Integrys Energy Group

WPS Energy Services, Inc. Opportunities and Challenges - August 20, 2001

by Mark A. Radtke - President

2000 Achievements

The year 2000 was a pivotal year for WPS Energy Services, and a year upon which we continue to build.

Revenues grew by 227 percent, and while extraordinary energy prices did contribute to that lift, having most of our customers hedged well below the winter's stratospheric spot market prices minimized the price impact on revenues. In fact, our delivered natural gas volumes doubled while our electricity volumes increased ten fold.

Our diversification into significant electric sales coupled with the operational excellence necessary to successfully move natural gas and electricity in each unique market combined to turn in a profitable year, with net income increasing 5.2 million dollars from the previous year. While the extraordinary price volatility did have a negative impact, our financial risk management and operational controls served us well to be able to reliably and economically deliver on all of our customer commitments.

Refocused Business to Improve Risk Profile

A principle focus of the past 18 months has been to reduce our risk profile. In the past, wholesale and some retail market activity had included price speculation. That no longer occurs.

Today we are creating structured solutions that provide the flexibility our wholesale and retail customers require, at a price point that is good business for our customers and for us.

It can be challenging to walk away from business, but we recognize that we will dilute the value we bring to all of our customers if we are not relentless in our pursuit of high quality business.

Continued Investment in Risk and Performance Management

This refocusing of our market activities required that we modify our management systems as well. We streamlined our deal entry and confirmation systems and processes to accommodate increased natural gas transaction volume. Substantial effort went into improving our options and gas inventory handling software. Prior to the economic downturn, we resourced enhancement to our credit function and its associated information monitoring systems and processes.

As we evolved the business, we enlisted the assistance of our auditors (Arthur Anderson), and identified that we met the criteria outlined in EITF 98-10, and appropriately moved the commodity portions of the business to mark-to-market accounting. From a performance management perspective, it is extremely helpful to get immediate feedback on forward transaction quality, and the conservative operating reserves challenge us to continue to improve our margins and operating performance. In the event we have a commitment that is not good business, it has an immediate P&L impact. We learn from it and adjust going forward, but it gives us a clearer picture of future performance of the company.

The commitment we made to strengthen our middle office has paid dividends in not only the early detection and mitigation of potential market risks, but also in the quality of performance management information and the integrity of our forward book of business.

You may have seen our releases related to the implementation of the KWI transaction and risk management system. This is a next generation system that we are implementing initially on the electric side of the business, and will later consider its ability to meet our dynamic needs in natural gas.

Maine Electric Markets

The revenue diversification I mentioned includes building on our success in Maine. As you know, we are the standard offer provider to electric customers in Northern Maine. We have successfully served this market since March 2000. Beginning March of this year, we are operating under the first year of a three-year standard offer supply commitment. At the same time, we have about one half of the load under long-term contracts, reducing the customer flight risk and associated stranded volume risk that must be managed with an obligation to serve.

At the same time, we are pleased with our progress in building a solid customer base in Southern Maine's competitive energy markets.

Ohio Electric Markets

This year we are successfully building on our Maine experience by serving customers now able to choose a supplier as a result of Ohio's restructuring legislation, legislation that became effective on January 1 of this year.

There are a couple of interesting constructs in Ohio-one being Market Support Generation or MSG. MSG is "below market bundled power" provided by a utility as part of their restructuring settlement. This power allowed us to serve some of our existing customers' needs while we put together the infrastructure and supply portfolio required to deliver competitive market electric supply.

Another opportunity was created through the enabling of municipal aggregation programs. We worked with the City of Cleveland to launch an education campaign and implemented the aggregation program protocol to serve the small commercial and residential customers on the First Energy system within the Cleveland city limits. This program has been well received by the City and other municipal entities as well. We have established an office in Cleveland with aggregation program expertise for the expressed purpose of serving the unique needs of this market.

I am pleased with our success in developing the electric segment of our business from a negligible level in 1999 to a margin contribution that equals our established natural gas business through the first six months of this year. Even with the slowed pace of deregulation, I am optimistic about our expanding ability to create value for customers through electric solutions.

Natural Gas Storage Field Development

We have been working for the past two years on the development of a high deliverability natural gas storage field in Southeast Michigan. Construction is well underway, and we are on schedule to begin initial injections next month. Kimball 27 is a smaller field at 3 billion cubic feet, but the field is significant because of its ability to allow us to more effectively manage the deliverability requirements of our upper Midwest customers, and also because of the area's potential to host natural gas-fired electric generation. Connection to this high deliverability storage facility would allow us to maximize gas/ electric arbitrage opportunities.

Combined Locks Energy Center

Working to create solutions to our customers' energy-related challenges has culminated in the development of the Combined Locks Energy Center. This facility will allow us to meet the process steam needs of one of our major customers and the electric energy needs of another very important customer. It also allows us to work with WPS Power Development to begin developing the system of generation we will need to have available to us when Wisconsin's electric markets eventually open up.

Creating solutions by combining the needs of multiple customers is one of the ways we can create value by understanding our customers' business well beyond that of a typical commodity supplier.

Growth Without Outgrowing Our Customers

While we have experienced significant growth in terms of both scale and scope, I am proud that we continue to improve our focus on the customer. Mastio & Company, who has been referred to as the "J D Powers" of the energy industry, conducts an annual customer satisfaction survey. I am pleased to tell you that WPS Energy Services improved a notch from last year to 5th in the nation for overall customer satisfaction.

One of the interesting findings of the survey is that larger marketing companies struggle to deliver on their customers' expectations. You have to look all the way down to number 19 on the list before you find a "Top 20" marketing company. Even though we've grown to a size that puts us at about number 30 on the list of gas marketers based on delivered volume, and have a total customer base exceeding 180,000, we continue to improve our historically strong showing. I believe it is this focus that allows us to create the innovative solutions that our customers need in an ever-challenging energy marketplace.

Conclusion

We made some significant positive progress in 2000, and we continue to build upon that foundation in 2001.

We have a strong team of talented players that will continue to build our natural gas solutions capability and work with aggregation groups to meet their needs in providing solutions to the unique challenges that municipal entities face when trying to improve the economic value of their constituent's energy supply.

We will continue to work with our large commercial and industrial customers to bring value beyond that of competitive and reliable energy supply. Cogeneration and customized energy products that have proven themselves in the wholesale marketplace are examples of ways we'll do that.

Our customers recognize and reward us for the value we create for them. I look forward to sharing that reward with our shareholders.