---

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

# FORM 10-Q

| |  |  | [X] | QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15 (d) OF            THE SECURITIES EXCHANGE ACT OF 1934
| |  |  | --- | ---------------------------------------------------------------------------------------------------

| |  |  |  | For the
quarterly period ended September 30, 2004
                     
                      
     OR
| |  |  |  | ------------------------------------------------------------------------------------------------------

| |  |  | [  ] | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
           THE SECURITIES EXCHANGE ACT OF 1934
| |  |  | ---- | ----------------------------------------------------------------------------------------------------

| |  |  |  | For
the Transition period from ________ to _________
| |  |  |  | ----------------------------------------------------

|Commission 
File Number | Exact name of registrant as specified 
in its charter, state of incorporation,
address of principal executive offices,
telephone number | I.R.S.
Employer
Identification
Number
|----------------------- | --------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------
|                       
|1-16305                 | PUGET ENERGY, INC.
A Washington Corporation
10885 N.E. 4th Street, Suite 1200
Bellevue, Washington 98004-5591
(425) 454-6363            | 91-1969407                           
|                       
|1-4393                  | PUGET SOUND ENERGY, INC.
A Washington Corporation
10885 N.E. 4th Street, Suite 1200
Bellevue, Washington 98004-5591
(425) 454-6363      | 91-0374630                           

|Indicate by check mark whether the registrants: (1) have filed all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrants were
required to file such reports), and (2) have been subject to such filing requirements for the past 90 days. |        
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------
|                                                                                                                                                                                                                                                                                                                                                               | YesX No

|Indicate by check mark whether Puget Energy, Inc. is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). |        
|------------------------------------------------------------------------------------------------------------------------- | -------
|                                                                                                                          | YesX No

|Indicate by check mark whether Puget Sound Energy, Inc. is an accelerated filer (as defined in Rule 12b-2 of the Exchange
Act). |        
|------------------------------------------------------------------------------------------------------------------------------- | -------
|                                                                                                                                | Yes NoX

As of October 28, 2004, (i) the number of shares of Puget Energy, Inc. common stock outstanding was 99,684,604 ($.01 par
value) and (ii) all of the outstanding shares of Puget Sound Energy, Inc. common stock were held by Puget Energy, Inc.

---

|Table of Contents         
|--------------------------
|                          
|Filing Format             
|                          
|Forward-Looking Statements
|                          
|Part I.                   
|Item 1.                   
|                          
|                          
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|                          
|Item 2.                   
|                          
|                          
|Item 3.                   
|                          
|Item 4.                   
|                          
|Part II.                  
|Item 1.                   
|Item 6.                   
|                          
|Signatures                
|Exhibit Index             
|                          

Filing Format 
        This
Quarterly Report on Form 10-Q is a combined quarterly report being filed separately by two
different registrants, Puget Energy, Inc. (Puget Energy) and Puget Sound Energy, Inc.
(PSE). Any references in this report to the Company are to Puget Energy and
PSE collectively. PSE makes no representation as to the information contained in this
report relating to Puget Energy and the subsidiaries of Puget Energy other than PSE and
its subsidiaries.

FORWARD-LOOKING STATEMENTS 
        Puget
Energy and PSE are including the following cautionary statements in this Form 10-Q to make
applicable and to take advantage of the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995 for any forward-looking statements made by or on behalf of
Puget Energy or PSE. This report includes forward-looking statements, which are statements
of expectations, beliefs, plans, objectives, assumptions of future events or performance.
Words or phrases such as anticipates, believes,
estimates, expects, intends, plans,
predicts, projects, will likely result, will
continue or similar expressions identify forward-looking statements. 
        Forward-looking
statements involve risks and uncertainties which could cause actual results or outcomes to
differ materially from those expressed. Puget Energys and PSEs expectations,
beliefs and projections are expressed in good faith and are believed by Puget Energy and
PSE, as applicable, to have a reasonable basis, including without limitation
managements examination of historical operating trends, data contained in records
and other data available from third parties; but there can be no assurance that Puget
Energys and PSEs expectations, beliefs or projections will be achieved or
accomplished. 
        In
addition to other factors and matters discussed elsewhere in this report, some important
factors that could cause actual results or outcomes for Puget Energy and PSE to differ
materially from those discussed in forward-looking statements include:

| | Risks relating
to the regulated utility business (PSE)
| | ------------------------------------------------------

| | governmental
policies and regulatory actions, including those of the Federal Energy Regulatory
Commission (FERC) and the Washington Utilities and Transportation Commission (Washington
Commission), with respect to allowed rates of return, financings, industry and rate
structures, transmission and generation business structures within PSE, acquisition and
disposal of assets and facilities, operation, maintenance and construction of electric
generating facilities, distribution and transmission facilities (gas and electric),
licensing of hydro operations and gas storage facilities, recovery of other capital
investments, recovery of power and gas costs, recovery of regulatory assets, and present
or prospective wholesale and retail competition;
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | financial
difficulties and energy supply disruptions of other energy companies and related events,
which may affect the regulatory and legislative process in unpredictable ways and also
adversely affect the availability of and access to capital and credit markets;
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | wholesale
market disruption, which may result in a deterioration in market liquidity, increase the
risk of counterparty default, affect the regulatory and legislative process in
unpredictable ways, limit the availability of and access to capital credit markets,
affect wholesale energy prices and/or impede PSEs ability to manage its energy
portfolio risks;
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | the
effect of wholesale market structures (including, but not limited to, new market design
such as Grid West, a regional transmission organization, and Standard Market Design);
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | weather,
which can have a potentially serious impact on PSEs revenues and its ability to
procure adequate supplies of gas, fuel or purchased power to serve its customers and on
the cost of procuring such supplies;
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | hydroelectric
conditions, which can have a potentially serious impact on electric capacity and PSEs
ability to generate electricity;
|- | -------------------------------------------------------------------------------------------------------------------------------------

| | the
amount of collection, if any, of PSEs receivables from the California Independent
System Operator (CAISO) and other parties, and the amount of refunds found to be due from PSE to the CAISO
or other parties;
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | industrial,
commercial and residential growth and demographic patterns in the service territories of
PSE;
|- | ---------------------------------------------------------------------------------------------------------

| | general
economic conditions in the Pacific Northwest, including any associated impact on PSEs
accounts receivable;
|- | -------------------------------------------------------------------------------------------------------------------

| | the
loss of significant customers or changes in the business of significant customers, which
may result in changes in demand for PSE's services;
|- | ------------------------------------------------------------------------------------------------------------------------------------------------

| | plant
outages,  which can have an impact on PSE's expenses and its ability to procure  adequate
 supplies to replace      the lost energy;
|- | ------------------------------------------------------------------------------------------------------------------------------------------

| | the
ability of gas or electric plant to operate as intended,  which if not in proper
 operating  condition or design could limit the capacity of the operating plant;
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | gas
pipeline failure, whether PSEs or others, which may impact PSEs ability
to adequately deliver gas supply to its customers and create other legal or regulatory
issues;
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | the
ability to renew contracts for electric and gas supply and the price of renewal;
|- | ------------------------------------------------------------------------------------

| | blackouts
or large curtailments of transmission systems, whether PSEs or others, which
can have an impact on PSEs ability to deliver load to its customers; and
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | the
ability to relicense FERC hydro projects at a cost-effective level.
|- | -----------------------------------------------------------------------

| | Risks relating
to the non-regulated utility service business (InfrastruX Group, Inc.)
| | -------------------------------------------------------------------------------------

| | the
failure of InfrastruX to service its obligations under its credit agreement, in which
case Puget Energy, as guarantor, may be required to satisfy these obligations, which
could have a negative impact on Puget Energys liquidity and access to capital;
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | the
inability to generate internal growth at InfrastruX, which could be affected by, among
other factors, InfrastruXs ability to expand the range of services offered to
customers, attract new customers, increase the number of projects performed for existing
customers, hire and retain employees and open additional facilities;
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | the
ability of InfrastruX to integrate acquired companies within existing operations without
substantial costs, delays or other operational or financial problems, which involves a
number of special risks;
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | the
effect of competition in the industry in which InfrastruX competes, including from
competitors that may have greater resources than InfrastruX, which may enable them to
develop expertise, experience and resources to provide services that are superior in both
price and quality;
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | the
extent to which existing electric power and gas companies or prospective customers will
continue to outsource services in the future, which may be impacted by, among other
things, regional and general economic conditions in the markets InfrastruX serves;
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | delinquencies,
including those associated with the financial conditions of InfrastruXs customers;
|- | --------------------------------------------------------------------------------------------------

| | the
impact of any goodwill impairments on the results of operations of InfrastruX arising
from its acquisitions, which could have a negative effect on the results of operations of
Puget Energy;
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | the
impact of adverse weather conditions that negatively affect operating conditions and
results; and
|- | -----------------------------------------------------------------------------------------------------

| | the
ability to obtain adequate bonding coverage and the cost of such bonding.
|- | -----------------------------------------------------------------------------

| | Risks relating
to both the regulated and non-regulated businesses
| | -----------------------------------------------------------------

| | the
impact of acts of terrorism or similar significant events;
|- | --------------------------------------------------------------

| | the
ability of Puget Energy, PSE and InfrastruX to access the capital markets to support
requirements for working capital, construction costs and the repayment of maturing debt;
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | capital
market conditions, including changes in the availability of capital or interest rate
fluctuations;
|- | ----------------------------------------------------------------------------------------------------------

| | changes
in Puget Energys or PSEs credit ratings, which may have an adverse impact on
the availability and cost of capital for Puget Energy, PSE and InfrastruX;
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

| | legal
and regulatory proceedings;
|- | ---------------------------------

| | the
ability to recover changes in enacted federal, state or local tax laws through revenue in
a timely manner;
|- | --------------------------------------------------------------------------------------------------------------

| | changes
in, adoption of, and compliance with laws and regulations including environmental and
endangered species laws, regulations, decisions and policies concerning the environment,
natural resources, and fish and wildlife (including the Endangered Species Act);
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | employee
workforce factors,  including strikes,  work stoppages,  availability of qualified
employees or the loss of      a key executive;
|- | ------------------------------------------------------------------------------------------------------------------------------------------

| | the
ability to obtain and keep patent or other intellectual property rights to generate
revenue;
|- | ------------------------------------------------------------------------------------------------

| | the
ability to obtain adequate insurance coverage and the cost of such insurance; and
|- | -------------------------------------------------------------------------------------

| | the
impacts of natural disasters such as earthquakes, hurricanes, floods, fires or
landslides.
|- | ----------------------------------------------------------------------------------------------

Any
forward-looking statement speaks only as of the date on which such statement is made, and,
except as required by law, Puget Energy and PSE undertake no obligation to update any
forward-looking statement to reflect events or circumstances after the date on which such
statement is made or to reflect the occurrence of unanticipated events. New factors emerge
from time to time and it is not possible for management to predict all such factors, nor
can it assess the impact of any such factor on the business or the extent to which any
factor, or combination of factors, may cause results to differ materially from those
contained in any forward-looking statement.

|PART I |  | FINANCIAL INFORMATION
|------ |  | ---------------------

|Item  1. |  | Financial Statements
|-------- |  | --------------------

PUGET ENERGY, INC. 
CONSOLIDATED STATEMENTS OF INCOME 
(Dollars in Thousands
except per share amounts) 
(Unaudited)

|                                                                         | Three Months Ended
September 30, | Nine Months Ended
September 30,
|------------------------------------------------------------------------ | -------------------------------- | -------------------------------
|                                                                         |                                 
|                                                                         |                                  |                                
|                                                                         |                                 
|Operating Revenues:                                                      |                                  |                                
|Electric                                                                 |                                  |                                
|Gas                                                                      |                                  |                                
|Non-utility construction services                                        |                                  |                                
|Other                                                                    |                                  |                                
|                                                                        
|Total operating revenues                                                 |                                  |                                
|                                                                        
|Operating Expenses:                                                      |                                  |                                
|Energy costs:                                                            |                                  |                                
|Purchased electricity                                                    |                                  |                                
|Purchased gas                                                            |                                  |                                
|Electric generation fuel                                                 |                                  |                                
|Residential Exchange                                                     |                                  |                                
|Unrealized (gain) loss on derivative instruments                         |                                  |                                
|Utility operations and maintenance                                       |                                  |                                
|Other operations and maintenance                                         |                                  |                                
|Depreciation and amortization                                            |                                  |                                
|Conservation amortization                                                |                                  |                                
|Taxes other than income taxes                                            |                                  |                                
|Income taxes                                                             |                                  |                                
|                                                                        
|Total operating expenses                                                 |                                  |                                
|                                                                        
|Operating Income                                                         |                                  |                                
|Other income, net of tax                                                 |                                  |                                
|                                                                        
|Income before interest charges and minority interest                     |                                  |                                
|                                                                        
|Interest Charges:                                                        |                                  |                                
|AFUDC                                                                    |                                  |                                
|Interest charges                                                         |                                  |                                
|Mandatorily redeemable securities interest expense                       |                                  |                                
|                                                                        
|Total interest charges                                                   |                                  |                                
|                                                                        
|Minority interest in earnings of consolidated subsidiary                 |                                  |                                
|                                                                        
|Net income before cumulative effect of accounting change                 |                                  |                                
|Cumulative effect of implementation of an accounting change, net of tax  |                                  |                                
|                                                                        
|Net income                                                               |                                  |                                
|Less:  preferred stock dividends accrual                                 |                                  |                                
|                                                                        
|Income for common stock                                                  |                                  |                                
|                                                                        
|Basic common shares outstanding - weighted average                       |                                  |                                
|Diluted common shares outstanding - weighted average                     |                                  |                                
|                                                                        
|Basic earnings per common share before cumulative effect of              |                                  |                                
|accounting change                                                        |                                  |                                
|Cumulative effect of accounting change                                   |                                  |                                
|                                                                        
|Basic earnings per common share                                          |                                  |                                
|                                                                        
|Diluted earnings per common share before cumulative effect of accounting |                                  |                                
|change                                                                   |                                  |                                
|Cumulative effect of accounting change                                   |                                  |                                
|                                                                        
|Diluted earnings per common share                                        |                                  |                                
|                                                                        

The accompanying
notes are an integral part of the financial statements.

PUGET ENERGY, INC. 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME 
(Dollars in Thousands) (Unaudited)

|                                                             | Three Months Ended
September 30, | Nine Months Ended
September 30,
|------------------------------------------------------------ | -------------------------------- | -------------------------------
|                                                             |                                 
|                                                             |                                  |                                
|                                                             |                                 
|Net income                                                   |                                  |                                
|                                                            
|Other comprehensive income, net of tax:                      |                                  |                                
|Unrealized holding losses arising on marketable securities   |                                  |                                
|during the period                                            |                                  |                                
|Reclassification adjustment for realized gains on            |                                  |                                
|marketable securities included in net income                 |                                  |                                
|Foreign currency translation adjustment                      |                                  |                                
|Unrealized gains on derivative instruments during the period |                                  |                                
|Reversal of unrealized (gain) loss on derivative             |                                  |                                
|instruments settled during the period                        |                                  |                                
|Deferral related to PCA mechanism                            |                                  |                                
|                                                            
|Other comprehensive income (loss)                            |                                  |                                
|                                                            
|Comprehensive income                                         |                                  |                                
|                                                            

The accompanying
notes are an integral part of the financial statements.

PUGET ENERGY, INC. 
CONSOLIDATED BALANCE SHEETS 
(Dollars in Thousands) 
(Unaudited)

ASSETS

|                                                                            
|----------------------------------------------------------------------------
|Utility Plant: (at original cost, including construction work in progress of
|$162,090 and $121,622, respectively)                                        
|Electric                                                                    
|Gas                                                                         
|Common                                                                      
|Less:  Accumulated depreciation and amortization                            
|                                                                            
|Net utility plant                                                           
|                                                                            
|Other property and investments:                                             
|Investment in Bonneville Exchange Power Contract                            
|Goodwill, net                                                               
|Intangibles, net                                                            
|Non-utility property, net                                                   
|Other                                                                       
|                                                                            
|Total other property and investments                                        
|                                                                            
|Current assets:                                                             
|Cash                                                                        
|Restricted cash                                                             
|Accounts receivable, net of allowance for doubtful accounts                 
|Unbilled revenue                                                            
|Purchased gas receivable                                                    
|Materials and supplies, at average cost                                     
|Current portion of unrealized gain on derivative instruments                
|Prepayments and other                                                       
|                                                                            
|Total current assets                                                        
|                                                                            
|Other long-term assets:                                                     
|Regulatory asset for deferred income taxes                                  
|Regulatory asset for PURPA contract buyout costs                            
|Unrealized gain on derivative instruments                                   
|PCA mechanism                                                               
|Other                                                                       
|                                                                            
|Total other long-term assets                                                
|                                                                            
|Total assets                                                                
|                                                                            
|The accompanying notes are an integral part of the financial statements     

PUGET ENERGY, INC. 
CONSOLIDATED BALANCE SHEETS 
(Dollars in Thousands) 
(Unaudited)

CAPITALIZATION AND LIABILITIES

|                                                                       
|-----------------------------------------------------------------------
|Capitalization:                                                        
|Common shareholders' investment:                                       
|Common stock $0.01 par value, 250,000,000 shares authorized, 99,676,388
|and 99,074,070 shares outstanding, respectively                        
|Additional paid-in capital                                             
|Earnings reinvested in the business                                    
|Accumulated other comprehensive loss - net of tax                      
|                                                                       
|Total shareholders' equity                                             
|                                                                       
|Redeemable securities and long-term debt:                              
|Preferred stock subject to mandatory redemption                        
|Junior subordinated debentures of the corporation payable to a         
|subsidiary trust holding mandatorily redeemable preferred securities   
|Long-term debt                                                         
|                                                                       
|Total redeemable securities and long-term debt                         
|                                                                       
|Total capitalization                                                   
|                                                                       
|Minority interest in a consolidated subsidiary                         
|                                                                       
|Current liabilities:                                                   
|Accounts payable                                                       
|Short-term debt                                                        
|Current maturities of long-term debt                                   
|Purchased gas liability                                                
|Accrued expenses:                                                      
|Taxes                                                                  
|Salaries and wages                                                     
|Interest                                                               
|Current portion of unrealized loss on derivative instruments           
|Tenaska disallowance reserve                                           
|Other                                                                  
|                                                                       
|Total current liabilities                                              
|                                                                       
|Long-term liabilities:                                                 
|Deferred income taxes                                                  
|Other deferred credits                                                 
|                                                                       
|Total long-term liabilities                                            
|                                                                       
|Total capitalization and liabilities                                   
|                                                                       
|The accompanying notes are an integral part of the financial statements

PUGET ENERGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS 
(Dollars in Thousands) 
(Unaudited)

|                                                                                 
|---------------------------------------------------------------------------------
|2004                                                                             
|Operating activities:                                                            
|Net income                                                                       
|Adjustments to reconcile net income to net cash provided by operating activities:
|Depreciation and amortization                                                    
|Deferred income taxes and tax credits - net                                      
|Net unrealized (gain) loss on derivative instruments                             
|Cash collateral received from energy suppliers                                   
|Increase (decrease) in Residential Exchange Program                              
|Gain on sale of securities                                                       
|Other                                                                            
|Change in certain current assets and liabilities:                                
|Accounts receivable and unbilled revenue                                         
|Materials and supplies                                                           
|Prepayments and other                                                            
|Purchased gas receivable/liability                                               
|Accounts payable                                                                 
|Taxes payable                                                                    
|Tenaska disallowance reserve                                                     
|Accrued expenses and other                                                       
|                                                                                 
|Net cash provided by operating activities                                        
|                                                                                 
|Investing activities:                                                            
|Construction and capital expenditures-excluding equity AFUDC                     
|Energy conservation expenditures                                                 
|Acquisitions by InfrastruX, net of cash acquired                                 
|Refundable cash received for customer construction projects                      
|Cash received from sale of securities                                            
|Restricted cash                                                                  
|Other                                                                            
|                                                                                 
|Net cash used by investing activities                                            
|                                                                                 
|Financing activities:                                                            
|Change in short-term debt - net                                                  
|Dividends paid                                                                   
|Issuance of common stock                                                         
|Redemption of mandatorily redeemable preferred stock                             
|Issuance of bonds and long-term debt                                             
|Redemption of trust preferred securities                                         
|Redemption of bonds and long-term debt                                           
|Issuance costs of bonds and other                                                
|                                                                                 
|Net cash provided (used) by financing activities                                 
|                                                                                 
|Net decrease in cash                                                             
|Cash at beginning of year                                                        
|                                                                                 
|Cash at end of period                                                            
|                                                                                 
|Supplemental cash flow information:                                              
|Cash payments for:                                                               
|Interest (net of capitalized interest)                                           
|Income taxes                                                                     
|                                                                                 
|The accompanying notes are an integral part of the financial statements          

