UNITED
      STATES


SECURITIES
      AND EXCHANGE COMMISSION


Washington,
      D.C. 20549


**FORM
      10-Q**








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








**For
                the quarterly period ended September 30, 2007**
              
              **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, or a non-accelerated filer.  See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange
      Act.




Puget
                Energy, Inc.
            Large
                accelerated filer
            /X/
            Accelerated
                filer
            /  /
            Non-accelerated
                filer
            /  /Puget
                Sound Energy, Inc.
            Large
                accelerated filer
            /  /
            Accelerated
                filer
            /  /
            Non-accelerated
                filer
            /X/





Indicate
      by check mark whether the registrant is a shell company (as defined in Exchange
      Act Rule 12b-2)


Puget
                Energy, Inc.
            Yes
            /  /
            No
            /X/
            
            Puget
                Sound Energy, Inc.
            Yes
            /  /
            No
            /X/





As
      of
      October 25, 2007, (i) the number of shares of Puget Energy, Inc. common stock
      outstanding was 117,176,878 ($.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**


**Definitions****Filing
                Format****Forward
                Looking
                Statements****Part
                I.**
            **Financial
                Information****Item
                1.**
            **Financial
                Statements****Puget
                Energy, Inc.**Consolidated
                Statements of Income –  Three and
                Nine Months Ended September 30, 2007 and 2006Consolidated
                Statements of Comprehensive Income – Three and Nine Months EndedSeptember
                30, 2007 and 2006Consolidated
                Balance Sheets – September 30, 2007 and
                December 31, 2006Consolidated
                Statements of Cash Flows – Nine Months
                Ended September 30, 2007 and 2006**Puget
                Sound Energy, Inc.**Consolidated
                Statements of Income – Three and Nine
                Months Ended September 30, 2007 and 2006Consolidated
                Statements of Comprehensive Income – Three and Nine Months EndedSeptember
                30, 2007 and 2006Consolidated
                Balance Sheets – September 30, 2007 and
                December 31, 2006Consolidated
                Statements of Cash Flows – Nine Months
                Ended September 30, 2007 and 2006**Notes**Combined
                Notes to Consolidated Financial
                Statements**Item
                2.**
            **Management’s
                Discussion and Analysis of Financial
                Condition****and Results of
                Operations****Item
                3.**
            **Quantitative
                and Qualitative Disclosure About Market
                Risk****Item
                4.**
            **Controls
                and Procedures****Part
                II.**
            **Other
                Information****Item
                1.**
            **Legal
                Proceedings****Item
                1A.**
            **Risk
                Factors****Item
                6.**
            **Exhibits****Signatures****Exhibit
                Index**








**DEFINITIONS**






AFUDC
            Allowance
                for Funds Used During ConstructionaMW
            Average
                MegawattBART
            Best
                Available Retrofit TechnologyBPA
            Bonneville
                Power AdministrationCAISO
            California
                Independent System OperatorEITF
            Emerging
                Issues Task ForceEPA
            U.
                S. Environmental Protection AgencyFASB
            Financial
                Accounting Standards BoardFERC
            Federal
                Energy Regulatory CommissionFIN
            Financial
                Accounting Standards Board InterpretationGAAP
            Generally
                Accepted Accounting PrinciplesIBEW
            International
                Brotherhood of Electrical WorkersInfrastruX
            InfrastruX
                Group, Inc.IRP
            Integrated
                Resource PlanIRS
            Internal
                Revenue ServicekW
            KilowattkWh
            Kilowatt
                HourLIBOR
            London
                Interbank Offered RateMMS
            Minerals
                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 CorporationNPNS
            Normal
                Purchase Normal SalePCA
            Power
                Cost AdjustmentPCORC
            Power
                Cost Only Rate CasePGA
            Purchased
                Gas AdjustmentPSE
            Puget
                Sound Energy, Inc.PSE
                Funding
            PSE
                Funding, Inc.PTC
            Production
                Tax CreditPuget
                Energy
            Puget
                Energy, Inc.RFP
            Request
                For ProposalSFAS
            Statement
                of Financial Accounting StandardsSumas
            Sumas
                Cogeneration Company, L.P.TBtu
            Trillion
                British Thermal UnitTenaska
            Tenaska
                Power Fund, L.P.Washington
                Commission
            Washington
                Utilities and Transportation CommissionWECC
            Western
                Electricity Coordinating CouncilWECO
            Western
                Energy Company









**FILING
      FORMAT**


This
      Quarterly 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 (gas and electric), licensing of hydroelectric operations
                  and
                  gas storage facilities, recovery of other capital investments,
                  recovery of
                  power and gas costs, recovery of regulatory assets and present
                  or
                  prospective wholesale and retail competition;·
              Failure
                  to comply with standards and/or rules governed by FERC or the Washington
                  Commission, which could result in penalties based on the discretion
                  of
                  either commission;·
              Failure
                  to comply with new 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 Company’s 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 that impact customer loads;·
              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 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 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 gas or electric plant to operate as
                  intended;·
              The
                  ability to renew contracts for electric and gas supply and the
                  price of
                  renewal;·
              Blackouts
                  or large curtailments of transmission systems, whether PSE’s or others’,
                  which can 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 gas pipeline delivering to PSE’s system, which may
                  impact PSE’s ability to adequately deliver gas supply 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;·
              Future
                  losses related to corporate guarantees provided by Puget Energy
                  as a part
                  of the sale of its InfrastruX subsidiary·
              The
                  ability to maintain effective internal controls over financial
                  reporting
                  and operational processes; and·
              The
                  risk that the stock purchase will not close or will be delayed,
                  including
                  as a result of the failure to obtain on a timely basis clearance
                  under the
                  Hart Scott Rodino Antitrust Improvements Act of 1976, as amended
                  (HSR
                  Act), which could adversely impact PSE’s liquidity and capital
                  resources;·
              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 shareholder approval or
                  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 million,
                  plus
                  out-of-pocket expenses of the acquiring entity and its members
                  of up to
                  $10 million;§
              Risks
                  related to diverting management's attention from ongoing business
                  operations;§
              The
                  effect of the announcement of the merger on our business relationships,
                  operating results and business generally, including our ability
                  to retain
                  key employees; and§
              Potential
                  litigation regarding the
                  merger.


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 our most recent annual report on
      Form 10-K and this quarterly report for updates.





**PART
      I                      FINANCIAL
      INFORMATION**





Item
      1.              **Financial
      Statements**


**PUGET
      ENERGY, INC.**


CONSOLIDATED
      STATEMENTS OF INCOME


(Dollars
      in thousands except per share amounts)


(Unaudited)


Three
                Months Ended
              September
                30,
            
            
            Nine
                Months Ended
              September
                30,2007
            
            
            2006
            
            
            2007
            
            
            2006Operating
                revenues:Electric
            
            $
            456,100
            
            
            $
            399,246
            
            
            $
            1,418,980
            
            
            $
            1,247,650Gas
            
            
            142,120
            
            
            
            119,610
            
            
            
            834,304
            
            
            
            718,655Non-utility
                operating revenues
            
            
            3,460
            
            
            
            685
            
            
            
            13,439
            
            
            
            5,776Total
                operating revenues
            
            
            601,680
            
            
            
            519,541
            
            
            
            2,266,723
            
            
            
            1,972,081Operating
                expenses:Energy
                costs:Purchased
                electricity
            
            
            185,778
            
            
            
            183,723
            
            
            
            640,627
            
            
            
            623,793Electric
                generation fuel
            
            
            43,528
            
            
            
            36,282
            
            
            
            93,312
            
            
            
            72,158Residential
                exchange
            
            
            (384
            )
            
            
            (35,923
            )
            
            
            (52,424
            )
            
            
            (131,226
            )Purchased
                gas
            
            
            80,914
            
            
            
            68,294
            
            
            
            530,616
            
            
            
            453,335Net
                unrealized (gain) loss on derivative instruments
            
            
            5,276
            
            
            
            (611
            )
            
            
            1,031
            
            
            
            214Utility
                operations and maintenance
            
            
            94,433
            
            
            
            87,687
            
            
            
            291,539
            
            
            
            258,653Non–utility
                expense and other
            
            
            3,301
            
            
            
            958
            
            
            
            8,199
            
            
            
            2,665Depreciation
                and amortization
            
            
            68,909
            
            
            
            65,530
            
            
            
            204,351
            
            
            
            193,959Conservation
                amortization
            
            
            8,530
            
            
            
            7,127
            
            
            
            27,608
            
            
            
            22,638Taxes
                other than income taxes
            
            
            56,907
            
            
            
            46,360
            
            
            
            207,269
            
            
            
            180,299Total
                operating expenses
            
            
            547,192
            
            
            
            459,427
            
            
            
            1,952,128
            
            
            
            1,676,488Operating
                income
            
            
            54,488
            
            
            
            60,114
            
            
            
            314,595
            
            
            
            295,593Other
                income (deductions):Other
                income
            
            
            6,725
            
            
            
            7,298
            
            
            
            17,710
            
            
            
            17,425Charitable
                foundation funding
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            (15,000
            )Other
                expense
            
            
            (686
            )
            
            
            (1,685
            )
            
            
            (4,546
            )
            
            
            (3,943
            )Interest
                charges:AFUDC
            
            
            3,554
            
            
            
            5,189
            
            
            
            8,915
            
            
            
            10,238Interest
                expense
            
            
            (54,681
            )
            
            
            (45,923
            )
            
            
            (158,133
            )
            
            
            (134,197
            )Income
                from continuing operations before income taxes
            
            
            9,400
            
            
            
            24,993
            
            
            
            178,541
            
            
            
            170,116Income
                tax (benefit) expense
            
            
            (2,218
            )
            
            
            9,072
            
            
            
            49,262
            
            
            
            60,048Income
                from continuing operations
            
            
            11,618
            
            
            
            15,921
            
            
            
            129,279
            
            
            
            110,068Income
                from discontinued segment (net of tax)
            
            
            (224
            )
            
            
            1
            
            
            
            (212
            )
            
            
            51,903Net
                income before cumulative effect of accounting change
            
            
            11,394
            
            
            
            15,922
            
            
            
            129,067
            
            
            
            161,971Cumulative
                effect of implementation of accounting change (net of tax)
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            89Net
                income
            
            $
            11,394
            
            
            $
            15,922
            
            
            $
            129,067
            
            
            $
            162,060Common
                shares outstanding weighted average (in thousands)
            
            
            116,821
            
            
            
            116,101
            
            
            
            116,650
            
            
            
            115,910Diluted
                shares outstanding weighted average (in thousands)
            
            
            117,365
            
            
            
            116,568
            
            
            
            117,225
            
            
            
            116,311Basic
                earnings per common share before cumulative effect of accounting
                change
            
            $
            0.10
            
            
            $
            0.14
            
            
            $
            1.11
            
            
            $
            0.95Basic
                earnings per common share from discontinued operations
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            0.45Cumulative
                effect from accounting change
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            --Basic
                earnings per common share
            
            $
            0.10
            
            
            $
            0.14
            
            
            $
            1.11
            
            
            $
            1.40Diluted
                earnings per common share before cumulative effect of accounting
                change
            
            $
            0.10
            
            
            $
            0.14
            
            
            $
            1.10
            
            
            $
            0.95Diluted
                earnings per common share from discontinued operations
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            0.44Cumulative
                effect from accounting change
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            --Diluted
                earnings per common share
            
            $
            0.10
            
            
            $
            0.14
            
            
            $
            1.10
            
            
            $
            1.39





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





**PUGET
      ENERGY, INC.**


CONSOLIDATED
      STATEMENTS OF COMPREHENSIVE INCOME


(Dollars
      in thousands)


(Unaudited)





Three
                Months Ended
              September
                30,
            
            
            Nine
                Months Ended
              September
                30,2007
            
            
            2006
            
            
            2007
            
            
            2006Net
                income
            
            $
            11,394
            
            
            $
            15,922
            
            
            $
            129,067
            
            
            $
            162,060Other
                comprehensive income, net of tax at 35%:Foreign
                currency translation adjustment, net of tax of $0, $0, $0 and $(176),
                respectively
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            (327
            )Unrealized
                gain from pension and postretirement plans, net of tax of $943, $0,
                $2,228
                and $78, respectively
            
            
            1,752
            
            
            
            --
            
            
            
            4,138
            
            
            
            145Net
                unrealized losses on derivative instruments during the period, net
                of tax
                of $(5,752), $(6,042), $(11,303) and $(15,687),
                respectively
            
            
            (10,683
            )
            
            
            (11,220
            )
            
            
            (20,992
            )
            
            
            (29,133
            )Reversal
                of net unrealized gains (losses) on derivative instruments settled
                during
                the period, net of tax of $2,488, $690, $3,556 and $(4,632),
                respectively
            
            
            4,620
            
            
            
            1,281
            
            
            
            6,604
            
            
            
            (8,603
            )Amortization
                of cash flow hedge contracts to earnings, net of tax of $43, $41,
                $128 and
                $246, respectively
            
            
            79
            
            
            
            76
            
            
            
            238
            
            
            
            457Settlement
                of cash flow hedge contracts net of tax of $0, $(224), $0 and $7,239,
                respectively
            
            
            --
            
            
            
            (416
            )
            
            
            --
            
            
            
            13,444Deferral
                of cash flow hedges related to the power cost adjustment mechanism,
                net of
                tax of $0, $0, $0 and $3,366, respectively
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            6,252Comprehensive
                loss
            
            
            (4,232
            )
            
            
            (10,279
            )
            
            
            (10,012
            )
            
            
            (17,765
            )Comprehensive
                income
            
            $
            7,162
            
            
            $
            5,643
            
            
            $
            119,055
            
            
            $
            144,295





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





**PUGET
      ENERGY, INC**.


CONSOLIDATED
      BALANCE SHEETS


(Dollars
      in thousands)








**ASSETS**





September
                30,
              2007
              (Unaudited)
            
            
            December
                31,
              2006Utility
                plant: (at original cost, including construction work in progress
                of$303,538
                and $ 206,459, respectively)Electric
            
            $
            5,841,288
            
            
            $
            5,334,368Gas
            
            
            2,270,518
            
            
            
            2,146,048Common
                plant
            
            
            482,374
            
            
            
            458,262Less:  Accumulated
                depreciation and amortization
            
            
            (3,072,245
            )
            
            
            (2,757,632
            )Net
                utility plant
            
            
            5,521,935
            
            
            
            5,181,046Other
                property and investments
            
            
            153,874
            
            
            
            151,462Current
                assets:Cash
            
            
            29,769
            
            
            
            28,117Restricted
                cash
            
            
            4,792
            
            
            
            839Accounts
                receivable, net of allowance for doubtful accounts
            
            
            119,554
            
            
            
            253,613Secured
                pledged accounts receivable
            
            
            126,000
            
            
            
            110,000Unbilled
                revenues
            
            
            115,238
            
            
            
            202,492Purchased
                gas adjustment receivable
            
            
            --
            
            
            
            39,822Materials
                and supplies, at average cost
            
            
            61,199
            
            
            
            43,501Fuel
                and gas inventory, at average cost
            
            
            116,797
            
            
            
            115,752Unrealized
                gain on derivative instruments
            
            
            12,523
            
            
            
            16,826Prepaid
                income tax
            
            
            35,859
            
            
            
            --Prepaid
                expenses
            
            
            8,883
            
            
            
            9,228Other
            
            
            16,303
            
            
            
            --Deferred
                income taxes
            
            
            6,049
            
            
            
            1,175Total
                current assets
            
            
            652,966
            
            
            
            821,365Other
                long-term assets:Restricted
                cash
            
            
            --
            
            
            
            3,814Regulatory
                asset for deferred income taxes
            
            
            106,068
            
            
            
            115,304Regulatory
                asset for PURPA contract buyout costs
            
            
            147,375
            
            
            
            167,941Unrealized
                gain on derivative instruments
            
            
            32
            
            
            
            6,934Power
                cost adjustment mechanism
            
            
            --
            
            
            
            6,357Other
            
            
            660,410
            
            
            
            611,816Total
                other long-term assets
            
            
            913,885
            
            
            
            912,166Total
                assets
            
            $
            7,242,660
            
            
            $
            7,066,039





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











**PUGET
      ENERGY,
      INC.**


CONSOLIDATED
      BALANCE SHEETS


(Dollars
      in thousands)





**CAPITALIZATION
      AND LIABILITIES**





September
                30,
              2007
              (Unaudited)
            
            
            December
                31,
              2006Capitalization:Common
                shareholders’ investment:Common
                stock $0.01 par value, 250,000,000 shares authorized, 117,170,298
                and
                116,576,636 shares outstanding, respectively
            
            $
            1,170
            
            
            $
            1,166Additional
                paid-in capital
            
            
            1,983,018
            
            
            
            1,969,032Earnings
                reinvested in the business
            
            
            213,976
            
            
            
            172,529Accumulated
                other comprehensive loss, net of tax at 35%
            
            
            (36,710
            )
            
            
            (26,698
            )Total
                shareholders’ equity
            
            
            2,161,454
            
            
            
            2,116,029Redeemable
                securities and long-term debt:Preferred
                stock subject to mandatory redemption
            
            
            1,889
            
            
            
            1,889Junior
                subordinated notes
            
            
            250,000
            
            
            
            --Junior
                subordinated debentures of the corporation payable to a subsidiary
                trust
                holding mandatorily redeemable preferred securities
            
            
            --
            
            
            
            37,750Long-term
                debt
            
            
            2,428,860
            
            
            
            2,608,360Total
                redeemable securities and long-term debt
            
            
            2,680,749
            
            
            
            2,647,999Total
                capitalization
            
            
            4,842,203
            
            
            
            4,764,028Current
                liabilities:Accounts
                payable
            
            
            238,922
            
            
            
            379,579Short-term
                debt
            
            
            378,039
            
            
            
            328,055Current
                maturities of long-term debt
            
            
            179,500
            
            
            
            125,000Accrued
                expenses:Purchased
                gas liability
            
            
            61,158
            
            
            
            --Taxes
            
            
            60,743
            
            
            
            54,977Salaries
                and wages
            
            
            19,597
            
            
            
            32,122Interest
            
            
            57,161
            
            
            
            36,915Unrealized
                loss on derivative instruments
            
            
            56,668
            
            
            
            70,596Other
            
            
            52,480
            
            
            
            43,889Total
                current liabilities
            
            
            1,104,268
            
            
            
            1,071,133Long-term
                liabilities:Deferred
                income taxes
            
            
            773,872
            
            
            
            745,095Unrealized
                loss on derivative instruments
            
            
            9,065
            
            
            
            415Power
                cost adjustment mechanism
            
            
            4,841
            
            
            
            --Other
                deferred credits
            
            
            508,411
            
            
            
            485,368Total
                long-term liabilities
            
            
            1,296,189
            
            
            
            1,230,878Total
                capitalization and liabilities
            
            $
            7,242,660
            
            
            $
            7,066,039





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





**PUGET
      ENERGY,
      INC.**


CONSOLIDATED
      STATEMENTS OF CASH FLOWS


(Dollars
      in thousands, Unaudited)


Nine
                Months Ended
              September
                30,2007
            
            
            2006Operating
                activities:Net
                income
            
            $
            129,067
            
            
            $
            162,060Adjustments
                to reconcile net income to net cash provided by operating
                activities:Depreciation
                and amortization
            
            
            204,351
            
            
            
            193,959Deferred
                income taxes and tax credits, net
            
            
            38,567
            
            
            
            (11,309
            )Net
                unrealized loss on derivative instruments
            
            
            1,031
            
            
            
            214Amortization
                of gas pipeline capacity assignment
            
            
            (8,169
            )
            
            
            (7,951
            )Impairment
                on InfrastruX investment
            
            
            --
            
            
            
            (7,269
            )Gain
                on sale of InfrastruX
            
            
            --
            
            
            
            (29,765
            )Cash
                collateral paid from energy suppliers
            
            
            --
            
            
            
