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 June 30,
      2008
              
              OR





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





For
      the Transition period from ________ to
_________




Commission
              File
      Number
            Exact
      name of registrant as specified
              in
      its charter, state of incorporation,
              address
      of principal executive offices,
              telephone
      number
            I.R.S.
              Employer
              Identification
              Number




1-16305
            PUGET
      ENERGY, INC.
              A
      Washington Corporation
              10885
      NE 4th
      Street, Suite 1200
              Bellevue,
      Washington 98004-5591
              (425)
      454-6363
            91-1969407




1-4393
            PUGET
      SOUND ENERGY, INC.
              A
      Washington Corporation
              10885
      NE 4th
      Street, Suite 1200
              Bellevue,
      Washington 98004-5591
              (425)
      454-6363
            91-0374630





Indicate
by check mark whether the registrants: (1) have filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrants were
required to file such reports), and (2) have been subject to such filing
requirements for the past 90 days.




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





Indicate
by check mark whether registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer or a smaller reporting company.  See
definition of “large accelerated filer, accelerated filer and smaller reporting
company” in Rule 12b-2 of the Exchange Act.




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





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


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





As of
August 1, 2008, (i) the number of shares of Puget Energy, Inc. common stock
outstanding was 129,678,489 ($.01 par value) and (ii) all of the outstanding
shares of Puget Sound Energy, Inc. common stock were held by Puget Energy,
Inc.





Table of
Contents
 DefinitionsFiling FormatForward Looking StatementsPart I.
              Financial InformationItem 1.
              Financial StatementsPuget
      Energy, Inc.Consolidated Statements of Income – Three and Six Months
      Ended June 30, 2008 and 2007Consolidated Statements of Comprehensive Income – Three
      and Six Months
                EndedJune
      30, 2008 and 2007Consolidated Balance Sheets – June 30, 2008 and December
      31, 2007Consolidated Statements of Cash Flows – Six Months Ended
      June 30, 2008 and 2007Puget
      Sound Energy, Inc.Consolidated Statements of Income – Three and Six Months
      Ended June 30, 2008 and 2007Consolidated Statements of Comprehensive Income – Three and
      Six Months
                EndedJune
      30, 2008 and 2007Consolidated Balance Sheets – June 30, 2008 and December 31,
      2007Consolidated Statements of Cash Flows – Six Months Ended June
      30, 2008 and 2007NotesCombined
      Notes to Consolidated Financial StatementsItem 2.
              Management’s Discussion and
      Analysis of Financial Condition and Results of
      OperationsItem 3.
              Quantitative and Qualitative Disclosure About Market
      RiskItem 4.
              Controls and ProceduresPart II.
              Other InformationItem 1.
              Legal ProceedingsItem 1A.
              Risk FactorsItem 4.
              Submission of Matters to a Vote of Security
      HoldersItem 6.
              ExhibitsSignaturesExhibit
Index


DEFINITIONS




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












FILING FORMAT


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








FORWARD-LOOKING STATEMENTS


Puget
Energy and PSE are including the following cautionary statements in this Form
10-Q to make applicable and to take advantage of the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995 for any forward-looking
statements made by or on behalf of Puget Energy or PSE.  This report
includes forward-looking statements, which are statements of expectations,
beliefs, plans, objectives and assumptions of future events or
performance.  Words or phrases such as “anticipates,” “believes,”
“estimates,” “expects,” “future,” “intends,” “plans,” “predicts,” “projects,”
“will likely result,” “will continue” or similar expressions identify
forward-looking statements.


Forward-looking
statements involve risks and uncertainties that could cause actual results or
outcomes to differ materially from those expressed.  Puget Energy’s
and PSE’s expectations, beliefs and projections are expressed in good faith and
are believed by Puget Energy and PSE, as applicable, to have a reasonable basis,
including without limitation management’s examination of historical operating
trends, data contained in records and other data available from third
parties.  However, there can be no assurance that Puget Energy’s and
PSE’s expectations, beliefs or projections will be achieved or
accomplished.


In
addition to other factors and matters discussed elsewhere in this report, some
important factors that could cause actual results or outcomes for Puget Energy
and PSE to differ materially from those discussed in forward-looking statements
include:




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




Any
forward-looking statement speaks only as of the date on which such statement is
made, and, except as required by law, Puget Energy and PSE undertake no
obligation to update any forward-looking statement to reflect events or
circumstances after the date on which such statement is made or to reflect the
occurrence of unanticipated events.  New factors emerge from time to
time and it is not possible for management to predict all such factors, nor can
it assess the impact of any such factor on the business or the extent to which
any factor, or combination of factors, may cause results to differ materially
from those contained in any forward-looking statement.  You are also
advised to consult Item 1A-“Risk Factors” in the Company’s most recent annual
report on Form 10-K.











PART
I            FINANCIAL
INFORMATION





Item
1.              Financial
Statements


PUGET ENERGY, INC.


CONSOLIDATED
STATEMENTS OF INCOME


(Dollars
in thousands except per share amounts)


(Unaudited)




Three
      Months Ended
              June
      30,
            
            
            Six
      Months Ended
              June
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007Operating
      revenues:Electric
            
            $
            478,038
            
            
            $
            435,261
            
            
            $
            1,084,172
            
            
            $
            962,880Gas
            
            
            233,840
            
            
            
            225,175
            
            
            
            677,077
            
            
            
            692,184Other
            
            
            526
            
            
            
            702
            
            
            
            2,088
            
            
            
            9,979Total
      operating revenues
            
            
            712,404
            
            
            
            661,138
            
            
            
            1,763,337
            
            
            
            1,665,043Operating
      expenses:Energy
      costs:Purchased
      electricity
            
            
            198,886
            
            
            
            172,757
            
            
            
            471,718
            
            
            
            454,849Electric
      generation fuel
            
            
            32,687
            
            
            
            23,726
            
            
            
            79,701
            
            
            
            49,784Residential
      exchange
            
            
            (20,298
            )
            
            
            (17,562
            )
            
            
            (20,305
            )
            
            
            (52,040
            )Purchased
      gas
            
            
            137,718
            
            
            
            139,055
            
            
            
            413,913
            
            
            
            449,702Net
      unrealized (gain) loss on derivative instruments
            
            
            (2,364
            )
            
            
            1,536
            
            
            
            (2,277
            )
            
            
            (4,246
            )Utility
      operations and maintenance
            
            
            116,449
            
            
            
            98,935
            
            
            
            228,613
            
            
            
            197,106Non-utility
      expense and other
            
            
            1,597
            
            
            
            2,768
            
            
            
            2,062
            
            
            
            4,898Merger
      related costs
            
            
            5,738
            
            
            
            --
            
            
            
            7,049
            
            
            
            --Depreciation
      and amortization
            
            
            76,322
            
            
            
            65,832
            
            
            
            151,688
            
            
            
            135,441Conservation
      amortization
            
            
            15,525
            
            
            
            8,749
            
            
            
            28,891
            
            
            
            19,078Taxes
      other than income taxes
            
            
            63,674
            
            
            
            63,294
            
            
            
            157,947
            
            
            
            150,363Total
      operating expenses
            
            
            625,934
            
            
            
            559,090
            
            
            
            1,519,000
            
            
            
            1,404,935Operating
      income
            
            
            86,470
            
            
            
            102,048
            
            
            
            244,337
            
            
            
            260,108Other
      income (deductions):Other
      income
            
            
            8,073
            
            
            
            6,223
            
            
            
            14,917
            
            
            
            10,987Other
      expense
            
            
            (841
            )
            
            
            (2,829
            )
            
            
            (1,817
            )
            
            
            (3,861
            )Interest
      charges:AFUDC
            
            
            1,782
            
            
            
            2,943
            
            
            
            4,211
            
            
            
            5,361Interest
      expense
            
            
            (48,543
            )
            
            
            (52,192
            )
            
            
            (99,591
            )
            
            
            (103,453
            )Income
      from continuing operations before income taxes
            
            
            46,941
            
            
            
            56,193
            
            
            
            162,057
            
            
            
            169,142Income
      tax expense
            
            
            13,287
            
            
            
            17,593
            
            
            
            48,590
            
            
            
            51,480Income
      from continuing operations
            
            
            33,654
            
            
            
            38,600
            
            
            
            113,467
            
            
            
            117,662Income
      from discontinued segment (net of tax)
            
            
            --
            
            
            
            12
            
            
            
            --
            
            
            
            12Net
      income
            
            $
            33,654
            
            
            $
            38,612
            
            
            $
            113,467
            
            
            $
            117,674Common
      shares outstanding weighted-average (in thousands)
            
            
            129,417
            
            
            
            116,659
            
            
            
            129,427
            
            
            
            116,567Diluted
      shares outstanding weighted-average (in thousands)
            
            
            129,967
            
            
            
            117,158
            
            
            
            129,862
            
            
            
            117,115Basic
      earnings per common share
            
            $
            0.26
            
            
            $
            0.33
            
            
            $
            0.88
            
            
            $
            1.01Basic
      earnings per common share from discontinued operations
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            --Basic
      earnings per common share
            
            $
            0.26
            
            
            $
            0.33
            
            
            $
            0.88
            
            
            $
            1.01Diluted
      earnings per common share
            
            $
            0.26
            
            
            $
            0.33
            
            
            $
            0.87
            
            
            $
            1.00Diluted
      earnings per common share from discontinued operations
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            --Diluted
      earnings per common share
            
            $
            0.26
            
            
            $
            0.33
            
            
            $
            0.87
            
            
            $
            1.00




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
              June
      30,
            
            
            Six
      Months Ended
              June
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007Net
      income
            
            $
            33,654
            
            
            $
            38,612
            
            
            $
            113,467
            
            
            $
            117,674Other
      comprehensive income:Unrealized
      gain from pension and postretirement plans, net of tax of $227, $642, $322
      and $1,285, respectively
            
            
            422
            
            
            
            1,193
            
            
            
            598
            
            
            
            2,386Net
      unrealized gains (losses) on energy derivative instruments during the
      period, net of tax of $60,710, $(7,465), $86,167 and $(5,551),
      respectively
            
            
            112,747
            
            
            
            (13,863
            )
            
            
            160,024
            
            
            
            (10,309
            )Reversal
      of net unrealized gains (losses) on energy derivative instruments settled
      during the period, net of tax of $­­­­­(1,802),
      $(585), $(845) and $1,068, respectively
            
            
            (3,347
            )
            
            
            (1,086
            )
            
            
            (1,569
            )
            
            
            1,984Amortization
      of financing cash flow hedge contracts to earnings, net of tax of $43,
      $43, $86 and $86, respectively
            
            
            79
            
            
            
            79
            
            
            
            159
            
            
            
            159Other
      comprehensive income (loss)
            
            
            109,901
            
            
            
            (13,677
            )
            
            
            159,212
            
            
            
            (5,780
            )Comprehensive
      income
            
            $
            143,555
            
            
            $
            24,935
            
            
            $
            272,679
            
            
            $
            111,894





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











PUGET ENERGY,
INC.


CONSOLIDATED
BALANCE SHEETS


(Dollars
in thousands)








ASSETS





June
      30,
              2008
              (Unaudited)
            
            
            December
      31,
              2007Utility
      plant: (at original cost, including construction work in progress
      of
              $273,147
      and $267,595 respectively)Electric
      plant
            
            $
            6,048,918
            
            
            $
            5,914,127Gas
      plant
            
            
            2,392,306
            
            
            
            2,313,477Common
      plant
            
            
            524,198
            
            
            
            506,211Less:  Accumulated
      depreciation and amortization
            
            
            (3,203,484
            )
            
            
            (3,091,176
            )Net
      utility plant
            
            
            5,761,938
            
            
            
            5,642,639Other
      property and investments:Investment
      in Bonneville Exchange Power contract
            
            
            31,739
            
            
            
            33,503Other
      property and investments
            
            
            115,302
            
            
            
            114,083Total
      other property and investments
            
            
            147,041
            
            
            
            147,586Current
      assets:Cash
            
            
            69,092
            
            
            
            40,797Restricted
      cash
            
            
            13,015
            
            
            
            4,793Accounts
      receivable, net of allowance for doubtful accounts
            
            
            160,019
            
            
            
            218,781Secured
      pledged accounts receivable
            
            
            115,000
            
            
            
            152,000Unbilled
      revenues
            
            
            106,202
            
            
            
            210,025Materials
      and supplies, at average cost
            
            
            62,755
            
            
            
            62,114Fuel
      and gas inventory, at average cost
            
            
            85,653
            
            
            
            99,772Unrealized
      gain on derivative instruments
            
            
            247,684
            
            
            
            17,130Prepaid
      income tax
            
            
            274
            
            
            
            44,303Prepaid
      expense and other
            
            
            10,327
            
            
            
            11,910Deferred
      income taxes
            
            
            --
            
            
            
            4,011Total
      current assets
            
            
            870,021
            
            
            
            865,636Other
      long-term and regulatory assets:Regulatory
      asset for deferred income taxes
            
            
            96,716
            
            
            
            104,928Regulatory
      asset for PURPA buyout costs
            
            
            124,974
            
            
            
            140,520Power
      cost adjustment mechanism
            
            
            --
            
            
            
            3,114Other
      regulatory assets
            
            
            480,784
            
            
            
            510,998Unrealized
      gain on derivative instruments
            
            
            199,368
            
            
            
            11,845Other
            
            
            163,307
            
            
            
            171,470Total
      other long-term and regulatory assets
            
            
            1,065,149
            
            
            
            942,875Total
      assets
            
            $
            7,844,149
            
            
            $
            7,598,736





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









PUGET ENERGY, INC.


CONSOLIDATED
BALANCE SHEETS


(Dollars
in thousands)





CAPITALIZATION
AND LIABILITIES





June
      30,
              2008
              (Unaudited)
            
            
            December
      31,
              2007Capitalization:Common
      shareholders’ investment:Common
      stock $0.01 par value, 250,000,000 shares authorized, 129,678,489 and
      129,678,489 shares outstanding, respectively
            
            $
            1,297
            
            
            $
            1,297Additional
      paid-in capital
            
            
            2,273,942
            
            
            
            2,278,500Earnings
      reinvested in the business
            
            
            282,860
            
            
            
            240,079Accumulated
      other comprehensive income, net of tax
            
            
            152,870
            
            
            
            2,078Total
      shareholders’ equity
            
            
            2,710,969
            
            
            
            2,521,954Redeemable
      securities and long-term debt:Preferred
      stock subject to mandatory redemption
            
            
            1,889
            
            
            
            1,889Junior
      subordinated notes
            
            
            250,000
            
            
            
            250,000Long-term
      debt
            
            
            2,278,860
            
            
            
            2,428,860Total
      redeemable securities and long-term debt
            
            
            2,530,749
            
            
            
            2,680,749Total
      capitalization
            
            
            5,241,718
            
            
            
            5,202,703Current
      liabilities:Accounts
      payable
            
            
            258,524
            
            
            
            310,398Short-term
      debt
            
            
            286,566
            
            
            
            260,486Current
      maturities of long-term debt
            
            
            179,500
            
            
            
            179,500Accrued
      expenses:Purchased
      gas liability
            
            
            26,764
            
            
            
            77,864Taxes
            
            
            73,994
            
            
            
            84,756Salaries
      and wages
            
            
            27,186
            
            
            
            28,516Interest
            
            
            42,709
            
            
            
            45,133Unrealized
      loss on derivative instruments
            
            
            8,546
            
            
            
            27,089Deferred
      income taxes
            
            
            16,923
            
            
            
            --Other
            
            
            81,904
            
            
            
            48,918Total
      current liabilities
            
            
            1,002,616
            
            
            
            1,062,660Long-term
      liabilities and regulatory liabilities:Deferred
      income taxes
            
            
            908,752
            
            
            
            818,161Unrealized
      loss on derivative instruments
            
            
            9,843
            
            
            
            --Power
      cost adjustment mechanism
            
            
            1,252
            
            
            
            --Regulatory
      liabilities
            
            
            203,382
            
            
            
            210,311Other
      deferred credits
            
            
            476,586
            
            
            
            304,901Total
      long-term liabilities and regulatory liabilities
            
            
            1,599,815
            
            
            
            1,333,373Total
      capitalization and liabilities
            
            $
            7,844,149
            
            
            $
            7,598,736





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











PUGET ENERGY,
INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(Dollars
in thousands, Unaudited)


Six
      Months Ended
              June
      30,2008
            
            
            2007Operating
      activities:Net
      income
            
            $
            113,467
            
            
            $
            117,674Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
      and amortization
            
            
            151,688
            
            
            
            135,441Conservation
      amortization
            
            
            28,891
            
            
            
            19,078Deferred
      income taxes and tax credits, net
            
            
            41,565
            
            
            
            19,809Power
      cost adjustment mechanism
            
            
            4,366
            
            
            
            2,788Amortization
      of gas pipeline capacity assignment
            
            
            (5,257
            )
            
            
            (5,411
            )Non
      cash return on regulatory assets
            
            
            (4,972
            )
            
