Our Major Challenges

Despite uncertainties and often conflicting state and federal regulatory actions, we’ve managed to meet Arizona’s remarkable growth. In the last five years, that growth spurred us to work even more efficiently – using better technology and new techniques to serve 180,000 additional customers with 40 new substations and 4,100 new miles of transmission and distribution wire – and little change in the number of employees.

Over the same five-year time frame, our peak elec­tricity load jumped from 5,687 megawatts to 7,652 megawatts, a 35 percent increase. To serve that increased demand, we’ve added more than 2,000 megawatts of capacity in the last five years.

We’re also meeting environmental challenges. While we’ve long been a leader in this area, 2006 marked great progress. We brought on line the Saguaro Solar Trough Power Plant, which quickly earned a spot among the top 12 power plants in the world according to Power Magazine. Also, just before the end of the year, we added our first wind-powered plant. All told, we expanded our renewable generation capacity by more than 100 megawatts, an important step in our efforts to positively impact our environment and sur­pass regulatory requirements.

Early in 2007, the U.S. Environmental Protection Agency and the U.S. Department of Energy named APS an “Energy Star” Partner of the Year for contributions in reducing greenhouse gas emissions by promoting energy-efficient compact fluorescent lightbulbs to our customers. The two million bulbs sold in little more than a year will save customers a combined $50 mil­lion in energy costs and reduce greenhouse emissions by 450,000 tons (roughly the equivalent of eliminating 800 million miles of driving) over the lives of the bulbs. This is just one of many energy saving tips and pro­grams we offer to all levels of customers.

Completing our hybrid regulatory platform presents an ongoing challenge. Our current rate case before the ACC is nearing a conclusion as this report goes to press. We feel strongly that the requested 20.4 percent price increase is crucial to our company, our cus­tomers and our shareholders, with roughly two-thirds of this request going to pay our rising fuel bills.

With the rapid rise in all energy prices in the last few years, we’re focused on the risk of volatile fuel prices. We will continue to manage both the volatility and cost of our fuel with prudent hedging. We are hedged today for 85 percent of our natural gas and purchased power needs for 2007 with prices below current for­ward market prices. We’re also hedged for 60 percent of 2008 and 40 percent of 2009 projected needs.

Related to fuel risk, the regional market risk must also be closely managed. Higher natural gas prices combined with lower spark spreads (the difference between the price of electricity and the cost of fuel to generate that electricity) may continue for a while, but we’re managing the situation to our customers’ and shareholders’ benefit. Also, California’s new “nodal” market structure is scheduled to begin in late 2007. With memories of the previous California energy debacle, we’ll be watching closely to see how this new structure performs, looking as always to protect our customers.

We will continue to reduce our exposure to both fuel price risk and regional market risk – first with a diverse mix of generation sources, and second with outstanding operations. With substantial amounts of nuclear, coal and natural gas capacity, we’re hedged against the risks related to any one fuel. For example, while natural gas prices remained high last year, our Cholla and Four Corners power plants set coal produc­tion records, and in combination with our other fossil plants, reduced our total power costs by $42 million over normally expected levels of performance.

Our nuclear plant has recently not met our standard for excellent performance. After more than a decade of world-class operations, the Palo Verde Nuclear Generating Station had an unacceptable dip in perfor­mance. To correct this situation, we recruited one of the nation’s top nuclear executives, Randy Edington. We have developed a plan to return the plant to excel­lence, and we are working closely with the U.S. Nuclear Regulatory Commission to monitor and adjust the plan as needed to assure steady progress.

With nuclear power on the verge of a revival, we under­stand the economic and environmental importance of this huge facility to the energy future of Arizona and the Southwest as a whole. We will accept nothing less than Palo Verde returning to its place as the premier nuclear operating facility in the United States.

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