The following discussion of Puget Energy and PSE's financial condition and results of operations contains forward-looking statements that involve risks and uncertainties, such as statements of Puget Energy and PSE'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. Puget Energy and PSE'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.

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. 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 cash flows by offering reliable electric and natural gas service in a cost effective manner through PSE. On February 6, 2009, Puget Holdings LLC (Puget Holdings) completed its merger with Puget Energy. PSE's basis of accounting will continue to be on a historical basis and PSE's financial statements will not include any Accounting Standards Codification No. 805, "Business Combinations" (ASC 805) purchase accounting adjustments.
PSE generates revenues and cash flow primarily from the sale of electric and natural gas services to residential and commercial customers within a service territory covering approximately 6,000 square miles, principally in the Puget Sound region of the State of Washington. To meet customer growth and replacement of expiring power contracts, PSE is increasing its energy efficiency programs to reduce the need for additional energy generation, pursuing additional renewable energy production resources (primarily wind) and base load natural gas-fired generation to meet its needs. As PSE acquires new long-term energy resources, it will require access to capital markets to meet its financing needs. The number of PSE's electric and natural gas customers continues to increase in 2009 but at a slower rate, approximately 1.0% annually for each. Electric retail kilowatt sales and gas therm sales for the nine months ended September 30, 2009 have declined 1.2% and 6.7%, respectively, as compared to the same period in 2008. The decline in sales volumes in 2009 is due to warmer temperatures, the impact of PSE's residential and commercial customer conservation programs and weaker economic conditions in the Puget Sound region. The average temperature in PSE's service territory during the first nine months of both 2009 and 2008 were colder than normal in the Puget Sound region which has resulted in an increase in heating degree days of 2.1% and 8.4%, respectively. However, the winter forecast provided by the National Oceanic and Atmospheric Administration's Climate Prediction Center is for an El Nino weather pattern, which may cause the Pacific Northwest to be drier and warmer than normal. As a result of drier weather conditions during the first nine months of 2009, PSE hydroelectric generation and hydroelectric generation obtained under take or pay contracts has declined by 11.6% as compared to the same period in 2008 causing an increase in overall power supply costs.

Factors and Trends Affecting PSE's Performance.
The principal business, economic and other factors that affect PSE's operations and financial performance include:
· The rates PSE is allowed to charge for its services;

· Weather conditions;

· Demand for electricity and natural gas among customers in PSE's service territory;

· Regulatory decisions allowing PSE to recover costs, including purchased power and fuel costs, on a timely basis;

· PSE's ability to supply electricity and natural gas, either through company-owned generation, purchase power contracts or by procuring natural gas or electricity in wholesale markets;

· Availability and access to capital and the cost of capital; and

· Regulatory compliance costs, including those related to new and developing federal regulations of electric system reliability, state regulations of natural gas pipelines and federal and state environmental standards.