            
            (3,517
            )Net
      unrealized loss on derivative instruments
            
            
            (2,277
            )
            
            
            (4,246
            )Change
      in residential exchange program
            
            
            32,473
            
            
            
            (25,673
            )Storm
      damage deferred costs
            
            
            (173
            )
            
            
            (16,359
            )Other
            
            
            (709
            )
            
            
            (7,047
            )Cash
      receipt from lease purchase option settlement
            
            
            --
            
            
            
            18,909Change
      in certain current assets and liabilities:Accounts
      receivable and unbilled revenue
            
            
            199,586
            
            
            
            195,971Materials
      and supplies
            
            
            (642
            )
            
            
            (16,635
            )Fuel
      and gas inventory
            
            
            14,119
            
            
            
            19,945Prepaid
      income taxes
            
            
            44,029
            
            
            
            5,266Prepayments
      and other
            
            
            1,583
            
            
            
            (25,730
            )Purchased
      gas receivable/payable
            
            
            (51,100
            )
            
            
            81,425Accounts
      payable
            
            
            (46,347
            )
            
            
            (168,806
            )Taxes
      payable
            
            
            (10,762
            )
            
            
            8,404Accrued
      expenses and other
            
            
            (1,740
            )
            
            
            (5,382
            )Net
      cash provided by operating activities
            
            
            507,788
            
            
            
            345,904Investing
      activities:Construction
      and capital expenditures - excluding equity AFUDC
            
            
            (255,776
            )
            
            
            (375,677
            )Energy
      efficiency expenditures
            
            
            (26,963
            )
            
            
            (18,464
            )Restricted
      cash
            
            
            (8,222
            )
            
            
            (91
            )Refundable
      cash received for customer construction projects
            
            
            4,491
            
            
            
            9,179Cash
      proceeds from property sales
            
            
            2,079
            
            
            
            93Other
            
            
            (4,084
            )
            
            
            1,301Net
      cash used by investing activities
            
            
            (288,475
            )
            
            
            (383,659
            )Financing
      activities:Change
      in short-term debt and leases, net
            
            
            26,080
            
            
            
            (38,201
            )Dividends
      paid
            
            
            (64,838
            )
            
            
            (52,653
            )Issuance
      of common stock
            
            
            --
            
            
            
            3,510Long
      term bond issued
            
            
            --
            
            
            
            250,000Redemption
      of trust preferred stock
            
            
            --
            
            
            
            (37,750
            )Redemption
      of bonds, notes and leases
            
            
            (150,000
            )
            
            
            (100,000
            )Issuance
      and redemption costs of bonds and other
            
            
            (2,260
            )
            
            
            1,247Net
      cash (used) provided by financing activities
            
            
            (191,018
            )
            
            
            26,153Net
      increase (decrease) in cash
            
            
            28,295
            
            
            
            (11,602
            )Cash
      at beginning of year
            
            
            40,797
            
            
            
            28,117Cash
      at end of period
            
            $
            69,092
            
            
            $
            16,515Supplemental
      cash flow information:Cash
      payments for interest (net of capitalized interest)
            
            $
            101,286
            
            
            $
            91,666Cash
      payments (refunds) from income taxes
            
            
            (42,392
            )
            
            
            23,000





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
              June
      30,
            
            
            Six
      Months Ended
              June
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007Operating
      revenues:Electric
            
            $
            478,038
            
            
            $
            435,261
            
            
            $
            1,084,172
            
            
            $
            962,880Gas
            
            
            233,840
            
            
            
            225,175
            
            
            
            677,077
            
            
            
            692,184Other
            
            
            526
            
            
            
            702
            
            
            
            2,088
            
            
            
            9,979Total
      operating revenues
            
            
            712,404
            
            
            
            661,138
            
            
            
            1,763,337
            
            
            
            1,665,043Operating
      expenses:Energy
      costs:Purchased
      electricity
            
            
            198,886
            
            
            
            172,757
            
            
            
            471,718
            
            
            
            454,849Electric
      generation fuel
            
            
            32,687
            
            
            
            23,726
            
            
            
            79,701
            
            
            
            49,784Residential
      exchange
            
            
            (20,298
            )
            
            
            (17,562
            )
            
            
            (20,305
            )
            
            
            (52,040
            )Purchased
      gas
            
            
            137,718
            
            
            
            139,055
            
            
            
            413,913
            
            
            
            449,702Net
      unrealized (gain) loss on derivative instruments
            
            
            (2,364
            )
            
            
            1,536
            
            
            
            (2,277
            )
            
            
            (4,246
            )Utility
      operations and maintenance
            
            
            116,449
            
            
            
            98,935
            
            
            
            228,608
            
            
            
            197,106Non-utility
      expense and other
            
            
            1,657
            
            
            
            2,609
            
            
            
            1,713
            
            
            
            4,576Depreciation
      and amortization
            
            
            76,322
            
            
            
            65,832
            
            
            
            151,688
            
            
            
            135,441Conservation
      amortization
            
            
            15,525
            
            
            
            8,749
            
            
            
            28,891
            
            
            
            19,078Taxes
      other than income taxes
            
            
            63,674
            
            
            
            63,294
            
            
            
            157,947
            
            
            
            150,363Total
      operating expenses
            
            
            620,256
            
            
            
            558,931
            
            
            
            1,511,597
            
            
            
            1,404,613Operating
      income
            
            
            92,148
            
            
            
            102,207
            
            
            
            251,740
            
            
            
            260,430Other
      income (deductions):Other
      income
            
            
            8,068
            
            
            
            6,223
            
            
            
            14,878
            
            
            
            10,985Other
      expense
            
            
            (841
            )
            
            
            (2,829
            )
            
            
            (1,818
            )
            
            
            (3,861
            )Interest
      charges:AFUDC
            
            
            1,782
            
            
            
            2,943
            
            
            
            4,211
            
            
            
            5,361Interest
      expense
            
            
            (48,543
            )
            
            
            (52,192
            )
            
            
            (99,591
            )
            
            
            (103,453
            )Interest
      expense on Puget Energy note
            
            
            (209
            )
            
            
            (340
            )
            
            
            (446
            )
            
            
            (674
            )Income
      before income taxes
            
            
            52,405
            
            
            
            56,012
            
            
            
            168,974
            
            
            
            168,788Income
      tax expense
            
            
            13,295
            
            
            
            17,654
            
            
            
            48,960
            
            
            
            51,652Net
      income
            
            $
            39,110
            
            
            $
            38,358
            
            
            $
            120,014
            
            
            $
            117,136





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
              June
      30,
            
            
            Six
      Months Ended
              June
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007Net
      income
            
            $
            39,110
            
            
            $
            38,358
            
            
            $
            120,014
            
            
            $
            117,136Other
      comprehensive income:Unrealized
      gain from pension and postretirement plans, net of tax of $277, $642, $322
      and $1,285, respectively
            
            
            422
            
            
            
            1,193
            
            
            
            598
            
            
            
            2,386Net
      unrealized gains (losses) on energy derivative instruments during the
      period, net of tax of $60,710, $(7,465), $86,167 and $(5,551),
      respectively
            
            
            112,747
            
            
            
            (13,863
            )
            
            
            160,024
            
            
            
            (10,309
            )Reversal
      of net unrealized gains (losses) on energy derivative instruments settled
      during the period, net of tax of $(1,802), $(858), $(845) and $1,068,
      respectively
            
            
            (3,347
            )
            
            
            (1,086
            )
            
            
            (1,569
            )
            
            
            1,984Amortization
      of financing cash flow hedge contracts to earnings, net of tax of $43,
      $43, $86 and $86, respectively
            
            
            79
            
            
            
            79
            
            
            
            159
            
            
            
            159Other
      comprehensive income
            
            
            109,901
            
            
            
            (13,677
            )
            
            
            159,212
            
            
            
            (5,780
            )Comprehensive
      income
            
            $
            149,011
            
            
            $
            24,681
            
            
            $
            279,226
            
            
            $
            111,356





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











PUGET SOUND ENERGY, INC.


CONSOLIDATED
BALANCE SHEETS


(Dollars
in thousands)





ASSETS





June
      30,
              2008
              (Unaudited)
            
            
            December
      31,
              2007Utility
      plant: (at original cost, including construction work in progress of
      $273,147 and $267,595, respectively)Electric
      plant
            
            $
            6,048,918
            
            
            $
            5,914,127Gas
      plant
            
            
            2,392,306
            
            
            
            2,313,477Common
      plant
            
            
            524,198
            
            
            
            506,211Less:  Accumulated
      depreciation and amortization
            
            
            (3,203,484
            )
            
            
            (3,091,176
            )Net utility plant
            
            
            5,761,938
            
            
            
            5,642,639Other
      property and investments:Investment
      in Bonneville Exchange Power contract
            
            
            31,739
            
            
            
            33,503Other
      property and investments
            
            
            115,302
            
            
            
            114,083Total
      other property and investments
            
            
            147,041
            
            
            
            147,586Current
      assets:Cash
            
            
            68,979
            
            
            
            40,773Restricted
      cash
            
            
            13,015
            
            
            
            798Accounts
      receivable, net of allowance for doubtful accounts
            
            
            163,205
            
            
            
            219,345Secured
      pledged accounts receivable
            
            
            115,000
            
            
            
            152,000Unbilled
      revenues
            
            
            106,202
            
            
            
            210,025Materials
      and supplies, at average cost
            
            
            62,755
            
            
            
            62,114Fuel
      and gas inventory, at average cost
            
            
            85,653
            
            
            
            99,772Unrealized
      gain on derivative instruments
            
            
            247,684
            
            
            
            17,130Prepaid
      income taxes
            
            
            274
            
            
            
            41,814Prepaid
      expenses and other
            
            
            9,782
            
            
            
            11,365Deferred
      income taxes
            
            
            --
            
            
            
            4,011Total current assets
            
            
            872,549
            
            
            
            859,147Other
      long-term and regulatory assets:Regulatory
      asset for deferred income taxes
            
            
            96,716
            
            
            
            104,928Regulatory
      asset for PURPA buyout costs
            
            
            124,974
            
            
            
            140,520Power
      cost adjustment mechanism
            
            
            --
            
            
            
            3,114Other
      regulatory assets
            
            
            480,784
            
            
            
            512,103Unrealized
      gain on derivative instruments
            
            
            199,368
            
            
            
            11,845Other
            
            
            163,307
            
            
            
            170,328Total other long-term and regulatory assets
            
            
            1,065,149
            
            
            
            942,838Total
      assets
            
            $
            7,846,677
            
            
            $
            7,592,210





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











PUGET
SOUND ENERGY, INC.


CONSOLIDATED
BALANCE SHEETS


(Dollars
in thousands)





CAPITALIZATION
AND LIABILITIES





June
      30,
              2008
              (Unaudited)
            
            
            December
      31,
              2007Capitalization:Common
      shareholder’s investment:Common
      stock ($10 stated value) - 150,000,000 shares authorized, 85,903,791
      shares outstanding
            
            $
            859,038
            
            
            $
            859,038Additional
      paid-in capital
            
            
            1,294,694
            
            
            
            1,297,076Earnings
      reinvested in the business
            
            
            379,064
            
            
            
            345,899Accumulated
      other comprehensive income, net of tax
            
            
            152,870
            
            
            
            2,078Total
      shareholder’s equity
            
            
            2,685,666
            
            
            
            2,504,091Redeemable
      securities and long-term debt:Preferred
      stock subject to mandatory redemption
            
            
            1,889
            
            
            
            1,889Junior
      subordinated notes
            
            
            250,000
            
            
            
            250,000Long-term
      debt
            
            
            2,278,860
            
            
            
            2,428,860Total
      redeemable securities and long-term debt
            
            
            2,530,749
            
            
            
            2,680,749Total
      capitalization
            
            
            5,216,415
            
            
            
            5,184,840Current
      liabilities:Accounts
      payable
            
            
            257,776
            
            
            
            310,083Short-term
      debt
            
            
            286,566
            
            
            
            260,486Short-term
      note owed to Puget Energy
            
            
            25,026
            
            
            
            15,766Current
      maturities of long-term debt
            
            
            179,500
            
            
            
            179,500Accrued
      expenses:Purchased
      gas liability
            
            
            26,764
            
            
            
            77,864Taxes
            
            
            76,846
            
            
            
            84,756Salaries
      and wages
            
            
            27,186
            
            
            
            28,516Interest
            
            
            42,769
            
            
            
            45,209Unrealized
      loss on derivative instruments
            
            
            8,546
            
            
            
            27,089Deferred
      income taxes
            
            
            16,923
            
            
            
            --Other
            
            
            81,904
            
            
            
            48,918Total
      current liabilities
            
            
            1,029,806
            
            
            
            1,078,187Long-term
      liabilities and regulatory liabilities:Deferred
      income taxes
            
            
            909,444
            
            
            
            821,382Unrealized
      loss on derivative instruments
            
            
            9,843
            
            
            
            --Power
      cost adjustment mechanism
            
            
            1,252
            
            
            
            --Regulatory
      liabilities
            
            
            203,382
            
            
            
            210,372Other
      deferred credits
            
            
            476,535
            
            
            
            297,429Total
      long-term liabilities and regulatory liabilities
            
            
            1,600,456
            
            
            
            1,329,183Total
      capitalization and liabilities
            
            $
            7,846,677
            
            
            $
            7,592,210





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











PUGET SOUND ENERGY, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(Dollars
in thousands)


(Unaudited)


Six
      Months Ended
              June
      30,2008
            
            
            2007Operating
      activities:Net
      income
            
            $
            120,014
            
            
            $
            117,136Adjustments
      to reconcile net income to net cash provided by
      operating activities:Depreciation
      and amortization
            
            
            151,688
            
            
            
            135,441Conservation
      amortization
            
            
            28,891
            
            
            
            19,078Deferred
      income taxes and tax credits, net
            
            
            39,037
            
            
            
            19,580Power
      cost adjustment mechanism
            
            
            4,366
            
            
            
            2,788Amortization
      of gas pipeline capacity assignment
            
            
            (5,257
            )
            
            
            (5,411
            )Non
      cash return on regulatory assets
            
            
            (4,972
            )
            
            
            (3,517
            )Net
      unrealized loss on derivative instruments
            
            
            (2,277
            )
            
            
            (4,246
            )Change
      in residential exchange program
            
            
            32,473
            
            
            
            (25,673
            )Storm
      damage deferred costs
            
            
            (173
            )
            
            
            (16,359
            )Other
            
            
            8,784
            
            
            
            (7,186
            )Cash
      receipt from lease purchase option settlement
            
            
            --
            
            
            
            18,909Change
      in certain current assets and liabilities:Accounts
      receivable and unbilled revenue
            
            
            196,963
            
            
            
            195,971Materials
      and supplies
            
            
            (642
            )
            
            
            (16,635
            )Fuel
      and gas inventory
            
            
            14,119
            
            
            
            19,945Prepaid
      income taxes
            
            
            41,540
            
            
            
            5,266Prepayments
      and other
            
            
            1,583
            
            
            
            (25,726
            )Purchased
      gas receivable/payable
            
            
            (51,100
            )
            
            
            81,425Accounts
      payable
            
            
            (46,780
            )
            
            
            (168,605
            )Taxes
      payable
            
            
            (7,909
            )
            
            
            8,814Accrued
      expenses and other
            
            
            (1,757
            )
            
            
            (4,856
            )Net
      cash provided by operating activities
            
            
            518,591
            
            
            
            346,139Investing
      activities:Construction
      expenditures - excluding equity AFUDC
            
            
            (255,776
            )
            
            
            (375,677
            )Energy
      efficiency expenditures
            
            
            (26,963
            )
            
            
            (18,464
            )Restricted
      cash
            
            
            (12,216
            )
            
            
            (2
            )Refundable
      cash received for customer construction projects
            
            
            4,491
            
            
            
            9,179Cash
      proceeds from property sales
            
            
            2,079
            
            
            
            93Other
            
            
            (4,084
            )
            
            
            1,301Net
      cash used by investing activities
            
            
            (292,469
            )
            
            
            (383,570
            )Financing
      activities:Change
      in short-term debt, net
            
            
            26,080
            
            
            
            (38,201
            )Dividends
      paid
            
            
            (81,001
            )
            
            
            (52,654
            )Loan
      from/to Puget Energy
            
            
            9,260
            
            
            
            164Long
      term bond issued
            
            
            --
            
            
            
            250,000Redemption
      of trust preferred stock
            
            
            --
            
            
            
            (37,750
            )Redemption
      of bonds and notes
            
            
            (150,000
            )
            
            
            (100,000
            )Investment
      from Puget EnergyIssuance
      and redemption cost of bonds and other
            
            
            (2,255
            )
            
            
            3,988Net
      cash (used) provided by financing activities
            
            
            (197,916
            )
            
            
            25,547Net
      increase (decrease) in cash from net income
            
            
            28,206
            
            
            
            (11,884
            )Cash
      at beginning of year
            
            
            40,773
            
            
            
            28,092Cash
      at end of period
            
            $
            68,979
            
            
            $
            16,208Supplemental
      cash flow information:Cash
      payments for interest (net of capitalized interest)
            
            $
            101,286
            
            
            $
            91,666Cash
      payments (refunds) from income taxes
            
            
            (39,730
            )
            
            
            23,000





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








COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(1)
              Summary
      of Consolidation Policy


Basis
of Presentation


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


The 2008
and 2007 consolidated financial statements of Puget Energy reflect the accounts
of Puget Energy and its subsidiary, PSE.  PSE’s consolidated financial
statements include the accounts of PSE and its subsidiaries.  Puget
Energy and PSE are collectively referred to herein as “the
Company.”  The consolidated financial statements are presented after
elimination of all significant intercompany items and
transactions.