PUGET SOUND ENERGY, INC. 
CONSOLIDATED STATEMENTS OF INCOME 
(Dollars in Thousands) 
(Unaudited)

|                                                                       
|-----------------------------------------------------------------------
|2004                                                                   
|Operating revenues:                                                    
|Electric                                                               
|Gas                                                                    
|Other                                                                  
|                                                                       
|Total operating revenues                                               
|                                                                       
|Operating expenses:                                                    
|Energy costs:                                                          
|Purchased electricity                                                  
|Purchased gas                                                          
|Electric generation fuel                                               
|Residential Exchange                                                   
|Unrealized (gain) loss on derivative instruments                       
|Utility operations and maintenance                                     
|Other operations and maintenance                                       
|Depreciation and amortization                                          
|Conservation amortization                                              
|Taxes other than income taxes                                          
|Income taxes                                                           
|                                                                       
|Total operating expenses                                               
|                                                                       
|Operating income                                                       
|Other income, net of tax                                               
|                                                                       
|Income before interest charges                                         
|                                                                       
|Interest charges:                                                      
|AFUDC                                                                  
|Interest charges                                                       
|Mandatorily redeemable securities interest expense                     
|                                                                       
|Total interest charges                                                 
|                                                                       
|Net income before cumulative effect of accounting change               
|Cumulative effect of implementation of an accounting change, net of tax
|                                                                       
|Net income                                                             
|Less: preferred stock dividends accrual                                
|                                                                       
|Income for common stock                                                
|                                                                       
|The accompanying notes are an integral part of the financial statements

PUGET SOUND ENERGY, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME 
(Dollars in Thousands) 
(Unaudited)

|                                                                       
|-----------------------------------------------------------------------
|2004                                                                   
|Net income                                                             
|                                                                       
|Other comprehensive income, net of tax:                                
|Unrealized holding losses on marketable securities arising             
|during the period                                                      
|Reclassification adjustment for realized gains on                      
|marketable securities included in net income                           
|Unrealized gains on derivative instruments                             
|during the period                                                      
|Reversal of unrealized (gain) loss on derivative                       
|instruments settled during the period                                  
|Deferral related to PCA mechanism                                      
|                                                                       
|Other comprehensive income (loss)                                      
|                                                                       
|Comprehensive income                                                   
|                                                                       
|The accompanying notes are an integral part of the financial statements

PUGET SOUND ENERGY, INC.
CONSOLIDATED BALANCE SHEETS 
(Dollars in Thousands) 
(Unaudited)

ASSETS

|                                                                       
|-----------------------------------------------------------------------
|Utility plant: (at original cost, including construction work in       
|progress of $162,090 and $121,622, respectively)                       
|Electric                                                               
|Gas                                                                    
|Common                                                                 
|Less:  Accumulated depreciation and amortization                       
|                                                                       
|Net utility plant                                                      
|                                                                       
|Other property and investments                                         
|                                                                       
|Current assets:                                                        
|Cash                                                                   
|Restricted cash                                                        
|Accounts receivable, net of allowance for doubtful accounts            
|Unbilled revenues                                                      
|Purchased gas receivable                                               
|Materials and supplies, at average cost                                
|Current portion of unrealized gain on derivative instruments           
|Prepayments and other                                                  
|                                                                       
|Total current assets                                                   
|                                                                       
|Other long-term assets:                                                
|Regulatory asset for deferred income taxes                             
|Regulatory asset for PURPA contract buyout costs                       
|Unrealized gain on derivative instruments                              
|PCA mechanism                                                          
|Other                                                                  
|                                                                       
|Total other long-term assets                                           
|                                                                       
|Total assets                                                           
|                                                                       
|The accompanying notes are an integral part of the financial statements

PUGET SOUND ENERGY, INC.
CONSOLIDATED BALANCE SHEETS 
(Dollars in Thousands) 
(Unaudited)

CAPITALIZATION AND
LIABILITIES

|                                                                         
|-------------------------------------------------------------------------
|Capitalization:                                                          
|Common shareholder's investment:                                         
|Common stock ($10 stated value) - 150,000,000 shares authorized,         
|85,903,791 shares outstanding                                            
|Additional paid-in capital                                               
|Earnings reinvested in the business                                      
|Accumulated other comprehensive loss - net of tax                        
|                                                                         
|Total shareholder's equity                                               
|                                                                         
|Redeemable securities and long-term debt:                                
|Preferred stock subject to mandatory redemption                          
|Junior subordinated debentures of the corporation payable to a subsidiary
|trust holding mandatorily redeemable preferred securities                
|Long-term debt                                                           
|                                                                         
|Total redeemable securities and long-term debt                           
|                                                                         
|Total capitalization                                                     
|                                                                         
|Current liabilities:                                                     
|Accounts payable                                                         
|Current maturities of long-term debt                                     
|Purchased gas liability                                                  
|Accrued expenses:                                                        
|Taxes                                                                    
|Salaries and wages                                                       
|Interest                                                                 
|Current portion of unrealized loss on derivative instruments             
|Tenaska disallowance reserve                                             
|Other                                                                    
|                                                                         
|Total current liabilities                                                
|                                                                         
|Long-term liabilities:                                                   
|Deferred income taxes                                                    
|Other deferred credits                                                   
|                                                                         
|Total long-term liabilities                                              
|                                                                         
|Total capitalization and liabilities                                     
|                                                                         
|The accompanying notes are an integral part of the financial statements  

PUGET SOUND ENERGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS 
(Dollars in Thousands) 
(Unaudited)

|                                                                       
|-----------------------------------------------------------------------
|2004                                                                   
|Operating activities:                                                  
|Net income                                                             
|Adjustments to reconcile net income to net cash                        
|provided by operating activities:                                      
|Depreciation and amortization                                          
|Deferred income taxes and tax credits - net                            
|Net unrealized (gain) loss on derivative instruments                   
|Cash collateral received from energy suppliers                         
|Increase (decrease) in Residential Exchange Program                    
|Gain on sale of securities                                             
|Other                                                                  
|Change in certain current assets and liabilities:                      
|Accounts receivable and unbilled revenue                               
|Materials and supplies                                                 
|Prepayments and other                                                  
|Purchased gas receivable/liability                                     
|Accounts payable                                                       
|Taxes payable                                                          
|Tenaska disallowance reserve                                           
|Accrued expenses and other                                             
|                                                                       
|Net cash provided by operating activities                              
|                                                                       
|Investing activities:                                                  
|Construction expenditures - excluding equity AFUDC                     
|Energy conservation expenditures                                       
|Restricted cash                                                        
|Refundable cash received for customer construction projects            
|Cash received from sale of securities                                  
|Other                                                                  
|                                                                       
|Net cash used by investing activities                                  
|                                                                       
|Financing activities:                                                  
|Change in short-term debt - net                                        
|Dividends paid                                                         
|Issuance of bonds                                                      
|Redemption of mandatorily redeemable preferred stock                   
|Redemption of trust preferred securities                               
|Redemption of bonds                                                    
|Issuance cost of bonds and other                                       
|                                                                       
|Net cash provided (used) by financing activities                       
|                                                                       
|Net decrease in cash                                                   
|Cash at beginning of year                                              
|                                                                       
|Cash at end of period                                                  
|                                                                       
|Supplemental cash flow information:                                    
|Cash payments for:                                                     
|Interest (net of capitalized interest)                                 
|Income taxes                                                           
|                                                                       
|The accompanying notes are an integral part of the financial statements

COMBINED NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS

(1)     Summary of
Consolidation Policy

BASIS OF PRESENTATION 
        Puget
Energy, Inc. (Puget Energy) is an exempt public utility holding company under the Public
Utility Holding Company Act of 1935. Puget Energy owns Puget Sound Energy, Inc. (PSE) and
has a 90.9% ownership interest in InfrastruX Group, Inc. (InfrastruX). PSE is a public
utility incorporated in the State of Washington and furnishes electric and gas services in
a territory covering 6,000 square miles, primarily in the Puget Sound region. InfrastruX
is a non-regulated construction service company incorporated in the State of Washington,
which provides construction services to electric and gas utility companies located
primarily in the midwest, Texas, south-central and eastern United States regions. 
        The
consolidated financial statements of Puget Energy include the accounts of Puget Energy and
its subsidiaries, PSE and InfrastruX. Puget Energy holds all the common shares of PSE and
holds a 90.9% interest in InfrastruX. The results of PSE and InfrastruX are presented on a
consolidated basis. PSEs consolidated financial statements include the accounts of
PSE and its subsidiaries. Puget Energy and PSE are collectively referred to herein as
the Company. The consolidated financial statements are presented after
elimination of all significant intercompany items and transactions. Minority interests of
InfrastruXs operating results are reflected in Puget Energys consolidated
financial statements. Certain amounts previously reported have been reclassified to
conform with current year presentations with no effect on total equity or net income. 
        The
consolidated financial statements contained in this Form 10-Q are unaudited. In the
respective opinions of the managements of Puget Energy and PSE, all adjustments necessary
for a fair presentation of the results for the interim periods have been reflected and
were of a normal recurring nature. These condensed financial statements should be read in
conjunction with the audited financial statements (and the Combined Notes thereto)
included in the combined Puget Energy and PSE annual report on Form 10-K for the year
ended December 31, 2003.

(2)    
          Earnings per Common Share (Puget Energy Only)

Puget
Energys basic earnings per common share have been computed based on weighted average
common shares outstanding of 99,580,000 and 99,373,000 for the three and nine months ended
September 30, 2004, respectively, and 94,125,000 and 93,930,000 for the three and nine
months ended September 30, 2003, respectively. 
        Puget
Energys diluted earnings per common share have been computed based on weighted
average common shares outstanding of 100,043,000 and 99,836,000 for the three and nine
months ended September 30, 2004, respectively, and 94,635,000 and 94,440,000 for the three
and nine months ended September 30, 2003, respectively. These shares include the dilutive
effect of securities related to employee and director equity plans.

(3)    
          Segment Information (Puget Energy Only)

Puget
Energy operates in primarily two business segments: regulated utility operations, or PSE,
and utility construction services, or InfrastruX. Puget Energys regulated utility
operation generates, purchases, transports and sells electricity and purchases, transports
and sells natural gas. One minor non-utility business segment, a PSE real estate
investment and development subsidiary, is described as other. Reconciling items between
segments are not material. Financial data for business segments are as follows:

|(Dollars in Thousands)
Three Months Ended September 30, 2004 | PSE | InfrastruX | Other | Total     
|------------------------------------------------------------ | --- | ---------- | ----- | ----------
|                                                            
|Revenues                                                     |     |            | $     | 412,101   
|Depreciation and amortization                                |     |            |       | 57,534    
|Income tax                                                   |     |            |       | 6,254     
|Operating income                                             |     |            |       | 48,738    
|Interest charges, net of AFUDC                               |     |            |       | 41,072    
|Minority interest in earnings                                |     |            |       | --        
|Net income                                                   |     |            |       | 8,126     
|                                                            
|Goodwill, net at September 30, 2004                          |     |            | $     | --        
|Total assets at September 30, 2004                           |     |            |       | 5,409,049 
|                                                            
|                                                            
|Three Months Ended September 30, 2003                        |     |            | PSE   | InfrastruX
|                                                            
|Revenues                                                     |     |            | $     | 396,332   
|Depreciation and amortization                                |     |            |       | 54,881    
|Income tax                                                   |     |            |       | (1,260    
|Operating income                                             |     |            |       | 51,081    
|Interest charges, net of AFUDC                               |     |            |       | 44,178    
|Minority interest in earnings                                |     |            |       | --        
|Net income (loss)                                            |     |            |       | 9,396     
|                                                            
|                                                            
|Nine Months Ended September 30, 2004                         |     |            | PSE   | InfrastruX
|                                                            
|Revenues                                                     |     |            | $     | 1,502,859 
|Depreciation and amortization                                |     |            |       | 169,845   
|Income tax                                                   |     |            |       | 40,153    
|Operating income                                             |     |            |       | 188,148   
|Interest charges, net of AFUDC                               |     |            |       | 124,900   
|Minority interest in earnings                                |     |            |       | --        
|Net income                                                   |     |            |       | 65,347    
|                                                            
|                                                            
|Nine Months Ended September 30, 2003                         |     |            | PSE   | InfrastruX
|                                                            
|Revenues                                                     |     |            | $     | 1,396,940 
|Depreciation and amortization                                |     |            |       | 164,074   
|Income tax                                                   |     |            |       | 35,528    
|Operating income                                             |     |            |       | 206,856   
|Interest charges, net of AFUDC                               |     |            |       | 135,349   
|Minority interest in earnings                                |     |            |       | --        
|Net income                                                   |     |            |       | 74,939    
|                                                            
|                                                            
|At December  31, 2003                                        |     |            | PSE   | InfrastruX
|                                                            
|Goodwill, net                                                |     |            | $     | --        
|Total assets                                                 |     |            |       | 5,257,157 
|                                                            

(4)     Accounting for
Derivative Instruments and Hedging Activities

Statement
of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended by SFAS No. 138 and SFAS No. 149,
requires that all contracts considered to be derivative instruments be recorded on the
balance sheet at their fair value. The Company enters into both physical and financial
contracts to manage its energy resource portfolio including forward physical and financial
contracts, option contracts and swaps. The majority of these contracts qualify for the
normal purchase normal sale exemption. Those contracts that do not meet normal purchase
normal sale exemption or cash flow hedge criteria are marked-to-market to current earnings
in the income statement, subject to deferral under SFAS No. 71 Accounting for the
Effects of Certain Types of Regulation, (SFAS No. 71) due to the Power Cost
Adjustment (PCA) mechanism. 
        During
the three months ended September 30, 2004, the Company recorded a decrease in earnings for
the change in the market value of derivative instruments not meeting cash flow hedge
criteria of approximately $1.9 million compared to a decrease in earnings of approximately
$0.9 million for the three months ended September 30, 2003. In 2004, a portion of the
total unrealized gain was deferred in accordance with SFAS No. 71 due to the Company
expecting to reach the $40 million cap under the PCA mechanism in the fourth quarter of
2004. When these transactions are realized, they will be reflected in the PCA calculation. 
        During
the nine months ended September 30, 2004, the Company recorded an increase in earnings for
the change in the market value of derivative instruments not meeting cash flow hedge
criteria of approximately $1.0 million compared to a decrease in earnings of approximately
$0.4 million for the nine months ended September 30, 2003. 
        PSE
has a contract with a counterparty whose debt ratings have been below investment grade
since 2002. The contract, a physical gas supply contract for one of PSEs electric
generating facilities, was marked-to-market beginning in the fourth quarter of 2003.
Although the counterparty continues to fully perform on the physical supply contract, the
counterpartys credit ratings have remained weak. Prior to October 1, 2003, the
contract was designated as a normal purchase under SFAS No. 133. PSE has concluded that it
is appropriate to reserve the mark-to-market gain on this contract due to the credit
quality of the counterparty in accordance with SFAS No. 133 guidance, as management deemed
that delivery is not probable through the term of the contract, which expires December
2008. There was no impact on earnings for the three and nine months ended September 30,
2004. 
        In
the first quarter of 2004, the counterparty of another physical gas supply contract for
one of PSEs electric generating facilities notified PSE that it would be unable to
deliver physical gas supply beginning in November 2005 through the end of the contract in
June 2008. Since physical delivery for the life of the contract was no longer probable,
the contract no longer met the criteria for normal purchase exemption under SFAS No. 133.
Therefore, the contract was marked-to-market in the first quarter of 2004, with an
offsetting reserve for the portion of the mark-to-market gain applicable to the impaired
period of November 2005 through June 2008. The unrealized gain to earnings, net of the
reserve, was $0.7 million in the third quarter of 2004. In October 2004, PSE and the
counterparty reached a settlement on the non-deliverable period of November 2005 through
June 2008. The agreement allows PSE to recover a portion of the present value of the
difference in future market prices of physical gas and the original contract price, for a
total recovery of approximately $10.1 million. PSE filed a petition with the Washington
Commission to defer the counterparty settlement amount as a regulatory liability and
amortize the benefit over the period of November 2005 through June 2008 as a reduction in
Electric Generation Fuel expense. 
        In
the third quarter 2004, the Company entered into two treasury lock contracts to hedge
against potential rising interest rate exposure for a debt offering anticipated to be
performed in the first half of 2005. A treasury lock is a financial arrangement between
the Company and a counterparty whereby one of the parties will be required to make a
payment to the other party on a specific valuation date based upon the change in value of
a 30 year treasury bond. If interest rates rise related to the hedged debt from the date
of issuance of the treasury lock instruments, the Company would receive a payment from the
counterparty for the change in the bond value. Alternatively, if interest rates decrease
related to the hedged debt from the date of issuance of the treasury lock instruments, the
Company would pay the counterparty for the change in bond value. These treasury lock
contracts were designated under SFAS No. 133 criteria as cash flow hedges, with all
changes in market value for each reporting period being presented net of tax in other
comprehensive income. When these treasury lock contracts are settled upon issuance of
debt, any gain or loss will be amortized from other
comprehensive income to interest expense over the 30 year life of the issued debt.
At September 30, 2004, the unrealized loss associated with these two
treasury lock contracts was $4.3 million, net of tax, and is included in other
comprehensive income.

