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 March 31,
      2008
                  
                  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
      NE 4th
      Street, Suite 1200
                  Bellevue,
      Washington 98004-5591
                  (425)
      454-6363
                91-1969407
 
 
 1-4393
                PUGET
      SOUND ENERGY, INC.
                  A
      Washington Corporation
                  10885
      NE 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.
  Puget
      Energy, Inc.
                Yes
                /X/
                No
                /  /
                
                Puget
      Sound Energy, Inc.
                Yes
                /X/
                No
                /  /
 
 Indicate
by check mark whether registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company.  See
definition of “large accelerated filer, accelerated filer and smaller reporting
company” in Rule 12b-2 of the Exchange Act.
  Puget
      Energy, Inc.
                Large
      accelerated filer
                /X/
                Accelerated
      filer
                /  /
                Non-accelerated
      filer
                /  /
                Smaller
      reporting company
                /  /Puget
      Sound Energy, Inc.
                Large
      accelerated filer
                /  /
                Accelerated
      filer
                /  /
                Non-accelerated
      filer
                /X/
                Smaller
      reporting company
                /  /
 
 Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
 Puget
      Energy, Inc.
                Yes
                /  /
                No
                /X/
                
                Puget
      Sound Energy, Inc.
                Yes
                /  /
                No
                /X/
 
 As of
April 30, 2008, (i) the number of shares of Puget Energy, Inc. common stock
outstanding was 129,678,489 ($.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


DefinitionsFiling FormatForward Looking StatementsPart I.
            Financial InformationItem 1.
            Financial StatementsPuget
      Energy, Inc.Consolidated Statements of Income – Three Months Ended
      March 31, 2008 and 2007Consolidated Statements of Comprehensive Income – Three
      Months Ended
              March 31, 2008 and 2007Consolidated Balance Sheets – March 31, 2008 and
      December 31, 2007Consolidated Statements of Cash Flows – Three Months Ended
      March 31, 2008 and 2007Puget
      Sound Energy, Inc.Consolidated Statements of Income – Three Months
      Ended March 31, 2008 and 2007Consolidated Statements of Comprehensive Income – Three
      Months Ended
              March 31, 2008 and 2007Consolidated Balance Sheets – March 31, 2008 and
      December 31, 2007Consolidated Statements of Cash Flows – Three Months
      Ended March 31, 2008 and 2007NotesCombined Notes to Consolidated Financial
      StatementsItem 2.
            Management’s Discussion and
      Analysis of Financial Condition and Results of
      OperationsItem 3.
            Quantitative and Qualitative Disclosure About Market
      RiskItem 4.
            Controls and ProceduresPart II.
            Other InformationItem 1.
            Legal ProceedingsItem 1A.
            Risk FactorsItem 4.
            Submission of Matters to a Vote of Security
      HoldersItem 5.
            Other InformationItem 6.
            ExhibitsSignaturesExhibit Index











DEFINITIONS




AFUDC
              Allowance
      for Funds Used During ConstructionBPA
              Bonneville
      Power AdministrationCAISO
              California
      Independent System OperatorConsortium
              Infrastructure
      investors led by Macquarie Infrastructure Partners, the Canada Pension
      Plan Investment Board and British Columbia Investment Management
      Corporation, and also includes Alberta Investment Management,
      Macquarie-FSS Infrastructure Trust and Macquarie Capital Group
      LimitedEITF
              Emerging
      Issues Task ForceEPA
              U.
      S. Environmental Protection AgencyERO
              FERC-certified
      Electric Reliability OrganizationFASB
              Financial
      Accounting Standards BoardFERC
              Federal
      Energy Regulatory CommissionFIN
              Financial
      Accounting Standards Board InterpretationFSP
              FASB
      Staff PositionGAAP
              Generally
      Accepted Accounting PrinciplesIBEW
              International
      Brotherhood of Electrical WorkersInfrastruX
              InfrastruX
      Group, Inc.IRP
              Integrated
      Resource PlankW
              KilowattkWh
              Kilowatt
      HourLIBOR
              London
      Interbank Offered RateMMS
              Mineral
      Management Service of the United StatesMW
              Megawatt
      (one MW equals one thousand kW)MWh
              Megawatt
      Hour (one MWh equals one thousand kWh)NERC
              North
      American Electric Reliability CorporationNinth
      Circuit
              United
      States Court of Appeals for the Ninth CircuitNPNS
              Normal
      Purchase Normal SalePCA
              Power
      Cost AdjustmentPCORC
              Power
      Cost Only Rate CasePGA
              Purchased
      Gas AdjustmentPSE
              Puget
      Sound Energy, Inc.PSE
      Funding
              PSE
      Funding, Inc.Puget
      Energy
              Puget
      Energy, Inc.REP
              BPA
      Residential Exchange ProgramSFAS
              Statement
      of Financial Accounting StandardsSumas
              Sumas
      Cogeneration Company, L.P.Tenaska
              Tenaska
      Power Fund, L.P.Washington
      Commission
              Washington
      Utilities and Transportation CommissionWECC
              Western
      Electricity Coordinating CouncilWECO
              Western
      Energy Co









FILING FORMAT


This
-Report on Form 10-Q is a combined quarterly report 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 and assumptions of future events or
performance.  Words or phrases such as “anticipates,” “believes,”
“estimates,” “expects,” “future,” “intends,” “plans,” “predicts,” “projects,”
“will likely result,” “will continue” or similar expressions identify
forward-looking statements.


Forward-looking
statements involve risks and uncertainties that 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.  However, 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:




·
              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, cost recovery, 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, operation of distribution and transmission
      facilities (natural gas and electric), licensing of hydroelectric
      operations and natural gas storage facilities, recovery of other capital
      investments, recovery of power and natural gas costs, recovery of
      regulatory assets and present or prospective wholesale and retail
      competition;·
              Failure
      to comply with FERC or Washington Commission standards and/or rules, which
      could result in penalties based on the discretion of either
      commission;·
              Failure
      to comply with electric reliability standards developed by the North
      American Electric Reliability Corporation (NERC) for users, owners and
      operators of the power system, which could result in penalties of up to
      $1.0 million per day per violation;·
              Changes
      in, adoption of and compliance with laws and regulations, including
      decisions and policies concerning the environment, climate change,
      emissions, natural resources, and fish and wildlife (including the
      Endangered Species Act);·
              The
      ability to recover costs arising from changes in enacted federal, state or
      local tax laws through revenue in a timely manner;·
              Changes
      in tax law, related regulations, or differing interpretation or
      enforcement of applicable law by the Internal Revenue Service (IRS) or
      other taxing jurisdiction, which could have a material adverse impact on
      the financial statements;·
              Natural
      disasters, such as hurricanes, windstorms, earthquakes, floods, fires and
      landslides, which can interrupt service and/or cause temporary supply
      disruptions and/or price spikes in the cost of fuel and raw materials and
      impose extraordinary costs;·
              Commodity
      price risks associated with procuring natural gas and power in wholesale
      markets;·
              Wholesale
      market disruption, which may result in a deterioration of market
      liquidity, increase the risk of counterparty default, affect the
      regulatory and legislative process in unpredictable ways, negatively
      affect wholesale energy prices and/or impede PSE’s ability to manage its
      energy portfolio risks and procure energy supply, affect the availability
      and access to capital and credit markets and/or impact delivery of energy
      to PSE from its suppliers;·
              Financial
      difficulties 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 and/or impact delivery of energy to PSE from it
      suppliers;·
              The
      effect of wholesale market structures (including, but not limited to,
      regional market designs or transmission organizations) or other related
      federal initiatives;·
              PSE
      electric or natural gas distribution system failure, which may impact
      PSE’s ability to deliver energy supply to its
customers;·
              Changes
      in weather conditions in the Pacific Northwest, which could have effects
      on customer usage and PSE’s revenues, thus impacting net
      income;·
              Weather,
      which can have a potentially serious impact on PSE’s ability to procure
      adequate supplies of natural gas, fuel or purchased power to serve its
      customers and on the cost of procuring such supplies;·
              Variable
      hydro conditions, which can impact streamflow and PSE’s ability to
      generate electricity from hydroelectric facilities;·
              Plant
      outages, which can have an adverse impact on PSE’s expenses with respect
      to repair costs, added costs to replace energy or higher costs associated
      with dispatching a more expensive resource;·
              The
      ability of natural gas or electric plant to operate as
      intended;·
              The
      ability to renew contracts for electric and natural gas supply and the
      price of renewal;·
              Blackouts
      or large curtailments of transmission systems, whether PSE’s or others’,
      which can affect PSE’s ability to deliver power or natural gas to its
      customers and generating facilities;·
              The
      ability to restart generation following a regional transmission
      disruption;·
              Failure
      of the interstate natural gas pipeline delivering to PSE’s system, which
      may impact PSE’s ability to adequately deliver natural gas supply or
      electric power to its customers;·
              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, which might impact customer
      consumption or affect 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;·
              The
      impact of acts of God, terrorism, flu pandemic or similar significant
      events;·
              Capital
      market conditions, including changes in the availability of capital or
      interest rate fluctuations;·
              Employee
      workforce factors, including strikes, work stoppages, availability of
      qualified employees or the loss of a key executive;·
              The
      ability to obtain insurance coverage and the cost of such
      insurance;·
              The
      ability to maintain effective internal controls over financial reporting
      and operational processes; and·
              With
      respect to merger transactions Puget Energy announced on October 26,
      2007:§
              The
      risk that the merger may not be consummated in a timely manner if at all,
      including due to the failure to receive any required regulatory
      approvals;§
              The
      risk that the merger agreement may be terminated in circumstances that
      require Puget Energy to pay a termination fee of up to $40.0 million, plus
      out-of-pocket expenses of the acquiring entity and its members of up to
      $10.0 million (or if no termination fee is payable, up to $15.0 million);
      and§
              The
      effect of the announcement of the merger on our business relationships,
      operating results and business generally, including our ability to retain
      key employees.


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.  You are also
advised to consult Item 1A-“Risk Factors” in the Company’s most recent annual
report on Form 10-K.


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
              March
      31,2008
            
            
            2007Operating
      revenues:Electric
            
            $
            606,134
            
            
            $
            527,619Gas
            
            
            443,236
            
            
            
            467,009Other
            
            
            1,562
            
            
            
            9,276Total
      operating revenues
            
            
            1,050,932
            
            
            
            1,003,904Operating
      expenses:Energy
      costs:Purchased
      electricity
            
            
            272,832
            
            
            
            282,092Electric
      generation fuel
            
            
            47,014
            
            
            
            26,058Residential
      exchange
            
            
            (7
            )
            
            
            (34,478
            )Purchased
      gas
            
            
            276,195
            
            
            
            310,647Net
      unrealized (gain) loss on derivative instruments
            
            
            88
            
            
            
            (5,782
            )Utility
      operations and maintenance
            
            
            112,163
            
            
            
            98,171Non–utility
      expense and other
            
            
            462
            
            
            
            2,130Merger
      related costs
            
            
            1,311
            
            
            
            --Depreciation
      and amortization
            
            
            75,367
            
            
            
            69,609Conservation
      amortization
            
            
            13,366
            
            
            
            10,328Taxes
      other than income taxes
            
            
            94,273
            
            
            
            87,069Total
      operating expenses
            
            
            893,064
            
            
            
            845,844Operating
      income
            
            
            157,868
            
            
            
            158,060Other
      income (deductions):Other
      income
            
            
            6,844
            
            
            
            4,764Other
      expense
            
            
            (976
            )
            
            
            (1,031
            )Interest
      charges:AFUDC
            
            
            2,429
            
            
            
            2,416Interest
      expense
            
            
            (51,048
            )
            
            
            (51,261
            )Income
      before income taxes
            
            
            115,117
            
            
            
            112,948Income
      tax expense
            
            
            35,304
            
            
            
            33,887Net
      income
            
            $
            79,813
            
            
            $
            79,061Common
      shares outstanding weighted-average (in thousands)
            
            
            129,428
            
            
            
            116,479Diluted
      shares outstanding weighted-average (in thousands)
            
            
            129,940
            
            
            
            116,974Basic
      earnings per common share
            
            $
            0.62
            
            
            $
            0.68Diluted
      earnings per common share
            
            $
            0.61
            
            
            $
            0.68


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
              March
      31,2008
            
            
            2007Net
      income
            
            $
            79,813
            
            
            $
            79,061Other
      comprehensive income:Unrealized
      gain from pension and postretirement plans, net of tax of $95 and $642,
      respectively
            
            
            176
            
            
            
            1,193Net
      unrealized gains on energy derivative instruments during the period, net
      of tax of $25,457 and $1,914, respectively
            
            
            47,277
            
            
            
            3,554Reversal
      of net unrealized losses on energy derivative instruments settled during
      the period, net of tax of $957 and $1,653, respectively
            
            
            1,778
            
            
            
            3,070Amortization
      of financing cash flow hedge contracts to earnings, net of tax of $43 and
      $43, respectively
            
            
            80
            
            
            
            80Other
      comprehensive income
            
            
            49,311
            
            
            
            7,897Comprehensive
      income
            
            $
            129,124
            
            
            $
            86,958





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











PUGET ENERGY, INC.


CONSOLIDATED
BALANCE SHEETS


(Dollars
in thousands)








ASSETS





March
      31,
              2008
              (Unaudited)
            
            
            December
      31,
              2007Utility
      plant: (at original cost, including construction work in progress
      of
              $244,046
      and $267,595, respectively)Electric
      plant
            
            $
            5,975,879
            
            
            $
            5,914,127Gas
      plant
            
            
            2,351,247
            
            
            
            2,313,477Common
      plant
            
            
            514,729
            
            
            
            506,211Less:  Accumulated
      depreciation and amortization
            
            
            (3,143,396
            )
            
            
            (3,091,176
            )Net
      utility plant
            
            
            5,698,459
            
            
            
            5,642,639Other
      property and investments:Investment
      in Bonneville Exchange Power contract
            
            
            32,621
            
            
            
            33,503Other
      property and investments
            
            
            113,465
            
            
            
            114,083Total
      other property and investments
            
            
            146,086
            
            
            
            147,586Current
      assets:Cash
            
            
            49,152
            
            
            
            40,797Restricted
      cash
            
            
            4,827
            
            
            
            4,793Accounts
      receivable, net of allowance for doubtful accounts
            
            
            340,280
            
            
            
            218,781Secured
      pledged accounts receivable
            
            
            85,000
            
            
            
            152,000Unbilled
      revenues
            
            
            181,632
            
            
            
            210,025Materials
      and supplies, at average cost
            
            
            61,184
            
            
            
            62,114Fuel
      and gas inventory, at average cost
            
            
            40,290
            
            
            
            99,772Unrealized
      gain on derivative instruments
            
            
            97,252
            
            
            
            17,130Prepaid
      income tax
            
            
            543
            
            
            
            44,303Prepaid
      expense and other
            
            
            8,764
            
            
            
            11,910Deferred
      income taxes
            
            
            --
            
            
            
            4,011Total
      current assets
            
            
            868,924
            
            
            
            865,636Other
      long-term and regulatory assets:Regulatory
      asset for deferred income taxes
            
            
            100,499
            
            
            
            104,928Regulatory
      asset for PURPA buyout costs
            
            
            132,747
            
            
            
            140,520Power
      cost adjustment mechanism
            
            
            3,149
            
            
            
            3,114Other
      regulatory assets
            
            
            503,559
            
            
            
            510,998Unrealized
      gain on derivative instruments
            
            
            45,122
            
            
            
            11,845Other
            
            
            172,801
            
            
            
            171,470Total
      other long-term and regulatory assets
            
            
            957,877
            
            
            
            942,875Total
      assets
            
            $
            7,671,346
            
            
            $
            7,598,736





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











PUGET ENERGY, INC.