The
consolidated financial statements contained in this Form 10-Q are
unaudited.  In the respective opinions of the management of Puget
Energy and PSE, all adjustments necessary for a fair statement of the results
for the interim periods have been reflected and were of a normal recurring
nature.  These condensed financial statements should be read in
conjunction with the audited financial statements (and the Combined Notes
thereto) included in the combined Puget Energy and PSE Report on Form 10-K for
the year ended December 31, 2007.


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


PSE
collected Washington State excise taxes (which are a component of general retail
rates) and municipal taxes of $53.2 million and $129.9 million for the three and
six months ended June 30, 2008, respectively, and $48.2 million and $122.9
million for the three and six months ended June 30, 2007,
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 129,417,000 and 129,427,000 for
the three and six months ended June 30, 2008, respectively, and 116,659,000 and
116,567,000 for the three and six months ended June 30, 2007,
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 129,967,000 and 129,862,000 for the three
and six months ended June 30, 2008, respectively, and 117,158,000 and
117,115,000 for the three and six months ended June 30, 2007,
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” (SFAS No. 133), as amended, requires that
all contracts considered to be derivative instruments be recorded on the balance
sheet at their fair value.  The Company enters into contracts to
manage its energy resource portfolio and interest rate exposure including
forward physical and financial contracts, option contracts and
swaps.  The majority of these contracts qualify for the normal
purchase normal sale (NPNS) exception to derivative accounting rules provided
they meet certain criteria.  Generally, NPNS applies if PSE deems the
counterparty creditworthy, if the counterparty owns or controls energy resources
within the western region to allow for physical delivery of the energy and if
the transaction is within PSE’s forecasted load requirements and adjusted from
time to time.  Those contracts that do not meet the NPNS exception or
cash flow hedge criteria are marked-to-market to current earnings in the income
statement, subject to deferral under SFAS No. 71, “Accounting for the Effects of
Certain Types of Regulation” (SFAS No. 71), for energy related derivatives due
to the Power Cost Adjustment (PCA) mechanism and Purchased Gas Adjustment (PGA)
mechanism.


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




The
following table presents the fair value of electric derivatives that are
designated as cash flow hedges or contracts that do not meet the NPNS exception
at June 30, 2008 and December 31, 2007:




Electric
              Derivatives(Dollars
      in Millions)
            
            June
      30,
              2008
            
            
            December
      31,
              2007Short-term
      asset
            
            $
            115.5
            
            
            $
            11.1Long-term
      asset
            
            
            143.1
            
            
            
            6.6Total
      assets
            
            $
            258.6
            
            
            $
            17.7Short-term
      liability
            
            $
            7.2
            
            
            $
            9.8Long-term
      liability
            
            
            6.6
            
            
            
            --Total
      liabilities
            
            $
            13.8
            
            
            $
            9.8





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


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


The
following tables present the impact of changes in the market value of derivative
instruments not meeting the NPNS or cash flow hedge criteria, and
ineffectiveness related to highly effective cash flow hedges, to the Company’s
earnings during the three and six months ended June 30, 2008 and June 30,
2007:





(Dollars
      in Millions)
              Three
      Months Ended June 30,
            2008
            2007
            ChangeIncrease
      (decrease) in earnings
            $
      2.4
            $
      (1.5)
            $   3.9





(Dollars
      in Millions)
              Six
      Months Ended June 30,
            2008
            2007
            ChangeIncrease
      (decrease) in earnings
            $
      2.3
            $  4.2
            $
      (1.9)





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


The
amount of net unrealized gain (loss), net of tax, related to the Company’s cash
flow hedges under SFAS No. 133 consisted of the following at June 30, 2008 and
December 31, 2007:





(Dollars
      in Millions, net of tax)
            June
      30,
              2008
            December
      31,
              2007Other
      comprehensive income – unrealized gain (loss)
            $
      161.9
            $  (3.4)







The
following table presents the fair value of derivative hedges of natural gas
contracts to serve natural gas customers at June 30, 2008 and December 31,
2007:





Gas
              Derivatives(Dollars in
      Millions)
            
            June
      30,
              2008
            
            
            December
      31,
              2007Short-term
      asset
            
            $
            132.2
            
            
            $
            6.0Long-term
      asset
            
            
            56.3
            
            
            
            5.3Total
      assets
            
            $
            188.5
            
            
            $
            11.3Short-term
      liability
            
            $
            1.4
            
            
            $
            17.3Long-term
      liability
            
            
            3.2
            
            
            
            --Total
      liabilities
            
            $
            4.6
            
            
            $
            17.3





At June
30, 2008, the Company had total assets of $188.6 million and total liabilities
of $4.6 million related to hedges of natural gas contracts to serve natural gas
customers.  All mark-to-market adjustments relating to the natural gas
business have been reclassified to a deferred account in accordance with SFAS
No. 71 due to the PGA mechanism.  All increases and decreases in the
cost of natural gas supply are passed on to customers with the PGA
mechanism.  As the gains and losses on the hedges are realized in
future periods, they will be recorded as natural gas costs under the PGA
mechanism.




(4)
            Corporate Guarantees(Puget Energy Only)




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


On April
29, 2008, Puget Energy and Tenaska entered into a Joint Notice of Distribution
and Termination Agreement (Termination Agreement) which resulted in the
extinguishment of all InfrastruX corporate guarantees made by Puget Energy which
management believed involved a risk of loss in connection with the sale of
InfrastruX.  In the second quarter 2008, Puget Energy made the
remaining payments under the terms of the Termination Agreement totaling $7.1
million bringing total cash outlays equal to the Company’s original aggregate
loss reserve amounts recorded in the second quarter of 2006.




(5)
            Retirement
      Benefits




The
Company has a defined benefit pension plan covering substantially all PSE
employees, with a cash balance feature for all but International Brotherhood of
Electrical Workers 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 June 30:





Pension
      Benefits
            
            
            Other
      Benefits(Dollars
      in Thousands)
            
            2008
            
            
            2007
            
            
            2008
            
            
            2007Service
      cost
            
            $
            3,555
            
            
            $
            3,392
            
            
            $
            43
            
            
            $
            91Interest
      cost
            
            
            7,358
            
            
            
            6,686
            
            
            
            283
            
            
            
            379Expected
      return on plan assets
            
            
            (10,327
            )
            
            
            (9,679
            )
            
            
            (197
            )
            
            
            (205
            )Amortization
      of prior service cost
            
            
            316
            
            
            
            511
            
            
            
            21
            
            
            
            134Recognized
      net actuarial (gain) loss
            
            
            655
            
            
            
            1,420
            
            
            
            (199
            )
            
            
            (56
            )Amortization
      of transition obligation
            
            
            --
            
            
            
            --
            
            
            
            13
            
            
            
            105Net
      periodic benefit cost
            
            $
            1,557
            
            
            $
            2,330
            
            
            $
            (36
            )
            
            $
            448








The
following table summarizes the net periodic benefit cost for the six months
ended June 30:





Pension
      Benefits
            
            
            Other
      Benefits(Dollars
      in Thousands)
            
            2008
            
            
            2007
            
            
            2008
            
            
            2007Service
      cost
            
            $
            6,843
            
            
            $
            6,655
            
            
            $
            87
            
            
            $
            183Interest
      cost
            
            
            14,409
            
            
            
            13,256
            
            
            
            566
            
            
            
            759Expected
      return on plan assets
            
            
            (20,782
            )
            
            
            (19,429
            )
            
            
            (394
            )
            
            
            (410
            )Amortization
      of prior service cost
            
            
            631
            
            
            
            1,021
            
            
            
            42
            
            
            
            267Recognized
      net actuarial (gain) loss
            
            
            838
            
            
            
            2,594
            
            
            
            (398
            )
            
            
            (112
            )Amortization
      of transition obligation
            
            
            --
            
            
            
            --
            
            
            
            25
            
            
            
            209Net
      periodic benefit cost
            
            $
            1,939
            
            
            $
            4,097
            
            
            $
            (72
            )
            
            $
            896





The
Company previously disclosed in its financial statements for the year ended
December 31, 2007 that it expected to contribute $4.0 million and less than $0.1
million to fund the non-qualified pension and other benefits plans,
respectively, for the year ending December 31, 2008.  During the three
and six months ended June 30, 2008, the actual cash contributions to the
Company’s non-qualified pension plans were $0.4 million and $0.8 million,
respectively.  Based on this activity, the Company anticipates
contributing an additional $3.2 million to the Company’s non-qualified pension
plan for the remaining period of 2008.  PSE plans to contribute $0.4
million to the qualified pension plan.  During the three and six
months ended June 30, 2008, actual other post-retirement medical benefit plan
contributions were less than $0.1 million and the Company does not expect to
make additional contributions for the remaining periods of
2008.


During
the second quarter 2008, PSE trued-up its actuarial data for employees of the
qualified pension plan for 2007.  As a result, PSE recorded $8.5
million expense to accumulated other comprehensive income.




(6)
            Regulation
      and Rates




On
December 3, 2007, PSE filed a general rate case with the Washington Utilities
and Transportation Commission (Washington Commission) which proposed an increase
in electric rates of $174.5 million, and in an increase in natural gas rates of
$56.8 million, effective November 3, 2008.  PSE requested a weighted
cost of capital of 8.6%, or 7.29% after-tax, and a capital structure that
included 45.0% common equity with a return on equity of 10.8%.  In
July 2008, PSE filed rebuttal testimony and revised its proposed increase in
electric rates to $165.2 million and natural gas rates to $55.5
million.  PSE expects an order to be issued by the Washington
Commission no later than October 31, 2008.


On April
11, 2007, the Washington Commission issued an accounting order that authorized
PSE to defer certain ownership and operating costs (and associated carrying
costs) related to its purchase of the Goldendale electric generating facility
(Goldendale) during the period prior to inclusion in PSE’s retail electric rates
in the Power Cost Only Rate Case (PCORC).  The deferral was for the
time period from March 15, 2007 through September 1, 2007, at which time the
Company began recovering Goldendale ownership and operation costs in electric
rates.  As of June 30, 2008, PSE had established a regulatory asset of
$12.1 million.  PSE anticipates amortization of the costs will begin
no later than November 2008 as determined in PSE’s pending general rate
case.


In May
2007, the Washington Commission Staff alleged that PSE’s natural gas system
service provider had violated certain Washington Commission recordkeeping
rules.  On April 3, 2008, the Washington Commission issued an order
approving a settlement agreement that required PSE to pay a regulatory penalty
of $1.25 million, to establish a quality assurance program to better monitor its
subcontractors and to complete an independent audit of natural gas system
recordkeeping procedures.  PSE paid the $1.25 million regulatory
penalty amount in the second quarter of 2008.


In March
2008, Bonneville Power Administration (BPA) and PSE signed an agreement pursuant
to which BPA (on April 2, 2008) paid PSE $53.7 million in Residential Exchange
Program (REP) benefits for fiscal year ending September 30, 2008, which payment
is subject to true-up depending upon the amount of any REP benefits ultimately
determined to be payable to PSE.  The Washington Commission approved
in April 2008 PSE’s tariff filing seeking to pass-through the net amount of the
benefits under the interim agreements to residential and small farm
customers.  The Washington Commission also approved PSE’s request to
credit the regulatory asset amount of $33.7 million against the $53.7 million
payment and pass-through to customers the remaining amount of approximately
$20.0 million, which occurred during the second quarter of
2008.  These amounts did not affect PSE’s net income.  The
accrued carrying charges on the regulatory asset totaling $3.1 million at June
30, 2008 will be addressed in PSE’s pending general rate case (Docket No.
UE-072300).


In
November 2007, the Western Electricity Coordinating Council (WECC) audited PSE’s
compliance with electric reliability standards adopted by Federal Energy
Regulatory Commission (FERC), the North American Electric Reliability
Corporation (NERC) and/or WECC.  Compliance with these standards
includes periodic self-certifications of compliance, self-reports of violations
after discovery of the violation, spot checks to review self-certifications and
external audits that review compliance with designated standards in
detail.  The WECC audit team identified four potential violations of
the standards that PSE had not previously self-reported.  Several
months after the audit, WECC issued a “Notice of Alleged Violations” to PSE,
adding details and proposed penalties to the proposed findings.  Under
the rules for the process, PSE met with WECC representatives in July to discuss
settlement.  PSE is hopeful that all issues concerning the four
potential violations will be resolved.  Resolution of reliability
standards issues will be an ongoing concern, however, PSE self-reports
violations when they are discovered.  Such self-reports could result
in settlement of issues or issuances of penalties in the future.  PSE
has established a loss reserve of $0.6 million related to these alleged
violations.


On
December 15, 2006, FERC began an audit of PSE’s Open Access Transmission Tariff
and Standards of Conduct for the period January 1, 2004 through December 31,
2006.  The focus of the audit was PSE’s operation of its electric
transmission system and tariff and its energy trading function.  On
July 16, 2008, FERC issued its final audit report which discussed five areas of
non-compliance with certain FERC requirements.  PSE was ordered to
take several remedial actions and develop a compliance plan, but incurred no
penalties as a result of the audit.




(7)
            Litigation




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


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


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 REP
benefit provided to customers and accrue monthly carrying charges on the
deferred balance from June 7, 2007 until the deferral is recovered from
customers or BPA.  On October 11, 2007, the Ninth Circuit remanded the
May 2004 agreement to BPA in light of the Portland Gen. Elec. V. BPA
opinion and dismissed the remaining three pending cases regarding settlement
agreements.


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


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


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


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





Lockyer
Case.In March and April 2008, FERC issued orders establishing
procedures for the Lockyer
remand.  The orders commence a seller-by-seller inquiry into the
transaction reports filed by entities that sold power in California during
2000.  The inquiry is to determine if the transaction reports as filed
masked the gathering of more than 20% of the market during the period, by that
seller.  PSE is confident that it will not be found to have possessed
20% of any relevant market during any relevant time.  The order also
mandates a settlement process before an Administrative Law Judge
(ALJ).  FERC staff and the ALJ requested data concerning energy
sellers’ transactions, and PSE provided such data to FERC
staff.  Settlement talks among various parties continue but PSE cannot
predict the ultimate outcome of any negotiations or subsequent process before
FERC or the ALJ.


California Receivable and California
Refund Proceeding.The California Independent System Operator (CAISO)
filed status reports in this matter from time to time, but has yet to report its
“who owes what to whom” calculation.


Orders to Show
Cause.  On June 25, 2003, FERC issued two show cause orders
pertaining to its western market investigations that commenced individual
proceedings against many sellers.  One show cause order investigated
26 entities that allegedly had potential “partnerships” with
Enron.  PSE was not named in that show cause order.  On
January 22, 2004, FERC stated that it did not intend to proceed further against
other parties.


The
second show cause order named PSE (Docket No. EL03-169) and approximately 54
other entities that alleg­edly had engaged in potential “gaming” practices
in the CAISO and California PX markets.  PSE and FERC staff filed a
proposed settlement of all issues pending against PSE in those proceedings on
August 28, 2003.  The proposed settlement, which admits no wrongdoing
on the part of PSE, would result in a payment of a nominal amount to settle all
claims.  FERC approved the settlement on January 22,
2004.  The California parties filed for rehearing of that
order.  On March 17, 2004, PSE moved to dismiss the California
parties’ rehearing request and awaits FERC action on that motion.


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


Colstrip
Matters.  In May 2003, approximately 50 plaintiffs initiated an
action against the owners of Colstrip alleging that (1) seepage from two
different wastewater pond areas caused groundwater contamination and threatened
to contaminate domestic water wells and the Colstrip water supply pond, and (2)
seepage from the Colstrip water supply pond caused structural damage to
buildings and toxic mold.  The defendants reached agreement on a
global settlement with all plaintiffs on April 29, 2008 and PSE paid its share
of the settlement in the amount of $10.7 million in July 2008.  PSE
had previously expensed the settlement in the first quarter 2008.  PSE
has also filed an accounting petition with the Washington Commission to recover
such costs in the future.


