Climate change is one of the most significant issues facing our global community.  It is a long-term problem requiring long-term vision and steadfast effort. APS has recognized the challenges presented by Climate Change since 1995 when APS signed the Department of Energy Climate Challenge and committed to limiting emissions to 1990 levels by 2000. We met that goal in large measure because of operational excellence at our Palo Verde Nuclear Power plant.  Since 2000 however, the rapid growth in Arizona, as discussed below, has created ever greater demands for electricity requiring APS to acquire additional fossil fueled baseload capacity. We have met that demand with natural gas and its lower carbon content enabling APS to establish a trend for reducing the carbon intensity of our electricity supply even while meeting the growing demand. Our ability to achieve this result in 2006, contributed to the United States Environmental Protection Agency recognizing APS’ with EPA's prestigious 2006  Climate Protection Award. 

Growth is our largest challenge as we look to address Climate Change.  With population growth three times the national average and electricity demand growth 4 times the national average, our peak demand growth has been nine percent year over year for the past three years. Looking forward, Arizona’s population is predicted to double by 2025 with a commensurate increase in the demand for electricity. Even as we increase our use of renewable energy and implement more time-of-use and demand side management programs, our energy outlook continues to require additional new capacity. 

By 2025, APS will be nearly twice the Electric Company we are today

Coordinating climate change considerations with our generation forecasting and planning efforts allows APS to evaluate the potential financial and operating impacts of proposed legislation and regulatory programs, including cap and trade programs, and facilitates appropriate early actions for responding to this issue in a competitive manner.  Our resource planning and models incorporate various scenarios for a future carbon constrained world and apply a range of potential carbon prices thus allowing us to internalize the potential carbon costs of fossil fuels over the life of generation options.   APS has historically recovered costs of environmental controls and programs in its rates approved by the ACC and we anticipate that the costs associated with any regulatory climate program will also be recovered through rate adjustments. The potential impact of these costs on rates is a concern to our customers and us, especially low and fixed income customers. We anticipate that such increased costs, will necessitate expanding our existing programs to assist these members of our community.

Many climate change activities are in process at the international, federal, regional and state levels, including potential legislation.  This results in a high degree of uncertainty about the regulatory future and potential financial and operational impacts to specific companies such as Pinnacle West. Our company is actively monitoring and participating in these activities on a number of levels. This includes legislative and regulatory participation through our Public Affairs Department, active participation through our many professional associations (see the Affiliations section of this report), participation in state and regional climate change initiatives such as the Arizona Climate Change Committee formed by Governor Napolitano, and other activities. 

PNW/APS Climate Change Position
APS supports a practical, long-term and sustainable approach to addressing Climate Change. The program must be national in scope and address all major sources of greenhouse gas emissions economy-wide.

Any program to reduce greenhouse gas emissions must realistically address the significant challenges presented by rapid growth in certain areas of the United States, like Arizona, which is the fastest growing state in the Nation with population growth three times the national average and electricity consumption growth four times the national average.

Under these rapid growth conditions short term mandates to roll-back greenhouse gas emissions to past levels are not realistic and will be practical only when low and no carbon technologies are commercially available to achieve the mandates AND meet the affordable energy needs of our customers.

Emission reduction goals must be predicated upon the development and commercial deployment of low and no carbon technologies. Timely and successful deployment of new energy technologies will require significant sustained levels of federal and state financial support.

In the short term, strategies should focus on (i) energy efficiency in all sectors of the economy, including transportation, construction, appliances, electric utilities and consumption patterns, (ii) deployment of cost effective renewable resources, and (iii) utilizing low and no carbon generation technologies that are available to address demand growth and fuel diversity risk.

In the longer term, APS supports a market based approach to addressing Climate Change, such as a cap and trade program. Such a program should be (i) phased-in and include a price cap to avoid the economic disruption that will occur in the event that the technology to achieve emission reductions are not developed or deployed, (ii)updated periodically to recognize and account for rapidly growing areas of the United States, (iii) conditioned to require participation by developing nations, and (iv) designed to create new economic opportunities arising from emerging new technologies and processes.

Any federal regulatory process and structure must avoid conflicts and redundancies with state climate change programs and be (i) crafted to allow regulatory rate-based treatment for associated costs, and (ii) developed to provide incentives for utilities to undertake early investment in low and no carbon technologies.

Finally, any legislation must recognize early action/investments to mitigate greenhouse gas emissions including the recognition of domestic and international green house gas offsets.

APS Voluntary Climate Change Goal
We have established an internal voluntary climate change goal in our 2005-2010 business plan.
The goal: To reduce carbon intensity in power plant emissions by 10 percent in target year 2010 from a baseline year 2000.  Carbon intensity has reduced to 1287 lbs/MWh in 2006 from 1324 lb/MWh in baseline year 2000.  This is a 3% reduction.