CONSOLIDATED
BALANCE SHEETS


(Dollars
in thousands)





CAPITALIZATION
AND LIABILITIES





March
      31,
              2008
              (Unaudited)
            
            
            December
      31,
              2007Capitalization:Common
      shareholders’ investment:Common
      stock $0.01 par value, 250,000,000 shares authorized, 129,678,489 and
      129,678,489 shares outstanding, respectively
            
            $
            1,297
            
            
            $
            1,297Additional
      paid-in capital
            
            
            2,273,197
            
            
            
            2,278,500Earnings
      reinvested in the business
            
            
            281,626
            
            
            
            240,079Accumulated
      other comprehensive income, net of tax at 35%
            
            
            51,390
            
            
            
            2,078Total
      shareholders’ equity
            
            
            2,607,510
            
            
            
            2,521,954Redeemable
      securities and long-term debt:Preferred
      stock subject to mandatory redemption
            
            
            1,889
            
            
            
            1,889Junior
      subordinated notes
            
            
            250,000
            
            
            
            250,000Long-term
      debt
            
            
            2,278,860
            
            
            
            2,428,860Total
      redeemable securities and long-term debt
            
            
            2,530,749
            
            
            
            2,680,749Total
      capitalization
            
            
            5,138,259
            
            
            
            5,202,703Current
      liabilities:Accounts
      payable
            
            
            284,228
            
            
            
            310,398Short-term
      debt
            
            
            101,604
            
            
            
            260,486Current
      maturities of long-term debt
            
            
            329,500
            
            
            
            179,500Accrued
      expenses:Purchased
      gas liability
            
            
            68,428
            
            
            
            77,864Taxes
            
            
            107,495
            
            
            
            84,756Salaries
      and wages
            
            
            17,551
            
            
            
            28,516Interest
            
            
            57,965
            
            
            
            45,133Unrealized
      loss on derivative instruments
            
            
            4,631
            
            
            
            27,089Deferred
      income taxes
            
            
            10,450
            
            
            
            --Other
            
            
            95,637
            
            
            
            48,918Total
      current liabilities
            
            
            1,077,489
            
            
            
            1,062,660Long-term
      liabilities and regulatory liabilities:Deferred
      income taxes
            
            
            845,020
            
            
            
            818,161Unrealized
      loss on derivative instruments
            
            
            7,001
            
            
            
            --Regulatory
      liabilities
            
            
            210,805
            
            
            
            210,311Other
      deferred credits
            
            
            392,772
            
            
            
            304,901Total
      long-term liabilities and regulatory liabilities
            
            
            1,455,598
            
            
            
            1,333,373Total
      capitalization and liabilities
            
            $
            7,671,346
            
            
            $
            7,598,736





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











PUGET ENERGY,
INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(Dollars
in thousands, Unaudited)


Three
      Months Ended
              March
      31,2008
            
            
            2007Operating
      activities:Net
      income
            
            $
            79,813
            
            
            $
            79,061Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
      and amortization
            
            
            75,367
            
            
            
            69,609Conservation
      amortization
            
            
            13,366
            
            
            
            11,328Deferred
      income taxes and tax credits, net
            
            
            22,283
            
            
            
            11,243Power
      cost adjustment mechanism
            
            
            (35
            )
            
            
            (104
            )Amortization
      of gas pipeline capacity assignment
            
            
            (2,614
            )
            
            
            (2,690
            )Non
      cash return on regulatory assets
            
            
            (3,363
            )
            
            
            (1,823
            )Net
      unrealized loss on derivative instruments
            
            
            88
            
            
            
            (5,782
            )Non
      cash Colstrip settlement
            
            
            10,487
            
            
            
            --Change
      in residential exchange program
            
            
            (921
            )
            
            
            (8,111
            )Storm
      damage deferred costs
            
            
            (179
            )
            
            
            (16,759
            )Other
            
            
            (2,115
            )
            
            
            6,347Change
      in certain current assets and liabilities:Accounts
      receivable and unbilled revenue
            
            
            27,594
            
            
            
            51,487Materials
      and supplies
            
            
            930
            
            
            
            (7,633
            )Fuel
      and gas inventory
            
            
            59,482
            
            
            
            56,523Prepaid
      income taxes
            
            
            43,760
            
            
            
            497Prepayments
      and other
            
            
            3,146
            
            
            
            (1,837
            )Purchased
      gas receivable/payable
            
            
            (9,436
            )
            
            
            43,666Accounts
      payable
            
            
            (17,116
            )
            
            
            (94,415
            )Taxes
      payable
            
            
            22,739
            
            
            
            30,751Accrued
      expenses and other
            
            
            11,297
            
            
            
            7,036Net
      cash provided by operating activities
            
            
            334,573
            
            
            
            228,394Investing
      activities:Construction
      and capital expenditures - excluding equity AFUDC
            
            
            (126,646
            )
            
            
            (239,681
            )Energy
      efficiency expenditures
            
            
            (14,010
            )
            
            
            (8,964
            )Restricted
      cash
            
            
            (35
            )
            
            
            (46
            )Refundable
      cash received for customer construction projects
            
            
            1,185
            
            
            
            4,456Cash
      proceeds from property sales
            
            
            2,076
            
            
            
            57Other
            
            
            (1,377
            )
            
            
            322Net
      cash used by investing activities
            
            
            (138,807
            )
            
            
            (243,856
            )Financing
      activities:Change
      in short-term debt and leases, net
            
            
            (158,882
            )
            
            
            133,440Dividends
      paid
            
            
            (32,419
            )
            
            
            (26,255
            )Issuance
      of common stock
            
            
            --
            
            
            
            1,940Redemption
      of bonds, notes and leases
            
            
            --
            
            
            
            (100,000
            )Issuance
      and redemption costs of bonds and other
            
            
            3,890
            
            
            
            5,104Net
      cash (used) provided by financing activities
            
            
            (187,411
            )
            
            
            14,229Net
      increase (decrease) in cash
            
            
            8,355
            
            
            
            (1,233
            )Cash
      at beginning of year
            
            
            40,797
            
            
            
            28,117Cash
      at end of period
            
            $
            49,152
            
            
            $
            26,884Supplemental
      cash flow information:Cash
      payments for interest (net of capitalized interest)
            
            $
            38,642
            
            
            $
            32,009Cash
      refunds from income taxes
            
            
            (42,392
            )
            
            
            --





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











PUGET
SOUND ENERGY, INC.


CONSOLIDATED
STATEMENTS OF INCOME


(Dollars
in thousands)


(Unaudited)





Three
      Months Ended
              March
      31,2008
            
            
            2007Operating
      revenues:Electric
            
            $
            606,134
            
            
            $
            527,619Gas
            
            
            443,236
            
            
            
            467,009Other
            
            
            1,562
            
            
            
            9,276Total
      operating revenues
            
            
            1,050,932
            
            
            
            1,003,904Operating
      expenses:Energy
      costs:Purchased
      electricity
            
            
            272,832
            
            
            
            282,092Electric
      generation fuel
            
            
            47,014
            
            
            
            26,058Residential
      exchange
            
            
            (7
            )
            
            
            (34,478
            )Purchased
      gas
            
            
            276,195
            
            
            
            310,647Unrealized
      (gain) loss on derivative instruments
            
            
            88
            
            
            
            (5,782
            )Utility
      operations and maintenance
            
            
            112,163
            
            
            
            98,171Non–utility
      expense and other
            
            
            55
            
            
            
            1,967Depreciation
      and amortization
            
            
            75,367
            
            
            
            69,609Conservation
      amortization
            
            
            13,366
            
            
            
            10,328Taxes
      other than income taxes
            
            
            94,273
            
            
            
            87,069Total
      operating expenses
            
            
            891,346
            
            
            
            845,681Operating
      income
            
            
            159,586
            
            
            
            158,223Other
      income (deductions):Other
      income
            
            
            6,814
            
            
            
            4,764Other
      expense
            
            
            (975
            )
            
            
            (1,031
            )Interest
      charges:AFUDC
            
            
            2,429
            
            
            
            2,416Interest
      expense
            
            
            (51,048
            )
            
            
            (51,261
            )Interest
      expense on Puget Energy note
            
            
            (237
            )
            
            
            (336
            )Income
      before income taxes
            
            
            116,569
            
            
            
            112,775Income
      tax expense
            
            
            35,665
            
            
            
            33,998Net
      income
            
            $
            80,904
            
            
            $
            78,777





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











PUGET
SOUND ENERGY, INC.


CONSOLIDATED
STATEMENTS OF COMPREHENSIVE INCOME


(Dollars
in thousands)


(Unaudited)





Three
      Months Ended
              March
      31,2008
            
            
            2007Net
      income
            
            $
            80,904
            
            
            $
            78,777Other
      comprehensive income:Unrealized
      gain from pension and postretirement plans, net of tax of $95 and $642,
      respectively
            
            
            176
            
            
            
            1,193Net
      unrealized gains on energy derivative instruments during the period, net
      of tax of $25,457 and $1,914, respectively
            
            
            47,277
            
            
            
            3,554Reversal
      of net unrealized losses on energy derivative instruments settled during
      the period, net of tax of $957 and $1,653, respectively
            
            
            1,778
            
            
            
            3,070Amortization
      of financing cash flow hedge contracts to earnings, net of tax of $43 and
      $43, respectively
            
            
            80
            
            
            
            80Other
      comprehensive income
            
            
            49,311
            
            
            
            7,897Comprehensive
      income
            
            $
            130,215
            
            
            $
            86,674





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











PUGET
SOUND ENERGY, INC.


CONSOLIDATED
BALANCE SHEETS


(Dollars
in thousands)





ASSETS





March
      31,
                2008
                (Unaudited)
              
              
              December
      31,
                2007Utility
      plant: (at original cost, including construction work in progress of
      $244,046 and $267,595, respectively)Electric
      plant
              
              $
              5,975,879
              
              
              $
              5,914,127Gas
      plant
              
              
              2,351,247
              
              
              
              2,313,477Common
      plant
              
              
              514,729
              
              
              
              506,211Less:  Accumulated
      depreciation and amortization
              
              
              (3,143,396
              )
              
              
              (3,091,176
              )Net
      utility plant
              
              
              5,698,459
              
              
              
              5,642,639Other
      property and investments:Investment
      in Bonneville Exchange Power contract
              
              
              32,621
              
              
              
              33,503Other
      property and investments
              
              
              113,466
              
              
              
              114,083Total
      other property and investments
              
              
              146,087
              
              
              
              147,586Current
      assets:Cash
              
              
              45,402
              
              
              
              40,773Restricted
      cash
              
              
              799
              
              
              
              798Accounts
      receivable, net of allowance for doubtful accounts
              
              
              342,981
              
              
              
              219,345Secured
      pledged accounts receivable
              
              
              85,000
              
              
              
              152,000Unbilled
      revenues
              
              
              181,632
              
              
              
              210,025Materials
      and supplies, at average cost
              
              
              61,184
              
              
              
              62,114Fuel
      and gas inventory, at average cost
              
              
              40,290
              
              
              
              99,772Unrealized
      gain on derivative instruments
              
              
              97,252
              
              
              
              17,130Prepaid
      income taxes
              
              
              543
              
              
              
              41,814Prepaid
      expenses and other
              
              
              8,219
              
              
              
              11,365Deferred
      income taxes
              
              
              --
              
              
              
              4,011Total
      current assets
              
              
              863,302
              
              
              
              859,147Other
      long-term and regulatory assets:Regulatory
      asset for deferred income taxes
              
              
              100,499
              
              
              
              104,928Regulatory
      asset for PURPA buyout costs
              
              
              132,747
              
              
              
              140,520Power
      cost adjustment mechanism
              
              
              3,149
              
              
              
              3,114Other
      regulatory assets
              
              
              503,559
              
              
              
              512,103Unrealized
      gain on derivative instruments
              
              
              45,122
              
              
              
              11,845Other
              
              
              172,790
              
              
              
              170,328Total
      other long-term and regulatory assets
              
              
              957,866
              
              
              
              942,838Total
      assets
              
              $
              7,665,714
              
              
              $
              7,592,210





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











PUGET
SOUND ENERGY, INC.


CONSOLIDATED
BALANCE SHEETS


(Dollars
in thousands)





CAPITALIZATION
AND LIABILITIES





March
      31,
              2008
              (Unaudited)
            
            
            December
      31,
              2007Capitalization:Common
      shareholder’s investment:Common
      stock ($10 stated value) - 150,000,000 shares authorized, 85,903,791
      shares outstanding
            
            $
            859,038
            
            
            $
            859,038Additional
      paid-in capital
            
            
            1,294,077
            
            
            
            1,297,076Earnings
      reinvested in the business
            
            
            372,373
            
            
            
            345,899Accumulated
      other comprehensive income, net of tax at 35%
            
            
            51,390
            
            
            
            2,078Total
      shareholder’s equity
            
            
            2,576,878
            
            
            
            2,504,091Redeemable
      securities and long-term debt:Preferred
      stock subject to mandatory redemption
            
            
            1,889
            
            
            
            1,889Junior
      subordinated notes
            
            
            250,000
            
            
            
            250,000Long-term
      debt
            
            
            2,278,860
            
            
            
            2,428,860Total
      redeemable securities and long-term debt
            
            
            2,530,749
            
            
            
            2,680,749Total
      capitalization
            
            
            5,107,627
            
            
            
            5,184,840Current
      liabilities:Accounts
      payable
            
            
            283,146
            
            
            
            310,083Short-term
      debt
            
            
            101,604
            
            
            
            260,486Short-term
      note owed to Puget Energy
            
            
            30,000
            
            
            
            15,766Current
      maturities of long-term debt
            
            
            329,500
            
            
            
            179,500Accrued
      expenses:Purchased
      gas liability
            
            
            68,428
            
            
            
            77,864Taxes
            
            
            107,656
            
            
            
            84,756Salaries
      and wages
            
            
            17,551
            
            
            
            28,516Interest
            
            
            58,058
            
            
            
            45,209Unrealized
      loss on derivative instruments
            
            
            4,631
            
            
            
            27,089Deferred
      income taxes
            
            
            10,450
            
            
            
            --Other
            
            
            95,636
            
            
            
            48,918Total
      current liabilities
            
            
            1,106,660
            
            
            
            1,078,187Long-term
      liabilities and regulatory liabilities:Deferred
      income taxes
            
            
            848,285
            
            
            
            821,382Unrealized
      loss on derivative instruments
            
            
            7,001
            
            
            
            --Regulatory
      liabilities
            
            
            210,805
            
            
            
            210,372Other
      deferred credits
            
            
            385,336
            
            
            
            297,429Total
      long-term liabilities and regulatory liabilities
            
            
            1,451,427
            
            
            
            1,329,183Total
      capitalization and liabilities
            
            $
            7,665,714
            
            
            $
            7,592,210





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











PUGET
SOUND ENERGY, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(Dollars
in thousands)


(Unaudited)


Three
      Months Ended
              March
      31,2008
            
            
            2007Operating
      activities:Net
      income
            
            $
            80,904
            
            
            $
            78,777Adjustments
      to reconcile net income to net cash provided by operating
         activities:Depreciation
      and amortization
            
            
            75,367
            
            
            
            69,609Conservation
      amortization
            
            
            13,366
            
            
            
            11,328Deferred
      income taxes and tax credits, net
            
            
            22,327
            
            
            
            11,148Power
      cost adjustment mechanism
            
            
            (35
            )
            
            
            (104
            )Amortization
      of gas pipeline capacity assignment
            
            
            (2,614
            )
            
            
            (2,690
            )Non
      cash return on regulatory assets
            
            
            (3,363
            )
            
            
            (1,823
            )Net
      unrealized loss on derivative instruments
            
            
            88
            
            
            
            (5,782
            )Non
      cash Colstrip settlement
            
            
            10,487
            
            
            
            --Change
      in residential exchange program
            
            
            (921
            )
            
            
            (8,111
            )Storm
      damage deferred costs
            
            
            (179
            )
            
            
            (16,759
            )Other
            
            
            (37
            )
            
            
            6,258Change
      in certain current assets and liabilities:Accounts
      receivable and unbilled revenue
            
            
            25,456
            
            
            
            51,487Materials
      and supplies
            
            
            930
            
            
            
            (7,633
            )Fuel
      and gas inventory
            
            
            59,482
            
            
            
            56,523Prepaid
      income taxes
            
            
            41,271
            
            
            
            497Prepayments
      and other
            
            
            3,146
            
            
            
            (1,833
            )Purchased
      gas receivable/payable
            
            
            (9,436
            )
            
            
            43,666Accounts
      payable
            
            
            (17,884
            )
            
            
            (94,487
            )Taxes
      payable
            
            
            22,900
            
            
            
            30,967Accrued
      expenses and other
            
            
            11,397
            
            
            
            7,298Net
      cash provided by operating activities
            
            
            332,652
            
            
            
            228,336Investing
      activities:Construction
      expenditures - excluding equity AFUDC
            
            
            (126,646
            )
            
            
            (239,681
            )Energy
      efficiency expenditures
            
            
            (14,010
            )
            
            
            (8,964
            )Restricted
      cash
            
            
            (1
            )
            
            
            (1
            )Refundable
      cash received for customer construction projects
            
            
            1,185
            
            
            
            4,456Cash
      proceeds from property sales
            
            
            2,076
            
            
            
            57Other
            
            
            (1,377
            )
            
            
            322Net
      cash used by investing activities
            
            
            (138,773
            )
            
            
            (243,811
            )Financing
      activities:Change
      in short-term debt, net
            
            
            (158,882
            )
            
            
            133,440Dividends
      paid
            
            
            (48,581
            )
            
            
            (26,255
            )Loan
      (payment) from/to Puget Energy
            
            
            14,234
            
            
            
            73Redemption
      of bonds and notes
            
            
            --
            
            
            
            (100,000
            )Investment
      from Puget Energy
            
            
            --
            
            
            
            1,705Issuance
      and redemption cost of bonds and other
            
            
            3,979
            
            
            
            5,104Net
      cash (used) provided by financing activities
            
            
            (189,250
            )
            
            
            14,067Net
      increase (decrease) in cash from net income
            
            
            4,629
            
            
            
            (1,408
            )Cash
      at beginning of year
            
            
            40,773
            
            
            
            28,092Cash
      at end of period
            
            $
            45,402
            
            
            $
            26,684Supplemental
      cash flow information:Cash
      payments for interest (net of capitalized interest)
            
            $
            38,642
            
            
            $
            32,009Cash
      refunds from income taxes
            
            
            (39,730
            )
            
            
            --





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 a holding company that owns Puget Sound Energy,
Inc. (PSE).  PSE is a public utility incorporated in the state of
Washington that furnishes electric and natural gas services in a territory
covering 6,000 square miles, primarily in the Puget Sound
region.


The 2008
and 2007 consolidated financial statements of Puget Energy reflect the accounts
of Puget Energy and its subsidiary, PSE.  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.


The
consolidated financial statements contained in this Form 10-Q are
unaudited.  In the respective opinions of the management of Puget
Energy and PSE, all adjustments necessary for a fair statement 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 Report on Form 10-K for
the year ended December 31, 2007.


The
preparation of financial statements in conformity with generally accepted
accounting principles (GAAP) requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period.  Actual results could differ from those
estimates.


PSE
collected Washington State excise taxes (which are a component of general retail
rates) and municipal taxes of $76.6 million for the three months ended March 31,
2008, and $74.6 million for the three months ended March 31,
2007.  The Company’s policy is to report such taxes on a gross basis
in operating revenues and taxes other than income taxes in the accompanying
consolidated statements of income.




(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 129,428,000 for the three months
ended March 31, 2008, and 116,479,000 for the three months ended March 31,
2007.


Puget
Energy’s diluted earnings per common share have been computed based on
weighted-average common shares outstanding and issuable upon exercise of options
or expiration of vesting periods of 129,940,000 for the three months ended March
31, 2008, and 116,974,000 for the three months ended March 31,
2007.  These shares include the dilutive effect of securities related
to employee and director equity plans.




(3)
            Accounting
      for Derivative Instruments and Hedging
  Activities




Statement
of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative
Instruments and Hedging Activities” (SFAS No. 133), as amended, requires that
all contracts considered to be derivative instruments be recorded on the balance
sheet at their fair value.  The Company enters into contracts to
manage its energy resource portfolio and interest rate exposure including
forward physical and financial contracts, option contracts and
swaps.  The majority of these contracts qualify for the normal
purchase normal sale (NPNS) exception to derivative accounting rules provided
they meet certain criteria.  Generally, NPNS applies if PSE deems the
counterparty creditworthy, if the counterparty owns or controls energy resources
within the western region to allow for physical delivery of the energy and if
the transaction is within PSE’s forecasted load requirements and adjusted from
time to time.  Those contracts that do not meet NPNS exception 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), for energy related derivatives due
to the Power Cost Adjustment (PCA) mechanism and Purchased Gas Adjustment (PGA)
mechanism.