The
Minerals Management Service of the United States Department of Interior
(MMS) has issued a series of orders to Western Energy Company (WECO) to pay
additional taxes and royalties concerning coal WECO sold to the owners of
Colstrip 3 & 4, and similar orders have been issued in the administrative
appellate process.  The orders assert that additional royalties are
owed in connection with payments received by WECO from Colstrip 3
& 4 owners (including PSE) for the construction and operation of a
conveyor system that runs several miles from the mine to Colstrip 3 &
4.  The state of Montana has also issued a demand to WECO consistent
with the MMS position.  WECO has challenged these orders, and the
issue has been on appeal for several years.WECO has won
some points during the appellate process that have reduced the claims;
however  under applicable law, to pursue the appeals, the principal in
dispute cannot be paid, which causes interest to accrue.  Moreover,
because the conveyor system continues to be used, the amount in
dispute grows.  In the aggregate, the accrued interest
plus unasserted claims to bring the amount current could make the
total claim (principal plus interest) pertaining to PSE’s 25.0% project share as
high as $10.0 million.  PSE and the other Colstrip 3 & 4 owners
authorized WECO to make a settlement offer to the Montana Department of Revenue
(DOR) and the MMS in connection with these claims.  PSE recorded a
$1.2 million pre-tax loss reserve in the second quarter of 2008 in that
regard.







Proceeding Relating to the Proposed
Merger.On February 6, 2008, the Company entered into a
memorandum of understanding providing for the settlement of the consolidated
shareholder lawsuit, subject to customary conditions including completion of
appropriate settlement documentation, confirmatory discovery and court
approval.  Pursuant to the memorandum of understanding, the Company
agreed to include certain additional disclosures in its proxy statement relating
to the merger.  The Company does not admit, however, that its prior
disclosures were in any way materially misleading or inadequate.  In
addition, the Company and the other defendants in the consolidated lawsuit deny
the plaintiffs’ allegations of wrongdoing and violation of law in connection
with the merger.  The settlement, if completed and approved by the
court, will result in dismissal with prejudice and release of all claims of the
plaintiffs and settlement class of the Company’s shareholders that were or could
have been brought on behalf of the plaintiffs and the settlement
class.  In connection with such settlement, the plaintiffs intend to
seek a court-approved award of attorneys’ fees and expenses in an amount up to
$290,000, which the Company has agreed to pay.  As of June 30, 2008,
the Company has a loss reserve of $290,000 related to this matter.




(8)
            Related
      Party Transactions




On June
1, 2006, PSE entered into a revolving credit facility with its parent, Puget
Energy, in the form of a Demand Promissory Note (Note).  Through the
Note, PSE may borrow up to $30.0 million from Puget Energy, subject to approval
by Puget Energy.  Under the terms of the Note, PSE pays interest on
the outstanding borrowings based on the lowest of the weighted-average interest
rate of (a) PSE’s outstanding commercial paper interest rate; (b) PSE’s senior
unsecured revolving credit facility; or (c) the interest rate available under
the receivable securitization facility of PSE Funding, Inc. (PSE Funding), a PSE
subsidiary, which is the London Interbank Offered Rate (LIBOR) plus a marginal
rate.  At June 30, 2008 and December 31, 2007, the outstanding balance
of the Note was $25.0 million and $15.8 million, respectively and the interest
rate was 2.87% and 5.31% respectively.  The outstanding balance and
the related interest under the Note are eliminated by Puget Energy upon
consolidation of PSE’s financial statements.  The $30.0 million credit
facility with Puget Energy is unaffected by the pending merger.


The
Company has a general liability claim from AEGIS Insurance Services Inc. (AEGIS)
and an insurance claim which AEGIS is a co-insurer.  The total of all
insurance receivables is $15.0 million as of June 30, 2008, of which
approximately $8.7 million is being sought from AEGIS.  One
nonemployee director of Puget Energy and PSE also serves on the board of AEGIS
and a PSE management employee serves on one of AEGIS’ risk management
committees.




(9)
            Other




Financial
Accounting Standards Board (FASB) Interpretation No. 46R, “Consolidation of
Variable Interest Entities” (FIN 46R) requires that if a business entity has a
controlling financial interest in a variable interest entity, the financial
statements of the variable interest entity must be included in the consolidated
financial statements of the business entity.  The Company has
evaluated its power purchase agreements and determined that two counterparties
during the six months ended June 30, 2008 may be considered variable interest
entities.  Consistent with FIN 46R, PSE submitted requests for
information to those two entities; however, the entities have refused to submit
to PSE the necessary information for PSE to determine whether they meet the
requirements of a variable interest entity.  PSE also determined that
it does not have a contractual right to such information.  PSE will
continue to submit requests for information to the counterparties in accordance
with FIN 46R.


Sumas
Cogeneration Company, L.P. (Sumas), an entity that potentially could have been
considered a variable interest entity prior to May 7, 2007, delivered a letter
to PSE on May 7, 2007, stating that it had sold its dedicated natural gas
reserves to a third party and that it no longer intended to deliver energy to
PSE through the remaining term of the contract, which expires on April 15,
2013.  The last energy delivered to PSE by Sumas occurred on March 15,
2007. PSE purchased from Sumas its 125 megawatt (MW) power plant located in
Sumas, Washington in a transaction effective July 25, 2008, resolving any
dispute between the parties.


For the
two power purchase agreements that may be considered variable interest entities
under FIN 46R as of the second quarter 2008, PSE is required to buy all the
generation from these plants, subject to displacement by PSE, at rates set forth
in the power purchase agreements.  If at any time the counterparties
cannot deliver energy to PSE, PSE would have to buy energy in the wholesale
market at prices which could be higher or lower than the power purchase
agreement prices.  PSE’s purchased electricity expense for the three
months ended June 30, 2008 and 2007 was $36.9 million and $30.6 million,
respectively, for the two entities and for the six months ended June 30, 2008,
and 2007 was $91.8 million and $97.2 million, respectively, for the two
entities.


In
November 2006, PSE’s Crystal Mountain Generation Station had an accidental
release of approximately 18,000 gallons of diesel fuel.  PSE crews and
consultants responded and worked with applicable state and federal agencies to
control and remove the spilled diesel.  On July 11, 2007, PSE received
a Notice of Completion for work performed pursuant to the Administrative Order
for Removal from the U. S. Environmental Protection Agency (EPA).  The
Notice stated that PSE had met the requirements of the Order and the
accompanying scope of work.  Total removal costs as of June 30, 2008
were approximately $14.5 million.  PSE estimates the total remediation
cost to be approximately $15.0 million, which has been accrued or
paid.  At June 30, 2008, PSE had an insurance receivable recorded in
the amount of $7.2 million associated with this fuel release.  PSE
received a partial payment of $5.0 million on this receivable in January
2008.  On February 13, 2008, the U.S. Department of Justice, on behalf
of the EPA, notified PSE of its intent to issue a fine of $0.5 million under the
Clean Water Act.  PSE paid this fine in July 2008.  On April
15, 2008, the Washington State Department of Ecology fined PSE $0.4 million as a
civil penalty pursuant to the Clean Water Act.  PSE reserved $0.9
million for the penalties.




(10)
            New
      Accounting Pronouncements




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


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


In
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations”
(SFAS No. 141(R)).  This Statement replaces FASB Statement No. 141,
“Business Combinations” and addresses the accounting for all transactions or
other events in which an entity obtains control of one or more
businesses.  The objective of this Statement is to improve the
relevance, representational faithfulness and comparability of the information
that a reporting entity provides in its financial reports about a business
combination and its effects. To accomplish that, this Statement establishes
principles and requirements for how the acquirer: 1) Recognizes and measures in
its financial statements the identifiable assets acquired, the liabilities
assumed and any noncontrolling interest in the acquiree; 2) Recognizes and
measures the goodwill acquired in the business combination or a gain from a
bargain purchase; and 3) Determines what information to disclose to enable users
of the financial statements to evaluate the nature and financial effects of the
business combination.  This Statement shall be applied prospectively
to business combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or after December
15, 2008.  The Company does not expect any impact from SFAS No. 141
(R).


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


In May
2008, FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting
Principles” (SFAS No. 162), which identifies the sources of accounting
principles and the framework for selecting the principles to be used in the
preparation of financial statements of nongovernmental entities that are
presented in conformity with generally accepted accounting
principles.  The FASB Board is responsible for identifying the sources
of accounting principles and providing entities with a framework for selecting
the principles used in the preparation of financial.  The current GAAP
hierarchy, as set forth in the American Institute of Certified Public
Accountants Statement on Auditing Standards No. 69, “The Meaning of Present
Fairly in Conformity With Generally Accepted Accounting Principles,” has been
criticized because it is directed to the auditor rather than the entity, it is
complex and it ranks FASB Statements of Financial Accounting Concepts, which are
subject to the same level of due process as FASB Statements of Financial
Accounting Standards, below industry practices that are widely recognized as
generally accepted but that are not subject to due process.  The Board
believes that the GAAP hierarchy should be directed to entities because it is
the entity that is responsible for selecting accounting principles for financial
statements that are presented in conformity with GAAP.  The Company
has reviewed the statement and has assessed there will be no significant impact
to the financial statements.


On June
16, 2008, FSP No. EITF 03-6-1, “Determining Whether Instruments Granted in
Share-Based Payment Transactions Are Participating Securities,” (EITF 03-6-1)
was issued.  This FSP addresses whether instruments granted in
share-based payment transactions are participating securities prior to vesting
and, therefore, need to be included in the earnings allocation in computing
earnings per share under the two-class method.  Unvested share-based
payment awards that contain nonforfeitable rights to dividends or dividend
equivalents (whether paid or unpaid) are participating securities and shall be
included in the computation of EPS pursuant to the two-class
method.  The Company is currently assessing the financial statement
presentation impact of FSP EITF No. 03-6-1.




(11)
            Fair
      Value Measurements




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


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


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





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





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





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


The following
table sets forth by level within the fair value hierarchy the Company’s
financial assets and liabilities that were accounted for at fair value on a
recurring basis as of June 30, 2008.  As required by SFAS No. 157,
financial assets and liabilities are classified in their entirety based on the
lowest level of input that is significant to the fair value
measurement.  The Company’s assessment of the significance of a
particular input to the fair value measurement requires judgment and may affect
the valuation of fair value assets and liabilities and their placement within
the fair value hierarchy levels.  The determination of the fair values
incorporates various factors required under SFAS No. 157.  These
factors include not only the credit standing of the counterparties involved and
the impact of credit enhancements (such as cash deposits, letters of credit and
priority interests), but also the impact of the Company’s nonperformance risk on
its liabilities.




Recurring
      Fair Value Measures
            At
      Fair Value as of June 30, 2008(Dollars
      in Millions)
            Level
      1
            Level
      2
            Level
      3
            TotalAssets:Energy
      derivative instruments
            $  --
            $
      287.7
            $
      159.4
            $
      447.1Total
      assets
            $  --
            $
      287.7
            $
      159.4
            $
      447.1Liabilities:Energy
      derivative instruments
            $  --
            $     6.4
            $   12.0
            $   18.4Total
      liabilities
            $  --
            $     6.4
            $   12.0
            $   18.4








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


(Dollars
      in Millions)
            
            Three
      Months
              Ended
              June
      30, 2008
            
            
            Six
      Months
              Ended
              June
      30, 2008Balance
      at beginning of period
            
            $
            17.2
            
            
            $
            (7.3
            )Realized
      energy derivative losses
            
            
            0.5
            
            
            
            (1.3
            )Unrealized
      energy derivative gains-
      included in earnings
            
            
            3.5
            
            
            
            1.9-
      included in other comprehensive income
            
            
            116.3
            
            
            
            145.0- included in regulatory assets/liabilities
            
            
            3.0
            
            
            
            3.0New
      energy purchase transactions
            
            
            --
            
            
            
            --Other
      financial items settled
            
            
            7.2
            
            
            
            7.2Energy
      derivatives transferred out of Level 3
            
            
            (0.3
            )
            
            
            (1.1
            )Balance
      as of June 30, 2008
            
            $
            147.4
            
            
            $
            147.4





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


Unrealized
gains and losses for Level 3 on energy derivatives recurring items are included
in net unrealized (gain) loss on derivative instruments in PSE’s income
statement.  SFAS No. 157 requires that financial assets and
liabilities be classified in their entirety based on the lowest level of input
that is significant to the fair value measurement.  As of June 30,
2008, energy derivative instruments are classified in Level 3 because Level 3
inputs are significant to their fair value measurement; however, the valuation
of these derivative instruments is primarily based upon observable inputs (Level
2), and the net unrealized gain recognized during the reporting period is
primarily due to a significant increase in observable prices.


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


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




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




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


The
consummation of the merger is subject to the satisfaction or waiver of certain
closing conditions, including the receipt of shareholder approval of the merger
and approval of it by various state and federal regulatory
authorities.  As of the date of this Quarterly Report, some of these
conditions have been satisfied while others remain outstanding or in
process.  On April 16, 2008, Puget Energy shareholders approved the
merger by more than the required two-thirds vote.  Also, on April 17,
2008, FERC conditionally approved the transaction pursuant to section 203 of the
Federal Power Act subject to reviewing the final conditions of merger approval
by the Washington Commission.  On December 17, 2007, PSE and the
Consortium filed a joint application seeking approval of the merger with the
Washington Commission.  A revised procedural schedule has been filed
in the merger proceeding with a proposed decision by the Washington Commission
on October 13, 2008.  If approved by the Washington Commission and
assuming receipt of approval by the other remaining federal authorities, closing
is expected to occur during the fourth quarter 2008.


On July
22, 2008, Puget Energy, the Consortium and several parties involved in the
merger proceeding reached a settlement to resolve all issues before the
Washington Commission.  On July 23, 2008, the parties to the merger
agreement filed a multiparty stipulated settlement with the Washington
Commission.













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




The
following discussion of the Company’s financial condition and results of
operations contains forward-looking statements that involve risks and
uncertainties, such as statements of the Company’s plans, objectives,
expectations and intentions.  Words or phrases such as “anticipates,”
“believes,” “estimates,” “expects,” “future,” “intends,” “plans,” “projects,”
“predicts,” “will likely result,” and “will continue” and similar expressions
are used to identify forward-looking statements.  However, these words
are not the exclusive means of identifying such statements.  In
addition, any statements that refer to expectations, projections or other
characterizations of future events or circumstances are forward-looking
statements.  The Company’s actual results could differ materially from
those anticipated in these forward-looking statements for many reasons,
including the factors described below and under the caption “Forward-Looking
Statements” at the beginning of this report.  Readers should not place
undue reliance on these forward-looking statements, which apply only as of the
date of this Form 10-Q.








Overview




Puget Energy, Inc. (Puget Energy) is an
energy services holding company and all of its operations are conducted through
its subsidiary Puget Sound Energy, Inc. (PSE), a regulated electric and natural
gas utility company.  Puget Energy is dependent upon the results of
PSE since PSE is its most significant asset.  PSE is the largest
electric and natural gas utility in the state of Washington, primarily engaged
in the business of electric transmission, distribution, generation and natural
gas distribution.  Puget Energy’s business strategy is to generate
stable earnings and cash flow by offering reliable electric and natural gas
service in a cost effective manner through PSE.





Puget Energy
Merger


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


The
consummation of the merger is subject to the satisfaction or waiver of certain
closing conditions, including the receipt of shareholder approval of the merger
and approval of it by various state and federal regulatory
authorities.  As of the date of this Quarterly Report, some of these
conditions have been satisfied while others remain outstanding or in
process.  On April 16, 2008, Puget Energy shareholders approved the
merger.  Also, on April 17, 2008 the Federal Energy Regulatory
Commission (FERC) conditionally approved the transaction pursuant to section 203
of the Federal Power Act subject to reviewing the final conditions of merger
approval by the Washington Utilities and Transportation Commission (Washington
Commission).  On December 17, 2007, PSE and the Consortium filed a
joint application seeking approval of the merger with the Washington Commission.
A revised procedural schedule has been filed in the merger proceeding with a
proposed decision by the Washington Commission on October 13,
2008.  If approved by the Washington Commission and assuming receipt
of approval by the other remaining federal authorities, closing is expected to
occur during the fourth quarter 2008.


On July
22, 2008, Puget Energy, the Consortium, and several parties involved in the
merger proceeding reached a settlement to resolve all issues before the
Washington Commission.  On July 23, 2008, the parties to the merger
agreement filed a multiparty stipulated settlement with the Washington
Commission.





Puget Sound
Energy


PSE generates revenues primarily from
the sale of electric and natural gas services to residential and commercial
customers within Washington State.  PSE’s operating revenues and
associated expenses are not generated evenly throughout the
year.  Variations in energy usage by consumers occur from season to
season and from month to month within a season, primarily as a result of weather
conditions.  PSE normally experiences its highest retail energy sales
and subsequently higher power costs during the winter heating season in the
first and fourth quarters of the year and its lowest sales in the third quarter
of the year.  Varying wholesale electric prices and the amount of
hydroelectric energy supplies available to PSE also make quarter-to-quarter
comparisons difficult.


As a regulated utility company, PSE is
subject to FERC and Washington Commission regulation which may impact a large
array of business activities, including limitation of future rate increases;
directed accounting requirements that may negatively impact earnings; licensing
of PSE-owned generation facilities; and other FERC and Washington Commission
directives that may impact PSE’s long-term goals.  In addition, PSE is
subject to risks inherent to the utility industry as a whole, including weather
changes affecting purchases and sales of energy; outages at owned and contracted
generation plants where energy is obtained; storms or other events which can
damage natural gas and electric distribution and transmission lines; increasing
regulatory standards for system reliability; wholesale market stability over
time; and significant evolving environmental legislation.