(5)    
          Intangibles(Puget Energy Only)

Identifiable
intangible assets acquired as a result of acquisitions of InfrastruX companies are
amortized over the expected useful lives of the assets, which range from four to 20 years.
Identifiable intangible assets are as follows:

|(Dollars in thousands)
At September 30, 2004 | Gross
Intangibles | Accumulated
Amortization | Net
Intangibles
|-------------------------------------------- | ----------------- | ------------------------ | ---------------
|Covenant not to compete                      |                   |                          | $              
|Developed technology                         |                   |                          |                
|Contractual customer relationships           |                   |                          |                
|Patents                                      |                   |                          |                
|                                            
|Total                                        |                   |                          | $              
|                                             |                  

|(Dollars in thousands)
At December 31, 2003 | Gross
Intangibles | Accumulated
Amortization | Net
Intangibles
|------------------------------------------- | ----------------- | ------------------------ | ---------------
|Covenant not to compete                     |                   |                          | $              
|Developed technology                        |                   |                          |                
|Contractual customer relationships          |                   |                          |                
|Patents                                     |                   |                          |                
|                                           
|Total                                       |                   |                          | $              
|                                            |                  

The
identifiable intangible asset amortization expense for the three and nine months ended
September 30, 2004 was $0.5 million and $1.5 million, respectively, and $0.4 million and
$1.4 million, respectively, for the same periods in 2003. The identifiable intangible
assets amortization for future periods based on the current acquisitions will be:

|(Dollars in thousands)         | 2004 | 2005 | 2006 | 2007 | 2008
|------------------------------ | ---- | ---- | ---- | ---- | ----
|Future Intangible Amortization |      |      | $    | 527  |     

(6)     Asset Retirement
Obligation

On
January 1, 2003 the Company adopted SFAS No. 143, Accounting for Asset Retirement
Obligations. SFAS No. 143 requires legal obligations associated with the retirement
of long-lived assets to be recognized at their fair value at the time that the obligations
are incurred. Upon initial recognition of a liability, that cost is capitalized as part of
the related long-lived asset and allocated to expense over the useful life of the asset.
The Company recorded an after-tax charge to income of $0.2 million in the first quarter of
2003 for the cumulative effect of the accounting change. 
        The
Company identified various asset retirement obligations at January 1, 2003, which were
included in the cumulative effect of the accounting change. The Company has an obligation
(1) to dismantle two leased electric generation turbine units and deliver the turbines to
the nearest railhead at the termination of the lease in 2009; (2) to remove certain
structures as a result of re-negotiations with the Department of Natural Resources of a
now expired lease; (3) to replace or line all cast iron pipes in its service territory by
2007 as a result of a 1992 Washington Commission order; and (4) to restore ash holding
ponds at a jointly-owned coal-fired electric generating facility in Montana. 
        The
following table describes all changes to the Companys asset retirement obligation
liability during the nine months ended September 30:

|(Dollars in thousands)
At September 30,          | 2004 | 2003
|------------------------------------------------ | ---- | ----
|Asset retirement obligation at beginning of year |      |     
|Liability recognized in the period               |      |     
|Liability settled in the period                  |      |     
|Accretion expense                                |      |     
|                                                
|Asset retirement obligation at September 30.     |      |     
|                                                 |     

(7)    
          Stock Compensation (Puget Energy Only)

The
Company has various stock-based compensation plans which prior to 2003 were accounted for
according to Accounting Principles Board (APB) No. 25, Accounting for Stock Issued
to Employees, and related interpretations as allowed by SFAS No. 123,
Accounting for Stock-Based Compensation. In 2003, the Company adopted the fair
value based accounting of SFAS No. 123 using the prospective method under the guidance of
SFAS No. 148, Accounting for Stock-Based Compensation  Transition and
Disclosure. The Company is applying SFAS No. 123 accounting prospectively to stock
compensation awards granted in 2003 and future years, while grants that were made in years
prior to 2003 will continue to be accounted for using the intrinsic value method of APB
No. 25. Had the Company used the fair value method of accounting specified by SFAS No. 123
for all grants at their grant date rather than prospectively implementing SFAS No. 123,
net income and earnings per share would have been as follows:

|                                                              | Three Months Ended
September 30, | Nine Months Ended
September 30,
|------------------------------------------------------------- | -------------------------------- | -------------------------------
|(Dollar in thousands, except per share)                       | 2004                             | 2003                           
|Income for common stock, as reported                          |                                  |                                
|Add: Total stock-based employee compensation expense included |                                  |                                
|in net income, net of tax                                     |                                  |                                
|Less: Total stock-based employee compensation expense per the |                                  |                                
|fair value method of SFAS No. 123, net of tax                 |                                  |                                
|                                                             
|Pro forma income for common stock                             |                                  |                                
|                                                              |                                 
|Earnings per share:                                           |                                  |                                
|Basic as reported                                             |                                  |                                
|Diluted as reported                                           |                                  |                                
|                                                             
|Basic and diluted pro forma                                   |                                  |                                

(8)     Retirement Benefits

The
following summarizes the net periodic benefit cost for the three months ended September
30.

|                                              | Pension Benefits | Other Benefits
|--------------------------------------------- | ---------------- | --------------
|(Dollars in thousands)                        | 2004             | 2003          
|Service cost                                  |                  |               
|Interest cost                                 |                  |               
|Expected return on plan assets                |                  |               
|Amortization of prior service cost            |                  |               
|Recognized net actuarial (gain) loss          |                  |               
|Amortization of transition (asset) obligation |                  |               
|Special recognition of prior service costs    |                  |               
|                                             
|Net periodic benefit cost (income)            |                  |               
|                                              |                 

The
following summarizes the net periodic benefit cost for the nine months ended September 30.

|                                             
|---------------------------------------------
|(Dollars in thousands)                       
|Service cost                                 
|Interest cost                                
|Expected return on plan assets               
|Amortization of prior service cost           
|Recognized net actuarial (gain) loss         
|Amortization of transition (asset) obligation
|Special recognition of prior service costs   
|                                             
|Net periodic benefit cost (income)           
|                                             

The Company
previously disclosed in its financial statements for the year ended December 31, 2003 that
it expected pension plan contributions to be $11.1 million in 2004. During the three and
nine months ended September 30, 2004, the actual cash contributions to the pension plans
were $0.3 million and $1.3 million, respectively. In addition, some plan participants
chose lump sum pension payments totaling $9.7 million and deferred them under the
Companys deferred compensation plan in the first quarter of 2004. Based on this
activity, the Company anticipates contributing an additional $0.1 million to the
Companys non-qualified supplemental retirement plan in 2004. 
        During
the three and nine months ended September 30, 2004, actual other post-retirement medical
benefit plan contributions were $0.5 million and $1.3 million, respectively, and the
Company expects to make additional contributions of $0.2 million for a total of $1.5
million in 2004.

(9)     Tenaska Disallowance

The
Washington Commission issued an order on May 13, 2004 determining that PSE did not
prudently manage gas costs for the Tenaska electric generating plant and ordered PSE to
adjust its PCA deferral account to reflect a one-time disallowance of $25.6 million for
the PCA 1 period (July 1, 2002 through June 30, 2003), which was recorded by PSE as a
Purchased Electricity expense in the second quarter of 2004. The order also established
guidelines for future recovery of Tenaska costs. The amounts were determined to be a $25.6
million one-time disallowance for the PCA 1 period and an estimated disallowance of $11.3
million for the PCA 3 period (July 1, 2004 to June 30, 2005), based upon applying the
Washington Commissions methodology of 50% disallowance on the return on the Tenaska
regulatory asset due to projected costs exceeding the benchmark during the period. For the
PCA 3 period, approximately $5.6 million would be disallowed in the period July 1, 2004
through December 31, 2004, primarily as a reduction to Electric Operating Revenue, for a
cumulative impact on earnings of $31.2 million in 2004 for the PCA 1 and 3 periods for
PSE. The PCA 3 reduction in Electric Operating Revenue is the result of the Washington
Commissions order that reflected a reduction in rates of approximately $9.9 million
annually. This reduction is to reflect the Washington Commissions estimate of the
Tenaska disallowance for the PCA 3 period. While the Washington Commission did not
expressly address the disallowance for the PCA 2 period (July 1, 2003 through June 30,
2004), PSE estimates the disallowance for the PCA 2 period to be approximately $12.2
million if the Washington Commission were to follow the same methodology as they have
ordered for the PCA 3 period. While PSE reserves the right to address the merits of any
disallowance in its PCA 2 compliance filing, which is currently being reviewed by the
Washington Commission staff, PSE recorded a $12.2 million disallowance to Purchased
Electricity expense in the second quarter of 2004 for the 50% disallowance of the return
on the Tenaska regulatory asset in accordance with the Washington Commissions
methodology discussed in their order of May 13, 2004. PSE anticipates the PCA 2 compliance
filing to be concluded no later than the first quarter of 2005. As a result of the
disallowance recorded, the PCA customer deferral of $17.6 million at March 31, 2004 was
expensed and a reserve was established to offset future PCA customer deferrals. The
reserve balance as of September 30, 2004 was $11.2 million, which is expected to be
utilized over the remaining months in 2004 as the excess power costs are shared through
the PCA mechanism. The Tenaska disallowance for the three months ended September 30, 2004
resulted in a reduction in Electric Operating Revenue of $2.8 million. The cumulative
disallowance for the nine months ended September 30, 2004 was $40.6 million, which is
comprised of a $4.1 million reduction in Electric Operating Revenue and a $36.5 million
one-time disallowance recorded in Purchased Electricity expense. The total for 2004 is
expected to be approximately $43.4 million ($28.1 million after-tax). 
        Prior
to the Tenaska disallowance, PSEs excess power costs under the PCA mechanism
exceeded the $40 million cap established whereas with the Tenaska disallowance the excess
power costs at September 30, 2004 are $26.8 million. The excess power costs from September
30, 2004 until the PCA mechanism cap of $40 million is reached, which is expected in
November 2004, will be offset by the Tenaska disallowance reserve of $11.2 million for the
PCA 1 and 2 periods that was recorded in the second quarter of 2004. PSE does not expect
earnings through year-end 2004, based on current market conditions, to be impacted by
excess power costs due to the Tenaska disallowance reserve liability recorded in the
second quarter of 2004.

Below
is a summary of the Tenaska disallowances by quarter through December 31, 2004:

|(Dollars in millions)
Quarter ending | 7/02 - 6/03PCA 1
(ordered/final) | 7/03 - 6/04PCA 2
(estimated) | 7/04 - 12/04PCA 3
(estimated) | Total
|------------------------------------ | -------------------------------- | ---------------------------- | ----------------------------- | -----
|June 30, 2004                        |                                  |                              | $                             | 25   
|September 30, 2004                   |                                  |                              |                               | --   
|December 31, 2004                    |                                  |                              |                               | --   
|                                     |                                 
|Total                                |                                  |                              | $                             | 25   
|                                     |                                 

In
the May 13, 2004 order, the Washington Commission established guidelines and a benchmark
to determine PSEs recovery on the Tenaska regulatory asset starting with the PCA 3
period (July 1, 2004) through the expiration of the Tenaska contract in the year 2011. The
benchmark is defined as the original cost of the Tenaska contract adjusted to reflect the
1.2% disallowance from a 1994 Prudence Order.

The
Washington Commission guidelines for determining future recovery of the Tenaska costs (gas
costs, recovery of the Tenaska regulatory asset and return on the Tenaska regulatory
asset) are as follows:

| | 1. | The
Washington Commission will determine if PSEs gas purchasing plan and gas purchases
for Tenaska are prudent through the PCA compliance filings.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | If
PSEs gas purchasing plan and gas purchases for Tenaska are prudent, and
          if PSEs actual Tenaska costs fall at or below the benchmark, it will
          recover fully its Tenaska costs.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | If
PSEs gas purchasing plan and gas purchases for Tenaska are prudent, but
          its actual Tenaska costs exceed the benchmark, PSE will only recover 50% of the
          lesser of:
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a) | Actual
Tenaska costs that exceed the benchmark or;
| | -- | --------------------------------------------------

| | b) | The
return on the Tenaska regulatory asset (return on the asset would be added last
to all other relevant Tenaska costs).
| | -- | -------------------------------------------------------------------------------------------------------------------------

| | 4. | If
PSEs gas purchasing plan or gas purchases are found to be imprudent in           a
future proceeding, PSE risks disallowance of any and all Tenaska costs.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------

The
Washington Commission confirmed that if the Tenaska gas costs are deemed prudent, PSE will
recover the full amount of actual gas costs and the recovery of the Tenaska regulatory
asset even if the benchmark is exceeded.

(10)     Colstrip Generating Facilities

In
September 2004, the owners of Colstrip Units 1 & 2 (PSE and PPL Montana) entered into
a tentative settlement agreement with certain homeowners in the Colstrip town site area
concerning a lawsuit filed in May 2003. The lawsuit alleged certain domestic water wells
may have been contaminated by seepage from a Colstrip Units 1 & 2 effluent holding
pond. The tentative settlement agreement would require extending municipal water to the
homeowners and abandoning the existing wells. The total estimated cost of the settlement
ranges from $1.4 million to $1.5 million. As a result of this tentative settlement
agreement, PSE recorded in the third quarter of 2004 a reserve for its 50% ownership of
the Colstrip Units 1 & 2 project of $0.7 million. The settlement agreement does not
resolve certain other claims by residents within the city limits. PSE cannot predict the
outcome or any potential financial impact of the claims by the residents within the city
limits at this time. 
        The
nine months ended September 30, 2004 also includes a $6.9 million charge related to a
binding arbitration settlement between PSE and Western Energy Company (WECO), the supplier
of coal to Colstrip Units 1 & 2, which was recorded in the second quarter of 2004. The
binding decision retroactively set a new baseline cost of coal per ton supplied from July
31, 2001, and is applicable for the remaining term of the coal supply agreement through
December 2009. Of the second quarter charge of $6.9 million, $5.0 million is included in
the PCA mechanism. PSE had previously accrued a reserve of $1.6 million in the fourth
quarter 2003 related to the arbitration. 
        The
nine months ended September 30, 2004 also includes a loss reserve in the amount of $1.1
million recorded in the second quarter of 2004 related to an order issued by the Minerals
Management Service of the United States Department of the Interior on April 29, 2004 to
pay additional royalties to WECO concerning coal purchased by PSE for Colstrip Units 3
& 4. The order seeks payment of an additional $1.1 million in royalties for coal mined
from federal lands between 1997 and June 30, 2000. During that period, PSEs coal
price was reduced by a settlement agreement entered into in February 1997 among PSE, WECO
and Montana Power Company that resolved disputes that were then pending. The order seeks
to impute the price charged to PSE based on the other Colstrip Units 3 & 4
owners contractual amounts. PSE is supporting WECOs appeal of the order which
was filed on October 1, 2004. The outcome of this matter cannot be predicted at this time. 
        In
addition, the Minerals Management Service of the United States Department of the Interior
issued two orders to WECO in 2002 and 2003 to pay additional royalties concerning coal
sold to Colstrip Units 3 & 4 owners. The orders assert that additional royalties are
owed as a result of WECO not paying royalties in connection with revenue received by WECO
from the Colstrip Units 3 & 4 owners under a coal transportation agreement during the
period October 1, 1991 through December 31, 2001. PSEs share of the alleged
additional royalties is $1.8 million, which is equivalent to PSEs 25% ownership
interest in Colstrip Units 3 & 4. The transportation agreement provides for the
construction and operation of a conveyor system that runs several miles from the mine to
Colstrip Units 3 & 4. WECO has appealed these orders and PSE is monitoring the
process. Based upon its review, PSE believes that the Colstrip Units 3 & 4 owners have
reasonable defenses in this matter. Neither the outcome of this matter nor the associated
costs can be predicted at this time. 
        On
December 5, 2003, Colstrip Units 1 & 2 and 3 & 4 received an information request
from the Environmental Protection Agency (EPA) relating to their compliance with the Clean
Air Act New Source Review regulations. PSE is currently in discussions with the EPA
concerning the information request. Neither the outcome of this matter nor any potential
associated costs can be predicted at this time.

(11)     Other

On
September 24, 2004, the Washington Commission approved PSEs request for a Purchased
Gas Adjustment (PGA) filed on August 31, 2004. The approved request will increase rates
and revenues by approximately 17.6% or $121.7 million annually. The increase in PGA rates
was to recover higher market prices of natural gas sold to customers. The PGA mechanism
passes through to customers increases or decreases in the gas supply portion of the
natural gas service rates based upon changes in gas prices. PSEs gas margin and net
income are not affected by the change in PGA rates.
        On
July 15, 2004, PSE issued $200 million in floating rate senior notes under its existing
$500 million shelf registration statement, reducing the available balance for future
issuances under the registration statement to $300 million. The notes float at the
three-month LIBOR rate plus 0.30%, mature on July 14, 2006, and can be redeemed at any
time after January 15, 2005. PSE used the net proceeds from the sale of the floating rate
senior notes to repay outstanding amounts under its commercial paper and accounts
receivable securitization programs, including amounts incurred to repay long-term debt.
PSE also used the proceeds to redeem $55 million in principal of first mortgage bonds at a
premium of 3.68% on August 14, 2004.
        In
2003, the Washington Commissions Pipeline Safety staff conducted a natural gas
standard inspection for three counties within Washington State in which PSE operates gas
pipeline activities. The inspection included a review of procedures, records, and
operations and maintenance activities. On June 29, 2004, the Washington Commission issued
a complaint to PSE related to that inspection. The Washington Commissions complaint
alleges certain violations of Washington Commission regulations and determined a maximum
aggregated fine for the violations of $4.5 million, although the Washington
Commissions Pipeline Safety staff recommended a fine of $1.3 million. PSE is
reviewing this matter and has been meeting with the Pipeline Safety staff to review their
allegations and develop a mutual resolution to this matter. Neither the outcome of this
matter nor the associated costs, including potential fines, can be predicted at this time. 
        In
September 2004, a natural gas fire destroyed a home and took the life of a PSE customer.
The cause of the fire remains under investigation by PSE, the Washington Commission and
other parties. PSE has tendered the matter to its general liability insurer. Neither the
potential regulatory or litigation outcomes of this matter nor the final associated costs
can be predicted at this time. 
        On
April 5, 2004, PSE filed general tariff electric and gas rate cases with the Washington
Commission. The rate cases propose increases of 5.8% or $82.8 million annually and 6.8% or
$48.9 million annually for electric and gas customers, respectively. These increases are
intended to recover costs associated with extending and upgrading facilities to serve a
growing number of gas and electric customers as well as strengthen PSE financially to
serve its customers. The Washington Commission staff and other intervenors responded to
PSEs general tariff electric and gas rate cases in the third quarter of 2004 and
proposed an electric general rate case increase of $21.4 million annually and a gas
general rate case increase of $8.1 million annually. PSE filed its rebuttal testimony to
the intervenors testimony on November 3, 2004 in which PSE revised its proposed
electric increase request to 7.3% or $103.3 million annually which reflects updated power
costs for increases in natural gas pricing for generating plants. The gas rebuttal
testimony revised the proposed gas increase request to 6.3% or $46.2 million annually. The
resolution of the general rate cases may be up to an 11-month process from the time the
general rate cases were filed. 
        On
April 23, 2004, the acquisition of a 49.85% interest in the Frederickson 1 generating
facility was approved by FERC. Prior to that approval, on April 7, 2004, the Washington
Commission had issued an order in PSEs power cost only rate case granting approval
for the acquisition of the Frederickson 1 generating facility. As a result of these
approvals, PSE completed the acquisition in the second quarter of 2004 and added $80.8
million in utility plant. In its order, the Washington Commission found the acquisition to
be prudent and the costs associated with the generating facility reasonable. The costs
associated with the generating facility, including projected baseline gas costs, are
approved for recovery in rates. 
        On
May 13, 2004, the Washington Commission also approved other adjustments to power costs
that resulted in an increase of cost recovery in rates of $44.1 million annually,
beginning May 24, 2004, which includes the ownership, operation and fuel costs of the
Frederickson 1 generating facility.
        Early
in 2003, the Colville Confederated Tribes (Colville Tribe) presented a claim to Douglas
County PUD based upon allegedly unpaid past annual charges for the Wells Hydroelectric
Project (the Project) for the use of Colville tribal lands, principally riverbed along the
tribal reservation. The Colville Tribe further claimed that annual charges would be due
for periods into the future. Beginning in April 2003, Douglas County PUD and Colville
Tribe representatives discussed settlement of these issues. On November 1, 2004, the
Douglas County PUD Commission approved entry into a settlement agreement with the Colville
Tribe that, subject to FERC approval, will resolve all of the Tribes claims. The
settlement would allocate 4.5% of the Projects output to the Tribe effective upon
FERC approval through 2018, when the allocation would increase to 5.5%. The allocation
would last as long as the Project exists. In addition, under the settlement, Douglas
County PUD would pay $13.5 million and convey certain real property to the Colville Tribe.
Douglas County PUD would also market the Colville Tribes Project output on behalf of
the Tribe for a period of time. PSE currently purchases 31.3% of the Projects
output. Upon approval, the settlement will slightly reduce the output available for PSE,
and slightly increase the cost of PSEs purchase under PSEs existing contract
with Douglas County PUD. PSE will support the Douglas County PUD filing for approval of
the settlement. PSE cannot predict how long it will take FERC to act upon the application.