The
nature of serving regulated electric customers with its wholesale portfolio of
owned and contracted electric generation 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 portfolio management
function monitors and manages these risks using analytical models and
tools.  The Company is not engaged in the business of assuming risk
for the purpose of realizing speculative trading revenues.  Therefore,
wholesale market transactions are focused on balancing the Company’s energy
portfolio, reducing costs and risks where feasible and reducing volatility in
wholesale costs and margin in the portfolio.  In order to manage risks
effectively, the Company enters into physical and financial transactions which
are appropriate for the service territory of the Company and are relevant to its
regulated electric and gas portfolios.





The following
table presents electric derivatives that are designated as cash flow hedges or
contracts that do not meet NPNS at March 31, 2008 and December 31,
2007:




Electric
              Derivatives(Dollars
      in Millions)
            
            March
      31,
              2008
            
            December
      31,
              2007Short-term
      asset
            
            $
            53.2
            
            
            $
            11.1Long-term
      asset
            
            
            31.4
            
            
            
            6.6Total
      assets
            
            $
            84.6
            
            
            $
            17.7Short-term
      liability
            
            $
            3.6
            
            
            $
            9.8Long-term
      liability
            
            
            6.6
            
            
            
            --Total
      liabilities
            
            $
            10.2
            
            
            $
            9.8





If it is
determined that it is uneconomical to operate PSE’s controlled electric
generating facilities in the future period, the fuel supply cash flow hedge
relationship is terminated and the hedge is de-designated which results in the
unrealized gains and losses associated with the contracts being recorded in the
income statement.  As these contracts are settled, the costs are
recognized as energy costs and are included as part of the PCA
mechanism.


At
December 31, 2007, the Company had an unrealized day one loss deferral of $9.0
million related to a three-year locational power exchange contract which was
modeled and therefore the day one gain was deferred under EITF No.
02-3.  The contract has economic benefit to the Company over its
terms.  The locational exchange will help ease electric transmission
congestion across the Cascade Mountains during the winter months as PSE will
take delivery of energy at a location that interconnects with PSE’s transmission
system in western Washington.  At the same time, PSE will make
available the quantities of power at the Mid-Columbia trading hub
location.  The day one loss deferral was transferred to retained
earnings on January 1, 2008 as required by SFAS No. 157, “Fair Value
Measurements” and any future day one loss on contracts will be recorded in the
income statement beginning January 1, 2008 in accordance with the
statement.


The
following tables present the impact of changes in the market value of derivative
instruments not meeting NPNS or cash flow hedge criteria, and ineffectiveness
related to highly effective cash flow hedges, to the Company’s earnings during
the three months ended March 31, 2008 and March 31, 2007:





(Dollars in
      Millions)
              Three
      Months Ended March 31,
            2008
            2007
            ChangeIncrease
      (decrease) in earnings
            $
      (0.1)
            $
      5.8
            $
      (5.9)





In the
first quarter 2007, the Company reversed a loss reserve due to credit worthiness
related to a physically delivered natural gas supply contract for electric
generation.  The counterparty’s financial outlook had changed and
delivery was determined to be probable through the life of the contract, which
expires on June 30, 2008.


The
amount of net unrealized gain (loss), net of tax, related to the Company’s cash
flow hedges under SFAS No. 133 consisted of the following at March 31, 2008 and
December 31, 2007:





(Dollars
      in Millions, net of tax)
            March
      31,
              2008
            December
      31,
              2007Other
      comprehensive income – unrealized gain (loss)
            $
      (52.5)
            $  3.4





The
following table presents derivative hedges of natural gas contracts to serve
natural gas customers at March 31, 2008 and December 31, 2007:





Gas
      Derivatives(Dollars
      in Millions)
            
            March
      31,
              2008
            
            December
      31,
              2007Short-term
      asset
            
            $
            44.0
            
            
            $
            6.0Long-term
      asset
            
            
            13.7
            
            
            
            5.3Total
      assets
            
            $
            57.7
            
            
            $
            11.3Short-term
      liability
            
            $
            1.0
            
            
            $
            17.3Long-term
      liability
            
            
            0.4
            
            
            
            --Total
      liabilities
            
            $
            1.4
            
            
            $
            17.3





At March
31, 2008, the Company had total assets of $57.7 million and total liabilities of
$1.4 million related to hedges of natural gas contracts to serve natural gas
customers.  All mark-to-market adjustments relating to the natural gas
business have been reclassified to a deferred account in accordance with SFAS
No. 71 due to the PGA mechanism.  All increases and decreases in the
cost of natural gas supply are passed on to customers with the PGA
mechanism.  As the gains and losses on the hedges are realized in
future periods, they will be recorded as natural gas costs under the PGA
mechanism.




(4)
            Corporate Guarantees(Puget Energy Only)




On May 7,
2006, Puget Energy sold InfrastruX Group Inc. (InfrastruX) to an affiliate of
Tenaska Power Fund, L.P. (Tenaska) in an all-cash transaction.  Puget
Energy accounted for InfrastruX as a discontinued operation under SFAS No. 144,
“Accounting for the Impairment or Disposal of Long-Lived Assets” in
2006.  As a part of the transaction, Puget Energy made certain
representations and warrantees concerning InfrastruX and indemnified Tenaska
against certain future losses not to exceed $15.0 million.  At the
time of the sale, Puget Energy purchased a warrantee insurance policy and
deposited $3.7 million into an escrow account, representing the full retention
under the insurance policy.  Additionally at the time of sale, Puget
Energy recorded a $5.0 million loss reserve in connection with the
indemnifications, which represented management's measurement of the fair value
of the corporate guarantees using a probability weighted approach.


On April
29, 2008, Puget Energy and Tenaska entered into a Joint Notice of Distribution
and Termination Agreement (Termination Agreement) that would result in the
extinguishment of all InfrastruX corporate guarantees made by Puget Energy in
connection with the sale of InfrastruX.  Under the terms of the
Termination Agreement, Puget Energy has agreed to release approximately $3.6
million of the $4.0 million currently held in the escrow account balance to
InfrastruX and make an additional payment of approximately $3.2 million in the
second quarter 2008.  In aggregate, payments will approximate the
remaining loss reserves recorded by Puget Energy at March 31, 2008 and thus will
not have a material impact on Puget Energy’s financial results for
2008.




(5)
            Retirement
      Benefits




The
Company has a defined benefit pension plan covering substantially all PSE
employees, with a cash balance feature for all but International Brotherhood of
Electrical Workers (IBEW) employees.  Benefits are a function of age,
salary and service.  Puget Energy also maintains a non-qualified
supplemental retirement plan for officers and certain director-level
employees.


The
following table summarizes the net periodic benefit cost for the three months
ended March 31:





Pension
      Benefits
            
            
            Other
      Benefits(Dollars
      in Thousands)
            
            2008
            
            
            2007
            
            
            2008
            
            
            2007Service
      cost
            
            $
            3,288
            
            
            $
            3,263
            
            
            $
            43
            
            
            $
            91Interest
      cost
            
            
            7,051
            
            
            
            6,570
            
            
            
            283
            
            
            
            379Expected
      return on plan assets
            
            
            (10,455
            )
            
            
            (9,750
            )
            
            
            (197
            )
            
            
            (205
            )Amortization
      of prior service cost
            
            
            315
            
            
            
            511
            
            
            
            21
            
            
            
            134Recognized
      net actuarial (gain) loss
            
            
            183
            
            
            
            1,173
            
            
            
            (199
            )
            
            
            (56
            )Amortization
      of transition obligation
            
            
            --
            
            
            
            --
            
            
            
            13
            
            
            
            105Net
      periodic benefit cost
            
            $
            382
            
            
            $
            1,767
            
            
            $
            (36
            )
            
            $
            448





The
Company previously disclosed in its financial statements for the year ended
December 31, 2007 that it expected to contribute $4.0 million and less than $0.1
million to fund the non-qualified pension and other benefits plans for the year
ending December 31, 2008, respectively.  During the three months ended
March 31, 2008, the actual cash contributions to the Company’s non-qualified
pension plans were $0.4 million.  Based on this activity, the Company
anticipates contributing an additional $3.6 million to the Company’s
non-qualified pension plan for the remaining period of 2008.  During
the three months ended March 31, 2008, actual other post-retirement medical
benefit plan contributions were less than $0.1 million and the Company does not
expect to make additional contributions for the remaining periods of
2008.




(6)
            Regulation
      and Rates




On April
11, 2007, the Washington Utilities and Transportation Commission (Washington
Commission) issued an accounting order that authorized PSE to defer certain
ownership and operating costs (and associated carrying costs) incurred related
to its purchase of the Goldendale electric generating facility (Goldendale)
during the period prior to inclusion in PSE’s retail electric rates in the Power
Cost Only Rate Case (PCORC).  The deferral was for the time period
from March 15, 2007 through September 1, 2007, at which time the Company began
recovering Goldendale ownership and operation costs in electric
rates.  As of March 31, 2008, PSE had established a regulatory asset
of $11.8 million.  PSE anticipates amortization of the costs will
begin no later than November 2008 as determined in PSE’s pending general rate
case.


In May
2007, the Washington Commission Staff alleged that PSE’s natural gas system
service provider had violated certain Washington Commission recordkeeping
rules.  The Washington Commission filed a complaint against PSE that
included Washington Commission Staff’s recommendation that PSE be assessed a
$2.0 million regulatory penalty.  On April 3, 2008, the Washington
Commission issued an order approving a settlement agreement that requires PSE to
pay a regulatory penalty of $1.25 million, to establish a quality control
program to better monitor its subcontractors and to complete an independent
audit of natural gas system recordkeeping procedures.  At March 31,
2008, PSE adjusted its loss reserve to $1.25 million for this
penalty.


On May
21, 2007, the Bonneville Power Administration (BPA) notified PSE and other
investor-owned utilities that BPA was suspending payments related to its
Residential Exchange Program (REP) due to adverse Ninth Circuit Court of Appeals
(Ninth Circuit) decisions issued on May 3, 2007.  The Ninth Circuit
concluded in its decisions that certain BPA actions in entering into residential
exchange settlements in 2000 were not in accordance with the law.  As
a result of the BPA suspension of payment, PSE filed revisions to the tariffs
which pass-through the benefits of the REP to all residential and small farm
customers.  Under federal law investor-owned utilities receiving REP
benefits must pass-through the benefits to their residential and small farm
electric customers.  The Washington Commission approved the tariff
revisions terminating the REP credit effective June 7, 2007.


At the
time of the suspension of payments, PSE had a credit of REP payments to
customers.  Accordingly, in addition to terminating the REP credit,
PSE also filed an accounting petition seeking approval to record carrying costs
on the deferred asset balance until it is recovered from
customers.  On August 29, 2007, the Washington Commission approved
PSE’s accounting petition to defer as a regulatory asset the excess REP benefit
provided to customers and accrue monthly carrying charges on the deferred
balance from June 7, 2007 until the deferral is recovered from customers or
BPA.  As of March 31, 2008, PSE has recorded a regulatory asset,
including carrying costs, of $36.6 million.


On
December 17, 2007, BPA released a proposal for public comment which would
provide temporary, interim relief to the region’s investor-owned utilities until
final REP contracts are reached and executed which are planned to go into effect
October 1, 2008.  These interim agreements are offered in exchange for
suspension of certain litigation activities, and will be trued-up to the actual
final REP benefits for each individual company as established in BPA’s upcoming
administrative proceedings.In March 2008,
BPA and PSE signed an agreement pursuant to which BPA (on April 2, 2008) paid
PSE $53.7 million in REP benefits for fiscal year ending September 30, 2008,
which payment is subject to true-up depending upon the amount of any REP
benefits ultimately determined to be payable to PSE.


On April
10, 2008, the Washington Commission approved PSE’s tariff filing seeking to
pass-through the net amount of the benefits under the interim agreements to
residential and small farm customers.  The Washington Commission also
approved PSE’s request to credit the regulatory asset amount of $33.7 million
against the $53.7 million payment and pass-through to customers the remaining
amount of approximately $20.0 million.  These amounts will not affect
PSE’s net income.  The accrued carrying charges on the regulatory
asset totaling $2.9 million at March 31, 2008 will be addressed in PSE’s pending
general rate case (Docket No. UE-072300).


In
November 2007, PSE was audited by the Western Electricity Coordinating Council
(WECC) under delegated authority of the North American Electric Reliability
Corporation (NERC), the FERC-certified Electric Reliability Organization
(ERO).  Previously, PSE had submitted several self-reports and mitigation
plans to WECC for review and approval.  The WECC audit team identified
four additional potential violations that were not previously
self-reported.  In response, PSE submitted self-reports and mitigation
plans for the four violations.  WECC issued the final audit report on
March 28, 2008.  As of April 16, 2008, PSE had not received notice of
penalties, but has established a loss reserve of $0.6 million related to these
potential violations.




(7)
            Litigation




Residential
Exchange.  Petitioners in several actions in the Ninth Circuit
against BPA asserted that BPA acted contrary to law in entering into or
performing or implementing a number of agreements, including the amended
settlement agreement (and the May 2004 agreement) between BPA and PSE regarding
the REP.  BPA rates used in such agreements between BPA and PSE for
determining the amounts of money to be paid to PSE by BPA under such agreements
during the period October 1, 2001 through September 30, 2006 were confirmed,
approved and allowed to go into effect by the Federal Energy Regulatory
Commission (FERC).  Petitioners in several actions in the Ninth
Circuit against BPA also asserted that BPA acted contrary to law in adopting or
implementing the rates upon which the benefits received or to be received from
BPA during the October 1, 2001 through September 30, 2006 period were
based.  A number of parties have claimed that the BPA rates proposed
or adopted in the BPA rate proceeding to develop BPA rates to be used in the
agreements for determining the amounts of money to be paid to PSE by BPA during
the period October 1, 2006 through September 30, 2009 are contrary to law and
that BPA acted contrary to law or without authority in deciding to enter into,
or in entering into or performing or implementing such agreements.  In
March 2008, BPA requested FERC to continue a stay of FERC’s review of such rates
in light of the reopened rate proceeding described below arising out of the
Ninth Circuit litigation.


On May 3,
2007, the Ninth Circuit issued an opinion in Portland Gen. Elec. v. BPA,
No. 01-70003, in which proceeding the actions of BPA in entering into settlement
agreements regarding the BPA REP with PSE and with other investor-owned
utilities were challenged.  In this opinion, the Ninth Circuit granted
petitions for review and held the settlement agreements entered into between BPA
and the investor-owned utilities being challenged in that proceeding to be
inconsistent with statute.  On May 3, 2007, the Ninth Circuit also
issued an opinion in Golden
Northwest Aluminum v. BPA, No. 03-73426, in which proceeding the
petitioners sought review of BPA’s 2002-06 power rates.  In this
opinion, the Ninth Circuit granted petitions for review and held that BPA
unlawfully shifted onto its preference customers the costs of its settlements
with the investor-owned utilities.  On October 5, 2007, petitions for
rehearing of these two opinions were denied.  On February 1, 2008, PSE
and other utilities filed in the U.S. Supreme Court a petition for a writ of
certiorari to review the decisions of the Ninth Circuit.


In May
2007, following the Ninth Circuit’s issuance of these two opinions, BPA
suspended payments to PSE under the amended settlement agreement (and the May
2004 agreement).  On August 29, 2007, the Washington Commission
approved PSE’s accounting petition to defer as a regulatory asset the excess BPA
Residential Exchange benefit provided to customers and accrue monthly carrying
charges on the deferred balance from June 7, 2007 until the deferral is
recovered from customers or BPA.  As of March 31, 2008, PSE has a
regulatory asset, including carrying cost, of $36.6 million.  On
October 11, 2007, the Ninth Circuit remanded the May 2004 agreement to BPA in
light of the Portland Gen.
Elec. V. BPA opinion and dismissed the remaining three pending cases
regarding settlement agreements.


On
February 8, 2008, BPA issued a notice reopening its WP-07 rate proceeding to
respond to the various Ninth Circuit opinions.  In the notice, BPA
proposed to adjust its fiscal year 2009 rates and to determine the amounts of
Residential Exchange benefits paid since 2002 that may be
recovered.  BPA is proposing to determine an amount that was
improperly passed through to residential and small farm customers of PSE and the
other regional investor-owned utilities during the 2002 to 2008 rate periods and
to recover this amount over time by reducing future benefits under the
REP.  The amount to be recovered over future periods from PSE’s
residential and small farm customers in BPA’s initial proposal is approximately
$150.0 million.  However, this is an initial proposal and is subject
to BPA’s rate case process resulting in a final decision in approximately August
2008, and is also subject to subsequent administrative and judicial
review.


In March
2008, BPA and PSE signed an agreement pursuant to which BPA made a payment to
PSE related to the REP benefits for the fiscal year ending September 30, 2008,
which payment is under such agreement subject to true-up depending upon the
amount of any REP benefits ultimately determined to be payable to
PSE.  In March and April 2008, Clatskanie People’s Utility District
filed petitions in the Ninth Circuit for review of BPA actions in connection
with offering or entering into such agreement with PSE and similar agreements
with other investor-owned utilities.


It is not
clear what impact, if any, such reopened rate proceeding, development or review
of such rates, review of such agreements and the above described Ninth Circuit
litigation may ultimately have on PSE.


Proceedings Relating to the Western
Power Market.  PSE is vigorously defending each case in the
western power market proceedings.  Litigation is subject to numerous
uncertainties and PSE is unable to predict the ultimate outcome of these
matters.  Accordingly, there can be no guarantee that these
proceedings, either individually or in the aggregate, will not materially and/or
adversely affect PSE’s financial condition, results of operations or
liquidity.


Lockyer Case.In
March and April 2008, FERC issued orders establishing procedures for the Lockyer
remand.  The orders commence a seller-by-seller inquiry into the
transaction reports filed by entities that sold power in California during
2000.  The inquiry is to determine if the transaction reports as filed
masked the gathering of more than 20% of the market during the period, by that
seller.  PSE is confident that it will not be found to have possessed
20% of any relevant market during any relevant time.  The order also
mandates a settlement process before an Administrative Law Judge.  The
California parties sought rehearing of these orders on April 21,
2008.


California Receivable and California
Refund Proceeding.On March 18, 2008, the California Independent System
Operator (CAISO) filed a status report with its calculations of interest owed by
and owing to parties.  The report also identified further work to
perform in the CAISO’s “who owes what to whom” calculation.  On March
25, 2008, FERC issued an order addressing, among other things, 11 pending
rehearing requests by the California parties – all of which the order
rejected.