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





Non-GAAP
Financial Measures – Energy Margins


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








Results
of Operations


Puget
Energy


All the
operations of Puget Energy are conducted through its subsidiary
PSE.  Net income for the three months ended June 30, 2008 was $33.7
million on operating revenues of $712.4 million as compared to net income of
$38.6 million on operating revenues of $661.1 million for the same period in
2007.


Basic and
diluted earnings per share for the three months ended June 30, 2008 was $0.26 as
compared to basic and diluted earnings per share for the three months ended June
30, 2007 of $0.33.  Net income for the three months ended June 30,
2008 as compared to the same period in 2007, was negatively impacted by a $0.9
million decrease in electric margin while it was positively impacted by an $8.4
million increase in gas margin.  Net income was negatively impacted by
a $17.5 million increase in utility operation and maintenance and by an increase
in depreciation and amortization of $10.5 million. The increase in expenses was
partially offset by a decrease in taxes other than income taxes, net of revenue
sensitive taxes, of $5.0 million.  Net income was also positively
impacted due to an increase in other income of $1.9 million ($1.2 million
after-tax) and by a $3.9 million increase in unrealized gain on energy
derivative instruments for PSE.  In the second quarter 2008, Puget
Energy incurred $5.7 million in costs related to the proposed merger with the
Consortium.


For the
six months ended June 30, 2008, Puget Energy’s net income was $113.5 million on
operating revenues from continuing operations of $1.8 billion, compared to net
income of $117.7 million on operating revenues from continuing operations of
$1.7 billion for the same period in 2007.  Basic and diluted earnings
per share for the six months ended June 30, 2008 were $0.88 and $0.87,
respectively, compared to basic and diluted earnings per share of $1.01 and
$1.00, respectively, for the same period in 2007.


Net
income for the six months ended June 30, 2008 was positively impacted by
increased electric and gas margins of $24.5 million and $20.9 million,
respectively, compared to the same period in 2007.  Net income was
negatively impacted by an increase of $31.5 million related to utility operation
and maintenance which includes the impact of a $10.5 million charge related to
PSE’s share of the settlement of a lawsuit against the Colstrip electric
generating station project owners, an increase in depreciation and amortization
of $16.2 and a decrease in unrealized gain on energy derivative instruments of
$2.0 million.  The increase in expenses was partially offset by a
decrease in non-utility operation and maintenance and other expenses of $2.9
million and an increase in other income of $3.8 million.  Net income
was also positively impacted due to a decrease in other expense of $2.0 million
and a decrease in interest expense of $2.7 million due to lower average debt
outstanding as a result of the equity issuance in December 2007.  For
the six months ended June 30, 2008, Puget Energy incurred $7.0 million in costs
related to the proposed merger with the Consortium.





Puget Sound
Energy


PSE’s
operating revenues and expenses are not generated evenly throughout the
year.  Variations in energy usage by customers occur from season to
season and from month to month within a season, primarily as a result of weather
conditions.  PSE normally experiences its highest retail energy sales
and subsequently higher power costs during the winter heating season in the
first and fourth quarters of the year, and its lowest sales in the third quarter
of the year.  Power cost recovery is seasonal, with underrecovery
normally in the first and fourth quarters and over recovery 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 June 30, 2008 as compared to the same period in
2007.  Electric margin is electric sales to retail and transportation
customers less pass-through tariff items and revenue-sensitive taxes, and the
cost of generating and purchasing electric energy sold to customers, including
transmission costs to bring electric energy to PSE’s service
territory.





Electric
      Margin(Dollars
      in Millions)
              Three
      Months Ended June 30,
            
            2008
            
            
            2007
            
            
            Change
            
            
            Percent
              ChangeElectric
      operating revenue1
            
            $
            478.0
            
            
            $
            435.3
            
            
            $
            42.7
            
            
            
            9.8
            %Less:
      Other electric operating revenue
            
            
            (20.3
            )
            
            
            (15.8
            )
            
            
            (4.5
            )
            
            
            (28.5
            )Add:
      Other electric operating revenue-gas supply resale
            
            
            8.3
            
            
            
            4.7
            
            
            
            3.6
            
            
            
            76.6Total
      electric revenue for margin
            
            
            466.0
            
            
            
            424.2
            
            
            
            41.8
            
            
            
            9.9Adjustments
      for amounts included in revenue:Pass-through
      tariff items
            
            
            (16.2
            )
            
            
            (9.7
            )
            
            
            (6.5
            )
            
            
            (67.0
            )Pass-through
      revenue-sensitive taxes
            
            
            (32.9
            )
            
            
            (29.1
            )
            
            
            (3.8
            )
            
            
            (13.1
            )Net
      electric revenue for margin
            
            
            416.9
            
            
            
            385.4
            
            
            
            31.5
            
            
            
            8.2Minus
      power costs:Purchased
      electricity1
            
            
            (198.9
            )
            
            
            (172.8
            )
            
            
            (26.1
            )
            
            
            (15.1
            )Electric
      generation fuel1
            
            
            (32.7
            )
            
            
            (23.7
            )
            
            
            (9.0
            )
            
            
            (38.0
            )Residential
      exchange1
            
            
            20.3
            
            
            
            17.6
            
            
            
            2.7
            
            
            
            15.3Total
      electric power costs
            
            
            (211.3
            )
            
            
            (178.9
            )
            
            
            (32.4
            )
            
            
            (18.1
            )Electric
      margin2
            
            $
            205.6
            
            
            $
            206.5
            
            
            $
            (0.9
            )
            
            
            (0.4
            )
      %


____________________________


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 decreased $0.9 million for the three months ended June 30, 2008 as
compared to the same period in 2007.  Contributing to higher power
costs was a 6.8% decline in hydroelectric energy production from both
Company-owned facilities and sources under long-term contract as well as higher
purchased power costs.  As a result, electric margin decreased $9.6
million due to lower over collection of net power costs during the
period.  The over collection for the three months ended June 30, 2008
totaled $26.9 compared to the same period in 2007 of $36.5
million.  Offsetting the decrease was an $8.8 million increase in
electric margin due to a 4.9% increase in retail sales.  Power cost
recovery is seasonal with under recovery in the first and fourth quarters and
over recovery in the second and third quarters.


The
following table displays the details of electric margin changes for the six
months ended June 30, 2008 compared to the same period in
2007.  Electric margin is electric sales to retail and transportation
customers less pass-through tariff items and revenue-sensitive taxes, and the
cost of generating and purchasing electric energy sold to customers, including
transmission costs to bring electric energy to PSE’s service
territory.





Electric
      Margin(Dollars
      in Millions)
                Six
      Months Ended June 30,
              
              2008
              
              
              2007
              
              
              Change
              
              
              Percent
                ChangeElectric
      operating revenue1
              
              $
              1,084.2
              
              
              $
              962.9
              
              
              $
              121.3
              
              
              
              12.6
              %Less:
      Other electric operating revenue
              
              
              (32.5
              )
              
              
              (26.7
              )
              
              
              (5.8
              )
              
              
              (21.7
              )Add:
      Other electric revenue-gas supply resale
              
              
              11.0
              
              
              
              6.4
              
              
              
              4.6
              
              
              
              71.9Total
      electric revenue for margin
              
              
              1,062.7
              
              
              
              942.6
              
              
              
              120.1
              
              
              
              12.7Adjustments
      for amounts included in revenue:Pass-through
      tariff items
              
              
              (29.1
              )
              
              
              (20.9
              )
              
              
              (8.2
              )
              
              
              (39.2
              )Pass-through
      revenue-sensitive taxes
              
              
              (74.6
              )
              
              
              (65.7
              )
              
              
              (8.9
              )
              
              
              (13.5
              )Net
      electric revenue for margin
              
              
              959.0
              
              
              
              856.0
              
              
              
              103.0
              
              
              
              12.0Minus
      power costs:Purchased
      electricity1
              
              
              (471.7
              )
              
              
              (454.8
              )
              
              
              (16.9
              )
              
              
              (3.7
              )Electric
      generation fuel1
              
              
              (79.7
              )
              
              
              (49.8
              )
              
              
              (29.9
              )
              
              
              (60.0
              )Residential
      exchange1
              
              
              20.3
              
              
              
              52.0
              
              
              
              (31.7
              )
              
              
              (61.0
              )Total
      electric power costs
              
              
              (531.1
              )
              
              
              (452.6
              )
              
              
              (78.5
              )
              
              
              (17.3
              )Electric
      margin2
              
              $
              427.9
              
              
              $
              403.4
              
              
              $
              24.5
              
              
              
              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 $24.5 million for the six months ended June 30, 2008 compared
to the same period in 2007.  This is primarily due to a Power Cost
Only Rate Case (PCORC) rate increase of 3.7% effective September 1, 2007, net of
a 1.3% general rate decrease effective January 13, 2007 which increased electric
margin by $5.3 million due in part to the recovery of Goldendale and Wild Horse
facilities.  In addition, a 4.4% increase in retail sales volumes
increased electric margin by $17.0 million.  Additionally, electric
margin is positively impacted by $1.4 million due to an increase in overrecovery
of power costs, $24.4 million for the six months ended June 30, 2008 compared to
$23.0 million for the same period in 2007.


The
following table displays the details of gas margin changes for the three months
ended June 30, 2008 as compared to the same period in 2007.  Gas
margin is natural gas sales to retail and transportation customers less
pass-through tariff items and revenue-sensitive taxes, and the cost of natural
gas purchased, including transportation costs to bring natural gas to PSE’s
service territory.





Gas
      Margin(Dollars
      in Millions)
                Three
      Months Ended June 30,
              
              2008
              
              
              2007
              
              
              Change
              
              
              Percent
                ChangeGas
      operating revenue1
              
              $
              233.8
              
              
              $
              225.2
              
              
              $
              8.6
              
              
              
              3.8
              %Less:
      Other gas operating revenue
              
              
              (4.2
              )
              
              
              (4.4
              )
              
              
              0.2
              
              
              
              4.5Total
      gas revenue for margin
              
              
              229.6
              
              
              
              220.8
              
              
              
              8.8
              
              
              
              4.0Adjustments
      for amounts included in revenue:Pass-through
      tariff items
              
              
              (2.3
              )
              
              
              (1.7
              )
              
              
              (0.6
              )
              
              
              (35.3
              )Pass-through
      revenue-sensitive taxes
              
              
              (20.3
              )
              
              
              (19.1
              )
              
              
              (1.2
              )
              
              
              (6.3
              )Net
      gas revenue for margin
              
              
              207.0
              
              
              
              200.0
              
              
              
              7.0
              
              
              
              3.5Minus
      purchased gas costs1
              
              
              (137.7
              )
              
              
              (139.1
              )
              
              
              1.4
              
              
              
              1.0Gas
      margin2
              
              $
              69.3
              
              
              $
              60.9
              
              
              $
              8.4
              
              
              
              13.8
              %
 ____________________


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 $8.4 million for the three months ended June 30, 2008 as
compared to the same period in 2007 primarily due to a 16.9% gas therm volume
sales increase resulting in $10.3 million increase to gas
margin.  This increase was partially offset by a $1.9 million decrease
in margin due to a change in customer mix and other pricing
variances.


The
following table displays the details of gas margin changes for the six months
ended June 30, 2008 compared to the same period in 2007.  Gas margin
is natural gas sales to retail and transportation customers less pass-through
tariff items and revenue-sensitive taxes, and the cost of natural gas purchased,
including transportation costs to bring natural gas to PSE’s service
territory.





Gas
      Margin(Dollars
      in Millions)
                Six
      Months Ended June 30,
              
              2008
              
              
              2007
              
              
              Change
              
              
              Percent
                ChangeGas
      operating revenue1
              
              $
              677.1
              
              
              $
              692.2
              
              
              $
              (15.1
              )
              
              
              (2.2
              )
      %Less:
      Other gas operating revenue
              
              
              (8.9
              )
              
              
              (9.2
              )
              
              
              0.3
              
              
              
              3.3Total
      gas revenue for margin
              
              
              668.2
              
              
              
              683.0
              
              
              
              (14.8
              )
              
              
              (2.2
              )Adjustments
      for amounts included in revenue:Pass-through
      tariff items
              
              
              (6.7
              )
              
              
              (4.9
              )
              
              
              (1.8
              )
              
              
              (36.7
              )Pass-through
      revenue-sensitive taxes
              
              
              (55.4
              )
              
              
              (57.1
              )
              
              
              1.7
              
              
              
              3.0Net
      gas revenue for margin
              
              
              606.1
              
              
              
              621.0
              
              
              
              (14.9
              )
              
              
              (2.4
              )Less:
      Purchased gas costs1
              
              
              (413.9
              )
              
              
              (449.7
              )
              
              
              35.8
              
              
              
              8.0Gas
      margin2
              
              $
              192.2
              
              
              $
              171.3
              
              
              $
              20.9
              
              
              
              12.2
              %
 ____________________


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 $20.9 million for the six months ended June 30, 2008 compared
to the same period in 2007 primarily due to a 2.8% general rate increase
effective January 13, 2007 which increased gas margin $5.4 million and a 11.0%
gas therm volume sales increase which increased gas margin $18.9
million.  This increase was offset by a $3.4 million decrease in
margin due to a change in customer mix and other pricing variances.






Electric
Operating Revenues


The table
below sets forth changes in electric operating revenues for PSE for the three
months ended June 30, 2008 as compared to the same period in 2007.





(Dollars
      in Millions)
              Three
      Months Ended June 30,
            
            2008
            
            
            2007
            
            
            Change
            
            
            Percent
              ChangeElectric
      operating revenues:Residential
      sales
            
            $
            237.1
            
            
            $
            199.4
            
            
            $
            37.7
            
            
            
            18.9
            %Commercial
      sales
            
            
            189.4
            
            
            
            173.5
            
            
            
            15.9
            
            
            
            9.2Industrial
      sales
            
            
            26.1
            
            
            
            25.1
            
            
            
            1.0
            
            
            
            4.0Other
      retail sales, including unbilled revenue
            
            
            (20.7
            )
            
            
            (7.9
            )
            
            
            (12.8
            )
            
            
            (162.0
            )Total
      retail sales
            
            
            431.9
            
            
            
            390.1
            
            
            
            41.8
            
            
            
            10.7Transportation
      sales
            
            
            1.4
            
            
            
            2.4
            
            
            
            (1.0
            )
            
            
            (41.7
            )Sales
      to other utilities and marketers
            
            
            24.4
            
            
            
            27.1
            
            
            
            (2.7
            )
            
            
            (10.0
            )Other
            
            
            20.3
            
            
            
            15.7
            
            
            
            4.6
            
            
            
            29.3Total
      electric operating revenues
            
            $
            478.0
            
            
            $
            435.3
            
            
            $
            42.7
            
            
            
            9.8
            %





Electric
retail sales increased $41.8 million for the three months ended June 30, 2008 as
compared to the same period in 2007.  The increase in electricity
usage was primarily related to customer growth and colder average temperatures
in the Pacific Northwest.  Second quarter 2008 heating degree days
were 17% above historic averages for the Pacific Northwest while 2007 heating
degrees were 5.9% below normal.  Retail electricity usage increased
236,349 MegawattHours(MWh) or 4.9% compared to the
same period in 2007, which resulted in an increase of approximately $20.1
million in electric operating revenue.  The PCORC rate increase
effective September 1, 2007 increased operating revenues $16.3 million for the
three months ended June 30, 2008 as compared to the same period in
2007.


Sales to
other utilities and marketers decreased $2.7 million for the three months ended
June 30, 2008 as compared to the same period in 2007 primarily due to a decrease
in sales volume of 2,915 MWh or 0.5% as a result of decreased surplus energy,
which resulted in a decrease of $0.2 million.  This decrease was also
caused by lower wholesale prices in the second quarter 2008 as compared to the
same period in 2007, which decreased sales by $2.5 million.


Other
electric operating revenues increased $4.6 million for the three months ended
June 30, 2008 as compared to the same period in 2007 primarily due to an
increase of $3.7 million in gas sales to third parties and an increase of $1.5
million in transmission revenues.


The table
below sets forth changes in electric operating revenues for PSE for the six
months ended June 30, 2008 compared to the same period in 2007.