(12)     New Accounting
Pronouncements

In
January 2003, FASB issued Financial Interpretation No. 46 Consolidation of Variable
Interest Entities (FIN 46), as further revised in December 2003 with FIN 46R, which
clarifies the application of Accounting Research Bulletin No. 51, Consolidated
Financial Statements, to certain entities in which equity investors do not have a
controlling interest or sufficient equity at risk for the entity to finance its activities
without additional financial support. FIN 46 requires that if a business entity has a
controlling financial interest in a variable interest entity, the financial statements
must be included in the consolidated financial statements of the business entity. The
adoption of FIN 46 for all interests in variable interest entities created after January
31, 2003 was effective immediately. For variable interest entities created before February
1, 2003, it was effective July 1, 2003. The adoption of FIN 46R was effective March 31,
2004. The Company has evaluated its contractual arrangements and determined PSEs
1995 conservation trust off-balance sheet financing transaction meets this guidance, and
therefore it was consolidated in the third quarter of 2003. As a result, revenues
increased while conservation amortization and interest expense increased by the
corresponding amount with no impact on earnings. FIN 46R also impacted the treatment of
the Companys mandatorily redeemable preferred securities of a subsidiary trust
holding solely junior subordinated debentures of the corporation (trust preferred
securities). Previously, these trust preferred securities were consolidated into the
Companys operations. As a result of FIN 46R, these securities have been
deconsolidated and were classified as junior subordinated debentures of the corporation
payable to a subsidiary trust holding mandatorily redeemable preferred securities in the
fourth quarter of 2003. This change had no impact on the Companys results of
operations. The Company evaluated its purchase power agreements and determined that three
counterparties may be considered variable interest entities. As a result, PSE submitted
requests for information to those parties; however, the parties have refused to submit to
PSE the necessary information for PSE to determine whether they meet the requirements of a
variable interest entity. PSE also determined it does not have a contractual right to such
information. PSE will continue to submit requests for information in the future to
determine if FIN 46R is applicable. 
        For
the three purchase power agreements that may be considered variable interest entities
under FIN 46R, PSE is required to buy all the generation from these plants, subject to
displacement by PSE, at rates set forth in the purchase power agreements. If at any time
the counterparties cannot deliver energy to PSE, PSE would have to buy energy in the
wholesale market at prices which could be higher or lower than the purchase power
agreement prices. PSEs Purchased Electricity expense for the three and nine months
ended September 30, 2004 for these three entities was $70.9 million and $180.9 million,
respectively. 
        In
December 2003, SFAS No. 132, Employers Disclosures about Pensions and Other
Postretirement Benefits (SFAS No. 132R), was revised to include various additional
disclosure requirements. SFAS No. 132R is effective for fiscal years ending after December
15, 2003. 
        The
Emerging Issues Task Force of the Financial Accounting Standards Board (EITF) at its July
2003 meeting came to a consensus concerning EITF Issue No. 03-11, Reporting Realized
Gains and Losses on Derivative Instruments That Are Subject to FASB Statement No. 133 and
Not Held for Trading Purposes as Defined in Issue No. 02-03. The
consensus reached was that determining realized gains and losses on physically settled
derivative contracts not held for trading purposes reported in the income statement on a
gross or net basis is a matter of judgment that depends on the relevant facts and
circumstances. Based on the guidance in EITF No. 03-11, the Company determined that its
non-trading derivative instruments should be reported net and implemented this treatment
effective January 1, 2004. Consequently, both Electric Operating Revenues and Purchased
Electricity for the three and nine months ended September 30, 2003 have been reduced by
$25.3 million and $94.4 million, respectively, to reflect the netting addressed by EITF
No. 03-11 with no effect on net income. 
        In
March 2004, the EITF came to a consensus concerning EITF Issue No. 03-16, Accounting
for Investments in Limited Liability Companies. The consensus reached was that an
investment in a limited liability company (LLC) should be accounted for using the equity
method for investments greater than 3% to 5%. The adoption of EITF No. 03-16 is effective
for reporting periods beginning after June 15, 2004, with any adjustments being accounted
for as a cumulative effect of a change in accounting principle. The Company reviewed its
investments and determined one investment held by PSE met the criteria established in EITF
No. 03-16. The adoption of the equity method had no cumulative effect on earnings for the
three and nine months ended September 30, 2004 as PSE had been carrying this investment at
fair value, which represents the equity basis, since December 31, 2003. 
        On
June 17, 2004, FASB issued a proposed interpretation titled Accounting for
Conditional Asset Retirement Obligations which is an interpretation of SFAS No. 143
Accounting for Asset Retirement Obligations. The proposed interpretation would
address the issue of whether SFAS No. 143 requires an entity to recognize a liability for
a legal obligation to perform asset retirement when the asset retirement activities are
conditional on a future event, and if so, the timing and valuation of the recognition.
This proposed interpretation could potentially have an impact on the Company as assets
that were previously outside the scope of SFAS No. 143 may be subject to its terms based
on the interpretation. Comments on the proposed interpretation were due on August 1, 2004.
The FASB is in the process of reviewing the comment letters and anticipates issuing a
final interpretation with an effective date for fiscal years ending after December 15,
2005.

Item 2.    Management's Discussion and
Analysis of Financial Condition and Results of Operations

The
following discussion of the Companys financial condition and results of operations
contains forward-looking statements that involve risks and uncertainties, such as
statements of the Companys plans, objectives, expectations and intentions. Words
such as anticipate, believe, expect,
future and intend and similar expressions are used to identify
forward-looking statements. However, these words are not the exclusive means of
identifying such statements. In addition, any statements that refer to expectations,
projections or other characterizations of future events or circumstances are
forward-looking statements. The Companys actual results could differ materially from
those anticipated in these forward-looking statements for many reasons, including the
factors described below and under the caption Forward-Looking Statements at
the beginning of this report. You should not place undue reliance on these forward-looking
statements, which apply only as of the date of this Form 10-Q.

Overview

Puget
Energy is an energy services holding company and all of its operations are conducted
through its two subsidiaries. These subsidiaries are PSE, a regulated electric and gas
utility company, and InfrastruX, a utility construction and services company.

Puget Sound Energy 
        PSE
generates revenues from the sale of electric and gas services, mainly to residential and
commercial customers within Washington State. A majority of PSEs revenues are
generated in the first and fourth quarters during the winter heating season in Washington
State.
        As
a regulated utility company, PSE is subject to Federal Energy Regulatory Commission (FERC)
and Washington Utilities and Transportation Commission (Washington Commission) regulation
which may impact a large array of business activities, including limitation of future rate
increases; issuance of orders that may negatively impact earnings; licensing of PSE-owned
generation facilities; and other FERC and Washington Commission directives that may impact
PSEs long-term goals. In addition, PSE is subject to risks inherent to the utility
industry as a whole including weather changes affecting purchases and sales of energy;
outages at owned and non-owned generation plants where energy is obtained; storms which
can damage distribution and transmission lines; and energy trading and wholesale market
stability over time.
        PSEs
main operational goal is to provide cost-effective and stable energy prices to its
customers. To help accomplish this goal, PSE is attempting to be more self-sufficient in
energy generation resources. Owning more generation resources rather than purchasing power
through short-term contracts and on the wholesale market is intended to allow
customers rates to remain stable. PSE has initiated the following transactions to
increase its owned pool of generation resources during the nine months ended September 30,
2004:

| | Purchased
a 49.85% interest in a 250 MW capacity gas-fired generation facility within Western
Washington, which went into service in May 2004.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------

| | Signed
a two-year purchase power agreement in the second quarter of 2004 with a utility for 85
MW of energy with delivery beginning January 1, 2005.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------

| | Signed
a non-binding letter of intent in September 2004 to purchase a wind generation facility
with up to 220 MW of generation to be developed in central Washington State.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

These
transactions are part of PSEs long-term electric Least Cost Plan that was filed
August 29, 2003 with the Washington Commission. The plan supports a strategy of diverse
resource acquisitions including resources fueled by natural gas and coal, renewable
resources and shared resources.

InfrastruX
        InfrastruX
generates revenues mainly from maintenance services and construction contracts in the
midwest, Texas, south-central and eastern United States regions. Generally, a majority of
its revenues are generated during the second and third quarters, which are typically the
most productive quarters for the construction industry due to longer daylight hours and
generally better weather conditions.

InfrastruX
is subject to risks associated with the construction industry including the ability to
adequately estimate costs of projects that are bid upon under fixed-fee contracts;
continued economic downturn that limits the amount of projects available thereby reducing
available profit margins from increased competition; the ability to integrate acquired
companies within its operations without significant cost; and the ability to obtain
adequate financing and bonding coverage to continue expansion and growth. 
        InfrastruXs
goals are continued growth and expansion into underdeveloped utility construction markets
and to utilize its acquired entities to capitalize on depth of expertise, asset base,
geographical location and workforce to provide services that local contractors cannot.
InfrastruX has acquired 12 entities since 2000 to fuel growth and diversify into these
underdeveloped markets. 
        Puget
Energy is currently evaluating strategic options related to its investment in InfrastruX.

# Results of Operations

Puget Energy 
        All
of the operations of Puget Energy are conducted through its subsidiaries, PSE and
InfrastruX. Puget Energys net income for the three months ended September 30, 2004
was $11.1 million on operating revenues of $515.0 million compared with net income of
$11.0 million on operating revenues of $490.3 million for the same period in 2003. Income
for common stock was $11.1 million for the three months ended September 30, 2004 compared
to income for common stock of $9.9 million for the same period in 2003. Puget
Energys basic and diluted earnings per common share was $0.11 for the three months
ended September 30, 2004 compared to basic and diluted earnings per common share of $0.10
for the same period in 2003. 
        Puget
Energys income for common stock for the three months ended September 30, 2004 was
positively impacted by higher electric margins, lower interest expense and lower preferred
stock dividends offset by higher depreciation expense as compared to the same period in
2003. The three months ended September 30, 2003 was positively impacted by a federal tax
benefit true-up and a gain on corporate-owned life insurance which did not recur in 2004. 
        For
the nine months ended September 30, 2004, Puget Energys net income was $70.7 million
on operating revenues of $1.8 billion compared to net income of $78.0 million on operating
revenues of $1.7 billion for the same period in 2003. Income for common stock was $70.7
million for the nine months ended September 30, 2004 compared to $73.2 million for the
same period in 2003. Basic and diluted earnings per common share were $0.71 for the nine
months ended September 30, 2004 and $0.78 and $0.77, respectively, for the same period in
2003. 
        Puget
Energys income for common stock for the nine months ended September 30, 2004 was
negatively impacted by a decrease in Puget Sound Energys net income for common stock
of $5.4 million. The negative change was due primarily to a $24.5 million after-tax
disallowance of the return on the regulatory asset for the Tenaska gas supply buyout cost
under PSEs Power Cost Adjustment (PCA) mechanism as a result of a Washington
Commission order in PSEs Power Cost Only Rate Case (PCORC). See further details
under PSEs Electric Rate Matters. In addition, the nine months ended
September 30, 2004 was not impacted by one-time federal tax benefits compared to the same
period in 2003. These negative impacts were partially offset by higher retail energy sales
resulting from more normal weather temperatures in the first quarter of 2004 as compared
to warmer temperatures in the same period in 2003 and lower interest expense and preferred
stock dividends. In addition, PSE was not impacted by excess power costs in 2004 compared
to 2003 as a result of reaching the PCA mechanism cap in 2003. Puget Energys income
for common stock was also positively impacted by a $3.2 million increase in earnings from
InfrastruX (net of minority interest) for the nine months ended September 30, 2004
compared to the same period in 2003. This positive impact from InfrastruX was due in part
to improved operating efficiencies and improvement in weather conditions compared to 2003,
which positively impacted productivity.

Puget Sound Energy 
        PSEs
operating revenues and associated expenses are not generated evenly during the year.
Variations in energy usage by consumers occur from season to season and from month to
month within a season, primarily as a result of weather conditions. PSE normally
experiences its highest retail energy sales during the heating season in the first and
fourth quarters of the year, with temperature variations from historical normal levels in
these quarters having a higher impact on margin and net income than in the second and
third quarters. Varying wholesale electric prices and the amount of hydroelectric energy
supplies available to PSE also make quarter-to-quarter comparisons difficult.
        To
meet customer demand, PSE dispatches resources in its power supply portfolio primarily
consisting of fossil-fuel generation, owned and contracted hydro capacity and energy, and
long-term contracted power. However, depending principally upon availability of
hydroelectric energy, plant availability, fuel prices and/or changing load as a result of
weather, PSE may sell surplus power or purchase deficit power in the wholesale market. PSE
manages its core energy portfolio through short and intermediate-term off-system physical
purchases and sales, and through other risk management techniques. A PSE Energy Risk
Management Committee oversees energy portfolio exposures.
        Electric
margin increased $9.7 million for the three months ended September 30, 2004 compared with
the same period in 2003. This increase was primarily due to PSE not being impacted by
excess power costs in the third quarter of 2004 as compared to excess power costs of $5.8
million for the same period in 2003. In addition, the PCORC tariff rate increase effective
May 24, 2004 provided $2.4 million to electric margin for the three months ended September
30, 2004. The tariff rate increase was designed to recover operation and maintenance costs
of the new Frederickson 1 generating facility. The higher electric margin for the three
months ended September 30, 2004 was partially offset by $2.8 million in lower Electric
Operating Revenue as a result of the Tenaska disallowance ordered by the Washington
Commission in the PCORC. 
        Electric
margin decreased $6.5 million for the nine months ended September 30, 2004 compared to the
same period in 2003 primarily as a result of the disallowance ordered by the Washington
Commission in the PCORC. The disallowance resulted in $4.1 million lower Electric
Operating Revenue and a one-time $36.5 million power cost disallowance. The lower electric
margin for the nine months ended September 30, 2004 was partially offset by PSE not being
impacted by excess power costs in 2004 as compared to excess power costs of $24.7 million
in 2003 and by more normal temperatures in the first quarter of 2004 as compared to warmer
than normal temperatures in the same period in 2003. In addition, the PCORC tariff rate
increase, which is designed to recover operation and maintenance costs of the new
Frederickson 1 generation facility, provided $3.3 million to the electric margin for the
nine months ended September 30, 2004. 
        Electric
margin is electric sales to retail and transportation customers less pass-through tariff
items, revenue sensitive taxes, and the cost of generating and purchasing electric energy
sold to customers including transmission costs to bring electric energy to PSEs
service territory. Electric margin for the three and nine months ended September 30, 2004
and 2003 is detailed further as follows:

Electric Margin for the
Three and Nine Months Ended 
September 30, 2004 and
September 30, 2003 
(Dollars in Millions)

|                                                  | Three Months Ended
September 30, | Nine Months Ended
September 30,
|------------------------------------------------- | -------------------------------- | -------------------------------
|                                                  | 2004                             | 2003                           
|Electric retail sales revenue                     |                                  |                                
|Electric transportation revenue                   |                                  |                                
|Other electric revenue-gas supply resale          |                                  |                                
|                                                 
|Total electric revenue for margin                 |                                  |                                
|Adjustments for amounts included in revenue:      |                                  |                                
|Pass-through tariff items                         |                                  |                                
|Pass-through revenue-sensitive taxes              |                                  |                                
|Residential exchange credit                       |                                  |                                
|                                                 
|Net electric revenue for margin                   |                                  |                                
|Minus power costs:                                |                                  |                                
|Fuel                                              |                                  |                                
|Purchased electricity, net of sales to other      |                                  |                                
|utilities and marketers                           |                                  |                                
|                                                 
|Total electric power costs                        |                                  |                                
|                                                 
|Electric margin before PCA                        |                                  |                                
|Tenaska disallowance reserve through May 23, 2004 |                                  |                                
|Tenaska reserve turnaround                        |                                  |                                
|Power cost deferred under the PCA mechanism       |                                  |                                
|                                                 
|Electric margin                                   |                                  |                                
|                                                  |                                 

Gas
margin increased $0.7 million and $1.6 million for the three and nine months ended
September 30, 2004 compared to the same periods in 2003. The increase for the nine months
ended September 30, 2004 was primarily a result of more normal temperatures in the first
quarter of 2004 compared to warmer than normal temperatures in the first quarter of 2003
and increased customers. 
        Gas
margin is gas sales to retail and transportation customers less pass-through tariff items
and revenue sensitive taxes, and the cost of gas purchased, including gas transportation
costs to bring gas to PSEs service territory. Gas margin for the three and nine
months ended September 30, 2004 and 2003 is detailed further as follows:

Gas Margin for the
Three and Nine Months Ended 
September 30, 2004 and
September 30, 2003 
(Dollars in Millions)

|                                             | Three Months Ended
September 30, | Nine Months Ended
September 30,
|-------------------------------------------- | -------------------------------- | -------------------------------
|                                             | 2004                             | 2003                           
|Gas retail revenue                           |                                  |                                
|Gas transportation revenue                   |                                  |                                
|                                            
|Total gas revenue for margin                 |                                  |                                
|Adjustments for amounts included in revenue: |                                  |                                
|Gas revenue hedge                            |                                  |                                
|Pass-through tariff items                    |                                  |                                
|Pass-through revenue-sensitive taxes         |                                  |                                
|                                            
|Net gas revenue for margin                   |                                  |                                
|Minus purchased gas costs                    |                                  |                                
|                                            
|Gas margin                                   |                                  |                                
|                                             |                                 

The
changes to items affecting net income for the three and nine months ended September 30,
2004, compared to the same periods in 2003, are summarized in the table below.

Comparative Three and
Nine Months Ended 
September 30, 2004 vs.
September 30, 2003 
Increase (Decrease) 
(Dollars in Millions)

|                                                      
|------------------------------------------------------
|Operating revenue changes:                            
|Electric:                                             
|Residential sales                                     
|Commercial sales                                      
|Industrial sales                                      
|Transportation sales                                  
|Sales to other utilities and marketers                
|Other                                                 
|                                                      
|Total electric operating change                       
|                                                      
|Gas:                                                  
|Residential sales                                     
|Commercial sales                                      
|Industrial sales                                      
|Transportation sales                                  
|Other                                                 
|                                                      
|Total gas operating change                            
|                                                      
|Other revenues change                                 
|                                                      
|Total operating revenue change                        
|                                                      
|Operating expense changes:                            
|Energy costs:                                         
|Purchased electricity                                 
|Purchased gas                                         
|Electric generation fuel                              
|Residential exchange power cost credit                
|Unrealized gain/loss on derivative instruments        
|Utility operations and maintenance:                   
|Production operations and maintenance                 
|Low income program pass through expenses              
|Other utility operations and maintenance              
|Depreciation and amortization                         
|Conservation amortization                             
|Taxes other than income taxes                         
|Income taxes                                          
|                                                      
|Total operating expense change                        
|Other income change (net of tax)                      
|Interest charges change                               
|Cumulative effect of an accounting change (net of tax)
|                                                      
|Net income change                                     
|                                                      

Operating Revenues 
Electric 
        Electric
operating revenues for the three months ended September 30, 2004 were $322.7 million, an
increase of $4.5 million compared to the same period in 2003, due primarily to higher
sales to residential and commercial customers which increased by $7.9 million and $8.6
million, respectively. Included in the residential and commercial sales increase was the
PCORC tariff rate increase effective May 24, 2004. The tariff rate increase provided an
increase of $4.5 million and $4.8 million in residential and commercial sales revenue,
respectively. Residential and commercial sales volumes for the three months ended
September 30, 2004 increased by 75.9 million kWh and 87.9 million kWh, respectively, or
4.1% and 4.3%, respectively, compared to the same period in 2003. These volume increases
were mainly attributable to slightly warmer temperatures in July and August 2004 as
compared to 2003, which increased electric load. These increases were partially offset
with lower sales to other utilities and marketers which decreased $10.3 million for the
three months ended September 30, 2004. Sales to other utilities and marketers volumes
decreased 244.8 million kWh or 39.2% compared to the same period in 2003. The sales to
other utilities and marketers decreased mainly due to higher retail electric sales in 2004
compared to 2003 which reduced excess generation available for sale in the wholesale
market. The hydro conditions for the three months ended September 30, 2003 improved
slightly compared to the forecasted adverse hydro conditions providing more hydro
generation than was originally forecasted. The result of these conditions in 2003 created
excess generation to sell in the 2003 wholesale market. 
        Electric
operating revenues for the nine months ended September 30, 2004 were $1,018.3 million, an
increase of $4.0 million compared to the same period in 2003, due primarily to higher
sales to residential and commercial customers which increased $16.8 million and $17.6
million, respectively. Included in the residential and commercial sales increases was the
PCORC tariff rate increase of $6.1 million and $6.4 million, respectively. Residential and
commercial sales volumes for the nine months ended September 30, 2004 increased by 187.6
million kWh and 215.2 million kWh, respectively, or 2.6% and 3.5%, respectively, compared
to the same period in 2003. These volumes were mainly attributable to more normal
temperatures in the first quarter of 2004 as compared to warmer than normal temperatures
in the same period in 2003, and slightly warmer temperatures in July and August of 2004 as
compared to 2003. These increases were partially offset with lower sales to other
utilities and marketers which decreased $28.5 million for the nine months ended September
30, 2004. Sales to other utilities and marketers volumes decreased 810.7 million kWh or
46.6% compared to the same period in 2003. The sales to other utilities and marketers
decreased mainly due to lower generation available for sale in the wholesale market in
2004 compared to 2003. In 2003, warmer than normal temperatures, mainly in the first
quarter, and improved hydro conditions as compared to the original hydro forecast provided
excess energy supplies for sale to the wholesale market. 
        PSEs
other electric operating revenues for the three and nine months ended September 30, 2004
compared to 2003 decreased $2.5 million and increased $1.0 million, respectively. The
decrease for the three months ended September 30, 2004 was due primarily to changes in
unbilled electric revenue. The increase for the nine months ended September 30, 2004 was
due in part to the implementation of FIN 46R. FIN 46R required PSE to consolidate
PSEs 1995 conservation trust transaction in the third quarter of 2003. The
consolidation increased revenues, while conservation amortization and interest expense
increased by a corresponding amount with no impact on earnings. This revenue increase was
partially offset with changes in unbilled electric revenue for the nine months ended
September 30, 2004. 
        For
the three and nine months ended September 30, 2004, the benefits of the Residential and
Farm Energy Exchange Benefit credited to customers were $34.0 million and $123.8 million,
respectively, with a related offset to power costs. PSE received payments from the
Bonneville Power Administration (BPA) in the amount of $44.0 million and $132.0 million
during the three and nine months ended September 30, 2004, respectively. The difference
between the customers credit and the amount received from BPA either increases or
decreases the previously deferred amount owed to customers and the aggregated deferred
amount is recorded on PSEs balance sheet as restricted cash. Absent certain
adjustments tied to the BPA rate adjustment clause, the modified amended settlement
agreement provides for payments from BPA in the amount of $630.6 million for the period
January 2003 through September 2006 and for a pass-through of the same amount to eligible
residential and small farm customers. See discussion under PSEs Electric Rate
Matters for additional residential exchange information. 
        PSE
operates within the western wholesale market and has made sales into the California energy
market. During the fourth quarter of 2000, PSE made such sales to the California energy
market on which the receivable amount is still outstanding. At September 30, 2004,
PSEs receivable from the California Independent System Operators (CAISO) and other
counterparties, net of reserves, was $21.3 million. See the discussion of the
California Receivable and California Refund Proceeding  under Proceedings
Relating to the Western Power Market.