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 investigated
26 entities that allegedly had potential “partnerships” with
Enron.  PSE was not named in that show cause order.  On
January 22, 2004, FERC stated that it did not intend to proceed further against
other parties.


The
second show cause order 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 a nominal amount to settle all
claims.  FERC approved the settlement on January 22,
2004.  The California parties filed for rehearing of that
order.  On March 17, 2004, PSE moved to dismiss the California
parties’ rehearing request and awaits FERC action on that motion.


Pacific Northwest Refund
Proceeding.In October 2000, PSE filed a complaint at FERC
(Docket No. EL01-10) against “all jurisdictional sellers” in the Pacific
Northwest seeking prospective price caps consistent with any result FERC ordered
for the California markets.  FERC dismissed PSE’s complaint, but PSE
challenged that dismissal.  On June 19, 2001, FERC ordered price
caps on energy sales throughout the West.  Various parties, including
the Port of Seattle and the cities of Seattle and Tacoma, then moved to
intervene in the proceeding seeking retroactive refunds for numerous
transactions.  The proceeding became known as the “Pacific Northwest
Refund Proceeding,” though refund claims were outside the scope of the
original complaint.  On June 25, 2003, FERC terminated the proceeding
on procedural, jurisdictional and equitable grounds and on November 10, 2003,
FERC on rehearing, confirmed the order terminating the proceeding.  On
August 24, 2007, the Ninth Circuit issued a decision concluding that FERC should
have evaluated and considered evidence of market manipulation in California and
its potential impact in the Pacific Northwest.  It also decided that
FERC should have considered purchases made by the California Energy Resources
Scheduler and/or the California Department of Water Resources in the Pacific
Northwest Proceeding.  On December 17, 2007, PSE and Powerex
separately filed requests for rehearing with the Ninth Circuit of this
decision.  Those requests remain pending.  PSE intends to
vigorously defend its position in this proceeding, but it is unable to predict
the outcome of this matter.


Colstrip
Matters.  In May
2003, approximately 50 plaintiffs brought an action against the owners of
Colstrip which has since been amended to add additional claims.  The
lawsuit alleges that (1) seepage from two different wastewater pond areas caused
groundwater contamination and threatened to contaminate domestic water wells and
the Colstrip water supply pond, and (2) seepage from the Colstrip water supply
pond caused structural damage to buildings and toxic mold.  Plaintiffs
were seeking compensatory (including but not limited to unjust enrichment and
abatement) and punitive damages.  After a failed attempt at settlement
in 2004, PSE established a reserve of approximately $0.7 million, of which $0.5
million was for PSE’s share of costs to extend city water to 13 plaintiffs and
PSE reduced its reserve to approximately $0.2 million.  Discovery was
completed and trial was scheduled for June 2008. Recent
developments in the litigation have caused PSE to change its
reserve.  On February 15, 2008, plaintiffs submitted supplemental
expert disclosures which, among other things, alleged new abatement claims
significantly higher than prior allegations.  On April 11, 2008 the
trial court judge issued an order denying defendant’s motion to dismiss
plaintiffs’ substantial unjust enrichment claims.  On April 22, 2008
the trial court judge issued an order that PSE along with two other defendants
would be held liable on all counts, including a finding of malice for punitive
damages, as a discovery sanction.    Although the defendants
submitted a motion for reconsideration of this sanction on April 25, 2008, the
defendants reached agreement on a global settlement with all plaintiffs on April
29, 2008 and PSE’s share of that settlement is approximately $10.7
million.  PSE expects settlement documents to be finalized in the
second quarter 2008 and as a result have increased the reserve to $10.7
million.  PSE is also evaluating whether it will file an accounting
petition to defer such costs.
 The
Minerals Management Service of the United States Department of Interior
(MMS) has issued a series of orders to Western Energy Company (WECO) to pay
additional taxes and royalties concerning coal WECO sold to the owners of
Colstrip 3 & 4, and similar orders have been issued in the administrative
appellate process.  The orders assert that additional royalties are
owed in connection with payments received by WECO from Colstrip 3
& 4 owners (including PSE) for the construction and operation of a
conveyor system that runs several miles from the mine to Colstrip 3 &
4.  The state of Montana has also issued a demand to WECO consistent
with the MMS position.  WECO has challenged these orders, and the
issue has been on appeal for several years.WECO has won
some points during the appellate process that have reduced the claims--but under
applicable law, to pursue the appeals, the principal in dispute cannot be paid,
which causes interest to accrue.  Moreover, because the conveyor
system continues to be used, the amount in
dispute grows.  In the aggregate, the accrued
interest--plus unasserted claims to bring the amount
current--could make the total claim (principal plus interest) pertaining to
PSE’s 25% project share as high as $10 million.  PSE is unable to
predict the ultimate outcome of this dispute.  PSE believes a future loss
in connection with this dispute is reasonably possible but not probable, and has
not recorded a loss reserve.   Proceeding Relating to the Proposed
Merger.On October 26, 2007 and November 2, 2007,
two separate lawsuits were filed against the Company and all of the members of
the Company’s Board of Directors in Superior Court in King County,
Washington.  The lawsuits, respectively, are entitled, Tansey v. Puget Energy, Inc.,
et al., Case No. 07-2-34315-6 SEA and Alaska Ironworkers Pension Trust v.
Puget Energy, Inc., et al., Case No. 07-2-35346-1
SEA.  The lawsuits are both denominated as class actions purportedly
on behalf of Puget Energy’s shareholders and assert substantially similar
allegations and causes of action relating to the proposed merger.  The
complaints allege that Puget Energy’s directors breached their fiduciary duties
in connection with the merger and seek virtually identical relief, including an
order enjoining the consummation of the merger.  Pursuant to a court
order dated November 26, 2007, the two cases were consolidated for all
purposes and entitled In re
Puget Energy, Inc. Shareholder Litigation, Case No. 07-2-34315-6
SEA.


On
February 6, 2008, the parties entered into a memorandum of understanding
providing for the settlement of the consolidated lawsuit, subject to customary
conditions including completion of appropriate settlement documentation,
confirmatory discovery and court approval.  Pursuant to the memorandum
of understanding, the Company agreed to include certain additional disclosures
in its proxy statement relating to the merger.  The Company does not
admit, however, that its prior disclosures were in any way materially misleading
or inadequate.  In addition, the Company and the other defendants in
the consolidated lawsuit deny the plaintiffs’ allegations of wrongdoing and
violation of law in connection with the merger.  The settlement, if
completed and approved by the court, will result in dismissal with prejudice and
release of all claims of the plaintiffs and settlement class of the Company’s
shareholders that were or could have been brought on behalf of the plaintiffs
and the settlement class.  In connection with such settlement, the
plaintiffs intend to seek a court-approved award of attorneys’ fees and expenses
in an amount up to $290,000, which the Company has agreed to pay.  At
March 31, 2008, the Company has a loss reserve of $290,000 recorded at March 31,
2008 related to this matter.




(8)
            Related
      Party Transactions




On June
1, 2006, PSE entered into a revolving credit facility with its parent, Puget
Energy, in the form of a Demand Promissory Note (Note).  Through the
Note, PSE may borrow up to $30.0 million from Puget Energy, subject to approval
by Puget Energy.  Under the terms of the Note, PSE pays interest on
the outstanding borrowings based on the lowest of the weighted-average interest
rate of (a) PSE’s outstanding commercial paper interest rate; (b) PSE’s senior
unsecured revolving credit facility; or (c) the interest rate available under
the receivable securitization facility of PSE Funding, Inc. (PSE Funding), a PSE
subsidiary, which is the London Interbank Offered Rate (LIBOR) plus a marginal
rate.  At March 31, 2008 and December 31, 2007, the outstanding
balance of the Note was $30.0 million and $15.8 million, respectively and the
interest rate was 3.57% and 5.31%, respectively.  The outstanding
balance and the related interest under the Note are eliminated by Puget Energy
upon consolidation of PSE’s financial statements.  The $30.0 million
credit facility with Puget Energy is unaffected by the pending
merger.


During
2007, the Company purchased certain insurance policies from AEGIS and had three
insurance claim receivables from AEGIS totaling $7.7 million and $15.2 million
at March 31, 2008 and December 31, 2007, respectively.  One
nonemployee director of Puget Energy and PSE also serves on the board of AEGIS
and a PSE management employee serves on one of AEGIS’ risk management
committees.




(9)
            Other




FASB
Interpretation No. 46R, “Consolidation of Variable Interest Entities” (FIN 46R)
requires that if a business entity has a controlling financial interest in a
variable interest entity, the financial statements of the variable interest
entity must be included in the consolidated financial statements of the business
entity.  The Company has evaluated its power purchase agreements and
determined that two counterparties during the three months ended March 31, 2008
may be considered variable interest entities.  Consistent with FIN
46R, PSE submitted requests for information to those two entities; however, the
entities 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 that it does not have a contractual right
to such information.  PSE will continue to submit requests for
information to the counterparties in accordance with FIN 46R.


Sumas
Cogeneration Company, L.P. (Sumas), an entity that potentially could have been
considered a variable interest entity prior to May 7, 2007, delivered a letter
to PSE on May 7, 2007, stating that it had sold its dedicated natural gas
reserves to a third party and that it no longer intended to deliver energy to
PSE through the remaining term of the contract, which expires on April 15,
2013.  The last energy delivered to PSE by Sumas occurred on March 15,
2007.  Following negotiations to resolve the breach of contract with
Sumas on December 7, 2007, PSE and Sumas signed a Membership Interest Purchase
and Sale Agreement for the acquisition of the 125 MW power plant located in
Sumas, Washington.  Sumas also agreed to transfer an undivided
ownership interest in the pipeline easements to PSE.  PSE expects the
transaction to close in the second half of 2008, after it receives approval from
FERC and presidential permits to operate the natural gas pipeline.


For the
two power purchase agreements that may be considered variable interest entities
under FIN 46R as of the first quarter 2008, PSE is required to buy all the
generation from these plants, subject to displacement by PSE, at rates set forth
in the power purchase 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 power purchase
agreement prices.  PSE’s purchased electricity expense for the three
months ended March 31, 2008 was $54.9 million for the two entities and for the
three months ended March 31, 2007 was $66.6 million for the three
entities.


In
November 2006, PSE’s Crystal Mountain Generation Station had an accidental
release of approximately 18,000 gallons of diesel fuel.  PSE crews and
consultants responded and worked with applicable state and federal agencies to
control and remove the spilled diesel.  On July 11, 2007, PSE received
a Notice of Completion for work performed pursuant to the Administrative Order
for Removal from the U. S. Environmental Protection Agency (EPA).  The
Notice stated that PSE had met the requirements of the Order and the
accompanying scope of work.  Total removal costs as of March 31, 2008
were approximately $14.1 million.  PSE estimates the total remediation
cost to be approximately $15.0 million, which has been accrued or
paid.  At March 31, 2008, PSE had an insurance receivable recorded in
the amount of $7.6 million associated with this fuel release.  PSE
received a partial payment of $5.0 million on this receivable in January
2008.  On February 13, 2008, the U.S. Department of Justice, on behalf
of the EPA, notified PSE of its intent to issue a fine of $0.5 million under the
Clean Water Act.  PSE has since agreed to pay this fine.  On
April 15, 2008, the Washington State Department of Ecology fined PSE $0.4
million as a civil penalty pursuant to the Clean Water Act.  PSE
reserved $1.0 million for the penalties in 2006.


As of
March 31, 2008, PSE had $18.1 million in insurance receivables recorded related
to two property damage claims and a general liability claim.  As of
March 31, 2008, PSE has received $8.8 million in payments from the insurers
associated with these claims.  $10.1 million of the receivable balance
represents an estimate based on the cost that would have been incurred to
repair, rather than replace, the damaged parts.  If PSE does not
receive full recovery of this receivable, the accrued amount will be recorded to
utility plant.




(10)
            New
      Accounting Pronouncements




On
September 15, 2006, FASB issued SFAS No. 157, which clarifies how companies
should use fair value measurements in accordance with GAAP for recognition and
disclosure purposes.  SFAS No. 157 establishes a common definition of
fair value and a framework for measuring fair value under GAAP, along with
expanding disclosures about fair value to eliminate differences in current
practice that exist in measuring fair value under the existing accounting
standards.  The definition of fair value in SFAS No. 157 retains the
notion of exchange price; however, it focuses on the price that would be
received to sell the asset or paid to transfer a liability (i.e. an exit price),
rather than the price that would be paid to acquire the asset or received to
assume the liability (i.e. an entrance price).  Under SFAS No. 157, a
fair value measure should reflect all of the assumptions that market
participants would use in pricing the asset or liability, including assumptions
about the risk inherent in a particular valuation technique, the effect of a
restriction on the sale or use of an asset, and the risk of
nonperformance.  To increase consistency and comparability in fair
value measures, SFAS No. 157 establishes a three-level fair value hierarchy to
prioritize the inputs used in valuation techniques between observable inputs
that reflect quoted market prices in active markets, inputs other than quoted
prices with observable market data, and unobservable data (e.g. a company’s own
data).


SFAS No.
157 is effective for fiscal years beginning after November 15, 2007, which was
January 1, 2008, for the Company.  On February 28, 2008, the FASB
issued a final FASB Staff Position (FSP) that partially deferred the effective
date of SFAS No. 157 for one year for non-financial assets and non-financial
liabilities that are recognized or disclosed at fair value, except for those
that are recognized or disclosed at fair value on an annual or more frequent
basis.  The Company adopted SFAS No. 157 on January 1, 2008,
prospectively, as required by the Statement, with certain
exceptions,  including the initial impact of changes in fair value
measurements of existing derivative financial instruments measured initially
using the transaction price under EITF 02-3.  On January 1, 2008, the
difference between the carrying amounts and the fair values of those instruments
originally recorded under guidance in EITF 02-3 was recognized as a
cumulative-effect adjustment to the opening balance of retained
earnings.  SFAS No. 157 nullified a portion of EITF
02-3.  Under EITF 02-3, the transaction price presumption prohibited
recognition of a trading profit at inception of a derivative unless the positive
fair value of that derivative was substantially based on quoted prices or a
valuation process incorporating observable inputs.  For transactions
that did not meet this criterion at inception, trading profits that had been
deferred were recognized in the period that inputs to value the derivative
became observable or when the contract performed.


On March
19, 2008, FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities – An Amendment of FASB Statement No. 133” (SFAS No.
161).  SFAS No. 161 is effective for the fiscal years and interim
years beginning after November 15, 2008, which will be the quarter ended March
31, 2009 for the Company.  SFAS No. 161 requires companies with
derivative instruments to disclose information that should enable financial
statement users to understand how and why a company uses derivative instruments,
how derivative instruments and related hedged items are accounted for under SFAS
No. 133 and how derivative instruments and related hedged items affect a
company’s financial position, financial performance and cash
flows.  SFAS No. 161 requirements will impact the following derivative
and hedging disclosures: objectives and strategies, balance sheet, financial
performance, contingent features and counterparty credit risk.  The
Company is currently assessing the impact of SFAS No. 161.




(11)
            Fair
      Value Measurements




Effective
January 1, 2008, the Company adopted SFAS No. 157 which clarifies how companies
should use fair value measurements and requires enhanced disclosures about
assets and liabilities carried at fair value.


As
defined in SFAS No. 157, fair value is the price that would be received to sell
an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date (exit price).  However, as
permitted under SFAS No. 157, the Company utilizes a mid-market pricing
convention (the mid-point price between bid and ask prices) as a practical
expedient for valuing the majority of its assets and liabilities measured and
reported at fair value.  The Company utilizes market data or
assumptions that market participants would use in pricing the asset or
liability, including assumptions about risk and the risks inherent in the inputs
to the valuation technique.  These inputs can be readily observable,
market corroborated, or generally unobservable.  The Company primarily
applies the market approach for recurring fair value measurements and endeavors
to utilize the best available information.  Accordingly, the Company
utilizes valuation techniques that maximize the use of observable inputs and
minimize the use of unobservable inputs.


PSE
values derivative instruments based on daily quoted prices from numerous
independent energy brokerage services.  When external quoted market
prices are not available for derivative contracts, PSE uses a valuation model
that uses volatility assumptions relating to future energy prices based on
specific energy markets and utilizes externally available forward market price
curves.  All derivative instruments are sensitive to market price
fluctuations that can occur on a daily basis.  The Company is focused
on commodity price exposure and risks associated with volumetric variability in
the natural gas and electric portfolios.  It is not engaged in the
business of assuming risk for the purpose of speculative trading.  The
Company hedges open natural gas and electric positions to reduce both the
portfolio risk and the volatility risk in prices.  The exposure
position is determined by using a probabilistic risk system that models 100
scenarios of how the Company’s natural gas and power portfolios will perform
under various weather, hydro and unit performance conditions.  PSE has
not made any material changes during the reporting period to those techniques or
models.


The
Company is able to classify fair value balances based on the observability of
those inputs.  SFAS No. 157 establishes a fair value hierarchy that
prioritizes the inputs used to measure fair value.  The hierarchy
gives the highest priority to unadjusted quoted prices in active markets for
identical assets or liabilities (Level 1 measurement) and the lowest priority to
unobservable inputs (Level 3 measurement).  The three levels of the
fair value hierarchy defined by SFAS No. 157 are as follows:





Level 1 –
Quoted prices are available in active markets for identical assets or
liabilities as of the reporting date.  Active markets are those in
which transactions for the asset or liability occur in sufficient frequency and
volume to provide pricing information on an ongoing basis.  Level 1
primarily consists of financial instruments such as exchange-traded derivatives
and listed equities.





Level 2 –
Pricing inputs are other than quoted prices in active markets included in Level
1, which are either directly or indirectly observable as of the reported
date.  Level 2 includes those financial instruments that are valued
using models or other valuation methodologies.  These models are
primarily industry-standard models that consider various assumptions, including
quoted forward prices for commodities, time value, volatility factors, and
current market and contractual prices for the underlying instruments, as well as
other relevant economic measures.  Substantially all of these
assumptions are observable in the marketplace throughout the full term of the
instrument, can be derived from observable data or are supported by observable
levels at which transactions are executed in the
marketplace.  Instruments in this category include non-exchange-traded
derivatives such as OTC forwards and options.





