Puget Energy Inc. shares fell more than $2 last week to near $20/share on Friday after the company warned in an 8-K filing with the Securities and Exchange Commission that drought conditions and low hydroelectric production in the Pacific Northwest would force it to buy high-cost replacement power, which probably would have a negative impact on 2003 earnings.

The company said its 2003 earnings may be cut by as much as 25 cents a share due to drought conditions associated with El Nino. In August 2002, the company estimated 2003 earnings of $1.75 to $1.90 a share.

The news was mixed, however, because the company also said that it expected to post earnings at the high end of $1.20 to $1.25 a share for 2002. Nevertheless, Merrill Lynch on Thursday said it downgraded Puget Energy to “neutral” from “buy” and lowered its profit forecast for 2003 to $1.55 a share from $1.75.

According to the 8-K filing, precipitation during the last three months of 2002 was only 67% of normal in the Columbia River Basin above Grand Coulee Dam. In addition, the Northwest Rivers Forecast Center predicted last Thursday that streamflows in that basin would be only 80% of normal, assuming average precipitation and snowpack for the balance of the winter season.

Puget Energy said that in a normal year, its Puget Sound Energy utility obtains about 38% of its energy supply from low-cost hydroelectric facilities, mainly dams on the Columbia River below Grand Coulee Dam.

If the forecast reduction in water flow occurs, Puget Sound Energy will need to replace its low-cost hydropower with more expensive thermally generated and purchased power, according to the filing.

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