Regulation of PSE Rates and Recovery of PSE Costs. The rates that PSE is allowed to charge for its services is the single most important item influencing its financial position, results of operations and liquidity. PSE is highly regulated and the rates that it charges its retail customers are determined by the Washington Utilities and Transportation Commission (Washington Commission). The Washington Commission determines these rates based in part on historic test year costs plus weather normalized assumptions about hydro conditions and power costs in the relevant rate year. If in a particular rate year PSE's costs are higher than what is allowed to be recovered in rates, revenues may not be sufficient to permit PSE to earn its allowed return or to cover its costs. In addition, the Washington Commission determines whether expenses and investments are reasonable and prudent in providing electric and natural gas service. If the Washington Commission determines that part of PSE's costs do not meet the standard, those costs may be disallowed partially or entirely and not recovered in rates. On May 8, 2009, PSE filed a general rate case requesting recovery of increased electric and natural gas revenue requirements. Based on supplemental general rate filings, PSE is requesting an electric general rate increase of approximately $153.6 million or 7.7% annually and an increase in natural gas rates of $30.4 million or 2.5% annually. This rate request includes an equity component of 48.0% and a requested return on equity of 10.8%. A final order from the Washington Commission is expected by April 2010. On May 28, 2009, the Washington Commission approved a purchased gas adjustment (PGA) rate decrease of $21.2 million or 1.7% annually effective June 1, 2009. On September 24, 2009, the Washington Commission approved a PGA rate decrease of $198.1 million or 17.1% annually effective October 1, 2009. PGA rate changes do not impact net income.
Currently, PSE has a power cost adjustment (PCA) mechanism that provides for recovery of power costs from customers or refunding of power cost savings to customers, as those costs vary from the "power cost baseline" level of power costs which are set, in part, based on normalized assumptions about weather and hydro conditions. Excess power costs or power cost savings will be apportioned between PSE and its customers pursuant to the graduated scale set forth in the PCA mechanism. As a result, if power costs are significantly higher than the baseline rate, PSE's expenses could significantly increase. PSE also has a PGA mechanism in retail natural gas rates to recover variations in natural gas supply and transportation costs. Variations in natural gas rates are passed through to customers; therefore PSE's natural gas margin and net income are not affected by such variations.
Weather Conditions. Weather conditions in PSE's service territory can have a significant impact on customer energy usage, thus PSE's revenues and energy supply expenses. PSE's operating revenues and associated energy supply expenses are not generated evenly throughout the year. While generally both PSE's electric and natural gas sales are greatest during winter months, 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. PSE is experiencing lower customer usage due in part to warmer temperatures beginning with the second quarter of 2009 as compared to 2008, although winter months of both 2008 and 2009 were colder than historical averages in the Puget Sound region. Customer Demand. Although in the long term PSE expects the number of natural gas customers to grow at rates slightly above electric customers, both residential electric and natural gas customers are expected to continue a long-term trend of slow decline of energy usage based on continued energy efficiency improvements and higher retail rates. Because the Washington Commission has not approved any "decoupling" or similar regulatory adjustment mechanism for PSE, energy efficiency or conservation programs lead to a direct reduction in energy margin. In addition, the effects of the current recession on Washington State's economy have caused a decline in customer usage in 2009 compared to 2008. Access to Capital. PSE relies on access to bank borrowings and short-term money markets as sources of liquidity and longer-term debt markets to fund its utility construction program and other capital expenditure requirements not satisfied by cash flow from its operations or equity investment from its parent, Puget Energy. Neither Puget Energy nor PSE has any debt outstanding that would accelerate debt maturity upon a credit rating downgrade. However, 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 Puget Energy's and PSE's credit facilities, both of which expire in 2014, the borrowing costs and commitment fees increase as their respective credit ratings decline. If PSE is unable to access capital on reasonable terms, its ability to pursue improvements or acquisitions, including generating capacity, which may be relied on for future growth and to otherwise implement its strategy, could be adversely affected. The current condition of capital markets and the economy have caused general concern regarding access to sufficient capital at a reasonable cost. However, PSE has not been significantly impacted by the recent disruption in the credit environment and expects to continue to be able to access the capital markets to meet is short and long term borrowing needs.
Regulatory Compliance Costs and Expenditures. PSE's operations are subject to extensive federal, state and local laws and regulations. Such regulations cover electric system reliability, gas pipeline system safety and energy market transparency, among other areas. Environmental regulations of air and water quality and endangered species protection also impact the Company's operations, as would possible climate change legislation. PSE must spend significant sums on measures including resource planning, remediation, monitoring, pollution control equipment and emissions-related abatement and fees in order to comply with these regulatory requirements.
Compliance with these or other future regulations, such as those pertaining to climate change, could require significant capital expenditures by PSE and adversely affect PSE's financial position, results of operations, cash flows and liquidity.

Other Challenges and Strategies
Energy Supply. As noted in PSE's Integrated Resource Plan (IRP) filed with the Washington Commission, PSE projects that future energy needs will exceed current resources from long-term power purchase agreements and Company-controlled power resources. The IRP identifies reductions in contractual supplies of energy and capacity available under certain long-term power purchase agreements, requiring replacement of supplies to meet projected demands. Therefore, PSE's IRP 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. If PSE cannot acquire further additional energy supply resources at a reasonable cost, it may be required to purchase additional power in the open market at a cost that could, in the absence of regulatory relief, significantly increase its expenses and reduce earnings and cash flows.