Operating Revenues 
Gas
        Gas
operating revenues for the three and nine months ended September 30, 2004 were $89.4
million and $484.6 million, respectively, an increase of $11.3 million and $101.9 million,
respectively, compared to the same periods in 2003. Increases in the purchased gas
adjustment (PGA) rate increased revenues approximately $8.2 million and $90.0 million for
the three and nine month periods ended September 30, 2004, respectively. The remaining
increase of $3.1 million in gas revenues for the three months ended September 30, 2004 was
attributable to higher gas therm sales volumes from customer growth and slightly cooler
temperatures in September 2004 as compared to the same period in 2003. Gas sales volumes
increased 0.8 million therms or 0.6%, and customer base increased by 3.9%. The remaining
increase of $11.9 million in gas revenues for the nine months ended September 30, 2004 was
mainly attributable to an increase in commercial customers and customers switching from
transportation tariffs. Volumes to retail commercial customers increased 4.8 million
therms or 2.7%. These customer increases were a result of previous transportation only
customers becoming retail commercial customers. Retail commercial volume increases sales
revenue since retail commercial tariff rates include the cost of gas in the tariff rate
compared to transportation tariff rates which do not include the cost of gas. 
        PSE
has a PGA mechanism in retail gas rates to recover expected gas costs (gas supply and
transportation costs) by deferring as a receivable or liability any gas costs that exceed
or fall short of the amount in PGA rates and accrues interest on any deferred balances
under the PGA. Therefore, PSEs gas margin and net income are not affected by changes
in the PGA rates. The PGA had a receivable balance at September 30, 2004 of $18.2 million
and a liability balance of $12.0 million at December 31, 2003. 
        The
following rate adjustments were approved by the Washington Commission in relation to the
PGA during 2003 that affect changes in gas revenue for the three and nine months ended
September 30, 2004 compared to the same periods in the prior year:

|Effective Date  | Percentage Increase in
Rates | Annual Increase
in Revenues
(Dollars in millions)
|--------------- | ---------------------------- | -------------------------------------------------
|October 1, 2003 |                              |                                                  
|April 10, 2003  |                              |                                                  

Operating Expenses
        Purchased
electricity expenses decreased $2.0 million and increased $5.3 million for the three and
nine months ended September 30, 2004, respectively, compared to the same periods in 2003.
The increase for the nine months ended September 30, 2004 was primarily due to a $37.8
million disallowance of the return on the Tenaska gas supply regulatory asset. The
increase was partially offset by lower purchases due to increased generation at PSE
generating facilities in the third quarter of 2004 compared to the same period in 2003,
and lower wholesale electricity prices in the first quarter of 2004 compared to the same
period in 2003. 
        The
August 5, 2004 Columbia Basin Runoff Forecast published by the National Weather Service
Northwest River Forecast Center indicated that the total observed runoff into the Grand
Coulee reservoir for the period January through September 2004 was 84% of normal. The
actual runoff for the same period in 2003 was also 84% of normal. Hydroelectric power is a
large percentage of PSEs power portfolio. 
        Purchased
gas expenses increased $9.1 million and $90.9 million for the three and nine months ended
September 30, 2004, respectively, compared to the same periods in 2003. The increase was
primarily due to increased usage as a result of more normal temperatures in the first
quarter of 2004 and higher PGA rates compared to the same periods in 2003. Gas costs are
passed through to customers through the PGA mechanism with no impact on gas margin or net
income. 
        Electric
generation fuel expense increased $3.9 million and $12.7 million for the three and nine
months ended September 30, 2004, respectively, compared to the same periods in 2003. The
increase for the three months ended September 30, 2004 was primarily due to higher cost of
gas and coal, despite lower thermal generation (gas and coal) at PSE generating
facilities. Thermal generation for the three months ended September 30, 2004 decreased
60.3 million kWh or 3.7%. The increase for the nine months ended September 30, 2004 was
primarily due to increased generation at PSE generation facilities, including Frederickson
1, which went in service in May 2004, and the higher cost of natural gas and coal in 2004.
Thermal generation for the nine months ended September 30, 2004 increased 110.3 million
kWh or 2.6%. Electric generation fuel costs can vary quarter to quarter and month to month
within a quarter based on several factors, including the cost of gas and other fuel,
secondary market prices of electricity, and hydroelectric water conditions. 
        The
nine months ended September 30, 2004 also includes a $6.9 million charge in June 2004
related to a binding arbitration settlement between PSE and Western Energy Company (WECO),
the supplier of coal to Colstrip Units 1 & 2, which was recorded in the second quarter
of 2004. The binding decision retroactively set a new baseline cost of coal per ton
supplied from July 31, 2001, and is applicable for the remaining term of the coal supply
agreement through December 2009. Of the second quarter charge of $6.9 million, $5.0
million is included in the PCA mechanism. PSE had previously accrued a reserve of $1.6
million in the fourth quarter of 2003 related to the arbitration. 
        The
nine months ended September 30, 2004 also includes a loss reserve of $1.1 million recorded
in the second quarter of 2004 related to an order issued by the Minerals Management
Service of the United States Department of the Interior on April 29, 2004 to pay
additional royalties to WECO concerning coal purchased by PSE for Colstrip Units 3 &
4. The order seeks payment of an additional $1.1 million in royalties for coal mined from
federal lands between 1997 and June 30, 2000. During that period, PSEs coal price
was reduced by a settlement agreement entered into in February 1997 among PSE, WECO and
Montana Power Company that resolved disputes that were then pending. The order seeks to
impute the price charged to PSE based on the other Colstrip Units 3 & 4 owners
contractual amounts. PSE is supporting WECOs appeal of the order which was filed on
October 1, 2004. The outcome of this matter cannot be predicted at this time. 
        In
addition, the Minerals Management Service of the United States Department of the Interior
issued two orders to WECO in 2002 and 2003 to pay additional royalties concerning coal
sold to Colstrip Units 3 & 4 owners. The orders assert that additional royalties are
owed as a result of WECO not paying royalties in connection with revenue received by WECO
from the Colstrip Units 3 & 4 owners under a coal transportation agreement during the
period October 1, 1991 through December 31, 2001. PSEs share of the alleged
additional royalties is $1.8 million, which is equivalent to PSEs 25% ownership
interest in Colstrip Units 3 & 4. The transportation agreement provides for the
construction and operation of a conveyor system that runs several miles from the mine to
Colstrip Units 3 & 4. WECO has appealed these orders and PSE is monitoring the
process. Based upon its review, PSE believes that the Colstrip Units 3 & 4 owners have
reasonable defenses in this matter. Neither the outcome of this matter nor the associated
costs can be predicted at this time. 
        Residential
exchange credits associated with the Residential Purchase and Sale Agreement with BPA
increased $1.1 million and $1.2 million for the three and nine months ended September 30,
2004, respectively, when compared to the same periods in 2003. The overall increase for
the three months ended September 30, 2004 was a result of increased residential electric
load. The residential exchange credit is a pass-through tariff item with a corresponding
credit in electric operating revenue. It has no impact on electric margin or net income. 
        Unrealized
gain on derivative instruments for the three and nine months ended September 30, 2004
decreased $1.0 million and increased $1.4 million, respectively, compared with the same
periods in 2003. SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, as amended by SFAS No. 138 and SFAS No. 149, requires that all contracts
considered to be derivative instruments be recorded on the balance sheet at their fair
value. The Company enters into both physical and financial contracts to manage its energy
resource portfolio including forward physical and financial contracts, option contracts
and swaps. The majority of these contracts qualify for the normal purchase normal sale
exemption. Those contracts that do not meet normal purchase normal sale exemption or cash
flow hedge criteria are marked-to-market to current earnings in the income statement,
subject to deferral under SFAS No. 71 Accounting for the Effects of Certain Types of
Regulation, (SFAS No. 71) due to the PCA mechanism. 
        PSE
has a contract with a counterparty whose debt ratings have been below investment grade
since 2002. The contract, a physical gas supply contract for one of PSEs electric
generating facilities, was marked-to-market beginning in the fourth quarter of 2003.
Although the counterparty continues to fully perform on the physical supply contract, the
counterpartys credit ratings have remained weak. Prior to October 1, 2003, the
contract was designated as a normal purchase under SFAS No. 133. PSE has concluded that it
is appropriate to reserve the marked-to-market gain on this contract due to the credit
quality of the counterparty in accordance with SFAS No. 133 guidance, as management deemed
that delivery is not probable through the term of the contract, which expires December
2008. There was no impact on earnings for the three and nine months ended September 30,
2004. 
        In
the first quarter of 2004, the counterparty of another physical gas supply contract for
one of PSEs electric generating facilities notified PSE that it would be unable to
deliver physical gas supply beginning in November 2005 through the end of the contract in
June 2008. Since physical delivery for the life of the contract was no longer probable,
the contract no longer met the criteria for normal purchase normal sale exemption under
SFAS No. 133. Therefore, the contract was marked-to-market in the first quarter of 2004,
with an offsetting reserve for the portion of the mark-to-market gain applicable to the
period of November 2005 through June 2008. The unrealized gain to earnings, net of the
reserve, was $0.7 million in the third quarter of 2004. In October 2004, PSE and the
counterparty reached a settlement on the non-deliverable period of November 2005 through
June 2008. The agreement allows PSE to recover a portion of the present value of the
difference in future market prices of physical gas and the original contract price, for a
total recovery of approximately $10.1 million. PSE filed a petition with the Washington
Commission to defer the counterparty settlement amount as a regulatory liability and
amortize the benefit over the period of November 2005 through June 2008 as a reduction in
Electric Generation Fuel expense. 
        Production
operations and maintenance expense increased $0.5 million for the three months ended
September 30, 2004 compared with the same period in 2003, primarily as a result of
increased expenses related to the Frederickson 1 generating facility placed in service in
May 2004. Production operations and maintenance expense decreased $0.8 million for the
nine months ended September 30, 2004 compared to the same period in 2003. This decrease
was primarily a result of lower overhaul maintenance performed on Colstrip Units 1 & 2
in the second quarter 2004 compared to the same period in 2003, offset by the expense
associated with the Frederickson 1 generating facility. 
        Low-income
Program costs, which are a pass-through tariff item, decreased $1.0 million and $3.7
million for the three and nine months ended September 30, 2004, respectively, compared to
the same periods in 2003. Low-income program costs are dependent upon the amount collected
from customers through rates. 
        Other
utility operations and maintenance costs decreased $0.1 million and increased $7.1 million
for the three and nine months ended September 30, 2004, respectively, compared to the same
periods in 2003. The increase for the nine months ended September 30, 2004 was due
primarily to a $6.5 million increase in storm damage costs associated with electric system
repairs following a severe ice storm in January 2004 that occurred in the Pacific
Northwest. 
        Depreciation
and amortization expense increased $2.7 million and $5.8 million for the three and nine
months ended September 30, 2004, respectively, compared to the same periods in 2003 due
primarily to the effects of new plant placed into service during 2004 and the latter half
of 2003. 
        Taxes
other than income taxes increased $2.5 million and $11.4 million for the three and nine
months ended September 30, 2004, respectively, compared to the same periods in 2003. The
increase for the three months ended September 30, 2004 was due to higher municipal and
state excise taxes of $1.6 million, which are revenue based, and a $0.7 million increase
in property taxes. The increase for the nine months ended September 30, 2004 was primarily
due to higher revenue based municipal and state excise taxes of $10.7 million. 
        Income
taxes increased $8.3 million and $5.4 million for the three and nine months ended
September 30, 2004, respectively, compared to the same periods in 2003. The increase for
the three months ended September 30, 2004 was the result of one time federal income tax
true-ups of the Companys 2003 and 2002 federal income tax returns, which increased
income tax expense by $3.5 million, and the result of higher taxable income. The increase
for the nine months ended September 30, 2004 was the result of the aforementioned third
quarter federal income tax return true-ups, and the non-recurrence of a one-time tax
benefit of $6.2 million recorded in the second quarter 2003 related to a favorable
resolution of a federal income tax matter from 1997 to 2002. These increases were
partially offset with reduced income tax expense associated with lower taxable income for
the nine months ended September 30, 2004 compared with the same period in 2003. 
        Other
income decreased $2.2 million and $3.6 million for the three and nine months ended
September 30, 2004, respectively, compared to the same periods in 2003. The decrease for
the three months ended September 30, 2004 was primarily due to a gain on corporate-owned
life insurance policies in the third quarter 2003 of $1.7 million that did not recur in
2004. In addition to the non-recurrence of the gain on corporate-owned life insurance, the
decrease for the nine months ended September 30, 2004 included the non-recurrence of a
$1.9 million gain on the sale of securities in the second quarter 2003. 
        Interest
charges decreased $3.1 million and $10.4 million for the three and nine months ended
September 30, 2004, respectively, compared to the same periods in 2003. This decrease was
primarily due to the redemption or maturity of $164.3 million of Medium-Term Notes with
interest rates ranging from 6.07% to 7.80% since September 30, 2003, and the refinancing
of $161.9 million of Pollution Control Bonds with interest rates ranging from 5.875% to
7.25% to rates ranging from 5.00% to 5.10% in March 2003. The decrease in interest expense
was partially offset by the issuance of $200 million of variable rate Senior Notes in July
2004 and the consolidation of the conservation trust bonds due to FIN 46R. 
        Also
included in earnings per share are preferred stock dividend accrual expenses. During the
three and nine months ended September 30, 2004, preferred stock dividend accrual expense
decreased $1.1 million and $4.8 million, respectively, compared with the same periods in
2003. This decrease was due to the redemption of $41.3 million of $100 par value 7.75%
preferred stock in August 2003 and $60.0 million of $25 par value 7.45% preferred stock in
November 2003.

InfrastruX 
        The
changes to items affecting net income for the three and nine months ended September 30,
2004 in comparison with the same periods in 2003 are summarized in the table below.

Comparative Three and
Nine Months Ended 
September 30, 2004 vs.
September 30, 2003 
Increase (Decrease) 
(Dollars in Millions)

|                                 
|---------------------------------
|Operating revenue change:        
|Non-utility construction services
|                                 
|Operating expense changes:       
|Other operations and maintenance 
|Depreciation and amortization    
|Taxes other than income taxes    
|Income taxes                     
|                                 
|Total operating expense change   
|                                 
|Other income change              
|Interest charges change          
|Minority interest change         
|                                 
|Net income change                
|                                 

The
following is additional information pertaining to the changes outlined in the above table.

InfrastruX
revenue increased $6.8 million and $11.3 million for the three and nine months ended
September 30, 2004, respectively, compared to the same periods in 2003. The increase for
the three months ended September 30, 2004 as compared to 2003 was due to stronger gas and
electric transmission service revenues in the Texas and south-central region. For the nine
months ended September 30, 2004, the increase in revenues was primarily due to the
acquisition of one company late in the second quarter of 2003, which contributed an
increase of $12.4 million to revenues. The increase was partially offset by lower revenues
from existing companies as a result of exiting unprofitable business activities and the
completion of a large project in 2003 that was not repeated in 2004. InfrastruX operations
are seasonal, with its highest revenues typically in the second and third quarters of the
year. 
        InfrastruX
operations and maintenance expenses increased $5.7 million and $3.4 million for the three
and nine months ended September 30, 2004, respectively, compared to the same periods in
2003. The increase for the three months ended September 30, 2004 was a result of the
revenue growth for the same period. The increase for the nine months ended September 30,
2004 was due primarily to the acquisition of one company late in the second quarter of
2003, which contributed an additional $11.8 million in operations and maintenance
expenses. This was partially offset by an $8.0 million reduction of operation and
maintenance expenses as a result of stringent cost control measures implemented as well as
exiting unprofitable business activities. 
        Depreciation
and amortization expense increased $0.4 million and $1.4 million for the three and nine
months ended September 30, 2004, respectively, compared to the same periods in 2003. The
increases were primarily due to an increase in assets through a company acquisition late
in the second quarter of 2003 and implementation of an integrated information technology
platform across InfrastruX. 
        Income
taxes changed by an insignificant amount and increased $2.7 million during the three and
nine months ended September 30, 2004, respectively, compared to the same periods in 2003
due primarily to higher operating income in the first quarter of 2004.