Level 3 –
Pricing inputs include significant inputs that are generally less observable
from objective sources.  These inputs may be used with internally
developed methodologies that result in management’s best estimate of fair
value.  Level 3 instruments include those that may be more structured
or otherwise tailored to customers’ needs.  At each balance sheet
date, the Company performs an analysis of all instruments subject to SFAS No.
157 and includes in Level 3 all of those whose fair value is based on
significant unobservable inputs.





The
following table sets forth by level within the fair value hierarchy the
Company’s financial assets and liabilities that were accounted for at fair value
on a recurring basis as of March 31, 2008.  As required by SFAS No.
157, financial assets and liabilities are classified in their entirety based on
the lowest level of input that is significant to the fair value
measurement.  The Company’s assessment of the significance of a
particular input to the fair value measurement requires judgment and may affect
the valuation of fair value assets and liabilities and their placement within
the fair value hierarchy levels.  The determination of the fair values
incorporates various factors required under SFAS No. 157.  These
factors include not only the credit standing of the counterparties involved and
the impact of credit enhancements (such as cash deposits, letters of credit and
priority interests), but also the impact of the Company’s nonperformance risk on
its liabilities.




Recurring
      Fair Value Measures
              
              At
      Fair Value as of March 31, 2008(Dollars
      in Millions)
              
              Level
      1
              
              
              Level
      2
              
              
              Level
      3
              
              
              TotalAssets:Energy
      derivative instruments
              
              $
              --
              
              
              $
              107.8
              
              
              $
              34.6
              
              
              $
              142.4Other
      financial items
              
              
              --
              
              
              
              --
              
              
              
              --
              
              
              
              --Total
      assets
              
              $
              --
              
              
              $
              107.8
              
              
              $
              34.6
              
              
              $
              142.4Liabilities:Energy
      derivative instruments
              
              $
              --
              
              
              $
              1.4
              
              
              $
              10.2
              
              
              $
              11.6Other
      financial items
              
              
              --
              
              
              
              --
              
              
              
              7.2
              
              
              
              7.2Total
      liabilities
              
              $
              --
              
              
              $
              1.4
              
              
              $
              17.4
              
              
              $
              18.8


The
following table sets forth a reconciliation of changes in the fair value of
derivatives classified as Level 3 in the fair value hierarchy.




(Dollars
      in millions)
            
            Three
      Months
              Ended
              March
      31, 2008Balance
      as of January 1, 2008
            
            $
            (7.3
            )Realized
      energy derivative losses
            
            
            (1.9
            )Unrealized
      energy derivative gains / (losses)-
      included in earnings
            
            
            (1.5
            )-
      included in other comprehensive income
            
            
            26.4New
      energy purchase transactions
            
            
            2.6Energy
      derivatives transferred out of Level 3
            
            
            (1.1
            )Balance
      as of March 31, 2008
            
            $
            17.2





The
Company believes an analysis of energy derivative instruments classified as
Level 3 should take into account the fact that these items are generally
economically hedged as a portfolio with instruments that may be classified in
Levels 1 and 2.  Realized gains and losses on energy derivatives for
Level 3 recurring items are included in Energy Costs in PSE’s income statement
under purchased electricity, electric generation fuel or purchased gas when
settled.


Unrealized
gains and losses for Level 3 on energy derivatives recurring items are included
in net unrealized (gain) loss on derivative instruments in PSE’s income
statement.  SFAS No. 157 requires that financial assets and
liabilities be classified in their entirety based on the lowest level of input
that is significant to the fair value measurement.  As of March 31,
2008, energy derivative instruments are classified in Level 3 because Level 3
inputs are significant to their fair value measurement; however, the valuation
of these derivative instruments is primarily based upon observable inputs (Level
2), and the net unrealized gain recognized during the reporting period is
primarily due to a significant increase in observable prices.


Energy
derivatives transferred out represent existing assets or liabilities that were
either previously classified as Level 3 for which the lowest significant input
became observable during the period.


The
Company does not believe that the fair values diverge materially from the
amounts the Company currently anticipates realizing on settlement or
maturity.


Other
financial items valuation is described in Note 4 “Corporate
Guarantees.”




(12)
            Agreement
      and Plan of Merger (Puget Energy
only)




On
October 26, 2007, Puget Energy announced that it had entered into a definitive
Agreement and Plan of Merger, dated as of October 25, 2007, pursuant to which
Puget Energy will be acquired by a consortium of long-term infrastructure
investors led by Macquarie Infrastructure Partners, the Canada Pension Plan
Investment Board and British Columbia Investment Management Corporation and also
includes Alberta Investment Management, Macquarie-FSS Infrastructure Trust and
Macquarie Capital Group (collectively, the Consortium).  At the
effective time of the merger, each issued and outstanding share of common stock
of Puget Energy, other than any shares in respect of which dissenter’s rights
are perfected and other than any shares owned by the Consortium, shall be
cancelled and shall be converted automatically into the right to receive $30.00
in cash, without interest.


The
consummation of the merger is subject to the satisfaction or waiver of certain
closing conditions, including the receipt of shareholder approval of the merger
and approval of it by various state and federal regulatory
authorities.  As of the date of this 10-Q, some of these conditions
have been satisfied while others remain outstanding or in process.  On
April 16, 2008, Puget Energy shareholders approved the merger by more than the
required two-thirds vote.  Also, on April 17, 2008, FERC conditionally
approved the transaction pursuant to section 203 of the Federal Power Act
subject to reviewing the final conditions of merger approval by the Washington
Commission.  On December 17, 2007, PSE and the Consortium filed a
joint application seeking approval of the merger with the Washington
Commission.  According to the procedural schedule set in the merger
proceeding, a decision by the Washington Commission is expected on September 2,
2008.  If approved by the Washington Commission and assuming receipt
of approval by the other remaining federal authorities, closing is expected to
occur during the fourth quarter 2008.


Further
information regarding the terms of the merger, including a copy of the Agreement
and Plan of Merger, is included in Puget Energy’s Definitive Proxy Statement
relating to the merger, filed with the Securities and Exchange Commission on
February 16, 2008.













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 or phrases such as “anticipates,”
“believes,” “estimates,” “expects,” “future,” “intends,” “plans,” “projects,”
“predicts,” “will likely result,” and “will continue” 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.  Readers 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, Inc. (Puget Energy) is an
energy services holding company and all of its operations are conducted through
its subsidiary Puget Sound Energy, Inc. (PSE), a regulated electric and natural
gas utility company.  Puget Energy is dependent upon the results of
PSE since PSE is its most significant asset.  PSE is the largest
electric and natural gas utility in the state of Washington, primarily engaged
in the business of electric transmission, distribution, generation and natural
gas distribution.  Puget Energy’s business strategy is to generate
stable earnings and cash flow by offering reliable electric and natural gas
service in a cost effective manner through PSE.





Puget Energy
Merger


On October 26, 2007, Puget Energy
announced that it had entered into a definitive Agreement and Plan of Merger,
dated as of October 25, 2007, pursuant to which Puget Energy will be acquired by
a consortium of long-term infrastructure investors led by Macquarie
Infrastructure Partners, the Canada Pension Plan Investment Board and British
Columbia Investment Management Corporation and also includes Alberta Investment
Management, Macquarie-FSS Infrastructure Trust and Macquarie Capital Group
(collectively, the Consortium).  At the effective time of the merger,
each issued and outstanding share of common stock of Puget Energy, other than
any shares in respect of which dissenter’s rights are perfected and other than
any shares owned by the Consortium, shall be cancelled and shall be converted
automatically into the right to receive $30.00 in cash, without
interest.


The
consummation of the merger is subject to the satisfaction or waiver of certain
closing conditions, including the receipt of shareholder approval of the merger
and approval of it by various state and federal regulatory
authorities.  As of the date of this 10-Q, some of these conditions
have been satisfied while others remain outstanding or in process.  On
April 16, 2008, Puget Energy shareholders approved the merger by more than the
required two-thirds vote.  Also, on April 17, 2008 the Federal Energy
Regulatory Commission (FERC) conditionally approved the transaction pursuant to
section 203 of the Federal Power Act subject to reviewing the final conditions
of merger approval by the Washington Utilities and Transportation Commission
(Washington Commission).  On December 17, 2007, PSE and the Consortium
filed a joint application seeking approval of the merger with the Washington
Commission.  According to the procedural schedule set in the merger
proceeding, a decision by the Washington Commission is expected on September 2,
2008.  If approved by the Washington Commission and assuming receipt
of approval by the other remaining federal authorities, closing is expected to
occur during the fourth quarter 2008.


Further
information regarding the terms of the merger, including a copy of the Agreement
and Plan of Merger, is included in Puget Energy’s Definitive Proxy Statement
relating to the merger, filed with the Securities and Exchange Commission on
February 16, 2008.





Puget Sound
Energy


PSE generates revenues primarily from
the sale of electric and natural gas services to residential and commercial
customers within Washington State.  PSE’s operating revenues and
associated expenses are not generated evenly throughout 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
and subsequently higher power costs during the winter heating season in the
first and fourth quarters of the year and its lowest sales in the third quarter
of the year.  Varying wholesale electric prices and the amount of
hydroelectric energy supplies available to PSE also make quarter-to-quarter
comparisons difficult.


As a regulated utility company, PSE is
subject to FERC and Washington Commission regulation which may impact a large
array of business activities, including limitation of future rate increases;
directed accounting requirements 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 contracted
generation plants where energy is obtained; storms or other events which can
damage natural gas and electric distribution and transmission lines; increasing
regulatory standards for system reliability; and wholesale market stability over
time and significant evolving environmental legislation.


PSE’s main business objective is to
provide reliable, safe and cost-effective energy to its customers.  To
help accomplish this objective, PSE seeks to become more energy efficient and
environmentally responsible in its energy supply portfolio on an ongoing
basis.  PSE filed its most recent Integrated Resource Plan (IRP) on
May 31, 2007 with the Washington Commission.  The plan supports a
strategy of significantly increasing energy efficiency programs, pursuing
additional renewable resources (primarily wind) and additional base load natural
gas fired generation to meet the growing needs of its
customers.





Non-GAAP
Financial Measures – Energy Margins


The following discussion includes
financial information prepared in accordance with generally accepted accounting
principles (GAAP), as well as two other financial measures, Electric Margin and
Gas Margin, that are considered “non-GAAP financial
measures.”  Generally, a non-GAAP financial measure is a numerical
measure of a company’s financial performance, financial position or cash flows
that exclude (or include) amounts that are included in (or excluded from) the
most directly comparable measure calculated and presented in accordance with
GAAP.  The presentation of Electric Margin and Gas Margin is intended
to supplement investors’ understanding of the Company’s operating
performance.  Electric Margin and Gas Margin are used by the Company
to determine whether the Company is collecting the appropriate amount of energy
costs from its customers to allow recovery of operating costs.  The
Company’s Electric Margin and Gas Margin measures may not be comparable to other
companies’ Electric Margin and Gas Margin measures.  Furthermore,
these measures are not intended to replace operating income as determined in
accordance with GAAP as an indicator of operating performance.








Results
of Operations


Puget
Energy


All the
operations of Puget Energy are conducted through its subsidiary
PSE.  Net income for the three months ended March 31, 2008 was $79.8
million on operating revenues of $1.1 billion as compared to net income of $79.1
million on operating revenues of $1.0 billion for the same period in
2007.


Basic and
diluted earnings per share for the three months ended March 31, 2008 were $0.62
and $0.61, respectively, as compared to basic and diluted earnings per share for
the three months ended March 31, 2007 of $0.68.  Net income for the
three months ended March 31, 2008 as compared to the same period in 2007, was
positively impacted by a $25.4 million increase in electric margin and a $12.5
million increase in gas margin.  Net income was negatively impacted by
a $14.0 million increase in utility operation and maintenance which includes the
impact of a $10.5 million charge related to PSE’s share of the settlement of a
lawsuit against the Colstrip electric generating station project owners, an
increase in depreciation and amortization of $5.8 million and an increase in
taxes other than income taxes, net of revenue sensitive taxes, of $5.4
million.  Net income was also negatively impacted due to lower real
estate sales by a PSE subsidiary of $7.7 million ($5.4 million after-tax) and by
a $5.9 million decrease in the Statement of Financial Accounting Standards
(SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities”
(SFAS No. 133) unrealized gain for PSE.  In the first quarter 2008,
Puget Energy incurred $1.3 million in costs related to the proposed merger with
the Consortium.





Puget Sound
Energy


PSE’s
operating revenues and associated expenses are not generated evenly throughout
the year.  Variations in energy usage by customers 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 and subsequently higher power costs during the winter heating
season in the first and fourth quarters of the year, and its lowest sales in the
third quarter of the year.  Power cost recovery is seasonal, with
underrecovery normally in the first and fourth quarters and overrecovery 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.







Energy
Margins


The
following table displays the details of electric margin changes for the three
months ended March 31, 2008 as compared to the same period in
2007.  Electric margin is electric sales to retail and transportation
customers less pass-through tariff items and 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(Dollars
      in Millions)
              Three
      Months Ended March 31,
            
            2008
            
            
            2007
            
            
            Change
            
            
            Percent
              ChangeElectric
      operating revenue1
            
            $
            606.1
            
            
            $
            527.6
            
            
            $
            78.5
            
            
            
            14.9
            %Less:
      Other electric operating revenue
            
            
            (12.2
            )
            
            
            (11.0
            )
            
            
            (1.2
            )
            
            
            (10.9
            )Add:
      Other electric operating revenue-gas supply resale
            
            
            2.6
            
            
            
            1.7
            
            
            
            0.9
            
            
            
            52.9Total
      electric revenue for margin
            
            
            596.5
            
            
            
            518.3
            
            
            
            78.2
            
            
            
            15.1Adjustments
      for amounts included in revenue:Pass-through
      tariff items
            
            
            (12.9
            )
            
            
            (11.2
            )
            
            
            (1.7
            )
            
            
            (15.2
            )Pass-through
      revenue-sensitive taxes
            
            
            (41.6
            )
            
            
            (36.6
            )
            
            
            (5.0
            )
            
            
            (13.7
            )Net
      electric revenue for margin
            
            
            542.0
            
            
            
            470.5
            
            
            
            71.5
            
            
            
            15.2Minus
      power costs:Purchased
      electricity1
            
            
            (272.8
            )
            
            
            (282.1
            )
            
            
            9.3
            
            
            
            3.3Electric
      generation fuel1
            
            
            (47.0
            )
            
            
            (26.1
            )
            
            
            (20.9
            )
            
            
            (80.1
            )Residential
      exchange1
            
            
            --
            
            
            
            34.5
            
            
            
            (34.5
            )
            
            
            (100.0
            )Total
      electric power costs
            
            
            (319.8
            )
            
            
            (273.7
            )
            
            
            (46.1
            )
            
            
            (16.8
            )Electric
      margin2
            
            $
            222.2
            
            
            $
            196.8
            
            
            $
            25.4
            
            
            
            12.9
            %


____________________________


1
            As
      reported on PSE’s Consolidated Statement of Income.2
            Electric
      margin does not include any allocation for amortization/depreciation
      expense or electric generation operation and maintenance
      expense.




Electric
margin increased $25.4 million for the three months ended March 31, 2008 as
compared to the same period in 2007.  A Power Cost Only Rate Case
(PCORC) rate increase of 3.7% effective September 1, 2007, net of a 1.3% general
rate decrease effective January 13, 2007, contributed an increase to electric
margin of $6.1 million.  Also driving the higher electric margin was a
4.1% increase in retail sales volumes which increased electric margin $7.8
million and an $11.0 million reduction in excess power costs ($13.5 million for
the three months ended March 31, 2007 as compared to $2.5 million for the same
period in 2008).  Power cost recovery is seasonal with underrecovery
in the first and fourth quarters and overrecovery in the second and third
quarters.







The following table
displays the details of gas margin changes for the three months ended March 31,
2008 as compared to the same period in 2007.  Gas margin is natural
gas sales to retail and transportation customers less pass-through tariff items
and revenue-sensitive taxes, and the cost of natural gas purchased, including
natural gas transportation costs to bring gas to PSE’s service
territory.





Gas
      Margin(Dollars
      in Millions)
                Three
      Months Ended March 31,
              
              2008
              
              
              2007
              
              
              Change
              
              
              Percent
                ChangeGas
      operating revenue1
              
              $
              443.2
              
              
              $
              467.0
              
              
              $
              (23.8
              )
              
              
              (5.1
              )
      %Less:
      Other gas operating revenue
              
              
              (4.7
              )
              
              
              (4.8
              )
              
              
              0.1
              
              
              
              2.1Total
      gas revenue for margin
              
              
              438.5
              
              
              
              462.2
              
              
              
              (23.7
              )
              
              
              (5.2
              )Adjustments
      for amounts included in revenue:Pass-through
      tariff items
              
              
              (4.3
              )
              
              
              (3.1
              )
              
              
              (1.2
              )
              
              
              (38.7
              )Pass-through
      revenue-sensitive taxes
              
              
              (35.0
              )
              
              
              (38.0
              )
              
              
              3.0
              
              
              
              7.9Net
      gas revenue for margin
              
              
              399.2
              
              
              
              421.1
              
              
              
              (21.9
              )
              
              
              (5.2
              )Minus
      purchased gas costs1
              
              
              (276.2
              )
              
              
              (310.6
              )
              
              
              (34.4
              )
              
              
              (11.1
              )Gas
      margin2
              
              $
              123.0
              
              
              $
              110.5
              
              
              $
              12.5
              
              
              
              11.3
              %
 ____________________


1
            As
      reported on PSE’s Consolidated Statement of Income.2
            Gas
      margin does not include any allocation for amortization/depreciation
      expense or electric generation operations and maintenance
      expense.





Gas
margin increased $12.5 million for the three months ended March 31, 2008 as
compared to the same period in 2007 primarily due to an 8.1% gas therm volume
sales increase resulting in $8.8 million increase to gas
margin.  Additionally, there was a $5.4 million increase due to a 2.8%
general rate increase effective January 13, 2007 which had a 9.8% effect on gas
margin.  The increases were offset by a $1.7 million decrease related
to industrial usage and pricing.




Electric
Operating Revenues


The table
below sets forth changes in electric operating revenues for PSE for the three
months ended March 31, 2008 as compared to the same period in 2007.