APS GHG Emissions
Based on an internal evaluation of APS direct emissions of greenhouse gases, we estimate that more than 98 percent of GHG emissions at APS owned facilities is carbon dioxide coming from smokestack emissions at our fossil fuel power plants. About one percent of our overall GHG emissions are from sulfur hexafluoride (SF6) emissions from electrical equipment located across our system (SF6 is discussed further below). The remaining small contribution is from activities such as our fleet transportation (line trucks, bucket trucks and other company vehicles).  We have a number of programs in place to address each of these areas, examples of which are discussed in this report.

As shown in the charts below for APS owned and operated generation, over time, the net effect of customer growth and increased electricity demand has been an increase in the overall company CO2 emissions, but with a corresponding reduction in CO2 intensity (lbs/MWH). This means APS has become more efficient at providing electricity to our customers with fewer CO2 emissions per megawatt-hour generated.   In 2006, our intensity increased a bit because of the effect of increased outages at our Palo Verde Nuclear Generating Station, which caused APS to utilize correspondingly more fossil fuel generation.  We expect that in 2007, our CO2 intensity will once again decline, and for that declining trend to continue through the next 10 years.

Climate Change Activities at Pinnacle West:
Our efforts in increasing energy production through renewable energy sources,  reducing energy demand through our Demand Side Management programs and researching innovative technologies are major components of our overall climate change program, and are discussed elsewhere in this report.   In addition to these efforts, here are some of our climate change response actions:

APS/DOE Climate Change Accord and Emissions Commitments
APS was one of the original signatories to the Department of Energy’s (DOE) “Climate Challenge Program” in 1995 and was one of the first utilities that committed to maintain system-wide GHG emissions (in tons) to below the 1990 level through 2000. Because of Arizona’s rapid growth, APS wanted an “insurance policy” to comply with that commitment.   In 1994, APS entered into a first of its kind “inter-pollutant trade agreement” with Niagara Mohawk Power Corporation (NMPC) of Syracuse, New York. The DOE and the Environmental Defense (formerly, Environmental Defense Fund) also were signatories to the agreement. Under the agreement, APS transferred 20,000 SO2 “allowances” (under the Acid Rain Program) in return for 2.5 million tons of CO2 reductions, which APS would be able to use, if necessary, to keep its commitment to the DOE. APS upheld its commitment with the DOE, and only a small fraction of the APS/NMPC insurance policy (CO2 reductions) was utilized in the final year of the agreement, 2000. Furthermore, as part of the agreement, the SO2 allowances were permanently “retired.” As a result, those 20,000 tons of S02 emissions will never be emitted into the atmosphere.

APS/CFE San Juanico Mini-Grid Project
The APS/NMPC agreement called for joint funding of a renewable energy (solar-wind) project in the small fishing village of San Juanico in Baja California Sur, Mexico. APS designed, engineered and oversaw the construction of the system. The renewable energy plant, supplemented with a battery back-up and diesel generator, provides 24-hour electricity to the village.  This project was completed in cooperation with the national electric utility of Mexico, la Comission Federal de Electricidad (CFE), and with additional financial support from DOE and the Mexico City office of the U.S. Agency for International Development (AID). The overall cost for the project exceeded $1 million. The San Juanico project has been fully operational since 1999 and at the time of its construction was the largest renewable energy project of its kind in North America. It was also selected as a USIJI Project (U.S. Initiative on Joint Implementation).

Up-Rating at PVNGS and Avoided GHG Emissions
The Palo Verde Nuclear Generating Station is the largest nuclear power plant in the U.S. with a generating capacity of 3,810 MW. It is owned by a consortium of utilities, including APS, which holds the largest share (29.1%) and operates the plant. On average, the plant displaces about 30 million tons of CO2 annually when compared to the equivalent amount of power produced by coal resources. About 9.5 million tons is APS’ annual share of the offset. By 2007, the plant’s total generating capacity will be increased by 210 MW, and it is estimated that it will avoid an additional 1.71 million tons of CO2 annually. APS’ share of that offset will be about 0.5 million tons per year.  As seen by the figure below, which shows the estimated impact of our renewables program and PVNGS on avoided emissions, PVNGS will continue to provide significant annual emissions reductions far into the future.

2025 Annual Estimated Emissions Avoided in Arizona

Ash Sales to reduce GHG
U.S. power plants produce millions of tons of coal fly ash annually. APS is using its fly ash to help reduce greenhouse gases while adding to its bottom line. APS sells much of its fly ash to Salt River Materials Group for use in concrete production. This allows them to use the coal ash as a base product in cement production, eliminating their need to produce this material and significantly reducing their energy consumption in cement production. In 2006, APS recycled 658,380 tons of coal ash for cement production or other use, reducing overall greenhouse gas emissions by over 150,000 tons of carbon dioxide.