            (22,020
            )Change
                in residential exchange program
            
            
            (27,205
            )
            
            
            434Cash
                receipt from lease purchase option settlement
            
            
            18,898
            
            
            
            --Chelan
                PUD contract initiation prepayment
            
            
            --
            
            
            
            (89,000
            )Power
                cost adjustment mechanism
            
            
            11,198
            
            
            
            15,696Goldendale
                deferred costs
            
            
            (11,211
            )
            
            
            --Storm
                damage deferred costs
            
            
            (16,460
            )
            
            
            (7,545
            )Other
            
            
            27,767
            
            
            
            10,214Change
                in certain current assets and liabilities:Accounts
                receivable and unbilled revenue
            
            
            215,363
            
            
            
            198,243Materials
                and supplies
            
            
            (17,698
            )
            
            
            (4,408
            )Fuel
                and gas inventory
            
            
            (1,045
            )
            
            
            (39,105
            )Prepayments
                and other
            
            
            (51,816
            )
            
            
            (16,696
            )Purchased
                gas adjustment receivable/payable
            
            
            100,980
            
            
            
            (16,318
            )Accounts
                payable
            
            
            (134,002
            )
            
            
            (119,308
            )Taxes
                payable
            
            
            5,766
            
            
            
            (78,357
            )Accrued
                expenses and other
            
            
            6,248
            
            
            
            20,718Net
                cash provided by operating activities
            
            
            491,630
            
            
            
            152,487Investing
                activities:Construction
                and capital expenditures - excluding equity AFUDC
            
            
            (548,043
            )
            
            
            (579,384
            )Energy
                efficiency expenditures
            
            
            (30,054
            )
            
            
            (21,859
            )Cash
                proceeds from property sales
            
            
            5,747
            
            
            
            196Refundable
                cash received for customer construction projects
            
            
            16,950
            
            
            
            12,004Restricted
                cash
            
            
            (139
            )
            
            
            (3,529
            )Gross
                proceeds from sale of InfrastruX, net of cash disposed
            
            
            --
            
            
            
            263,575Other
            
            
            (340
            )
            
            
            5,835Net
                cash used by investing activities
            
            
            (555,879
            )
            
            
            (323,162
            )Financing
                activities:Change
                in short-term debt and leases, net
            
            
            49,984
            
            
            
            65,323Dividends
                paid
            
            
            (79,135
            )
            
            
            (78,123
            )Payments
                to minority shareholders of InfrastruX
            
            
            --
            
            
            
            (10,451
            )Issuance
                of common stock
            
            
            4,379
            
            
            
            4,241Issuance
                of bonds and notes
            
            
            250,000
            
            
            
            550,000Redemption
                of trust preferred stock
            
            
            (37,750
            )
            
            
            (200,000
            )Redemption
                of bonds, notes and leases
            
            
            (125,000
            )
            
            
            (190,096
            )Settlement
                of cash flow hedge of interest rate derivative
            
            
            --
            
            
            
            20,682Issuance
                and redemption costs of bonds and other
            
            
            3,423
            
            
            
            (3,760
            )Net
                cash provided by financing activities
            
            
            65,901
            
            
            
            157,816Net
                increase (decrease) in cash
            
            
            1,652
            
            
            
            (12,859
            )Cash
                at beginning of year
            
            
            28,117
            
            
            
            22,897Cash
                at end of period
            
            $
            29,769
            
            
            $
            10,038Supplemental
                cash flow information:Cash
                paid for interest (net of capitalized interest)
            
            $
            128,755
            
            
            $
            118,848Income
                taxes paid
            
            
            23,000
            
            
            
            97,725


*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
              September
                30,
            
            
            Nine
                Months Ended
              September
                30,2007
            
            
            2006
            
            
            2007
            
            
            2006Operating
                revenues:Electric
            
            $
            456,100
            
            
            $
            399,246
            
            
            $
            1,418,980
            
            
            $
            1,247,650Gas
            
            
            142,120
            
            
            
            119,610
            
            
            
            834,304
            
            
            
            718,655Non-utility
                operating revenues
            
            
            3,460
            
            
            
            685
            
            
            
            13,439
            
            
            
            5,776Total
                operating revenues
            
            
            601,680
            
            
            
            519,541
            
            
            
            2,266,723
            
            
            
            1,972,081Operating
                expenses:Energy
                costs:Purchased
                electricity
            
            
            185,778
            
            
            
            183,723
            
            
            
            640,627
            
            
            
            623,793Electric
                generation fuel
            
            
            43,528
            
            
            
            36,282
            
            
            
            93,312
            
            
            
            72,158Residential
                exchange
            
            
            (384
            )
            
            
            (35,923
            )
            
            
            (52,424
            )
            
            
            (131,226
            )Purchased
                gas
            
            
            80,914
            
            
            
            68,294
            
            
            
            530,616
            
            
            
            453,335Unrealized
                (gain) loss on derivative instruments
            
            
            5,276
            
            
            
            (611
            )
            
            
            1,031
            
            
            
            214Utility
                operations and maintenance
            
            
            94,433
            
            
            
            87,687
            
            
            
            291,539
            
            
            
            258,653Non-utility
                expense and other
            
            
            2,178
            
            
            
            707
            
            
            
            6,755
            
            
            
            1,432Depreciation
                and amortization
            
            
            68,909
            
            
            
            65,530
            
            
            
            204,351
            
            
            
            193,959Conservation
                amortization
            
            
            8,530
            
            
            
            7,127
            
            
            
            27,608
            
            
            
            22,638Taxes
                other than income taxes
            
            
            56,907
            
            
            
            46,360
            
            
            
            207,269
            
            
            
            180,299Total
                operating expenses
            
            
            546,069
            
            
            
            459,176
            
            
            
            1,950,684
            
            
            
            1,675,255Operating
                income
            
            
            55,611
            
            
            
            60,365
            
            
            
            316,039
            
            
            
            296,826Other
                income (deductions):Other
                income
            
            
            6,725
            
            
            
            7,298
            
            
            
            17,710
            
            
            
            17,069Other
                expense
            
            
            (686
            )
            
            
            (1,685
            )
            
            
            (4,546
            )
            
            
            (3,943
            )Interest
                charges:AFUDC
            
            
            3,554
            
            
            
            5,189
            
            
            
            8,915
            
            
            
            10,238Interest
                expense
            
            
            (54,681
            )
            
            
            (45,923
            )
            
            
            (158,133
            )
            
            
            (134,197
            )Interest
                expense on Puget Energy note
            
            
            (352
            )
            
            
            (382
            )
            
            
            (1,027
            )
            
            
            (503
            )Income
                before income taxes
            
            
            10,171
            
            
            
            24,862
            
            
            
            178,958
            
            
            
            185,490Income
                tax (benefit) expense
            
            
            (1,875
            )
            
            
            9,230
            
            
            
            49,777
            
            
            
            66,008Net
                income before cumulative effect of accounting change
            
            
            12,046
            
            
            
            15,632
            
            
            
            129,181
            
            
            
            119,482Cumulative
                effect of implementation of accounting change (net of tax)
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            89Net
                income
            
            $
            12,046
            
            
            $
            15,632
            
            
            $
            129,181
            
            
            $
            119,571





*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
              September
                30,
            
            
            Nine
                Months Ended
              September
                30,2007
            
            
            2006
            
            
            2007
            
            
            2006Net
                income
            
            $
            12,046
            
            
            $
            15,632
            
            
            $
            129,181
            
            
            $
            119,571Other
                comprehensive income, net of tax at 35%:Unrealized
                gain from pension and postretirement plans, net of tax of $943, $0,
                $2,228
                and $78, respectively
            
            
            1,752
            
            
            
            --
            
            
            
            4,138
            
            
            
            145Net
                unrealized losses on derivative instruments during the period, net
                of tax
                of $(5,752), $(6,042), $(11,303) and $(15,687),
                respectively
            
            
            (10,683
            )
            
            
            (11,220
            )
            
            
            (20,992
            )
            
            
            (29,133
            )Reversal
                of net unrealized gains (losses) on derivative instruments settled
                during
                the period, net of tax of $2,488, $690, $3,556 and $(4,632),
                respectively
            
            
            4,620
            
            
            
            1,281
            
            
            
            6,604
            
            
            
            (8,603
            )Amortization
                of cash flow hedge contracts to earnings, net of tax of $43, $41,
                $128 and
                $246, respectively
            
            
            79
            
            
            
            76
            
            
            
            238
            
            
            
            457Settlement
                of cash flow hedge contracts net of tax of $0, $(224), $0 and $7,239,
                respectively
            
            
            --
            
            
            
            (416
            )
            
            
            --
            
            
            
            13,444Deferral
                of cash flow hedges related to the power cost adjustment mechanism,
                net of
                tax of $0, $0, $0 and $3,366, respectively
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            6,252Comprehensive
                loss
            
            
            (4,232
            )
            
            
            (10,279
            )
            
            
            (10,012
            )
            
            
            (17,438
            )Comprehensive
                income
            
            $
            7,814
            
            
            $
            5,353
            
            
            $
            119,169
            
            
            $
            102,133





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





**PUGET
      SOUND ENERGY, INC.**


CONSOLIDATED
      BALANCE SHEETS


(Dollars
      in thousands)





**ASSETS**





September
                30,
              2007
              (Unaudited)
            
            
            December
                31,
              2006Utility
                plant: (at original cost, including construction work in progress
                of
                $303,538 and $206,459, respectively)Electric
            
            $
            5,841,288
            
            
            $
            5,334,368Gas
            
            
            2,270,518
            
            
            
            2,146,048Common
                plant
            
            
            482,374
            
            
            
            458,262Less:  Accumulated
                depreciation and amortization
            
            
            (3,072,245
            )
            
            
            (2,757,632
            )Net
                utility plant
            
            
            5,521,935
            
            
            
            5,181,046Other
                property and investments
            
            
            153,874
            
            
            
            151,462Current
                assets:Cash
            
            
            29,677
            
            
            
            28,092Restricted
                cash
            
            
            841
            
            
            
            839Accounts
                receivable, net of allowance for doubtful accounts
            
            
            119,775
            
            
            
            253,613Secured
                pledged accounts receivable
            
            
            126,000
            
            
            
            110,000Unbilled
                revenues
            
            
            115,238
            
            
            
            202,492Purchased
                gas adjustment receivable
            
            
            --
            
            
            
            39,822Materials
                and supplies, at average cost
            
            
            61,199
            
            
            
            43,501Fuel
                and gas inventory, at average cost
            
            
            116,797
            
            
            
            115,752Unrealized
                gain on derivative instruments
            
            
            12,523
            
            
            
            16,826Prepaid
                income taxes
            
            
            34,821
            
            
            
            --Prepaid
                expenses
            
            
            8,309
            
            
            
            8,659Other
            
            
            16,303
            
            
            
            --Deferred
                income taxes
            
            
            6,049
            
            
            
            1,175Total
                current assets
            
            
            647,532
            
            
            
            820,771Other
                long-term assets:Regulatory
                asset for deferred income taxes
            
            
            106,068
            
            
            
            115,304Regulatory
                asset for PURPA contract buyout costs
            
            
            147,375
            
            
            
            167,941Unrealized
                gain on derivative instruments
            
            
            32
            
            
            
            6,934Power
                cost adjustment mechanism
            
            
            --
            
            
            
            6,357Other
            
            
            660,329
            
            
            
            611,598Total
                other long-term assets
            
            
            913,804
            
            
            
            908,134Total
                assets
            
            $
            7,237,145
            
            
            $
            7,061,413





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





**PUGET
      SOUND ENERGY, INC.**


CONSOLIDATED
      BALANCE SHEETS


(Dollars
      in thousands)





**CAPITALIZATION
      AND LIABILITIES**





September
                30,
              2007
              (Unaudited)
            
            
            December
                31,
              2006Capitalization: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
            
            
            1,001,534
            
            
            
            996,737Earnings
                reinvested in the business
            
            
            313,251
            
            
            
            263,206Accumulated
                other comprehensive loss, net of tax at 35%
            
            
            (36,710
            )
            
            
            (26,698
            )Total
                shareholder’s equity
            
            
            2,137,113
            
            
            
            2,092,283Redeemable
                securities and long-term debt:Preferred
                stock subject to mandatory redemption
            
            
            1,889
            
            
            
            1,889Junior
                subordinated notes
            
            
            250,000
            
            
            
            --Junior
                subordinated debentures of the corporation payable to a subsidiary
                trust
                holding mandatorily redeemable preferred securities
            
            
            --
            
            
            
            37,750Long-term
                debt
            
            
            2,428,860
            
            
            
            2,608,360Total
                redeemable securities and long-term debt
            
            
            2,680,749
            
            
            
            2,647,999Total
                capitalization
            
            
            4,817,862
            
            
            
            4,740,282Current
                liabilities:Accounts
                payable
            
            
            238,337
            
            
            
            379,494Short-term
                debt
            
            
            378,039
            
            
            
            328,055Short-term
                note owed to Puget Energy
            
            
            24,282
            
            
            
            24,303Current
                maturities of long-term debt
            
            
            179,500
            
            
            
            125,000Accrued
                expenses:Purchased
                gas liability
            
            
            61,158
            
            
            
            --Taxes
            
            
            60,743
            
            
            
            55,365Salaries
                and wages
            
            
            19,597
            
            
            
            31,591Interest
            
            
            57,280
            
            
            
            37,031Unrealized
                loss on derivative instruments
            
            
            56,668
            
            
            
            70,596Other
            
            
            52,480
            
            
            
            43,889Total
                current liabilities
            
            
            1,128,084
            
            
            
            1,095,324Long-term
                liabilities:Deferred
                income taxes
            
            
            777,459
            
            
            
            749,033Unrealized
                loss on derivative instruments
            
            
            9,065
            
            
            
            415Power
                cost adjustment mechanism
            
            
            4,841
            
            
            
            --Other
                deferred credits
            
            
            499,834
            
            
            
            476,359Total
                long-term liabilities
            
            
            1,291,199
            
            
            
            1,225,807Total
                capitalization and liabilities
            
            $
            7,237,145
            
            
            $
            7,061,413





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





**PUGET
      SOUND ENERGY, INC.**


CONSOLIDATED
      STATEMENTS OF CASH FLOWS


(Dollars
      in thousands)


(Unaudited)





Nine
                Months Ended
              September
                30,2007
            
            
            2006Operating
                activities:Net
                income
            
            $
            129,181
            
            
            $
            119,571Adjustments
                to reconcile net income to net cash provided by operating
                activities:Depreciation
                and amortization
            
            
            204,351
            
            
            
            193,959Deferred
                income taxes and tax credits, net
            
            
            38,216
            
            
            
            2,276Net
                unrealized loss on derivative instruments
            
            
            1,031
            
            
            
            214Amortization
                of gas pipeline capacity assignment
            
            
            (8,169
            )
            
            
            (7,951
            )Cash
                collateral paid from energy suppliers
            
            
            --
            
            
            
            (22,020
            )Change
                in residential exchange program
            
            
            (27,205
            )
            
            
            434Cash
                receipt from lease purchase option settlement
            
            
            18,898
            
            
            
            --Chelan
                PUD contract initiation payment
            
            
            --
            
            
            
            (89,000
            )Power
                cost adjustment mechanism
            
            
            11,198
            
            
            
            15,969Goldendale
                deferred costs
            
            
            (11,211
            )
            
            
            --Storm
                damage deferred costs
            
            
            (16,460
            )
            
            
            (7,545
            )Other
            
            
            28,050
            
            
            
            13,839Change
                in certain current assets and liabilities:Accounts
                receivable and unbilled revenue
            
            
            215,142
            
            
            
            210,578Materials
                and supplies
            
            
            (17,698
            )
            
            
            (5,324
            )Fuel
                and gas inventory
            
            
            (1,045
            )
            
            
            (39,105
            )Prepayments
                and other
            
            
            (50,774
            )
            
            
            (14,012
            )Purchased
                gas adjustment receivable/payable
            
            
            100,980
            
            
            
            (16,318
            )Accounts
                payable
            
            
            (134,503
            )
            
            
            (122,257
            )Taxes
                payable
            
            
            5,378
            
            
            
            (80,119
            )Accrued
                expenses and other
            
            
            6,782
            
            
            
            26,393Net
                cash provided by operating activities
            
            
            492,142
            
            
            
            179,582Investing
                activities:Construction
                expenditures - excluding equity AFUDC
            
            
            (548,043
            )
            
            
            (575,108
            )Energy
                efficiency expenditures
            
            
            (30,054
            )
            
            
            (21,859
            )Cash
                proceeds from property sales
            
            
            5,747
            
            
            
            196Refundable
                cash received for customer construction projects
            
            
            16,950
            
            
            
            12,004Restricted
                cash
            
            
            (3
            )
            
            
            209Other
            
            
            (340
            )
            
            
            5,939Net
                cash used by investing activities
            
            
            (555,743
            )
            
            
            (578,619
            )Financing
                activities:Change
                in short-term debt, net
            
            
            49,984
            
            
            
            62,154Loan
                from Puget Energy
            
            
            (21
            )
            
            
            24,211Dividends
                paid
            
            
            (79,136
            )
            
            
            (83,550
            )Investment
                from Puget Energy
            
            
            3,684
            
            
            
            68,635Issuance
                of bonds and notes
            
            
            250,000
            
            
            
            550,000Redemption
                of trust preferred stock
            
            
            (37,750
            )
            
            
            (200,000
            )Redemption
                of bonds and notes
            
            
            (125,000
            )
            
            
            (46,000
            )Settlement
                of cash flow hedge interest rate derivative
            
            
            --
            
            
            
            20,682Issuance
                and redemption cost of bonds and other
            
            
            3,425
            
            
            
            (3,809
            )Net
                cash provided by financing activities
            
            
            65,186
            
            
            
            392,323Net
                increase (decrease) in cash
            
            
            1,585
            
            
            
            (6,714
            )Cash
                at beginning of year
            
            
            28,092
            
            
            
            16,709Cash
                at end of period
            
            $
            29,677
            
            
            $
            9,995Supplemental
                cash flow information:Cash
                paid for interest (net of capitalized interest)
            
            $
            128,755
            
            
            $
            115,951Income
                taxes paid
            
            
            23,000
            
            
            
            91,621





*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) and until May 7, 2006, InfrastruX Group, Inc.
        (InfrastruX).  PSE is a public utility incorporated in the state of
        Washington that furnishes electric and gas services in a territory covering
        6,000 square miles, primarily in the Puget Sound region.


The
        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.  Certain amounts previously reported have been
        reclassified to conform to current year presentations with no effect on total
        equity or net income.  The reclassification relates to the income
        statements of Puget Energy and PSE, which have been changed from a utility
        presentation format based on Federal Energy Regulatory Commission (FERC)
        guidelines to a presentation based on generally accepted accounting principles
        (GAAP).


The
        2006
        consolidated financial statements of Puget Energy reflect the accounts of
        Puget
        Energy and its subsidiaries, PSE and InfrastruX.  Puget Energy holds
        all the common shares of PSE and until May 7, 2006, a 90.9% interest in
        InfrastruX.  The results of PSE and InfrastruX are presented on a
        consolidated basis.  The financial position and results of operations
        for InfrastruX are presented as discontinued operations.  At the time
        that it was owned by Puget Energy, InfrastruX was a non-regulated utility
        construction service company incorporated in the state of Washington, which
        provides construction services to the electric and gas utility industries
        primarily in the Midwest, Texas, south-central and eastern United States
        regions.


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, 2006.


The
        preparation of financial statements in conformity with 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 $40.5 million and $163.4 million for the three
        and
        nine months ended September 30, 2007, respectively, and $35.9 million and
        $141.2
        million for the three and nine months ended September 30, 2006,
        respectively.  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 116,821,000 and 116,650,000 for the
        three
        and nine months ended September 30, 2007, respectively, and 116,101,000 and
        115,910,000 for the three and nine months ended September 30, 2006,
        respectively.