Capital Expenditures,
Capital Resources and Liquidity

Capital Requirements Contractual Obligations
and Commercial Commitments 
            Puget Energy.  The following are Puget Energy's  aggregate  consolidated  (including  PSE)  contractual  obligations and
commercial commitments as of September 30, 2004:

|Puget Energy                                  |       | Payments Due Per Period
|--------------------------------------------- | ----- | -----------------------
|Contractual Obligations
(Dollars in millions) | Total | 2004                   
|Short-term debt                               |       |                        
|Long-term debt                                |       |                        
|Junior subordinated debentures payable        |       |                        
|to a subsidiary trust (1)                     |       |                        
|Mandatorily redeemable preferred stock        |       |                        
|Service contract obligations                  |       |                        
|Capital lease obligations                     |       |                        
|Non-cancelable operating leases               |       |                        
|Fredonia combustion turbines lease (2)        |       |                        
|Energy purchase obligations                   |       |                        
|Financial hedge obligations                   |       |                        
|Non-qualified pension funding                 |       |                        
|                                             
|Total contractual cash obligations            |       |                        
|                                              |      

|                                             |       | Amount of Commitment
Expiration Per Period
|-------------------------------------------- | ----- | ------------------------------------------
|Commercial Commitments
(Dollars in millions) | Total | 2004                                      
|Guarantees (3)                               |       |                                           
|Liquidity facilities  available (4)         |       |                                           
|Lines of credit  available (5)              |       |                                           
|Energy operations letter of credit           |       |                                           
|                                            
|Total commercial commitments                 |       |                                           
|                                             |      

---

|(1) | In 1997 and 2001, PSE formed Puget Sound Energy Capital Trust I and Puget Sound
          Energy Capital Trust II, respectively, for the sole purpose of issuing and
          selling preferred securities (Trust Securities) to investors and issuing common
          securities to PSE. The proceeds from the sale of Trust Securities were used by
          the Trusts to purchase Junior Subordinated Debentures (Debentures) from PSE. The
          Debentures are the sole assets of the Trusts and PSE owns all common securities
          of the Trusts.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | See Fredonia 3 and 4 Operating Lease under Off-Balance Sheet
          Arrangements below.
|--- | ----------------------------------------------------------------------------------------------

|(3) | In May 2004, InfrastruX signed a three-year credit agreement with a group of
          banks to provide up to $150 million in financing. Under the credit agreement,
          Puget Energy is the guarantor of the line of credit. Certain InfrastruX
          subsidiaries also have certain borrowing capacities for working capital purposes
          of which Puget Energy is not a guarantor.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | At September 30, 2004, PSE had available a three-year $350 million unsecured
          credit agreement and a three-year $150 million receivables securitization
          facility. At September 30, 2004, PSE had $61.0 million of receivables available
          for sale under its receivables securitization facility. See Accounts
          Receivable Securitization Program under Off-Balance Sheet
          Arrangements below for further discussion. The credit agreement and
          securitization facility provide credit support for an outstanding letter of
          credit totaling $0.5 million, thereby effectively reducing the available
          borrowing capacity under these liquidity facilities to $410.5 million.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Puget Energy has a $15 million line of credit with a bank. At September 30,
          2004, $5.0 million was outstanding, reducing the available borrowing capacity
          under this line of credit to $10.0 million. InfrastruX has $186.7 million in
          lines of credit with various banks to fund capital credit requirements of
          InfrastruX and its subsidiaries. InfrastruX and its subsidiaries had $160.5
          million outstanding under their credit agreements and letters of credit of $3.8
          million at September 30, 2004, effectively reducing the available borrowing
          capacity under these lines of credit to $22.4 million.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Puget
Sound Energy. The following are PSEs aggregate contractual obligations and
commercial commitments as of September 30, 2004:

|Puget Sound Energy                            |       | Payments Due Per Period
|--------------------------------------------- | ----- | -----------------------
|Contractual Obligations
(Dollars in millions) | Total | 2004                   
|Long-term debt                                |       |                        
|Junior subordinated debentures payable        |       |                        
|to a subsidiary trust (1)                     |       |                        
|Mandatorily redeemable preferred stock        |       |                        
|Service contract obligations                  |       |                        
|Non-cancelable operating leases               |       |                        
|Fredonia combustion turbines lease (2)        |       |                        
|Energy purchase obligations                   |       |                        
|Financial hedge obligations                   |       |                        
|Non-qualified pension funding                 |       |                        
|                                             
|Total contractual cash obligations            |       |                        
|                                              |      

|                                             |       | Amount of Commitment
Expiration Per Period
|-------------------------------------------- | ----- | ------------------------------------------
|Commercial Commitments
(Dollars in millions) | Total | 2004                                      
|Liquidity facilities  available (3)         |       |                                           
|Energy operations letter of credit           |       |                                           
|                                            
|Total commercial commitments                 |       |                                           
|                                             |      

---

|(1) | See
note (1) above.
|--- | -------------------

|(2) | See
note (2) above.
|--- | -------------------

|(3) | See
note (4) above.
|--- | -------------------

Off-Balance Sheet
ArrangementsAccounts Receivable Securitization
Program. In order to provide a source of liquidity to PSE at an attractive cost, PSE
entered into a Receivables Sales Agreement with Rainier Receivables, Inc., a wholly owned
subsidiary of PSE in December 2002. Pursuant to the Receivables Sales Agreement, PSE sold
all of its utility customers accounts receivable and unbilled utility revenues to
Rainier Receivables. Concurrently with entering into the Receivables Sales Agreement,
Rainier Receivables entered into a Receivables Purchase Agreement with PSE and a third
party. The Receivables Purchase Agreement allows Rainier Receivables to sell the
receivables purchased from PSE to the third party. The amount of receivables sold by
Rainier Receivables is not permitted to exceed $150 million at any time. However, the
maximum amount may be less than $150 million depending on the outstanding eligible amount
of PSEs receivables, which fluctuate with the seasonality of energy sales to
customers. 
        The
receivables securitization facility is the functional equivalent of a revolving line of
credit secured by receivables. In the event Rainier Receivables elects to sell receivables
under the Receivables Purchase Agreement, Rainier Receivables is required to pay fees to
the purchasers that are comparable to interest rates on a revolving line of credit. As
receivables are collected by PSE as agent for the receivables purchasers, the outstanding
amount of receivables held by the purchasers declines until Rainier Receivables elects to
sell additional receivables to the purchasers. 
        The
receivables securitization facility has a three-year term, but is terminable by PSE and
Rainier Receivables upon notice to the receivables purchasers. At September 30, 2004,
Rainier Receivables had an outstanding eligible receivable balance of $122.0 million. Of
that amount, $61.0 million of accounts receivable had been sold and the maximum
receivables available for sale was $61.0 million. 
        During
the three and nine months ended September 30, 2004, Rainier Receivables sold a cumulative
$81.0 million and $348.0 million of receivables. No amounts were sold for the same periods
in 2003.

Fredonia 3 and 4 Operating Lease. PSE
leases two combustion turbines for its Fredonia 3 and 4 electric generation facility
pursuant to a master lease that was amended for this purpose in April 2001. The lease has
a term expiring in 2011, but can be canceled by PSE after August 2004. Payments under the
lease vary with changes in the London Interbank Offered Rate (LIBOR). At September 30,
2004, PSEs outstanding balance under the lease was $57.0 million. The expected
residual value under the lease is the lesser of $37.4 million or 60% of the cost of the
equipment. In the event the equipment is sold to a third party upon termination of the
lease and the aggregate sales proceeds are less than the unamortized value of the
equipment, PSE would be required to pay the lessor contingent rent in an amount equal to
the deficiency up to a maximum of 87% of the unamortized value of the equipment.

New Generation Resources 
        In
April 2004, PSE completed the purchase of a 49.85% interest in a gas-fired electric
generating station located within Western Washington (Frederickson 1). The purchase has
added $80.8 million in utility plant and approximately 124 MW of electric generation
capacity to serve PSEs retail customers. PSE submitted a power cost only rate case
in October 2003 to the Washington Commission to recover the cost of the new generating
facility and other power costs. The acquisition of Frederickson 1 was approved by the
Washington Commission on April 7, 2004 and was also approved by FERC under the Federal
Power Act on April 23, 2004. 
        In
September 2004, PSE signed a non-binding letter of intent to obtain a 100% ownership
interest in the proposed Wild Horse wind power project (Wild Horse Project) to be located
in central Washington State. The Wild Horse Project is expected to have approximately 100
to 133 wind turbines and generate from 150 to 220 MW of power, depending on the final
design agreement. The project will require final binding agreement between PSE and the
developer, which is anticipated to be signed in the fourth quarter of 2004 with an
anticipated in-service date in 2006. To fund the proposed project, PSE anticipates issuing
a combination of short and long-term debt as well as using its existing liquidity
arrangements. 
        In
addition to the above projects, PSE has issued requests for proposals to acquire up to 355
average MW of electric power resources, including generation energy from additional wind
power for its electric-resource portfolio and is continuing to evaluate responses.

Utility Construction
Program
        Current
utility construction expenditures for generation, transmission and distribution are
designed to meet continuing customer growth and to improve efficiencies of PSEs
energy delivery systems. Construction expenditures, excluding equity Allowance for Funds
Used During Construction (AFUDC), totaled $311.4 million for the nine months ended
September 30, 2004. PSE estimates construction expenditures will total approximately $408
million in 2004, which includes the acquisition of the 49.85% interest in the Frederickson
1 generating facility. Expenditures in 2005 and 2006 are expected to be $387 million and
$357 million, respectively, excluding amounts for new generating resources currently under
evaluation. Construction expenditure estimates are subject to periodic review and
adjustment in light of changing economic, regulatory, environmental and conservation
factors.

Other Additions 
        Other
property, plant and equipment additions were $12.9 million for the nine months ended
September 30, 2004. Puget Energy expects InfrastruXs capital additions to be $16.7
million in 2004, $18.0 million in 2005, and $20.0 million in 2006. Capital addition
estimates are subject to periodic review and adjustment in light of changing economic and
regulatory factors.

Capital Resources Cash From Operations. Cash generated
from operations for the nine months ended September 30, 2004 was $282.1 million. During
the period, $68.9 million in cash was used for AFUDC and payment of dividends.
Consequently, cash flows available for utility construction expenditures and other capital
expenditures were $213.2 million or 63.9% of the $333.8 million in construction
expenditures (net of AFUDC) and other capital expenditure requirements for the period. For
the same period in 2003, cash generated from operations was $200.1 million, $68.6 million
of which was used for AFUDC and payment of dividends. Therefore, cash flows available for
utility construction expenditures and other capital expenditures for the nine months ended
September 30, 2003 were $131.5 million or 58.8% of the $223.8 million in construction
expenditures (net of AFUDC). The overall increase in cash generated from operating
activity for the nine months ended September 30, 2004 was $82.0 million as compared to the
same period in 2003. The increase in cash from operating activity was the result of
increases in PGA rates in April and October 2003, combined with lower cash paid to
customers under the PGA mechanism for liability balances in 2003 for a total positive cash
flow of $46.9 million between the periods. Cash from operating activity also increased
$27.0 million due to higher cash payments received from BPA than provided to customers
under the residential exchange program compared to 2003 when PSE provided customers more
cash than BPA paid to PSE. In addition, changes in deferred taxes contributed $20.0
million to positive cash flow. These increases were partially offset by a reduction in
current tax liabilities of $30.6 million. 
        Puget
Energy and PSE expect to continue financing the utility construction program and other
capital expenditure requirements with internally generated funds and externally financed
capital.

Financing Program. Financing utility
construction requirements and operational needs are dependent upon the cost and
availability of external funds through capital markets and from financial institutions.
Access to funds is dependent upon factors such as general economic conditions, regulatory
authorizations and policies, and Puget Energys and PSEs credit ratings. The
Company expects to meet capital and operational needs for the balance of 2004 and 2005
with cash generated from operations and borrowings under its liquidity facilities.

Restrictive Covenants. In determining
the type and amount of future financing, PSE may be limited by restrictions contained in
its electric and gas mortgage indentures, articles of incorporation and certain loan
agreements. Under the most restrictive tests, at September 30, 2004, PSE could issue:

| |  | approximately
$633.0 million of first mortgage bonds, as PSE has approximately $1.1 billion of electric
and gas bondable property available for use, subject to the interest coverage ratio
limitation of 2.0 times net earnings available for interest at an assumed interest rate
of approximately 4.90% on a thirty-year first mortgage bond. PSEs interest coverage
ratio at September 30, 2004 was 2.8 times net earnings available for interest. PSE
currently has $3.7 billion in electric and gas ratebase to support the interest coverage
ratio limitation test for net earnings available for interest;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | approximately
$326.2 million of additional preferred stock at an assumed dividend rate of 6.63%; and
| | - | ----------------------------------------------------------------------------------------------------

| |  | approximately
$275.5 million of unsecured long-term debt.
| | - | ---------------------------------------------------------

Credit Ratings. Neither Puget Energy
nor PSE has any rating downgrade triggers that would accelerate the maturity dates of
outstanding debt. However, a downgrade in the credit ratings could adversely affect the
Companies ability to renew existing, or obtain access to new credit facilities and
could increase the cost of such facilities. For example, under PSEs revolving credit
facility, the interest rate spreads over the index and commitment fee increase as
PSEs secured long-term debt ratings decline. An interest rate downgrade in
commercial paper ratings could preclude PSEs ability to issue commercial paper under
its current programs. The marketability of PSE commercial paper is currently limited by
the A-3/P-2 ratings by Standard & Poors and Moodys Investors Service,
respectively. A further downgrade in commercial paper ratings could preclude entirely
PSEs ability to issue commercial paper. In addition, downgrades in any or a
combination of PSEs debt ratings may allow counterparties on a contract by contract
basis in the wholesale electric, wholesale gas and financial derivative markets to require
PSE to post a letter of credit or other collateral, make cash prepayments, obtain a
guarantee agreement or provide other mutually agreeable security.

The ratings of Puget Energy and PSE
as of October 28, 2004 were:

|                               | Ratings          
|------------------------------ | -----------------
|                               | Standard & Poors
|Puget Sound Energy             |                  
|                              
|Corporate credit/issuer rating | BBB-             
|Senior secured debt            | BBB              
|Shelf debt senior secured      | BBB              
|Trust preferred securities     | BB               
|Preferred stock                | BB               
|Commercial paper               | A-3              
|Revolving credit facility      | *                
|Ratings outlook                | Positive         
|                              
|Puget Energy                  
|                              
|Corporate credit/issuer rating | BBB-             

| | *
  Standard & Poor's does not rate credit facilities.
| | ------------------------------------------------------

Shelf Registrations. In January 2004,
Puget Energy and PSE filed a shelf registration statement with the Securities and Exchange
Commission for the offering, on a delayed or continuous basis, of up to $500 million of:

| |  | common
stock of Puget Energy,
| | - | -----------------------------

| |  | senior
notes of PSE, secured by a pledge of PSEs first mortgage bonds.
| | - | -----------------------------------------------------------------------

On
July 15, 2004, PSE issued $200 million in floating rate senior notes under its existing
$500 million shelf registration statement, reducing the available balance for issuance
under the shelf registration statement to $300 million. The notes float at the three-month
LIBOR rate plus 0.30%, mature on July 14, 2006, and can be redeemed at par any time after
January 15, 2005. PSE used the net proceeds from the sale of the floating rate senior
notes to repay outstanding amounts under its commercial paper and accounts receivable
securitization programs, including amounts incurred to repay long-term debt, and also used
the proceeds to redeem $55 million in principal of first mortgage bonds at a premium of
3.68% on August 14, 2004. It is anticipated the $200 million in senior notes will be paid
off with a combination of long-term debt and internally generated funds.

Liquidity Facilities and Commercial
Paper. PSEs short-term borrowings and sales of commercial paper are used to provide
working capital and funding of utility construction programs. 
        In
May 2004, PSE entered into a three-year, $350 million unsecured credit agreement with a
group of banks which replaced its previous $250 million unsecured credit agreement. PSE
also has a $150 million 3-year receivables securitization program which expires in
December 2005. The receivables available for sale under the securitization program may be
less than $150 million depending on the outstanding amount of PSEs receivables,
which fluctuate with the seasonality of energy sales to customers. At September 30, 2004,
PSE had available $350 million in the unsecured credit agreement and $61.0 million
available from the receivable securitization facility (net of $61.0 million sold), which
provide credit support for outstanding commercial paper and outstanding letters of credit.
At September 30, 2004, there was $0.5 million outstanding under a letter of credit,
effectively reducing the available borrowing capacity under the liquidity facilities to
$410.5 million. 
        In
May 2004, InfrastruX entered into a three-year, $150 million credit agreement with a group
of banks, replacing its previous $150 million credit agreement. Puget Energy is the
guarantor of the line of credit. In addition, InfrastruXs subsidiaries have an
additional $36.7 million in lines of credit with various banks, for a total capacity for
InfrastruX and its subsidiaries of $186.7 million under their line of credit agreements.
Borrowings available for InfrastruX are used to fund acquisitions and working capital
requirements of InfrastruX and its subsidiaries. At September 30, 2004, InfrastruX and its
subsidiaries had $160.5 million outstanding under their credit agreements and letters of
credit of $3.8 million, effectively reducing the available borrowing capacity under these
lines of credit to $22.4 million. 
        In
May 2003, Puget Energy entered into a $15 million, three-year credit agreement with a
bank. Under the terms of the agreement, Puget Energy will pay a floating interest rate on
borrowings based on LIBOR. The interest rate is set for one, two, or three-month periods
at the option of Puget Energy with interest due at the end of each period. Puget Energy
will also pay a commitment fee on any unused portion of the credit facility. Puget Energy
has $5.0 million outstanding under the credit agreement at September 30, 2004.

Stock Purchase and Dividend
Reinvestment Plan. Puget Energy has a Stock Purchase and Dividend Reinvestment Plan
pursuant to which shareholders and other interested investors may invest cash and cash
dividends in shares of Puget Energys common stock. Since new shares of common stock
may be purchased directly from Puget Energy, funds received may be used for general
corporate purposes. Puget Energy issued common stock from the Stock Purchase and Dividend
Reinvestment Plan of $3.8 million (176,227 shares) and $11.6 million (530,430 shares) for
the three and nine months ended September 30, 2004 compared to $4.0 million (184,870
shares) and $11.6 million (554,441 shares) for the same periods in 2003.

Common Stock Offering Programs. To
provide additional financing options, Puget Energy entered into agreements in July 2003
with two financial institutions under which Puget Energy may offer and sell shares of its
common stock from time to time through these institutions as sales agents, or as
principals. Sales of the common stock, if any, may be made by means of negotiated
transactions or in transactions that may be deemed to be at-the-market
offerings as defined in Rule 415 promulgated under the Securities Act of 1933, including
in ordinary brokers transactions on the New York Stock Exchange at market prices.

Other

FERC Hydroelectric
LicensesBaker River Project. The Baker River
Project is located upstream of the confluence of the Baker and Skagit Rivers in Whatcom
and Skagit Counties and consists of the Lower Baker Development (constructed in 1925) and
the Upper Baker Development (constructed in 1959). The Baker River Projects current
license expires on April 30, 2006, and PSE submitted an application for a new license to
FERC on April 30, 2004. In addition, PSE continues to work with numerous interested
participants to achieve a comprehensive settlement agreement to be submitted to FERC
during the fall of 2004.

Snoqualmie Falls Project. The
Snoqualmie Falls Project, built in 1898, had its original license issued May 13, 1975,
which was made effective retroactively to March 1, 1956, and expired on December 31, 1993.
PSE filed its application to relicense the project on November 25, 1991, and has been
operating the project pursuant to annual licenses issued by FERC since the original
license expired. On June 29, 2004, FERC granted PSE a new 40-year operating license for
the Snoqualmie Falls Project. PSE estimates that the investment required to implement the
conditions of the new license agreement will cost approximately $44 million. These
conditions include modified operating procedures and various project upgrades that include
better protection of fish, development of riparian habitat to promote fish propagation,
increased minimum flows in the Snoqualmie River during low-water periods and the
development of recreational amenities near the down-river power house. PSE accepted the
FERC license in July 2004. On July 29, 2004, the Snoqualmie Tribe and certain other
parties filed a request for rehearing and request for stay with FERC. FERC issued a
subsequent order indicating it would respond in the fall of 2004.

