustainable technologies and processes here in Arizona. We’re offering our customers substantial incentives to put solar panels on their homes, or switch to a solar water heater. We’re also offering discounts throughout Arizona on energy-efficient appliances and compact fluorescent light bulbs.

Through efficiency promotion and programs, we’re working to change how our customers use and perceive energy. Still, history has shown that large-scale changes tend to take place when the market determines the current situation has gotten to a crisis point and there is little other option remaining other than change.

The reality is, when it comes to making substantial behavioral changes, necessity trumps marketing. For example, when I was a young man in this business in the early 1970s, we had a gas moratorium that dictated our industry curtail the use of natural gas for generation. In fact, we couldn’t serve new gas customers and it looked like we would be curtailing existing customer use. As a result, we planned to use more oil. Then, in 1973 when the Arab oil embargo hit, we found out that oil wouldn’t be workable either.

This crisis situation left our industry and our country looking for another alternative, which added considerable momentum to the age of nuclear development. Federal legislation prohibited new natural gas generation and encouraged new nuclear plants. In 1973, U.S. utilities ordered the construction of 41 nuclear plants – a one year record. Without that crisis and the resulting response, we would not have most of the nuclear power plants we have in the U.S. today.

Today in our company, we have the same feeling of crisis regarding our country’s energy future and its skyrocketing costs. Clearly, energy isn’t just an industry concern, it’s a global concern. More than ever before, we are receiving calls to our call center, and questions from young people, looking for some perspective on the energy situation for their future. Just last week, Arizona State University opened a new building for its School of Sustainability with plans for over 2,000 students. The response has been overwhelming, with students clamoring for the opportunity to learn about energy, its impacts and alternatives. What this means to me is that our country’s sense of energy entitlement – the idea that an endless stream of power will always exist no matter how much we consume – is waning.

Just as $5 a gallon gasoline may be the tipping point for consumers to change from their SUVs to public transportation, carpooling or a new hybrid, that same feeling of necessity could be what it takes to push new nuclear development. As well as moving renewable technologies from intellectual discussion to widespread adoption.

With these issues in mind, we have worked and will continue to work with our regulators to plan and build Arizona’s future energy structure. Our proposals and the resulting decisions made by the Arizona Corporation Commission in the last five years to restructure our industry have been substantial and have had a profound effect on our state and our company. By contrast, in other states, electric restructuring has displaced political leaders, driven companies into bankruptcy and imposed unnecessary costs on residents.

We did not do that in Arizona.

In the last five years, our state reversed the course of a competitive electric market plan and restructured the entire regulatory process. Clearly there have been costs involved with these decisions. Raising the prices our customers pay for electricity is not something we take lightly, and I know the Arizona Commission feels the same way. Our shareholders also paid a price with lower-than-allowed returns during this period.

Which leads me to one of those tough decisions I mentioned earlier…In March, we filed a retail rate case that seeks a net increase in rates of $266 million, and proposes ways to reduce regulatory lag and support investment in electric facilities.

At its core, this rate case boils down to whether Pinnacle West will have the financial strength necessary to invest in and build Arizona’s energy future. Since we cannot control who we serve or what we charge, our earnings and related financial strength are directly impacted by the regulatory process.

The restructuring process of the last five years has:

  • redesigned our electric markets
  • established new requirements and approvals for new generating plants
  • provided a new mechanism to review and recover fuel costs
  • created a new approach to recover transmission costs
  • approved new financing and capital approval thresholds
  • given approval to new power plants in Coolidge and Yuma
  • and established a new mechanism to recover investments in renewable and conservation programs.

This re-regulatory transition has produced more structural change over the last five years than we have experienced in our entire 123-year history. However, one very important issue has not been sufficiently addressed, our financial health.

As a result of this transition, our financial strength has declined, as measured in part by our stock price. Just since the first of the year, our stock is down 20 percent compared to the industry as measured by the Dow Jones Utility Index.

Clearly, this decline has not been due to reduced electric markets, employee productivity, operational efficiency, electric reliability or a lower priority on customer service. It’s not due to a new technology in the market, a failed risk management strategy or poor operational performance. The essential issue is that our prices don’t reflect our cost of doing business. It is time for our regulators to recognize that, as efficiently as we work, and as innovative as we are, we cannot invest in the infrastructure needed to meet our customers’ growing energy needs without sufficient financial health.

This places our state’s energy future in jeopardy…a situation we will not ignore. Therefore our rate filing was designed with the following goals:

  1. Support investment in Arizona.
  2. Strengthen our financial base.
  3. Implement a recovery system for environmental investments.
  4. Establish an approval process for new base load generation additions.
  5. Implement a new mechanism to reduce regulatory lag.
  6. And, achieve 100 percent cash coverage of our capital expenditures in three years.

As I said earlier, no one likes to increase prices. However, our company will not allow short-term impacts and political pressures to impair our ability to provide long-term value to our customers and shareholders. We intend to aggressively work with our regulators to make sure they fully appreciate the long-term risks of minimizing short-term prices. As recently as the early part of this decade, our ability to separate ourselves from the electric debacle in California protected Arizona and our customers from outages and the economic disruption of five-fold increases in peak electric prices. California’s electric price today is over 40 percent greater than ours, largely because they focused on the short term to the detriment of the future.

This is a serious situation at an important turning point for our state. However, as I described earlier it has been our history to make the tough long-term decisions that have proven to be beneficial for our state and our customers.

We will continue to do so. As I said in my opening, Arizona is our home, our passion and our focus.

From each member of our company, you have our unwavering commitment:

To meet the energy needs of our customers.

To balance short-term issues with long-term challenges.

To work with our regulators to find the best solutions.

To create a more sustainable state for our customers.

And to deliver long-term value for our shareholders.

Thank you for your time and your investment in Pinnacle West Capital Corporation.