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 117,365,000 and 117,225,000 for the three
        and
        nine months ended September 30, 2007, respectively, and 116,568,000 and
        116,311,000 for the three and nine months ended September 30, 2006,
        respectively.  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,” as amended, requires that all contracts
      considered to be derivative instruments be recorded on the balance sheet at
      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: 1) deems the counterparty
      creditworthy; 2) if the counterparty owns or controls energy resources within
      the western region to allow for physical delivery of the energy; and 3) if
      the
      transaction is within PSE’s forecasted load requirements as adjusted from time
      to time.  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,” 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 tables present the impact of changes in the market value of derivative
      instruments not meeting NPNS or cash flow hedge criteria to the Company’s
      earnings during the three and nine months ended September 30, 2007 and September
      30, 2006:




(Dollars
                  in Millions)
                Three
                  Months Ended September 30,
              2007
              2006
              ChangeUnrealized
                  (gain) loss on derivative instruments
              $  5.3
              $
                  (0.6)
              $  5.9


(Dollars
                in Millions)
              Nine
                Months Ended September 30,
            2007
            2006
            ChangeUnrealized
                (gain) loss on derivative instruments
            $  1.0
            $
                0.2
            $  0.8





During
      the three and nine months ended September 30, 2007, the Company recorded a
      decrease in earnings for the change in the market value of derivative
      instruments not meeting NPNS or cash flow hedge criteria of $5.3 million and
      $1.0 million,  respectively.   The increase in expense
      is primarily due to the change in the mark-to-market valuation of a physically
      delivered gas supply contract for electric generation that did not meet NPNS
      or
      cash flow hedge criteria and the ineffective portion of two long-term power
      purchase agreements designated as cash flow hedges.  During the three
      months ended September 30, 2007, in order to replace the energy that was lost
      due to the early termination of a contract by the counterparty in the second
      quarter 2007, the Company entered into two long-term power purchase contracts
      that met cash flow hedge criteria.  The ineffective portion relates to
      periods in which the Company has enough projected energy resources to meet
      the
      expected customer usage without the two contracts.  In addition, a
      decline in the unrealized gain on a physical gas supply contract recorded in
      the
      second quarter 2007 contributed to the unrealized loss in the three months
      ended
      September 30, 2007 due to the lower market value of natural gas and settlement
      of contracts during the third quarter 2007.  During the three and nine
      months ended September 30, 2006, the Company recorded an increase in earnings
      for the change in the market value of derivative instruments not meeting NPNS
      or
      cash flow hedge criteria of $0.6 million and a decrease in earnings of $0.2
      million,  respectively.


The
      following
      table presents electric derivatives that are designated as cash flow hedges
      or
      contracts that do not meet NPNS at September 30, 2007 and December 31,
      2006:




Electric
              Derivatives(Dollars
                in Millions)
            
            September
                30,
              2007
            
            
            December
                31,
              2006Short-term
                asset
            
            $
            10.1
            
            
            $
            10.1Long-term
                asset
            
            
            --
            
            
            
            6.8Total
                assets
            
            $
            10.1
            
            
            $
            16.9Short-term
                liability
            
            $
            17.1
            
            
            $
            9.0Long-term
                liability
            
            
            8.7
            
            
            
            0.4Total
                liabilities
            
            $
            25.8
            
            
            $
            9.4





If
      it is
      determined that it is uneconomical to operate PSE’s controlled electric
      generating facilities in future periods, 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 September 30, 2007, the Company had net unrealized day one loss deferral
      of
      $9.6 million primarily related to a locational power exchange contract which
      was
      modeled and therefore the day one loss was deferred under Emerging Issues Task
      Force (EITF) 02-3, “Issues Involved in Accounting for Derivative Contracts Held
      for Trading Purposes and Involved in Energy Trading and Risk Management
      Activities.”  The deferred loss is being amortized over the term of
      the contract through December 31, 2010.  Any future changes in the
      mark-to-market value will be recorded through the income
      statement.  The contract throughout its term has economic benefit to
      the Company.  The locational exchange will help ease electric
      transmission congestion across the Cascade Mountains during 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 same quantities of power at the Mid-Columbia trading hub
      location.


The
      amount of net unrealized gain (loss), net of tax, related to the Company’s
      energy-related cash flow hedges under SFAS No. 133 consisted of the following
      at
      September 30, 2007 and December 31, 2006:





(Dollars
                in Millions, net of tax)
            September
                30,
              2007
            December
                31,
              2006Other
                comprehensive income – unrealized (gain) loss
            $
                9.5
            $  (4.9)





The
      following table presents derivative hedges of natural gas contracts to serve
      natural gas customers at September 30, 2007 and December 31, 2006:





Gas
                Derivatives(Dollars
                in Millions)
            
            September
                30,
              2007
            
            
            December
                31,
              2006Short-term
                asset
            
            $
            2.5
            
            
            $
            6.7Long-term
                asset
            
            
            --
            
            
            
            0.1Total
                assets
            
            $
            2.5
            
            
            $
            6.8Short-term
                liability
            
            $
            39.6
            
            
            $
            61.6Long-term
                liability
            
            
            0.4
            
            
            
            --Total
                liabilities
            
            $
            40.0
            
            
            $
            61.6








Due
      to
      the PGA mechanism, mark-to-market adjustments relating to the natural gas
      business have been reclassified to a deferred account in accordance with SFAS
      No. 71.  The PGA mechanism passes increases and decreases in the cost
      of natural gas supply to customers.  As the gains and losses on the
      hedges are realized in future periods, they will be recorded as gas costs under
      the PGA mechanism.


At
      September 30, 2007, a portion of the ending balance in other comprehensive
      income relates to previously settled treasury interest rate swap contracts
      resulting in a net loss of $8.3 million after-tax and accumulated
      amortization.  At December 31, 2006, the ending balance in other
      comprehensive income was a loss of $8.5 million.




**(4)**
              **Discontinued
                  Operations and Corporate Guarantees**(Puget Energy
                  Only)




On
      May 7,
      2006, Puget Energy sold InfrastruX to an affiliate of Tenaska Power Fund, L.P.
      (Tenaska).  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
      part
      of the transaction, Puget Energy made certain representations and warranties
      concerning InfrastruX.  Puget Energy obtained a representation and
      warranty insurance policy and deposited $3.7 million into an escrow account
      to
      serve as retention under the policy.  At September 30, 2007,
      restricted cash in the escrow account was $4.0 million, which is included in
      Puget Energy’s balance sheets, representing management’s estimate of the
      aggregate fair value of Puget Energy’s maximum risk of loss related to those
      representations and warranties.  Should Tenaska make any such claims
      against Puget Energy, payment for the claims would be made from the escrow
      account.  The representation and warranty obligation expires May 7,
      2008.


Puget
      Energy also agreed to indemnify Tenaska for certain costs and expenses incurred
      after closing related to an investigation of one of InfrastruX’s subsidiary
      companies.  Under the indemnity agreement, Puget Energy is also liable
      for refunding a portion of the purchase price paid by Tenaska for InfrastruX
      if
      the subsidiary does not achieve certain operating results during the measurement
      year.  The maximum obligation of Puget Energy for defense costs and a
      refund of a portion of the purchase price is capped at $15.0
      million.  Tenaska has notified Puget Energy that 2008 will be the
      measurement year for purposes of calculating the potential purchase price refund
      obligation.  At September 30, 2007, a liability in the amount of $4.5
      million is included in the accompanying balance sheets after payment of $0.5
      million related to the guarantee.  During the fourth quarter 2007,
      Puget Energy will pay InfrastruX $1.3 million to resolve a claim under this
      guarantee.  The obligation expires May 7, 2011.


Puget
      Energy’s accounting policy for its representations and warranties loss reserve
      and the indemnity agreement is to reduce the loss reserve only when the
      guarantee expires or is settled.  Any increase to the loss reserves
      subsequent to the initial recognition would be determined if it is probable
      that
      a future event will occur confirming the additional loss and the amount of
      the
      additional loss can be reasonably estimated in accordance with SFAS No. 5,
      “Accounting for Contingencies.”


Puget
      Energy also provided an environmental guarantee as part of the sale
      agreement.  Under the terms of the agreement, Tenaska will be
      responsible for the first $0.1 million of environmental claims, Tenaska and
      Puget Energy will share the next $6.4 million equally and Puget Energy will
      be
      responsible for the next $3.5 million.  Puget Energy believes it will
      not have a future loss in connection with the environmental
      guarantee.


The
      following table summarizes Puget Energy’s income from discontinued
      operations:





Three
                Months Ended
              September
                30,
            
            
            Nine
                Months Ended
              September
                30,(Dollars
                in Thousands)
            
            2007
            
            
            2006
            
            
            2007
            
            
            2006Revenues
            
            $
            --
            
            
            $
            --
            
            
            $
            --
            
            
            $
            138,573Goodwill
                impairment
            
            
            --
            
            
            
            --
            
            
            
            --Operating
                expenses (including interest expense)
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            (128,605
            )Pre-tax
                income
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            9,968Income
                tax expense
            
            
            (224
            )
            
            
            --
            
            
            
            (224
            )
            
            
            (3,544
            )Puget
                Energy carrying value adjustment of InfrastruX
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            7,269Puget
                Energy cost of sale related to InfrastruX, net of tax
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            (937
            )Puget
                Energy deferred tax basis adjustment of InfrastruX
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            9,966Gain
                on sale, net of tax
            
            
            --
            
            
            
            1
            
            
            
            12
            
            
            
            29,765Minority
                interest in income of discontinued operations
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            (584
            )Income
                from discontinued operations
            
            $
            (224
            )
            
            $
            1
            
            
            $
            (212
            )
            
            $
            51,903





In
      accordance with SFAS No. 144, InfrastruX discontinued depreciation and
      amortization of its assets effective February 8, 2005.  This
      discontinuation of depreciation and amortization resulted in $6.7 million ($4.3
      million after-tax) lower depreciation and amortization expense than otherwise
      would have been recorded as continuing operations for the nine months ended
      September 30, 2006.  Puget Energy did not record any amortization
      expense related to the intangible assets of InfrastruX in 2006.




**(5)**
            **Retirement
                Benefits**




The
      Company has a defined benefit pension plan with a cash balance feature covering
      substantially all PSE 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 September 30:





Pension
                Benefits
            
            
            Other
                Benefits(Dollars
                in Thousands)
            
            2007
            
            
            2006
            
            
            2007
            
            
            2006Service
                cost
            
            $
            3,328
            
            
            $
            3,293
            
            
            $
            33
            
            
            $
            99Interest
                cost
            
            
            6,628
            
            
            
            6,171
            
            
            
            204
            
            
            
            426Expected
                return on plan assets
            
            
            (9,715
            )
            
            
            (9,310
            )
            
            
            (210
            )
            
            
            (290
            )Amortization
                of prior service cost
            
            
            510
            
            
            
            585
            
            
            
            43
            
            
            
            134Recognized
                net actuarial (gain) loss
            
            
            1,297
            
            
            
            1,423
            
            
            
            (493
            )
            
            
            49Amortization
                of transition obligation
            
            
            --
            
            
            
            --
            
            
            
            12
            
            
            
            104Net
                periodic benefit cost
            
            $
            2,048
            
            
            $
            2,162
            
            
            $
            (411
            )
            
            $
            522Curtailment/settlement
                cost
            
            $
            --
            
            
            $
            --
            
            
            $
            708
            
            
            $
            --











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





Pension
                Benefits
            
            
            Other
                Benefits(Dollars
                in Thousands)
            
            2007
            
            
            2006
            
            
            2007
            
            
            2006Service
                cost
            
            $
            9,983
            
            
            $
            9,415
            
            
            $
            216
            
            
            $
            270Interest
                cost
            
            
            19,884
            
            
            
            18,501
            
            
            
            962
            
            
            
            1,142Expected
                return on plan assets
            
            
            (29,144
            )
            
            
            (28,179
            )
            
            
            (620
            )
            
            
            (653
            )Amortization
                of prior service cost
            
            
            1,532
            
            
            
            1,756
            
            
            
            310
            
            
            
            401Recognized
                net actuarial (gain) loss
            
            
            3,890
            
            
            
            3,922
            
            
            
            (605
            )
            
            
            (205
            )Amortization
                of transition obligation
            
            
            --
            
            
            
            --
            
            
            
            222
            
            
            
            314Net
                periodic benefit cost
            
            $
            6,145
            
            
            $
            5,415
            
            
            $
            485
            
            
            $
            1,269Curtailment/settlement
                cost
            
            $
            --
            
            
            $
            --
            
            
            $
            708
            
            
            $
            --





The
      Company previously disclosed in its financial statements for the year ended
      December 31, 2006 that it expected contributions by the Company to fund the
      pension and other benefits plans for the year ending December 31, 2007 to be
      $4.5 million and $0.3 million, respectively.  During the three and
      nine months ended September 30, 2007, the actual cash contributions to the
      Company’s non-qualified pension plans were $0.4 million and $1.2 million,
      respectively.  Based on this activity, the Company anticipates
      contributing an additional $1.0 million to the Company’s non-qualified pension
      plan in 2007.  The full amount of the pension plan funding for 2007 is
      for the Company’s non-qualified supplemental retirement plan.


During
      the three and nine months ended September 30, 2007, actual other post-retirement
      medical benefit plan contributions were less than $0.1 million and $0.8 million,
      respectively, and the Company does not expect to make additional contributions
      for the remaining period of 2007.


On
      June
      20, 2007, the International Brotherhood of Electrical Workers (IBEW) ratified
      a
      collective bargaining agreement with PSE.  The collective bargaining
      agreement included changes to the Company’s subsidy for retiree medical
      insurance.  Effective June 20, 2007, no new IBEW employees will
      receive a retiree medical subsidy at retirement.


Current
      IBEW-represented employees with less than five years of service will no longer
      receive a medical subsidy at retirement and those employees with more that
      one
      year of service but less than five years of service received a one-time cash
      payment.  Current IBEW-represented employees with five or more years
      of service had a one-time opportunity to elect a cash payment that varied
      depending on the years of employment with PSE in lieu of continuing eligibility
      for the retiree medical subsidy.  As a result of the termination, the
      curtailment loss was $0.7 million.




**(6)**
            **Income
                Taxes**




During
      the three and nine months ended September 30, 2007, PSE recorded an income
      tax
      benefit of $1.9 million and an expense of $49.2 million, respectively, compared
      to an expense of $9.1 million and $60.0 million for the three and nine months
      ended September 30, 2006, respectively.  Lower income tax expense in
      2007 was primarily related to lower net income in 2007 and a true-up of the
      2006
      federal tax provision which resulted in an adjustment to the 2007 effective
      tax
      rate.  The effective tax rate was also lower due to higher tax credits
      associated with the production of wind-powered energy.  The true-up of
      the 2006 tax provision was a benefit of $1.9 million for the three months ended
      September 30, 2007 as compared to an expense of $0.5 million in 2006 for the
      2005 tax provision true-up.  The production tax credits for the three
      and nine months ended September 30, 2007 were $1.1 million and $13.9 million,
      respectively, compared to $0.3 million and $4.9 million for the three and nine
      months ended September 30, 2006, respectively.


The
      additional credits were made available due to the addition of the Wild Horse
      wind project, which was placed in service in December 2006.  In July
      2006, Financial Accounting Standards Board (FASB) issued Interpretation No.
      48
      (FIN 48), “Accounting for Uncertainty in Income Taxes, an Interpretation of FASB
      Statement No. 109,” which clarifies the accounting for uncertainty in income
      taxes recognized in the financial statements in accordance with FASB Statement
      No. 109, “Accounting for Income Taxes.”  FIN 48 requires the use of a
      two-step approach for recognizing and measuring tax positions taken or expected
      to be taken in a tax return.  First, a tax position should only be
      recognized when it is more likely than not, based on technical merits, that
      the
      position will be sustained upon examination by the taxing
      authority.  Second, a tax position that meets the recognition
      threshold should be measured at the largest amount that has a greater than
      50%
      likelihood of being sustained.


FIN
      48
      was effective for the Company as of January 1, 2007.  As of the date
      of adoption, the Company had no material unrecognized tax benefits but accrued
      $6.6 million in interest expense related to tax deductions for certain
      capitalized internal labor and related overhead costs previously deducted before
      repayment in 2005 and 2006.  Additionally, the Company has reversed
      $1.9 million and $1.2 million in interest expense for the three and nine months
      ended September 30, 2007, respectively, related to the tax deductions for the
      capitalized internal labor and overheads due to a change in estimate related
      to
      settlement guidelines established by the Internal Revenue Service (IRS) national
      office.  The balance at September 30, 2007 was $5.4
      million.


In
      its
      2001 tax return, PSE claimed a deduction when it changed its tax accounting
      method with respect to capitalized internal labor and
      overheads.  Under the new method, the Company could immediately deduct
      certain costs that it had previously capitalized.  In the IRS audit of
      the Company’s 2001, 2002 and 2003 federal income tax returns, the IRS disallowed
      the deduction, citing Revenue Ruling 2005-53.  The Company believes
      the original deductions were valid as filed and has formally appealed the IRS
      adjustment.  The Company repaid the tax benefits in 2005 and 2006 as
      provided in the new Regulations, issued on August 2, 2005 (Regulation
      1.263(a)-1).  At December 31, 2006, the full tax benefit had been
      repaid.  The IRS national office established settlement guidelines
      which will apply to its settlement offers on this issue.  It is
      possible that this issue could be resolved in the next 12 months.


Based on prior Washington Utilities and Transportation Commission (Washington
      Commission) orders on this issue, it is management’s expectation that if the IRS
      is ultimately successful in challenging some portion of the deduction the
      Company could request rate recovery of the regulatory asset for the interest
      accrued.


For federal income tax purposes, the Company has open tax years from 2001
      through 2007.  The Company continues its policy of classifying
      interest as interest expense and penalties as other expense in the financial
      statements.




**(7)**
            **Regulation
                and Rates**




On
      September 26, 2007, the Washington Commission approved PSE’s requested revisions
      to its purchased gas adjustment (PGA) tariff schedules resulting in a decrease
      of $148.1 million or 13% on an annual basis in gas sales revenues effective
      October 1, 2007.  The rate decrease was the result of lower costs of
      natural gas in the forward market and a refund of the accumulated PGA payable
      balance over a 12-month period beginning October 1, 2007.  The PGA
      rate change will decrease PSE’s revenue but will not impact the Company’s net
      income as the decreased revenue will be offset by decreased purchased gas costs
      and revenue sensitive taxes.


On
      March
      20, 2007, PSE submitted a Power Cost Only Rate Case (PCORC) filing to request
      approval of an updated power cost baseline rate beginning September
      2007.  The PCORC filing also requested recovery of the Goldendale
      generating facility (Goldendale) ownership and operating costs through retail
      electric rates.  On May 23, 2007, PSE filed updated power costs due to
      changes in market conditions of natural gas and other costs which resulted
      in a
      revised proposed increase of $77.8 million or 4.4% annually.  On July
      5, 2007, a settlement agreement in this PCORC signed by PSE and certain other
      parties to the proceeding was filed with the Washington Commission, the terms
      of
      which included an electric rate increase of $64.7 million.  On August
      2, 2007, the Washington Commission approved the settlement agreement and
      authorized an increase in PSE’s electric rates of $64.7 million or an average
      increase of 3.7% annually effective September 1, 2007.   The
      investment in Goldendale was found prudent, thus allowing for recovery of
      certain ownership and operating costs through electric retail rates effective
      September 1, 2007 along with updating other power costs.


In
      accordance with the August 2, 2007 Washington Commission order approving the
      PCORC settlement, PSE and other parties have agreed to conduct a collaborate
      stakeholder review of the PCORC process to consider the scope and timing of
      the
      PCORC mechanism and whether the mechanism should continue.  The
      collaborative review will include but is not limited to: 1) the number of PCORCs
      that a company will be allowed to file in any given year; 2) the number and
      timing of updates that a company my submit in the PCORC process; 3) the items
      directly associated with power costs that may be included and considered in
      a
      PCORC filing; and 4) whether the number and timing of updates may vary depending
      on if other parties can easily verify.  Any agreements reached by the
      parties in the collaborative will be presented to the Washington Commission
      for
      approval during PSE’s next general rate case and any issues on which agreement
      has not been reached may be raised in the same general rate case.