Infrastructure Investment. PSE is investing heavily in its utility infrastructure and customer service functions in order to meet increasing regulatory requirements, customer energy needs and aging infrastructure. These investments and operating requirements give rise to significant growth in depreciation expense and operating expense, which are not recovered through the ratemaking process in a timely manner. This "regulatory lag" is expected to continue for the foreseeable future.
Operational Risks Associated With Generating Facilities. PSE owns and operates coal, natural gas-fired, hydro, wind-powered and oil-fired generating facilities. Operation of electric generating facilities involves risks that can adversely affect energy output and efficiency levels, including facility shutdowns due to equipment and process failures or fuel supply interruptions. Colstrip Unit 4, for example, has been out of service since March 2009 due to significant repair work required to the unit which was discovered during its routine overhaul. It is estimated that the unit will be out of service until early November 2009 and that PSE will incur higher power costs of approximately $16.0 million from July through October 2009. PSE does not have business interruption insurance coverage to cover replacement power costs and the physical loss is not covered by the project's insurance policy.

Puget Sound Energy
All the operations of Puget Energy are conducted through its subsidiary PSE. Net income for the three months ended September 30, 2009 was $7.8 million on operating revenues of $592.6 million as compared to net loss of $7.3 million on operating revenues of $606.2 million for the same period in 2008. Electric revenues were favorably impacted by an electric general tariff rate increase approved by the Washington Commission of 7.1% effective November 1, 2008 which contributed $4.7 million. Gas revenues were favorably impacted by a general tariff rate increase approved by the Washington Commission of 4.6% effective November 1, 2008, which contributed $4.2 million. Electric revenues were also favorably impacted by a 1.8% increase in electric customer usage which contributed $3.0 million, while gas sales were impacted by lower customer usage which declined 6.8% or $3.2 million, primarily due to warmer average temperatures in the Pacific Northwest during the month of July 2009 compared to the same period in 2008 combined with the impact of the recession on Washington State's economy. Also positively impacting gas revenues is a $4.4 million increase due to customer mix and other pricing variances. Net income was also impacted due to the extended Colstrip outage resulting in a decline in Company-owned coal fired electric generation of 19.0% and lower hydroelectric generation due to drier weather conditions which reduced hydroelectric generation by 21.7%. PSE owns a 25.0% interest in Colstrip Unit 4 with its share of the output being 217 megawatts (MWs). Company-owned gas fired electric generation increased during 2009 as compared to the same period in 2008 by 160.0% due to the Colstrip Unit 4 outage. Net income was positively impacted by an increase in unrealized gains related to derivatives of $30.7 million primarily due to the de-designation of all energy supply related cash flow hedges on July 1, 2009 and increasing volatility in market prices. Also positively impacting net income was a $7.4 million net increase in other income and expenses due primarily to an increase in regulatory interest income from the Mint Farm Generation Station (Mint Farm) of $4.6 million, an increase in the allowance for funds used during construction (AFUDC) of $1.6 million and a $1.4 million gain on corporate owned life insurance. These increases were partially offset by an increase in utility operations and maintenance expenses of $10.1 million, a $12.0 million increase in income taxes and an increase in depreciation and amortization of $5.8 million.
Net income for the nine months ended September 30, 2009 was $136.6 million on operating revenues of $2.4 billion as compared to net income of $112.7 million on operating revenues of $2.4 billion for the same period in 2008. Electric sales were favorably impacted by an electric general tariff rate increase approved by the Washington Commission of 7.1% effective November 1, 2008 which contributed $38.7 million. Gas sales were favorably impacted by a gas general tariff rate increase of 4.6% effective November 1, 2008 that was approved by the Washington Commission which contributed $32.0 million. Electric and gas sales were impacted by lower customer usage which declined 1.2% and 6.7%, respectively. Net income was also impacted by the extended Colstrip outage resulting in a decline in Company-owned coal fired electric generation of 14.0% and lower hydroelectric generation due to drier weather conditions which reduced hydroelectric generation by 11.6% for the period. Company-owned gas fired electric generation increased during 2009 as compared to the same period in 2008 by 103.0% due to the Colstrip Unit 4 outage. Net income was positively impacted by an increase in unrealized gains related to derivatives of $36.0 million primarily due to the de-designation of all cash flow hedges on July 1, 2009 and increasing volatility in market prices. Also positively impacting net income was a $12.5 million net increase in other income and expenses due primarily to an increase in regulatory interest income from Mint Farm. These increases were partially offset by one-time merger costs of $23.9 million related to the merger of Puget Energy with Puget Holdings. These costs were primarily related to PSE employee compensation triggered by Puget Energy's change of control, credit agreement related expenses and the income statement impact of deferred compensation related liability increases triggered by the merger. Net income was also negatively impacted due to an increase of $18.5 million in utility operations and maintenance, a $17.9 million increase in depreciation and amortization and a $10.0 million increase in income taxes.