(Dollars
      in Millions)
              Three
      Months Ended March 31,
            
            2008
            
            
            2007
            
            
            Change
            
            
            Percent
              ChangeElectric
      operating revenues:Residential
      sales
            
            $
            346.6
            
            
            $
            292.0
            
            
            $
            54.6
            
            
            
            18.7
            %Commercial
      sales
            
            
            212.0
            
            
            
            199.5
            
            
            
            12.5
            
            
            
            6.3Industrial
      sales
            
            
            27.5
            
            
            
            27.1
            
            
            
            0.4
            
            
            
            1.5Other
      retail sales, including unbilled revenue
            
            
            (11.7
            )
            
            
            (23.5
            )
            
            
            11.8
            
            
            
            50.2Total
      retail sales
            
            
            574.4
            
            
            
            495.1
            
            
            
            79.3
            
            
            
            16.0Transportation
      sales
            
            
            1.5
            
            
            
            2.3
            
            
            
            (0.8
            )
            
            
            (34.8
            )Sales
      to other utilities and marketers
            
            
            18.0
            
            
            
            19.2
            
            
            
            (1.2
            )
            
            
            (6.3
            )Other
            
            
            12.2
            
            
            
            11.0
            
            
            
            1.2
            
            
            
            10.9Total
      electric operating revenues
            
            $
            606.1
            
            
            $
            527.6
            
            
            $
            78.5
            
            
            
            14.9
            %





Electric
retail sales increased $79.3 million for the three months ended March 31, 2008
as compared to the same period in 2007 due primarily to a decrease of $36.1
million in the benefits of the Residential and Farm Energy Exchange Benefit
credited to customers during the three-month period ended March 31,
2008.  This credit also reduced power costs by a corresponding amount
with no impact on earnings.  The Residential Exchange Program (REP)
Benefit was suspended effective June 7, 2007 due to adverse rulings from the
Ninth Circuit Court of Appeals (Ninth Circuit) which state that Bonneville Power
Administration (BPA) actions in entering into residential exchange settlement
agreements with investor-owned utilities were not in accordance with the
law.  The PCORC rate increase of September 1, 2007 offset by the
electric general rate decrease of January 13, 2007 increased electric operating
revenues by $11.9 million for the three months ended March 31, 2008 as compared
to the same period in 2007.  Retail electricity usage increased
246,493 megawatt hours (MWh) or 4.1% for the three months ended March 31, 2008
as compared to the same period in 2007, which resulted in an increase of
approximately $22.4 million in electric operating revenue.  The
increase in electricity usage was primarily related to 1.7% higher average
number of customers served in 2008 as compared to 2007.


Sales to
other utilities and marketers decreased $1.2 million for the three months ended
March 31, 2008 as compared to the same period in 2007 primarily due to a
decrease in sales volume of 172,066 MWh or 41.3% as a result of decreased
surplus energy, which resulted in a decrease of $12.7 million.  This
decrease was partially offset by higher wholesale prices in the first quarter
2008 as compared to the same period in 2007, which increased sales by $11.5
million.


The following electric rate changes
were approved by the Washington Commission in 2007:





Type
      of Rate
              Adjustment
            Effective
      Date
            Average
              Percentage
              Increase
      (Decrease)
              in
      Rates
            Annual
              Increase
      (Decrease)
              in
      Revenues
              (Dollars
      in Millions)Electric
      General Rate Case
            January
      13, 2007
            (1.3
            )
      %
            $
      (22.8)Power
      Cost Only Rate Case
            September
      1, 2007
            3.7
            
            64.7





Gas
Operating Revenues


The table
below sets forth changes in gas operating revenues for PSE for the three months
ended March 31, 2008 as compared to the same period in 2007.





(Dollars
      in Millions)
              Three
      Months Ended March 31,
            
            2008
            
            
            2007
            
            
            Change
            
            
            Percent
              ChangeGas
      operating revenues:Residential
      sales
            
            $
            294.2
            
            
            $
            300.9
            
            
            $
            (6.7
            )
            
            
            (2.2
            )
      %Commercial
      sales
            
            
            127.8
            
            
            
            135.5
            
            
            
            (7.7
            )
            
            
            (5.7
            )Industrial
      sales
            
            
            12.8
            
            
            
            22.3
            
            
            
            (9.5
            )
            
            
            (42.6
            )Total
      retail sales
            
            
            434.8
            
            
            
            458.7
            
            
            
            (23.9
            )
            
            
            (5.2
            )Transportation
      sales
            
            
            3.8
            
            
            
            3.5
            
            
            
            0.3
            
            
            
            8.6Other
            
            
            4.6
            
            
            
            4.8
            
            
            
            (0.2
            )
            
            
            (4.2
            )Total
      gas operating revenues
            
            $
            443.2
            
            
            $
            467.0
            
            
            $
            (23.8
            )
            
            
            (5.1
            )
      %




Gas
retail sales decreased $23.9 million for the three months ended March 31, 2008
as compared to the same period in 2007 due to lower Purchased Gas Adjustment
(PGA) mechanism rates and offset by increased customer natural gas
usage.  The Washington Commission approved a PGA mechanism rate
increase effective October 1, 2007 that decreased rates 13.0%
annually.  The PGA mechanism passes through to customers increases or
decreases in the natural gas supply portion of the natural gas service rates
based upon changes in the price of natural gas purchased from producers and
wholesale marketers or changes in natural gas pipeline transportation
costs.  PSE’s gas margin and net income are not affected by changes
under the PGA mechanism.  For the three months ended March 31, 2008,
the effects of the PGA mechanism rate resulted in a decrease of $60.9 million in
gas operating revenues.  The PGA mechanism decrease was offset by
higher natural gas sales of 32.9 million therms or $37.4 million for the three
months ended March 31, 2008 as compared to the same period in 2007, which was
related to colder temperatures for the three months ended March 31, 2008 as
compared to the same period in 2007 and a 2.4% increase in the number of
customers.


The
following natural gas rate adjustments were approved by the Washington
Commission in 2007:





Type
      of Rate
              Adjustment
            Effective
      Date
            Average
              Percentage
              Increase
      (Decrease)
              in
      Rates
            Annual
              Increase
      (Decrease)
              in
      Revenues
              (Dollars
      in Millions)Gas
      General Rate Case
            January
      13, 2007
            2.8
            %
            $   29.5Purchased
      Gas Adjustment
            October
      1, 2007
            (13.0
            )
            (148.1
            )





Non-Utility
Operating Revenues


The table
below sets forth changes in non-utility operating revenues for PSE for the three
months ended March 31, 2008 as compared to the same period in 2007.





(Dollars
      in Millions)
              Three
      Months Ended March 31,
            2008
            2007
            Change
            Percent
              ChangeNon-utility
      operating revenue
            $  1.6
            
            $  9.3
            
            $
      (7.7
            )
            (82.8
            )
      %








Non-utility operating revenues
decreased $7.7 million for the three months ended
March 31, 2008 as compared to the same period in 2007due to multiple
property sales during the first quarter 2007 by PSE’s real estate subsidiary
that did not occur in the first quarter 2008.





Operating
Expenses


The table
below sets forth significant changes in operating expenses for PSE and its
subsidiaries for the three months ended March 31, 2008 as compared to the same
period in 2007.





(Dollars
      in Millions)
              Three
      Months Ended March 31,
            
            2008
            
            
            2007
            
            
            Change
            
            
            Percent
              ChangePurchased
      electricity
            
            $
            272.8
            
            
            $
            282.1
            
            
            $
            (9.3
            )
            
            
            (3.3
            )
      %Electric
      generation fuel
            
            
            47.0
            
            
            
            26.1
            
            
            
            20.9
            
            
            
            80.1Residential
      exchange
            
            
            --
            
            
            
            (34.5
            )
            
            
            34.5
            
            
            
            100.0Purchased
      gas
            
            
            276.2
            
            
            
            310.6
            
            
            
            (34.4
            )
            
            
            (11.1
            )Unrealized
      (gain) loss on derivative instruments
            
            
            0.1
            
            
            
            (5.8
            )
            
            
            5.9
            
            
            
            101.7Utility
      operations and maintenance
            
            
            112.2
            
            
            
            98.2
            
            
            
            14.0
            
            
            
            14.3Non-utility
      expense and other
            
            
            0.1
            
            
            
            2.0
            
            
            
            (1.9
            )
            
            
            (95.0
            )Depreciation
      and amortization
            
            
            75.4
            
            
            
            69.6
            
            
            
            5.8
            
            
            
            8.3Conservation
      amortization
            
            
            13.4
            
            
            
            10.3
            
            
            
            3.1
            
            
            
            30.1Taxes
      other than income taxes
            
            
            94.3
            
            
            
            87.1
            
            
            
            7.2
            
            
            
            8.3





Purchased electricity expenses
decreased $9.3 million for the three months ended March 31, 2008 as compared to
the same period in 2007.  This decrease was primarily due to a
reduction in the amount of purchased power, 335,446 MWh or 6.8%, because of
increased generation from the Frederickson and Goldendale combustion turbines,
Colstrip generation plant and PSE’s wind generation facilities, which resulted
in a gross reduction of $18.0 million in purchased electricity
expenses.  This reduction was offset by an increase in wholesale
market prices and transmission, transmission and other power supply expenses of
$7.4 million and additional transmission expenses of $1.5 million due to
increased transmission volumes.


The May 1, 2008 Columbia Basin Runoff
Forecast published by the National Weather Service Northwest River Forecast
Center indicated that the total forecasted runoff above Grand Coulee Reservoir
for the period January through July 2008 is 95% of normal, which compares to
105% of normal runoff observed for the same period in 2007.


To meet customer demand, PSE
economically dispatches resources in its power supply portfolio such as
fossil-fuel generation, owned and contracted hydroelectric 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 regulated
power portfolio through short-term and intermediate-term off-system physical
purchases and sales and through other risk management techniques.


Electric generation fuel
expense increased $20.9 million for the three months ended March 31, 2008, as
compared to the same period in 2007.  The increase for the three
months ended March 31, 2008 was due in part to increased generation from
Goldendale and Frederickson combustion turbines which contributed $16.8 million
and $5.8 million, respectively, partially offset by lower costs of $2.1 million
at other combustion turbine generation facilities.  Colstrip fuel
costs increased $0.5 million for the three months ended March 31, 2008, as
compared to the same period in 2007.


Residential exchange credits
associated with the REP with BPA decreased $34.5 million for the three months
ended March 31, 2008 as compared to the same period in 2007 as a result of the
suspension of the residential and small farm customer electric credit in rates
effective June 7, 2007.  The suspension was due to an adverse ruling
from the Ninth Circuit which states that BPA actions in entering into
residential exchange settlement agreements with investor owned utilities were
not in accordance with the law.  The REP credit is a pass-through
tariff item with a corresponding credit in electric operating revenue; thus, it
has no impact on electric margin or net income.


Purchased gas expenses
decreased $34.4 million for the three months ended March 31, 2008 as compared to
the same period in 2007 primarily due to an increase in PGA rates as approved by
the Washington Commission partially offset by higher customer therm
sales.  The PGA mechanism allows PSE to recover expected natural gas
costs, and defer, as a receivable or liability, any natural gas costs that
exceed or fall short of this expected gas cost amount in PGA mechanism rates,
including accrued interest.  The PGA mechanism payable balance at
March 31, 2008 was $68.4 million as compared to $77.9 million at December 31,
2007.  PSE is authorized by the Washington Commission to accrue
carrying costs on PGA receivable and payable balances.  A receivable
balance in the PGA mechanism reflects an underrecovery of market natural gas
cost through rates.  A payable balance reflects overrecovery of market
natural gas cost through rates.


Unrealized gain on derivative
instrumentsdecreased $5.9 million forthe three months ended
March 31, 2008 as compared to the same period in 2007.  The decrease
was primarily the result of the reversal of a loss reserve for a physically
delivered natural gas supply contract for PSE’s electric generating facilities
during the three months ended March 31, 2007.


Utility operations and maintenanceexpense increased $14.0 million for the three months ended March 31, 2008
as compared to the same period in 2007.  The increase includes the
impact of a $10.5 million pre-tax charge related to PSE’s share of the
settlement of a lawsuit against the Colstrip electric generating station project
owners.  The remaining increase was the result of a $2.6 million
increase in production operations and maintenance at PSE’s generating facilities
primarily due to the addition of Goldendale, which was acquired in February
2007, $2.4 million higher gas operations and distribution costs and a $1.5
million increase in customer service costs.  Goldendale operations and
maintenance expense is fully recovered in rates beginning September 1,
2007.  These increases were partially offset by a decrease in
transmission and distribution operations and maintenance costs of $2.5 million
primarily due to a reduction in electric storm damage expense.


Non-utility expense and other
decreased $1.9 million for the three months ended March 31, 2008 as compared to
the same period in 2007 primarily due to a decrease in PSE’s long-term incentive
plan costs.


Depreciation and amortization
expense increased $5.8 million for the three months ended March 31, 2008 as
compared to the same period in 2007.  The increase was primarily due
to the placement into service of the Goldendale project on February 22, 2007 as
well as the placement into service of other depreciable property during
2007.  In addition, there was an increase of $1.0 million due to the
credit related to the deferral of Goldendale ownership and operating costs that
was discontinued September 1, 2007.


Conservation amortization
increased $3.1 million for the three months ended March 31, 2008 as compared to
the same period in 2007 due to higher authorized recovery of electric
conservation expenditures.  Conservation amortization is a
pass-through tariff item with no impact on earnings.


Taxes other than income taxes
increased $7.2 million for the three months ended March 31, 2008 as compared to
the same period in 2007 due primarily to additional plant placed in service
during 2007 which increase property taxes.





Other
Income, Other Expenses, Interest Expense and Income Tax Expense


The table
below sets forth significant changes in other income, other expenses, interest
expense and income tax expense for PSE and its subsidiaries for the three months
ended March 31, 2008 as compared to the same period in 2007.





(Dollars
      in Millions)

              Three
      Months Ended March 31,
            2008
            2007
            Change
            Percent
              ChangeOther
      income
            $  6.8
            $  4.8
            $  2.0
            41.7
            %Income
      tax expense
            35.7
            34.0
            1.7
            5.0




Other incomeincreased $2.0
million for the three months ended March 31, 2008 as compared to the same period
in 2007 primarily due a $0.9 million increase related to Washington Commission
allowance for funds used during construction, a $0.9 million increase due to
interest earned on the Residential Exchange regulatory asset and a $0.3 million
increase due to Goldendale regulatory assets.


Income tax expenseincreased
$1.7 million for the three months ended March 31, 2008 as compared to the same
period in 2007 due primarily to the increase in net income.








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 March 31, 2008:





Puget
      Energy
            
            
            
            Payments
      Due Per PeriodContractual
      Obligations
              (Dollars
      in Millions)
            Total
            2008
            2009-
              2010
            2011-
              2012
            2013
      & ThereafterLong-term
      debt including interest
            $
            6,435.2
            $
            361.3
            $
            712.8
            $
            520.9
            $
            4,840.2Short-term
      debt including interest
            
            101.6
            
            101.6
            
            --
            
            --
            
            --Mandatorily
      redeemable preferred stock
            
            1.9
            
            --
            
            --
            
            --
            
            1.9Service
      contract obligations
            
            423.3
            
            58.4
            
            129.0
            
            94.8
            
            141.1Non-cancelable
      operating leases
            
            166.7
            
            12.4
            
            50.8
            
            25.7
            
            77.8Fredonia
      combustion turbines lease 1
            
            53.1
            
            3.7
            
            9.4
            
            40.0
            
            --Energy
      purchase obligations
            
            6,714.2
            
            988.2
            
            2,007.2
            
            1,160.8
            
            2,558.0Contract initiation payment/collateral requirement
            
            18.5
            
            --
            
            --
            
            18.5
            
            --Financial
      hedge obligations
            
            (56.6
            )
            (37.1
            )
            (19.5
            )
            --
            
            --Purchase
      obligations
            
            66.7
            
            27.9
            
            22.7
            
            --
            
            16.1Non-qualified pension and other benefits funding and
    payments
            
            39.9
            
            4.1
            
            8.1
            
            8.0
            
            19.7Other obligations
            
            18.2
            
            18.2
            
            --
            
            --
            
            --Total
      contractual cash obligations
            $
            13,982.7
            $
            1,538.7
            $
            2,920.5
            $
            1,868.7
            $
            7,654.8








Puget
      Energy
              
              
              
              Amount
      of Commitment
                Expiration
      Per PeriodCommercial
      Commitments
                (Dollars
      in Millions)
              Total
              2008
              2009-
                2010
              2011-
                2012
              2013
      & ThereafterIndemnity
      agreements 2
              $
              7.2
              $
              4.0
              $
              --
              $
              3.2
              $
              --Credit
      agreement - available 3
              
              826.0
              
              --
              
              --
              
              --
              
              826.0Receivable
      securitization facility 4
              
              115.0
              
              --
              
              --
              
              115.0
              
              --Energy
      operations letter of credit
              
              7.4
              
              7.4
              
              --
              
              --
              
              --Total
      commercial commitments
              $
              955.6
              $
              11.4
              $
              --
              $
              118.2
              $
              826.0
 ___________________


1
            See
      “Fredonia 3 and 4 Operating Lease” under “Off-Balance Sheet Arrangements”
      below.2
            Under
      the InfrastruX sale agreement, Puget Energy is obligated for certain
      representations and warranties concerning InfrastruX’s business and
      anti-trust inquiries.  The fair value of the business warranty
      is $4.0 million at March 31, 2008 and the obligation expires on May 7,
      2008. Puget
      Energy also agreed to indemnify the buyer relating to an inquiry of an
      InfrastruX subsidiary and the fair value of the warranty was $3.2 million
      at March 31, 2008.3
            At
      March 31, 2008, PSE had available a $500.0 million and a $350.0 million
      unsecured credit agreement expiring in April 2012.  The credit
      agreements provide credit support for letters of credit and commercial
      paper.  At March 31, 2008, PSE had $7.4 million outstanding
      under four letters of credit and $16.6 million commercial paper
      outstanding, effectively reducing the available borrowing capacity to
      $826.0 million.4
            At
      March 31, 2008, PSE had available a $200.0 million receivables
      securitization facility that expires in December 2010.  $85.0
      million was outstanding under the receivables securitization facility at
      March 31, 2008 thus leaving $115.0 million available.  The
      facility allows receivables to be used as collateral to secure short-term
      loans, not exceeding the lesser of $200.0 million or the borrowing base of
      eligible receivables, which fluctuate with the seasonality of energy sales
      to customers.  See “Receivables Securitization Facility” below
      for further discussion.