PSE’s
      storm accounting, which allows deferral of certain storm damage costs, is
      subject to review by the Washington Commission at the end of the current three
      year period, which is December 31, 2007.  During the fourth quarter
      2007,****PSE intends to seek approval from the Washington
      Commission to continue its storm deferral accounting treatment at current levels
      beyond December 31, 2007.


On
      April
      11, 2007, the Washington Commission approved PSE’s petition for issuance of an
      accounting order that authorizes PSE to defer certain ownership and operating
      costs (and associated carrying costs) the Company incurred related to its
      purchase of Goldendale during the period prior to inclusion in PSE’s retail
      electric rates in the PCORC.  The deferral is for the time period from
      March 15, 2007 through September 1, 2007.  As of September 30, 2007,
      PSE had established a regulatory asset of $11.2 million.  PSE
      anticipates amortization of the costs will begin no later than January 1, 2009
      as determined in PSE’s next general rate case.


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 due to an adverse Ninth Circuit Court of Appeals
      (Ninth Circuit) decision of May 3, 2007.  The Ninth Circuit concluded
      in its decision that certain BPA actions in entering into residential exchange
      settlements in 2000 were not in accordance with the law.  BPA
      suspended payments under the residential exchange program until final decisions
      by the Ninth Circuit are determined.  As a result of the BPA
      suspension of payment, PSE filed revisions to the tariffs which pass through
      the
      benefits of the Residential Exchange to all residential and small farm
      customers.  The Washington Commission approved the termination of the
      Residential Exchange Credit effective June 7, 2007.  Under Federal
      law, investor-owned utilities receiving residential exchange benefits must
      pass-through the benefits to their residential and small farm electric
      customers.


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.  The
      accounting petition sought approval to record carrying costs on the deferred
      balance until the deferred balance is recovered from customers.  As of
      September 30, 2007, PSE has recorded a regulatory asset of $34.8
      million.


In
      May
      2007, the Washington Commission Staff alleged that PSE’s gas system service
      provider had violated certain Washington Commission recordkeeping
      rules.  The Washington Commission has since filed a complaint against
      PSE that includes Washington Commission Staff’s recommendation that PSE be
      assessed a $2.0 million regulatory penalty.  As of June 30, 2007, PSE
      management determined the penalty met the SFAS No. 5, “Accounting for
      Contingencies” criteria for recording a loss contingency and thus recorded a
      $2.0 million loss reserve.  The Washington Commission investigation is
      ongoing.


On
      January 5, 2007, the Washington Commission issued its order in PSE’s electric
      general rate case filed in February 2006, approving a general rate decrease
      for
      electric customers of $22.8 million or 1.3% annually.  The rates for
      electric customers became effective beginning January 13, 2007.  In
      its order, the Washington Commission approved a weighted cost of capital of
      8.4%, or 7.06% after-tax and a capital structure that included 44.0% common
      equity with a return on equity of 10.4%.  The Washington Commission
      had earlier approved (on June 28, 2006) a PCORC increase of $96.1 million
      annually effective July 1, 2006.


On
      June
      20, 2002, the Washington Commission approved a PCA mechanism that becomes
      operative if PSE’s costs to provide customers electricity fall outside certain
      bands established in an electric rate case.  The cumulative maximum
      pre-tax earnings exposure due to power cost variations over the four-year period
      ended June 30, 2006 was limited to $40.0 million plus 1.0% of the
      excess.  In October 2005, the Washington Commission approved a shift
      to an annual PCA mechanism measurement period from January through December
      starting in 2007.  On January 5, 2007, the Washington Commission
      approved the PCA mechanism for continuation under the same annual graduated
      scale without a cumulative cap for excess power costs.  All
      significant variable power supply cost variables (i.e. hydroelectric and wind
      generation, market price for purchased power and surplus power, natural gas
      and
      coal fuel price, generation unit forced outage risk and transmission cost)
      are
      included in the PCA mechanism.


On
      January 5, 2007, the Washington Commission also issued its order in PSE’s
      natural gas general rate case, granting an increase for gas customers of $29.5
      million or 2.8% annually, effective January 13, 2007.




**(8)**
            **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 BPA Residential Exchange Program.  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 have been confirmed, approved and allowed to go into effect
      by 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.  The
      parties to these various actions presented oral arguments to the Ninth Circuit
      in November 2005.  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 June 2007, BPA requested FERC to continue a stay of
      FERC’s review of such rates in light of uncertainties created by 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 Residential Exchange Program 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.


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 September 30, 2007, PSE has a
      regulatory asset of $34.8 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.  It is not clear what
      impact, if any, development or review of such rates, review of such agreements
      and the above described Ninth Circuit litigation may ultimately have on
      PSE.


**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 certain domestic water
      wells, groundwater and the Colstrip water supply pond were contaminated by
      seepage from a Colstrip Units 1 & 2 effluent holding pond, that seepage from
      Colstrip Units 1 & 2 have decreased property values and that seepage from
      the Colstrip water supply pond caused structural damage to buildings and toxic
      mold.  Discovery is ongoing.  The trial date has been
      postponed until June 2008.  The Company has established a reserve for
      the expected liability.


On
      March
      29, 2007, a second complaint related to pond seepage was filed on behalf of
      two
      ranch owners alleging damage due to the Colstrip Units 3 & 4 effluent
      holding pond.


On
      June
      15, 2005, the U. S. Environmental Protection Agency (EPA) issued the Clean
      Air
      Visibility Rule to address regional haze or regionally-impaired visibility
      caused by multiple sources over a wide area.  The rule defines Best
      Available Retrofit Technology (BART) requirements for electric generating units,
      including presumptive limits for sulfur dioxide, particulate matter and nitrogen
      oxide controls for large units.  In February 2007, Colstrip was
      notified by EPA that Colstrip Units 1 & 2 were determined to be subject to
      the BART requirements, PSE submitted a  BART engineering analysis for
      Colstrip Units 1 & 2 in August 2007.  PSE cannot yet determine the
      need for or costs of additional controls to comply with this rule.


**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.


*CPUC
      Decision.*Proceedings, including filings of requests for
      rehearing or further review, before the Ninth Circuit and/or FERC, have been
      stayed upon the Court’s own motion until November 16, 2007 to allow for possible
      settlement discussions to proceed.


*Lockyer
      Case.*On June 18, 2007, the U.S. Supreme Court denied the
      petition that PSE and other energy sellers had submitted that sought Supreme
      Court review of the Ninth Circuit decision.  As such, this matter will
      be remanded to FERC for further proceedings, but not before November 16, 2007,
      when the stay of the mandate back to FERC expires.


*Pacific
      Northwest Refund 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.  The court remanded the matter to FERC for further
      proceedings but subsequently issued an order staying further deadlines,
      including the remand, to November 16, 2007 to allow parties to engage in
      court-sponsored mediation.  PSE intends to vigorously defend its
      position in this proceeding, but it is unable to predict the outcome of this
      matter.


**Proceeding
        Relating to the Proposed****Merger****.** On October 26, 2007, a lawsuit was filed in
        King County
        Superior Court, Seattle, Washington, naming Puget Energy and its directors
        as
        defendants. The lawsuit is a purported class action filed by Edward Tansey
        on
        behalf of an alleged class of Puget Energy's shareholders.  Plaintiff
        alleges, among other things, that the director defendants breached their
        fiduciary duties in approving the proposed acquisition of Puget Energy 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 that was publicly announced on October
        26,
        2007 (see Note 13 for more information regarding the proposed
        acquisition).  The suit seeks to enjoin the defendants from
        consummating the proposed acquisition and other relief.




**(9)**
              **Related
                  Party Transaction**




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 September 30, 2007, the outstanding balance of the Note was
      $24.3 million and the interest rate was 5.9%.  The outstanding balance
      and the related interest under the Note are eliminated by Puget Energy upon
      consolidation of PSE’s financial statements.




**(10)**
            **Financings**




On
      June
      1, 2007, PSE redeemed all remaining $37.8 million of its 8.231% Capital Trust
      Preferred Securities (classified as Junior Subordinated Debentures of the
      Corporation Payable to a Subsidiary Trust Holding Mandatorily Redeemable
      Preferred Securities on the balance sheet and referred to herein as
“Securities”).  The purpose of the redemption was to reduce interest
      costs by retiring higher cost debt.  The Securities were redeemed at a
      4.12% premium, or $39.3 million, plus accrued interest on the redemption
      date.


On
      June
      4, 2007, PSE issued $250 million of Junior Subordinated Notes (Notes) due June
      2067.  The Notes bear a fixed rate of interest for the first 10.5
      years with interest payable semiannually in May and November of each year,
      after
      which the Notes will bear a variable rate of interest (3-month LIBOR plus
      2.35%).  Proceeds were used to repay short-term debt, incurred in part
      to redeem the Securities.  The Notes are structured to be treated as
      debt by the IRS, yet they are considered to have equity-like characteristics
      by
      the credit rating agencies.  In addition, the Notes contain a call
      option feature and are callable in whole or in part by PSE on or after June
      1,
      2017.  The Notes are not derivatives and the call option is not
      required to be bifurcated.  They are presented on the balance sheet as
      a separate line item in the redeemable securities and long-term
      debt.


In
      March
      2007, PSE entered into a five-year, $350 million credit agreement with a group
      of banks.  The agreement supports the Company’s energy hedging
      activities.  Pursuant to the Washington Commission order in PSE’s
      electric and gas general rate cases issued on January 5, 2007, the costs of
      this
      hedging credit facility will be recovered through the PCA and PGA
      mechanisms.  Under the terms of the credit agreement, PSE pays a
      floating interest rate on outstanding borrowings based either on the agent
      bank’s prime rate or on LIBOR plus a marginal rate based on PSE’s long-term
      credit rating at the time of borrowing.  The facility can also be used
      to provide letters of credit.  PSE pays a commitment fee on any unused
      portion of the credit agreement based on long-term credit ratings of
      PSE.


In
      March
      2005, PSE entered into a five-year, $500 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 million facility.




**(11)**
            **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 three counterparties during the nine months ended September
      30,
      2007 may be considered variable interest entities.  Consistent with
      FIN 46R, PSE submitted requests for information to those three 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.


One
      of
      these counterparties, Sumas Cogeneration Company, L.P. (Sumas), delivered a
      letter to PSE on May 7, 2007, stating that it had sold its dedicated 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.  PSE and Sumas have initiated discussion relating to Sumas’
actions under the contract, but PSE cannot yet determine what may result from
      such discussions.


For
      the
      two remaining power purchase agreements that may be considered variable interest
      entities under FIN 46R as of the third quarter 2007, 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 September 30, 2007 was $60.0 million for the two entities
      and for the three months ended September 30, 2006 was $78.8 million for the
      three entities.  PSE’s purchased electricity expense for the nine
      months ended September 30, 2007 and 2006 for these three entities was $157.2
      million and $174.7 million, respectively.


The
      EPA
      required states to produce regulations by November 15, 2006 to bring their
      mercury emissions in line with those mandated by the Clean Air Mercury
      Rule.  The Montana Board of Environmental Review approved the state of
      Montana’s regulation to limit mercury emissions from coal-fired plants on
      October 16, 2006.  The new rule takes a two-tiered approach to
      reducing mercury emissions, allowing power plants burning lower-quality lignite
      coal to release more emissions than plants such as Colstrip that burn cleaner
      sub-bituminous coal.  The new rule has a more stringent limit than the
      federal rule (0.9 lbs/Trillion British thermal unit (TBtu), instead of the
      federal 1.4 lbs/TBtu), but includes a cap-and-trade provision as well as
      alternative emission limits for plants that have tried to meet the new standards
      but have demonstrated that they cannot.  PSE and the Colstrip owners
      are still evaluating the potential impact of the new rule and have not
      determined whether to appeal the new rule.


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 EPA.  The Notice stated that PSE had met the
      requirements of the Order and the accompanying scope of work.  Total
      removal costs as of September 30, 2007 were approximately $13.0
      million.  PSE estimates the total remediation cost to be approximately
      $15.0 million, which has been accrued or paid.  At September 30, 2007,
      PSE had an insurance receivable recorded in the amount of $12.6 million
      associated with this fuel release.  PSE has also responded to a
      request for information under the Clean Water Act from the EPA.  PSE
      has filed a petition with the Washington Commission to defer costs associated
      with the remediation effort.  The Washington Commission has not yet
      ruled on this matter.


On
      May
      30, 2007, PSE agreed to extend the terms of the existing leases of its Bellevue
      corporate office complex from 10 years to 15 years.  PSE’s lease
      agreement included a one-time right to purchase the office
      complex.  PSE elected to monetize the value of this purchase option
      and negotiated for a cash payment of $18.9 million, net of transaction fees,
      in
      exchange for the termination of the purchase option.  PSE has filed an
      accounting petition with the Washington Commission seeking deferred accounting
      treatment of the net proceeds and amortization of the net proceeds to match
      the
      near-term contractual lease payment increases.  The Washington
      Commission has not yet ruled on this matter.


In
      a
      recent decision, Washington State Supreme Court ruled that certain job reporting
      practices involving the use of company vehicles are compensable time under
      Washington State’s wage and hour laws.  One union representing a
      portion of PSE's workforce claims its members should now be compensated for
      PSE
      job site reporting practices as a result of this decision.  The extent
      of the claims and financial impact on PSE currently is unknown.




**(12)**
            **New
                Accounting Pronouncements**




In
      September 2006, FASB issued SFAS No, 157, “Fair Value
      Measurements.”  SFAS No. 157 establishes a common definition for fair
      value to be applied to GAAP, a framework for measuring fair value, and expands
      disclosure about such fair value measurements.  SFAS No. 157 is
      effective for fiscal years beginning after November 15, 2007 which will be
      the
      calendar year beginning January 1, 2008 for the Company.  The Company
      is currently assessing the impact of SFAS No. 157 on its financial
      statements.




**(13)**
            **Subsequent
                Event**




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 Bank Limited (together 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 approval of the transaction by the affirmative
      vote of two-thirds of the votes entitled to be cast thereon by Puget Energy’s
      shareholders, the termination or expiration of the waiting period under the
      Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR
      Act"), and the receipt of required regulatory approvals.  The
      transaction is expected to close during the second half of 2008.


The
      merger agreement contains termination rights for both Puget Energy and the
      Consortium under certain circumstances.  In the event Puget Energy
      elects to terminate the merger agreement under specified circumstances, it
      would
      be required to pay to the acquiring entity either $30 million if the termination
      is based on the submission of an alternative proposal meeting certain
      requirements by a party with whom Puget Energy had been in discussions prior
      to
      December 10, 2007, or $40 million if such fee becomes payable in all
      other circumstances, plus, in each case, documented out-of-pocket expenses
      of
      the Consortium of up to $10 million.  In addition, Puget Energy may be
      required to pay the Consortium documented out-of-pocket expenses incurred by
      the
      Consortium not in excess of $15 million if the merger agreement is terminated
      due to a breach of the terms of the Merger Agreement by Puget Energy and such
      breach is incurable or has not been cured within a specified
      time.  The acquiring entity may be required to pay Puget Energy an
      amount equal to $130 million if the merger agreement is terminated due to a
      breach of the terms of the merger agreement by the acquiring entity and such
      breach is incurable or has not been cured within a specified time.


Further
      information regarding the terms of the merger, including a copy of the Agreement
      and Plan of Merger, is included in Puget Energy's Current Report on Form 8-K
      relating to the merger, filed with the Securities and Exchange Commission on
      October 29, 2007.


On
      the
      same day, Puget Energy announced that it had entered into a separate transaction
      pursuant to a Stock Purchase Agreement, dated as of October 25, 2007,
      with certain members of the Consortium (collectively, the
“Purchasers”).  Under the Stock Purchase Agreement, the Purchasers
      will severally acquire, and Puget Energy will issue to the Purchasers,
      12,500,000 shares of Puget Energy common stock at a purchase price of $23.67
      per
      share.  Puget Energy intends to use the proceeds from this issuance to
      invest in its wholly owned subsidiary, Puget Sound Energy, Inc., for capital
      expenditures, debt redemption and working capital.  The consummation
      of the sale of securities to the Purchasers pursuant to the Agreement is subject
      to the satisfaction of customary closing conditions, including termination
      or
      expiration of the waiting period under the HSR Act.  Puget Energy
      anticipates that the stock purchase will close before then end of
      2007.  Further information regarding the terms of the Stock Purchase
      Agreement, including a copy of the agreement, is included in Puget Energy's
      Current Report on Form 8-K relating to the Stock Purchase Agreement, filed
      with
      the Securities and Exchange Commission on October 29, 2007.











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




*The
      following discussion of the Company’s financial condition and results of
      operations contains forward-looking statements that involve risks and
      uncertainties, such as statements of the Company’s plans, objectives,
      expectations and intentions.  Words such as “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.  You should not place undue reliance on these
      forward-looking statements, which apply only as of the date of this Form
      10-Q.*








**Overview**




Puget
      Energy, 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 gas
      utility company.  Until May 7, 2006, Puget Energy owned a 90.9%
      interest in InfrastruX Group, Inc. (InfrastruX), a utility construction and
      services company that was sold to an affiliate of Tenaska Power Fund, L.P.
      (Tenaska).  Puget Energy is substantially 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 gas service
      in a
      cost effective manner through PSE.





**Recent
      Developments**


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 Bank Limited
      (together 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 approval of the transaction by the affirmative
      vote of two-thirds of the votes entitled to be cast thereon by Puget Energy’s
      shareholders, the termination or expiration of the waiting period under the
      Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR
      Act"), and the receipt of required regulatory approvals.  The
      transaction is expected to close during the second half of
      2008.


The
      merger agreement contains termination rights for both Puget Energy and the
      Consortium under certain circumstances.  In the event Puget Energy
      elects to terminate the merger agreement under specified circumstances, it
      would
      be required to pay to the acquiring entity either $30 million if the termination
      is based on the submission of an alternative proposal meeting certain
      requirements by a party with whom Puget Energy had been in discussions prior
      to
      December 10, 2007, or $40 million if such fee becomes payable in all
      other circumstances, plus, in each case, documented out-of-pocket expenses
      of
      the Consortium of up to $10 million.  In addition, Puget Energy may be
      required to pay the Consortium documented out-of-pocket expenses incurred by
      the
      Consortium not in excess of $15 million if the merger agreement is terminated
      due to a breach of the terms of the Merger Agreement by Puget Energy and such
      breach is incurable or has not been cured within a specified
      time.  The acquiring entity may be required to pay Puget Energy an
      amount equal to $130 million if the merger agreement is terminated due to a
      breach of the terms of the merger agreement by the acquiring entity and such
      breach is incurable or has not been cured within a specified
      time.


Further
      information regarding the terms of the merger, including a copy of the Agreement
      and Plan of Merger, is included in Puget Energy's Current Report on Form 8-K
      relating to the merger, filed with the Securities and Exchange Commission on
      October 29, 2007.


On
      the
      same day, Puget Energy announced that it had entered into a separate transaction
      pursuant to a Stock Purchase Agreement, dated as of October 25, 2007,
      with certain members of the Consortium (collectively, the
“Purchasers”).  Under the Stock Purchase Agreement, the Purchasers
      will severally acquire, and Puget Energy will issue to the Purchasers,
      12,500,000 shares of Puget Energy common stock at a purchase price of $23.67
      per
      share.  Puget Energy intends to use the proceeds from this issuance to
      invest in its wholly owned subsidiary, Puget Sound Energy, Inc., for capital
      expenditures, debt redemption and working capital.  The consummation
      of the sale of securities to the Purchasers pursuant to the Agreement is subject
      to the satisfaction of customary closing conditions, including termination
      or
      expiration of the waiting period under the HSR Act.  Puget Energy
      anticipates that the stock purchase will close before then end of
      2007.  Further information regarding the terms of the Stock Purchase
      Agreement, including a copy of the agreement, is included in Puget Energy's
      Current Report on Form 8-K relating to the Stock Purchase Agreement, filed
      with
      the Securities and Exchange Commission on October 29, 2007.