Electric Operating Revenues
The table below sets forth changes in electric operating revenues for PSE for
the three months ended September 30, 2009 as compared to the same period in
2008.

  (Dollars in Millions)                                                   Percent
  Three Months Ended September 30,                  2009    2008   Change Change
  Electric operating revenues:
  Residential sales                              $ 195.6 $ 199.7  $ (4.1)  (2.1)%
  Commercial sales                                 199.3   191.6      7.7    4.0
  Industrial sales                                  24.0    25.7    (1.7)  (6.6)
  Other retail sales, including unbilled revenue    12.8     4.3      8.5      *
  Total retail sales                               431.7   421.3     10.4    2.5
  Transportation sales                               3.1     2.6      0.5   19.2
  Sales to other utilities and marketers            33.2    27.6      5.6   20.3
  Other                                           (18.3)    15.9   (34.2)      *
  Total electric operating revenues              $ 449.7 $ 467.4 $ (17.7)  (3.8)%


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Electric retail sales increased $10.4 million for the three months ended September 30, 2009 as compared to the same period in 2008. The increase was due in part to the electric general rate increase of November 1, 2008 that was partially offset by a merger rate credit effective February 13, 2009, which combined, contributed to an increase in electric retail sales of $24.5 million for 2009 as compared to 2008, including a decrease in the conservation rider charged to customers for PSE's energy efficiency programs. Also contributing to the increases was an increase in retail electricity usage of 86,777 megawatt hours (MWhs) or 1.8% related to increased customer usage primarily related to higher temperatures in July 2009 as compared to the same period in 2008, which resulted in an increase of approximately $7.8 million to electric operating revenue. The benefits of the Residential and Farm Energy Exchange Benefit credited to customers reduced electric operating revenues by $20.3 million. This credit also reduced power costs and revenue sensitive taxes by a corresponding amount with no impact on earnings.
Sales to other utilities and marketers increased $5.6 million for the three months ended September 30, 2009 as compared to the same period in 2008 primarily due to a decrease in wholesale electric energy prices which decreased revenues by $12.5 million which was offset by $17.9 million due to an increase in volume. Other electric operating revenues decreased $34.2 million for the three months ended September 30, 2009 as compared to the same period in 2008 primarily due to a decrease of $31.7 million in non-core gas sales and related losses from hedging contracts entered into to manage these natural gas costs for electric generation. Such gains or losses on the sale of natural gas, which was intended to be used for electric generation, are included as a component of PSE's PCA mechanism.
The table below sets forth changes in electric operating revenues for PSE for the nine months ended September 30, 2009 as compared to the same period in 2008.

(Dollars in Millions)                                                       Percent
Nine Months Ended September 30,                     2009      2008   Change Change
Electric operating revenues:
Residential sales                               $  794.8  $  783.3   $ 11.5    1.5%
Commercial sales                                   628.8     593.1     35.7     6.0
Industrial sales                                    74.4      79.2    (4.8)   (6.1)
Other retail sales, including unbilled revenue    (42.2)    (28.1)   (14.1)  (50.2)
Total retail sales                               1,455.8   1,427.5     28.3     2.0
Transportation sales                                 7.9       5.5      2.4    43.6
Sales to other utilities and marketers              53.4      70.1   (16.7)  (23.8)
Other                                             (10.5)      48.4   (58.9)       *
Total electric operating revenues              $ 1,506.6 $ 1,551.5 $ (44.9)  (2.9)%