Puget Sound
Energy.  The following are PSE’s aggregate contractual
obligations and commercial commitments as of March 31, 2008:





Puget
      Sound Energy
            Payments
      Due Per PeriodContractual
      Obligations
              (Dollars
      in Millions)
            Total
            2008
            2009-
              2010
            2011-
              2012
            2013
      & ThereafterLong-term
      debt including interest
            $
            6,435.2
            $
            361.3
            $
            712.8
            $
            520.9
            $
            4,840.2Short-term
      debt including interest
            
            131.7
            
            131.7
            
            --
            
            --
            
            --Mandatorily
      redeemable preferred stock
            
            1.9
            
            --
            
            --
            
            --
            
            1.9Service
      contract obligations
            
            423.3
            
            58.4
            
            129.0
            
            94.8
            
            141.1Non-cancelable
      operating leases
            
            166.7
            
            12.4
            
            50.8
            
            25.7
            
            77.8Fredonia
      combustion turbines lease 1
            
            53.1
            
            3.7
            
            9.4
            
            40.0
            
            --Energy
      purchase obligations
            
            6,714.2
            
            988.2
            
            2,007.2
            
            1,160.8
            
            2,558.0Contract initiation payment/collateral requirement
            
            18.5
            
            --
            
            --
            
            18.5
            
            --Financial
      hedge obligations
            
            (56.6
            )
            (37.1
            )
            (19.5
            )
            --
            
            --Purchase
      obligations
            
            66.7
            
            27.9
            
            22.7
            
            --
            
            16.1Non-qualified pension and other benefits funding and
    payments
            
            39.9
            
            4.1
            
            8.1
            
            8.0
            
            19.7Other obligations
            
            18.2
            
            18.2
            
            --
            
            --
            
            --Total
      contractual cash obligations
            $
            14,012.8
            $
            1,568.8
            $
            2,920.5
            $
            1,868.7
            $
            7,654.8





Puget
      Sound Energy
              
              
              
              Amount
      of Commitment
                Expiration
      Per PeriodCommercial
      Commitments
                (Dollars
      in Millions)
              Total
              2008
              2009-
                2010
              2011-
                2012
              2013
      & ThereafterCredit
      agreement - available 2
              $
              826.0
              $
              --
              $
              --
              $
              --
              $
              826.0Receivable
      securitization facility 3
              
              115.0
              
              --
              
              --
              
              115.0
              
              --Energy
      operations letter of credit
              
              7.4
              
              7.4
              
              --
              
              --
              
              --Total
      commercial commitments
              $
              948.4
              $
              7.4
              $
              --
              $
              115.0
              $
              826.0
 ________________


1
            See
      note 1 under Puget Energy above.2
            See
      note 3 under Puget Energy above.3
            See
      note 4 under Puget Energy above.





Off-Balance
Sheet Arrangements


Fredonia 3 and 4 Operating
Lease.PSE
leases two combustion turbines for its Fredonia 3 and 4 electric generating
facility pursuant to a master operating lease that was amended for this purpose
in April 2001.  The lease has a term expiring in 2011, but can be
canceled by PSE at any time.  Payments under the lease vary with
changes in the London Interbank Offered Rate (LIBOR).  At March 31,
2008, PSE’s outstanding balance under the lease was $47.6
million.  The expected residual value under the lease is the lesser of
$37.4 million or 60.0% 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 87.0% of the unamortized value of the
equipment.





Utility
Construction Program


PSE’s
construction programs for generating facilities, the electric transmission
system and the natural gas and electric distribution systems are designed to
meet continuing customer growth and to support reliable energy
delivery.  The cash flow construction expenditures, excluding equity
Allowance for Funds Used During Construction (AFUDC) and customer refundable
contributions was $125.5 million for the three months ended March 31,
2008.  The anticipated utility construction expenditures, excluding
AFUDC, for 2008, 2009 and 2010 are:





Capital
      Expenditure Estimates
              (Dollars
      in Millions)
            
            2008
            
            2009
            
            2010Energy
      delivery, technology and facilities
            $
            595.0
            $
            568.0
            $
            743.0New
      supply resources
            
            72.0
            
            220.0
            
            514.0Total
      expenditures
            $
            667.0
            $
            788.0
            $
            1,257.0










The
proposed utility construction expenditures and any new generation resource
expenditures that may be incurred are anticipated to be funded with a
combination of cash from operations, short-term debt, long-term debt and
equity.  Construction expenditure estimates, including any new
generation resources, are subject to periodic review and adjustment in light of
changing economic, regulatory, environmental and efficiency
factors.





Capital
Resources


Cash
From Operations


Cash
generated from operations for the three months ended March 31, 2008 was $334.6
million, which is 238.0% of the $140.6 million cash used for utility
construction expenditures and other capital expenditures.  For the
three months ended March 31, 2007, cash from operations was $228.4 million,
which was 91.8% of the $248.7 million cash used for utility construction
expenditures and other capital expenditures.


The
overall cash generated from operating activities for the three months ended
March 31, 2008 increased $106.2 million as compared to the same period in
2007.  The increase was primarily the result of lower cash payments of
$77.3 million related to accounts payable and lower cash payments of $16.6
million related to deferred storm damage costs.  Cash from operations
increased due to the receipt of $42.4 million for an income tax refund and a
$11.0 million increase in deferred income taxes for 2008.  Cash from
operations also increased due to $11.5 million increase in recovery of materials
and supplies, and fuel and gas inventories for the three months end March 31,
2008 as compared to the same period in 2007.  The increase in cash
from operations was also positively impacted by lower payments of $7.2 million
in 2008 as compare to 2007 related to the Residential Exchange Program and a
$5.0 million decrease in prepayments.  These increases were partially
offset by a reduction in the purchased gas liability in 2008 of $9.4 million as
compared to an increase in the purchased gas liability in 2007 of $43.7 million
which accounted for a decrease in cash of $53.1 million.  In addition,
the increase was offset by lower amount of cash collected from accounts
receivable of $23.9 million.





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 depends upon factors such as
general economic conditions, regulatory authorizations and policies and Puget
Energy’s and PSE’s credit ratings.




Restrictive
Covenants


In
determining the type and amount of future financing, PSE may be limited by
restrictions contained in its electric and natural gas mortgage indentures,
restated articles of incorporation and certain loan agreements.  Under
the most restrictive tests, at March 31, 2008, PSE could issue:


·
            approximately
      $592.0 million of additional first mortgage bonds under PSE’s electric
      mortgage indenture based on approximately $986.7 million of electric
      bondable property available for issuance, subject to an interest coverage
      ratio limitation of 2.0 times net earnings available for interest (as
      defined in the electric utility mortgage), which PSE exceeded at March 31,
      2008;


·
            approximately
      $507.0 million of additional first mortgage bonds under PSE’s natural gas
      mortgage indenture based on approximately $845.0 million of gas bondable
      property available for issuance, subject to interest coverage ratio
      limitations of 1.75 times and 2.0 times net earnings available for
      interest (as defined in the natural gas utility mortgage), which PSE
      exceeded at March 31, 2008;


·
            approximately
      $1.1 billion of additional preferred stock at an assumed dividend rate of
      8.5%; and


·
            approximately
      $779.1 million of unsecured long-term
debt.


At March
31, 2008, PSE had approximately $4.7 billion in electric and natural gas
ratebase to support the interest coverage ratio limitation test for net earnings
available for interest.








Credit
Ratings


Neither
Puget Energy nor PSE has any debt outstanding that would accelerate debt
maturity upon a credit rating downgrade.  A ratings downgrade could
adversely affect the 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 borrowing costs and
commitment fee increase as PSE’s secured long-term debt ratings
decline.  A 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.  In
addition, downgrades in PSE’s debt ratings may prompt counterparties to require
PSE to post a letter of credit or other collateral, make cash prepayments,
obtain a guarantee or provide other security.


The
ratings of Puget Energy and PSE, as of April 25, 2008, were as
follows:








RatingsStandard & Poor’s1,2
              Moody’s3Puget
      Sound EnergyCorporate
      credit/issuer rating
              BBB-
              Baa3Senior
      secured debt
              BBB+
              Baa2Junior
      subordinated notes
              BB
              Ba1Preferred
      stock
              BB
              Ba2Commercial
      paper
              A-3
              P-2Revolving
      credit facility
              Note
      1
              Baa3Ratings
      outlook
              Note
      2
              Note
      3Puget
      EnergyCorporate
      credit/issuer rating
              BBB-
              Ba1Ratings
      outlook
              Note
      2
              Note
      3
 _______________


1
            Standard
      & Poor’s does not rate PSE’s credit
      facilities.2
            On
      October 26, 2007, Standard & Poor’s placed the ratings of Puget Energy
      (BBB-) and PSE (BBB-/A-3) on CreditWatch with negative
      implications.  The CreditWatch listing reflects the possibility
      that debt ratings for Puget Energy could be lowered dependent on the final
      outcome of regulatory approval proceedings.3
            On
      October 29, 2007, Moody’s placed the Ba1 Issuer rating of Puget Energy on
      review for possible downgrade.  Moody’s also affirmed the
      long-term ratings of PSE and changed its rating outlook to stable from
      positive.  On this same date, Moody’s placed PSE’s P-2
      short-term rating for commercial paper under review for possible
      downgrade.







Shelf
Registrations, Long-Term Debt and Common Stock Activity


Liquidity
Facilities and Commercial Paper


PSE’s
short-term borrowings and sales of commercial paper are used to provide working
capital to fund utility construction programs.  PSE has not been
significantly impacted by the current credit environment.





PSE
Credit Facilities


The
Company has three committed credit facilities that provide, in aggregate, $1.05
billion in short-term borrowing capability.  These include a $500.0
million credit agreement, a $200.0 million accounts receivable securitization
facility and a $350.0 million credit agreement to support hedging
activity.





Credit
Agreements.  In March 2007, PSE entered into a five-year,
$350.0 million credit agreement with a group of banks.  The agreement
is used to support the Company’s energy hedging activities and may also be used
to provide letters of credit.  The interest rate on outstanding
borrowings is based either on the agent bank’s prime rate or on LIBOR plus a
marginal rate related to PSE’s long-term credit rating at the time of
borrowing.  PSE pays a commitment fee on any unused portion of the
credit agreement also related to long-term credit ratings of PSE.  At
March 31, 2008, there were no borrowings or letters of credit outstanding under
the credit facility.


In March
2005, PSE entered into a five-year $500.0 million unsecured credit agreement
with a group of banks.  In March 2007, PSE restated this credit
agreement to extend the expiration date to April 2012.  The agreement
is primarily used to provide credit support for commercial paper and letters of
credit.  The terms of this agreement, as restated, are essentially
identical to those contained in the $350.0 million facility described
above.


At March
31, 2008, there was $7.4 million outstanding under four letters of credit and
$16.6 million commercial paper outstanding, effectively reducing the available
borrowing capacity under the two credit agreements to $826.0
million.





Receivables Securitization
Facility.  PSE entered into a five-year Receivable Sales
Agreement with PSE Funding, Inc. (PSE Funding), a wholly owned subsidiary, on
December 20, 2005.  Pursuant to the Receivables Sales Agreement, PSE
sells all of its utility customer accounts receivable and unbilled utility
revenues to PSE Funding.  In addition, PSE Funding entered into a Loan
and Servicing Agreement with PSE and two banks.  The Loan and
Servicing Agreement allows PSE Funding to use the receivables as collateral to
secure short-term loans, not exceeding the lesser of $200.0 million or the
borrowing base of eligible receivables which fluctuate with the seasonality of
energy sales to customers.  All loans from this facility are reported
as short-term debt in the financial statements.  The PSE Funding
facility expires in December 2010, and is terminable by PSE and PSE Funding upon
notice to the banks.  There were $85.0 million in loans that were
secured by accounts receivable pledged at March 31, 2008.  The
remaining borrowing base of eligible receivables at March 31, 2008 was $115.0
million.





Demand Promissory Note.On
June 1, 2006, PSE entered into an uncommitted revolving credit facility with its
parent, Puget Energy, pursuant to a Demand Promissory Note (Note) under which
PSE may borrow up to $30.0 million from Puget Energy.  Under the terms
of the Note, PSE pays interest on the outstanding borrowings based on the lowest
of the weighted-average interest rate of (a) PSE’s outstanding commercial paper
interest rate; (b) PSE’s senior unsecured revolving credit facility; or (c) the
interest rate available under the receivable securitization facility of PSE
Funding, a PSE subsidiary.  At March 31, 2008, the outstanding balance
of the Note was $30.0 million.  The outstanding balance and the
related interest under the Note are eliminated by Puget Energy upon
consolidation of PSE’s financial statements.





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 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 did not issue common
stock under the Stock Purchase and Dividend Reinvestment Plan for the three
months ended March 31, 2008 as compared to $3.2 million (130,896 shares) for the
three months ended March 31, 2007.  The proceeds from sales of stock
under the Stock Purchase and Dividend Reinvestment Plan are used for general
corporate needs.  Pending the outcome of the merger, Puget Energy does
not intend to fund the Stock Purchase and Dividend Reimbursement Plan with
authorized but unissued shares.





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





Regulation
and Rates


In
November 2007, PSE was audited by the Western Electricity Coordinating Council
(WECC) under delegated authority of the North American Electric Reliability
Corporation (NERC), the FERC-certified Electric Reliability Organization
(ERO).  Previously, PSE had submitted several self-reports and
mitigation plans to WECC for review and approval.  The WECC audit team
identified four additional potential violations that were not previously
self-reported.  In response, PSE submitted self-reports and mitigation
plans for the four violations.  WECC issued the final audit report on
March 28, 2008.  As of April 16, 2008, PSE had not received notice of
penalties, but has established a loss reserve $0.6 million related to these
potential violations.


In May
2007, the Washington Commission Staff alleged that PSE’s natural gas system
service provider had violated certain Washington Commission recordkeeping
rules.  The Washington Commission filed a complaint against PSE that
included Washington Commission Staff’s recommendation that PSE be assessed a
$2.0 million regulatory penalty.  On April 3, 2008, the Washington
Commission issued an order approving a settlement agreement that requires PSE to
pay a regulatory penalty of $1.25 million, to establish a quality control
program to better monitor its subcontractors and to complete an independent
audit of natural gas system recordkeeping procedures.  At March 31,
2008, PSE adjusted its loss reserve to $1.25 million for this
penalty.





Accounting
Petition.  On August 29, 2007, the Washington Commission
approved PSE’s accounting petition to defer as a regulatory asset the excess BPA
REP benefit provided to customers and accrue monthly carrying charges on the
deferred balance from June 7, 2007 until the deferral is recovered from
customers or BPA.  As of March 31, 2008, PSE has recorded a regulatory
asset, including carrying costs, of $36.6 million.


On December 17, 2007, BPA released a
proposal for public comment which would provide temporary, interim relief to the
region’s investor-owned utilities until final REP contracts are reached and
executed which are planned to go into effect October 1, 2008.  These
interim agreements are offered in exchange for suspension of certain litigation
activities and will be trued-up to the actual final REP benefits for each
individual company as established in BPA’s upcoming administrative
proceedings.In March 2008,
BPA and PSE signed an agreement pursuant to which BPA (on April 2, 2008) paid
PSE $53.7 million in REP benefits for fiscal year 2008, which payment is subject
to true-up depending upon the amount of any REP benefits ultimately determined
to be payable to PSE.


On April 10, 2008, the Washington
Commission approved PSE’s tariff filing seeking to pass-through the net amount
of the benefits under the interim agreements to residential and small farm
customers.  The Washington Commission also approved PSE’s request to
credit the regulatory asset amount of $33.7 million against the $53.7 million
payment and pass-through to customers the remaining amount of approximately
$20.0 million.  The accrued carrying charges on the regulatory asset
totaling $2.9 million at March 31, 2008 will be addressed in PSE’s pending
general rate case (Docket No. UE-072300).




Colstrip
Matters


Colstrip
Matters.  In May
2003, approximately 50 plaintiffs brought an action against the owners of
Colstrip which has since been amended to add additional claims.  The
lawsuit alleges that (1) seepage from two different wastewater pond areas caused
groundwater contamination and threatened to contaminate domestic water wells and
the Colstrip water supply pond, and (2) seepage from the Colstrip water supply
pond caused structural damage to buildings and toxic mold.  Plaintiffs
were seeking compensatory (including but not limited to unjust enrichment and
abatement) and punitive damages.  After a failed attempt at settlement
in 2004, PSE established a reserve of approximately $0.7 million, of which $0.5
million was for PSE’s share of costs to extend city water to 13 plaintiffs and
PSE reduced its reserve to approximately $0.2 million.  Discovery was
completed and trial was scheduled for June 2008.


Recent developments in the litigation have caused PSE to change its
reserve.  On February 15, 2008, plaintiffs submitted supplemental
expert disclosures which, among other things, alleged new abatement claims
significantly higher than prior allegations.  On April 11, 2008 the
trial court judge issued an order denying defendant’s motion to dismiss
plaintiffs’ substantial unjust enrichment claims.  On April 22, 2008
the trial court judge issued an order that PSE along with two other defendants
would be held liable on all counts, including a finding of malice for punitive
damages, as a discovery sanction.    Although the defendants
submitted a motion for reconsideration of this sanction on April 25, 2008, the
defendants reached agreement on a global settlement with all plaintiffs on April
29, 2008 and PSE’s share of that settlement is approximately $10.7
million.  PSE expects settlement documents to be finalized in the
second quarter 2008 and as a result have increased the reserve to $10.7
million.  PSE is also evaluating whether it will file an accounting
petition to defer such costs.


