With investors sweating bullets over the carnage enveloping energy stocks, executives with Phoenix-based electric utility Pinnacle West Capital Corp. last Tuesday assured the financial community that its earnings are improving over the short term and its counterparty risk with two of the sector’s most troubled players, Williams and Dynegy, is minimal.

“It looks like the market’s telling us that Williams and Dynegy are going to go bankrupt here any second,” said an analyst participating in Pinnacle West’s second quarter earnings conference call, as a lead-in to questioning company executives about whether Pinnacle West has any counterparty risk with the two companies.

“We have actually some, but again it’s not significant and with netting of various exposures, it’s a very manageable exposure,” a Pinnacle West executive responded.

That answer didn’t satisfy the analyst. “What’s manageable? Give me an idea,” the analyst pressed the utility’s management. “If these guys go bankrupt tomorrow, which it looks like maybe sometime in the next week it’s going to happen, do we have to worry about an impact?” In response, the Pinnacle West official said he didn’t think such a scenario would materially alter Pinnacle West’s earnings potential.

Meanwhile, Jack Davis, president of Pinnacle West, parent of Arizona Public Service, used Tuesday’s conference call to offer a glum assessment of the western power market. “The market is currently illiquid and volumes are practically non-existent,” Davis said. “Market prices are low and there’s very little volatility.” He said that some of the factors behind the decrease in liquidity in the western markets include “perceived uncertainty” around the sanctity of contracts, the reduction in the use of online trading systems and wider bid/ask spreads.

Davis also offered some interesting comments on FERC’s recent move to continue a Westwide power price cap for generators starting Oct. 1 at the $250/MWh level. “This represents almost a tripling of the existing cap,” Davis pointed out. “So far, though, the forward curve for electricity here in the West has not seen much movement as a result of the cap increase.”

But Davis said that this is “not surprising at this point in time due to other uncertainties that overhang the electricity market.” The Pinnacle West executive said that “many parties may be working off hedges taken earlier and there may be significant reduction in the amount of unhedged positions compared to previous positions.”

Pinnacle West reported consolidated net income for its most recent second quarter of $75.4 million, or $0.89 per diluted share of common stock, compared with net income of $66.9 million, or $0.79 per share, for the same quarter a year ago, an increase of 13%.

While the utility could boast of solid results for the most recent second quarter, Pinnacle West management warned investors on Tuesday that results for the entire year are not likely to match the utility’s performance in 2001.

“We have indicated since last October that matching 2001 earnings this year would be a real challenge, based on an assumed 50% reduction in power marketing margins,” said Pinnacle West Chairman Bill Post in a prepared statement. “It now appears that we will not be able to repeat last year’s earnings because the contribution from power marketing is expected to be down 75% from the record levels of 2001.”

Pinnacle West also announced cost-containment measures that include a voluntary workforce reduction of 500-600 positions. These reductions will be implemented in the second half of this year and are expected to produce annual operating expense savings of $30-35 million beginning in 2003, and a comparable one-time charge to earnings later in 2002.

The company said that second quarter wholesale power sales were 4.8 billion kWh, down about 2.9% from the comparable period in 2001. On a brighter note, the retail service territory of subsidiary Arizona Public Service Co. continued to experience strong customer growth of 3.2%, about three times the national average. Retail energy sales were about the same as the comparable year-ago period as the increase in customer growth was offset by the effects of milder weather.

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