Ownership of GHG reductions from activities such as ash recycling are current established by APS in contractual language with the other parties involved, in order to prevent "double reporting" of reduction numbers and to establish potential ownership of future emission credits.

EPA SF6 Partnership
In 2004, APS joined the EPA’s SF6 Emission Reduction Partnership for Electric Power Systems. This is a voluntary, collaborative effort between EPA and the electric power industry to identify and implement cost-effective solutions to reduce sulfur hexafluoride (SF6) emissions. SF6 is a highly potent greenhouse gas used for insulation and current interruption in electric transmission and distribution equipment. As part of this partnership, APS is taking voluntary efforts to significantly reduce SF6 emissions. APS' goal in the SF6 partnership is to reduce equipment leak rate from 18.38 percent in the base year of 2001, down to 5 percent by the end of 2008. APS implemented a number of industry-leading steps to reduce the leak rate, including:

• Utilizing SF6 recycling gas carts to minimize atmospheric releases by reclaiming and purifying the SF6, which was placed back into the equipment after service or repair activities
• Use of a laser-imaging camera to effectively identify SF6 leaks and confirm repairs
• Development of an inventory of our top priority SF6 containing equipment for planning the maintenance, repair and replacement activities of SF6 breakers

By the end of 2006, APS had reduced equipment leak rate from 18.38 percent down to 4.9%, beating our target date  by 2 years.  We will continue to work on voluntarily reducing our emissions even further.  Our results in 2006 resulted in eliminated an estimated 19,624 pounds of SF6 emissions in 2006 compared to our baseline year of 2001.   Based on the EPA's greenhouse gas equivalencies, this reduction of SF6 is equivalent to a reduction of 212,741 tons of carbon dioxide.

SF6 Leak Rate Base on EPA Calculations

PowerTree Carbon Company
To achieve additional CO2 reductions, APS joined 24 other electric utilities in the PowerTree Carbon Company, which plants trees in ecologically sensitive areas of the lower Mississippi Valley in cooperation with local and national, governmental and conservation organizations. Planting began in 2003 and over two million tons of CO2 are expected to be sequestered over the 100-year life of the project. In 2006, APS' share of PowerTree Carbon Company sequestration results was the equivalent of a reduction of over 60 short tons of carbon dioxide.

Emission Reduction/Sequestration
APS has an active technology research and development program which is exploring new ways to reduce or sequester carbon dioxide emissions from existing and future electric generation. This includes the development of renewal energy sources, innovate pollution reduction technologies for fossil fuel power plants and other clean energy strategies. 

In addition, we are looking at other types of innovative (and sometimes unusual) technologies that can help create a sustainable energy future and reduce greenhouse gases (See Technology Innovation section for details). An example of this effort is our Emissions to Fuel project in which APS is evaluating the possibility of using carbon dioxide in stack emissions to grow algae, which will then be used for bio-fuel. The company and its partner, Green Fuel Technologies, recently shared the  Emissions Energy Project of the Year Award at the 8th Annual Platts Global Energy Awards for this project.  Another example is our Manure to Renewable Energy project, which explores using methane generated from animal wastes from Concentrated Animal Feeding Operations (CAFOs) to generate electricity and lower methane emissions, a powerful source of greenhouse gases.

Trees for the Rim
APS also partnered with Trees for the Rim, an organization dedicated to replanting trees on Arizona’s residential, commercial and community lands damaged by the Rodeo-Chedeski fires of June 2002. APS donated $25,000 and transported trees, provided volunteers, dug holes for the trees and will continue to be involved as the project unfolds.

Changes to Generation Mix
In addition to our other greenhouse gas-reducing projects, changes to APS’ generation mix have helped reduce the intensity of CO2 emissions measured in pounds per megawatt hour of energy. This reduction is illustrated in the chart above. Key to these reductions is the addition of high-efficiency natural gas capacity, increasing emphasis on renewable energy and the capacity improvements at the Palo Verde Nuclear Generating Station discussed above.

Participation in Industry Climate Change Activities
APS employees build their knowledge of climate change issues through active involvement with industry groups with effective Climate Change programs and activities, including the Edison Electric Institute, the Electric Power Research Institute, the Center for Clean Air Policy and others. The company and its partner, GreenFuel Technologies, recently shared the Emissions Energy Project of the Year Award for work using carbon dioxide (CO2) emissions to create reusable biodiesel and ethanol fuel at APS' Redhawk Power Plant. The award came at the 8th Annual Platts Global Energy Awards

Green House Gas Emission Reporting
APS voluntarily reports GHG emissions and GHG reduction results to the U.S. Department of Energy (DOE)  through its 1605(b) voluntary GHG reporting program. APS also provides an annual report to the EPA (starting in 2005) regarding results in SF6 emission reduction through the EPA Utility SF6 Partnership program.