**Puget
      Sound Energy**


PSE
      generates revenues from the sale of
      electric and gas services, mainly to residential and commercial customers within
      Washington State.  PSE’s operating revenues and associated expenses
      are not generated evenly during the year.  Variations in energy usage
      by consumers occur from season to season and from month to month within a
      season, primarily as a result of weather conditions.  PSE normally
      experiences its highest retail energy sales 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 Federal Energy Regulatory Commission (FERC) and Washington Utilities
      and Transportation Commission (Washington Commission) regulation which may
      impact a large array of business activities, including limitation of future
      rate
      increases related to retail rates, transmission rates and wholesale power sales;
      directed accounting requirements that could 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 gas and electric distribution and transmission lines;
      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.  PSE is
      continually exploring new electric-power resource generation and long-term
      power
      purchase agreements to meet this goal on an ongoing basis.  On
      February 21, 2007, PSE acquired the Goldendale generating facility (Goldendale),
      a 277 megawatt (MW) capacity natural gas generating facility in the state of
      Washington, from the Calpine Corporation through its bankruptcy
      proceeding.  PSE paid $120.0 million for this generating facility plus
      transaction costs totaling $2.4 million.  On March 20, 2007, PSE filed
      a Power Cost Only Rate Case (PCORC) seeking recovery of related ownership and
      operating costs with the Washington Commission.  PSE filed a
      settlement agreement in the PCORC on July 5, 2007 which approved the Goldendale
      acquisition.  On August 2, 2007, the Washington Commission adopted the
      settlement agreement thus finding PSE’s acquisition of Goldendale
      prudent.  Recovery of the costs began effective September 1, 2007 with
      the new electric rates.  Certain ownership and operating costs
      incurred for the time period March 15, 2007 through September 1, 2007 were
      deferred pursuant to an approved petition for accounting order.


On
      May 31, 2007, PSE filed its 2007
      Integrated Resource Plan (IRP) with the Washington Commission.  The
      plan supports a strategy of diverse acquisitions to cost-effectively meet
      growing demand for energy and reduce carbon emissions.  According to
      the IRP, PSE can secure additional power supplies through heightened
      energy-efficiency efforts and expanded wind-power generation.  PSE
      believes that a cost-effective and environmentally responsible way to source
      generation will likely include additional natural gas-fired
      resources.


In
      August 2006, PSE announced the
      selection of seven projects for further discussion and possible negotiation
      as a
      result of the 2005 Request For Proposal (RFP) process.  Of the seven,
      PSE has completed three, which include the purchase of Goldendale, a four-year
      power purchase agreement for 150 MW of winter on-peak energy commencing in
      2008
      and a power purchase agreement executed on July 12, 2007, for a portion of
      the
      output of Klondike Wind Power III, LLC, a wind-powered electric generating
      facility in north-central Oregon scheduled to be completed in the fourth quarter
      2007.  Of the remaining four, PSE remains in discussion on one project
      and has discontinued discussions on the other three.  In October 2007,
      PSE filed two draft RFPs with the Washington Commission to continue expansion
      of
      its energy-efficiency programs and power supplies.  PSE plans to
      release the final RFPs in January 2008.  The first RFP seeks to
      broaden and expand PSE’s program for helping customers conserve
      energy.  The second RFP will ask outside power producers, markets and
      power-plant developers to help PSE procure up to 1,340 average megawatts (aMW)
      of new electricity resources by 2015.





**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.  PSE’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 PSE and until May 7, 2006,
      InfrastruX.  Net income for the three months ended September 30, 2007
      was $11.4 million on operating revenues of $601.7 million compared to net income
      of $15.9 million on operating revenues from continuing operations of $519.5
      million for the same period in 2006.  Net income for 2007 and 2006
      includes the results of discontinued operations for InfrastruX.


Basic
      and
      diluted earnings per share for the three months ended September 30, 2007 were
      $0.10 compared to basic and diluted earnings per share for the three months
      ended September 30, 2006 of $0.14.  The discontinued operations of
      InfrastruX had no impact on the basic and diluted earnings per share for the
      three months ended September 30, 2006.  Electric margin increased $6.3
      million and gas margin increased $7.5 million for the three months ended
      September 30, 2007, compared to the same period in 2006.  Offsetting
      the
      increases in margin were an increase of $6.7 million in utility operation and
      maintenance expense, a $2.3 million increase in non-utility operation and
      maintenance and other expenses, a $3.4 million increase in depreciation
      and amortization, an increase of $6.0 million in taxes other than income taxes,
      net of revenue sensitive taxes, a $10.4 million increase in interest expense
      due
      to higher debt levels and higher interest rates and a decrease of $5.9 million
      in the unrealized gain on derivative instruments.


For
      the
      nine months ended September 30, 2007, Puget Energy’s net income was $129.1
      million on operating revenues from continuing operations of $2.3 billion
      compared to net income of $162.1 million on operating revenues from continuing
      operations of $2.0 billion for the same period in 2006.  Basic and
      diluted earnings per share for the nine months ended September 30, 2007 were
      $1.11 and $1.10, respectively, compared to basic and diluted earnings per share
      of $1.40 and $1.39, respectively, for the same period in 2006.


Net
      income for the nine months ended September 30, 2007 was positively impacted
      by
      increased electric and gas margins of $33.7 million and $25.7 million,
      respectively, compared to the same period in 2006.  Net income was
      negatively impacted by an increase of $32.9 million related to utility operation
      and maintenance, a $5.3 million increase in non-utility operation and
      maintenance, an increase in depreciation and amortization of $10.4 million,
      a
      $4.8 million increase in taxes other than income taxes, net of revenue sensitive
      taxes and a $25.7 million increase in interest expense due to increased debt
      levels and higher short-term interest rates.  Net income
      for the
      nine months ended September 30, 2006 was positively impacted by income from
      discontinued operations of InfrastruX of $51.9 million
      (after-tax).  The income from discontinued operations for the nine
      months ended September 30, 2006 included a gain on disposal of $29.8 million
      (after-tax) resulting from the sale of InfrastruX.  The increase was
      partially offset by the charitable contribution of $15.0 million ($9.75 million
      after-tax) by Puget Energy.





**Puget
      Sound Energy**


PSE’s
      operating revenues and associated expenses are not generated evenly during
      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 September 30, 2007 compared to the same period in
      2006.  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 September 30,
            
            2007
            
            
            2006
            
            
            Change
            
            
            Percent
              ChangeElectric
                operating revenue1
            
            $
            456.1
            
            
            $
            399.2
            
            
            $
            56.9
            
            
            
            14.3
            %Less:
                Other electric operating revenue
            
            
            (3.2
            )
            
            
            (8.2
            )
            
            
            5.0
            
            
            
            61.0Add:
                Other electric revenue-gas supply resale
            
            
            (6.6
            )
            
            
            (0.1
            )
            
            
            (6.5
            )
            
            
            *Total
                electric revenue for margin
            
            
            446.3
            
            
            
            390.9
            
            
            
            55.4
            
            
            
            14.2Adjustments
                for amounts included in revenue:Pass-through
                tariff items
            
            
            (9.8
            )
            
            
            (8.3
            )
            
            
            (1.5
            )
            
            
            (18.1
            )Pass-through
                revenue-sensitive taxes
            
            
            (29.5
            )
            
            
            (26.7
            )
            
            
            (2.8
            )
            
            
            (10.5
            )Net
                electric revenue for margin
            
            
            407.0
            
            
            
            355.9
            
            
            
            51.1
            
            
            
            14.4Minus
                power costs:Purchased
                electricity1
            
            
            (185.8
            )
            
            
            (183.7
            )
            
            
            (2.1
            )
            
            
            (1.1
            )Electric
                generation fuel1
            
            
            (43.5
            )
            
            
            (36.3
            )
            
            
            (7.2
            )
            
            
            (19.8
            )Residential
                exchange1
            
            
            0.4
            
            
            
            35.9
            
            
            
            (35.5
            )
            
            
            (98.9
            )Total
                electric power costs
            
            
            (228.9
            )
            
            
            (184.1
            )
            
            
            (44.8
            )
            
            
            (24.3
            )Electric
                margin2
            
            $
            178.1
            
            
            $
            171.8
            
            
            $
            6.3
            
            
            
            3.7
            %


____________________________


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 $6.3 million for the three months ended September 30, 2007
      compared to the same period in 2006 due to an increase in customer pricing
      due
      to the January 13, 2007 general rate case which resulted in an increase to
      margin of $13.2 million and a PCORC rate increase of 3.7% effective September
      1,
      2007, net of a 1.3% general rate decrease effective January 13, 2007, which
      increased electric margin by $1.3 million due in part to recovery of ownership
      and operating costs of new generation facilities.  In addition, a 1.2%
      increase in retail-sales volumes increased electric margin $2.1
      million.  These increases were partially offset by a decrease in
      electric margin of $3.6 million due to an increase of production tax credits
      (PTCs) provided to customers.  PTCs provided to customers through
      lower rates are recovered through a lower effective tax rate.  Such
      favorable changes in the allocation of power costs between PSE and the customer
      may not be repeated in the future and should not be considered a recurring
      element in operating income for the quarter.


The
      Power
      Cost Adjustment (PCA) mechanism allows PSE to recover power costs according
      to
      certain terms.  The PCA mechanism was revised effective July 1, 2006
      resulting in a shift in PSE’s power cost recovery between quarters and within
      the calendar year.  The increase in the third quarter 2007 electric
      margin reflects a decrease of $6.7 million related to the PCA
      mechanism.  PSE overrecovered power costs under the PCA mechanism by
      $7.2 million in the third quarter 2007 compared to $13.9 million in the third
      quarter 2006 due to revisions in the PCA sharing bands during 2006.









The
      following table displays the details of electric margin changes for the nine
      months ended September 30, 2007 compared to the same period in
      2006.  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)
              Nine
                Months Ended September 30,
            
            2007
            
            
            2006
            
            
            Change
            
            
            Percent
              ChangeElectric
                operating revenue1
            
            $
            1,419.0
            
            
            $
            1,247.6
            
            
            $
            171.4
            
            
            
            13.7
            %Less:
                Other electric operating revenue
            
            
            (29.9
            )
            
            
            (38.2
            )
            
            
            8.3
            
            
            
            21.7Add:
                Other electric revenue-gas supply resale
            
            
            (0.2
            )
            
            
            11.9
            
            
            
            (12.1
            )
            
            
            (101.7
            )Total
                electric revenue for margin
            
            
            1,388.9
            
            
            
            1,221.3
            
            
            
            167.6
            
            
            
            13.7Adjustments
                for amounts included in revenue:Pass-through
                tariff items
            
            
            (30.7
            )
            
            
            (25.4
            )
            
            
            (5.3
            )
            
            
            (20.9
            )Pass-through
                revenue-sensitive taxes
            
            
            (95.3
            )
            
            
            (83.4
            )
            
            
            (11.9
            )
            
            
            (14.3
            )Net
                electric revenue for margin
            
            
            1,262.9
            
            
            
            1,112.5
            
            
            
            150.4
            
            
            
            13.5Minus
                power costs:Purchased
                electricity1
            
            
            (640.6
            )
            
            
            (623.7
            )
            
            
            (16.9
            )
            
            
            (2.7
            )Electric
                generation fuel1
            
            
            (93.3
            )
            
            
            (72.2
            )
            
            
            (21.1
            )
            
            
            (29.2
            )Residential
                exchange1
            
            
            52.4
            
            
            
            131.2
            
            
            
            (78.8
            )
            
            
            (60.1
            )Total
                electric power costs
            
            
            (681.5
            )
            
            
            (564.7
            )
            
            
            (116.8
            )
            
            
            (20.7
            )Electric
                margin2
            
            $
            581.4
            
            
            $
            547.8
            
            
            $
            33.6
            
            
            
            6.1
            %


____________________________


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 $33.6 million for the nine months ended September 30, 2007
      compared to the same period in 2006 due to lower power costs related to
      increased production of low cost hydroelectric power and company-owned
      generating facilities.  The increase was also due to a PCORC rate
      increase of 5.9% effective July 1, 2006 and 3.7% effective September 1, 2007
      net
      of a 1.3% general rate decrease effective January 13, 2007 which increased
      electric margin by $31.9 million for recovery of ownership and operating costs
      of new generating facilities.  In addition, a 2.1% increase in retail
      sales volumes increased electric margin by $9.5 million.  These
      increases were partially offset by a decrease in electric margin of $12.1
      million due to an increase of PTCs provided to customers.  PTCs
      provided to customers through lower rates are recovered through a lower
      effective tax rate.


The
      increase in 2007 electric margin for the nine months ended September 30, 2007
      reflects $3.3 million related to the PCA mechanism.  PSE overrecovered
      power costs under the PCA mechanism by $30.1 million during 2007 compared to
      $26.8 million during 2006.  Such favorable changes in the allocation
      of power costs between PSE and the customer may not be repeated in the future
      and should not be considered a recurring element in operating
      income.









The
      following table displays the details of gas margin changes for the three months
      ended September 30, 2007 compared to the same period in 2006.  Gas
      margin is gas sales to retail and transportation customers less pass-through
      tariff items and revenue-sensitive taxes, and the cost of gas purchased,
      including gas transportation costs to bring gas to PSE’s service
      territory.





Gas
                Margin(Dollars
                in Millions)
              Three
                Months Ended September 30,
            
            2007
            
            
            2006
            
            
            Change
            
            
            Percent
              ChangeGas
                operating revenue1
            
            $
            142.1
            
            
            $
            119.6
            
            
            $
            22.5
            
            
            
            18.8
            %Less:
                Other gas operating revenue
            
            
            (4.1
            )
            
            
            (3.8
            )
            
            
            (0.3
            )
            
            
            (7.9
            )Total
                gas revenue for margin
            
            
            138.0
            
            
            
            115.8
            
            
            
            22.2
            
            
            
            19.2Adjustments
                for amounts included in revenue:Pass-through
                tariff items
            
            
            (1.1
            )
            
            
            (0.7
            )
            
            
            (0.4
            )
            
            
            (57.1
            )Pass-through
                revenue-sensitive taxes
            
            
            (11.0
            )
            
            
            (9.3
            )
            
            
            (1.7
            )
            
            
            (18.3
            )Net gas revenue for margin
            
            
            125.9
            
            
            
            105.8
            
            
            
            20.1
            
            
            
            19.0Less:
                Purchased gas costs1
            
            
            (80.9
            )
            
            
            (68.3
            )
            
            
            (12.6
            )
            
            
            (18.4
            )Gas
                margin2
            
            $
            45.0
            
            
            $
            37.5
            
            
            $
            7.5
            
            
            
            20.0
            % ____________________


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 $7.5 million for the three months ended September 30, 2007
      compared to the same period in 2006 primarily due to a 2.8% general rate
      increase effective January 13, 2007 which increased gas margin $3.0 million,
      increased usage by residential and commercial customers and a change in pricing
      which increased margin $2.7 million and a 4.8% increase in gas therm volume
      sales which contributed $1.8 million to gas margin.


The
      following table displays the details of gas margin changes for the nine months
      ended September 30, 2007 compared to the same period in 2006.  Gas
      margin is gas sales to retail and transportation customers less pass-through
      tariff items and revenue-sensitive taxes, and the cost of gas purchased,
      including gas transportation costs to bring gas to PSE’s service
      territory.





Gas
                Margin(Dollars
                in Millions)
              Nine
                months Ended September 30,
            
            2007
            
            
            2006
            
            
            Change
            
            
            Percent
              ChangeGas
                operating revenue1
            
            $
            834.3
            
            
            $
            718.6
            
            
            $
            115.7
            
            
            
            16.1
            %Less:
                Other gas operating revenue
            
            
            (13.3
            )
            
            
            (12.4
            )
            
            
            (0.9
            )
            
            
            (7.3
            )Total
                gas revenue for margin
            
            
            821.0
            
            
            
            706.2
            
            
            
            114.8
            
            
            
            16.3Adjustments
                for amounts included in revenue:Pass-through
                tariff items
            
            
            (6.0
            )
            
            
            (4.5
            )
            
            
            (1.5
            )
            
            
            (33.3
            )Pass-through
                revenue-sensitive taxes
            
            
            (68.1
            )
            
            
            (57.7
            )
            
            
            (10.4
            )
            
            
            (18.0
            )Net gas revenue for margin
            
            
            746.9
            
            
            
            644.0
            
            
            
            102.9
            
            
            
            16.0Less:
                Purchased gas costs1
            
            
            (530.6
            )
            
            
            (453.4
            )
            
            
            (77.2
            )
            
            
            (17.0
            )Gas
                margin2
            
            $
            216.3
            
            
            $
            190.6
            
            
            $
            25.7
            
            
            
            13.5
            % ____________________


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 $25.7 million for the nine months ended September 30, 2007
      compared to the same period in 2006 primarily due to a 2.8% general rate
      increase effective January 13, 2007 which increased gas margin $15.6 million,
      a
      3.8% gas therm volume sales increase which increased gas margin $7.3 million
      and
      a change in customer usage and pricing which increased margin $2.8
      million.





**Electric
      Operating Revenues**


The
      table
      below sets forth changes in electric operating revenues for PSE for the three
      months ended September 30, 2007 compared to the same period in
      2006.





(Dollars
                in Millions)
              Three
                Months Ended September 30,
            2007
            2006
            Change
            Percent
              ChangeElectric
                operating revenues:Residential
                sales
            $      184.2
            
            $      150.2
            
            $       34.0
            
            22.6
            %Commercial
                sales
            177.6
            
            174.7
            
            2.9
            
            1.7Industrial
                sales
            25.5
            
            26.0
            
            (0.5
            )
            (1.9
            )Other
                retail sales, including unbilled revenue
            17.6
            
            12.4
            
            5.2
            
            41.9Total
                retail sales
            404.9
            
            363.3
            
            41.6
            
            11.5Transportation
                sales
            2.8
            
            3.4
            
            (0.6
            )
            (17.6
            )Sales
                to other utilities and marketers
            45.3
            
            24.3
            
            21.0
            
            86.4Other
            3.1
            
            8.2
            
            (5.1
            )
            (62.2
            )Total
                electric operating revenues
            $      456.1
            
            $      399.2
            
            $       56.9
            
            14.3
            %





Electric
      retail sales increased $41.6 million for the three months ended September 30,
      2007 compared to the same period in 2006 due primarily to a decrease in the
      benefits of the Residential and Farm Energy Exchange Benefit credited to
      customers during the three month period ended September 30, 2007 which reduced
      electric operating revenues by $0.4 million compared to $37.6 million for the
      same period in 2006.  This credit also reduced power costs by a
      corresponding amount with no impact on earnings.  The Residential and
      Farm Energy Exchange Benefit was suspended to residential and small farm
      customers effective June 7, 2007 due to adverse rulings from the Ninth Circuit
      Court of Appeals (Ninth Circuit) which states 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 increase was also related to the PCORC rate increase of
      September 1, 2007 and retail sales volumes offset by the electric general rate
      decrease of January 13, 2007.  The electric tariff changes provided
      $1.3 million to electric operating revenues for the three months ended September
      30, 2007 compared to the same period in 2006.  Retail electricity
      usage increased 54,917 megawatt hours (MWh) or 1.2% for the three months ended
      September 30, 2007 compared to the same period in 2006, which resulted in an
      increase of approximately $4.2 million in electric operating
      revenue.  The increase in electricity usage was primarily related to
      1.8% higher average number of customers served in 2007 compared to
      2006.