Electric Rate Matters
        On
April 5, 2004, PSE filed a general tariff electric rate case with the Washington
Commission. The electric rate case proposes a 5.8% or $82.8 million annual increase to
electric rates to recover costs associated with extending and upgrading facilities to
serve a growing number of electric customers as well as strengthen PSE financially to
serve its customers. The Washington Commission staff and other intervenors responded to
PSEs general tariff electric rate case in the third quarter of 2004, and the
Washington Commission staff proposed an electric rate case increase of $21.4 million. PSE
filed its rebuttal testimony to the intervenors testimony on November 3, 2004 in
which PSE revised its proposed electric increase request to 7.3% or $103.3 million
annually which reflects updated power costs for increases in natural gas pricing for
generating plants. The resolution of the electric general rate case may be up to an
11-month process from the time the electric general rate case was filed. 
        On
April 23, 2004, the acquisition of a 49.85% interest in the Frederickson 1 generating
facility was approved by FERC. Prior to that approval, on April 7, 2004, the Washington
Commission had issued an order in PSEs power cost only rate case granting approval
for the acquisition of the Frederickson 1 generating facility as well. As a result of
these approvals, PSE completed the acquisition in the second quarter of 2004. In its
order, the Washington Commission found the acquisition to be prudent and the cost
associated with the generating facility reasonable. The costs associated with the
generating facility, including projected baseline gas costs, are approved for recovery in
rates.
        On
May 13, 2004, the Washington Commission also approved other adjustments to power costs
that resulted in an increase of cost recovery in rates of $44.1 million annually,
beginning May 24, 2004, which includes the ownership, operation and fuel costs of the
Frederickson 1 generating facility. 
        In
December 2003, PSE notified FERC that it rejected the 1997 license for the White River
Project because the 1997 license contained terms and conditions that rendered ongoing
operations of the project uneconomical relative to alternative resources. As a result of
rejecting the license, generation of electricity ceased at the White River Project on
January 15, 2004. The Company is actively seeking to sell the project to one or more
entities interested in maintaining the reservoir for commercial purposes.
        In
the April 7, 2004 proceeding described above, the Washington Commission also approved
PSEs recovery on the unamortized White River plant investment. At September 30,
2004, the White River Project net book value totaled $65.1 million, which included $46.8
million of net utility plant, $14.5 million of capitalized FERC licensing costs, $3.2
million of costs related to construction work in progress, and $0.6 million related to dam
operations and safety. PSE is seeking recovery of the relicensing, other construction work
in progress and dam operations and safety costs totaling $18.3 million in its general rate
filing of April 2004, over a 10-year amortization period. In the third quarter of 2004,
the Washington Commission staff recommended that PSE be allowed recovery of the White
River net utility plant costs noted above, but defer any amortization of the FERC
licensing and other costs until all costs and any sales proceeds are known. The outcome of
this matter is expected no later than the first quarter of 2005. 
        In
June 2003, the Washington State Department of Ecology (WSDE) approved an application for
new municipal water rights related to the White River Project reservoir. This approval was
sought in connection with PSEs ongoing efforts to sell the White River Project to be
used for commercial purposes. An appeal of WSDEs decision approving the new
municipal water rights was subsequently filed with the Washington State Pollution Control
Hearings Board. In July 2004, this decision was remanded back to WSDE for further analysis
of non-hydropower operations. The Company has been advised by WSDE that WSDE anticipates
issuing a revised decision by the end of the year; however, no firm date has been set for
any such revised decision. Any proceeds from the sale of the White River water rights will
reduce the balance of the deferred regulatory asset. 
        In
May 2004, the Puyallup Indian Tribe gave PSE notice of intent to sue for an alleged
violation of water quality laws associated with the release of water from the White River
Project reservoir. No such lawsuit has been filed and PSE is in discussion with the
Puyallup Indian Tribe regarding their concerns. Additionally, PSE has sought, and is
awaiting, further direction from the WSDE as to whether any additional actions are
necessary to maintain compliance with applicable water quality laws. 
        In
March 2004, the Company entered into an agreement with certain homeowner associations that
addresses, in part, the concerns of these homeowner associations with regard to
preserving the project reservoir. In September 2004, the Company renewed its contract with
the United States Army Corps of Engineers (COE) to maintain operation of the White River
diversion dam to support the COEs ongoing operation of its Mud Mountain Dam fish
passage facilities. The agreement provides for reimbursement of a portion of the
Companys operating costs and directs the Company to operate the diversion dam in
accordance with measures determined by federal agencies to be necessary to protect listed
species and habitat. 
        In
June 2001, PSE and the Bonneville Power Administration (BPA) entered into an amended
settlement agreement regarding the Residential Purchase and Sale Program, under which
PSEs residential and small farm customers would continue to receive benefits of
federal power. Completion of this agreement enabled PSE to continue to provide a
Residential and Farm Energy Exchange Benefit credit to residential and small farm
customers. The amended settlement agreement provides that, for its residential and small
farm customers, PSE will receive: (a) cash payment benefits during the period July 1, 2001
through September 30, 2006 and (b) benefits in the form of power or cash payment during
the period October 1, 2006 through September 30, 2011. The payments received from BPA and
the credits provided to residential and small farm customers have no impact on earnings. 
        In
June 2002, PSE entered into an agreement with BPA, which modified the payment provisions
of the June 2001 amended settlement agreement to provide for conditional deferral of
payment by BPA of certain amounts to be paid under the original agreement for an eight
month period beginning February 2003, for a total deferral of $27.7 million. Absent
certain adjustments tied to a BPA rate adjustment clause, BPA is to begin paying back the
amount deferred with interest over a 60-month period beginning October 1, 2006. In January
2003, PSE filed revised tariff sheets with the Washington Commission to reflect this
modification to the agreement, which was approved by the Washington Commission. 
        In
June 2003, BPA adopted its final Record of Decision in its February 2003 rate case, which
established a formula under the BPA rate adjustment clause to be used in adjusting the
rate that would affect the level of residential exchange benefits for PSEs
customers. The adjustment was approved by FERC on an interim basis and went into effect
October 1, 2003. FERC issued final approval of this formula in May 2004. 
        In
May 2004, PSE and BPA entered into an agreement that modified the payment of Residential
Exchange Program benefits for the period October 1, 2006 through September 30, 2011. The
agreement provides that all benefits in this period will be in the form of cash payments
only and defined a new methodology to be used to calculate the residential benefits. In
addition, PSE agreed to waive payment of approximately one-half of an available
reduction-in-risk discount and deferred payment of the other half of the discount, plus
interest, until October 2007. 
        There
are several actions in the U.S. Ninth Circuit Court of Appeals against BPA, in which the
petitioners assert or may assert that BPA acted contrary to law or without authority in
deciding to enter into, or in entering into or performing or implementing, a number of
contracts, including the above-described amended settlement agreement, the conditional
deferral agreement between BPA and PSE, and the May 2004 agreement between BPA and PSE.
There are also several actions in the U.S. Ninth Circuit Court of Appeals against BPA, in
which petitioners assert that BPA acted contrary to law in adopting or implementing the
rates or rate adjustment clause upon which the benefits received or to be received from
BPA during the October 1, 2001 through September 30, 2006 period are based. It is not
clear what impact, if any, review of such rates and contracts and the above-described U.S.
Ninth Circuit Court of Appeals actions may have on PSE.

Tenaska Disallowance. The Washington
Commission issued an order on May 13, 2004 determining that PSE did not prudently manage
gas costs for the Tenaska electric generating plant and ordered PSE to adjust its PCA
deferral account to reflect a one-time disallowance of $25.6 million for the PCA 1 period
(July 1, 2002 through June 30, 2003), which was recorded by PSE as a Purchased Electricity
expense in the second quarter of 2004. The order also established guidelines for future
recovery of Tenaska costs. The amounts were determined to be a $25.6 million one-time
disallowance for the PCA 1 period and an estimated disallowance of $11.3 million for the
PCA 3 period (July 1, 2004 to June 30, 2005), based upon applying the Washington
Commissions methodology of 50% disallowance on the return on the Tenaska regulatory
asset due to projected costs exceeding the benchmark during the period. For the PCA 3
period, approximately $5.6 million would be disallowed in the period July 1, 2004 through
December 31, 2004, primarily as a reduction to Electric Operating Revenue, for a
cumulative impact on earnings of $31.2 million in 2004 for the PCA 1 and 3 periods for
PSE. The PCA 3 reduction in Electric Operating Revenue is the result of the Washington
Commissions order that reflected a reduction in rates of approximately $9.9 million
annually. This reduction is to reflect the Washington Commission estimate of the Tenaska
disallowance for the PCA 3 period. While the Washington Commission did not expressly
address the disallowance for the PCA 2 period (July 1, 2003 through June 30, 2004), PSE
estimates the disallowance for the PCA 2 period to be approximately $12.2 million if the
Washington Commission were to follow the same methodology as they have ordered for the PCA
3 period. While PSE reserves the right to address the merits of any disallowance in its
PCA 2 compliance filing, which is currently being reviewed by the Washington Commission
staff, PSE recorded a $12.2 million disallowance to Purchased Electricity expense in the
second quarter of 2004 for the 50% disallowance of the return on the Tenaska regulatory
asset in accordance with the Washington Commissions methodology discussed in their
order of May 13, 2004. PSE anticipates the PCA 2 compliance filing to be concluded by no
later than the end of the first quarter 2005. As a result of the disallowance recorded,
the PCA customer deferral of $17.6 million at March 31, 2004 was expensed and a reserve
was established to offset future PCA customer deferrals. The reserve balance as of
September 30, 2004 was $11.2 million, which is expected to be utilized over the remaining
months in 2004 as the excess power costs are shared through the PCA mechanism. The
cumulative disallowance for the nine months ended September 30, 2004 was $40.6 million
which is comprised of a $4.1 million reduction in Electric Operating Revenue and a $36.5
million one-time disallowance recorded in Purchased Electricity expense. The total for
2004 is expected to be approximately $43.4 million ($28.1 million after-tax). 
        Prior
to the Tenaska disallowance, PSEs excess power costs under the PCA mechanism
exceeded the $40 million cap established whereas with the Tenaska disallowance the excess
power costs at September 30, 2004 are $26.8 million. The excess power cost from September
30, 2004 until the PCA mechanism cap of $40 million is reached, which is expected in
November 2004, will be offset by the Tenaska disallowance reserve of $11.2 million for the
PCA 1 and 2 periods that was recorded in the second quarter of 2004. PSE does not expect
earnings through year-end 2004, based on current market conditions, to be impacted by
excess power costs due to the Tenaska disallowance reserve recorded in the second quarter
of 2004. 
        Below
is a summary of the Tenaska disallowances by quarter through December 31, 2004:

|(Dollars in millions)
Quarter ending | 7/02 - 6/03PCA 1
(ordered/final) | 7/03 - 6/04PCA 2
(estimated) | 7/04 - 12/04PCA 3
(estimated) | Total
|------------------------------------ | -------------------------------- | ---------------------------- | ----------------------------- | -----
|June 30, 2004                        |                                  |                              | $                             | 25   
|September 30, 2004                   |                                  |                              |                               | --   
|December 31, 2004                    |                                  |                              |                               | --   
|                                     |                                 
|Total                                |                                  |                              | $                             | 25   
|                                     |                                 

In
the May 13, 2004 order, the Washington Commission established guidelines and a benchmark
to determine PSEs recovery on the Tenaska regulatory asset starting with the PCA 3
period (July 1, 2004) through the expiration of the Tenaska contract in the year 2011. The
benchmark is defined as the original cost of the Tenaska contract adjusted to reflect the
1.2% disallowance from a 1994 Prudence Order.

The
Washington Commission guidelines for determining future recovery of the Tenaska costs (gas
costs, recovery of the Tenaska regulatory asset and return on the Tenaska regulatory
asset) are as follows:

| | 1. | The
Washington Commission will determine if PSEs gas purchasing plan and gas purchases
for Tenaska are prudent through the PCA compliance filings.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | If
PSEs gas purchasing plan and gas purchases for Tenaska are prudent, and
          if PSEs actual Tenaska costs fall at or below the benchmark, it will
          recover fully its Tenaska costs.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | If
PSEs gas purchasing plan and gas purchases for Tenaska are prudent, but
          its actual Tenaska costs exceed the benchmark, PSE will only recover 50% of the
          lesser of:
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a) | Actual
Tenaska costs that exceed the benchmark or;
| | -- | --------------------------------------------------

| | b) | The
return on the Tenaska regulatory asset (return on the asset would be added last
to all other relevant Tenaska costs).
| | -- | -------------------------------------------------------------------------------------------------------------------------

| | 4. | If
PSEs gas purchasing plan or gas purchases are found to be imprudent in a
future proceeding, PSE risks disallowance of any and all Tenaska costs.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------

The
Washington Commission confirmed that if the Tenaska gas costs are deemed prudent, PSE will
recover the full amount of actual gas costs and the recovery of the Tenaska regulatory
asset even if the benchmark is exceeded. The projected costs and projected benchmark costs
for Tenaska have been updated as of September 30, 2004 to reflect higher forward gas
prices and are as follows:

|(Dollars in millions)               | Remainder
2004 | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 | 2011
|----------------------------------- | -------------- | ---- | ---- | ---- | ---- | ---- | ---- | ----
|Projected Tenaska costs (*)         |                |      | $    | 51   | .7   | $    | 199  | .4  
|Projected Tenaska benchmark costs   |                |      |      | 41   | .7   |      | 159  | .6  
|                                    |               
|Over (under) benchmark costs        |                |      | $    | 10   | .0   | $    | 39   | .8  
|                                    |               
|Projected 50% disallowance based on |                |     
|Washington Commission methodology   |                |      | $    | 2    | .8   | $    | 10   | .7  
|                                    |               

_________________

* Projection will change based on
market conditions of gas and replacement power costs.

Gas Rate Matters 
        On
September 24, 2004, the Washington Commission approved PSEs request for a PGA filed
on August 31, 2004. The approved request will increase rates and revenues by approximately
17.6% or $121.7 million annually. The increase in PGA rates was to recover higher market
prices of natural gas sold to customers. The PGA mechanism passes through to customers
increases or decreases in the gas supply portion of the natural gas service rates based
upon changes in gas prices. PSEs gas margin and net income are not affected by the
change in PGA rates. 
        On
April 5, 2004, PSE filed a general tariff gas rate case with the Washington Commission.
The gas rate case proposes a 6.8% or $48.9 million annual increase to gas rates to recover
costs associated with extending and upgrading facilities to serve a growing number of gas
customers as well as strengthen PSE financially to serve its customers. The Washington
Commission staff and other intervenors responded to PSEs general tariff gas rate
case in the third quarter 2004 and the Washington Commission staff proposed a gas rate
case increase of $8.1 million. PSE filed its rebuttal testimony on November 3, 2004 in
which PSE revised its proposed increase request to 6.3% or $46.2 million annually for gas
customers. The resolution of the gas general rate case may be up to an 11-month process
from the time the gas general rate case was filed. 
        In
2003, the Washington Commissions Pipeline Safety staff conducted a natural gas
standard inspection for three counties within Washington State in which PSE operates gas
pipeline activities. The inspection included a review of procedures, records, and
operations and maintenance activities. On June 29, 2004, the Washington Commission issued
a complaint to PSE related to that inspection. The Washington Commissions complaint
alleges certain violations of Washington Commission regulations and determined a maximum
aggregated fine for the violations of $4.5 million, although the Washington
Commissions Pipeline Safety staff recommended a fine of $1.3 million. PSE is
reviewing this matter and has been meeting with the Pipeline Safety staff to review their
allegations and develop a mutual resolution to this matter. Neither the outcome of this
matter nor the associated costs, including potential fines, can be predicted at this time. 
        In
September 2004, a natural gas fire destroyed a home and took the life of a PSE customer.
The cause of the fire remains under investigation by PSE, the Washington Commission and
other parties. PSE has tendered the matter to its general liability insurer. Neither the
potential regulatory or litigation outcomes of this matter nor the final associated costs
can be predicted at this time.

Colstrip Generating Facilities 
        In
September 2004, the owners of Colstrip Units 1 & 2 (PSE and PPL Montana) entered into
a tentative settlement agreement with certain homeowners in the Colstrip town site area
concerning a lawsuit filed in May 2003. The lawsuit alleged certain domestic water wells
may have been contaminated by seepage from a Colstrip Units 1 & 2 effluent holding
pond. The tentative settlement agreement would require extending municipal water to the
homeowners and abandoning the existing wells. The total estimated cost of the settlement
ranges from $1.4 million to $1.5 million. As a result of this tentative settlement
agreement, PSE recorded in the third quarter of 2004 a reserve for its 50% ownership of
the Colstrip Units 1 & 2 project of $0.7 million. The settlement agreement does not
resolve certain other claims by residents within the city limits. PSE cannot predict the
outcome or any potential financial impact of the claims by the residents within the city
limits at this time. 
        On
December 5, 2003, Colstrip Units 1 & 2 and 3 & 4 received an information request
from the Environmental Protection Agency (EPA) relating to their compliance with the Clean
Air Act New Source Review regulations. PSE is currently in discussions with the EPA
concerning the information request. Neither the outcome of this matter nor any potential
associated costs can be predicted at this time.

Douglas County PUD 
        Early
in 2003, the Colville Confederated Tribes (Colville Tribe) presented a claim to Douglas
County PUD based upon allegedly unpaid past annual charges for the Wells Hydroelectric
Project (the Project) for the use of Colville tribal lands, principally riverbed along the
tribal reservation. The Colville Tribe further claimed that annual charges would be due
for periods into the future. Beginning in April 2003, Douglas County PUD and Colville
Tribe representatives discussed settlement of these issues. On November 1, 2004, the
Douglas County PUD Commission approved entry into a settlement agreement with the Colville
Tribe that, subject to FERC approval, will resolve all of the Tribes claims. The
settlement would allocate 4.5% of the Projects output to the Tribe effective upon
FERC approval through 2018, when the allocation would increase to 5.5%. That allocation
would last as long as the Project exists. In addition, under the settlement, Douglas
County PUD would pay $13.5 million and convey certain real property to the Colville Tribe.
Douglas County PUD would also market the Colville Tribes Project output on behalf of
the Tribe for a period of time. PSE currently purchases 31.3% of the Projects
output. Upon approval, the settlement will slightly reduce the output available for PSE,
and slightly increase the cost of PSEs purchase under PSEs existing contract
with Douglas County PUD. PSE will support the Douglas County PUD filing for approval of
the settlement. PSE cannot predict how long it will take FERC to act upon the application.

Proceedings Relating to
the Western Power Market California Independent
System Operator (CAISO) Receivable and California Proceedings
        Puget
Energys and PSEs Annual Report on Form 10-K for the year ended December 31,
2003 includes a summary of the Western power market proceedings described below. The
following discussion provides a summary of material developments in these proceedings that
occurred during the period covered by this report and of any material new proceedings
instituted during the period covered by this report. While PSE cannot predict the outcome
of any of the individual ongoing proceedings relating to the Western power markets, in the
aggregate, PSE does not expect the ultimate resolution of the issues and cases discussed
below to have a material adverse impact on the financial condition, results of operations
or liquidity of the Company.