The
Minerals Management Service of the United States Department of Interior
(MMS) has issued a series of orders to Western Energy Company (WECO) to pay
additional taxes and royalties concerning coal WECO sold to the owners of
Colstrip 3 & 4, and similar orders have been issued in the administrative
appellate process.  The orders assert that additional royalties are
owed in connection with payments received by WECO from Colstrip 3
& 4 owners (including PSE) for the construction and operation of a
conveyor system that runs several miles from the mine to Colstrip 3 &
4.  The state of Montana has also issued a demand to WECO consistent
with the MMS position.  WECO has challenged these orders, and the
issue has been on appeal for several years.WECO has won
some points during the appellate process that have reduced the claims--but under
applicable law, to pursue the appeals, the principal in dispute cannot be paid,
which causes interest to accrue.  Moreover, because the conveyor
system continues to be used, the amount in
dispute grows.  In the aggregate, the accrued
interest--plus unasserted claims to bring the amount
current--could make the total claim (principal plus interest) pertaining to
PSE’s 25% project share as high as $10 million.  PSE is unable to
predict the ultimate outcome of this dispute.  PSE believes a future loss
in connection with this dispute is reasonably possible but not probable, and has
not recorded a loss reserve.


Proceedings
Relating to the Western Power Market


Puget
Energy’s and PSE’s Annual Report on Form 10-K for the year ended December 31,
2007 includes a summary relating to the western power market
proceedings.  The following discussion provides a summary of material
developments in these proceedings that occurred during and subsequent to the
period covered by that report.  PSE is vigorously defending each of
these cases.  Litigation is subject to numerous uncertainties and PSE
is unable to predict the ultimate outcome of these
matters.  Accordingly, there can be no guarantee that these
proceedings, either individually or in the aggregate, will not materially and/or
adversely affect PSE’s financial condition, results of operations or
liquidity.


Lockyer Case.In
March and April 2008, FERC issued orders establishing procedures for the Lockyer
remand.  The orders commence a seller-by-seller inquiry into the
transaction reports filed by entities that sold power in California during
2000.  The inquiry is to determine if the transaction reports as filed
masked the gathering of more than 20% of the market during the period, by that
seller.  PSE is confident that it will not be found to have possessed
20% of any relevant market during any relevant time.  The order also
mandates a settlement process before an Administrative Law Judge.  The
California parties sought rehearing of these orders on April 21,
2008;


California Receivable and California
Refund Proceeding.  On March 18, 2008, the California
Independent Systems Operator (CAISO) filed a status report with its calculations
of interest owed by and owing to parties.  The report also identified
further work to perform in the CAISO’s “who owes what to whom”
calculation.  On March 25, 2008, FERC issued an order addressing,
among other things, 11 pending rehearing requests by the California parties—all
of which the order rejected.




Proceeding
Relating to the Proposed Merger


On
October 26, 2007 and November 2, 2007, two separate lawsuits were
filed against the Company and all of the members of the Company’s Board of
Directors in Superior Court in King County, Washington.  The lawsuits,
respectively, are entitled, Tansey v. Puget Energy, Inc.,
et al., Case No. 07-2-34315-6 SEA and Alaska Ironworkers Pension Trust v.
Puget Energy, Inc., et al., Case No. 07-2-35346-1
SEA.  The lawsuits are both denominated as class actions purportedly
on behalf of Puget Energy’s shareholders and assert substantially similar
allegations and causes of action relating to the proposed merger.  The
complaints allege that Puget Energy’s directors breached their fiduciary duties
in connection with the merger and seek virtually identical relief, including an
order enjoining the consummation of the merger.  Pursuant to a court
order dated November 26, 2007, the two cases were consolidated for all
purposes and entitled In re
Puget Energy, Inc. Shareholder Litigation, Case No. 07-2-34315-6
SEA.


On
February 6, 2008, the parties entered into a memorandum of understanding
providing for the settlement of the consolidated lawsuit, subject to customary
conditions including completion of appropriate settlement documentation,
confirmatory discovery and court approval.  Pursuant to the memorandum
of understanding, the Company agreed to include certain additional disclosures
in its proxy statement relating to the merger.  The Company does not
admit, however, that its prior disclosures were in any way materially misleading
or inadequate.  In addition, the Company and the other defendants in
the consolidated lawsuit deny the plaintiffs’ allegations of wrongdoing and
violation of law in connection with the merger.  The settlement, if
completed and approved by the court, will result in dismissal with prejudice and
release of all claims of the plaintiffs and settlement class of the Company’s
shareholders that were or could have been brought on behalf of the plaintiffs
and the settlement class.  In connection with such settlement, the
plaintiffs intend to seek a court-approved award of attorneys’ fees and expenses
in an amount up to $290,000, which the Company has agreed to pay.  At
March 31, 2008, the Company has a loss reserve of $290,000 recorded at March 31,
2008 related to this matter.




New
Accounting Pronouncements


On
September 15, 2006, FASB issued Statement of Financial Accounting Standards No.
157, “Fair Value Measurements” (SFAS No. 157), which clarifies how companies
should use fair value measurements in accordance with GAAP for recognition and
disclosure purposes.  SFAS No. 157 establishes a common definition of
fair value and a framework for measuring fair value under GAAP, along with
expanding disclosures about fair value to eliminate differences in current
practice that exist in measuring fair value under the existing accounting
standards.  The definition of fair value in SFAS No. 157 retains the
notion of exchange price; however, it focuses on the price that would be
received to sell the asset or paid to transfer a liability (i.e. an exit price),
rather than the price that would be paid to acquire the asset or received to
assume the liability (i.e. an entrance price).  Under SFAS No. 157, a
fair value measure should reflect all of the assumptions that market
participants would use in pricing the asset or liability, including assumptions
about the risk inherent in a particular valuation technique, the effect of a
restriction on the sale or use of an asset and the risk of
nonperformance.  To increase consistency and comparability in fair
value measures, SFAS No. 157 establishes a three-level fair value hierarchy to
prioritize the inputs used in valuation techniques between observable inputs
that reflect quoted market prices in active markets, inputs other than quoted
prices with observable market data and unobservable data (e.g., a company’s own
data).


SFAS No.
157 is effective for fiscal years beginning after November 15, 2007, which was
January 1, 2008, for the Company.  On February 28, 2008, the FASB
issued a final FASB Staff Position (FSP) that partially deferred the effective
date of SFAS No. 157 for one year for non-financial assets and non-financial
liabilities that are recognized or disclosed at fair value, except for those
that are recognized or disclosed at fair value on an annual or more frequent
basis.  The Company adopted SFAS No. 157 on January 1, 2008,
prospectively, as required by SFAS No. 157, with certain
exceptions,  including the initial impact of changes in fair value
measurements of existing derivative financial instruments measured initially
using the transaction price under Emerging Issues Task Force (EITF) Issue No.
02-3, “Issues Involved in Accounting for Derivative Contracts Held for Trading
Purposes and Contracts Involved in Energy Trading and Risk Management
Activities” (EITF 02-3).  On January 1, 2008, the difference between
the carrying amounts and the fair values of those instruments originally
recorded under guidance in EITF 02-3 was recognized as a cumulative-effect
adjustment to the opening balance of retained earnings.  SFAS No. 157
nullified a portion of EITF 02-3.  Under EITF 02-3, the transaction price
presumption prohibited recognition of a trading profit at inception of a
derivative unless the positive fair value of that derivative was substantially
based on quoted prices or a valuation process incorporating observable
inputs.  For transactions that did not meet this criterion at
inception, trading profits that had been deferred were recognized in the period
that inputs to value the derivative became observable or when the contract
performed.  SFAS No. 157 nullified this portion of EITF 02-3.


On March
19, 2008, FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities – An Amendment of FASB Statement No. 133” (SFAS No.
161).  SFAS No. 161 is effective for the fiscal years and interim
years beginning after November 15, 2008, which will be the quarter ended March
31, 2009 for the Company.  SFAS No. 161 requires companies with
derivative instruments to disclose information that should enable financial
statement users to understand how and why a company uses derivative instruments,
how derivative instruments and related hedged items are accounted for under SFAS
No. 133 and how derivative instruments and related hedged items affect a
company’s financial position, financial performance and cash
flows.  SFAS No. 161 requirements will impact the following derivative
and hedging disclosures: objectives and strategies, balance sheet, financial
performance, contingent features and counterparty credit risk.  The
Company is currently assessing the impact of SFAS No. 161.







Item 3.  Quantitative
and Qualitative Disclosure About Market Risk




Energy
Portfolio Management


The
Company has energy risk policies and procedures to manage commodity and
volatility risks.  The Company’s Energy Management Committee
establishes the Company’s energy risk management policies and procedures, and
monitors compliance.  The Energy Management Committee is comprised of
certain Company officers and is overseen by the Audit Committee of the Company’s
Board of Directors.


The
Company is focused on commodity price exposure and risks associated with
volumetric variability in the natural gas and electric portfolios.  It
is not engaged in the business of assuming risk for the purpose of speculative
trading.  The Company hedges open natural gas and electric positions
to reduce both the portfolio risk and the volatility risk in
prices.  The exposure position is determined by using a probabilistic
risk system that models 100 scenarios of how the Company’s natural gas and power
portfolios will perform under various weather, hydro and unit performance
conditions.  The objectives of the hedging strategy are
to:





·
            Ensure
      physical energy supplies are available to reliably and cost-effectively
      serve retail load;·
            Manage
      energy portfolio risks prudently to serve retail load at overall least
      cost and limit undesired impacts on PSE’s customers and shareholders;
      and·
            Reduce
      power costs by extracting the value of the Company’s
    assets.





The
following table presents electric derivatives that are designated as cash flow
hedges or contracts that do not meet Normal Purchase Normal Sale (NPNS) at March
31, 2008 and December 31, 2007:




Electric
              Derivatives(Dollars
      in Millions)
            
            March
      31,
              2008
            
            
            December
      31,
              2007Short-term
      asset
            
            $
            53.2
            
            
            $
            11.1Long-term
      asset
            
            
            31.4
            
            
            
            6.6Total
      assets
            
            $
            84.6
            
            
            $
            17.7Short-term
      liability
            
            $
            3.6
            
            
            $
            9.8Long-term
      liability
            
            
            6.6
            
            
            
            --Total
      liabilities
            
            $
            10.2
            
            
            $
            9.8





If it is
determined that it is uneconomical to operate PSE’s controlled electric
generating facilities in the future period, the fuel supply cash flow hedge
relationship is terminated and the hedge is de-designated which results in the
unrealized gains and losses associated with the contracts being recorded in the
income statement.  As these contracts are settled, the costs are
recognized as energy costs and are included as part of the PCA
mechanism.


At December 31, 2007, the Company had an unrealized day one loss deferral of
$9.0 million related to a three-year locational power exchange contract which
was modeled and therefore the day one gain was deferred under EITF No.
02-3.  The contract has economic benefit to the Company over its
terms.  The locational exchange will help ease electric transmission
congestion across the Cascade Mountains during the winter months as PSE will
take delivery of energy at a location that interconnects with PSE’s transmission
system in western Washington.  At the same time, PSE will make
available the quantities of power at the Mid-Columbia trading hub
location.  The day one loss deferral was transferred to retained
earnings on January 1, 2008 as required by SFAS No. 157, “Fair Value
Measurements” and any future day one loss on contracts will be recorded in the
income statement beginning January 1, 2008 in accordance with the
statement.


The
following tables present the impact of changes in the market value of derivative
instruments not meeting NPNS or cash flow hedge criteria, and ineffectiveness
related to highly effective cash flow hedges, to the Company’s earnings during
the three months ended March 31, 2008 and March 31, 2007:





(Dollars in
      Millions)
              Three
      Months Ended March 31,
            2008
            2007
            ChangeIncrease
      (decrease) in earnings
            $
      (0.1)
            $
      5.8
            $
      (5.9)





In the
first quarter 2007, the Company reversed a loss reserve due to credit worthiness
related to a physically delivered natural gas supply contract for electric
generation.  The counterparty’s financial outlook had changed and
delivery was now probable through the life of the contract which expires June
30, 2008.


The
amount of net unrealized gain (loss), net of tax, related to the Company’s cash
flow hedges under SFAS No. 133 consisted of the following at March 31, 2008 and
December 31, 2007:





(Dollars
      in Millions, net of tax)
            March
      31,
              2008
            December
      31,
              2007Other
      comprehensive income – unrealized gain (loss)
            $
      (52.5)
            $  3.4




The
following table presents derivative hedges of natural gas contracts to serve
natural gas customers at March 31, 2008 and December 31, 2007:





Gas
      Derivatives(Dollars
      in Millions)
            
            March
      31,
              2008
            
            
            December
      31,
              2007Short-term
      asset
            
            $
            44.0
            
            
            $
            6.0Long-term
      asset
            
            
            13.7
            
            
            
            5.3Total
      assets
            
            $
            57.7
            
            
            $
            11.3Short-term
      liability
            
            $
            1.0
            
            
            $
            17.3Long-term
      liability
            
            
            0.4
            
            
            
            --Total
      liabilities
            
            $
            1.4
            
            
            $
            17.3





At March 31, 2008, the Company had total assets of $57.7 million and total
liabilities of $1.4 million related to hedges of natural gas contracts to serve
natural gas customers.  All mark-to-market adjustments relating to the
natural gas business have been reclassified to a deferred account in accordance
with SFAS No. 71 due to the PGA mechanism.  All increases and
decreases in the cost of natural gas supply are passed on to customers with the
PGA mechanism.  As the gains and losses on the hedges are realized in
future periods, they will be recorded as natural gas costs under the PGA
mechanism.


A
hypothetical 10.0% decrease in the market prices of natural gas and electricity
would decrease the fair value of qualifying cash flow hedges by $43.5 million
after-tax, with a corresponding impact in comprehensive income and earnings (due
to ineffectiveness) of $42.7 million and $0.9 million, respectively, after-tax,
and would increase the fair value of those contracts marked-to-market in
earnings by $0.4 million after-tax.




Credit
Risk


The Company is exposed to
credit risk primarily through buying and selling electricity and natural gas to
serve customers.  Credit risk is the potential loss resulting from a
counterparty’s non-performance under an agreement.  The Company
manages credit risk with policies and procedures for, among other things,
counterparty analysis, exposure measurement, exposure monitoring and exposure
mitigation.  The Company has entered into master netting arrangements
with counterparties when available to mitigate credit exposure to those
counterparties.  The Company believes that entering into such
agreements reduces risk of settlement default for the ability to make only one
net payment.


It is possible that
extreme volatility in energy commodity prices could cause the Company to have
credit risk exposures with one or more counterparties.  If such
counterparties fail to perform their obligations under one or more agreements,
the Company could suffer a material financial loss.  However, as of
March 31, 2008, approximately 96% of the counterparties comprising the sources
of our energy portfolio are rated at least investment grade by the major rating
agencies.  The Company assesses credit risk internally for
counterparties that are not 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 anticipated
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 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.


The
ending balance in other comprehensive income related to the forward starting
swaps and previously settled treasury lock contracts at March 31, 2008 was a net
loss of $8.1 million after-tax and accumulated amortization.  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.







Item
4.             Controls
and Procedures




Puget
Energy


Evaluation
of Disclosure Controls and Procedures


Under the supervision and
with the participation of Puget Energy’s management, including the Chairman,
President and Chief Executive Officer and the Executive Vice President and Chief
Financial Officer, Puget Energy has evaluated the effectiveness of its
disclosure controls and procedures (as defined in Rule 13a-15(e) under the
Securities Exchange Act of 1934) as of March 31, 2008, the end of the period
covered by this report.  Based upon that evaluation, the Chairman,
President and Chief Executive Officer and the Executive Vice President and Chief
Financial Officer of Puget Energy concluded that these disclosure controls and
procedures are effective.




Changes
in Internal Control Over Financial Reporting


There have been no changes
in Puget Energy’s internal control over financial reporting during the quarter
ended March 31, 2008 that have materially affected, or are reasonably likely to
materially affect, Puget Energy’s internal control over financial
reporting.




Puget
Sound Energy


Evaluation
of Disclosure Controls and Procedures


Under the supervision and
with the participation of PSE’s management, including the Chairman, President
and Chief Executive Officer and the Executive Vice President and Chief Financial
Officer, PSE has evaluated the effectiveness of its disclosure controls and
procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of
1934) as of March 31, 2008, the end of the period covered by this
report.  Based upon that evaluation, the Chairman, President and Chief
Executive Officer and the Executive Vice President and Chief Financial Officer
of PSE concluded that these disclosure controls and procedures are
effective.




Changes
in Internal Control Over Financial Reporting


There have been no changes
in PSE’s internal control over financial reporting during the quarter ended
March 31, 2008, that have materially affected, or are reasonably likely to
materially affect, PSE’s internal control over financial reporting.








PART
IIOTHER
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 Report on Form 10-Q.  Contingencies arising out
of the normal course of the Company’s business exist at March 31,
2008.  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
1A.          Risk
Factors





There have been no material changes from the risk factors set forth in Part I,
Item 1A in the Company’s Annual Report on Form 10-K for the year ended December
31, 2007.




Item
4.             Submission
of Matters to a Vote of Security Holders




Puget Energy’s special meeting of shareholders was held on April 16,
2008.  At the special meeting, the shareholders approved by more than
two-thirds required vote a merger with the Consortium of North American
infrastructure investors.  The vote on the proposals were as
follows:





Proposal
1:  Approval of the Plan of Merger dated as of October 26, 2007
between Puget Energy, Puget Holdings LLC, Puget Intermediate Holdings Inc. and
Puget Merger Sub, Inc.





For
            Against
            Abstain
            Broker
      Non-Vote101,640,757
            2,362,394
            1,408,869
            --









Proposal 2:  Approval to adjourn the special meeting to a later date,
if necessary, to permit solicitation of proxies.





For
            Against
            Abstain
            Broker
      Non-Vote96,584,206
            7,196,655
            1,631,159
            --


Item
5.              Other
Information




In view of the pending merger with the Consortium, we have not established a
date for our 2008 annual meeting of shareholders.  However, if, as may
become necessary, the annual meeting is held at some later time, we will inform
shareholders of the new date and the deadline for shareholders to submit
proposals that will be eligible for consideration for inclusion in our proxy
materials, which deadline will be a reasonable time before we begin to print and
send our proxy materials.




Item
6.              Exhibits




See Exhibit Index for list of exhibits.












SIGNATURES


Pursuant
to the requirements 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. EldredgeJames
      W. EldredgeVice
      President, Controller and Chief Accounting OfficerDate:  May
      6, 2008Chief
      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 (2003
      through 2007 and 12 months ended March 31, 2008) for Puget
      Energy.12.2
            Statement
      setting forth computation of ratios of earnings to fixed charges (2003
      through 2007 and 12 months ended March 31, 2008) 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.