(Dollars
      in Millions)
              Six
      Months Ended June 30,
            
            2008
            
            
            2007
            
            
            Change
            
            
            Percent
              ChangeElectric
      operating revenues:Residential
      sales
            
            $
            583.7
            
            
            $
            491.4
            
            
            $
            92.3
            
            
            
            18.8
            %Commercial
      sales
            
            
            401.5
            
            
            
            373.0
            
            
            
            28.5
            
            
            
            7.6Industrial
      sales
            
            
            53.5
            
            
            
            52.3
            
            
            
            1.2
            
            
            
            2.3Other
      retail sales, including unbilled revenue
            
            
            (32.3
            )
            
            
            (31.6
            )
            
            
            (0.7
            )
            
            
            (2.2
            )Total
      retail sales
            
            
            1,006.4
            
            
            
            885.1
            
            
            
            121.3
            
            
            
            13.7Transportation
      sales
            
            
            2.9
            
            
            
            4.8
            
            
            
            (1.9
            )
            
            
            (39.6
            )Sales
      to other utilities and marketers
            
            
            42.4
            
            
            
            46.3
            
            
            
            (3.9
            )
            
            
            (8.4
            )Other
            
            
            32.5
            
            
            
            26.7
            
            
            
            5.8
            
            
            
            21.7Total
      electric operating revenues
            
            $
            1,084.2
            
            
            $
            962.9
            
            
            $
            121.3
            
            
            
            12.6
            %





Electric
retail sales increased $121.3 million for the six months ended June 30, 2008
compared to the same period in 2007 due primarily to an increase in customer
growth and colder average temperatures in the Pacific Northwest during the first
half of 2008.  Retail electricity usage increased 482,842 MWh or 4.4%
for the six months ended June 30, 2008 compared to the same period in 2007,
which resulted in an increase of approximately $43.0 million in electric
operating revenue.  The increase was also related to the PCORC rate
increase of September 1, 2007 offset by the electric general rate decrease of
January 13, 2007 which resulted in an increase of $51.4
million.  During the six month period ended June 30, 2008, the
benefits of the Residential and Farm Energy Exchange Benefit credited to
customers reduced electric operating revenues by $21.2 million compared to $54.5
million for the same period in 2007.  This credit also reduced power
costs by a corresponding amount with no impact on earnings.





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





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





Gas
Operating Revenues


The table
below sets forth changes in gas operating revenues for PSE for the three months
ended June 30, 2008 as compared to the same period in 2007.





(Dollars
      in Millions)
              Three
      Months Ended June 30,
            
            2008
            
            
            2007
            
            
            Change
            
            
            Percent
              ChangeGas
      operating revenues:Residential
      sales
            
            $
            144.3
            
            
            $
            135.0
            
            
            $
            9.3
            
            
            
            6.9
            %Commercial
      sales
            
            
            72.1
            
            
            
            72.4
            
            
            
            (0.3
            )
            
            
            (0.4
            )Industrial
      sales
            
            
            9.7
            
            
            
            10.2
            
            
            
            (0.5
            )
            
            
            (4.9
            )Total
      retail sales
            
            
            226.1
            
            
            
            217.6
            
            
            
            8.5
            
            
            
            3.9Transportation
      sales
            
            
            3.4
            
            
            
            3.2
            
            
            
            0.2
            
            
            
            6.3Other
            
            
            4.3
            
            
            
            4.4
            
            
            
            (0.1
            )
            
            
            (2.3
            )Total
      gas operating revenues
            
            $
            233.8
            
            
            $
            225.2
            
            
            $
            8.6
            
            
            
            3.8
            %





Gas
retail sales increased $8.5 million for the three months ended June 30, 2008 as
compared to the same period in 2007 due to an increase in gas therm sales of
34.9 million or 16.9% reflecting customer growth and colder average temperatures
in the Pacific Northwest which contributed $39.2 million. The increase was
negatively impacted by the $31.5 million reduction in gas operating revenues as
a result of a 13.0% Purchased Gas Adjustment (PGA) mechanism rate decrease for
retail customers effective October 1, 2007.  The PGA mechanism passes
through to customers increases or decreases in the natural gas supply portion of
the natural gas service rates based upon changes in the price of natural gas
purchased from producers and wholesale marketers or changes in natural gas
pipeline transportation costs.  PSE’s gas margin and net income are
not affected by changes under the PGA mechanism.


The table
below sets forth changes in gas operating revenues for PSE for the six months
ended June 30, 2008 compared to the same period in 2007.





(Dollars
      in Millions)
              Six
      Months Ended June 30,
            
            2008
            
            
            2007
            
            
            Change
            
            
            Percent
              ChangeGas
      operating revenues:Residential
      sales
            
            $
            438.5
            
            
            $
            435.8
            
            
            $
            2.7
            
            
            
            0.6
            %Commercial
      sales
            
            
            200.0
            
            
            
            207.9
            
            
            
            (7.9
            )
            
            
            (3.8
            )Industrial
      sales
            
            
            22.5
            
            
            
            32.5
            
            
            
            (10.0
            )
            
            
            (30.8
            )Total
      retail sales
            
            
            661.0
            
            
            
            676.2
            
            
            
            (15.2
            )
            
            
            (2.2
            )Transportation
      sales
            
            
            7.2
            
            
            
            6.8
            
            
            
            0.4
            
            
            
            5.9Other
            
            
            8.9
            
            
            
            9.2
            
            
            
            (0.3
            )
            
            
            (3.3
            )Total
      gas operating revenues
            
            $
            677.1
            
            
            $
            692.2
            
            
            $
            (15.1
            )
            
            
            (2.2
            )%





Gas
retail sales decreased $15.2 million for the six months ended June 30, 2008
compared to the same period in 2007 due to lower PGA mechanism rates and
increased customer natural gas usage.  The Washington Commission
approved a PGA mechanism rate decrease effective October 1,
2007.  PSE’s gas margin and net income are not affected by changes
under the PGA mechanism.  The effects of the PGA mechanism rate
decrease of 13.0% were offset by a 2.8% natural gas general rate increase
effective January 13, 2007 provided a decrease of $87.0 million in natural gas
operating revenues.  The decrease was offset by higher gas sales of
67.8 million therms or 11.0% which increased gas operating revenue by $71.6
million.  A 2.3% increase in natural gas customers and colder than
average temperatures contributed to the higher natural gas sales.





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





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





Non-Utility
Operating Revenues


The table
below sets forth changes in non-utility operating revenues for PSE for the six
months ended June 30, 2008 as compared to the same period in 2007.





(Dollars
      in Millions)
              Six
      Months Ended June 30,
            
            2008
            
            2007
            
            Change
            
            Percent
              ChangeNon-utility
      operating revenue
            
            $
            2.1
            
            
            $
            10.0
            
            
            $
            (7.9
            )
            
            
            (79.0
            )
      %





Non-utility operating revenues
decreased $7.9 million for the six months ended June
30, 2008 as compared to the same period in 2007due to higher 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 June 30, 2008 as compared to the same
period in 2007.





(Dollars
      in Millions)
                Three
      Months Ended June 30,
              
              2008
              
              
              2007
              
              
              Change
              
              
              Percent
                ChangePurchased
      electricity
              
              $
              198.9
              
              
              $
              172.8
              
              
              $
              26.1
              
              
              
              15.1
              %Electric
      generation fuel
              
              
              32.7
              
              
              
              23.7
              
              
              
              9.0
              
              
              
              38.0Residential
      exchange
              
              
              (20.3
              )
              
              
              (17.6
              )
              
              
              (2.7
              )
              
              
              (15.3
              )Purchased
      gas
              
              
              137.7
              
              
              
              139.1
              
              
              
              (1.4
              )
              
              
              (1.0
              )Unrealized
      (gain) loss on derivative instruments
              
              
              (2.4
              )
              
              
              1.5
              
              
              
              (3.9
              )
              
              
              *Utility
      operations and maintenance
              
              
              116.5
              
              
              
              98.9
              
              
              
              17.6
              
              
              
              17.8Depreciation
      and amortization
              
              
              76.3
              
              
              
              65.7
              
              
              
              10.6
              
              
              
              16.1Conservation
      amortization
              
              
              15.5
              
              
              
              8.8
              
              
              
              6.8
              
              
              
              76.1Taxes
      other than income taxes
              
              
              63.7
              
              
              
              63.3
              
              
              
              0.4
              
              
              
              0.6
 _________________


*
            Percent
      change not applicable or meaningful





The table
below sets forth significant changes in operating expenses for PSE and its
subsidiaries for the six months ended June 30, 2008 compared to the same period
in 2007.





(Dollars
      in Millions)
              Six
      Months Ended June 30,
            
            2008
            
            
            2007
            
            
            Change
            
            
            Percent
              ChangePurchased
      electricity
            
            $
            471.7
            
            
            $
            454.8
            
            
            $
            16.9
            
            
            
            3.7
            %Electric
      generation fuel
            
            
            79.7
            
            
            
            49.8
            
            
            
            29.9
            
            
            
            60.0Residential
      exchange credit
            
            
            (20.3
            )
            
            
            (52.0
            )
            
            
            31.7
            
            
            
            61.0Purchased
      gas
            
            
            413.9
            
            
            
            449.7
            
            
            
            (35.8
            )
            
            
            (8.0
            )Unrealized
      (gain) loss on derivative instruments
            
            
            (2.3
            )
            
            
            (4.3
            )
            
            
            2.0
            
            
            
            46.5Utility
      operations and maintenance
            
            
            228.6
            
            
            
            197.1
            
            
            
            31.5
            
            
            
            16.0Non-utility
      expense and other
            
            
            1.7
            
            
            
            4.6
            
            
            
            (2.9
            )
            
            
            (63.0
            )Depreciation
      and amortization
            
            
            151.7
            
            
            
            135.4
            
            
            
            16.3
            
            
            
            12.0Conservation
      amortization
            
            
            28.9
            
            
            
            19.1
            
            
            
            9.8
            
            
            
            51.3Taxes
      other than income taxes
            
            
            158.0
            
            
            
            150.4
            
            
            
            7.6
            
            
            
            5.1





Purchased electricity expenses
increased $26.1 million and $16.9 million for the three and six months ended
June 30, 2008, respectively, as compared to the same period in
2007.  This increase for the three months ended June 30, 2008 was
primarily due to an increase in the amount of purchased power, 229,324 MWh or
5.7%.  The increase in purchased power was caused by increased load
due to cooler temperatures during the three months ended June 30, 2008 and from
lower hydroelectric energy supplies from both company-owned facilities and long
term power supply contracts, as well as higher market prices for purchased
power.  The lower hydroelectric and Colstrip generation was offset by
increased generation from PSE’s wind generation facilities, and combustion
turbines (primarily Goldendale and Frederickson).  The additional
purchased power resulted in an increase of $8.6 million in purchased electricity
expenses.  This increase was also impacted by higher wholesale market
prices which caused an increase of $15.7 million and transmission and other
power supply expenses of $2.2 million due in part to increased kilowatt hour
(kWh) sales to customers.  The increase for the six months ended June
30, 2008 was primarily the result of higher wholesale market prices which
contributed $18.6 million offset by a decrease in purchased power of 106,122 MWh
or 1.2%, resulting in a decrease of $4.9 million.  The decrease in
purchased power is related to increased production from company-owned combustion
turbines, wind facilities and thermal generating facilities.  Also
contributing to the increase were increased transmission costs and other
expenses, which contributed $3.2 million due in part to increased kWh sales to
customers.


The July 8, 2008 Columbia Basin Runoff
Forecast published by the National Weather Service Northwest River Forecast
Center indicated that the total forecasted runoff above Grand Coulee Reservoir
for the period January through July 2008 is 97% of normal, which compares to
102% of normal runoff observed for the same period in 2007.


To meet customer demand, PSE
economically dispatches resources in its power supply portfolio such as
fossil-fuel generation, owned and contracted hydroelectric capacity and energy
and long-term contracted power.  However, depending principally upon
availability of hydroelectric energy, plant availability, fuel prices and/or
changing load as a result of weather, PSE may sell surplus power or purchase
deficit power in the wholesale market.  PSE manages its regulated
power portfolio through short-term and intermediate-term off-system physical
purchases and sales and through other risk management techniques.


Electric generation fuel
expense increased $9.0 million and $29.9 million for the three and six months
ended June 30, 2008, respectively, as compared to the same period in
2007.  The increase for the three months ended June 30, 2008 was due
in part to increased generation from Goldendale and Frederickson combustion
turbines which contributed $5.3 million and $4.1 million. The increase for the
six months ended June 30, 2008 was primarily due to the operations of Goldendale
and Frederickson combustion turbines which contributed $22.1 million and $10.0
million in 2008 compared to 2007.


Residential exchange credits
associated with the Bonneville Power Administration (BPA) Residential Exchange
Program (REP) decreased $2.7 million and increased $31.7 million for the three
and six months ended June 30, 2008, respectively, as compared to the same period
in 2007 as a result of the suspension of the residential and small farm customer
electric credit in rates effective June 7, 2007.  The suspension was
due to an adverse ruling from the U.S. Court of Appeals for the Ninth Circuit
(Ninth Circuit) which states that BPA actions in entering into residential
exchange settlement agreements with investor owned utilities were not in
accordance with the law.  In April 2008, PSE signed an agreement
pursuant to which BPA would pay PSE $53.7 million for fiscal year 2008 REP
benefits.  Of this amount PSE received approval to pass-through to
customers approximately $20.0 million over a one-month period.  The
remaining $33.7 million was used to offset PSE’s regulatory
asset.  The REP credit is a pass-through tariff item with a
corresponding credit in electric operating revenue; thus, it has no impact on
electric margin or net income.


Purchased gas expenses
decreased $1.4 million and $35.8 million for the three and six months ended June
30, 2008, respectively, as compared to the same period in 2007 primarily due to
a decrease in PGA rates, partially offset by higher customer therm
sales.  The PGA mechanism allows PSE to recover expected natural gas
supply and transportation costs, and defer, as a receivable or liability, any
natural gas supply and transportation 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 June 30, 2008 was
$26.8 million as compared to $77.9 million at December 31, 2007.  PSE
is authorized by the Washington Commission to accrue carrying costs on PGA
receivable and payable balances.  A receivable balance in the PGA
mechanism reflects an under recovery of market natural gas cost through
rates.  A payable balance reflects over recovery of market natural gas
cost through rates.


Unrealized gain on derivative
instrumentsincreased $3.9 million and decreased $2.0 million forthe three and six months
ended June 30, 2008, respectively, as compared to the same period in
2007.  The increase for the three months ended June 30, 2008 as
compared to the same period in 2007 was primarily related to the ineffective
portion of a cash flow hedge due to an increase in future wholesale market
electric prices as compared to the contract price.  The increase was
partially offset by an unrealized loss on a locational exchange power
contract.  The decrease for the six months ended June 30, 2008 as
compared to the same period in 2007 was primarily due to the reversal in 2007 of
the loss reserve and settlement of a physically delivered natural gas supply
contract for PSE’s electric generating facilities along with an increase in the
loss of a locational exchange power contract.  The decrease was offset
by an unrealized gain on the ineffective portion of a cash flow hedge due to
increase in future wholesale market electric prices as compared to the contract
price.


Utility operations and maintenanceexpense increased $17.6 million and $31.5 million for the three and six
months ended June 30, 2008, respectively, as compared to the same period in
2007.  The increase for the three months ended June 30, 2008 was
primarily due to an increase of $5.5 million in production operations and
maintenance at PSE’s generating facilities, $3.8 million increase in electric
transmission and distribution expenses, $3.6 million increase in administrative
and general costs, $3.5 million higher gas operations and distribution costs and
a $1.3 million increase in customer service costs.  The increase for
the six months ended June 30, 2008 was primarily due to $18.5 million in
production operations and maintenance at PSE’s generating facilities, $5.8
million increases in gas operations and distribution costs, $3.6 million
increase in administrative and general costs, and $2.9 million increase in
customer service costs.


Non-utility expense and other
decreased $2.9 million for the six months ended June 30, 2008, as compared to
the same period in 2007 primarily due to a decrease in PSE’s long-term incentive
plan costs.


Depreciation and amortization
expense increased $10.5 million and $16.3 million for the three and six months
ended June 30, 2008, respectively, as compared to the same period in
2007.  These increases include the benefit of the 2007 deferral of
Goldendale ownership and operating costs of $5.9 million and $6.9 million for
the three and six months ended June 30, 2007, respectively, which, had it not
been included, would have resulted in an increase to depreciation and
amortization expense of $4.6 million and $9.3 million for the three and six
months ended June 30 2008, respectively, as compared to the same periods in
2007.  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. The increase, excluding Goldendale deferral, was primarily
due to placing additional utility plants into service during the last 12
months.


Conservation amortization
increased $6.8 million and $9.8 million for the three and six months ended June
30, 2008, respectively, as compared to the same period in 2007 due to higher
authorized recovery of electric conservation
expenditures.  Conservation amortization is a pass-through tariff item
with no impact on earnings.


Taxes other than income taxes
increased $0.4 million and $7.6 million for the three and six months ended June
30, 2008, respectively, as compared to the same period in 2007.  The
increase for the three months ended June 30, 2008 was due to increases in
revenue-based Washington State excise tax and municipal tax due to increased
operating revenue.  Revenue sensitive Washington State excise and
municipal taxes have no impact on earnings.  Excluding the impact of
revenue sensitive taxes, taxes other than income taxes decreased $5.0 million
primarily as a result of truing up 2007 levy rates based on property tax
billings.  The increase for the six months ended June 30, 2008 was due
to increases in revenue-based Washington State excise tax and municipal tax as a
result of increased operating revenues.