|1. | California
Receivable and California Refund Proceeding. In 2001, PG&E and           Southern
California Edison failed to pay the California Independent System           Operator
Corporation (CAISO) and the California PX for energy purchases. The           CAISO in
turn failed to pay various energy suppliers, including PSE, for energy           sales
made by PSE into the California energy market during the fourth quarter of
          2000. Both PG&E and the California PX filed for bankruptcy in 2001, further
          constraining PSEs ability to receive payments due to bankruptcy court
          controls placed on the distribution of funds by the California PX and due to
the           fact that all funds are still owed directly to the CAISO for purchases
during           the fourth quarter of 2000.
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a. | California
Refund Proceeding. On July 25, 2001, FERC ordered an evidentiary hearing
(Docket No. EL00-95) to determine the amount of refunds due to California
energy buyers for purchases made in the spot markets operated by the CAISO and
the California PX during the period October 2, 2000 through June 20, 2001
(refund period). The CAISO continues its efforts to recalculate costs and
charges for spot market sales to California during the refund period and
currently estimates that it will complete the initial refund calculations
between mid-December 2004 and mid-January 2005, and the financial clearing as
to who owes what to whom in February 2005. On September 2, 2004,
FERC issued an order selecting Ernst & Young LLP as the independent auditor of
fuel cost allowance claims made by sellers, including PSE, subject to refund
orders. FERC issued a subsequent order on September 24, 2004 addressing rehearing requests
related to the calculation methodology for fuel cost allowances. On October 7, 2004,
FERC held a technical conference on issues raised by the two orders, as well as by
an August 17, 2004 CAISO proposal to allocate fuel cost allowance claims, and a September 13, 2004 CAISO template
for the submission of fuel cost allowance claims. PSE filed protests to both
the CAISO allocation proposal and the CAISO template, and submitted additional
comments at the technical conference. PSE has also commenced working with Ernst
& Young LLP on the audit of PSEs fuel claims and awaits further
directives from FERC on the issues addressed at the October 7, 2004 technical
conference. Many of the numerous orders that FERC issued in Docket No. EL00-95
are on appeal and have been consolidated before the United States Court of
Appeals for the Ninth Circuit. On September 21, 2004, the Ninth Circuit held a
case management conference to identify issues to be raised and to consider
whether some issues could be severed from the consolidated proceedings and
decided separately. On October 22, 2004, the Ninth Circuit lifted a stay that
had held the proceeding in abeyance for more than two years, and directed that
FERC file the record by November 22, 2004. The Ninth Circuit also established
an additional case management conference for November 9, 2004, required that
issues be briefed in two phases, and required that briefing on phase one issues
be completed by March 1, 2005. 
        Over
the course of the last six months, settlement agreements with the California parties have
been filed at FERC by each of the following: the Williams Companies, Dynegy, Inc. and Duke
Energy, Inc. Each settlement resolves most issues between the settling parties and any
other party willing to opt in to the settlement. PSE elected to opt into the Williams
Companies settlement and specifically reserved its rights against the settling parties
other than the Williams Companies. PSE is entitled to a nominal deemed distribution
(approximately $4,382) from this settlement agreement. FERC approved the Williams
Companies settlement on July 2, 2004, and the Dynegy, Inc. settlement on October 25, 2004,
but has not yet approved the Duke Energy, Inc. settlement. FERC staff held a settlement
conference on June 30, 2004 to facilitate further settlement discussions in this
proceeding. No other settlements other than the Williams Companies, Dynegy, Inc. and Duke Energy, Inc.
settlements have been announced.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | CAISO
Receivable. PSE has a bad debt reserve and a transaction fee reserve           applied to
the CAISO receivable, such that PSEs net receivable from the           CAISO as of
September 30, 2004 is approximately $21.3 million. PSE estimates the           range for
the receivable to be between $21.3 million and $22.2 million, which           includes
estimated credits for fuel and power purchase costs and interest. In           its
October 16, 2003 Order on Rehearing in this docket, FERC expressly adopted           and
approved a stipulation that confirmed that two of PSEs non-spot
market transactions are not subject to mitigation in the Refund
Proceeding. On October 17, 2003, PSE formally presented CAISO with a request
that payment be made on these amounts. The CAISO responded to the letter on
November 13, 2003, expressing an unwillingness to take the issue up separately
or in advance of its cost re-run activities. PSE continues to pursue the issue
in filings through FERC processes. 
        On
May 6, 2004, the Los Angeles Department of Water and Power filed a motion at FERC in
Docket No. EL00-95 requesting that FERC issue an order permitting monies to be disbursed
from the California PX Settlement Clearing Account and an escrow account established as
part of PG&Es bankruptcy proceeding. The bulk of the monies owed by the CAISO,
including the monies owed to PSE, are held in those two accounts. PSE filed an answer in
support of the motion on May 21, 2004, and awaits an order from FERC.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2. | Pacific
Northwest Refund Proceeding. On June 25, 2003, FERC issued an order           terminating
the Pacific Northwest refund proceeding, Docket No. EL01-10, largely           on
procedural, jurisdictional and equitable grounds. Various parties filed
          rehearing requests on July 25, 2003. On November 10, 2003, FERC denied the
          rehearing requests. Seven petitions for review are now pending before the
United           States Court of Appeals for the Ninth Circuit. On September 29, 2004,
the court           denied the Port of Seattles request to adduce additional
evidence brought           to light in the Enron proceedings. On October 21, 2004, the
Ninth Circuit           established an updated briefing schedule. PSEs initial
brief is due on           November 19, 2004.
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3. | Orders to Show Cause. On June 25, 2003, FERC issued two show cause orders
          pertaining to its Western market investigations that commenced individual
          proceedings against many sellers. One show cause order (Docket Nos. EL03-180, et
          seq.) seeks to investigate approximately 26 entities that allegedly had
          potential partnerships with Enron. PSE was not named in that show
          cause order. In an order dismissing many of the already-named respondents in the
          partnerships proceeding on January 22, 2004, FERC states that it
          does not intend to proceed further against other parties. 
        The
second show cause order (Docket Nos. EL03-137, et seq.) named PSE (Docket No. EL03-169)
and approximately 54 other entities that allegedly had engaged in potential
gaming practices in the CAISO and California PX markets. PSE and FERC staff
filed a proposed settlement of all issues pending against PSE in those proceedings on
August 28, 2003. The proposed settlement, which admits no wrongdoing on the part of PSE,
would result in a payment of $17,092 to settle all claims. FERC approved the settlement on
January 22, 2004. The California parties filed for rehearing of that order, repeating
arguments that have already been addressed by FERC. On March 17, 2004, PSE filed a motion
to dismiss the California parties rehearing request, and awaits FERC action on that
motion. PSE continues to believe that the orders to show cause do not raise new issues or
concerns and will not have a material adverse impact on the financial condition, results
of operation or liquidity of the Company.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4. | Port of Seattle Suit. On May 21, 2003, the Port of Seattle commenced suit in
          federal court in Seattle against 22 energy sellers, alleging that their conduct
          during 2000 and 2001 constituted market manipulation, violated antitrust laws
          and damaged the Port of Seattle. The Port had a contract to purchase its energy
          supply from PSE at the time. The Ports contract linked the price of the
          energy sold to the Port to an index price for energy sold at wholesale at the
          Mid-Columbia trading hub. The Port alleged that the Mid-Columbia price was
          intentionally affected improperly by the defendants, including PSE. On May 12,
          2004 the district court dismissed the lawsuit. The Port of Seattle filed an
          appeal to the United States Court of Appeals for the Ninth Circuit, and on
          September 13, 2004, filed a brief in the Ninth Circuit arguing that the district
          court erred in dismissing its claims. Responses to the Ports brief were
          filed November 2, 2004.
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|5. | Wah Chang Suit. In June 2004, Puget Energy and PSE were served a federal summons
          and complaint by Wah Chang, an Oregon company. Wah Chang claims that during 1998
          through 2001 the Company and other energy companies (and in a separate
          complaint, energy marketers) engaged in various fraudulent and illegal
          activities including the transmittal of electronic wire communications to
          transmit false or misleading information to manipulate the California energy
          market. The claims include submitting false information such as energy schedules
          and bids to the California PX, CAISO, electronic trading platforms and
          publishers of energy indexes. The complaint is similar to the allegations made
          by the Port of Seattle currently on appeal in the Ninth Circuit. The Judicial
          Panel on Multi District Litigation consolidated this case with another pending
          Multi District case and transferred it to Federal District Court in San Diego on
          August 20, 2004. The defendants in both cases filed motions to dismiss on
          October 25, 2004.
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|6. | California Litigation. Attorney General Cases. On September 9, 2004, the Ninth
          Circuit issued a decision on the California Attorney Generals challenge to
          the validity of FERCs market-based rate system. (Lockyer v. FERC). This
          case was originally presented to FERC. The Ninth Circuit upheld FERCs
          authority to authorize sales of electric energy at market based rates, but found
          the requirement that all sales at market-based rates be contained in quarterly
          reports filed with FERC to be integral to a market-based rate tariff. The
          California parties, among others, have interpreted the decision as providing
          authority to FERC to order refunds for different time frames and based on
          different rationales than are currently pending in the California Refund
          Proceedings, discussed above in California Refund Proceedings. The
          decision itself defers the question of whether to seek refunds to FERC. PSE,
          along with other defendants in the proceeding, sought rehearing of the Ninth
          Circuits decision on October 25, 2004. 
        In
addition, the day after the initial FERC decision in the Lockyer case, the California
Attorney General filed similar claims in state court in California, including one suit
against PSE. These complaints alleged that the wholesale seller defendants in the
California energy market engaged in anti-competitive behavior in violation of the
California Business Practices Act for sales in the California energy market (Lockyer v.
Transalta). Those cases were removed to federal court and dismissed. On October 12, 2004,
the Ninth Circuit issued a decision affirming the dismissal of all thirteen complaints
filed by the California Attorney General, including a complaint against PSE. The Ninth
Circuit decision concluded that the opinions in People of the State of California ex rel.
Bill Lockyer v. Dynegy, et al. and Public Utility District No. 1 of Snohomish County v.
Dynegy Power Marketing, Inc., decided earlier this year by the Ninth Circuit, controlled
the outcome of the matters and warranted dismissal. It has been reported that the
California Attorney General plans to seek a rehearing. 
        California
Class Actions. In May 2002, PSE was served with two cross-complaints, by Reliant Energy
Services and Duke Energy Trading & Marketing, respectively, in six consolidated class
actions filed in Superior Court in San Diego, California. Plaintiffs in the lawsuit seek,
among other things, restitution of all funds acquired by means that violate the law and
payment of treble damages, interest and penalties. The cross complaints asserted
essentially that the cross-defendants, including PSE, were also participants in the
California energy market at the relevant times, and that any remedies ordered against some
market participants should be ordered against all. Reliant and Duke also seek
indemnification and conditional relief as buyers in transactions involving
cross-defendants should the plaintiffs prevail. The case was removed to federal court and
some of the newly added defendants, including PSE, moved to dismiss the action. In
December 2002, the federal district court remanded the proceeding to state court, an
action which Duke and Reliant later appealed to the Ninth Circuit. The appeal stayed
further action in the state court proceeding pending the outcome of the appeal. The cross
complaints and the addition of the 40 new defendants raised issues of foreign sovereign
immunity, jurisdiction and indemnity in the case, all of which are now part of the appeal.
In June 2003, PSE and other defendants filed motions to respond to the indemnity issues.
On May 13, 2004, the Ninth Circuit issued an order granting PSE status as a cross
appellant but did not permit PSE to participate in the oral argument heard on June 14,
2004. The parties await the courts ruling on the appeal.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Item 3.     Quantitative and
Qualitative Disclosure About Market Risk

The
Company is exposed to market risks, including changes in commodity prices and interest
rates.

Portfolio Management. The nature of
serving regulated electric customers with its wholesale portfolio of owned and contracted
resources exposes the Company and its customers to some volumetric and commodity price
risks within the sharing mechanism of the PCA. The Companys energy risk management
function monitors and manages these risks using analytical models and tools. The Company
manages its energy supply portfolio to achieve three primary objectives:

| |  | Ensure
that physical energy supplies are available to serve retail customer requirements;
| | - | -----------------------------------------------------------------------------------------

| |  | Manage
portfolio risks to limit undesired impacts on the Companys costs; and
| | - | -----------------------------------------------------------------------------

| |  | Maximize
the value of the Companys energy supply assets.
| | - | ---------------------------------------------------------

The
portfolio is subject to major sources of variability (e.g., hydro generation, outage risk,
regional economic factors, temperature-sensitive retail sales, and market prices for gas
and power supplies). At certain times, these sources of variability can mitigate portfolio
imbalances; at other times they can exacerbate portfolio imbalances. The Companys
energy risk management staff develops hedging strategies for the Companys energy
supply portfolio. Portfolio exposure is managed in accordance with Company polices and
procedures. The Energy Risk Management Committee, which is composed of Company officers,
provides policy-level and strategic direction for management of the energy portfolio. The
Audit Committee of the Companys Board of Directors has oversight of the Energy Risk
Management Committee. 
        The
prices of energy commodities are subject to fluctuations due to unpredictable factors
including weather, generation outages and other factors, which impact supply and demand.
The volumetric and commodity price risk is a consequence of purchasing energy at fixed and
variable prices and providing deliveries at different tariffs and variable prices. Costs
associated with ownership and operation of production facilities are another component of
this risk. The Company may use forward physical delivery agreements and financial
derivatives for the purpose of hedging commodity price risk. Without jeopardizing the
security of supply within its portfolio, the Company will also engage in optimizing the
portfolio. Optimization may take the form of utilizing excess capacity, shaping flexible
resources to capture their highest value, utilizing transmission capacity or capitalizing
on market price movement. As a result, portions of the Companys energy portfolio are
monetized through the use of forward price instruments. 
        The
PGA and the PCA mechanisms mitigate the impact of commodity price volatility upon the
Company. The PGA mechanism passes through to customers increases and decreases in the cost
of natural gas supply. The PCA mechanism provides for a sharing of costs and benefits that
are graduated over four levels of power cost variances with an overall cap of $40 million
(+/-) plus 1% of the excess over the $40 million cap over the four-year period ending June
30, 2006. 
        Transactions
that qualify as hedge transactions under SFAS No. 133 are recorded on the balance sheet at
fair value. Changes in fair value of the Companys derivatives are recorded each
period in current earnings or other comprehensive income. Short-term derivative contracts
for the purchase and sale of electricity are valued based upon daily quoted prices from an
independent energy brokerage service. Valuations for short-term and medium-term natural
gas financial derivatives are derived from a combination of quotes from several
independent energy brokers and are updated daily. Long-term gas financial derivatives are
valued based on published pricing from a combination of independent brokerage services and
are updated monthly. Option contracts are valued using market quotes and a Monte Carlo
simulation-based model approach. The Company has hedged a significant portion of its 2004
 2005 winter energy supply for both electric and gas portfolios at prices below
current market prices. Hedging costs are passed through in the PGA and PCA mechanisms. The
majority of these hedges are normal purchase or cash flow hedges under SFAS No. 133. 
        At
September 30, 2004, the Company had a SFAS No. 133 after-tax net asset of approximately
$25.2 million of energy contracts designated as qualifying cash flow hedges and a
corresponding unrealized gain recorded in other comprehensive income. Of the amount in
other comprehensive income, 99% of the mark-to-market gain beginning November 2004 has
been reclassified out of other comprehensive income to a deferred account in accordance
with SFAS No. 71 due to the Company expecting to reach the $40 million cap under the PCA
mechanism. The Company also had energy contracts that were marked-to-market at a loss of
$1.2 million after-tax through current earnings for the three months ended September 30,
2004 and at a gain of $0.7 million for the nine months ended September 30, 2004. These
mark-to-market adjustments were primarily the result of excluding certain contracts from
the normal purchase normal sale exemption under SFAS No. 133. A portion of the
mark-to-market adjustments beginning November 2004 has been reclassified to a deferred
account in accordance with SFAS No. 71 due to the Company expecting to reach the $40
million cap under the PCA mechanism. A hypothetical 10% increase in the market prices of
natural gas and electricity would increase the fair value of qualifying cash flow hedges
by approximately $4.9 million after-tax and would increase current earnings for those
contracts marked-to-market in earnings by an insignificant amount as a result of applying
SFAS No. 71 for the portion that exceeds the $40 million PCA mechanism cap.

Counterparty Credit Risk. The Company
is subject to credit risk from counterparties based on transactions it enters into during
the normal course of business. The Company is exposed to risk to the extent that
counterparties fail to perform on their contractual obligations. These counterparties
include other utilities, energy trading companies, financial institutions and natural gas
production companies. The Company mitigates its exposure by transacting with
counterparties that meet minimum credit thresholds, setting credit limits and obtaining
master agreements. Credit exposures are reviewed daily to ensure transactions continually
meet the Companys standards. The Company monitors both utilization of open credit,
as well as potential credit exposure to its counterparties. The majority of the
Companys counterparties are investment grade rated.

Interest Rate Risk. The Company
believes its interest rate risk primarily relates to the use of short-term debt
instruments, variable rate notes and leases and long-term debt financing needed to fund
capital requirements. The Company manages its interest rate risk through the issuance of
mostly fixed-rate debt of various maturities. The Company utilizes bank borrowings,
commercial paper, line of credit facilities and accounts receivable securitization to meet
short-term cash requirements. These short-term obligations are commonly refinanced with
fixed-rate bonds or notes when needed and when interest rates are considered favorable.
The Company may enter into swap instruments or other financial hedge instruments to manage
the interest rate risk associated with these debts. 
        In
the third quarter 2004, the Company entered into two treasury lock contracts to hedge
against potential rising interest rate exposure for a debt offering anticipated to be
performed in the first half of 2005. A treasury lock is a financial arrangement between
the Company and a counterparty whereby one of the parties will be required to make a
payment to the other party on a specific valuation date based upon the change in value of
a 30 year treasury bond. If interest rates rise related to the hedged debt from the date
of issuance of the treasury lock instruments, the Company would receive a payment from the
counterparty for the change in the bond value. Alternatively, if interest rates decrease
related to the hedged debt from the date of issuance of the treasury lock instruments, the
Company would pay the counterparty for the change in bond value. These treasury lock
contracts were designated under SFAS No. 133 criteria as cash flow hedges, with all
changes in market value for each reporting period being presented net of tax in other
comprehensive income. All financial hedge contracts of this type are reviewed by senior
management and presented to the Securities Pricing Committee of the Board of Directors,
and are approved prior to execution. At September 30, 2004, the unrealized loss associated
with the two treasury lock contracts was $4.3 million net of tax, and is included in other
comprehensive income. When these treasury lock contracts are settled upon issuance of debt,
any gain or loss will be amortized from other comprehensive income to interest expense
over the 30 year life of the issued debt.  A hypothetical 10% decrease in the price of a
30 year treasury note would result in an additional loss of $14.0 million net of tax in
other comprehensive income.

Item 4. Controls and
Procedures

Evaluation of disclosure controls and
procedures. Under the supervision and with the participation of Puget Energys and
PSEs management, including the Companies President and Chief Executive Officer
and Senior Vice President and Chief Financial Officer, Puget Energy and PSE have evaluated
the effectiveness of the Companies disclosure controls and procedures (as defined in
Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the fiscal
quarter covered by this report. Based upon that evaluation, the President and Chief
Executive Officer and Senior Vice President and Chief Financial Officer of Puget Energy
and PSE concluded that these disclosure controls and procedures are effective as of the
end of the quarter.

Pursuant
to Section 404 of the Sarbanes-Oxley Act and related Securities and Exchange Commission
rules, Puget Energy will be required to furnish a report of managements assessment
of the effectiveness of its internal controls as part of its Annual Report on Form 10-K
for the fiscal year ending December 31, 2004. Puget Energys auditors will be
required to attest to and report on managements assessment. To issue the report,
Puget Energy management must document both the design for its internal controls and the
testing processes that support managements evaluation and conclusion. Puget Energy
has begun the necessary processes and procedures for issuing its report on internal
controls. There can be no assurance, however, that Puget Energy will be able to complete
the work necessary to issue its report in a timely manner or that management or its
auditors will conclude that internal controls are effective.

Changes in internal controls over
financial reporting. There have been no significant changes in Puget Energys or
PSEs internal control over financial reporting during the quarter covered by this
report that have materially affected, or are reasonably likely to materially affect, Puget
Energys or PSEs internal control over financial reporting.

PART II   OTHER INFORMATION

Item 1. Legal Proceedings

See
the section titled Proceedings Relating to the Western Power Market under Item
2 Managements Discussion and Analysis of Financial Conditions and Results of
Operations of this Quarterly Report on Form 10-Q. 
        Contingencies
arising out of the normal course of the Companys business exist at September 30,
2004. The ultimate resolution of these issues in part or in the aggregate is not expected
to have a material adverse impact on the financial condition, results of operations or
liquidity of the Company.

Item 6.       Exhibits

| | See
Exhibit Index for list of exhibits.
| | ---------------------------------------

SIGNATURES

Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, each
registrant has duly caused this report to be signed on their behalf by the undersigned
thereunto duly authorized.

|                       | PUGET ENERGY, INC.
PUGET SOUND ENERGY, INC.                                                          
|---------------------- | -----------------------------------------------------------------------------------------------------
|                       | /s/ James W. Eldredge                                                                                
|                       | James W. Eldredge
Corporate Secretary and ChiefAccounting Officer                                    
|                       |                                                                                                      
|Date: November 4, 2004 | Chief accounting officer and officer duly authorized
to sign this report on behalf of each registrant

EXHIBIT INDEX

The following exhibits are filed
herewith:

| | 12.1 | Statement
setting forth computation of ratios of earnings to fixed charges (1999 through 2003 and
12 months ended September 30, 2004) for Puget Energy.
| | ---- | -------------------------------------------------------------------------------------------------------------------------------------------------------

| | 12.2 | Statement
setting forth computation of ratios of earnings to fixed charges (1999 through 2003 and
12 months ended September 30, 2004) for PSE.
| | ---- | ----------------------------------------------------------------------------------------------------------------------------------------------

| | 31.1 | Chief
Executive Officer certification of Puget Energy pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
| | ---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 31.2 | Chief
Financial Officer certification of Puget Energy pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
| | ---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 31.3 | Chief
Executive Officer certification of Puget Sound Energy pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
| | ---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 31.4 | Chief
Financial Officer certification of Puget Sound Energy pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
| | ---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 32.1 | Chief
Executive Officer certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
| | ---- | -----------------------------------------------------------------------------------------------------------------------------------------------

| | 32.2 | Chief
Financial Officer certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
| | ---- | -----------------------------------------------------------------------------------------------------------------------------------------------