Sales
      to
      other utilities and marketers increased $21.0 million for the three months
      ended
      September 30, 2007 compared to the same period in 2006 primarily due to an
      increase in sales volume of 429,099 MWh or 96.8%, which resulted in an increase
      of $22.3 million, partially offset by lower wholesale market prices for the
      third quarter 2007 compared to the same period in 2006 resulting in a decrease
      of $1.3 million.


Other
      electric revenues decreased $5.1 million for the three months ended September
      30, 2007 compared to the same period in 2006 primarily due to higher losses
      from
      non-core gas financial hedges and physical sales of surplus natural gas
      purchased for electric generating use in 2007 compared to the same period in
      2006.


The
      table
      below sets forth changes in electric operating revenues for PSE for the nine
      months ended September 30, 2007 compared to the same period in
      2006.





(Dollars
                in Millions)
              Nine
                months Ended September 30,
            2007
            2006
            Change
            Percent
              ChangeElectric
                operating revenues:Residential
                sales
            $     675.7
            
            $      559.3
            
            $     116.4
            
            20.8
            %Commercial
                sales
            550.6
            
            516.9
            
            33.7
            
            6.5Industrial
                sales
            77.8
            
            76.4
            
            1.4
            
            1.8Other
                retail sales, including unbilled revenue
            (14.0
            )
            (8.9
            )
            (5.1
            )
            (57.3
            )Total
                retail sales
            1,290.1
            
            1,143.7
            
            146.4
            
            12.8Transportation
                sales
            7.6
            
            8.8
            
            (1.2
            )
            (13.6
            )Sales
                to other utilities and marketers
            91.5
            
            56.9
            
            34.6
            
            60.8Other
            29.8
            
            38.3
            
            (8.5
            )
            (22.2
            )Total
                electric operating revenues
            $   1,419.0
            
            $   1,247.7
            
            $     171.3
            
            13.7
            %





Electric
      retail sales increased $146.4 million for the nine months ended September 30,
      2007 compared to the same period in 2006 due primarily to a decrease in the
      benefits of the Residential and Farm Energy Exchange Benefit credited to
      customers during the nine months ended September 30, 2007 which reduced electric
      operating revenues by $54.9 million compared to $137.4 million for the same
      period in 2006.  This credit also reduced power costs by a
      corresponding amount with no impact on earnings.  The PCORC rate
      increases of July 1, 2006 and September 1, 2007 offset by the electric general
      rate decrease of January 13, 2007 increased electric retail sales along with
      an
      increase in retail sales volumes.  The electric tariff changes
      provided $37.9 million to electric operating revenues for the nine months ended
      September 30, 2007 compared to the same period in 2006.  Retail
      electricity usage increased 313,554 MWh or 2.1% for the nine months ended
      September 30, 2007 compared to the same period in 2006, which resulted in an
      increase of approximately $23.5 million in electric operating
      revenue.  The increase in electricity usage was related to 2.1% higher
      average number of customers served in 2007 compared to 2006.


Transportation
      sales decreased $1.2 million for the nine months ended September 30, 2007
      compared to the same period in 2006 as a result of transportation customers
      balancing their scheduled load.  For the nine months ended September
      2006, transportation customers purchased power in excess of their scheduled
      load
      whereas for the same period in 2007, the scheduled load was less than actual
      usage.  This decrease was offset by an increase in sales volume of
      22,976 MWh or 1.4%.


Sales
      to
      other utilities and marketers increased $34.6 million for the nine months ended
      September 30, 2007 compared to the same period in 2006 due to an increase in
      sales volume of 378,141 MWh or 24.4%, which resulted in a $18.0 million increase
      and an increase in wholesale market prices during 2007 compared to 2006 which
      resulted in an increase of $15.6 million.


Other
      electric revenues decreased $8.5 million for the nine months ended September
      30,
      2007 compared to the same period in 2006, primarily due to gains from gas
      financial hedges on natural gas sold to third parties in 2006 that did not
      recur
      in 2007.


The
      following electric rate changes
      were approved by the Washington Commission in 2007 and 2006:





Type
                of Rate
              Adjustment
            Effective
                Date
            Average
              Percentage
              Increase
                (Decrease)
              in
                Rates
            Annual
              Increase
                (Decrease)
              in
                Revenues
              (Dollars
                in Millions)Power
                Cost Only Rate Case
            September
                1, 2007
            3.7
            %
            $ 64.7Power
                Cost Only Rate Case
            July
                1, 2006
            5.9
            
            45.31Electric
                General Rate Case
            January
                13, 2007
            (1.3
            )
            (22.8)


____________________


1
            *The
                rate increase is for the period July 1, 2006 through December 31,
                2006.  The annualized basis of the PCORC rate increase is $96.1
                million.*





**Gas
      Operating Revenues**


The
      table
      below sets forth changes in gas operating revenues for PSE for the three months
      ended September 30, 2007 compared to the same period in 2006.





(Dollars
                in Millions)
              Three
                Months Ended September 30,
            2007
            2006
            Change
            Percent
              ChangeGas
                operating revenues:Residential
                sales
            $      74.7
            
            $        60.9
            
            $     13.8
            
            22.7
            %Commercial
                sales
            49.3
            
            41.8
            
            7.5
            
            17.9Industrial
                sales
            10.6
            
            10.0
            
            0.6
            
            6.0Total
                retail sales
            134.6
            
            112.7
            
            21.9
            
            19.4Transportation
                sales
            3.4
            
            3.1
            
            0.3
            
            9.7Other
            4.1
            
            3.8
            
            0.3
            
            7.9Total
                gas operating revenues
            $    142.1
            
            $      119.6
            
            $     22.5
            
            18.8
            %





Gas
      retail sales increased $21.9 million for the three months ended September 30,
      2007 compared to the same period in 2006 due to higher Purchased Gas Adjustment
      (PGA) mechanism rates, the approval of a 2.8% general gas rate increase
      effective January 13, 2007 and increased customer gas usage.  The
      Washington Commission approved a PGA mechanism rate increase effective October
      1, 2006 that increased rates 10.2% annually.  The PGA mechanism passes
      through to customers increases or decreases in the gas supply portion of the
      natural gas service rates based upon changes in the price of natural gas
      purchased from producers and wholesale marketers or changes in 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 September 30, 2007, the effects of the PGA mechanism rate increases
      provided an increase of $9.4 million in gas operating revenues.  The
      gas general rate case provided an additional $3.0 million in gas revenues for
      the three months ended September 30, 2007 as compared to the same period in
      2006.  The remaining increase in gas retail revenues was primarily due
      to higher gas sales of 6.5 million therms or $5.6 million for the three months
      ended September 30, 2007 compared to the same period in 2006, which was related
      to a 2.7% increase in customers.


The
      table
      below sets forth changes in gas operating revenues for PSE for the nine months
      ended September 30, 2007 compared to the same period in 2006.





(Dollars
                in Millions)
              Nine
                Months Ended September 30,
            2007
            2006
            Change
            Percent
              ChangeGas
                operating revenues:Residential
                sales
            $     510.5
            
            $      436.0
            
            $     74.5
            
            17.1
            %Commercial
                sales
            257.2
            
            221.0
            
            36.2
            
            16.4Industrial
                sales
            43.1
            
            39.4
            
            3.7
            
            9.4Total
                retail sales
            810.8
            
            696.4
            
            114.4
            
            16.4Transportation
                sales
            10.2
            
            9.8
            
            0.4
            
            4.1Other
            13.3
            
            12.4
            
            0.9
            
            7.3Total
                gas operating revenues
            $     834.3
            
            $      718.6
            
            $   115.7
            
            16.1
            %





Gas
      retail sales increased $114.4 million for the nine months ended September 30,
      2007 compared to the same period in 2006 due to higher PGA mechanism rates,
      the
      approval of a 2.8% general gas rate increase effective January 13, 2007 and
      increased customer gas usage.  The Washington Commission approved a
      PGA mechanism rate increase effective October 1, 2006 that increased rates
      10.2%
      annually.  The PGA mechanism passes through to customers increases or
      decreases in the gas supply portion of the natural gas service rates based
      upon
      changes in the price of natural gas purchased from producers and wholesale
      marketers or changes in gas pipeline transportation costs.  PSE’s gas
      margin and net income are not affected by changes under the PGA
      mechanism.  For the nine months ended September 30, 2007, the effects
      of the PGA mechanism rate increases provided an increase of $62.3 million in
      gas
      operating revenues.  The gas general rate case provided an additional
      $15.6 million in gas revenues for the nine months ended September 30, 2007
      as
      compared to the same period in 2006.  The remaining increase in gas
      retail revenues was primarily due to higher gas sales of 27.9 million therms
      or
      $27.2 million for the nine months ended September 30, 2007 compared to the
      same
      period in 2006, which was related to a 2.7% increase in customers.


The
      following gas rate adjustments were approved by the Washington Commission in
      2007 and 2006:





Type
                of Rate
              Adjustment
            Effective
                Date
            Average
              Percentage
              Increase
                (Decrease)
              in
                Rates
            Annual
              Increase
                (Decrease)
              in
                Revenues
              (Dollars
                in Millions)Purchased
                Gas Adjustment
            October
                1, 2007
            (13.0
            )
                %
            $(148.1
            )Purchased
                Gas Adjustment
            October
                1, 2006
            10.2
            
            95.1Gas
                General Rate Case
            January
                13, 2007
            2.8
            
            29.5





**Non-Utility
      Operating Revenues**


The
      table
      below sets forth changes in non-utility operating revenues for PSE for the
      three
      months ended September 30, 2007 compared to the same period in
      2006.





(Dollars
                in Millions)
              Three
                Months Ended September 30,
            2007
            2006
            Change
            Percent
              ChangeNon-Utility
                Operating Revenue
            $3.5
            
            $0.7
            
            $2.8
            
            * _________________


*
            *Percent
                change not applicable or
                meaningful*




The
      table
      below sets forth changes in non-utility operating revenues for PSE for the
      nine
      months ended September 30, 2007 compared to the same period in
      2006.





(Dollars
                in Millions)
              Nine
                Months Ended September 30,
            2007
            2006
            Change
            Percent
              ChangeNon-Utility
                Operating Revenue
            $13.4
            
            $5.8
            
            $7.6
            
            131.0
            %





Non-utility
      operating revenues
      increased $2.8 million and $7.6 million for the three
      and nine
      months ended September 30, 2007, respectively, compared to the same periods
      in
      2006due to additional property sales during 2007 by PSE’s real estate
      subsidiary.





**Operating
      Expenses**


The
      table
      below sets forth significant changes in operating expenses for PSE and its
      subsidiaries for the three months ended September 30, 2007 compared to the
      same
      period in 2006.





(Dollars
                in Millions)
              Three
                Months Ended September 30,
            2007
            2006
            Change
            Percent
              ChangePurchased
                electricity
            $     185.8
            
            $      183.7
            
            $       2.1
            
            1.1
            %Electric
                generation fuel
            43.5
            
            36.3
            
            7.2
            
            19.8Residential
                exchange credit
            (0.4
            )
            (35.9
            )
            (35.5
            )
            (98.9
            )Purchased
                gas
            80.9
            
            68.3
            
            12.6
            
            18.4Unrealized
                (gain) loss on derivative instruments
            5.3
            
            (0.6
            )
            5.9
            
            *Utility
                operations and maintenance
            94.4
            
            87.7
            
            6.7
            
            7.6Non-utility
                expense and other
            2.2
            
            0.7
            
            1.5
            
            *Depreciation
                and amortization
            68.9
            
            65.5
            
            3.4
            
            5.2Conservation
                amortization
            8.5
            
            7.1
            
            1.4
            
            19.7Taxes
                other than income taxes
            56.9
            
            46.3
            
            10.6
            
            22.9 _________________


*
            *Percent
                change not applicable or
                meaningful*





The
      table
      below sets forth significant changes in operating expenses for PSE and its
      subsidiaries for the nine months ended September 30, 2007 compared to the same
      period in 2006.





(Dollars
                in Millions)
              Nine
                Months Ended September 30,
            2007
            2006
            Change
            Percent
              ChangePurchased
                electricity
            $     640.6
            
            $      623.8
            
            $     16.8
            
            2.7
            %Electric
                generation fuel
            93.3
            
            72.2
            
            21.1
            
            29.2Residential
                exchange credit
            (52.4
            )
            (131.2
            )
            (78.8
            )
            (60.1
            )Purchased
                gas
            530.6
            
            453.3
            
            77.3
            
            17.1Unrealized
                loss on derivative instruments
            1.0
            
            0.2
            
            0.8
            
            *Utility
                operations and maintenance
            291.5
            
            258.7
            
            32.8
            
            12.7Non-utility
                expense and other
            6.8
            
            1.4
            
            5.4
            
            *Depreciation
                and amortization
            204.4
            
            194.0
            
            10.4
            
            5.4Conservation
                amortization
            27.6
            
            22.6
            
            5.0
            
            22.1Taxes
                other than income taxes
            207.3
            
            180.3
            
            27.0
            
            15.0 _________________


*
            *Percent
                change not applicable or
                meaningful*





**Purchased
      electricity** expenses increased $2.1 million and $16.8 million for the
      three and nine months ended September 30, 2007, respectively, compared to the
      same periods in 2006.  The increase for the three months ended
      September 30, 2007 was primarily the result of an increase in transmission
      and
      other expenses of $5.4 million and a deferral of $4.5 million owed to customers
      related to the PCA mechanism, which reflected an increase in the overrecovery
      of
      allowable power costs shared with customers due to lower wholesale market prices
      during the three months ended September 30, 2007 as compared to the same period
      in 2006.  A change in the PCA mechanism sharing bands effective
      January 2007 resulted in sharing more overrecovered power costs with customers
      in the three months ended September 30, 2007 as compared to the same period
      in
      2006.  In addition, total purchased power for the three months ended
      September 30, 2007 increased $3.8 million due to an increase in purchases
      (88,443 MWh or 2.5%) compared to the same period in 2006.  This
      increase was offset by a decrease in wholesale market prices, which resulted
      in
      a net decrease in purchased power of $11.6 million.  The increase for
      the nine months ended September 30, 2007 was primarily the result of higher
      wholesale market prices which resulted in an increase of $21.2 million offset
      to
      purchased electricity expense by a decrease in purchased power of 297,669 MWh
      or
      2.3%, resulting in a decrease of $13.0 million.  Increases in
      transmission and other expenses contributed $13.8 million due in part to
      increased kilowatt hour (kWh) sales to customers.  The PCA mechanism
      reflected a $5.2 million decrease in the deferral of power costs for the nine
      months ended September 30, 2007 as compared to the same period in
      2006.


The
      July 9, 2007 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 April through September 2007 is 99% of normal, which compares
      to
      106% of normal runoff observed for the same period in 2006.  PSE’s
      hydroelectric production and related power costs in 2006 for the January to
      September period were positively impacted by above-normal precipitation and
      snow
      pack in the Pacific Northwest region.  The 2008 Columbia Basin Runoff
      Forecast will be available in December 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 $7.2 million and $21.1 million for
      the three and nine months ended September 30, 2007, respectively, compared
      to
      the same periods in 2006.  The increase for the three months ended
      September 30, 2007 was due in part to the operations of Goldendale, acquired
      on
      February 21, 2007, which increased costs by $4.6 million.  In
      addition, higher volumes of electricity generated at Colstrip combined with
      an
      increase in the cost of coal increased costs by $1.8 million compared to the
      same period in 2006.  The increase for the nine months ended September
      30, 2007 was the result of an increase of $11.4 million primarily due to the
      operations of Goldendale and an increase of $7.1 million due to higher volumes
      of electricity generated at Colstrip combined with an increase in the cost
      of
      coal in 2007 compared to 2006.  In addition, higher volumes of
      electricity generation and natural gas fuel costs at PSE’s combustion turbine
      contributed $2.6 million for the nine months ended September 30, 2007 as
      compared to the same period in 2006.


**Residential
      exchange credits** associated with the Residential Exchange Program with
      BPA decreased $35.5 million and $78.8 million for the three and nine months
      ended September 30, 2007, respectively, compared to the same periods in 2006
      as
      a result of lower residential and small farm customer electric credit in rates
      effective October 1, 2006.  The residential exchange 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.  The
      residential exchange credit provided to residential and small farm customers
      was
      suspended effective June 7, 2007.


**Purchased
      gas** expenses increased $12.6 million and $77.3 million for the three
      and nine months ended September 30, 2007, respectively, compared to the same
      periods in 2006 primarily due to an increase in PGA rates as approved by the
      Washington Commission and higher customer therm sales.  The PGA
      mechanism allows PSE to recover expected gas costs, and defer, as a receivable
      or liability, any 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 September 30, 2007 was $61.2 million compared
      to a
      receivable balance at December 31, 2006 of $39.8 million.  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 gas cost through
      rates.  A payable balance reflects overrecovery of market gas cost
      through rates.


**Unrealized
      gain on derivative instruments**decreased $5.9 million and $0.8 million
      for****the three and nine months ended September 30, 2007,
      respectively, compared to the same periods in 2006.  The decrease for
      the three months ended September 30, 2007 was primarily the result of a loss
      incurred during the third quarter 2007 related to the ineffective portion of
      cash flow hedge contracts for physical power beginning January 2009 and the
      decrease in the fair value of the unrealized gain related to a physical gas
      supply contract for PSE’s electric generating facilities.  The cash
      flow hedge contracts replace the energy that was lost due to the early
      termination of a contract by the counterparty in the second quarter
      2007.  The ineffective portion relates to periods in which PSE has
      enough projected energy resources to meet the expected customer usage without
      the two contracts.  The mark-to-market gain or loss on the physical
      gas supply contracts is the difference between the forward market price of
      natural gas and the contract price for natural gas based on volumes
      purchased.  As the contracts near termination, the gain or loss will
      continue to reverse due to settlement of the contract on a monthly basis and
      the
      mark-to-market value will decrease as long as the price for natural gas is
      at or
      near the current forward market price.


**Utility
      operations and maintenance**expense increased $6.7 million and $32.8
      million for the three and nine months ended September 30, 2007, respectively,
      compared to the same periods in 2006.  The increases were the result
      of higher operating and maintenance costs of $3.0 million and $14.1 million
      at
      PSE’s generating facilities primarily due to the addition of Wild Horse which
      began operations on December 22, 2006 and Goldendale, which was acquired during
      February 2007.  Wild Horse operations and maintenance expense is fully
      recovered in rates and beginning September 1, 2007, Goldendale is fully
      recovered in rates.  The balance of the increases was the result of
      higher expenses of operating and maintaining PSE’s energy delivery systems,
      support services and increased customer service costs.


**Non-utility
      expense and other** increased $1.5 million and $5.4 million for the three
      and nine months ended September 30, 2007, respectively, compared to the same
      periods in 2006 primarily due to an increase in PSE’s long-term share-based
      incentive plan costs.


**Depreciation
      and amortization** expense increased $3.4 million and $10.4 million for
      the three and nine months ended September 30, 2007, respectively, compared
      to
      the same periods in 2006.  These increases include the benefit of the
      deferral of Goldendale ownership and operating costs of $3.9 million and $10.8
      million for the three and nine months ended September 30, 2007, respectively,
      which, had it not been included, would have resulted in an increase to
      depreciation and amortization expense of $7.3 million and $21.2 million for
      the
      three and nine months ended September 30, 2007, respectively, as compared to
      the
      same periods in 2006.  The increase in depreciation and amortization
      for the three months ended September 30, 2007 includes $3.3 million from placing
      Wild Horse into service on December 16, 2006, $1.2 million from placing
      Goldendale into service on February 22, 2007 and $2.8 million from other
      depreciable property placed into service during 2007.  The increase in
      depreciation and expense for the nine months ended September 30, 2007 includes
      $9.9 million due to Wild Horse, $4.0 million from additions of computer software
      and leasehold improvements, $2.9 million due to Goldendale and $4.4 million
      from
      other depreciable property placed into service during 2007.  On August
      2, 2007, the Washington Commission approved a PCORC settlement agreement filed
      July 5, 2007 finding the acquisition of Goldendale to be prudent. The Goldendale
      deferral of ownership and operating costs ceased to be effective September
      1,
      2007, when PSE was authorized to begin recovering the costs in
      rates.