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


The table
below sets forth significant changes in other income, other expenses, interest
expense and income tax expense for PSE and its subsidiaries for the three months
ended June 30, 2008 as compared to the same period in 2007.





(Dollars
      in Millions)
              Three
      Months Ended June 30,
            
            2008
            
            
            2007
            
            
            Change
            
            
            Percent
              ChangeOther
      income
            
            $
            8.1
            
            
            $
            6.2
            
            
            $
            1.9
            
            
            
            30.6
            %Other
      expense
            
            
            (0.8
            )
            
            
            (2.8
            )
            
            
            2.0
            
            
            
            71.4Interest
      charge
            
            
            (47.0
            )
            
            
            (49.6
            )
            
            
            2.6
            
            
            
            5.2Income
      tax expense
            
            
            (13.3
            )
            
            
            (17.7
            )
            
            
            4.4
            
            
            
            24.9





Other incomeincreased $1.9
million for the three months ended June 30, 2008 as compared to the same period
in 2007 primarily due a $0.9 million increase related to Washington Commission
Allowance for Funds Used During Construction (AFUDC) and $0.6 million increase
due to Washington Commission AFUDC equity.


Other expensedecreased $2.0
million for the three months ended June 30, 2008 as compared to the same period
in 2007 primarily due to the accrual in 2007 of a recordkeeping violation
penalty assessed by the Washington Commission, which is not
tax-deductible.


Interest expensedecreased
$2.6 million due primarily to the decrease in average debt outstanding as a
result of the equity issuance in December 2007 and lower average interest rates
on outstanding debt.


Income tax expensedecreased
$4.4 million for the three months ended June 30, 2008 as compared to the same
period in 2007 due primarily to a lower effective tax rate as a result of an
increased amount of production tax credits.


The table
below sets forth significant changes in other income, interest charges and
income taxes for PSE and its subsidiaries for the six months ended June 30, 2008
compared to the same period in 2007.





(Dollars
      in Millions)
              Six
      Months Ended June 30,
            
            2008
            
            
            2007
            
            
            Change
            
            
            Percent
              ChangeOther
      income
            
            $
            14.9
            
            
            $
            11.0
            
            
            $
            3.9
            
            
            
            35.5
            %Other
      expense
            
            
            (1.8
            )
            
            
            (3.9
            )
            
            
            2.1
            
            
            
            53.8Interest
      charge
            
            
            (95.8
            )
            
            
            (98.8
            )
            
            
            3.0
            
            
            
            3.0Income
      tax expense
            
            
            (49.0
            )
            
            
            (51.7
            )
            
            
            2.7
            
            
            
            5.2





Other incomeincreased $3.9
million for the six months ended June 30, 2008 compared to the same period in
2007 primarily due to an increase in Washington Commission AFUDC and an increase
in regulatory interest on the Residential Exchange Regulatory
Asset.


Other expensesdecreased $2.1
million for the six months ended June 30, 2008 compared to the same period in
2007 primarily due to a decrease in non-tax deductible penalties of $2.3
million. The decrease is primarily related to the 2007 recordkeeping violation
penalty assessed by the Washington Commission, which is not
tax-deductible.


Interest expensedecreased
$3.0 million due primarily to lower average debt outstanding as a result of the
equity issuance in December 2007 and lower average interest rate on outstanding
debt.


Income tax expensedecreased
$2.7 million for the six months ended June 30, 2008 compared to the same period
in 2007 due primarily to higher tax credits associated with the production of
wind-powered energy.  The production tax credits for the six months
ended June 30, 2008 increased $3.7 million compared to the same period in
2007.






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 June 30, 2008:





Puget
      Energy
            
            
            
            Payments
      Due Per PeriodContractual
      Obligations
              (Dollars
      in Millions)
            Total
            2008
            2009-
              2010
            2011-
              2012
            2013
      &
              ThereafterLong-term
      debt including interest
            $
            6,283.1
            $
            209.2
            $
            712.8
            $
            520.9
            $
            4,840.2Short-term
      debt including interest
            
            286.6
            
            286.6
            
            --
            
            --
            
            --Mandatorily
      redeemable preferred stock
            
            1.9
            
            --
            
            --
            
            --
            
            1.9Service
      contract obligations
            
            398.0
            
            36.8
            
            128.4
            
            94.5
            
            138.3Non-cancelable
      operating leases
            
            162.7
            
            8.3
            
            50.9
            
            25.7
            
            77.8Fredonia
      combustion turbines lease 1
            
            49.5
            
            2.3
            
            7.7
            
            39.5
            
            --Energy
      purchase obligations
            
            6,962.0
            
            910.1
            
            2,307.8
            
            1,220.6
            
            2,523.5Contract initiation payment/collateral requirement
            
            18.5
            
            --
            
            --
            
            18.5
            
            --Financial
      hedge obligations
            
            (154.0
            )
            (64.6
            )
            (89.4
            )
            --
            
            --Purchase
      obligations
            
            66.1
            
            27.3
            
            22.7
            
            --
            
            16.1Pension and other benefits funding and payments
            
            40.3
            
            4.5
            
            8.1
            
            8.0
            
            19.7Other obligations
            
            6.7
            
            6.7
            
            --
            
            --
            
            --Total
      contractual cash obligations
            $
            14,121.4
            $
            1,427.2
            $
            3,149.0
            $
            1,927.7
            $
            7,617.5








Puget
      Energy
            
            
            
            Amount
      of Commitment
              Expiration
      Per PeriodCommercial
      Commitments
              (Dollars
      in Millions)
            Total
            2008
            2009-
              2010
            2011-
              2012
            2013
      &
              ThereafterCredit
      agreement - available 2
            $
            671.0
            $
            --
            $
            --
            $
            671.0
            $
            --Receivable
      securitization facility 3
            
            85.0
            
            --
            
            85.0
            
            --
            
            --Energy
      operations letter of credit
            
            7.4
            
            7.4
            
            --
            
            --
            
            --Total
      commercial commitments
            $
            763.4
            $
            7.4
            $
            85.0
            $
            671.0
            $
            --





1
            See
      “Fredonia 3 and 4 Operating Lease” under “Off-Balance Sheet Arrangements”
      below.2
            At
      June 30, 2008, PSE had available a $500.0 million and a $350.0 million
      unsecured credit agreements expiring in April 2012.  The credit
      agreements provide credit support for letters of credit and commercial
      paper.  At June 30, 2008, PSE had $7.4 million outstanding under
      four letters of credit and $171.6 million commercial paper outstanding,
      effectively reducing the available borrowing capacity to $671
      million.3
            At
      June 30, 2008, PSE had available a $200.0 million receivables
      securitization facility that expires in December 2010.  $115.0
      million was outstanding under the receivables securitization facility at
      June 30, 2008 thus leaving $85.0 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 June 30, 2008:





Puget
      Sound Energy
            
            Payments
      Due Per PeriodContractual
      Obligations
              (Dollars
      in Millions)
            Total
            2008
            2009-
              2010
            2011-
              2012
            2013
      &
              ThereafterLong-term
      debt including interest
            $
            6,283.1
            $
            209.2
            $
            712.8
            $
            520.9
            $
            4,840.2Short-term
      debt including interest
            
            311.7
            
            311.7
            
            --
            
            --
            
            --Mandatorily
      redeemable preferred stock
            
            1.9
            
            --
            
            --
            
            --
            
            1.9Service
      contract obligations
            
            398.0
            
            36.8
            
            128.4
            
            94.5
            
            138.3Non-cancelable
      operating leases
            
            162.7
            
            8.3
            
            50.9
            
            25.7
            
            77.8Fredonia
      combustion turbines lease 1
            
            49.5
            
            2.3
            
            7.7
            
            39.5
            
            --Energy
      purchase obligations
            
            6,962.0
            
            910.1
            
            2,307.8
            
            1,220.6
            
            2,523.5Contract initiation payment/collateral requirement
            
            18.5
            
            --
            
            --
            
            18.5
            
            --Financial
      hedge obligations
            
            (154.0
            )
            (64.6
            )
            (89.4
            )
            --
            
            --Purchase
      obligations
            
            66.1
            
            27.3
            
            22.7
            
            --
            
            16.1Pension and other benefits funding and payments
            
            40.3
            
            4.5
            
            8.1
            
            8.0
            
            19.7Other obligations
            
            6.7
            
            6.7
            
            --
            
            --
            
            --Total
      contractual cash obligations
            $
            14,146.5
            $
            1,452.3
            $
            3,149.0
            $
            1,927.7
            $
            7,617.5




Puget
      Sound Energy
              
              
              
              Amount
      of Commitment
                Expiration
      Per PeriodCommercial
      Commitments
                (Dollars
      in Millions)
              Total
              2008
              2009-
                2010
              2011-
                2012
              2013
      &
                ThereafterCredit
      agreement - available 2
              $
              671.0
              $
              --
              $
              --
              $
              671.0
              $
              --Receivable
      securitization facility 3
              
              85.0
              
              --
              
              85.0
              
              --
              
              --Energy
      operations letter of credit
              
              7.4
              
              7.4
              
              --
              
              --
              
              --Total
      commercial commitments
              $
              763.4
              $
              7.4
              $
              85.0
              $
              671.0
              $
              --


________________


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





Off-Balance
Sheet Arrangements


Fredonia 3 and 4 Operating
Lease.PSE
leases two combustion turbines for its Fredonia 3 and 4 electric generating
facility pursuant to a master operating lease that was amended for this purpose
in April 2001.  The lease has a term expiring in 2011, but can be
canceled by PSE at any time.  Payments under the lease vary with
changes in the London Interbank Offered Rate (LIBOR).  At June 30,
2008, PSE’s outstanding balance under the lease was $46.9
million.  The expected residual value under the lease is the lesser of
$37.4 million or 60.0% of the cost of the equipment.  In the event the
equipment is sold to a third party upon termination of the lease and the
aggregate sales proceeds are less than the unamortized value of the equipment,
PSE would be required to pay the lessor contingent rent in an amount equal to
the deficiency up to a maximum of 87.0% of the unamortized value of the
equipment.





Utility
Construction Program


PSE’s
construction programs for generating facilities, the electric transmission
system and the natural gas and electric distribution systems are designed to
meet continuing customer growth and to support reliable energy
delivery.  The cash flow construction expenditures, excluding equity
AFUDC and customer refundable contributions was $251.3 million for the three
months ended June 30, 2008.  The anticipated utility construction
expenditures, excluding AFUDC, for 2008, 2009 and 2010 are:





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









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





Capital
Resources


Cash
From Operations


Cash
generated from operations for the six months ended June 30, 2008 was $507.8
million, which is 179.6% of the $282.8 million cash used for utility
construction expenditures and other capital expenditures. For the six months
ended June 30, 2007, cash from operations was $345.9 million, which was 87.7% of
the $394.2 million cash used for utility construction expenditures and other
capital expenditures.


The
overall cash generated from operating activities for the six months ended June
30, 2008 increased $161.9 million compared to the same period in
2007.  The increase was primarily the result of lower cash payments of
$122.5 million related to accounts payable, cash received in 2008 compared to
payments in 2007 related to the REP which contributed $58.1 million and income
tax refunds of $42.4 million.  Further, cash from operations increased
due to lower cash payments for prepaid expenses of $27.3 million, lower cash
payments of $16.2 million related to deferred storm damage costs and $16.0
million recovery in materials and supplies for the six months ended June 30,
2008.  Cash from operations also increased due to $9.8 million
collection of energy conservation expenditures.  The increase was
partially offset by a reduction of the purchased gas liability in 2008 of $51.1
million as compared to under collection of $81.4 million in 2007, which resulted
in a decrease in cash of $132.5 million.  In addition, the increase
was offset by a cash receipt of $18.9 million in 2007 from the lease purchase
option settlement for the Bellevue offices.





Financing
Program


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




Restrictive
Covenants


In
determining the type and amount of future financing, PSE may be limited by
restrictions contained in its electric and natural gas mortgage indentures,
restated articles of incorporation and certain loan agreements.  Under
the most restrictive tests, at June 30, 2008, PSE could issue:


·
            approximately
      $742.0 million of additional first mortgage bonds under PSE’s electric
      mortgage indenture based on approximately $1.2 billion 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 June 30,
      2008;


·
            approximately
      $507.0 million of additional first mortgage bonds under PSE’s natural gas
      mortgage indenture based on approximately $845.0 million of gas bondable
      property available for issuance, subject to interest coverage ratio
      limitations of 1.75 times and 2.0 times net earnings available for
      interest (as defined in the natural gas utility mortgage), which PSE
      exceeded at June 30, 2008;


·
            approximately
      $1.3 billion of additional preferred stock at an assumed dividend rate of
      8.5%; and


·
            approximately
      $771.9 million of unsecured long-term
debt.


At June
30, 2008, PSE had approximately $4.8 billion in electric and natural gas
ratebase to support the interest coverage ratio limitation test for net earnings
available for interest.





Credit
Ratings


Neither
Puget Energy nor PSE has any debt outstanding that would accelerate debt
maturity upon a credit rating downgrade.  A ratings downgrade could
adversely affect the ability to renew existing, or obtain access to new credit
facilities and could increase the cost of such facilities.  For
example, under PSE’s revolving credit facility, the borrowing costs and
commitment fee increase as PSE’s secured long-term debt ratings
decline.  A downgrade in commercial paper ratings could preclude PSE’s
ability to issue commercial paper under its current programs.  The
marketability of PSE commercial paper is currently limited by the A-3/P-2
ratings by Standard & Poor’s and Moody’s Investors Service.  In
addition, downgrades in PSE’s debt ratings may prompt counterparties to require
PSE to post a letter of credit or other collateral, make cash prepayments,
obtain a guarantee or provide other security.





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




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


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


Shelf
Registrations, Long-Term Debt and Common Stock Activity


Liquidity
Facilities and Commercial Paper


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





PSE
Credit Facilities


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





Credit
Agreements.  In March 2007, PSE entered into a five-year,
$350.0 million credit agreement with a group of banks.  The agreement
is used to support the Company’s energy hedging activities and may also be used
to provide letters of credit.  The interest rate on outstanding
borrowings is based either on the agent bank’s prime rate or on LIBOR plus a
marginal rate related to PSE’s long-term credit rating at the time of
borrowing.  PSE pays a commitment fee on any unused portion of the
credit agreement also related to long-term credit ratings of PSE.  At
June 30, 2008, there were no borrowings or letters of credit outstanding under
the credit facility.


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


At June
30, 2008, there was $7.4 million outstanding under four letters of credit and
$171.6 million commercial paper outstanding, effectively reducing the available
borrowing capacity under the two credit agreements to $671.0
million.





Receivables Securitization
Facility.  PSE entered into a five-year Receivable Sales
Agreement with PSE Funding, Inc. (PSE Funding), a wholly owned subsidiary, on
December 20, 2005.  Pursuant to the Receivables Sales Agreement, PSE
sells all of its utility customer accounts receivable and unbilled utility
revenues to PSE Funding.  In addition, PSE Funding entered into a Loan
and Servicing Agreement with PSE and two banks.  The Loan and
Servicing Agreement allows PSE Funding to use the receivables as collateral to
secure short-term loans, not exceeding the lesser of $200.0 million or the
borrowing base of eligible receivables which fluctuate with the seasonality of
energy sales to customers.  All loans from this facility are reported
as short-term debt in the financial statements.  The PSE Funding
facility expires in December 2010, and is terminable by PSE and PSE Funding upon
notice to the banks.  There were $115.0 million in loans that were
secured by accounts receivable pledged at June 30, 2008.  The
remaining borrowing base of eligible receivables at June 30, 2008 was $85.0
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 June 30, 2008, the outstanding balance
of the Note was $25.0 million.  The outstanding balance and the
related interest under the Note are eliminated by Puget Energy upon
consolidation of PSE’s financial statements.





Stock
Purchase and Dividend Reinvestment Plan


Puget
Energy has a Stock Purchase and Dividend Reinvestment Plan pursuant to which
shareholders and other interested investors may invest cash and cash dividends
in shares of Puget Energy common stock.  Since new shares of common
stock may be purchased directly from Puget Energy, funds received may be used
for general corporate purposes.  Puget Energy did not issue common
stock under the Stock Purchase and Dividend Reinvestment Plan for the three and
six months ended June 30, 2008, as compared to $3.2 million (124,995 shares) and
$6.5 million (255,891 shares) for the three and months ended June 30, 2007,
respectively.  The proceeds from sales of stock under the Stock
Purchase and Dividend Reinvestment Plan are used for general corporate
needs.  Pending the outcome of the merger, Puget Energy intends to
fund the Stock Purchase and Dividend Reimbursement Plan with shares acquired in
the public markets.