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Electric retail sales increased $28.3 million for the nine months ended September 30, 2009 as compared to the same period in 2008. The increase was due in part to the electric general rate increase of November 1, 2008 that was partially offset by a merger rate credit effective February 13, 2009, which combined, contributed to an increase in electric retail sales of $100.4 million for 2009 as compared to 2008, including an increase in the conservation rider charged to customers for PSE's energy efficiency programs. This increase was partially offset by the benefits of the Residential and Farm Energy Exchange Benefit credited to customers which reduced electric operating revenues by $54.5 million. This credit also reduced power costs and revenue sensitive taxes by a corresponding amount with no impact on earnings. Also partially offsetting these increases was a decrease in retail electricity usage of 187,467 MWhs or 1.2% related to decreased customer usage for 2009 as compared to the same period in 2008, which resulted in a decrease of approximately $17.3 million to electric operating revenue.
Sales to other utilities and marketers decreased $16.7 million for the nine months ended September 30, 2009 as compared to the same period in 2008 primarily due to a decline in wholesale electric energy prices which decreased revenues by $31.3 million which was offset by $15.1 million due to an increase in volume. Other electric operating revenues decreased $58.9 million for the nine months ended September 30, 2009 as compared to the same period in 2008 primarily due to $56.5 million decrease in non-core gas sales and related losses from hedging contracts entered into to manage these natural gas costs.
The following electric rate changes were approved by the Washington Commission in 2008 and 2009:

                                                         Average              Annual
                                                       Percentage       Increase (Decrease)
          Type of Rate                             Increase (Decrease)      in Revenues
           Adjustment             Effective Date        in Rates       (Dollars in Millions)
Electric General Rate Case       November 1, 2008                7.1 %               $ 130.2
Merger Rate Credit               February 13, 2009               (0.4)                 (6.7)

Gas Operating Revenues
The table below sets forth changes in gas operating revenues for PSE for the
three months ended September 30, 2009 as compared to the same period in 2008.

          (Dollars in Millions)                                    Percent
          Three Months Ended September 30,     2009    2008 Change  Change
          Gas operating revenues:
          Residential sales                 $  77.2 $  71.3  $ 5.9    8.3%
          Commercial sales                     50.3    46.3    4.0     8.6
          Industrial sales                      6.6     8.0  (1.4)  (17.5)
          Total retail sales                  134.1   125.6    8.5     6.8
          Transportation sales                  3.3     3.3     --      --
          Other                                 4.7     4.3    0.4     9.3
          Total gas operating revenues      $ 142.1 $ 133.2  $ 8.9    6.7%

Gas retail sales increased $8.5 million for the three months ended September 30, 2009 as compared to the same period in 2008 primarily due to a $24.3 million increase in gas operating revenues as a result of a 11.1% PGA mechanism rate increase for retail customers effective October 1, 2008, a general rate increase effective November 1, 2008 and a 1.7% PGA mechanism rate decrease effective June 1, 2009. 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. Partially offsetting this increase is a 10.1 million or 10.5% decrease in gas therm sales related to warmer temperatures for the three months ended September 30, 2009 as compared to the same period in 2008, which decreased revenue by $15.8 million.
The table below sets forth changes in gas operating revenues for PSE for the nine months ended September 30, 2009 as compared to the same period in 2008.

(Dollars in Millions) Percent Nine Months Ended September 30, 2009 2008 Change Change

          Gas operating revenues:
          Residential sales               $ 563.5 $ 509.8  $ 53.7   10.5%
          Commercial sales                  257.9   246.2    11.7     4.8
          Industrial sales                   29.6    30.5   (0.9)   (3.0)
          Total retail sales                851.0   786.5    64.5     8.2
          Transportation sales                9.6    10.6   (1.0)   (9.4)
          Other                              14.9    13.2     1.7    12.9
          Total gas operating revenues    $ 875.5 $ 810.3 $  65.2    8.0%
. . .