**Conservation
      amortization** increased $1.4 million and $5.0 million for the three and
      nine months ended September 30, 2007, respectively, compared to the same periods
      in 2006 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 $10.6 million and $27.0 million for
      the three and nine months ended September 30, 2007, respectively, compared
      to
      the same periods in 2006 due primarily to a property tax reduction settlement
      in
      2006 with the Washington State Department of Revenue which resulted in lower
      property valuations in 2006.  The increases also reflect additional
      plant placed in service as well as revenue sensitive taxes due to increased
      revenue.





**Other
      Income, Expense, Interest Charges and Income Tax Expense**


The
      table
      below sets forth significant changes in other income, interest charges and
      income taxes for PSE and its subsidiaries for the three months ended September
      30, 2007 compared to the same period in 2006.





(Dollars
                in Millions)
              Three
                Months Ended September 30,
            
            2007
            
            
            2006
            
            
            Change
            
            
            Percent
              ChangeOther
                expense
            
            $
            0.7
            
            
            $
            1.7
            
            
            $
            (1.0
            )
            
            
            (58.8
            )%Interest
                charge
            
            
            51.5
            
            
            
            41.1
            
            
            
            10.4
            
            
            
            25.3Income
                tax (benefit) expense
            
            
            (1.9
            )
            
            
            9.2
            
            
            
            (11.1
            )
            
            
            * _________________


*
            *Percent
                change not applicable or
                meaningful*





The
      table
      below sets forth significant changes in other income, interest charges and
      income taxes for PSE and its subsidiaries for the nine months ended September
      30, 2007 compared to the same period in 2006.





(Dollars
                in Millions)
              Nine
                Months Ended September 30,
            
            2007
            
            
            2006
            
            
            Change
            
            
            Percent
              ChangeInterest
                charge
            
            $
            150.2
            
            
            $
            124.5
            
            
            $
            25.7
            
            
            
            20.6
            %Income
                tax expense
            
            
            49.8
            
            
            
            66.0
            
            
            
            (16.2
            )
            
            
            (24.5
            )





**Other
      expenses**decreased $1.0 million for the three months ended September
      30, 2007 compared to the same period in 2006 primarily due to a penalty that
      was
      assessed by the Washington Commission in the third quarter 2006, which is not
      tax-deductible.


**Interest
      expense**increased $10.4 million and $25.7 million for the three and
      nine months ended September 30, 2007, respectively, as compared to the same
      period in 2006.  The increase for the three months ended September 30,
      2007 was primarily due to additional debt financing in 2007 during which average
      balances were higher than 2006 levels.  The increase was also driven
      by more favorable pricing on gas purchases in 2007 which resulted in the
      interest-bearing PGA transferring from a receivable balance in 2006 to a payable
      balance in 2007.  The remainder of the increase was related to
      additional construction projects in 2007.  The increase for the nine
      months ended September 30, 2007 as compared to the same period in 2006 was
      due
      primarily to additional debt financing in 2007 during which average balances
      were higher than 2006 levels.  The increase was also driven by more
      favorable pricing on gas purchases in 2007 which resulted in the
      interest-bearing PGA transferring from a receivable balance in 2006 to a payable
      balance in 2007.  The remainder of the increase was related to
      additional construction projects in 2007.


**Income
      tax expense**decreased $11.1 million and $16.2 million for the three and
      nine months ended September 30, 2007, respectively compared to the same period
      in 2006.  The increase for the three months ended September 30, 2007
      was primarily due to lower net income in 2007 and a true-up of the 2006 federal
      tax provision which resulted in an adjustment to the 2007 effective tax
      rate.  The effective tax rate was also lower due to higher tax credits
      associated with the production of wind-powered energy.  The true-up of
      the 2006 tax provision was a benefit of $1.9 million for the three months ended
      September 30, 2007 as compared to an expense of $0.5 million in 2006 for the
      2005 tax provision true-up.  The PTCs for the three months ended
      September 30, 2007 were $1.1 million compared to $0.3 million for the same
      period in 2006.  These additional credits were made available due to
      the addition of Wild Horse, which was placed in service in December
      2006.  The decrease for the nine months ended September 30, 2007
      compared to the same period in 2006 was primarily due to a true-up of the 2006
      federal tax provision as a result of filing the federal income tax return which
      adjusted the 2007 effective tax rate.  The effective tax rate was also
      lower due to higher tax credits associated with the production of wind-powered
      energy.  The PTCs for the nine months ended September 30, 2007 were
      $13.9 million compared to $4.9 million for the same period in
      2006.  These additional credits were made available due to the
      addition of Wild Horse, which was placed in service in December
      2006.








**Capital
      Requirements**


**Contractual
      Obligations and Commercial Commitments**


**Puget
      Energy.**  The following are Puget Energy’s aggregate
      consolidated (including PSE) contractual obligations and commercial commitments
      as of September 30, 2007:





Puget
                Energy
            
            
            
            Payments
                Due Per PeriodContractual
                Obligations
              (Dollars
                in Millions)
            Total
            2007
            2008-
              2009
            2010-
              2011
            2012
                & ThereafterLong-term
                debt including interest
            $
            6,613.3
            $
            178.1
            $
            689.6
            $
            775.8
            $
            4,969.8Short-term
                debt including interest
            
            378.0
            
            378.0
            
            --
            
            --
            
            --Mandatorily
                redeemable preferred stock
            
            1.9
            
            --
            
            --
            
            --
            
            1.9Service
                contract obligations
            
            444.5
            
            35.7
            
            126.5
            
            118.5
            
            163.8Non-cancelable
                operating leases
            
            175.0
            
            7.9
            
            53.8
            
            25.4
            
            87.9Fredonia
                combustion turbines lease 1
            
            61.4
            
            1.5
            
            12.9
            
            47.0
            
            --Energy
                purchase obligations
            
            6,561.8
            
            333.2
            
            2,036.1
            
            1,324.2
            
            2,868.3Contract initiation payment/collateral requirement
            
            18.5
            
            --
            
            --
            
            18.5
            
            --Financial
                hedge obligations
            
            10.6
            
            6.6
            
            4.0
            
            --
            
            --Purchase
                obligations
            
            34.7
            
            9.9
            
            24.8
            
            --
            
            --Non-qualified pension and other benefits funding
            
            46.7
            
            6.1
            
            7.4
            
            5.1
            
            28.1Interest liability on uncertain tax positions
            
            5.4
            
            --
            
            5.4
            
            --
            
            --Total
                contractual obligations
            $
            14,351.8
            $
            957.0
            $
            2,960.5
            $
            2,314.5
            $
            8,119.8





Puget
                Energy
            
            
            
            Amount
                of Commitment
              Expiration
                Per PeriodCommercial
                Commitments
              (Dollars
                in Millions)
            Total
            2007
            2008-
              2009
            2010-
              2011
            2012
                & ThereafterIndemnity
                agreements 2
            $
            8.5
            $
            --
            $
            4.0
            $
            --
            $
            4.5Credit
                agreement - available 3
            
            590.6
            
            --
            
            --
            
            --
            
            590.6Receivable
                securitization facility 4
            
            74.0
            
            --
            
            --
            
            74.0
            
            --Energy
                operations letter of credit
            
            7.4
            
            7.4
            
            --
            
            --
            
            --Total
                commercial commitments
            $
            680.5
            $
            7.4
            $
            4.0
            $
            74.0
            $
            595.1


_________________


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 September 30, 2007 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 $4.5 million at September 30,
                2007.*3
            *At
                September 30, 2007, 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 September 30, 2007, PSE had $7.4 million
                outstanding under four letters of credit, $90.0 million in loans
                outstanding under the $500 million agreement and $162.0 million commercial
                paper outstanding, effectively reducing the available borrowing capacity
                to $590.6 million.*4
            *At
                September 30, 2007, PSE had available a $200.0 million receivables
                securitization facility that expires in December 2010.  $126.0
                million was outstanding under the receivables securitization facility
                at
                September 30, 2007 thus leaving $74.0 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 September 30, 2007:





Puget
                Sound Energy
            Payments
                Due Per PeriodContractual
                Obligations
              (Dollars
                in Millions)
            Total
            2007
            2008-
              2009
            2010-
              2011
            2012
                & ThereafterLong-term
                debt including interest
            $
            6,613.3
            $
            178.1
            $
            689.6
            $
            775.8
            $
            4,969.8Short-term
                debt including interest
            
            402.4
            
            402.4
            
            --
            
            --
            
            --Mandatorily
                redeemable preferred stock
            
            1.9
            
            --
            
            --
            
            --
            
            1.9Service
                contract obligations
            
            444.5
            
            35.7
            
            126.5
            
            118.5
            
            163.8Non-cancelable
                operating leases
            
            175.0
            
            7.9
            
            53.8
            
            25.4
            
            87.9Fredonia
                combustion turbines lease 1
            
            61.4
            
            1.5
            
            12.9
            
            47.0
            
            --Energy
                purchase obligations
            
            6,561.8
            
            333.2
            
            2,036.1
            
            1,324.2
            
            2,868.3Contract initiation payment/collateral requirement
            
            18.5
            
            --
            
            --
            
            18.5
            
            --Financial
                hedge obligations
            
            10.6
            
            6.6
            
            4.0
            
            --
            
            --Purchase
                obligations
            
            34.7
            
            9.9
            
            24.8
            
            --
            
            --Non-qualified
                pension and other benefits funding
            
            46.7
            
            6.1
            
            7.4
            
            5.1
            
            28.1Interest liability on uncertain tax positions
            
            5.4
            
            --
            
            5.4
            
            --
            
            --Total
                contractual obligations
            $
            14,376.2
            $
            981.4
            $
            2,960.5
            $
            2,314.5
            $
            8,119.8





Puget
                Sound Energy
            
            
            
            Amount
                of Commitment
              Expiration
                Per PeriodCommercial
                Commitments
              (Dollars
                in Millions)
            Total
            2007
            2008-
              2009
            2010-
              2011
            2012
                & ThereafterCredit
                agreement - available 2
            $
            590.6
            $
            --
            $
            --
            $
            --
            $
            590.6Receivable
                securitization facility 3
            
            74.0
            
            --
            
            --
            
            74.0
            
            --Energy
                operations letter of credit
            
            7.4
            
            7.4
            
            --
            
            --
            
            --Total
                commercial commitments
            $
            672.0
            $
            7.4
            $
            --
            $
            74.0
            $
            590.6


_________________


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 lease in April
      2001.  The term of the lease expires 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 September 30, 2007, PSE’s
      outstanding balance under the lease was $49.0 million.  The expected
      residual value under the lease is the lesser of $37.4 million or 60% of the
      cost
      of the equipment.  In the event the equipment is sold to a third party
      upon termination of the lease and the aggregate sales proceeds are less than
      the
      unamortized value of the equipment, PSE would be required to pay the lessor
      contingent rent in an amount equal to the deficiency up to a maximum of 87%
      of
      the unamortized value of the equipment.





**Utility
      Construction Program**


Utility
      construction expenditures for generation, transmission and distribution are
      designed to meet continuing customer growth and to improve efficiencies of
      PSE’s
      energy delivery systems.  Construction expenditures, excluding equity
      Allowance for Funds Used During Construction (AFUDC) and customer refundable
      contributions, were $548.0 million for the nine months ended September 30,
      2007.  Utility construction expenditures, excluding AFUDC and
      excluding new generation resources other than Wild Horse (which will be
      determined as the Company proceeds through the integrated resource planning
      process) are anticipated to be as follows in 2007, 2008 and 2009:





Capital
                Expenditure Estimates
              (Dollars
                in Millions)
            
            2007
            
            
            2008
            
            
            2009Energy
                delivery, technology and facilities
            
            $
            565
            
            
            $
            600
            
            
            $
            570New
                supply resources
            
            
            145
            
            
            
            70
            
            
            
            220Total
                expenditures
            
            $
            710
            
            
            $
            670
            
            
            $
            790





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 year ended September 30, 2007 was $491.6
      million which is 85.0% of the $578.1 million used for utility construction
      expenditures and other capital expenditures.  For the nine months
      ended September 30, 2006, cash generated from operations was $152.5 million
      which is 25.4% of the $601.2 million used for utility construction expenditures
      and other capital expenditures.


The
      overall cash generated from operating activities for the nine months ended
      September 30, 2007 increased $339.1 million compared to the same period in
      2006.  The increase was primarily the result of collection of the
      purchased gas receivable of $117.3 million and transactions that occurred in
      2006 which did not recur in 2007.  These transactions included the
      Chelan PUD contract initiation payment of $89.0 million, cash collateral
      re-payment to energy suppliers of $22.0 million and a gain on the sale of
      InfrastruX of $29.8 million.  Also contributing to the increase was
      $97.7 million in income taxes paid in the first nine months of 2006 compared
      to
      $23.0 million paid in the same period in 2006 and a decrease in fuel and gas
      inventory costs of $38.1 million.  These increases were partially
      offset by a $27.7 million increase in payments to customers related to the
      Residential Exchange program.





**Financing
      Program**


Financing
      utility construction requirements and operational needs are dependent upon
      the
      cost and availability of external funds through capital markets and from
      financial institutions.  Access to funds is dependent upon factors
      such as general economic conditions, regulatory authorizations and policies
      and
      Puget Energy’s and PSE’s credit ratings.





**Restrictive
      Covenants**


In
      determining the type and amount of future financing, PSE may be limited by
      restrictions contained in its electric and gas mortgage indentures, articles
      of
      incorporation and certain loan agreements.  Under the most restrictive
      tests, at September 30, 2007, PSE could issue:


·
            approximately
                $608.0 million of additional first mortgage bonds under PSE’s electric
                mortgage indenture based on approximately $1,013.3 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
                September
                30, 2007;


·
            approximately
                $447.0 million of additional first mortgage bonds under PSE’s gas mortgage
                indenture based on approximately $745.0 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 gas utility mortgage), which PSE exceeded at September 30,
                2007;


·
            approximately
                $859.4 million of additional preferred stock at an assumed dividend
                rate
                of 7.0%; and


·
            approximately
                $712.1 million of unsecured long-term
                debt.


At
      September 30, 2007, PSE had approximately $4.3 billion in electric and 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 October 29, 2007, were as
      follows:





RatingsStandard
                & Poor’s
            Moody’s**Puget
                Sound Energy**Corporate
                credit/issuer rating
            BBB-
            Baa3Senior
                secured debt
            BBB+
            Baa2Shelf
                debt senior secured
            BBB+
            (P)Baa2Junior
                Subordinated Notes
            BB
            Ba1Preferred
                stock
            BB
            Ba2Commercial
                paper
            A-3
            P-2Revolving
                credit facility
            *
            Baa3Ratings
                outlook
            Stable
            Stable**Puget
                Energy**Corporate
                credit/issuer rating
            BBB-
            Ba1


____________


*
      *Standard & Poor’s does not rate credit facilities*.





**Shelf
      Registrations, Long-Term Debt and Common Stock Activity**


On
      June
      1, 2007, PSE redeemed the remaining 8.231% Capital Trust Preferred Securities
      (classified on the balance sheet as Junior Subordinated Debentures of the
      Corporation Payable to a Subsidiary Trust Holding Mandatorily Redeemable
      Preferred Securities and referred to herein as “Securities”).  The
      purpose of the redemption was to help reduce interest costs by retiring higher
      cost debt.  The remaining $37.8 million of the Securities outstanding
      were redeemed on June 1, 2007 at a 4.12% premium, or $39.3 million, plus accrued
      interest on the redemption date.


On
      June
      4, 2007, PSE issued $250.0 million of Junior Subordinated Notes (Notes) due
      June
      2067.  The Notes bear a fixed rate of interest for the first ten and a
      half years with interest payable semiannually in May and November of each year,
      after which the notes will bear a variable rate of interest (3-month LIBOR
      plus
      2.35%).  Proceeds were used to fund the redemption of the remaining
      $37.8 million 8.231% Securities and to repay short-term debt.  The
      Notes are structured to be treated as debt by the IRS, yet they are considered
      to be similar to equity by the credit rating agencies.  In addition,
      the Notes contain a call option feature and are callable in whole or in part
      by
      PSE on or after June 1, 2017.  They are presented on the balance sheet
      as a separate line item in the redeemable securities and long-term
      debt.


**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 and support the Company’s energy
      hedging activities.





**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
      September 30, 2007, 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
      September 30, 2007, there was $7.4 million outstanding under four letters of
      credit, $90.0 million in loans outstanding under this agreement and $162.0
      million commercial paper outstanding, effectively reducing the available
      borrowing capacity under the two credit agreements to $590.6
      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 $126.0 million in loans that were secured by accounts receivable pledged
      at
      September 30, 2007.  The remaining borrowing base of eligible
      receivables at September 30, 2007 was $74.0 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 September 30, 2007, the outstanding
      balance of the Note was $24.3 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 issued common stock
      under the Stock Purchase and Dividend Reinvestment Plan of $3.2 million (140,079
      shares) and $9.7 million (395,970 shares) for the three and nine months ended
      September 30, 2007, respectively, compared to $3.3 million (150,295 shares)
      and
      $10.2 million (481,930 shares) for the three and nine months ended September
      30,
      2006, respectively.





**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**





**Electric
      Regulation and Rates**


**Integrated
      Resource Plan.**  PSE filed its IRP on May 31, 2007 with the
      Washington Commission.  The plan supports a strategy of diverse
      acquisitions to cost-effectively meet growing demand for energy and reduce
      carbon emissions.  According to the IRP, PSE can secure additional
      power supplies through heightened energy-efficiency efforts and expanded
      wind-power generation.  PSE believes that a cost-effective and
      environmentally responsible way to source generation will likely include
      additional natural gas-fired resources.  PSE’s analysis targets a need
      to acquire 1,600 aMW of additional power supply in the next decade and 2,600
      aMW
      by 2025.





**Mandatory
      Electric Reliability Standards.**  On March 16, 2007, FERC
      issued Order 693, “Mandatory Reliability Standards for the Bulk-Power System,”
which imposes penalties of up to $1.0 million per day per violation for failure
      to comply with new electric reliability standards.  FERC approved 83
      reliability standards developed by the North American Electric Reliability
      Corporation (NERC).  The 83 standards comprise 586 requirements and
      sub-requirements that PSE must comply with.  On June 18, 2007, the
      standards became mandatory and enforceable under federal law.  PSE
      expects that the existing standards will often change as a result of
      modifications, guidance and clarification following industry implementation
      and
      ongoing audits and enforcement.


Per
      NERC
      and Western Electricity Coordinating Council (WECC) guidelines, users, owners
      and operators of the bulk power system that self-report non-compliance with
      any
      of the NERC standards and that submit mitigation plans to address the
      non-compliance will not be subject to sanctions if the mitigation plans were
      submitted on or before June 18, 2007 and approved by WECC.  In June
      2007, PSE submitted self reports and mitigation plans to WECC for review and
      approval.  Neither the outcome of this submission nor the financial
      impact to PSE of complying with Order 693, if any, can be predicted at this
      time.  PSE’s compliance with these standards will be audited at least
      every three years.  The first such audit will be conducted during the
      fourth quarter 2007.





**Power
      Cost Only Rate Case.**  On March 20, 2007, PSE submitted a
      PCORC filing to request approval of an updated power cost baseline rate
      beginning September 2007.  The PCORC filing also requested recovery of
      Goldendale ownership and operating costs through retail electric
      rates.  The requested electric rate increase was $64.7 million or 3.7%
      annually.  On May 23, 2007, PSE filed updated power costs due to
      changes in market conditions of natural gas and other costs which resulted
      in a
      revised proposed increase of $77.8 million or 4.4% annually.  On July
      5, 2007, a settlement agreement in this PCORC signed by PSE and other parties
      to
      the proceeding was filed with the Washington Commission.  The terms of
      the settlement agreement include an increase in electric rates and a finding
      that Goldendale ownership and operating costs are agreed upon as prudent, thus
      allowing for recovery of the costs through electric retail rates.  On
      August 2, 2007, the Washington Commission approved and adopted the settlement
      agreement which provides for an electric rate increase of $64.7 million or
      3.7%
      effective September 1, 2007.