Common
Stock Offering Programs


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








Other





Regulation
and Rates


On December 3, 2007, PSE filed a general rate case with the Washington
Commission which proposed an increase in electric rates of $174.5 million, and
in an increase in natural gas rates of $56.8 million, effective November 3,
2008.  PSE requested a weighted cost of capital of 8.6%, or 7.29%
after-tax, and a capital structure that included 45.0% common equity with a
return on equity of 10.8%.  In July 2008, PSE filed rebuttal testimony
and revised its proposed increase in electric rates to $165.2 million and
natural gas rates to $55.5 million.  PSE expects an order to be issued
by the Washington Commission no later than October 31, 2008.


In
November 2007, the Western Electricity Coordinating Council (WECC) audited PSE’s
compliance with electric reliability standards adopted by FERC, the North
American Electric Reliability Corporation (NERC) and/or
WECC.  Compliance with these standards includes periodic
self-certifications of compliance, self-reports of violations after discovery of
the violation, spot checks to review self-certifications and external audits
that review compliance with designated standards in detail.  The WECC
audit team identified four potential violations of the standards that PSE had
not previously self-reported.  Several months after the audit, WECC
issued a “Notice of Alleged Violations” to PSE, adding details and proposed
penalties to the proposed findings.  Under the rules for the process,
PSE met with WECC representatives in July to discuss settlement.  PSE
is hopeful that all issues concerning the four potential violations will be
resolved.  Resolution of reliability standards issues will be an
ongoing concern, however, PSE self-reports violations when they are
discovered.  Such self-reports could result in settlement of issues or
issuances of penalties in the future.


In May
2007, the Washington Commission Staff alleged that PSE’s natural gas system
service provider had violated certain Washington Commission recordkeeping
rules.  On April 3, 2008, the Washington Commission issued an order
approving a settlement agreement that requires PSE to pay a regulatory penalty
of $1.25 million, to establish a quality assurance program to better monitor its
subcontractors and to complete an independent audit of natural gas system
recordkeeping procedures.





Accounting
Petition.  On August 29, 2007, the Washington Commission
approved PSE’s accounting petition to defer as a regulatory asset the excess BPA
REP benefit provided to customers and accrue monthly carrying charges on the
deferred balance from June 7, 2007 until the deferral is recovered from
customers or BPA.


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


On April 10, 2008, the Washington
Commission approved PSE’s tariff filing seeking to pass-through the net amount
of the benefits under the interim agreements to residential and small farm
customers.  The Washington Commission also approved PSE’s request to
credit the regulatory asset amount of $33.7 million against the $53.7 million
payment and pass-through to customers the remaining amount of approximately
$20.0 million.  The accrued carrying charges on the regulatory asset
totaling $3.1 million at June 30, 2008 will be addressed in PSE’s pending
general rate case (Docket No. UE-072300).




Colstrip
Matters


In May
2003, approximately 50 plaintiffs initiated an action against the owners of
Colstrip alleging that (1) seepage from two different wastewater pond areas
caused groundwater contamination and threatened to contaminate domestic water
wells and the Colstrip water supply pond, and (2) seepage from the Colstrip
water supply pond caused structural damage to buildings and toxic
mold.  The defendants reached agreement on a global settlement with
all plaintiffs on April 29, 2008 and PSE paid its share of the settlement in the
amount of $10.7 million in July 2008.  PSE had previously expensed the
settlement in the first quarter 2008.  PSE has also filed an
accounting petition with the Washington Commission to recover such costs in the
future.


The
Minerals Management Service of the United States Department of Interior
(MMS) has issued a series of orders to Western Energy Company (WECO) to pay
additional taxes and royalties concerning coal WECO sold to the owners of
Colstrip 3 & 4, and similar orders have been issued in the administrative
appellate process.  The orders assert that additional royalties are
owed in connection with payments received by WECO from Colstrip 3
& 4 owners (including PSE) for the construction and operation of a
conveyor system that runs several miles from the mine to Colstrip 3 &
4.  The state of Montana has also issued a demand to WECO consistent
with the MMS position.  WECO has challenged these orders, and the
issue has been on appeal for several years.WECO has won
some points during the appellate process that have reduced the claims; however
under applicable law, to pursue the appeals, the principal in dispute cannot be
paid, which causes interest to accrue.  Moreover, because the conveyor
system continues to be used, the amount in
dispute grows.  In the aggregate, the accrued interest
plus unasserted claims to bring the amount current could make the
total claim (principal plus interest) pertaining to PSE’s 25.0% project share as
high as $10.0 million.  PSE and the other Colstrip 3 & 4 owners
authorized WECO to make a settlement offer to the Montana Department of Revenue
(DOR) and the MMS in Connection with these claims.  PSE recorded a
$1.2 million pre-tax loss reserve in the second quarter of 2008 in that
regard.





Proceedings
Relating to the Western Power Market


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


Lockyer Case.In
March and April 2008, FERC issued orders establishing procedures for the Lockyer
remand.  The orders commence a seller-by-seller inquiry into the
transaction reports filed by entities that sold power in California during
2000.  The inquiry is to determine if the transaction reports as filed
masked the gathering of more than 20% of the market during the period, by that
seller.  PSE is confident that it will not be found to have possessed
20% of any relevant market during any relevant time.  The order also
mandates a settlement process before an Administrative Law Judge
(ALJ).  FERC staff and the ALJ requested data concerning energy
sellers’ transactions, and PSE provided such data to FERC
staff.  Settlement talks among various parties continue but PSE cannot
predict the ultimate outcome of any negotiations or subsequent process before
FERC or the ALJ.


California Receivable and California
Refund Proceeding.The California Independent System Operator (CAISO)
filed status reports in this matter from time to time, but has yet to report its
“who owes what to whom” calculation.




Proceeding
Relating to the Bonneville Power Administration


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


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


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.  On October 11, 2007, the Ninth
Circuit remanded the May 2004 agreement to BPA in light of the Portland Gen. Elec. V. BPA
opinion and dismissed the remaining three pending cases regarding settlement
agreements.


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


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


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




Proceeding
Relating to the Proposed Merger


On
February 6, 2008, the Company entered into a memorandum of understanding
providing for the settlement of the consolidated shareholder lawsuit, subject to
customary conditions including completion of appropriate settlement
documentation, confirmatory discovery and court approval.  Pursuant to
the memorandum of understanding, the Company agreed to include certain
additional disclosures in its proxy statement relating to the
merger.  The Company does not admit, however, that its prior
disclosures were in any way materially misleading or inadequate.  In
addition, the Company and the other defendants in the consolidated lawsuit deny
the plaintiffs’ allegations of wrongdoing and violation of law in connection
with the merger.  The settlement, if completed and approved by the
court, will result in dismissal with prejudice and release of all claims of the
plaintiffs and settlement class of the Company’s shareholders that were or could
have been brought on behalf of the plaintiffs and the settlement
class.  In connection with such settlement, the plaintiffs intend to
seek a court-approved award of attorneys’ fees and expenses in an amount up to
$290,000, which the Company has agreed to pay.  As of June 30, 2008,
the Company has a loss reserve of $290,000.




New
Accounting Pronouncements


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


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


In
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations”
(SFAS No. 141 (R)).  This Statement replaces FASB Statement No. 141,
“Business Combinations” and addresses the accounting for all transactions or
other events in which an entity obtains control of one or more
businesses.  The objective of this Statement is to improve the
relevance, representational faithfulness and comparability of the information
that a reporting entity provides in its financial reports about a business
combination and its effects. To accomplish that, this Statement establishes
principles and requirements for how the acquirer: 1) Recognizes and measures in
its financial statements the identifiable assets acquired, the liabilities
assumed and any noncontrolling interest in the acquiree; 2) Recognizes and
measures the goodwill acquired in the business combination or a gain from a
bargain purchase; and 3) Determines what information to disclose to enable users
of the financial statements to evaluate the nature and financial effects of the
business combination.  This Statement shall be applied prospectively
to business combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or after December
15, 2008.  The Company does not expect any impact from SFAS No. 141
(R).


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


In May
2008, FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting
Principles” (SFAS No. 163), which identifies the sources of accounting
principles and the framework for selecting the principles to be used in the
preparation of financial statements of nongovernmental entities that are
presented in conformity with generally accepted accounting
principles.  The FASB Board is responsible for identifying the sources
of accounting principles and providing entities with a framework for selecting
the principles used in the preparation of financial.  The current GAAP
hierarchy, as set forth in the American Institute of Certified Public
Accountants Statement on Auditing Standards No. 69, “The Meaning of Present
Fairly in Conformity With Generally Accepted Accounting Principles”, has been
criticized because it is directed to the auditor rather than the entity, it is
complex and it ranks FASB Statements of Financial Accounting Concepts, which are
subject to the same level of due process as FASB Statements of Financial
Accounting Standards, below industry practices that are widely recognized as
generally accepted but that are not subject to due process.  The Board
believes that the GAAP hierarchy should be directed to entities because it is
the entity that is responsible for selecting accounting principles for financial
statements that are presented in conformity with GAAP.  The Company
has reviewed the statement and has assessed there will be no significant impact
to the financial statements.


On June
16, 2008, FSP No. EITF 03-6-1, “Determining Whether Instruments Granted in
Share-Based Payment Transactions Are Participating Securities”, was
issued.  This FSP addresses whether instruments granted in share-based
payment transactions are participating securities prior to vesting and,
therefore, need to be included in the earnings allocation in computing earnings
per share under the two-class method.  Unvested share-based payment
awards that contain nonforfeitable rights to dividends or dividend equivalents
(whether paid or unpaid) are participating securities and shall be included in
the computation of EPS pursuant to the two-class method.  The Company
is currently assessing the financial statement presentation impact of FSP EITF
No. 03-6-1.


Item 3.   Quantitative
and Qualitative Disclosure About Market Risk




Energy
Portfolio Management


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


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





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







The following table presents electric derivatives that are designated as cash
flow hedges or contracts that do not meet Normal Purchase Normal Sale (NPNS) at
June 30, 2008 and December 31, 2007:


Electric
              Derivatives


(Dollars
      in Millions)
            
            June
      30,
              2008
            
            
            December
      31,
              2007Short-term
      asset
            
            $
            115.5
            
            
            $
            11.1Long-term
      asset
            
            
            143.1
            
            
            
            6.6Total
      assets
            
            $
            258.6
            
            
            $
            17.7Short-term
      liability
            
            $
            7.2
            
            
            $
            9.8Long-term
      liability
            
            
            6.6
            
            
            
            --Total
      liabilities
            
            $
            13.8
            
            
            $
            9.8




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


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


The
following tables present the impact of changes in the market value of derivative
instruments not meeting NPNS or cash flow hedge criteria, and ineffectiveness
related to highly effective cash flow hedges, to the Company’s earnings during
the three and six months ended June 30, 2008 and June 30, 2007:





(Dollars
      in Millions)
              Three
      Months Ended June 30,
            2008
            2007
            ChangeIncrease
      (decrease) in earnings
            $
      2.4
            $
      (1.5)
            $  3.9








(Dollars
      in Millions)
              Six
      Months Ended June 30,
            2008
            2007
            ChangeIncrease
      (decrease) in earnings
            $
      2.3
            $  4.2
            $ (1.9)




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


The
amount of net unrealized gain (loss), net of tax, related to the Company’s cash
flow hedges under SFAS No. 133 consisted of the following at June 30, 2008 and
December 31, 2007:





(Dollars
      in Millions, net of tax)
            June
      30,
              2008
            December
      31,
              2007Other
      comprehensive income – unrealized gain (loss)
            $
      161.9
            $  (3.4)







The following table presents derivative hedges of natural gas contracts to serve
natural gas customers at June 30, 2008 and December 31, 2007:


Gas
              Derivatives(Dollars
      in Millions)
            
            June
      30,
              2008
            
            
            December
      31,
              2007Short-term
      asset
            
            $
            132.2
            
            
            $
            6.0Long-term
      asset
            
            
            56.3
            
            
            
            5.3Total
      assets
            
            $
            188.5
            
            
            $
            11.3Short-term
      liability
            
            $
            1.4
            
            
            $
            17.3Long-term
      liability
            
            
            3.2
            
            
            
            --Total
      liabilities
            
            $
            4.6
            
            
            $
            17.3





At June
30, 2008, the Company had total assets of $188.6 million and total liabilities
of $4.6 million related to hedges of natural gas contracts to serve natural gas
customers.  All mark-to-market adjustments relating to the natural gas
business have been reclassified to a deferred account in accordance with SFAS
No. 71 due to the PGA mechanism.  All increases and decreases in the
cost of natural gas supply are passed on to customers with the PGA
mechanism.  As the gains and losses on the hedges are realized in
future periods, they will be recorded as natural gas costs under the PGA
mechanism.


A
hypothetical 10.0% decrease in the market prices of natural gas and electricity
would decrease the fair value of qualifying cash flow hedges by $59.4 million
after-tax, with a corresponding impact in comprehensive income and earnings (due
to ineffectiveness) of $57.9 million and $1.5 million, respectively, after-tax,
and would increase the fair value of those contracts marked-to-market in
earnings by $1.2 million after-tax.




Credit
Risk


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


It is possible that extreme volatility
in energy commodity prices could cause the Company to have credit risk exposures
with one or more counterparties.  If such counterparties fail to
perform their obligations under one or more agreements, the Company could suffer
a material financial loss.  However, as of June 30, 2008,
approximately 92.0% of the counterparties with transaction amounts outstanding
in the Company’s energy portfolio are rated at least investment grade by the
major rating agencies.  The Company assesses credit risk internally
for counterparties that are not rated.




Interest
Rate Risk


The Company believes its interest rate
risk primarily relates to the use of short-term debt instruments, variable-rate
notes and leases and anticipated long-term debt financing needed to fund capital
requirements.  The Company manages its interest rate risk through the
issuance of mostly fixed-rate debt of various maturities.  The Company
utilizes commercial paper, line of credit facilities and accounts receivable
securitization to meet short-term cash requirements.  These short-term
obligations are commonly refinanced with fixed-rate bonds or notes when needed
and when interest rates are considered favorable.  The Company may
enter into swap instruments or other financial hedge instruments to manage the
interest rate risk associated with these debts.


The ending balance in other
comprehensive income related to the forward starting swaps and previously
settled treasury lock contracts at June 30, 2008 was a net loss of $8.0 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 June 30, 2008, the end of the period covered by this
report.  Based upon that evaluation, the Chairman, President and Chief
Executive Officer and the Executive Vice President and Chief Financial Officer
of Puget Energy concluded that these disclosure controls and procedures are
effective.




Changes
in Internal Control Over Financial Reporting


There have been no changes in Puget
Energy’s internal control over financial reporting during the quarter ended June
30, 2008 that have materially affected, or are reasonably likely to materially
affect, Puget Energy’s internal control over financial reporting.




Puget
Sound Energy


Evaluation
of Disclosure Controls and Procedures


Under the supervision and with the
participation of PSE’s management, including the Chairman, President and Chief
Executive Officer and the Executive Vice President and Chief Financial Officer,
PSE has evaluated the effectiveness of its disclosure controls and procedures
(as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of
June 30, 2008, the end of the period covered by this report.  Based
upon that evaluation, the Chairman, President and Chief Executive Officer and
the Executive Vice President and Chief Financial Officer of PSE concluded that
these disclosure controls and procedures are effective.




Changes
in Internal Control Over Financial Reporting


There have been no changes in PSE’s
internal control over financial reporting during the quarter ended June 30,
2008, 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 June 30,
2008.  The ultimate resolution of these issues in part or in the
aggregate is not expected to have a material adverse impact on the financial
condition, results of operations or liquidity of the Company.




Item
1A.           Risk
Factors





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




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




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





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





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





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





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




Item
6.              Exhibits




See
Exhibit Index for list of exhibits.











SIGNATURES


Pursuant
to the requirements of the Securities Exchange Act of 1934, each registrant has
duly caused this report to be signed on their behalf by the undersigned
thereunto duly authorized.





PUGET
      ENERGY, INC.PUGET
      SOUND ENERGY, INC./s/
      James W. EldredgeJames
      W. EldredgeVice
      President, Controller and Chief Accounting OfficerDate:  August
      4, 2008Chief
      accounting officer and officer duly authorized to sign this report on
      behalf of each registrant





EXHIBIT
INDEX





The following exhibits are filed
herewith:





12.1
            Statement
      setting forth computation of ratios of earnings to fixed charges (2003
      through 2007 and 12 months ended June 30, 2008) for Puget
      Energy.12.2
            Statement
      setting forth computation of ratios of earnings to fixed charges (2003
      through 2007 and 12 months ended June 30, 2008) for
PSE.31.1
            Chief
      Executive Officer certification of Puget Energy pursuant to 18 U.S.C.
      Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
      of 2002.31.2
            Chief
      Financial Officer certification of Puget Energy pursuant to 18 U.S.C.
      Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
      of 2002.31.3
            Chief
      Executive Officer certification of Puget Sound Energy pursuant to 18
      U.S.C. Section 1350, as adopted pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.4
            Chief
      Financial Officer certification of Puget Sound Energy pursuant to 18
      U.S.C. Section 1350, as adopted pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.1
            Chief
      Executive Officer certification pursuant to 18 U.S.C. Section 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.32.2
            Chief
      Financial Officer certification pursuant to 18 U.S.C. Section 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.