In
      accordance with the August 2, 2007 Washington Commission order approving the
      PCORC settlement, PSE and other parties have agreed to conduct a collaborate
      stakeholder review of the PCORC process to consider the scope and timing of
      the
      PCORC mechanism and whether the mechanism should continue.  The
      collaborative review will include but is not limited to: 1) the number of PCORCs
      that a company will be allowed to file in any given year; 2) the number and
      timing of updates that a company my submit in the PCORC process; 3) the items
      directly associated with power costs that may be included and considered in
      a
      PCORC filing; and 4) whether the number and timing of updates may vary depending
      on if other parties can easily verify.  Any agreements reached by the
      parties in the collaborative will be presented to the Washington Commission
      for
      approval during PSE’s next general rate case and any issues on which agreement
      has not been reached may be raised in the same general rate case.





**Storm
      Accounting Mechanism**.  PSE’s storm accounting, which allows
      deferral of certain storm damage costs, is subject to review by the Washington
      Commission at the end of the current three year period, which is December 31,
      2007.  During the fourth quarter 2007,****PSE
      intends to seek approval from the Washington Commission to continue its storm
      deferral accounting treatment at current levels beyond December 31,
      2007.





**Accounting
      Petition.**  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 to accrue monthly
      carrying charges on the deferred balance from June 7, 2007 until the deferral
      is
      recovered from customers or from BPA.  As of September 30, 2007, PSE
      has a regulatory asset recorded for the benefit provided to customers and
      related carrying charges of $34.8 million.





**Electric
      General Rate Case.**  On January 5, 2007, the Washington
      Commission issued its order in PSE’s electric general rate case filed in
      February 2006, approving a general rate decrease for electric customers of
      $22.8
      million or 1.3% annually.  The rates for electric customers were
      effective beginning January 13, 2007.  In its order, the Washington
      Commission approved a weighted cost of capital of 8.4%, or 7.06% after-tax,
      and
      a capital structure that included 44.0% common equity with a return on equity
      of
      10.4%.  The Washington Commission had earlier approved (on June 28,
      2006) a PCORC increase of $96.1 million annually effective July 1,
      2006.





**Production
      Tax Credit.**  On October 30, 2006, PSE revised its PTC
      electric tariff to increase the revenue credit to customers from $13.1 million
      to $28.8 million, effective January 1, 2007.  The credit is based on
      expected wind generation and reflects the true-up of prior years’ credits
      provided to customers versus credits for actual wind generation taken for
      federal income taxes and the addition of Wild Horse to the wind
      portfolio.  PSE will be revising its tariff effective January 1, 2008
      based on actual PTC results for 2007 and project 2008 PTCs based on a filing
      to
      be made in the fourth quarter 2007.





**PCA
      Mechanism.**  On June 20, 2002, the Washington Commission
      approved a PCA mechanism that triggers if PSE’s costs to provide customers’
electricity falls outside certain bands established in an electric rate
      case.  The cumulative maximum pre-tax earnings exposure due to power
      cost variations over the four-year period ending June 30, 2006 was limited
      to
      $40.0 million plus 1% of the excess.  On January 5, 2007, the
      Washington Commission approved the PCA mechanism for continuation under the
      same
      annual graduated scale without a cumulative cap for excess power
      costs.  All significant variable power supply cost variables
      (hydroelectric and wind generation, market price for purchased power and surplus
      power, natural gas and coal fuel price, generation unit forced outage risk
      and
      transmission cost) are included in the PCA mechanism.  The PCA
      mechanism apportions increases or decreases in power costs, on a calendar year
      basis, between PSE and its customers on a graduated scale:





Annual
                Power
              Cost
                Variability
            Customers’
                Share
            Company’s
                Share1+/-
                $20 million
            0%
            100%+/-
                $20 - $40 million
            50%
            50%+/-
                $40 - $120 million
            90%
            10%+/-
                $120 million
            95%
            5%


_________________


1
            *Over
                the four-year period July 1, 2002 through June 30, 2006, the Company’s
                share of pre-tax power cost variations was capped at a cumulative
                $40
                million plus 1% of the excess.  Power cost variations after June
                30, 2006 are apportioned on an annual basis, on the graduated scale
                without a cumulative cap.*




**Gas
      Regulation and Rates**


**Purchased
      Gas Adjustment Mechanism.**On September 26, 2007, the
      Washington Commission approved PSE’s requested revisions to its PGA tariffs
      resulting in a rate decrease for gas customers of $148.1 million or 13.0%
      annually effective October 1, 2007.  The rate decrease was the result
      of lower costs of natural gas in the forward market and a refund of the
      accumulated PGA payable balance over a 12-month period beginning October 1,
      2007.  The PGA rate change will decrease PSE’s revenue but will not
      impact the Company’s net income as the decreased revenue will be offset by
      decreased purchased gas costs and decreased revenue sensitive
      taxes.





**Gas
      General Rate Case.**  On January 5, 2007, the Washington
      Commission issued its order in PSE’s gas general rate case, granting a rate
      increase for gas customers of $29.5 million or 2.8% annually, effective January
      13, 2007.  In its order the Washington Commission approved the same
      weighted cost of capital of 8.4%, or 7.06% after-tax and a capital structure
      that included 44.0% common equity with a return on equity of 10.4%, consistent
      with the Company’s electric operations.




**Proceedings
      Relating to the Western Power Market**


Puget
      Energy’s and PSE’s Report on Form 10-K for the year ended December 31, 2006
      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 this 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.


*CPUC
      Decision.*Proceedings, including filings of requests for
      rehearing or further review, before the Ninth Circuit and/or FERC, have been
      stayed upon the Court’s own motion until November 16, 2007 to allow for possible
      settlement discussions to proceed.


*Lockyer
      Case.*On June 18, 2007, the U.S. Supreme Court denied the
      petition for a writ of certiorari that PSE and other energy sellers had
      submitted.  As such, this matter will be remanded to FERC for further
      proceedings, but not before November 16, 2007, when the stay of the mandate
      back
      to FERC expires.


*Pacific
      Northwest Refund 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.  The court remanded the matter to FERC for further
      proceedings but subsequently issued an order staying further deadlines,
      including the remand, to November 16, 2007 to allow parties to engage in
      court-sponsored mediation.  PSE intends to vigorously defend its
      position in this proceeding, but it is unable to predict the outcome of this
      matter.




**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 certain domestic water
      wells, groundwater and the Colstrip water supply pond were contaminated by
      seepage from a Colstrip Units 1 & 2 effluent holding pond, that seepage from
      Colstrip Units 1 & 2 have decreased property values and that seepage from
      the Colstrip water supply pond caused structural damage to buildings and toxic
      mold.  Discovery is ongoing.  The trial date has been
      postponed until May 21, 2008.


On
      March
      29, 2007, a second complaint related to pond seepage was filed on behalf of
      two
      ranch owners alleging damage due to the Colstrip Units 3 & 4 effluent
      holding pond.


On
      June
      15, 2005, the U.S. Environmental Protection Agency (EPA) issued the Clean Air
      Visibility Rule to address regional haze or regionally-impaired visibility
      caused by multiple sources over a wide area.  The rule defines Best
      Available Retrofit Technology (BART) requirements for electric generating units,
      including presumptive limits for sulfur dioxide, particulate matter and nitrogen
      oxide controls for large units.  In February 2007, Colstrip was
      notified by EPA that Colstrip Units 1 & 2 were determined to be subject to
      the BART requirements.  PSE submitted a BART engineering analysis for
      Colstrip Units 1 & 2 in August 2007.  PSE cannot yet determine the
      need for or costs of additional controls to comply with this rule, though any
      such costs could be significant and would most likely be capitalized to
      plant.





**Sumas
      Cogeneration Company Contract**


Sumas
      Cogeneration Company, L.P. (Sumas), owner of a 135 MW gas-fired co-generation
      facility in the state of Washington and the counterparty to a power purchase
      agreement with PSE, delivered a letter to PSE on May 7, 2007, stating that
      it
      had sold its dedicated 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.  PSE and Sumas have initiated
      discussion relating to Sumas’ actions under the contract, but PSE cannot yet
      determine what may result from such discussions.





**Washington
      State Supreme Court Ruling**


****In
      a
      recent decision, Washington State Supreme Court ruled that certain job reporting
      practices involving the use of company vehicles are compensable time under
      Washington State’s wage and hour laws.  One union representing a
      portion of PSE's workforce claims its members should now be compensated for
      PSE
      job site reporting practices as a result of this decision.  The extent
      of the claims and financial impact on PSE currently is
      unknown.




**New
      Accounting Pronouncements**


In
      September 2006, Financial Accounting Standards Board (FASB) issued SFAS No,
      157,
“Fair Value Measurements.”  SFAS No. 157 establishes a common
      definition for fair value to be applied to GAAP, establishes a framework for
      measuring fair value, and expands disclosure about such fair value
      measurements.  SFAS No. 157 is effective for fiscal years beginning
      after November 15, 2007 which will be the calendar year beginning January 1,
      2008 for the Company.  The Company is currently assessing the impact
      of SFAS No. 157 on its financial statements.


In
      July
      2006, FASB issued Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in
      Income Taxes, an Interpretation of FASB Statement No. 109,” which clarifies the
      accounting for uncertainty in income taxes recognized in the financial
      statements in accordance with FASB Statement No. 109, “Accounting for Income
      Taxes.”  FIN 48 provides guidance on recognition threshold and
      measurement attributed to a tax position taken or expected to be taken in a
      tax
      return.  The tax positions should only be recognized when it is more
      likely than not, based on technical merits, that the position will be sustained
      upon examination by the taxing authority.  FIN 48 was effective for
      the Company as of January 1, 2007.  The Company has performed a review
      of all open tax years (2001 through 2007) and identified one tax position that
      must be reported under the provisions of FIN 48.  The Company has
      determined that the proper amount of interest to accrue under FIN 48 is $5.4
      million as of September 30, 2007.  See discussion at Note 6, “Income
      Taxes.”





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 gas and electric portfolios.  It is not
      engaged in the business of assuming risk for the purpose of speculative
      trading.  The Company hedges open gas and electric positions to reduce
      both portfolio risk and volatility risk in prices.  The exposure
      position is determined by using a probabilistic risk system that models 100
      scenarios of how the Company’s 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;·
            prudently
                manage energy portfolio risks 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
      September 30, 2007 and December 31, 2006:




Electric
              Derivatives(Dollars
                in Millions)
            
            September
                30,
              2007
            
            
            December
                31,
              2006Short-term
                asset
            
            $
            10.1
            
            
            $
            10.1Long-term
                asset
            
            
            --
            
            
            
            6.8Total
                assets
            
            $
            10.1
            
            
            $
            16.9Short-term
                liability
            
            $
            17.1
            
            
            $
            9.0Long-term
                liability
            
            
            8.7
            
            
            
            0.4Total
                liabilities
            
            $
            25.8
            
            
            $
            9.4





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
      September 30, 2007, the Company had net unrealized day one loss deferral of
      $9.6
      million primarily related to a three year locational power exchange contract
      which was modeled and therefore the day one loss was deferred under Emerging
      Issues Task Force (EITF) 02-3, “Issues Involved in Accounting for Derivative
      Contracts Held for Trading Purposes and Involved in Energy Trading and Risk
      Management Activities.”  The deferred loss is being amortized over the
      term of the contract through December 31, 2010.  Any future changes in
      the mark-to-market value will be recorded through the income
      statement.  The contract throughout its term has economic benefit to
      the Company.  The locational exchange will help ease electric
      transmission congestion across the Cascade Mountains during 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 same quantities of power at the Mid-Columbia trading hub
      location.


The
      following tables present the impact of changes in the market value of derivative
      instruments not meeting NPNS or cash flow hedge criteria to the Company’s
      earnings during the three and nine months ended September 30, 2007 and September
      30, 2006:





(Dollars
                in Millions)
              Three
                Months Ended September 30,
            2007
            2006
            ChangeUnrealized
                (gain) loss on derivative instruments
            $  5.3
            $
                (0.6)
            $
                5.9





(Dollars
                in Millions)
              Nine
                Months Ended September 30,
            2007
            2006
            ChangeUnrealized
                (gain) loss on derivative instruments
            $  1.0
            $  0.2
            $  0.8





During the three and nine months ended September 30. 2007, the Company recorded
      a decrease in earnings for the change in the market value of derivative
      instruments not meeting NPNS or cash flow hedge criteria of $5.3 million and
      $1.0 million,  respectively.  The increase in expense is
      primarily due to the change in the mark-to-market valuation of a physically
      delivered gas supply contract for electric generation that did not meet NPNS
      or
      cash flow hedge criteria and due to the ineffective portion of two long-term
      power purchase agreements designated as cash flow hedges.  During the
      three months ended September 30, 2007, in order to replace the energy that
      was
      lost due to the early termination of a contract by the counterparty in the
      second quarter 2007, the Company entered into two long-term power purchase
      contracts that met cash flow hedge criteria.  The ineffective portion
      relates to periods in which the Company has enough projected energy resources
      to
      meet the expected customer usage without the two contracts.  In
      addition, a decline in the unrealized gain on a physical gas supply contract
      recorded in the second quarter 2007 contributed to the unrealized loss in the
      three months ended September 30, 2007 due to the lower market value of natural
      gas and settlement of contracts during the third quarter 2007.  During
      the three and nine months ended September 30, 2006, the Company recorded an
      increase in earnings for the change in the market value of derivative
      instruments not meeting NPNS or cash flow hedge criteria of $0.6 million and
      a
      decrease in earnings of $0.2 million,  respectively.


The
      amount of net unrealized gain (loss), net of tax, related to the Company’s
      energy-related cash flow hedges under SFAS No. 133 consisted of the following
      at
      September 30, 2007 and December 31, 2006:





(Dollars
                in Millions, net of tax)
            September
                30,
              2007
            December
                31,
              2006Other
                comprehensive income – unrealized (gain) loss
            $  9.5
            $  (4.9)




The following table presents derivative hedges of natural gas contracts to
      serve
      natural gas customers at September 30, 2007 and December 31, 2006:





Gas
                Derivatives(Dollars
                in Millions)
            
            September
                30,
              2007
            
            
            December
                31,
              2006Short-term
                asset
            
            $
            2.5
            
            
            $
            6.7Long-term
                asset
            
            
            --
            
            
            
            0.1Total
                assets
            
            $
            2.5
            
            
            $
            6.8Short-term
                liability
            
            $
            39.6
            
            
            $
            61.6Long-term
                liability
            
            
            0.4
            
            
            
            --Total
                liabilities
            
            $
            40.0
            
            
            $
            61.6






Due to the PGA mechanism, mark-to-market adjustments relating to the natural
      gas
      business have been reclassified to a deferred account in accordance with SFAS
      No. 71.  The PGA mechanism passes increases and decreases in the cost
      of natural gas supply to customers.  As the gains and losses on the
      hedges are realized in future periods, they will be recorded as 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 and comprehensive
      income by $24.1 million after-tax and would decrease the fair value of those
      contracts marked-to-market in earnings by $1.0 million after-tax.




**Credit
      Risk**


The
      Company is exposed to credit risk primarily through buying and selling
      electricity and gas to serve its customers.  Credit risk is the
      potential loss resulting from 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.


It
      is
      possible that extreme volatility in energy commodity prices could cause the
      Company to have sub-optimal 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 September 30, 2007, approximately 99%
      of the Company’s energy portfolio was rated investment grade or higher by
      Standard & Poor's Ratings Services and/or Moody's Investor Services,
      Inc.




**Interest
      Rate Risk**


The
      Company believes its interest rate risk primarily relates to the use of
      short-term debt instruments, variable-rate 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 September 30, 2007
      was a
      net loss of $8.3 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 September 30, 2007, 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 period ended
      September 30, 2007 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
      September 30, 2007, 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 period ended September
      30,
      2007, that have materially affected, or are reasonably likely to materially
      affect, PSE’s internal control over financial reporting.











**PART
      II                      OTHER
      INFORMATION**




Item
      1.              **Legal
      Proceedings**




See
      the
      section titled “Proceedings Relating to the Western Power Market” under Item 2
“Management’s Discussion and Analysis of Financial Conditions and Results of
      Operations” of this Report on Form 10-Q.  Contingencies arising out of
      the normal course of the Company’s business exist at September 30,
      2007.  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**




The
        following risk factor is an update to previously disclosed risk factors by
        Puget
        Energy and PSE in their Form 10-K, Item 1A for the period ending December
        31,
        2006 and the Company’s Quarterly Report on Form 10-Q for the quarter ended June
        30, 2007.
 
 **There
        are risks if we do not complete the proposed merger with the
        Consortium.**
 If
        the
        merger we announced on October 26, 2007 is not completed for any
        reason, Puget Energy will remain an independent public company and the common
        stock will continue to be listed and traded on the New York Stock Exchange.
        While we expect that management will operate the business in a manner similar
        to
        that in which it is being operated today, if the merger is not completed,
        Puget
        Energy may suffer negative financial ramifications, including the
        following:
 ·
              The
                  current market price of Puget Energy’s common stock may reflect a market
                  assumption that the merger will occur, and a failure to complete
                  the
                  merger could result in a negative perception by investors in Puget
                  Energy
                  generally and could cause a decline in the market price of Puget
                  Energy’s
                  common stock. This could affect Puget Energy’s ability to access the
                  equity markets to fund PSE’s construction program and working capital
                  needs.
 ·
              Puget
                  Energy might be required to pay an up to $40 million termination
                  fee, and
                  up to $10 million of expenses, to the Consortium, which could adversely
                  impact liquidity.
 
 **The
        Company’s business may be adversely affected if the closing of the proposed
        stock purchase transaction with certain members of the Consortium does not
        occur
        or is delayed.**
 The
        stock
        purchase transaction we announced on October 26, 2007, pursuant to
        which certain members of the Consortium of long-term infrastructure investors
        led by Macquarie Infrastructure Partners, The Canada Pension Plan Investment
        Board and British Columbia Investment Management Corporation will severally
        purchase shares of Puget Energy’s common stock is subject to customary closing
        conditions, including receipt of all applicable regulatory
        approvals.  If this transaction is not completed or if the closing is
        significantly delayed for any reason, the Company’s liquidity and capital
        resources may be adversely effected.  In that case, the Company may be
        required to obtain alternative financing, which may not be available on
        acceptable terms, if at all.  Moreover, the Company’s ability to
        secure any such alternative financing could be limited by covenants in the
        merger agreement with the Consortium that restrict the Company's ability
        to
        issue equity or incur indebtedness without first obtaining the consent of
        the
        Consortium.  The Company’s inability to complete an equity financing
        may also adversely impact the equity ratio that is likely to be requested
        in
        Puget Sound Energy's general rate case filing.


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. Eldredge****James
                W. Eldredge**Vice
                President, Controller and Chief Accounting OfficerDate:  November
                1, 2007Chief
                accounting officer and officer duly authorized to sign this report
                on
                behalf of each registrant








**EXHIBIT
      INDEX**




The following exhibits are filed herewith:





3(i).1
            Articles
                of Amendment of Puget Energy, Inc., as filed with the Washington
                Secretary
                of State on May 10, 2007.3(ii).1
            Amended
                and Restated Bylaws of Puget Energy effective May 4,
                2007.12.1
            Statement
                setting forth computation of ratios of earnings to fixed charges
                (2002
                through 2006 and 12 months ended September 30, 2007) for Puget
                Energy.12.2
            Statement
                setting forth computation of ratios of earnings to fixed charges
                (2002
                through 2006 and 12 months ended September 30, 2007) 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.